Back to GetFilings.com



Table of Contents
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

 
FORM 10-Q
 
x
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2002
 
OR
 
¨
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from                      to                     
 
Commission File No. 0-20740
 

 
EPICOR SOFTWARE CORPORATION
(Exact name of registrant as specified in its charter)
 
Delaware
 
33-0277592
(State or other jurisdiction of
 
(IRS Employer
incorporation or organization)
 
Identification No.)
 
195 Technology Drive
Irvine, California 92618-2402
(Address of principal executive offices, zip code)
 
Registrant’s telephone number, including area code: (949) 585-4000
 

 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
 
As of August 1, 2002, there were 44,916,906 shares of common stock outstanding.


Table of Contents
 
FORM 10-Q INDEX
 
        
Page

PART I.
 
FINANCIAL INFORMATION
    
      
      
3
      
4
      
5
      
6
    
14
    
30
PART II.
 
OTHER INFORMATION
    
    
30
    
31
    
31
  
32
 

2


Table of Contents
PART I
 
FINANCIAL INFORMATION
 
Item 1—Financial Statements:
 
EPICOR SOFTWARE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(Unaudited)
 
    
June 30,
2002

    
December 31,
2001

 
     
ASSETS
                 
Current assets:
                 
Cash and cash equivalents
  
$
29,326
 
  
$
24,435
 
Accounts receivable, net
  
 
22,469
 
  
 
31,382
 
Prepaid expenses and other current assets
  
 
4,213
 
  
 
5,322
 
    


  


Total current assets
  
 
56,008
 
  
 
61,139
 
 
Property and equipment, net
  
 
4,649
 
  
 
6,263
 
Software development costs, net
  
 
1,975
 
  
 
2,946
 
Intangible assets, net
  
 
10,003
 
  
 
12,560
 
Other assets
  
 
2,937
 
  
 
3,863
 
    


  


Total assets
  
$
75,572
 
  
$
86,771
 
    


  


LIABILITIES AND STOCKHOLDERS’ EQUITY
                 
Current liabilities:
                 
Accounts payable
  
$
4,986
 
  
$
6,542
 
Accrued expenses
  
 
24,430
 
  
 
25,266
 
Current portion of long-term debt
  
 
3,603
 
  
 
3,655
 
Accrued restructuring costs
  
 
2,207
 
  
 
3,990
 
Deferred revenue
  
 
35,376
 
  
 
37,918
 
    


  


Total current liabilities
  
 
70,602
 
  
 
77,371
 
    


  


Long-term debt, net of current portion
  
 
556
 
  
 
2,229
 
    


  


Commitments and contingencies
                 
Stockholders’ equity:
                 
Convertible preferred stock
  
 
5,000
 
  
 
7,501
 
Common stock
  
 
45
 
  
 
44
 
Additional paid-in capital
  
 
247,425
 
  
 
244,771
 
Less: treasury stock at cost
  
 
(39
)
  
 
—  
 
Less: unamortized stock compensation expense
  
 
(1,173
)
  
 
(1,711
)
Less: notes receivable from officers for issuance of restricted stock
  
 
(10,570
)
  
 
(10,292
)
Accumulated other comprehensive loss
  
 
(2,682
)
  
 
(3,264
)
Accumulated deficit
  
 
(233,592
)
  
 
(229,878
)
    


  


Net stockholders’ equity
  
 
4,414
 
  
 
7,171
 
    


  


Total liabilities and stockholders’equity
  
$
75,572
 
  
$
86,771
 
    


  


 
See accompanying notes to condensed consolidated financial statements.

3


Table of Contents
 
EPICOR SOFTWARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE
OPERATIONS
(in thousands, except per share amounts)
(Unaudited)
 
    
Three Months Ended
June 30,

    
Six Months Ended
June 30,

 
    
2002

    
2001

    
2002

    
2001

 
Revenues:
                                   
License fees
  
$
9,250
 
  
$
13,276
 
  
$
17,656
 
  
$
25,602
 
Consulting
  
 
9,731
 
  
 
13,746
 
  
 
19,523
 
  
 
28,254
 
Maintenance
  
 
16,991
 
  
 
19,329
 
  
 
34,132
 
  
 
39,665
 
Other
  
 
835
 
  
 
864
 
  
 
1,480
 
  
 
1,624
 
    


  


  


  


Total revenues
  
 
36,807
 
  
 
47,215
 
  
 
72,791
 
  
 
95,145
 
 
Cost of revenues
  
 
14,663
 
  
 
19,179
 
  
 
30,139
 
  
 
40,793
 
Amortization of intangible assets and capitalized
software development costs
  
 
1,776
 
  
 
2,178
 
  
 
3,556
 
  
 
4,286
 
    


  


  


  


Total cost of revenues
  
 
16,439
 
  
 
21,357
 
  
 
33,695
 
  
 
45,079
 
    


  


  


  


 
Gross profit
 
  
 
20,368
 
 
  
 
25,858
 
 
  
 
39,096
 
 
  
 
50,066
 
 
Operating expenses:
                                   
Sales and marketing
  
 
11,273
 
  
 
14,879
 
  
 
21,995
 
  
 
31,808
 
Research and development
  
 
4,543
 
  
 
6,317
 
  
 
9,349
 
  
 
14,348
 
General and administrative
  
 
5,052
 
  
 
6,418
 
  
 
10,970
 
  
 
27,493
 
Stock based compensation expense
  
 
207
 
  
 
452
 
  
 
434
 
  
 
698
 
Restructuring charges and other
  
 
—  
 
  
 
7,610
 
  
 
—  
 
  
 
7,610
 
Gain on sales of product lines
  
 
—  
 
  
 
(10,367
)
  
 
—  
 
  
 
(10,367
)
    


  


  


  


Total operating expenses
  
 
21,075
 
  
 
25,309
 
  
 
42,748
 
  
 
71,590
 
    


  


  


  


Income (loss) from operations
  
 
(707
)
  
 
549
 
  
 
(3,652
)
  
 
(21,524
)
Other income (expense), net
  
 
(280
)
  
 
5
 
  
 
(62
)
  
 
(17
)
    


  


  


  


Income (loss) before income taxes
  
 
(987
)
  
 
554
 
  
 
(3,714
)
  
 
(21,541
)
Provision for income taxes
  
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
—  
 
    


  


  


  


Net income (loss)
  
$
(987
)
  
$
554
 
  
$
(3,714
)
  
$
(21,541
)
    


  


  


  


Unrealized foreign currency translation gain
  
 
681
 
  
 
304
 
  
 
582
 
  
 
1
 
    


  


  


  


Comprehensive income (loss)
  
$
(306
)
  
$
858
 
  
$
(3,132
)
  
$
(21,540
)
    


  


  


  


Net income (loss) per share—basic
  
$
(0.02
)
  
$
.01
 
  
$
(0.09
)
  
$
(0.52
)
Net income (loss) per share—diluted
  
$
(0.02
)
  
$
.01
 
  
$
(0.09
)
  
$
(0.52
)
 
Weighted average common shares outstanding—basic
  
 
43,781
 
  
 
41,789
 
  
 
43,482
 
  
 
41,733
 
Weighted average common shares outstanding—diluted
  
 
43,781
 
  
 
42,770
 
  
 
43,482
 
  
 
41,733
 
 
See accompanying notes to condensed consolidated financial statements.

4


Table of Contents
 
EPICOR SOFTWARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
 
    
Six Months Ended June 30,

 
    
2002

    
2001

 
Operating activities
                 
Net loss
  
$
(3,714
)
  
$
(21,541
)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
                 
Depreciation and amortization
  
 
5,611
 
  
 
7,745
 
Stock based compensation expense
  
 
434
 
  
 
698
 
Write-down of capitalized software development costs and
prepaid assets
  
 
571
 
  
 
1,026
 
Provision for doubtful accounts
  
 
229
 
  
 
9,259
 
Interest accrued on notes receivable from officers
  
 
(341
)
  
 
—  
 
Restructuring charges and other
  
 
—  
 
  
 
7,610
 
Gain on sales of product lines
  
 
—  
 
  
 
(10,367
)
Changes in operating assets and liabilities:
                 
Accounts receivable
  
 
9,474
 
  
 
8,869
 
Prepaid expenses and other current assets
  
 
588
 
  
 
398
 
Other assets
  
 
934
 
  
 
785
 
Accounts payable
  
 
(1,677
)
  
 
(3,870
)
Accrued expenses
  
 
(1,288
)
  
 
(6,601
)
Accrued restructuring costs
  
 
(1,954
)
  
 
(1,779
)
Deferred revenue
  
 
(3,118
)
  
 
(2,630
)
    


  


Net cash provided by (used in) operating activities
  
 
5,749
 
  
 
(10,398
)
Investing activities
                 
Proceeds from sales of product lines
  
 
—  
 
  
 
9,900
 
Purchases of property and equipment
  
 
(380
)
  
 
(1,124
)
    


  


Net cash (used in) provided by investing activities
  
 
(380
)
  
 
8,776
 
Financing activities
                 
Proceeds from exercise of options to purchase common stock
  
 
6
 
  
 
—  
 
Proceeds from purchases under employee stock purchase plan
  
 
298
 
  
 
527
 
Net proceeds from issuance of restricted stock
  
 
—  
 
  
 
2
 
Purchase of treasury stock
  
 
(401
)
  
 
—  
 
Proceeds from sale of treasury stock
  
 
316
 
  
 
—  
 
Proceeds from notes receivable from officers
  
 
64
 
  
 
—  
 
Payments on long-term debt
  
 
(1,750
)
  
 
(2,946
)
    


  


Net cash used in financing activities
  
 
(1,467
)
  
 
(2,417
)
Effect of exchange rate changes on cash
  
 
989
 
  
 
365
 
    


  


Net increase (decrease) in cash and cash equivalents
  
 
4,891
 
  
 
(3,674
)
Cash and cash equivalents at beginning of period
  
 
24,435
 
  
 
26,825
 
    


  


Cash and cash equivalents at end of period
  
$
29,326
 
  
$
23,151
 
    


  


 
See accompanying notes to condensed consolidated financial statements.

5


Table of Contents
 
EPICOR SOFTWARE CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
Basis of Presentation
 
The accompanying unaudited condensed consolidated financial statements included herein have been prepared by Epicor Software Corporation (the Company) in accordance with accounting principles generally accepted in the United States of America and pursuant to the rules and regulations of the Securities and Exchange Commission (the SEC) for interim financial information for reporting on Form 10-Q. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2001.
 
Certain prior period amounts in the Condensed Consolidated Statement of Operations have been reclassified to conform to the current period presentation.
 
In the opinion of management, the unaudited condensed consolidated financial statements contain all adjustments (consisting of normal recurring adjustments and the write-down of prepaid software royalty and the write-down of capitalized software development costs as discussed below) necessary for a fair presentation of the Company’s financial position, results of operations and cash flows.
 
The results of operations for the three months and six months ended June 30, 2002, are not necessarily indicative of the results of operations that may be reported for any other interim period or for the entire year ending December 31, 2002. The balance sheet at December 31, 2001 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements, as permitted by SEC rules and regulations for interim reporting.
 
Revenue Recognition
 
The Company recognizes revenue in accordance with a wide-ranging set of standards and interpretations of those standards under accounting principles generally accepted in the United States of America, consisting principally of:
 
 
 
Statement of Position (SOP) No. 97-2, “Software Revenue Recognition,” issued by the American Institute of Certified Public Accountants (AICPA)
 
 
AICPA SOP No. 98-9, “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions,”
 
 
Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements,” issued by the United States Securities and Exchange Commission
 
The Company enters into contractual arrangements with end users of its products that may include software licenses, maintenance services, consulting services, resale of third-party hardware, or various combinations thereof, including the sale of such elements separately. For each arrangement, revenues are recognized when both parties have signed an agreement, the fees to be paid by the customer are fixed or determinable, collection of the fees is probable, delivery of the product has occurred and no other significant obligations on the part of the Company remain.
 
