Annual Reports

 
Quarterly Reports

  • 10-Q (Nov 9, 2007)
  • 10-Q (Aug 9, 2007)
  • 10-Q (May 15, 2007)
  • 10-Q (Nov 13, 2006)
  • 10-Q (Aug 11, 2006)
  • 10-Q (May 15, 2006)

 
8-K

 
Other

Document Sciences 10-Q 2005

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-32.1
  4. Ex-32.1
Form 10-Q
Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2005

 

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                      to                     

 

Commission File Number 000-20981

 

DOCUMENT SCIENCES CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware   33-0485994
(State or Other Jurisdiction of Incorporation or Organization)   (IRS Employer Identification No.)

 

5958 Priestly Drive

Carlsbad, California 92008

(Address of Principal Executive Offices including Zip Code)

 

(760) 602-1400

(Registrant’s Telephone Number including Area Code)

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes þ  No ¨

 

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).     Yes ¨  No þ

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes ¨  No þ

 

As of November 11, 2005, there were 4,202,372 shares of common stock of the registrant outstanding.

 



Table of Contents

DOCUMENT SCIENCES CORPORATION

 

     Page
No.


PART I. FINANCIAL INFORMATION     

Item 1. Financial Statements (Unaudited)

    

Consolidated balance sheets

   3

Consolidated statements of operations

   4

Consolidated statements of cash flows

   5

Notes to consolidated financial statements

   6

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

   8

Item 3. Quantitative and Qualitative Disclosures About Market Risk

   23

Item 4. Controls and Procedures

   23
PART II. OTHER INFORMATION     

Item 1. Legal Proceedings

   24

Item 6. Exhibits

   24

Signatures

   26

 

2


Table of Contents

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS (Unaudited)

 

DOCUMENT SCIENCES CORPORATION

CONSOLIDATED BALANCE SHEETS

 

     September 30,
2005


    December 31,
2004


 
     (Unaudited)     (See note below)  

ASSETS

                

Current assets:

                

Cash and cash equivalents

   $ 4,935,900     $ 5,193,440  

Short-term investments

     1,277,791       1,530,523  

Accounts receivable, net

     9,973,370       7,601,485  

Other current assets

     1,175,779       876,201  
    


 


Total current assets

     17,362,840       15,201,649  

Property and equipment, net

     826,791       511,318  

Software development costs, net

     1,953,372       3,247,194  

Goodwill, net

     4,495,192       4,495,192  

Other assets

     —         57,536  
    


 


Total assets

   $ 24,638,195     $ 23,512,889  
    


 


LIABILITIES AND STOCKHOLDERS’ EQUITY

                

Current liabilities:

                

Accounts payable

   $ 207,749     $ 137,886  

Accrued compensation

     2,057,661       1,456,261  

Other accrued liabilities

     538,886       649,525  

Deferred revenue

     12,014,784       12,092,782  
    


 


Total current liabilities

     14,819,080       14,336,454  

Obligations under capital leases

     32,726       48,342  

STOCKHOLDERS’ EQUITY

                

Common stock, $.001 par value

     4,280       4,205  

Treasury stock

     (404,071 )     (440,930 )

Additional paid-in capital

     13,117,251       12,943,243  

Accumulated comprehensive loss

     (66,548 )     (68,276 )

Retained deficit

     (2,864,523 )     (3,310,149 )
    


 


Total stockholders’ equity

     9,786,389       9,128,093  
    


 


Total liabilities and stockholders’ equity

   $ 24,638,195     $ 23,512,889  
    


 


 

Note: The balance sheet at December 31, 2004 has been derived from the audited consolidated financial statements at that date but does not include all of the information and disclosures required by generally accepted accounting principles for complete financial statements. See notes to unaudited consolidated financial statements.

 

3


Table of Contents

DOCUMENT SCIENCES CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

 

    

Three Months Ended

September 30,


  

Nine Months Ended

September 30,


     2005

   2004

   2005

   2004

Revenues:

                           

Initial license fees

   $ 2,258,463    $ 1,908,337    $ 5,604,736    $ 5,109,358

Annual renewal license and support fees

     3,285,477      2,952,828      9,646,572      8,690,972

Services and other

     2,400,265      1,174,813      7,076,970      2,973,905
    

  

  

  

Total revenues

     7,944,205      6,035,978      22,328,278      16,774,235

Cost of revenues:

                           

Initial license fees

     465,815      493,645      1,641,571      1,027,744

Annual renewal license and support fees

     612,980      455,835      1,676,284      1,473,588

Services and other

     2,081,653      941,975      5,567,692      2,373,340
    

  

  

  

Total cost of revenues

     3,160,448      1,891,455      8,885,547      4,874,672
    

  

  

  

Gross margin

     4,783,757      4,144,523      13,442,731      11,899,563

Operating expenses:

                           

Research and development

     1,613,984      957,725      4,311,484      2,789,432

Selling and marketing

     2,082,535      2,229,625      6,262,050      6,212,809

General and administrative

     773,927      765,289      2,572,890      2,450,393
    

  

  

  

Total operating expenses

     4,470,446      3,952,639      13,146,424      11,452,634
    

  

  

  

Income from operations

     313,311      191,884      296,307      446,929

Interest and other income, net

     47,314      13,577      168,859      55,037
    

  

  

  

Income before income taxes

     360,625      205,461      465,166      501,966

Provision for income taxes

     6,375      —        19,540      19,123
    

  

  

  

Net income

   $ 354,250    $ 205,461    $ 445,626    $ 482,843
    

  

  

  

Net income per share - basic

   $ 0.09    $ 0.05    $ 0.11    $ 0.14
    

  

  

  

Weighted average shares used in basic calculation

     4,158,371      3,952,686      4,128,384      3,486,379
    

  

  

  

Net income per share - diluted

   $ 0.07    $ 0.04    $ 0.08    $ 0.10
    

  

  

  

Weighted average shares used in diluted calculation

     5,454,155      5,044,337      5,310,417      4,635,532
    

  

  

  

 

See notes to unaudited consolidated financial statements.