For multiple-element arrangements, each element of the arrangement is analyzed and the Company allocates a portion of the total fee under the arrangement to the elements based on the fair value of the element, regardless of any separate prices stated within the contract for each element. Fair value is generally considered the price a customer would be required to pay if the element were to be sold separately. The Company applies the “residual method” as allowed under SOP 98-9 in accounting for any element of an arrangement that remains undelivered.

6


Table of Contents
 
Basic and Diluted Net Loss Per Share
 
Net income (loss) per share is calculated in accordance with SFAS No. 128, “Earnings per Share.” Under the provisions of SFAS No. 128, basic net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of common shares outstanding during the period, excluding shares of non-vested restricted stock. Diluted net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of common and common equivalent shares outstanding during the period if their effect is dilutive. Common equivalent shares of 1,490,819 for the three month period ended June 30, 2002, and 1,641,376 and 1,171,277 for the six month periods ended June 30, 2002 and 2001, respectively, have been excluded from diluted weighted average common shares as the effect would be anti-dilutive.
 
The following table presents the calculation of basic and diluted net income (loss) per common share (in thousands, except per share amounts):
 
    
Three Months Ended June 30,

    
Six Months Ended June 30,

 
    
2002

    
2001

    
2002

    
2001

 
Net income (loss)
  
$
(987
)
  
$
554
 
  
$
(3,714
)
  
$
(21,541
)
Basic:
                                   
Weighted average common shares outstanding
  
 
44,696
 
  
 
44,256
 
  
 
44,590
 
  
 
43,999
 
Weighted average common shares of non-
vested restricted stock
  
 
(915
)
  
 
(2,467
)
  
 
(1,108
)
  
 
(2,266
)
    


  


  


  


Shares used in the computation of basic net
income (loss) per share
  
 
43,781
 
  
 
41,789
 
  
 
43,482
 
  
 
41,733
 
    


  


  


  


Net income (loss) per share—basic
  
$
(0.02
)
  
$
0.01
 
  
$
(0.09
)
  
$
(0.52
)
    


  


  


  


Diluted:
                                   
Weighted average common shares outstanding
  
 
43,781
 
  
 
41,789
 
  
 
43,482
 
  
 
41,733
 
Convertible preferred stock
  
 
—  
 
  
 
953
 
  
 
—  
 
  
 
—  
 
Common stock equivalents
  
 
—  
 
  
 
28
 
  
 
—  
 
  
 
—  
 
    


  


  


  


Shares used in the computation of diluted net
income (loss) per share
  
 
43,781
 
  
 
42,770
 
  
 
43,482
 
  
 
41,733
 
    


  


  


  


Net income (loss) per share—diluted
  
$
(0.02
)
  
$
0.01
 
  
$
(0.09
)
  
$
(0.52
)
    


  


  


  


 
Segment Information
 
In accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” the Company has prepared operating segment information to report components that are evaluated regularly by the Company’s chief operating decision maker, or decision making groups, in deciding how to allocate resources and in assessing performance.
 
The Company’s reportable operating segments include software licenses, consulting, maintenance and other. Other consists primarily of resale of third-party hardware and sales of business forms. Currently, the Company does not separately allocate operating expenses to these segments, nor does it allocate specific assets to these segments. Therefore, the segment information reported includes only revenues, cost of revenues and gross profit.

7


Table of Contents
 
Operating segment data for the three and six months ended June 30, 2002 and 2001 is as follows (in thousands):
 
    
Software
Licenses

  
Consulting

  
Maintenance

  
Other

  
Total

Three months ended June 30, 2002:
 
                                  
Revenues
  
$
9,250
  
$
9,731
  
$
16,991
  
$
835
  
$
36,807
Cost of revenues
  
 
3,278
  
 
8,513
  
 
4,173
  
 
475
  
 
16,439
    

  

  

  

  

Gross Profit
  
$
5,972
  
$
1,218
  
$
12,818
  
$
360
  
$
20,368
    

  

  

  

  

 
Three months ended June 30, 2001:
 
                                  
Revenues
  
$
13,276
  
$
13,746
  
$
19,329
  
$
864
  
$
47,215
Cost of revenues
  
 
3,966
  
 
11,389
  
 
5,451
  
 
551
  
 
21,357
    

  

  

  

  

Gross Profit
  
$
9,310
  
$
2,357
  
$
13,878
  
$
313
  
$
25,858
    

  

  

  

  

 
Six months ended June 30, 2002:
 
                                  
Revenues
  
$
17,656
  
$
19,523
  
$
34,132
  
$
1,480
  
$
72,791
Cost of revenues
  
 
6,869
  
 
17,632
  
 
8,345
  
 
849
  
 
33,695
    

  

  

  

  

Gross Profit
  
$
10,787
  
$
1,891
  
$
25,787
  
$
631
  
$
39,096
    

  

  

  

  

 
Six months ended June 30, 2001:
 
                                  
Revenues
  
$
25,602
  
$
28,254
  
$
39,665
  
$
1,624
  
$
95,145
Cost of revenues
  
 
9,260
  
 
23,418
  
 
11,341
  
 
1,060
  
 
45,079
    

  

  

  

  

Gross Profit
  
$
16,342
  
$
4,836
  
$
28,324
  
$
564
  
$
50,066
    

  

  

  

  

 
The following schedule presents the Company’s operations by geographic area for the three months and six months ended June 30, 2002 and 2001 (in thousands):
 
    
United
States

    
Australia
and Asia

    
Europe

    
Canada

  
Latin
America

    
Consolidated

 
Three months ended June 30, 2002:
 
                                                   
Revenues
  
$
26,055
 
  
$
2,433
 
  
$
6,466
 
  
$
1,460
  
$
393
 
  
$
36,807
 
Operating income (loss)
  
 
(2,882
)
  
 
406
 
  
 
1,310
 
  
 
740
  
 
(281
)
  
 
(707
)
Identifiable assets
  
 
43,827
 
  
 
10,802
 
  
 
18,963
 
  
 
1,730
  
 
250
 
  
 
75,572
 
 
Three months ended June 30, 2001:
 
                                                   
Revenues
  
$
32,957
 
  
$
3,027
 
  
$
7,864
 
  
$
2,580
  
$
787
 
  
$
47,215
 
Operating income (loss)
  
 
3,163
 
  
 
(253
)
  
 
(4,317
)
  
 
2,295
  
 
(339
)
  
 
549
 
Identifiable assets
  
 
68,595
 
  
 
8,027
 
  
 
17,936
 
  
 
5,216
  
 
278
 
  
 
100,052
 

8


Table of Contents
    
United
States

    
Australia
and Asia

    
Europe

    
Canada

  
Latin
America

    
Consolidated

 
 
Six months ended June 30, 2002:
 
                                                   
Revenues
  
$
51,381
 
  
$
4,486
 
  
$
12,721
 
  
$
3,362
  
$
841
 
  
$
72,791
 
Operating income (loss)
  
 
(7,744
)
  
 
685
 
  
 
1,961
 
  
 
1,945
  
 
(499
)
  
 
(3,652
)
Identifiable assets
  
 
43,827
 
  
 
10,802
 
  
 
18,963
 
  
 
1,730
  
 
250
 
  
 
75,572
 
 
Six months ended June 30, 2001:
 
                                                   
Revenues
  
$
67,071
 
  
$
5,324
 
  
$
15,720
 
  
$
5,390
  
$
1,640
 
  
$
95,145
 
Operating income (loss)
  
 
(15,872
)
  
 
(166
)
  
 
(8,807
)
  
 
3,694
  
 
(373
)
  
 
(21,524
)
Identifiable assets
  
 
68,595
 
  
 
8,027
 
  
 
17,936
 
  
 
5,216
  
 
278
 
  
 
100,052
 
 
New Accounting Pronouncements
 
In July 2001, the FASB issued SFAS No. 141, “Business Combinations.” SFAS No. 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method.
 
In July 2001, the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 was adopted on January 1, 2002. SFAS No. 142 changes the accounting for goodwill from an amortization method to an impairment-only approach. As a result the Company no longer amortizes goodwill, including goodwill recorded in past business combinations and other intangible assets with indefinite lives. The adoption of SFAS No. 142 did not have a material impact on the Company’s consolidated financial statements because as of December 31, 2001, the Company had no goodwill or other intangible assets with indefinite lives recorded in its consolidated financial statements.
 
The following summarizes the components of intangible assets (in thousands):
 
    
As of June 30, 2002

  
As of December 31, 2001

    
Gross
Carrying
Amount

  
Accumulated
Amortization

  
Net

  
Gross
Carrying
Amount

  
Accumulated
Amortization

  
Net

Acquired technology
  
$
19,146
  
$
13,571
  
$
5,575
  
$
19,146
  
$
11,637
  
$
7,509
Customer base
  
 
8,857
  
 
4,429
  
 
4,428
  
 
8,857
  
 
3,806
  
 
5,051
    

  

  

  

  

  

Total
  
$
28,003
  
$
18,000
  
$
10,003
  
$
28,003
  
$
15,443
  
$
12,560
    

  

  

  

  

  

 
Amortization expense of intangible assets for the three months ended June 30, 2002 and 2001 was $1,278,000 and $1,511,000, respectively, and for the six months ended June 30, 2002 and 2001, amortization expense was $2,557,000 and $3,025,000, respectively. Estimated amortization expense for the remainder of 2002, 2003, 2004 and 2005 approximates $2,622,000, $4,883,000, $1,244,000 and $1,254,000, respectively.
 
In August 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations,” which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The Company adopted SFAS No. 143 on January 1, 2002. The adoption of SFAS No. 143 did not have a material impact on the Company’s consolidated financial statements.
 
Also in August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which supersedes FASB Statement No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.” This new statement also supersedes certain aspects of APB 30, “Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions,” with regard to reporting the effects of a disposal of a segment of a business and will require expected future operating losses from discontinued operations to be reported in discontinued operations in the period incurred (rather than as of the measurement date as presently required by Accounting Principles Board No. 30). In addition, more dispositions may qualify for discontinued operations

9


Table of Contents
 
treatment. The Company adopted SFAS No. 144 on January 1, 2002. The adoption of SFAS No. 144 did not have a material impact on the Company’s consolidated financial statements.
 
In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which addresses financial accounting and reporting for costs associated with exit or disposal activities and supersedes Emerging Issues Task Force (EITF) Issue 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity to be recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost as defined in EITF 94-3 was recognized at the date of an entity’s commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. The Company will adopt the provisions of SFAS No. 146 for exit or disposal activities that are initiated after December 31, 2002.
 
In November 2001, the Emerging Issues Task Force (EITF) issued EITF D-103, “Income Statement Characterization of Reimbursements Received for ‘Out-Of-Pocket’ Expenses Incurred,” which requires companies to classify certain reimbursements received for out-of-pocket expenses as revenues in the statement of operations. Historically, the Company netted reimbursements received for out-of-pocket expenses against the related expense in the statement of operations. The Company adopted EITF D-103 on January 1, 2002 and has reclassified amounts shown in prior period financial statements to conform to the requirements of EITF D-103. The impact of this adoption for the three and six months ended June 30, 2001 was an increase in consulting revenues and consulting cost of revenues of $944,000 and $1,930,000, respectively. As a result of this adoption, there was an increase in consulting revenues and consulting cost of revenues of $698,000 and $1,307,000 for the three and six months ended June 30, 2002, respectively. The adoption of EITF D-103 and the related reclassification did not have an impact on the Company’s net loss or net loss per share.
 