 

4


Table of Contents

DOCUMENT SCIENCES CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

     Nine Months Ended
September 30,


 
     2005

    2004

 

Operating activities

                

Net income

   $ 445,626     $ 482,843  

Adjustments to reconcile net income to net cash (used in) provided by operating activities:

                

Depreciation and amortization

     206,686       245,420  

Loss on disposal of fixed assets

     3,475       —    

Amortization of software development costs

     1,293,822       730,093  

Provision for doubtful accounts

     (84,741 )     (164,222 )

Changes in operating assets and liabilities:

                

Accounts receivable

     (2,333,667 )     (567,579 )

Other assets

     (242,042 )     (310,050 )

Accounts payable

     69,863       154,262  

Accrued compensation

     601,400       399,869  

Other accrued liabilities

     (102,382 )     (434,552 )

Deferred revenue

     (77,998 )     406,750  
    


 


Net cash (used in) provided by operating activities

     (219,958 )     942,834  

Investing activities

                

Purchases of short-term investments

     (4,167,818 )     (904,820 )

Maturities of short-term investments

     4,525,000       2,935,000  

Purchases of property and equipment, net

     (525,634 )     (181,054 )

Additions to software development costs

     —         (1,731,858 )
    


 


Net cash (used in) provided by investing activities

     (168,452 )     117,268  

Financing activities

                

Principal payments under capital lease obligations

     (15,616 )     (15,857 )

Acquisition of Objectiva Software Solutions

     —         (392,844 )

Sale of treasury stock

     36,859       72,734  

Issuance of common stock

     174,083       209,464  
    


 


Net cash provided by (used in) financing activities

     195,326       (126,503 )
    


 


(Decrease) increase in cash and cash equivalents

     (193,084 )     933,599  

Effect of foreign currency on cash

     (64,456 )     (15,155 )

Cash and cash equivalents at beginning of period

     5,193,440       1,916,595  
    


 


Cash and cash equivalents at end of period

   $ 4,935,900     $ 2,835,039  
    


 


Supplemental disclosure of cash flow information:

                

Interest paid

   $ 2,172     $ 2,079  
    


 


Income taxes paid

   $ 19,540     $ 19,123  
    


 


Acquisition of Objectiva Software Solutions in exchange for common stock

   $ —       $ 3,216,983  
    


 


 

See notes to unaudited consolidated financial statements.

 

5


Table of Contents

DOCUMENT SCIENCES CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

September 30, 2005

 

Note A - Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States for interim financial statements and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain information and disclosures normally included in complete financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the statements include all adjustments necessary, which are of a normal and recurring nature, for the fair presentation of our financial position and of the results of operations and cash flows for the interim periods presented.

 

These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2004, included in Document Sciences Corporation’s Annual Report on Form 10-K filed with the Securities and Exchange Commission. Operating results for the three and nine months ended September 30, 2005 are not necessarily indicative of the results that may be expected for any other interim period or for the year ending December 31, 2005. The consolidated balance sheet at December 31, 2004 has been derived from the audited financial statements at that date but does not include all of the information and disclosures required by accounting principles generally accepted in the United States for complete financial statements.

 

Note B - Revenue Recognition

 

We derive our revenues from the licensing of software, annual renewal license and support fees and professional services. We recognize revenue in accordance with Statement of Position (SOP) 97-2, Software Revenue Recognition, and Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition in Financial Statements. Revenues generated from consulting services and training are recognized as the related services are performed and collectibility is deemed probable. Please see our revenue recognition note located in our critical accounting policies for more details.

 

Note C - Computation of Net Income (Loss) Per Share

 

We present our earnings (loss) per share (EPS) information in accordance with Statement of Financial Accounting Standards (SFAS) No. 128, Earnings per Share. Basic EPS is computed by dividing income or loss available to common stockholders (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period. Shares issued during the period and shares reacquired during the period are weighted for the portion of the period that they were outstanding. Basic EPS excludes any dilutive effects of options, warrants and convertible securities.

 

The computation of diluted EPS is similar to the computation of basic EPS, except that the denominator is increased to include the number of additional common shares that would have been outstanding if the common shares underlying outstanding options and warrants had been issued. The dilutive effect of outstanding options and warrants has been reflected in EPS by application of the treasury stock method. The treasury stock method recognizes the use of proceeds that could be obtained upon exercise of options and warrants in computing diluted EPS. It assumes that any proceeds would be used to purchase common

 

6


Table of Contents

stock at the average market price during the period. Options and warrants will have a dilutive effect under the treasury stock method only when the average market price of the common stock during the period exceeds the exercise price of the options or warrants. Common stock options to purchase 25,971 and 267,844 shares were excluded from the calculation of weighted-average shares used in determining diluted EPS for the three months ended September 30, 2005 and 2004, respectively, and 21,881 and 138,357 shares were excluded for the nine months ended September 30, 2005 and 2004, respectively, as their effect would have been antidilutive.

 

The following table reconciles the shares used in computing basic and diluted EPS for the periods indicated:

 

     Three Months Ended
September 30,


   Nine Months Ended
September 30,


     2005

   2004

   2005

   2004

Weighted average common shares outstanding used in basic EPS calculation

   4,158,371    3,952,686    4,128,384    3,486,379

Effect of dilutive stock options

   1,295,784    1,091,651    1,182,033    1,149,153
    
  
  
  

Shares used in diluted EPS calculation

   5,454,155    5,044,337    5,310,417    4,635,532
    
  
  
  

 

Note D - Stock-Based Compensation

 

As permitted by SFAS No. 123, Accounting for Stock-based Compensation, we have elected to follow Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for our employee stock options. Under APB Opinion No. 25, among other things, when the exercise price of our employee stock options is not less than the market price of the underlying stock on the date of grant, no compensation expense is recognized.

 

As required under SFAS No. 123, the pro forma effects of stock-based compensation on net income (loss) and net earnings (loss) per common share have been estimated at the date of grant using the Black-Scholes option pricing model based on the following weighted-average expected life of the option of seven years and the following weighted average assumptions:

 

     Three Months Ended
September 30,


    Nine Months Ended
September 30,


 
     2005

    2004

    2005

    2004

 

Expected volatility

   47 %   55 %   55 %   55 %

Risk-free interest rates

   6 %   4 %   6 %   4 %

Dividend yields

   0 %   0 %   0 %   0 %

 

7


Table of Contents

For purposes of adjusted pro forma disclosures, the estimated fair value of the options is amortized to expense over the option’s vesting period. The effect of applying SFAS No. 123 for purposes of providing pro forma disclosures is not likely to be representative of the effects on our operating results for future years because changes in the subjective input assumptions can materially affect future value estimates. Our pro forma information is as follows:

 

     Three Months Ended
September 30,


   

Nine Months Ended

September 30,


 
     2005

    2004

    2005

    2004

 

Net income as reported

   $ 354,250     $ 205,461     $ 445,626     $ 482,843  

Less stock-based compensation expense

     (383,627 )     (206,273 )     (1,063,370 )     (449,994 )
    


 


 


 


Net income (loss), as reported less stock-based compensation expense

   $ (29,377 )   $ (812 )   $ (617,744 )   $ 32,849  
    


 


 


 


Adjusted pro forma basic net income (loss) per share

   $ (0.01 )   $ 0.00     $ (0.15 )   $ 0.01  

Adjusted pro forma diluted net income (loss) per share

   $ (0.01 )   $ 0.00     $ (0.15 )   $ 0.01  

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

Critical Accounting Policies

 

Our discussion and analysis of the financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates and judgments, including those related to revenue recognition, software development costs, allowance for doubtful accounts and valuation allowance for net deferred tax assets. We base our estimates on historical and anticipated results and trends and on assumptions that we believe are reasonable under the circumstances, including assumptions as to future events. These estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. By their nature, estimates are subject to an inherent degree of uncertainty. Actual results may differ from our estimates. We believe that the following critical accounting policies and assumptions may involve a higher degree of judgment and complexity than others.