Restructurings
 
The following table summarizes the activity in the Company’s reserves associated with its restructurings (in thousands):
 
      
Balance at
December 31,
2001

  
Cash
Payments

    
Balance at
June 30,
2002

Separation costs for terminated employees and contractors
    
$
1,526
  
$
(1,507
)
  
$
19
Facilities closing and downsizing
    
 
2,072
  
 
(233
)
  
 
1,839
Remaining restructuring accrual from prior periods – 1999, 1998, 1997 and 1996
    
 
392
  
 
(43
)
  
 
349
      

  


  

Accrued restructuring costs
    
$
3,990
  
$
(1,783
)
  
$
2,207
      

  


  

 
In April 2001, the Company underwent a restructuring of its operations in an effort to reduce its cost structure through a workforce reduction and the closure or reduction in size of certain of its facilities. In connection with this restructuring, the Company recorded a restructuring charge of $5,890,000 during the quarter ended June 30, 2001. As part of the restructuring the Company terminated 199 employees or 15% of the workforce from all functional areas of the Company. As of June 30, 2002, these terminations were completed.
 
In December 2001, the Company underwent another restructuring to further reduce its cost structure. In connection with this restructuring, the Company recorded a restructuring charge of $2,035,000 during the quarter ended December 31, 2001. As part of this restructuring, the Company terminated 162 employees or approximately 15% of the workforce from all functional areas of the Company. As of June 30, 2002, these terminations were completed.
 
The Company expects the remaining severance costs and a substantial amount of the facilities costs to be paid out by the end of 2002. The severance costs represent remaining payments to already terminated employees, ongoing outplacement services and other benefit costs. Although the facility closure and consolidation efforts were substantially completed as of the end of 2001, lease payments on buildings being vacated or downsized will continue to be made until the respective noncancelable terms of the leases expire.
 
For the quarters ended June 30, 2001 and December 31, 2001, additional charges of $1,720,000 and $13,000, respectively, were recorded for the write-down of fixed assets related to assets to be disposed of as a result of the

10


Table of Contents
 
facility closures in accordance with SFAS No. 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.” These assets consist primarily of leasehold improvements and computer equipment related to buildings being vacated or downsized.
 
The remaining restructuring reserves from prior periods of $349,000 relate primarily to lease commitments on which the Company will continue to make payments until the respective noncancelable term of the leases expire.
 
Credit Facility
 
On July 26, 2000, the Company entered into a $30 million senior credit facility with a financial institution comprised of a $10 million term loan and a $20 million revolving line of credit. In August 2000, the Company received the $10 million proceeds from the term loan. The term loan is due in 36 equal monthly installments, plus interest at the greater of the lender’s prime rate plus 3%, or 9%. As of June 30, 2002, the interest rate on the term loan was 9%. The revolving line of credit expires in August 2003, bears interest at the greater of a variable rate equal to either the prime rate or at LIBOR, at the Company’s option, plus a margin ranging from 0.25% to 1.25% on prime rate loans and 2.5% to 3.75% on LIBOR loans, depending on the Company’s results of operations, or 9%. Borrowings under the revolving line of credit are limited to 85% of eligible accounts receivable, as defined. To date, the Company has not borrowed any amounts against the revolving line of credit facility. As of June 30, 2002, the Company has borrowing capacity of $4.9 million under its revolving line of credit.
 
Borrowings under the credit facility are secured by substantially all of the Company’s assets and the Company is required to comply with certain financial covenants and conditions, including minimum levels of earnings before interest, taxes, depreciation and amortization (EBITDA) and tangible net worth. As of June 30, 2002, the Company was in compliance with all covenants included in the terms of the credit agreement, as amended.
 
Write-Down of Prepaid Software Royalty
 
During the first quarter of 2002, the Company determined that the carrying value of certain prepaid software royalties exceeded their net realizable value as a result of a revised forecast of future revenues prepared during the quarter showing lower than anticipated product sales. Accordingly, a charge of approximately $600,000 was included in cost of revenues for the first quarter of 2002 to reflect the write-down of the prepaid software royalty to its estimated net realizable value.
 
Write-Down of Capitalized Software Development Costs
 
During the first quarter of 2001, the Company determined that the carrying value of its capitalized software development costs related to localized products marketed in Europe as well as a component of one of its manufacturing products exceeded their net realizable value. Accordingly, a charge of approximately $1.0 million was included in cost of revenues for the first quarter of 2001 for the write-down of these capitalized costs to their estimated net realizable value.
 
Conversion of Preferred Stock
 
During the first quarter of 2002, two preferred shareholders elected to convert 31,770 shares of Series C preferred stock into common stock. The Series C preferred stock converts on a 10 to 1 basis, and therefore, the 31,770 shares of preferred stock were converted into 317,770 shares of common stock of the Company.

11


Table of Contents
 
Restricted Stock Purchase Agreements
 
On March 27, 2002, the Company entered into Restricted Stock Purchase Agreements with two separate accredited non-affiliated investors, which provide for the sale at $2.00 per share of 25,000 and 133,239 shares, respectively, of the Company’s common stock being held in treasury. The total net proceeds from the sale were $316,000. The shares in treasury were acquired by the Company as a result of the vesting of shares on January 26, 2002 pursuant to the stock option exchange program executed in January 2001 (see Stock Option Exchange Program below). The Company repurchased a portion of the vested shares as consideration for the Company’s payment of applicable employee withholding taxes. Under the terms of the Restricted Stock Purchase Agreements, the shares must be held indefinitely by the purchasers unless subsequently registered or unless and until the purchasers hold the shares for a minimum of one year and fulfill the other requirements of Rule 144 promulgated under the Securities Act.
 
Treasury Stock
 
In April 2002, the Company acquired 21,227 shares of treasury stock valued at $1.85 per share as a result of the vesting of shares on April 26, 2002 pursuant to the stock option exchange program executed in January 2001 (see Stock Option Exchange Program below). The Company repurchased a portion of the vested shares as consideration for the Company’s payment of applicable employee withholding taxes. As of June 30, 2002, these repurchased shares are held in treasury and are available for future reissuance.
 
Stock Option Exchange Program
 
In January 2001, the Company offered to current employees that held stock options the opportunity to exchange all of their outstanding stock options for restricted shares of the Company’s common stock, at a price equal to the par value of such Common Stock. All employees who accepted the offer received one share of restricted stock for every two options exchanged. The restricted stock vests over a period of two to four years, depending upon whether the exchanged options were vested or unvested at the time of the exchange. Employees who elected to exchange their options were ineligible for stock option grants for a period of six months and one day following the exchange date of January 26, 2001. For the three months ended June 30, 2002 and 2001, the Company recorded compensation expense of $207,000 and $452,000, respectively, related to restricted stock. For the six months ended June 30, 2002 and 2001, the Company recorded compensation expense of $434,000 and $698,000, respectively. The Company will record future compensation expense of up to $1,173,000 over the vesting period of the restricted shares, which represents the fair market value of the restricted common stock issued on the exchange date. Compensation expense to be charged to operations for the remainder of 2002, 2003, 2004 and 2005 approximates $415,000, $385,000, $344,000, and $29,000 respectively, assuming all restricted stock grants vest.
 
The breakdown of the stock based compensation charge for the three and six months ended June 30, 2002 and 2001 by the Company’s operating functions is as follows:
 
    
Three Months ended June 30,

  
Six Months ended June 30,

    
2002

  
2001

  
2002

  
2001

Cost of revenues
  
$
47,000
  
$
53,000
  
$
97,000
  
$
98,000
Sales and marketing
  
 
58,000
  
 
78,000
  
 
116,000
  
 
143,000
Research and development
  
 
23,000
  
 
32,000
  
 
46,000
  
 
56,000
General and administrative
  
 
79,000
  
 
289,000
  
 
175,000
  
 
401,000
    

  

  

  

Total compensation expense
  
$
207,000
  
$
452,000
  
$
434,000
  
$
698,000
    

  

  

  

 
Sales of Product Lines
 
In April 2001, the Company sold the assets of its Impresa for MRO (Impresa) product line, which primarily consisted of intellectual property, accounts receivable, customer lists, contracts and fixed assets, for approximately $2,900,000 in cash, plus other future consideration. Additionally, certain liabilities of the Impresa product line were assumed by the buyer. This resulted in an after tax gain of approximately $1,683,000 included in the results of operations for the quarter ended June 30, 2001. In September 2001, the Company received final cash consideration of $1,513,000 for this sale, resulting in an after tax gain of $1,513,000 included in the results of operations for the quarter ended September 30, 2001. The operations of the Impresa product line were not material to the Company’s results of operations.

12


Table of Contents
 
In May 2001, the Company sold the assets of its Platinum for Windows (PFW) product line, which primarily consisted of intellectual property, accounts receivable, inventories, customer lists, contracts and fixed assets, for $7,000,000 in cash. Additionally, certain liabilities of the PFW product line were assumed by the buyer. This sale resulted in an after tax gain of approximately $8,684,000 included in the results of operations for the quarter ended June 30, 2001. The operations of the PFW product line were not material to the Company’s results of operations.
 
Contingencies
 
In November 1998, a securities class action was filed in the United States District Court for the Southern District of California (the Court) against DataWorks, certain of its current and former officers and directors, and the Company. The consolidated complaint was purportedly brought on behalf of purchasers of DataWorks stock between October 30, 1997 and July 16, 1998. The complaint alleged that the defendants made material misrepresentations and omissions concerning DataWorks’ acquisition of Interactive Group, Inc. and demand for DataWorks’ products. The Company was named as a defendant solely as DataWorks’ successor, and was not alleged to have taken part in the alleged misconduct. No damage amount was specified in the complaint. On January 31, 2002, the Court issued an order granting the defendants’ motion to dismiss the complaint with prejudice as to all claims and defendants. Subsequently, the plaintiffs appealed the dismissal. Effective June 11, 2002, Plaintiff’s appeal was voluntarily dismissed by plaintiff and the securities lawsuit is therefore concluded.
 
The Company is subject to other legal proceedings and claims in the normal course of business. The Company is currently defending these proceedings and claims, and anticipates that it will be able to resolve these matters in a manner that will not have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

13


Table of Contents
 
Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations:
 
Overview
 
The Company designs, develops, markets and supports integrated enterprise business software solutions for use by mid-sized companies, as well as divisions and subsidiaries of larger corporations worldwide. These integrated solutions address customers’ requirements in the areas of customer relationship management, financials, distribution, manufacturing and eBusiness. The Company’s business solutions are focused on the midmarket, which generally includes companies between $10 million and $500 million in annual revenues. The Company also offers support, consulting and education services in support of its customers’ use of its software products. The Company’s products and services are sold worldwide by its direct sales force and an authorized network of VARs, distributors and authorized consultants.
 
Critical Accounting Policies
 
The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America. As such, management is required to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. The significant accounting policies which are most critical to aid in fully understanding and evaluating reported financial results include the following:
 
Revenue Recognition
 
The Company enters into contractual arrangements with end users that may include licensing of the Company’s software products, product support and maintenance services, consulting services, resale of third-party hardware, or various combinations thereof, including the sale of such products or services separately. The Company’s accounting policies regarding the recognition of revenue for these contractual arrangements is fully described in Notes to Unaudited Condensed Consolidated Financial Statements.
 