 

Revenue Recognition. We derive our revenues from the licensing of software, annual renewal license and support fees (ALF) and professional services. We recognize revenue in accordance with SOP 97-2, Software Revenue Recognition, and SAB No. 104, Revenue Recognition in Financial Statements. Initial license fees (ILF) are recognized when a contract exists, the fee is fixed and determinable, software delivery has occurred and collection of the receivable is deemed probable. If an arrangement includes multiple elements, we allocate the contract amount to the various elements based on vendor-specific objective evidence (VSOE) of fair value, regardless of any separate prices stated within the contract for each element. We base our VSOE on the price charged when the same element is sold separately.

 

We use the residual method to recognize revenue for all of our license models when bundled with ALF (post-contract support). Under the residual method, the fair value of the undelivered element (ALF) is deferred and the remaining value of the contract is recognized as revenue (ILF) when the license has been delivered, the fee is fixed and collectibility is probable. ALF is recognized ratably over the contract period. Included in our ALF are unspecified maintenance releases.

 

Our contracts do not provide for specific upgrades. In addition, our standard contracts do not provide for rights of return or conditions of acceptance; however, in the rare case that acceptance criteria are provided, revenue is deferred and not recognized until all conditions are satisfied and written customer acceptance is obtained. Where acceptance criteria exist, we believe our approach to revenue recognition would not result in materially different amounts being reported under different conditions or using different assumptions.

 

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Table of Contents

If an undelivered element of the arrangement exists under the license arrangement, revenue is deferred based on VSOE of the fair value of the undelivered element. If VSOE of fair value does not exist for all undelivered elements, all revenue is deferred until sufficient evidence exists or all elements have been delivered. We recognize revenue on transactions with payment terms less than twelve months from the contract date, if we have a history of successfully collecting from the specific customer without providing concessions. Amounts billed or payments received in advance of revenue recognition are recorded as deferred revenue.

 

Professional services revenue includes consulting services and training related to our software products. Revenues generated from consulting services and training are recognized as the related services are performed and collectibility is deemed probable. However, when consulting services are deemed to be essential to the functionality of the delivered software product, revenue from the entire arrangement is recognized on a percentage of completion method or not until the contract is completed in accordance with SOP 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts, and Accounting Research Bulletin (ARB) No. 45, Long-Term Construction-Type Contracts. We measure progress under the percentage of completion method, depending on how the contract language is written, either by using the percentage of total project hours completed or by the completion of phases in the consulting project. Because (i) the phases of our consulting projects are generally not of great duration (2-6 weeks on average) and (ii) we have a variety of projects progressing at the same time, we believe that there are very limited circumstances where materially different amounts would be reported under different conditions or using different assumptions.

 

We work in conjunction with our established value added resellers (VARs), with whom we have formal contracts defining the rights and obligations of the parties, to license software to end-users. We license software to our VARs, less a discount, from a fixed price list. We require a binding purchase order as evidence of an unconditional order by an end user from our VARs, with no rights of return or acceptance. License revenue from our VARs is recognized when software is licensed to an end user.

 

Software Development Costs. In accordance with SFAS No. 86, Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed, costs incurred in the research and development of new software products and significant enhancements to existing software products are expensed as incurred until technological feasibility of the product has been established. After technological feasibility has been established, direct production costs, including programming and testing, are capitalized until general release of the product.

 

Capitalized costs of software to be sold, licensed or otherwise marketed are amortized using the greater of the amount computed using the ratio of current period product revenues to estimated total product revenues or the straight-line method over the remaining estimated economic lives of the products. It is possible that estimated total product revenues, the estimated economic life of the product, or both, will be reduced in the future. As a result, the carrying amount of capitalized software costs may be reduced in the future, which could cause our operating results in future periods to be adversely affected.

 

Impairment of Goodwill. The value of our goodwill could be impacted by future adverse changes such as declines in our operating results or failure to meet the performance projections included in our forecasts of future operating results. We evaluate these assets on an annual basis or more frequently if indicators of impairment exist. In the process of our annual impairment review, we primarily use the income approach methodology of valuation that includes the discounted cash flow method as well as other generally accepted valuation methodologies to determine the fair value of our assets. Significant management judgment is required in the forecasts of future operating results that are used in the discounted cash flow

 

9


Table of Contents

method of valuation. The estimates we have used are consistent with the plans and estimates that we use to manage our business. It is possible, however, that the plans and estimates used may be incorrect. If our actual results, or the plans and estimates used in future impairment analyses, are lower than the original estimates used to assess the recoverability of these assets, we could incur impairment charges.

 

Allowance for Doubtful Accounts. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required, which would result in an additional general and administrative expense in the period such determination is made. At the end of each reporting period, we perform a detailed review of outstanding balances by customer and invoice. We utilize statistical and account specific analysis to determine the adequacy of our reserve, as well as comparing balances to historical losses. If our assumptions or analysis are incorrect, our operating results for future periods may be adversely affected.

 

Deferred Income Taxes. Deferred income taxes reflect the net effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. At December 31, 2004, we had net deferred tax assets of $2.9 million. Due to the uncertainty of realizing a portion of these net deferred tax assets, we have maintained a valuation allowance of $2.6 million for net deferred tax assets. Such uncertainty primarily relates to the potential for future taxable income as well as loss carryforwards and tax credits expiring in 2018 and 2012, respectively. In addition, pursuant to Sections 382 and 383 of the Internal Revenue Code, annual use of our net operating loss carryforwards may be limited in the event of a cumulative change in ownership of more than 50% within a three-year period. No valuation allowance has been recorded to offset the remaining $275,000 of net deferred tax assets as we have determined that it is more likely than not that these assets will be realized within the next twelve months. We will continue to assess the likelihood of realization of such assets; however, if future events occur which do not make the realization of such assets more likely than not, we will record a valuation allowance against all or a portion of the remaining net deferred tax assets. An example of a future event that might occur which could make the realization of such assets not likely is a lack of taxable income resulting from poor operating results. At September 30, 2005, our net deferred tax asset remained at $275,000.