The Company considers many factors when applying accounting principles generally accepted in the United States of America related to revenue recognition. These factors include, but are not limited to:
 
 
 
The actual contractual terms, such as payment terms, delivery dates, and pricing of the various product and service elements of a contract
 
 
Availability of products to be delivered
 
 
Time period over which services are to be performed
 
 
Creditworthiness of the customer
 
 
The complexity of customizations to the Company’s software required by service contracts
 
 
The sales channel through which the sale is made (direct, VAR, distributor, etc.)
 
 
Discounts given for each element of a contract
 
 
Any commitments made as to installation or implementation “go live” dates
 
Each of the relevant factors is analyzed to determine its impact, individually and collectively with other factors, on the revenue to be recognized for any particular contract with a customer. Management is required to make judgments regarding the significance of each factor in applying the revenue recognition standards, as well as whether or not each factor complies with such standards. Any misjudgment or error by management in its evaluation of the factors and the application of the standards, especially with respect to complex or new types of transactions, could have a material adverse affect on the Company’s future revenues and operating results.
 
Allowance for Doubtful Accounts
 
The Company sells its products directly to end users, generally requiring a significant up-front payment and remaining terms appropriate for the creditworthiness of the customer. The Company also sells its products to VARs and other software distributors generally under terms appropriate for the creditworthiness of the VAR or distributor. The Company believes no significant concentrations of credit risk existed at June 30, 2002. Receivables from customers are generally unsecured. The Company continuously monitors its customer account balances and actively pursues collections on past due balances. The Company maintains an allowance for doubtful accounts which is comprised of a general reserve based on historical collections performance plus a specific reserve for certain known customer collections issues. If actual bad debts are greater then the reserves calculated based on historical trends

14


Table of Contents
 
and known customer issues, the Company may be required to record additional bad debt expense which could have a material adverse impact on the Company’s operating results for the periods in which such additional expense occurs.
 
Capitalized Software Development Costs
 
Software development costs incurred subsequent to the determination of technological feasibility and marketability of a software product are capitalized. Amortization of capitalized software development costs commences when the products are available for general release. Amortization is determined on a product by product basis using the greater of a ratio of current product revenues to projected current and future product revenues or an amount calculated using the straight-line method over the estimated economic life of the product, generally three to five years. In addition to in-house software development costs, the Company purchases certain software from third-party software providers and capitalizes such costs in software development costs. The Company continually evaluates the recoverability of its capitalized software development costs and considers any events or changes in circumstances that would indicate that the carrying amount of an asset may not be recoverable. Any material changes in circumstances, such as a large decrease in revenues or the discontinuation of a particular product line could require future write-downs of the Company’s capitalized software development costs and could have a material adverse impact on the Company’s operating results for the periods in which such write-downs occur.
 
Intangible Assets
 
The Company’s intangible assets were recorded as a result of an acquisition in December 1998 and represent acquired technology and customer base. These intangibles are amortized on a straight-line basis over the estimated economic life of the asset. The Company continually evaluates the recoverability of the intangible assets and considers any events or changes in circumstances that would indicate that the carrying amount of an asset may not be recoverable. Any material changes in circumstances, such as large decreases in revenue or the discontinuation of a particular product line could require future write-downs of the Company’s intangibles assets and could have a material adverse impact on the Company’s operating results for the periods in which such write-downs occur.
 
Restructurings
 
The following table summarizes the activity in the Company’s reserves associated with its restructurings (in thousands):
 
    
Balance at
December 31,
2001

  
Cash
Payments

    
Balance at
June 30,
2002

Separation costs for terminated employees and contractors
  
$
1,526
  
$
(1,507
)
  
$
19
Facilities closing and downsizing
  
 
2,072
  
 
(233
)
  
 
1,839
Remaining restructuring accrual from prior periods – 1999, 1998, 1997 and 1996
  
 
392
  
 
(43
)
  
 
349
    

  


  

Accrued restructuring costs
  
$
3,990
  
$
(1,783
)
  
$
2,207
    

  


  

 
In April 2001, the Company underwent a restructuring of its operations in an effort to reduce its cost structure through a workforce reduction and the closure or reduction in size of certain of its facilities. In connection with this restructuring, the Company recorded a restructuring charge of $5,890,000 during the quarter ended June 30, 2001. As part of the restructuring the Company terminated 199 employees or 15% of the workforce from all functional areas of the Company. As of June 30, 2002, these terminations were completed.
 
In December 2001, the Company underwent another restructuring to further reduce its cost structure. In connection with this restructuring, the Company recorded a restructuring charge of $2,035,000 during the quarter ended December 31, 2001. As part of this restructuring, the Company terminated 162 employees or approximately 15% of the workforce from all functional areas of the Company. As of June 30, 2002, these terminations were completed.
 
The Company expects the remaining severance costs and a substantial amount of the facilities costs to be paid out by the end of 2002. The severance costs represent remaining payments to already terminated employees, ongoing outplacement services and other benefit costs. Although the closure and consolidation efforts were substantially completed as of the end of 2001, lease payments on buildings being vacated or downsized will continue to be made

15


Table of Contents
 
until the respective noncancelable terms of the leases expire. The Company believes these obligations will be funded from existing cash reserves, operations and its credit facility.
 
For the quarters ended June 30, 2001 and December 31, 2001, additional charges of $1,720,000 and $13,000, respectively, were recorded for the write-down of fixed assets related to assets to be disposed of as a result of the facility closures in accordance with SFAS No. 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of. These assets consist primarily of leasehold improvements and computer equipment related to buildings being vacated or downsized.
 
Although the Company believes the restructuring activities were necessary, no assurance can be given that the anticipated benefits of the restructuring will be achieved or that similar action will not be required in the future. The 2001 restructurings enabled the Company to reduce its recurring quarterly costs and expenses by approximately $10 million in each of the first and second quarters of 2002, as compared to the first quarter of 2001. The Company expects that the 2001 restructurings will continue to provide approximately $10 million in quarterly cost savings for the remainder of 2002, as compared to the first quarter of 2001.
 
The remaining restructuring reserves from prior periods of $349,000 relate primarily to lease commitments on which the Company will continue to make payments until the respective noncancelable term of the leases expire.
 
Sales of Product Lines
 
In April 2001, the Company sold the assets of its Impresa for MRO (Impresa) product line, which primarily consisted of intellectual property, accounts receivable, customer lists, contracts and fixed assets, for approximately $2,900,000 in cash, plus other future consideration. Additionally, certain liabilities of the Impresa product line were assumed by the buyer. This resulted in an after tax gain of approximately $1,683,000 included in the results of operations for the quarter ended June 30, 2001. In September 2001, the Company received final cash consideration of $1,513,000 for this sale, resulting in an after tax gain of $1,513,000 included in the results of operations for the quarter ended September 30, 2001. The operations of the Impresa product line were not material to the Company’s results of operations.
 
In May 2001, the Company sold the assets of its Platinum for Windows (PFW) product line, which primarily consisted of intellectual property, accounts receivable, inventories, customer lists, contracts and fixed assets, for $7,000,000 in cash. Additionally, certain liabilities of the PFW product line were assumed by the buyer. This sale resulted in an after tax gain of approximately $8,684,000 included in the results of operations for the quarter ended June 30, 2001. The operations of the PFW product line were not material to the Company’s results of operations.

16


Table of Contents
 
Results of Operations
 
The following table summarizes certain aspects of the Company’s results of operations for the three and six months ended June 30, 2002 compared to the three and six months ended June 30, 2001 (in millions, except percentages):
 
    
Three Months Ended June 30,

    
Six Months Ended June 30,

 
    
2002

    
2001

    
Change $

    
Change %

    
2002

    
2001

    
Change $

    
Change %

 
Revenues:
                                                                   
License fees
  
$
9.3
 
  
$
13.3
 
  
$
(4.0
)
  
(30.3
)%
  
$
17.7
 
  
$
25.6
 
  
$
(7.9
)
  
(31.0
)%
Consulting
  
 
9.7
 
  
 
13.7
 
  
 
(4.0
)
  
(29.2
)%
  
 
19.5
 
  
 
28.2
 
  
 
(8.7
)
  
(30.9
)%
Maintenance
  
 
17.0
 
  
 
19.3
 
  
 
(2.3
)
  
(12.1
)%
  
 
34.1
 
  
 
39.7
 
  
 
(5.6
)
  
(13.9
)%
Other
  
 
0.8
 
  
 
0.9
 
  
 
(0.1
)
  
(3.4
)%
  
 
1.5
 
  
 
1.6
 
  
 
(0.1
)
  
(8.9
)%
    


  


  


  

  


  


  


  

Total revenues
  
 
36.8
 
  
 
47.2
 
  
 
(10.4
)
  
(22.0
)%
  
 
72.8
 
  
 
95.1
 
  
 
(22.3
)
  
(23.5
)%
As a percentage of total revenues:
                                                                   
License fees
  
 
25.1
%
  
 
28.1
%
                  
 
24.3
%
  
 
26.9
%
               
Consulting
  
 
26.4
%
  
 
29.1
%
                  
 
26.8
%
  
 
29.7
%
               
Maintenance
  
 
46.2
%
  
 
40.9
%
                  
 
46.9
%
  
 
41.7
%
               
Other
  
 
2.3
%
  
 
1.9
%
                  
 
2.0
%
  
 
1.7
%
               
    


  


                  


  


               
Total revenues
  
 
100.0
%
  
 
100.0
%
                  
 
100.0
%
  
 
100.0
%
               
                                                                     
Amortization of intangible assets and capitalized software development costs
  
$
1.8
 
  
$
2.2
 
  
$
(0.4
)
  
(18.5
)%
  
$
3.6
 
  
$
4.3
 
  
$
(0.7
)
  
(17.0
)%
As a percentage of total revenues
  
 
4.8
%
  
 
4.6
%
                  
 
4.9
%
  
 
4.5
%
               
Gross profit
  
$
20.4
 
  
$
25.9
 
  
$
(5.5
)
  
(21.2
)%
  
$
39.1
 
  
$
50.1
 
  
$
(11.0
)
  
(21.9
)%
As a percentage of total revenues
  
 
55.3
%
  
 
54.8
%
                  
 
53.7
%
  
 
52.6
%
               
Sales and marketing
  
$
11.3
 
  
$
14.9
 
  
$
(3.6
)
  
(24.2
)%
  
$
22.0
 
  
$
31.8
 
  
$
(9.8
)
  
(30.9
)%
As a percentage of total revenues
  
 
30.6
%
  
 
31.5
%
                  
 
30.2
%
  
 
33.4
%
               
Research and development
  
$
4.5
 
  
$
6.3
 
  
$
(1.8
)
  
(28.1
)%
  
$
9.3
 
  
$
14.3
 
  
$
(5.0
)
  
(34.8
)%
As a percentage of total revenues
  
 
12.3
%
  
 
13.4
%
                  
 
12.8
%
  
 
15.1
%
               
General and administrative
  
$
5.1
 
  
$
6.4
 
  
$
(1.3
)
  
(21.3
)%
  
$
11.0
 
  
$
27.5
 
  
$
(16.5
)
  
(60.1
)%
As a percentage of total revenues
  
 
13.7
%
  
 
13.6
%
                  
 
15.1
%
  
 
28.9
%
               
Other income (expense), net
  
$
(0.3
)
  
$
0.0
 
  
$
(0.3
)
  
—  
 
  
$
0.0
 
  
$
0.0
 
  
$
0.0
 
  
—  
 
As a percentage of total revenues
  
 
0.8
%
  
 
—  
 
                  
 
—  
 
  
 
—  
 
               

17


Table of Contents
 
Revenues
 
License fee revenues decreased in both absolute dollars and as a percentage of total revenues for the three and six months ended June 30, 2002, as compared to the same periods in 2001. This decrease is due largely to the downturn in the North American economy. The Company believes that these economic conditions are causing businesses, including mid-market businesses, to delay capital expenditures and reduce their information technology budgets, which has had a negative impact on software sales. The Company expects third quarter license fee revenues to be slightly down from that of the second quarter 2002 and fourth quarter license revenues to trend back up, due to normal seasonality of the Company’s software sales.
 
Consulting revenues decreased in both absolute dollars and as a percentage of total revenues. For the three and six months ended June 30, 2002, the Company had a decrease in consulting revenues of $4.0 million and $8.7 million, respectively, as compared to the same periods of 2001. This decrease is mainly due to fewer implementation engagements as a result of lower software sales. The previously discussed sale of the Impresa product line in the second quarter of 2001 also resulted in a decrease in consulting revenues of approximately $0.2 million and $0.7 million for the three and six months ended June 30, 2002, respectively. The Company expects consulting revenues to remain at or near current levels for the remainder of 2002.
 
Maintenance revenues decreased in absolute dollars for the three and six months ended June 30, 2002, as compared to the same periods in 2001. This decrease is due to lower new software sales over the last few quarters and the previously discussed sales of the Company’s PFW and Impresa product lines in the second quarter of 2001. The absence of revenues of the two product lines sold in May 2001 resulted in decreases of approximately $1.1 million and $2.8 million for the three and six months ended June 30, 2002, as compared to the same periods in 2001, respectively. Although maintenance revenues decreased in absolute dollars, as a percentage of total revenues, maintenance revenues increased. This is primarily due to the decrease in the total revenue base. The Company expects maintenance revenues to remain at or near current levels for the remainder of 2002.
 
Other revenues consist primarily of resale of third-party hardware and sales of business forms. The decrease in other revenues in absolute dollars for the three and six months ended June 30, 2002, as compared with the same periods in 2001, is due to a decrease in third-party hardware sales directly attributable to the aforementioned decrease in software license fees.
 
International revenues were $10.8 million and $14.2 million in the second quarter of 2002 and 2001, representing 29.2% and 30.1%, respectively, of total revenues. International revenues were $21.4 million and $28.0 million for the six months ended June 30, 2002 and 2001 representing 29.4% and 30.0%, respectively, of total revenues. With sales offices located in the Europe, Australia, Asia and South America, the Company expects international revenues to remain a significant portion of total revenues.
 
Amortization of Intangible Assets and Capitalized Software Development Costs
 
Amortization of intangible assets consists of amortization of capitalized acquired technology and customer base that were recorded as a result of the DataWorks acquisition in December 1998. The Company’s intangible assets are amortized on a straight-line basis over the estimated economic life of the asset. For the three months ended June 30, 2002 and 2001, the Company recorded amortization expense related to intangible assets of $1.3 million and $1.5 million, respectively. For the six months ended June 30, 2002 and 2001, the Company recorded amortization expense related to intangible assets of $2.6 million and $3.0 million, respectively. Amortization of the acquired technology costs will be complete in 2003 and amortization of the customer base will be complete in 2005.
 
Amortization of capitalized software development costs is determined on a product by product basis using the greater of a ratio of current product revenues to projected current and future product revenues or an amount calculated using the straight-line method over the estimated economic life of the product, generally three to five years. For the three months ended June 30, 2002 and 2001, the Company recorded amortization expense related to capitalized software development costs of $0.5 million and $0.7 million, respectively. For the six months ended June 30, 2002 and 2001, the Company recorded amortization expense related to capitalized software development costs of $1.0 million and $1.3 million, respectively. The Company did not capitalize any software development costs for the three or six months ended June 30, 2002, as no costs were eligible for capitalization. Amortization of software development costs that were capitalized prior to 2002 will be complete in 2003.

18


Table of Contents
 
Gross Profit
 
Cost of revenues consists of royalties paid for licensed software incorporated into the Company’s products; costs associated with product packaging, documentation and software duplication; costs of consulting, custom programming, education and support; amortization and write-down of capitalized software development costs; the amortization of acquired intangible assets; and the write-down of prepaid software royalties. A charge of approximately $0.6 million is included in cost of revenues for the first quarter of 2002 to write-down certain of the Company’s prepaid software royalties to net realizable value due to lower than anticipated product sales. Additionally, a charge of approximately $1.0 million is included in cost of revenues for the first quarter of 2001 to write-down capitalized software development costs due to the Company’s decision to discontinue marketing one of its products in a particular region overseas and declining revenues in a component of one of the Company’s manufacturing products.
 
The decline in gross profit in absolute dollars for the three and six months ended June 30, 2002, as compared to the same periods in 2001, is primarily due to the decrease in total revenues. However, the gross profit as a percentage of total revenues increased. The increases over the same periods in 2001 are primarily due to improved margins from maintenance revenues as a result of the 2001 restructurings and the Company’s continued cost savings measures, offset by reduced margins from consulting revenues. The reduction in consulting margins is due to the decrease in consulting revenues and the short-term, fixed nature of the underlying service costs.
 
Sales and Marketing
 
Sales and marketing expenses consist primarily of salaries, commissions, travel, advertising and promotional expenses. The decrease in both absolute dollars and as a percentage of total revenues for the three and six months ended June 30, 2002, as compared to the same periods of 2001, is primarily due to a decrease in the cost of salaries, benefits and other headcount related expenses as a result of the previously discussed 2001 restructurings, and lower commissions expense resulting from decreased software license fees revenue. Additionally, during the three and six month periods ended June 30, 2002, the Company decreased its advertising and related costs as compared to the same periods in 2001, as a result of the 2001 restructurings and cost savings measures implemented in 2001. The Company expects sales and marketing expenses to remain at these reduced levels for the remainder of 2002.
 
Research and Development
 
Research and development costs consist primarily of compensation of development personnel, related overhead incurred to develop the Company’s products as well as fees paid to outside consultants. Software development costs are accounted for in accordance with Statement of Financial Accounting Standards No. 86 “Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed,” under which the Company is required to capitalize software development costs between the time technological feasibility is established and the product is ready for general release. Costs that do not qualify for capitalization are charged to research and development expense when incurred. During the three and six months ended June 30, 2002 and 2001, no software development costs were capitalized because the time period between technological feasibility and general release for all software product releases during the three and six month periods ended June 30, 2002 and 2001, was insignificant. Capitalized software development costs include both internally generated development costs for development of the Company’s future product releases and third party development costs related to the localization and translation of certain of the Company’s products for foreign markets.
 
The decrease in software development expenses for the three and six months ended June 30, 2002, as compared to the same periods of 2001, is due to a decrease in the cost of salaries, benefits and other headcount related expenses as a result of the 2001 restructurings, the previously discussed sales of the PFW and Impresa product lines in the second quarter of 2001 and the Company’s efforts to move certain software development activities to lower-cost offshore locations. The Company expects software development expenses for the remainder of 2002 to remain at these reduced levels for the remainder of 2002, due to the 2001 restructurings and cost savings measures implemented in 2001.

19


Table of Contents
 
General and Administrative
 
General and administrative expenses consist primarily of costs associated with the Company’s executive, financial, human resources and information services functions. The decrease in absolute dollars in general and administrative expenses for the three months ended June 30, 2002, as compared to the same period in 2001, is due to a decrease in the cost of salaries, benefits and other headcount related expenses as a result of the previously discussed 2001 restructurings and decreased expense related to customer disputes due to the Company’s continued focus and execution on product quality and successful implementations leading to increasing customer satisfaction. For the six months ended June 30, 2002, as compared to the same period of 2001, general and administrative expenses decreased both in absolute dollars and as a percentage of total revenues due to the decrease in the cost of salaries, benefits and other headcount related expenses as a result of the 2001 restructurings and a decrease in the Company’s provision for doubtful accounts as a result of improved collection efforts. The Company expects general and administrative expenses to remain at these reduced levels for the remainder of 2002, due to the 2001 restructurings and cost savings measures implemented in 2001.
 
Other Income and Expense, Net
 
Other income and expense, net consists primarily of interest income, interest expense and gains and losses on foreign currency transactions. For the three months ended June 30, 2002, as compared to the same period in 2001, other income and expense, net decreased due to foreign currency losses of $0.5 million realized in the second quarter of 2002, primarily due to the strengthening of the Euro against the British pound. These losses were offset by a $0.2 million decrease in interest expense due to repayments on the Company’s debt obligations.
 
Liquidity and Capital Resources
 
The following table summarizes the Company’s cash and cash equivalents, working capital deficit, long-term debt and cash flows as of and for the six months ended June 30, 2002 (in millions):
 
Cash and cash equivalents
  
$    29.3
 
Working capital deficit
  
(14.6
)
Long-term debt, net of current portion
  
0.6
 
Net cash provided by operating activities
  
5.7
 
Net cash used in investing activities
  
(0.4
)
Net cash used in financing activities
  
(1.5
)
 
As of June 30, 2002, the Company’s principal sources of liquidity included cash and cash equivalents of $29.3 million. The Company’s operating activities provided $5.7 million in cash during the six month period ended June 30, 2002 despite the reported net loss of $3.7 million. This is primarily due to the Company’s ongoing improvements in its accounts receivable collection efforts, a $5.6 million non-cash impact of depreciation and amortization recorded in the first half of 2002 and a $1.2 million federal income tax refund received during the second quarter of 2002. At June 30, 2002, the Company has $2.2 million in cash obligations for severance costs, lease terminations and other costs related to the Company’s restructurings and $1.0 million in cash obligations for lease terminations and other costs related to the 1998 DataWorks merger which is included in accrued expenses in the accompanying unaudited condensed consolidated financial statements. The Company believes these obligations will be funded from existing cash reserves, operations and its credit facility.
 
The Company’s principal investing activities for the six month period ended June 30, 2002 included capital expenditures of $0.4 million. For the remainder of 2002, the Company anticipates capital spending on property and equipment will remain at current levels, and these expenditures will be funded from existing cash reserves, operations and its credit facility.
 
Financing activities for the six months ended June 30, 2002 included payments of $1.8 million made against the Company’s debt obligations and payments of $0.4 million to acquire treasury stock in connection with the stock option exchange program. Cash provided by financing activities included proceeds from the issuance of stock under the employee stock purchase program of $0.3 million and proceeds from the sale of treasury stock of $0.3 million.
 
On July 26, 2000, the Company entered into a $30 million senior credit facility with a financial institution comprised of a $10 million term loan and a $20 million revolving line of credit. In August 2000, the Company received the $10 million proceeds from the term loan. The term loan is due in 36 equal monthly installments, plus

20


Table of Contents
 
interest at the greater of the lender’s prime rate plus 3%, or 9%. As of June 30, 2002, the interest rate on the term loan was 9%. The revolving line of credit expires in August 2003, bears interest at the greater of a variable rate equal to either the prime rate or at LIBOR, at the Company’s option, plus a margin ranging from 0.25% to 1.25% on prime rate loans and 2.5% to 3.75% on LIBOR loans, depending on the Company’s results of operations, or 9%. Borrowings under the revolving line of credit are limited to 85% of eligible accounts receivable, as defined. To date, the Company has not borrowed any amounts against the revolving line of credit facility. As of June 30, 2002, the Company has borrowing capacity of $4.9 million under its revolving line of credit.
 
Borrowings under the credit facility are secured by substantially all of the Company’s assets and the Company is required to comply with certain financial covenants and conditions, including minimum levels of earnings before interest, taxes, depreciation and amortization (EBITDA) and tangible net worth. As of June 30, 2002, the Company was in compliance with all covenants included in the terms of the credit agreement, as amended.
 