 

Results of Operations for the Three and Nine Months Ended September 30, 2005 and 2004

 

The following table shows the percentage of revenues, cost of revenues, operating expenses and other items to total revenues in our consolidated statements of operations for the periods indicated:

 

    

Three Months Ended

September 30,


    Nine Months Ended
September 30,


 
     2005

    2004

    2005

    2004

 

Revenues:

                        

Initial license fees

   29 %   32 %   25 %   30 %

Annual renewal license and support fees

   41     49     43     52  

Services and other

   30     19     32     18  
    

 

 

 

Total revenues

   100     100     100     100  

Cost of revenues:

                        

Initial license fees

   6     8     7     6  

Annual renewal license and support fees

   8     7     8     9  

Services and other

   26     16     25     14  
    

 

 

 

Total cost of revenues

   40     31     40     29  
    

 

 

 

 

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Gross profit

   60     69     60     71  

Operating expenses:

                        

Research and development

   20     16     19     17  

Selling and marketing

   26     37     28     37  

General and administrative

   10     13     12     14  
    

 

 

 

Total operating expenses

   56     66     59     68  
    

 

 

 

Income from operations

   4     3     1     3  

Interest and other income, net

   1     —       1     —    
    

 

 

 

Income before income taxes

   5     3     2     3  

Provision for income taxes

   —       —       —       —    
    

 

 

 

Net income

   5 %   3 %   2 %   3 %
    

 

 

 

 

Revenues

 

Our revenues are divided into three categories based upon the sources from which they are derived: initial license fees, annual renewal license and support fees, and services and other revenues. The following discussion is separated into these categories. We sell our products principally through our direct sales force domestically and through distributors and VARs internationally.

 

The following table summarizes revenues (in thousands) and the percentage change over the same period of the prior year:

 

    

Three Months Ended

September 30,


   

Nine Months Ended

September 30,


 
     2005

         2004

         2005

         2004

      

Initial license fees

   $ 2,258    18 %   $ 1,908    89 %   $ 5,605    10 %   $ 5,109    45 %

Annual renewal license and support fees

     3,286    11       2,953    11       9,646    11       8,691    11  

Services and other

     2,400    104       1,175    29       7,077    138       2,974    1  
    

        

        

        

      

Total revenues

   $ 7,944    32 %   $ 6,036    32 %   $ 22,328    33 %   $ 16,774    17 %
    

        

        

        

      

 

Initial license fees. Initial license fees consist primarily of upfront license fees for the first year of use of our products.

 

The components of initial license fees (in thousands) of our product families consist of the following:

 

    

Three Months Ended

September 30,


  

Nine Months Ended

September 30,


     2005

   2004

   2005

   2004

Products:

                           

xPression

   $ 1,820    $ 981    $ 4,055    $ 2,388

CompuSet

     358      203      1,437      840

Document Library Services

     80      724      113      1,881
    

  

  

  

Total initial license fees

   $ 2,258    $ 1,908    $ 5,605    $ 5,109
    

  

  

  

 

The increases in initial license fees for the three and nine months ended September 30, 2005 were due to higher sales from our Canadian and Australian operations and improvement in xPression product sales.

 

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Annual renewal license and support fees. Annual renewal license and support fees consist of license fees for the initial and continued support and use of our licensed products. The increases for the three and nine months ended September 30, 2005 were due primarily to increases in our base of licensed software.

 

Services and other. Services and other revenues consist of fees for consulting, software outsourcing, application development and training services performed by us as well as miscellaneous other operational revenues. A majority of the growth for the three and nine months ended September 30, 2005 was from the delivery of implementation services to customers who have licensed our xPression software. Additionally, results for the nine months ended September 30, 2005 benefited from consulting services delivered by our Objectiva subsidiary.

 

Cost of Revenues

 

The following table summarizes cost of revenues (in thousands) and the percentage change over the same period of the prior year:

 

     Three Months Ended September 30,

    Nine Months Ended September 30,

 
     2005

         2004

         2005

         2004

      

Initial license fees

   $ 466    (6 )%   $ 493    73 %   $ 1,642    60 %   $ 1,028    31 %

Annual renewal license and support fees

     613    34       456    2       1,676    14       1,474    17  

Services and other

     2,081    121       942    34       5,568    135       2,373    13  
    

        

        

        

      

Total cost of revenues

   $ 3,160    67 %   $ 1,891    32 %   $ 8,886    82 %   $ 4,875    17 %
    

        

        

        

      

 

Cost of initial license fees. Cost of initial license fees includes amortization of previously capitalized software development costs, costs of third party software, employment costs for distribution personnel and product packaging. The decrease for the three months ended September 30, 2005 was due to a decrease in royalty fees. The increase for the nine months ended September 30, 2005 was due to an increase in amortization of software development costs due to the release of xPression 2.0 in the fourth quarter of 2004.

 

Amortization of software development costs were $360,400 and $1.3 million for the three and nine months ended September 30, 2005, respectively, and $353,800 and $730,100 for the three and nine months ended September 30, 2004, respectively. For the nine months ended September 30, 2005, cost of initial license fees grew at a faster rate than initial license fees due to higher amortization of software development costs, causing gross margins to decrease.

 

Cost of annual renewal license and support fees. Cost of annual renewal license fees consist principally of the employee related costs for our technical support staff. The increases for the three and nine months ended September 30, 2005 were primarily due to increases in personnel costs of $67,500 and $74,600, respectively, to support our growing customer base.

 

Cost of services and other. Cost of services and other consist principally of the employee related costs of our consulting and training staff. The increases for the three and nine months ended September 30, 2005 were due to an increase in personnel costs to support our increasing project workload.

 

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Operating Expenses

 

The following table summarizes operating expenses (in thousands) and the percentage change over the same period of the prior year:

 

     Three Months Ended September 30,

    Nine Months Ended September 30,

 
     2005

         2004

         2005

         2004

      

Research and development

   $ 1,614    69 %   $ 958    10 %   $ 4,311    55 %   $ 2,789    (21 )%

Selling and marketing

     2,082    (7 )     2,230    21       6,262    1       6,213    (6 )

General and administrative

     774    1       765    11       2,573    5       2,450    18  
    

        

        

        

      

Total operating expenses

   $ 4,470    13 %   $ 3,953    16 %   $ 13,146    15 %   $ 11,453    (6 )%
    

        

        

        

      

 

Research and development. Research and development expenses consist primarily of the employee related costs of personnel associated with developing new products, enhancing existing products, testing software products and developing product documentation. We anticipate that we will continue to direct significant resources to the development of new products and enhancement of our existing products.

 

The following table adds back capitalized software development costs (in thousands) and shows the percentage change over the same period of the prior year:

 

     Three Months Ended September 30,

    Nine Months Ended September 30,

 
     2005

         2004

         2005

         2004

      

Research and development (net)

   $ 1,614    69 %   $ 958    10 %   $ 4,311    55 %   $ 2,789    (21 )%

Capitalized software development costs

     —      (100 )     449    (25 )     —      (100 )     1,732    26  
    

        

        

        

      

Research and development (gross)

   $ 1,614    15 %   $ 1,407    (5 )%   $ 4,311    (5 )%   $ 4,521    (8 )%
    

        

        

        

      

 

Capitalized software development costs mainly include payroll related costs of our engineering resources, allocated facilities costs and consulting fees related to the development of xPression. We expect the amount of capitalized software development costs to continue to be less in 2005 because we expect the time between the establishment of technological feasibility and general releases of our products to be substantially the same. We incurred no capitalized software development costs for the three and nine months ended September 30, 2005, but capitalized $449,000 and $1.7 million, respectively, related to xPression 2.0 development in the three and nine months ended September 30, 2004.

 

The increase in gross research and development costs for the three months ended September 30, 2005 was primarily due to an increase in personnel costs of $336,800 offset by a decrease in outside consultant costs of $80,800. The decrease in gross research and development costs for the nine months ended September 30, 2005 was primarily due to a decrease in outside consultant costs of $1.0 million offset by an increase in personnel costs of $816,000, largely driven by the impact of our Objectiva acquisition.

 

Selling and marketing. Selling and marketing expenses consist primarily of salaries, commissions, marketing programs and related costs for pre- and post-sales activity. The decrease for the three months ended September 30, 2005 was primarily due to decreases in personnel costs of $113,700 and outside

 

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consultant costs of $129,100, offset by an increase in sales commissions of $90,100. Costs were largely unchanged for the nine months ended September 30, 2005.

 

General and administrative. General and administrative expenses consist of employee related costs for finance, administration and human resources, allowance for doubtful accounts and general corporate management expenses, including legal and accounting fees. The increase for the three months ended September 30, 2005 was primarily due to increases in personnel costs of $201,000, outside consultant costs of $59,300 and bad debt expense of $107,500, offset by a French VAT refund of $391,000 which we had previously taken as an expense in the fourth quarter of 2003. The increase for the nine months ended September 30, 2005 was primarily due to increases in personnel costs of $311,400 and outside consultant costs of $94,100, offset by a French VAT refund of $391,000.

 

Other items

 

Interest and other income, net. Interest and other income, net is composed primarily of interest income from cash and cash equivalents and short-term investments, offset by interest expense related to capital leases and gains/losses on disposals of assets. Interest and other income, net was $47,300 and $13,600 for the three months ended September 30, 2005 and 2004, respectively, and $168,900 and $55,000 for the nine months ended September 30, 2005 and 2004, respectively. The increases for the three and nine months ended September 30, 2005 were largely the result of a one-time sale of stock acquired in conjunction with the acquisition of Objectiva, as well as more interest income due to higher cash balances and interest rates.

 

Provision for income taxes. Provision for income taxes is comprised of foreign taxes. Provision for income taxes was $6,375 and $0 for the three months ended September 30, 2005 and 2004, respectively, and $19,500 and $19,100 for the nine months ended September 30, 2005 and 2004, respectively. We will continue to assess the likelihood of realization of our net deferred tax assets. If future events occur that do not make the realization of such assets more likely than not, a valuation allowance will be established against all or a portion of the net deferred tax assets.

 

Trends and Factors That May Affect Future Operating Results

 

Our total revenues and operating results can vary, sometimes substantially, from quarter to quarter and are expected to vary significantly in the future. Our revenues and operating results are difficult to forecast. Future results will depend upon many factors, including the demand for our products, the level of product and price competition, the length of our sales cycle, the size and timing of individual license transactions, the delay or deferral of customer implementations, the budget cycles of our customers, our success in expanding our direct sales force and indirect distribution channels, the acceptance and timing of new product introductions and product enhancements by us and our competitors, the mix of products and services sold, levels of international sales, capitalization or amortization of software development costs, our ability to successfully implement our operational, growth and other strategies, activities of and acquisitions by competitors, the timing of new hires, changes in foreign currency exchange rates, our ability to develop and market new products and control costs and general domestic and international economic conditions. In addition, a high percentage of our total revenues are generated by a relatively low number of orders, and, therefore, the loss or delay of individual orders could have a significant impact on our revenues and quarterly operating results. In addition, a significant amount of our revenues occur predominantly in the third month of each fiscal quarter and tend to be concentrated in the latter half of that third month.

 

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Our software products generally are shipped as orders are received. As a result, initial license fees in any quarter are substantially dependent on orders booked and shipped in that quarter. The timing of receipt of initial license fees is difficult to predict because of the length of our sales cycle. For Autograph products, our sales cycle is typically three to nine months from initial contact. For xPression products, our sales cycle is typically six months to over one year from initial contact. Because our operating expenses are based on anticipated revenue trends and because a high percentage of our expenses are relatively fixed, a delay in the recognition of revenue from a limited number of initial license transactions could cause significant variations in operating results from quarter to quarter and could result in losses. To the extent such expenses precede, or are not subsequently followed by, increased revenues, our operating results could be materially adversely affected.

 

Due to the foregoing factors, revenues and operating results for any quarter are subject to significant variation, and we believe that period-to-period comparisons are not necessarily meaningful and should not be relied upon as indications of future performance.

 

Liquidity and Capital Resources

 

Our sources of cash come mainly from operations and sales and maturities of short-term investments. Our main uses of cash are for payroll. Our main project underway is a maintenance program, xPression 2.1.1, which we intend to release in the fourth quarter of 2005. We currently have no debt from borrowed money. Our short-term investments are invested in U.S. government agency obligations and high quality commercial paper.

 

We believe that our existing cash balances and anticipated cash flows from operations will be sufficient to meet our anticipated cash needs for working capital and capital expenditures at least through the next twelve months. In this regard, a portion of our cash could be used to acquire or invest in complementary businesses or products or to obtain the right to use complementary technologies.

 

At September 30, 2005, we had $6.2 million in cash, cash equivalents and short-term investments. This is a decrease of $510,300 from December 31, 2004 and reflects seasonality in our cash balance, largely around the collection of annual license fees. The corresponding balance on September 30, 2004 was $4.8 million.

 

The decline for the first nine months of 2005 is due in part to a net increase of $2.1 million in operating assets and liabilities, most notably an increase in accounts receivable of $2.3 million. Accounts receivable typically grow significantly in the third quarter on billings associated with annual license renewals coming due at the end of the year. Also contributing to the decline is the purchases of fixed assets of $525,600. Partially offsetting these items are the year-to-date net income of $445,600 as well as non-cash depreciation and amortization expense of $1.5 million, much of which relates to amortization of previously capitalized software development costs.

 

We have no significant capital spending or purchase commitments other than normal purchase commitments and commitments under facilities and equipment leases. We currently anticipate lease commitments for our next five fiscal years to be $1.1 million, $1.1 million, $1.1 million, $598,500 and $509,700, respectively.