The Company had taken steps to reduce its operating expenses as part of its December 1999, April 2001 and December 2001 restructurings, all of which included a reduction in workforce and facilities consolidation and closure. Based on the savings generated from the 2001 restructurings and cash proceeds from the sales of the Company’s PFW and Impresa product lines, the Company generated positive cash flow in the second, third and fourth quarters of 2001. Additionally, in the first and second quarters of 2002, the Company generated positive cash flow from operations primarily due to the savings from the 2001 restructuring, ongoing improvements in its accounts receivable collection efforts, the $5.6 million non-cash impact of depreciation and amortization recorded in 2002 and a $1.2 million federal income tax refund received during the second quarter of 2002. The Company expects to generate positive cash flow from operations for the year ended December 31, 2002.
 
As of June 30, 2002, the Company had cash and cash equivalents of $29.3 million. In addition, at such date, the Company had borrowing capacity under its $20 million revolving line of credit facility of $4.9 million. The Company is dependent upon its ability to generate cash flows from license fees, providing services to its customers and other operating revenues and through collection of its accounts receivable to maintain current liquidity levels. If the Company is not successful in achieving targeted 2002 revenues and expenses or positive cash flows from operations, the Company may be required to take further cost-cutting measures and restructuring actions.
 
The Company reported a net loss for the six months ended June 30, 2002 of $3.7 million. While management’s goal is to continue to reduce and eliminate losses and return to profitability, there can be no assurance that the Company’s restructuring and other cost control actions will enable the Company to achieve operating profitability. Considering current cash reserves, and other existing sources of liquidity, including its revolving line of credit, management believes that the Company will have sufficient sources of financing to continue its operations throughout at least the next twelve months.
 
New Accounting Pronouncements
 
In July 2001, the FASB issued SFAS No. 141, “Business Combinations.” SFAS No. 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method.
 
In July 2001, the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 was adopted on January 1, 2002. SFAS No. 142 changes the accounting for goodwill from an amortization method to an impairment-only approach. As a result the Company no longer amortizes goodwill, including goodwill recorded in past business combinations and other intangible assets with indefinite lives. The adoption of SFAS No. 142 did not have a material impact on the Company’s consolidated financial statements because as of December 31, 2001, the Company had no goodwill or other intangible assets with indefinite lives recorded in its consolidated financial statements.

21


Table of Contents
 
The following summarizes the components of intangible assets (in thousands):
 
    
As of June 30, 2002

  
As of December 31, 2001

    
Gross
Carrying
Amount

  
Accumulated
Amortization

  
Net

  
Gross
Carrying
Amount

  
Accumulated
Amortization

  
Net

Acquired technology
  
$
19,146
  
$
13,571
  
$
5,575
  
$
19,146
  
$
11,637
  
$
7,509
Customer base
  
 
8,857
  
 
4,429
  
 
4,428
  
 
8,857
  
 
3,806
  
 
5,051
    

  

  

  

  

  

Total
  
$
28,003
  
$
18,000
  
$
10,003
  
$
28,003
  
$
15,443
  
$
12,560
    

  

  

  

  

  

 
Amortization expense of intangible assets for the three months ended June 30, 2002 and 2001 was $1,278,000 and $1,511,000, respectively, and for the six months ended June 30, 2002 and 2001, amortization expense was $2,557,000 and $3,025,000, respectively. Estimated amortization expense for the remainder of 2002, 2003, 2004 and 2005 approximates $2,622,000, $4,883,000, $1,244,000 and $1,254,000, respectively.
 
In August 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations,” which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The Company adopted SFAS No. 143 on January 1, 2002. The adoption of SFAS No. 143 did not have a material impact on the Company’s consolidated financial statements.
 
Also in August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which supersedes FASB Statement No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.” This new statement also supersedes certain aspects of APB 30, “Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions,” with regard to reporting the effects of a disposal of a segment of a business and will require expected future operating losses from discontinued operations to be reported in discontinued operations in the period incurred (rather than as of the measurement date as presently required by Accounting Principles Board No. 30). In addition, more dispositions may qualify for discontinued operations treatment. The Company adopted SFAS No. 144 on January 1, 2002. The adoption of SFAS No. 144 did not have a material impact on the Company’s consolidated financial statements.
 
In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which addresses financial accounting and reporting for costs associated with exit or disposal activities and supersedes Emerging Issues Task Force (EITF) Issue 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity to be recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost as defined in EITF 94-3 was recognized at the date of an entity’s commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. The Company will adopt the provisions of SFAS No. 146 for exit or disposal activities that are initiated after December 31, 2002.
 
In November 2001, the Emerging Issues Task Force (EITF) issued EITF D-103, “Income Statement Characterization of Reimbursements Received for ‘Out-Of-Pocket’ Expenses Incurred,” which requires companies to classify certain reimbursements received for out-of-pocket expenses as revenues in the statement of operations. Historically, the Company netted reimbursements received for out-of-pocket expenses against the related expense in the statement of operations. The Company adopted EITF D-103 on January 1, 2002 and has reclassified amounts shown in prior period financial statements to conform to the requirements of EITF D-103. The impact of this adoption for the three and six months ended June 30, 2001 was an increase in consulting revenues and consulting cost of revenues of $944,000 and $1,930,000, respectively. As a result of this adoption, there was an increase in consulting revenues and consulting cost of revenues of $698,000 and $1,307,000 for the three and six months ended June 30, 2002, respectively. The adoption of EITF D-103 and the related reclassification did not have an impact on the Company’s net loss or net loss per share.

22


Table of Contents
 
Certain Factors that May Affect Future Results
 
Forward Looking Statements – Safe Harbor.
 
Certain statements in this Quarterly Report on Form 10-Q are forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended, that involve risks and uncertainties. Any statements contained herein (including without limitation statements to the effect that the Company or Management “estimates,” “expects,” “anticipates,” “plans,” “believes,” “projects,” “continues,” “may,” or “will” or statements concerning “potential” or “opportunity” or variations thereof or comparable terminology or the negative thereof) that are not statements of historical fact should be construed as forward looking statements. These statements include the Company’s expectation that (i) severance costs and a substantial amount of the facilities costs will be paid out by the end of 2002, (ii) restructuring obligations will be funded from existing cash reserves, operations and its credit facility, (iii) the 2001 restructurings will provide approximately $10 million in quarterly cost savings for the remainder of 2002, as compared to the first quarter of 2001, (iv) third quarter license fee revenues to be slightly down from that of the second quarter 2002 and fourth quarter license revenues to trend back up due to normal seasonality of the Company’s software sales, (v) consulting revenues will remain at or near current levels for the remainder of 2002, (vi) maintenance revenues will remain at or near current levels for the remainder of 2002, (vii) 2002 international revenues will remain a significant portion of total revenues, (viii) operating expenses will remain at or near 2001 levels in 2002 due to the 2001 restructurings and cost savings measures implemented in 2001, (ix) capital spending on property and equipment will remain at current levels, and these expenditures will be funded from existing cash reserves, operations and its credit facility, (x) the Company will generate positive cash flow from operations for the year ended December 31, 2002, and (xi) the Company will have sufficient sources of financing to continue its operations throughout at least the next twelve months. Actual results could differ materially and adversely from those anticipated in such forward looking statements as a result of certain factors, including the factors listed at pages 23 to 30. Because of these and other factors that may affect the Company’s operating results, past performance should not be considered an indicator of future performance and investors should not use historical results to anticipate results or trends in future periods. The Company undertakes no obligation to revise or publicly release the results of any revision to these forward-looking statements. Readers should carefully review the risk factors described in other documents the Company files from time to time with the Securities and Exchange Commission including its annul report on Form 10-K for the year ending December 31, 2001 at pages 14 to 21 and quarterly reports on Form 10-Q to be filed by the Company during 2002.
 
The Company has in the past suffered from decreasing cash reserves and working capital. We may not be able to collect aged accounts receivable and we may need to raise additional cash to fund our working capital requirements.
 
The Company’s cash and cash equivalents have increased from $24.4 million at December 31, 2001 to $29.3 million at June 30, 2002. The Company’s working capital has improved from a working capital deficit at December 31, 2001 of $16.2 million to a working capital deficit at June 30, 2002 of $14.6 million. However, if the Company is not successful in achieving targeted revenues and expenses or maintaining a positive cash flow during 2002, the Company may be required to take further actions to reduce its operating expenses, such as additional reductions in work force, and/or seek additional sources of funding. In addition, although the Company currently has in place a bank line of credit, the Company has in prior quarters violated the financial covenants included in the terms of that credit agreement. The Company received waivers from its lender for these prior violations. In addition, the Company renegotiated the financial covenants during the second quarter 2002 to reduce the thresholds required for compliance with the covenants. The Company complied with the revised covenants in the second quarter of 2002. However, if the Company is unable to maintain a positive cash flow or achieve operating profitability, there can be no assurance that the Company will not violate the covenants in the future. Should such violations occur, there can be no assurance that the Company would be able to secure alternative funding or, if secured, on favorable terms. Since December 31, 1999, the Company has also experienced fluctuations in the proportion of accounts receivable over 90 days old. Although the proportion of accounts receivables over 90 days old has decreased since the end of 2000, if the Company cannot successfully collect a significant portion of its net accounts receivable, the Company may be required to seek alternative financing sources in addition to its current bank credit facility. In addition, should the Company not reduce its aged receivables, its ability to borrow against the revolving portion of the credit facility may be severely restricted due to the fact that borrowings are limited to 85% of eligible receivables, as defined, which excludes receivables over ninety days old.

23


Table of Contents
 
Our quarterly operating results are subject to fluctuations and if we fail to meet expectations of securities analysts or investors our share price may decrease.
 
The Company’s quarterly operating results have fluctuated in the past. The Company’s operating results may fluctuate in the future as a result of many factors that may include:
 
 
The demand for the Company’s products, including reduced demand related to changes in marketing focus for certain products, software market conditions or general economic conditions
 
Fluctuations in the length of the Company’s sales cycles
 
Changes in accounting standards, including revenue recognition standards
 
The size and timing of orders for the Company’s products
 
The number, timing and significance of new product announcements by the Company and its competitors
 
The Company’s ability to introduce and market new and enhanced versions of its products on a timely basis
 
The level of product and price competition
 
Changes in operating expenses of the Company
 
Changes in average selling prices
 
In addition, the Company has historically realized a significant portion of its revenues in the final month of any quarter with a concentration of such revenues recorded in the final ten business days of that month.
 
Due to the above factors, among others, the Company’s revenues are difficult to forecast. The Company, however, will base its expense levels, in significant part, on its expectations of future revenue. As a result, the Company expects its expense levels to be relatively fixed in the short term. The Company’s failure to meet revenue expectations could adversely affect operating results. Further, an unanticipated decline in revenue for a particular quarter may disproportionately affect the Company’s operating results because a relatively small amount of the Company’s expenses will vary with its revenues in the short run. As a result, the Company believes that period-to-period comparisons of the Company’s results of operations are not and will not necessarily be meaningful, and you should not rely upon them as an indication of future performance. Due to the foregoing factors, it is likely that in some future quarter the Company’s operating results will be below the expectations of public market analysts and investors. Such an event would likely have a material adverse effect upon the price of the Company’s Common Stock.
 
If we fail to rapidly develop and introduce new products and services, we will not be able to compete effectively and our ability to generate revenues will suffer.
 
The market for the Company’s software products is subject to ongoing technological developments, evolving industry standards and rapid changes in customer requirements. The Company believes the Internet is transforming the way businesses operate and the software requirements of customers. Specifically, the Company believes that customers desire eBusiness software applications, or applications that enable a customer to engage in commerce or service over the Internet. As companies introduce products that embody new technologies or as new industry standards emerge, such as web-based applications or applications that support eBusiness, existing products may become obsolete and unmarketable. Development of new technologies may also cause the Company to change how it licenses or prices its products, possibly adversely impacting the Company’s revenues and operating results. Such emerging licensing models include subscription based licensing in which the licensee essentially rents the software for a defined period of time as opposed to the current perpetual license model. The Company’s future business, operating results and financial condition will depend on its ability to:
 
 
Enhance its existing products
 
Develop, deliver and achieve market acceptance of new and/or improved products that address the increasingly sophisticated needs of its customers, particularly in the areas of eBusiness and eCommerce
 
Develop products for additional platforms
 
Effectively train its sales force to sell an integrated suite of eBusiness products
 
Effectively recognize and implement emerging industry standards and models
 
Further, if the Company fails to respond to technological advances, emerging industry standards, including licensing models, and end-user requirements, or experiences any significant delays in product development or introduction, the Company’s competitive position and revenues could be adversely affected. The Company’s success will depend on its ability to continue to develop and successfully introduce new products and services, including those in the

24


Table of Contents
 
eBusiness arena. The Company cannot assure you that it will successfully develop and market such new and/or improved products on a timely basis, if at all. In developing new products, the Company may encounter software errors or failures that force the delay in the commercial release of the new products. Any such delay or failure to develop could have a material adverse effect on the Company’s business, results of operations and financial condition. From time to time, the Company or its competitors may announce new products, capabilities or technologies that have the potential to replace or shorten the life cycles of the Company’s existing products. The Company cannot assure you that such announcements will not cause customers to delay or alter their purchasing decisions, which could have a material adverse effect on the Company’s business, operating results and financial condition.
 
Our software products may contain errors or defects, which could result in the rejection of our products and damage our reputation as well as cause lost revenue, delays in collecting accounts receivable, diverted development resources and increased service costs and warranty claims.
 
Software products as complex as the ERP products offered by the Company may contain undetected errors or failures when first introduced or as new versions are released. Despite testing by the Company, and by current and potential customers, the Company’s products may contain errors after their commercial shipment. Such errors may cause loss of or delay in market acceptance of the Company’s products, damage to the Company’s reputation, and increased service and warranty costs. The Company from time to time is notified by some of its customers of errors in its various product lines. Although it has not occurred to date, the possibility of the Company being unable to correct such errors in a timely manner could have a material adverse effect on the Company’s results of operations and its cash flows. In addition, technical problems with the current release of the database platforms on which the Company’s products operate could impact sales of these products, which could have a material adverse effect on the Company’s results of operations.
 
Business interruptions could adversely affect our business.
 
Our operations are vulnerable to interruption by fire, earthquake, power loss, telecommunications failure and other events beyond our control. A substantial portion of our facilities, including our corporate headquarters and other critical business operations, are located near major earthquake faults. We do not carry earthquake insurance and do not fund for earthquake-related losses. Although the facilities in which we host our computer systems are designed to be fault tolerant, the systems are susceptible to damage from fire, floods, earthquakes, power loss, telecommunications failures, and similar events. Our facilities in California were subjected to an increased probability of rolling electrical blackouts during the summer of 2001 as a consequence of a shortage of available electrical power. It is possible that we could again be subject to such blackouts in the future including during the summer of 2002. In the event these blackouts occur or increase in severity, they could disrupt the operations of our affected facilities. The Company also currently contracts with Worldcom/MCI for the majority of its telecommunications services. The recent events surrounding Worldcom, including financial fraud allegations and its bankruptcy filings could possibly result in a disruption of Epicor’s telecommunication capabilities and thus, disrupt Epicor’s business operations. The Company is currently considering its options and developing contingency plans to avoid and/or minimize potential disruptions to its Telecommunication Services. In addition, terrorist acts or acts of war may cause damage or disruption to the Company, its employees, facilities, suppliers, distributors and VARs, and customers, which could have a material adverse effect on the Company’s operations and financial results. We do not carry financial reserves against business interruptions and although we do carry business interruption insurance limited to special causes of loss, if a business interruption occurs, our business could be seriously harmed.
 
Revenue recognition accounting standards and interpretations may change, causing the Company to recognize lower revenues.
 
In October 1997, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) No. 97-2, “Software Revenue Recognition.” The Company adopted SOP 97-2, as amended by SOP 98-4 “Deferral of the Effective Date of a Provision of SOP 97-2” as of July 1, 1998. In December 1998, the AICPA issued SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions.” The Company adopted SOP 98-9 on January 1, 2000. These standards address software revenue recognition matters primarily from a conceptual level and do not include specific implementation guidance. The Company believes that it is currently in compliance with SOPs 97-2 and SOP 98-9. In addition, in December 1999, the Securities and Exchange Commission (SEC) staff issued Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements” (SAB 101), which provides further guidance with regard to revenue recognition, presentation and disclosure. The Company adopted SAB 101 during the fourth quarter of fiscal 2000.

25


Table of Contents
 
The accounting profession and the SEC continue to discuss certain provisions of SOP 97-2, SAB 101 and other revenue recognition standards and related interpretations with the objective of providing additional guidance on potential application of the standards and interpretations. These discussions could lead to unanticipated changes in revenue recognition standards and, as a result, in the Company’s current revenue accounting practices, which could cause the Company to recognize lower revenues. As a result, the Company may need to change its business practices.
 
We may pursue strategic acquisitions, investments, and relationships. We may not be able to successfully manage our operations if we fail to successfully integrate acquired businesses and technologies.
 
As part of its business strategy, the Company intends to continue to expand its product offerings to include application software products that are complementary to its existing ERP applications, particularly in the areas of eBusiness and eCommerce. This strategy may involve acquisitions, investments in other businesses that offer complementary products, joint development agreements or technology licensing agreements. The risks commonly encountered in the acquisitions of businesses would accompany any future acquisitions or investments by the Company. Such risks may include the following:
 
 
The difficulty of integrating previously distinct businesses into one business unit
 
The substantial management time devoted to such activities
 
The potential disruption of the Company’s ongoing business
 
Undisclosed liabilities
 
Failure to realize anticipated benefits (such as synergies and cost savings)
 
Issues related to product transition (such as development, distribution and customer support)
 
The Company expects that the consideration it would pay in such future acquisitions would consist of stock, rights to purchase stock, cash or some combination of the aforementioned. If the Company issues stock or rights to purchase stock in connection with these future acquisitions, earnings (loss) per share and then-existing holders of the Company’s Common Stock may experience dilution.
 
The risks that the Company may encounter in licensing technology from third parties include the following:
 
 
The difficulty in integrating the third party product with the Company’s products
 
Undiscovered software errors in the third party product
 
Difficulties in selling the third party product
 
Difficulties in providing satisfactory support for the third party product
 
Potential infringement claims from the use of the third party product
 
Discontinuation of third party product lines
 
We rely in part, on distributors and VARs to sell our products. Disruptions to these channels would adversely affect our ability to generate revenues from the sale of our products.
 
The Company distributes products through a direct sales force as well as through VARs and distributors. The Company’s distribution channel includes distributors, VARs and authorized consultants, which consist primarily of professional firms. If the Company’s VARs or authorized consultants cease distributing or recommending the Company’s products or emphasize competing products, the Company’s results of operations could be materially and adversely affected. The Company recently announced that effective February 1, 2002, the Company’s e by Epicor VAR program would no longer require VARs to sell the Company’s products exclusive of competing product lines. The Company is currently in the process of implementing this change to its VAR program. The long term impact of this change in the VAR channel to the Company’s performance is as of yet undetermined, as is whether the Company’s ability to generate license revenue from its e by Epicor products will prove to be adversely or favorably impacted, which would effect the Company’s consolidated results of operations and cash flows.
 
There can be no assurance that having a direct sales force will not lead to conflicts with the Company’s VAR channels.

26


Table of Contents
 
We derive a substantial portion of our revenue from the sale of enterprise application software and related support services. If those sales suffer, our business will be negatively impacted.
 
The Company derives its revenue from the sale of its various ERP application software packages and related services. Accordingly, any event that adversely affects fees derived from the sale of such systems would have a material adverse affect on the Company’s business, results of operations and performance. For example, the market for ERP applications was negatively impacted in 1999 and the first half of 2000 by Year 2000 concerns. Similarly, in 2001 and continuing through the second quarter of 2002, the market for ERP applications continued to be negatively impacted by the domestic economic slowdown and slow recovery. Other such events may include:
 
 
Competition from other products
 
Significant flaws in the Company’s products
 
Incompatibility with third-party hardware or software products
 
Negative publicity or evaluation of the Company or its products
 
Obsolescence of the hardware platforms or software environments in which the Company’s systems run
 
Our products rely on third party software products and our reputation and results of operations could be adversely affected by our inability to control their operations.
 
The Company’s products incorporate and use software products developed by other entities. The Company cannot assure you that such third parties will:
 
 
Remain in business
 
Support the Company’s product lines
 
Maintain viable product lines
 
Make their product lines available to the Company on commercially acceptable terms
 
Any significant interruption in the supply of such third-party technology could have a material adverse effect on the Company’s business, results of operation, cash flows and financial condition.
 
The market for web-based development tools, application products and consulting and education services is emerging and it could negatively affect our client/server-based products.
 
The Company’s development tools, application products and consulting and education services generally help organizations build, customize or deploy solutions that operate in a client/server computing environment. There can be no assurance that these markets will continue to grow or that the Company will be able to respond effectively to the evolving requirements of these markets. The Company believes that the environment for application software is continuing to change from client/server to a web-based environment to facilitate eBusiness. If the Company fails to respond effectively to evolving requirements of this market, the Company’s business, financial condition, results of operations and cash flows will be materially and adversely affected.
 
The continuing impact on the Company of emerging areas such as the Internet, on-line services, eBusiness applications and electronic commerce is uncertain and could negatively impact our business.
 
There can be no assurance that the Company will be able to continue to provide a product offering that will satisfy new customer demands in these areas. In addition, standards for web-enabled and eBusiness applications, as well as other industry adopted and de facto standards for the Internet, are continuing to evolve rapidly. There can be no assurance that standards chosen by the Company will position its products to compete effectively for business opportunities as they arise on the Internet and other emerging areas. The success of the Company’s product offerings depends, in part, on its ability to continue developing products that are compatible with the Internet. The increased commercial use of the Internet will require substantial modification and customization of the Company’s products and the introduction of new products. The Company may not be able to effectively compete in the Internet-related products and services market.
 
Critical issues concerning the commercial use of the Internet, including security, demand, reliability, cost, ease of use, accessibility, quality of service and potential tax or other government regulation, remain partially and/or fully unresolved and may affect the use of the Internet as a medium to support the functionality of our products and
 

27


Table of Contents
distribution of our software. If these critical issues are not favorably resolved, the Company’s business, operating results, cash flows and financial condition could be materially and adversely affected.
 
The market for our products is highly competitive. If we are unable to compete effectively with existing or new competitors our business could be negatively impacted.
 
The business information systems industry in general and the ERP computer software industry in particular are very competitive and subject to rapid technological change. Many of the Company’s current and potential competitors have (1) longer operating histories, (2) significantly greater financial, technical and marketing resources, (3) greater name recognition, (4) larger technical staffs, and (5) a larger installed customer base than the Company has. A number of companies offer products that are similar to the Company’s products and that target the same markets. In addition, any of these competitors may be able to respond quicker to new or emerging technologies and changes in customer requirements (such as eBusiness and Web-based application software), and to devote greater resources to the development, promotion and sale of their products than the Company. Furthermore, because there are relatively low barriers to entry in the software industry, the Company expects additional competition from other established and emerging companies. Such competitors may develop products and services that compete with those offered by the Company or may acquire companies, businesses and product lines that compete with the Company. It also is possible that competitors may create alliances and rapidly acquire significant market share. Accordingly, there can be no assurance that the Company’s current or potential competitors will not develop or acquire products or services comparable or superior to those that the Company develops, combine or merge to form significant competitors, or adapt quicker than will the Company to new technologies, evolving industry trends and changing customer requirements. Competition could cause price reductions, reduced margins or loss of market share for the Company’s products and services, any of which could materially and adversely affect the Company’s business, operating results and financial condition. There can be no assurance that the Company will be able to compete successfully against current and future competitors or that the competitive pressures that the Company may face will not materially adversely affect its business, operating results, cash flows and financial condition.
 