 

Forward-looking Statements

 

We make forward-looking statements in this quarterly report on Form 10-Q that are subject to risks and uncertainties. These forward-looking statements include information about possible or assumed future

 

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results of our financial condition, operations, plans, objectives and performance. When we use the words “believe,” “expect,” “anticipate,” “estimate” or similar expressions, we are making forward-looking statements. Many possible events or factors could affect our future financial results and performance. This could cause our results or performance to differ materially from those expressed in our forward-looking statements. You should consider these risks when you review this document, along with the following possible events or factors:

 

    national, international, regional and local economic, competitive, geopolitical and regulatory conditions and developments;

 

    the market for dynamic content publishing software;

 

    market acceptance of enhancements to our existing products and introduction of new products;

 

    continued profitability of our professional services; and

 

    maintaining our relationships with our other distribution partners.

 

Our actual results could differ materially from those discussed herein due to a number of factors, including those set forth in this discussion, under “Certain Factors Affecting Document Sciences Corporation” and other risks detailed from time to time in our SEC reports. In addition, the discussion of our results of operations should be read in conjunction with the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2004 Annual Report on Form 10-K for the fiscal year ended December 31, 2004 and in reports we file with the Securities and Exchange Commission. You are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date of that statement. We undertake no obligation to publicly release the results of any revision of the forward-looking statements.

 

Certain Factors Affecting Document Sciences Corporation

 

The following is a discussion of certain factors that currently impact or may impact our business, operating results and/or financial condition. Anyone making an investment decision with respect to our common stock or other securities is cautioned to carefully consider these factors. If any of the following risks actually occur, our business, results of future operations and financial condition could be materially adversely affected. In such case, the trading price of our common stock could decline and you may lose part or all of your investment.

 

Our quarterly results fluctuate significantly and we may not be able to grow our business.

 

Our total revenues and operating results can vary, sometimes substantially, from quarter to quarter, and we expect them to vary significantly in the future. Additionally, our revenues and operating results are difficult to forecast, and our future results will depend upon many factors, including the following:

 

    the demand for our products;

 

    the level of product and price competition;

 

    the length of our sales cycle;

 

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    the size and timing of individual license transactions;

 

    the delay or deferral of customer implementations;

 

    the budget cycles of our customers;

 

    our success in expanding our direct sales force or indirect distribution channels;

 

    the acceptance and timing of our new product introductions and enhancements, as well as those of our competitors;

 

    our mix of products and services;

 

    our level of international sales;

 

    our ability to successfully implement our operational, growth and other strategies;

 

    the activities of and acquisitions by our competitors;

 

    our timing of new hires;

 

    changes in foreign currency exchange rates;

 

    our ability to develop and market new products and to control costs; and

 

    general domestic and international economic conditions.

 

Our initial license fee revenues mainly depend on when orders are received and shipped. However, because of our sales model, our customers’ implementation schedule and the complexity of the implementation process, revenue from some software shipments may not be recognized in the same quarter as the shipment occurs. Our operating expenses are primarily based on anticipated revenue levels. Since a high percentage of those expenses are relatively fixed, a delay in the recognition of revenue from license transactions could cause significant variations in operating results from quarter to quarter, and we may sustain losses as a result. To the extent such expenses precede, and/or are not subsequently followed by, increased revenues, our operating results could be materially adversely affected.

 

As a result of these factors, results from operations for any quarter are subject to significant variation, and we believe that period-to-period comparisons of our results of operations are not necessarily meaningful. Accordingly, you should not rely upon them as an indication of our future performance. Furthermore, our operating results in future quarters may fall below the expectations of market analysts and investors. If this occurs, the price of our common stock could be materially adversely affected.

 

Our growth depends on market acceptance of our existing products, enhancements to existing products and our introduction of new products.

 

Our future business, operating results and financial condition depend upon market acceptance of our existing products, as well as our ability to respond to emerging industry standards and practices and to develop new products that address the future needs of our target markets. Our Autograph family of products has been applied mainly to document automation applications producing paper-based documents. We have started to extend our core technology to the Internet, intranets and commercial on-line services. However, we cannot assure you that we will be successful in developing, introducing and marketing new products or product enhancements, including new products or the extension of existing products for the Internet, intranets and commercial on-line services, on a timely and cost effective basis, if at all. In addition, we cannot assure you that our newer products, such as xPression, or enhancements to existing products will adequately meet the requirements of the marketplace or achieve market acceptance. Moreover, delays in our commercial shipments of new products or enhancements may result in client dissatisfaction and a delay or loss of product revenues.

 

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If for technological or other reasons we are unable to develop and introduce new products or enhancements of existing products in a timely manner in response to changing market conditions or client requirements, this may impact our ability to grow our services revenues and our business, operating results and financial condition could be materially adversely affected. In addition, we cannot assure you that our existing products, new products or new versions of our existing products will achieve market acceptance. In order to provide our customers with integrated product solutions, our future success will also depend in part upon our ability to maintain and enhance relationships with our technology partners.

 

Longer than expected sales cycles and implementation periods have and may continue to affect our revenues and operating results.

 

The licensing of our software products is often an enterprise-wide decision by prospective customers and generally involves a sales cycle of three months to more than one year in order to educate our prospective customers regarding the use and benefits of our products. In addition, the implementation of our products by customers involves a significant commitment of their resources over an extended period of time and is commonly associated with substantial customer business process reengineering efforts. Sales of our enterprise-wide xPression product line often involve many participants in the corporate decision-making process. Additionally, we have experienced and may, from time to time, continue to experience defects in our software which cause implementation problems and affect our sales and our sales cycle. For these and other reasons, our sales cycles and customer implementation periods are subject to a number of significant delays over which we have little or no control. Any delay in the sale or customer implementation of a limited number of license transactions could have a material adverse effect on our business and results of operations and cause our operating results to vary significantly from quarter to quarter.

 

We currently derive a significant portion of our revenues from Xerox.

 

We currently have a variety of contractual and informal relationships with Xerox and affiliates of Xerox, including a cooperative marketing agreement, a transfer and license agreement and various distribution agreements. We rely on these relationships and agreements for a significant portion of our total revenues. Revenues derived from relationships with Xerox and affiliates of Xerox accounted for approximately $3.0 million and $2.6 million for the nine months ended September 30, 2005 and 2004, respectively, representing 13% and 15% of our total revenues, respectively.

 

In November 2003, we paid $2.7 million to Xerox to repurchase the remaining 740,024 shares of Document Sciences’ common stock owned by Xerox. Since Xerox no longer has an equity interest in us, there may be less incentive in continuing to do business with us at the same level. Though we intend to continue our existing relationships with Xerox, our strategy has been, and continues to be, to lessen our dependence on Xerox. However, there can be no assurance that we will be able to do so and, because of our current level of dependence on Xerox, there can be no assurance that our plans to become more independent will not adversely affect our business, results of operations and financial condition. Our failure to maintain these relationships or to establish new relationships in the future could have a material adverse effect on our business, operating results and financial condition.