We may not be able to maintain and expand our business if we are not able to retain, hire and integrate sufficiently qualified personnel.
 
The Company’s success depends on the continued service of key management personnel that are not subject to an employment agreement. In addition, the competition to attract, retain and motivate qualified technical, sales and operations personnel is intense. The Company has at times experienced, and continues to experience, difficulty in recruiting qualified personnel, particularly in software development and customer support. There is no assurance that the Company can retain its key personnel or attract other qualified personnel in the future. The failure to attract or retain such persons could have a material adverse effect on the Company’s business, operating results, cash flows and financial condition.
 
Our future results could be harmed by economic, political, regulatory and other risks associated with international sales and operations.
 
The Company believes that any future growth of the Company will be dependent, in part, upon the Company’s ability to maintain and increase revenues in international markets. There is no assurance that the Company will maintain or expand its international sales. If the revenues that the Company generates from foreign activities are inadequate to offset the expense of maintaining foreign offices and activities, the Company’s business, financial condition and results of operations could be materially and adversely affected. International sales are subject to inherent risks, including:
 
 
Changes in regulatory requirements
 
Tariffs and other barriers
 
Unfavorable intellectual property laws
 
Fluctuating exchange rates
 
Difficulties in staffing and managing foreign sales and support operations
 
Longer accounts receivable payment cycles
 
Potentially adverse tax consequences, including repatriation of earnings
 
Development and support of localized and translated products
 
Lack of acceptance of localized products in foreign countries
 
Burdens of complying with a wide variety of foreign laws

28


Table of Contents
 
Effects of high local wage scales and other expenses
 
Shortage of skilled personnel required for the local operation
 
Euro adoption
 
Any one of these factors could materially and adversely affect the Company’s future international sales and, consequently, the Company’s business, operating results, cash flows and financial condition. A portion of the Company’s revenues from sales to foreign entities, including foreign governments, has been in the form of foreign currencies. The Company does not have any hedging or similar foreign currency contracts. Fluctuations in the value of foreign currencies could adversely impact the profitability of the Company’s foreign operations.
 
If third parties infringe our intellectual property, we may expend significant resources enforcing our rights or suffer competitive injury.
 
The Company relies on a combination of copyright, trademark and trade secret laws, employee and third-party nondisclosure agreements and other industry standard methods for protecting ownership of its proprietary software. However, the Company cannot assure you that in spite of these precautions, an unauthorized third party will not copy or reverse-engineer certain portions of the Company’s products or obtain and use information that the Company regards as proprietary. From time to time, the Company does take legal action against third parties whom the Company believes are infringing upon the Company’s intellectual property rights. However, there is no assurance that the mechanisms that the Company uses to protect its intellectual property will be adequate or that the Company’s competitors will not independently develop products that are substantially equivalent or superior to the Company’s products.
 
The Company may from time to time receive notices from third parties claiming that its products infringe upon third-party intellectual property rights. The Company expects that as the number of software products in the country increases and the functionality of these products further overlaps, the number of these types of claims will increase. Any such claim, with or without merit, could result in costly litigation and require the Company to enter into royalty or licensing arrangements. The terms of such royalty or license arrangements, if required, may not be favorable to the Company.
 
In addition, in certain cases, the Company provides the source code for some of its application software under licenses to its customers and distributors to enable them to customize the software to meet their particular requirements or translate or localize the products for resale in foreign countries, as the case may be. Although the source code licenses contain confidentiality and nondisclosure provisions, the Company cannot be certain that such customers or distributors will take adequate precautions to protect the Company’s source code or other confidential information.
 
Substantial sales of our stock could cause our stock price to decline.
 
As of August 1, 2002, the Company had 44,916,906 shares of common stock outstanding as well as 63,535 shares of Series C Preferred Stock outstanding. Each share of Series C Preferred Stock is convertible into ten shares of common stock, as adjusted for stock dividends, combinations or splits at the option of the holder and is entitled to vote with the holders of common stock on an as-converted basis on all matters presented for shareholder approval. The holders of the Series C Preferred Stock have the right to cause the Company to register the sale of the shares of common stock issuable upon conversion of the Series C Preferred Stock. Also, the Company has a substantial number of options or shares issuable to employees under employee option, stock grant, or restricted stock grant plans. As a result, a substantial number of shares of common stock will be eligible for sale in the public market at various times in the future. Sales of substantial amounts of such shares could adversely affect the market price of the Company’s Common Stock.
 
The market for our stock is volatile and fluctuations in operating results, changes in the Company’s guidance on revenues and earnings estimates, and other factors could negatively impact our stock’s price.
 
The market prices for securities of technology companies, including the Company’s, have been quite volatile. Quarter to quarter variations in operating results, changes in the Company’s guidance on revenues and earnings estimates, announcements of technological innovations or new products by the Company or its competitors, announcements of major contract awards, changes in accounting standards or regulatory requirements as promulgated by the FASB, SEC, NASDAQ or other regulatory entities, and other events or factors may have a significant impact on the market

29


Table of Contents
price of the Company’s Common Stock. In addition, the securities of many technology companies have experienced extreme price and volume fluctuations, which have often been unrelated to the companies’ operating performance. These conditions may adversely affect the market price of the Company’s Common Stock.
 
Because of these and other factors affecting the Company’s operating results, past financial performance should not be considered an indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods.
 
Item 3 – Quantitative and Qualitative Disclosures About Market Risk
 
Interest Rate Risk.    The Company’s exposure to market risk for changes in interest rates relates primarily to the Company’s cash and cash equivalents. At June 30, 2002 the Company had $29.3 million in cash and cash equivalents. Based on the investment interest rate, a hypothetical 1% decrease in interest rates would decrease interest income by approximately $118,000 on an annual basis, and likewise decrease our earnings and cash flows. The Company does not use derivative financial instruments in its investment portfolio. The Company places its investments with high credit quality issuers and, by policy, limits the amount of credit exposure to any one issuer. The Company is averse to principal loss and ensures the safety and preservation of its invested funds by limiting default risk, market risk, and reinvestment risk. The Company mitigates default risk by investing in only the safest and highest credit quality securities and by constantly positioning its portfolio to respond appropriately to a significant reduction in a credit rating of any investment issuer or guarantor.
 
The Company’s interest expense associated with its term loan and revolving credit facility will vary with market rates. The Company had approximately $3.9 million in variable rate debt outstanding at June 30, 2002. Based upon these variable rate debt levels, a hypothetical 1% increase in interest rates would increase interest expense by approximately $15,000 on an annual basis, and likewise decrease our earnings and cash flows. The Company cannot predict market fluctuations in interest rates and their impact on its variable rate debt, nor can there be any assurance that fixed rate long-term debt will be available to the Company at favorable rates, if at all. Consequently, future results may differ materially from the estimated adverse changes discussed above.
 
Foreign Currency Risk.    The Company transacts business in various foreign currencies, primarily in certain European countries, Canada, Australia and Asia. Foreign currency fluctuations may result in foreign exchange gains and losses for non-dollar denominated transactions. These gains and losses could have a material impact on the Company’s results of operations. The Company does not have any hedging or similar foreign currency contracts. International revenues represented 29.4% of the Company’s total revenues for the six months ended June 30, 2002 and 27.9% of revenues were denominated in foreign currencies. Significant currency fluctuations may adversely impact foreign revenues.
 
PART II
 
OTHER INFORMATION
 
Item 1 – Legal Proceedings
 
In November 1998, a securities class action was filed in the United States District Court for the Southern District of California (the Court) against DataWorks, certain of its current and former officers and directors, and the Company. The consolidated complaint was purportedly brought on behalf of purchasers of DataWorks stock between October 30, 1997 and July 16, 1998. The complaint alleged that the defendants made material misrepresentations and omissions concerning DataWorks’ acquisition of Interactive Group, Inc. and demand for DataWorks’ products. The Company was named as a defendant solely as DataWorks’ successor, and was not alleged to have taken part in the alleged misconduct. No damage amount was specified in the complaint. On January 31, 2002, the Court issued an order granting the defendants’ motion to dismiss the complaint with prejudice as to all claims and defendants. Subsequently, the plaintiffs appealed the dismissal. Effective June 11, 2002, Plaintiff’s appeal was voluntarily dismissed by plaintiff and the securities lawsuit is therefore concluded.

30


Table of Contents
 
The Company is subject to other legal proceedings and claims in the normal course of business. The Company is currently defending these proceedings and claims, and anticipates that it will be able to resolve these matters in a manner that will not have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.
 
Item 4.    Submission of Matters to a Vote of Security Holders
 
On May 14, 2002, the Company held its annual meeting of stockholders. At this meeting 35,096,681 shares of Common Stock were available for voting and 381,200 shares of Series C Preferred Stock (on an as-converted basis) were available for voting. Each share of Series C Preferred Stock is convertible into ten (10) shares of Common Stock and is entitled to vote with the holders of Common Stock on an as-converted basis on all matters presented for stockholder approval.
 
At the meeting, L. George Klaus, Donald R. Dixon, Thomas F. Kelly, Harold D. Copperman and Charles M. Boesenberg were elected as directors of the Company by the Common and Series C stockholders. All shares of Series C Preferred Stock voted in favor of all of the nominated directors. With respect to the election of directors, the following nominees received the votes by common stockholders as noted below:
 
                Name                                         
    
Votes For
    
Withheld Authority





               





    L. George Klaus
    
32,894,422
    
2,202,259





    Donald R. Dixon
    
34,347,698
    
   748,983





    Thomas F. Kelly
    
34,348,573
    
   748,108





    Harold D. Copperman
    
34,351,749
    
   744,932





    Charles M. Boesenberg
    
34,351,082
    
   745,599





 
With respect to the proposal to ratify the appointment of Deloitte & Touché LLP as independent auditors for the fiscal year ended December 31, 2002, 32,375,604 shares of Common Stock and 381,200 shares of Series C Preferred Stock (on an as-converted basis) voted in favor of the proposal, 2,617,574 shares of Common Stock voted against, and 103,503 shares of Common Stock abstained from voting. There were no broker non-votes on this proposal.
 
With respect to the proposal to approve the Company’s 2002 Employee Stock Purchase Plan, 32,339,711 shares of Common Stock voted in favor of the proposal, 1,264,543 shares of Common Stock voted against, and 1,492,427 shares of Common Stock and 381,200 shares of Series C Preferred Stock (on an as-converted basis) abstained from voting. There were no broker non-votes on this proposal.
 
Item 6.    Exhibits and Reports on Form 8-K
 
(a)  Exhibits
 
 
10.78
 
Amendment to Loan and Security Agreement dated June 25, 2002
 
 
99.1
 
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
99.2
 
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
(b)  Reports on Form 8-K
 
None

31


Table of Contents
SIGNATURE
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
        EPICOR SOFTWARE CORPORATION                
                    (Registrant)
 
Date: August 14, 2002
/s/ Lee Kim                                                       
Lee Kim
Senior Vice President and Chief Financial
Officer (Principal Financial and
Accounting Officer)

32