 

There can be no assurance that existing and potential customers will continue to do business with us because of these relationships or our historical ties with Xerox and its affiliates. Xerox has strategic alliances and other business relationships with other companies who supply software and services used in high volume electronic publishing applications and who now are, or in the future may become, our competitors. There can be no assurance that Xerox or one of its affiliated companies will not engage in a business that directly competes with us. In addition, Xerox has ongoing internal development activities

 

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that could in the future lead to products that compete with us. Xerox could in the future expand these relationships or enter into additional ones, and as a result our business could be materially adversely affected.

 

Our growth depends on our ability to compete successfully against current and future competitors.

 

The market for our dynamic content publishing products is intensely competitive. We face competition from a broad range of competitors, many of whom have greater financial, technical and marketing resources than we do. Our principal competition currently comes from systems developed in-house by the internal MIS departments of large organizations and direct competition from numerous software vendors, including Docucorp International, Inc., InSystems Technologies, Inc., Group 1 Software, Inc., Exstream Software, Inc. and Metavante Corporation. We believe that the principal competitive factors affecting our market include product performance and functionality, ease of use, scalability, operating across multiple computer and operating system platforms, product and company reputation, client service and support and price. Although we believe we currently compete favorably with respect to such factors, we can not assure you that we will be able to maintain our competitive position against current and future competitors, especially those with greater financial, technical and marketing resources than us, or that we will be successful in the face of increasing competition from new products, new solutions introduced by existing competitors or by new companies entering the market.

 

Our operating results are substantially dependent on sales of a small number of products in highly concentrated industries.

 

As of September 30, 2005, we had derived 72%, 26% and 2% of our initial license revenues from our xPression, CompuSet and DLS product lines, respectively. As a result, factors that may adversely impact the pricing of or demand for these products, such as competition from other products, negative publicity or obsolescence of the hardware or software environments in which our products run, could have a material adverse effect on our business, operating results and financial condition. Our financial performance will depend significantly on the successful development, introduction and customer acceptance of new and enhanced versions of our xPression software, as well as continued customer acceptance of CompuSet, DLS and related products.

 

Initial licenses to end users in the insurance, finance, government and manufacturing industries in the United States accounted for 54%, 14%, 11% and 10%, respectively, of initial license revenues in fiscal year 2005 to date. Our future success will depend on our ability to continue to successfully market our products in these and other industries. Our failure to do so could have a material adverse effect on our business, operating results and financial condition.

 

Our growth is dependent upon successfully focusing our distribution channels.

 

To grow our business, we must streamline our worldwide sales and distribution channels by focusing on key target industry market segments where our current and planned products can enjoy a significant competitive advantage and high market demand. We also must leverage our existing relationships with Xerox and other partners by launching targeted joint marketing and value added reseller programs and by introducing new product offerings that are optimized for selected target markets and marketing channels. Additionally, we must form additional partnerships with system integrators and consultants in order to broaden our capacity to deliver complete dynamic content publishing solutions that incorporate significant services content, while also maintaining our core domain expertise. We cannot assure you that we will be able to successfully streamline and focus our worldwide channels, leverage our existing

 

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relationships or form new alliances. If we fail to do so, it could have a material adverse effect on our business, operating results and financial condition.

 

Our products may suffer from defects or errors.

 

Software products as complex as those we offer may contain undetected defects or errors when first introduced or as new versions are released. As a result, we could in the future lose or delay recognition of revenues as a result of software errors or defects. In addition, our products are typically intended for use in applications that may be critical to a customer’s business. As a result, we expect that our customers and potential customers have a greater sensitivity to product defects than the general market for software products. We have experienced defects in connection with the introduction of our xPression product line and we have worked to address this problem, but we cannot assure you that, despite our testing as well as testing by current and potential customers, errors will not be found in our existing products or new products or releases. Defects discovered after the commencement of commercial shipments can result in any of the following:

 

    loss of revenue;

 

    delay in market acceptance;

 

    diversion of our development resources;

 

    damage to our reputation; and/or

 

    increased service and warranty costs.

 

Maintaining our professional services expertise is necessary for our future growth.

 

We are continuing our focus on the consulting services component of our professional services to assist customers in the planning and implementation of enterprise-wide, mission-critical dynamic content publishing applications. This strategy is dependent on retaining and hiring professionals to perform these consulting services. Should we be unable to maintain the necessary services workforce, our business and financial condition could be materially adversely affected.

 

We may be exposed to risks associated with international operations.

 

Our revenues from export sales accounted for 23% and 19% for the three months ended September 30, 2005 and 2004, respectively, and 22% and 21% for the nine months ended September 30, 2005 and 2004, respectively.

 

We license our products in Europe through VARs and to a much lesser extent, direct sales. Revenues generated by these activities were $685,900 and $706,000 for the three months ended September 30, 2005 and 2004, respectively, and $2.3 million for each of the nine month periods ended September 30, 2005 and 2004.

 

Our wholly owned subsidiary, Objectiva, develops, markets and supports our products in Asia. As of September 30, 2005, they had 210 employees.

 

In Australia, Canada and Latin America, our products are distributed and/or supported by Xerox affiliates and also by direct sale in Canada. In Asia, our products are distributed and/or supported by our subsidiary, Objectiva. Revenues generated in these regions were $1.1 million and $444,000 for the three

 

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months ended September 30, 2005 and 2004, respectively, and $2.6 million and $1.3 million for the nine months ended September 30, 2005 and 2004, respectively.

 

In order to successfully expand export sales, we must establish additional foreign operations, hire additional personnel and develop relationships with additional international resellers. If we are unable to do so in a timely manner, our growth in international export sales could be limited, and our business, operating results and financial condition could be materially adversely affected. In addition, we cannot assure you that we will be able to maintain or increase international market demand for our products.

 

Additional risks inherent in our international business activities include:

 

    losing the services of our key resellers;

 

    difficulties in managing our international operations;

 

    lack of acceptance of our localized products in foreign countries;

 

    our limited experience in localizing products for foreign countries;

 

    longer accounts receivable payment cycles;

 

    currency fluctuations;

 

    unexpected changes in regulatory requirements;

 

    tariffs and other trade barriers;

 

    potentially adverse tax consequences including restrictions on the repatriation of earnings; and

 

    the burdens of complying with a wide variety of foreign laws.

 

A portion of our business is conducted in currencies other than the U.S. Dollar, primarily the Euro and the Chinese Yuan. Although exchange rate fluctuations have not had a significant impact on us, fluctuations in the value of the currencies in which we conduct our business relative to the U.S. Dollar could cause currency transaction gains and losses in future periods. We do not currently engage in currency hedging transactions, and we cannot assure you that fluctuations in currency exchange rates in the future will not have a material adverse impact on our international revenues and our business, operating results and financial condition.

 

Our business is dependent on the market for dynamic content publishing software.

 

The market for dynamic content publishing software is intensely competitive, highly fragmented and subject to rapid change. We cannot assure you that the market for dynamic content publishing software will continue to grow or that, if it does grow, organizations will adopt our products. We have spent, and intend to continue to spend, significant resources educating potential customers about the benefits of our products. However, we cannot assure you that such expenditures will enable our products to achieve further market acceptance, and if the dynamic content publishing software market develops more slowly than we currently anticipate, our business, operating results and financial condition could be materially adversely affected.

 

In addition, the commercial market for dynamic content publishing of electronic documents designed for use with the Internet, intranets and commercial on-line services has only recently begun to develop, and the success of our products designed for this market will depend in part on their compatibility with such services. It is difficult to predict whether the demand for related products and services would increase or decrease in the future. Since the increased commercial use of the Internet, intranets and commercial

 

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on-line services could require substantial modification and customization of certain of our products and services as well as the introduction of new products and services, we cannot assure you that we will be able to effectively or successfully compete in the future in this market.

 

Our ability to manage future change could affect our business.

 

Our ability to compete effectively and to manage future change will require us to continue to improve our financial and management controls, reporting systems and procedures on a timely basis and to expand, train and manage our work force. We cannot assure you that we will be able to do so successfully. Our failure to do so could have a material adverse effect on our business, operating results and financial condition.

 

Our executive officers and certain key personnel are critical to our business, and these officers and key personnel may not remain with us in the future.

 

Our future performance depends in significant part upon the continued service of our key technical, sales and senior management personnel. The loss of the services of one or more of our executive officers could have a material adverse effect on our business, operating results and financial condition. Our future success also depends on our continuing ability to attract and retain highly qualified product development, sales and management personnel. Competition for such personnel is intense, and there can be no assurance that we will be able to retain our key employees or that we will be able to attract or retain other highly qualified product development, sales and managerial personnel in the future.

 

Our business is dependent upon successfully protecting our proprietary rights.

 

We rely on a combination of copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions to protect our proprietary rights. Despite these protective measures, it may be possible for unauthorized third parties to copy portions of our products or use information we consider proprietary. Policing unauthorized use of our products is difficult and, while we are unable to determine the extent to which piracy of our software products exists, we expect software piracy to be a persistent problem. In addition, the laws of some foreign countries do not protect our proprietary rights to as great an extent as do the laws of the United States. We cannot assure you that our means of protecting our proprietary rights will be adequate or that our competitors will not independently develop similar technology.

 

We are not aware of any infringement of our products upon the proprietary rights of third parties. However, we cannot assure you that third parties will not claim infringement by us with respect to current or future products. We expect that software product developers will increasingly be subject to infringement claims as the number of products and competitors in our industry segment grows and the functionality of products in different industry segments overlaps. Any such claims, with or without merit, could be time consuming, result in costly litigation, cause product shipment delays or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to us or at all, which could have a material adverse effect upon our business, operating results and financial condition.

 

Our failure to adequately limit our exposure to product liability claims may adversely affect us.

 

Our license agreements with our customers typically contain provisions designed to limit our exposure to potential product liability claims. However, it is possible that the limitation of liability provisions contained in our license agreements may not be effective under the laws of certain jurisdictions.

 

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Although we have not experienced any product liability claims to date, sale and support of our products may entail the risk of such claims in the future. A successful product liability claim brought against us or a claim arising as a result of our professional services could have a material adverse effect upon our business, operating results and financial condition.

 

If any of these factors occur, it could have a material adverse effect upon our business, operating results and financial condition.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Foreign Currency Exchange Risk

 

Our earnings and cash flows are subject to fluctuations due to changes in foreign currency exchange rates. To a certain extent, foreign currency exchange rate movements also affect our competitive position, as exchange rate changes may affect business practices and/or pricing strategies on non-U.S. based competitors. Our primary foreign currency risk exposure is related to U.S. Dollar to Euro conversions. Our subsidiary in China conducts business primarily in the Chinese Yuan. Considering the anticipated cash flows from firm sales commitments and anticipated sales for the next quarter, a hypothetical 10% weakening of the U.S. Dollar relative to the Euro would not materially adversely affect expected third quarter 2005 earnings or cash flows. This analysis is dependent on actual export sales during the next quarter occurring within 90% of budgeted forecasts. The effect of the hypothetical change in exchange rates ignores the affect this movement may have on other variables, including competitive risk. If it were possible to quantify this competitive impact, the results could well be different than the sensitivity effects described above. Each month, we review our position for expected currency exchange rate movements.

 

Interest Rate Risk

 

We are exposed to changes in interest rates primarily from our short-term available-for-sale investments. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair value of our interest sensitive financial instruments at September 30, 2005. Declines in interest rates over time will, however, reduce our interest income.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

As of the end of the period covered by this quarterly report on Form 10-Q, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures. That evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer, who also serves as our Chief Financial Officer. Based on that evaluation, our Chief Executive Officer concluded that our disclosure controls and procedures are effective in timely alerting him to material information relating to Document Sciences required to be included in our periodic SEC filings.

 

Changes in Internal Control over Financial Reporting

 

We have made no change in our internal control over financial reporting during the most recent fiscal quarter covered by this quarterly report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

We are not involved in any material legal proceedings.

 

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

 

(a) Exhibits.

 

Set forth below is a list of the exhibits included as part of this Quarterly Report.

 

Exhibit
Number


  

Exhibit Description


  3.1   (1)    Amended and Restated Certificate of Incorporation.
  3.2   (1)    Amended and Restated Bylaws.
  4.1   (2)    Specimen Stock Certificate.
  4.2   (3)    Rights Agreement between the Registrant and U.S. Stock Transfer Corporation, as Rights Agent, dated May 11, 2001, which includes as Exhibit A thereto the form of Rights Certificate to be Distributed to Holders of Rights after the Distribution Date (as that term is defined in the Rights Agreement).
10.1   (2, #)    Form of Indemnity Agreement Between the Registrant and each of its Officers and Directors.
10.2   (3)    Form of Software License and Software Support Agreement.
10.3   (3)    Form of Professional Services Agreement.
10.4   (3)    Form of Value Added Reseller Agreement.
10.5   (4, #)    1997 Employee Stock Purchase Plan, as Amended.
10.6   (4)    Lease for Principal Facilities, as Amended, and Assignment of Lease.
10.7   (5)    Stock Repurchase Agreement Between Xerox and the Registrant.
10.8   (6)    Development Services and Referral Agreement Between Objectiva Software Solutions, Inc. and the Registrant dated January 16, 2004.
10.9   (7)    2004 Stock Incentive Plan.
10.10   (8)    Stock Purchase Agreement Between Objectiva Software Solutions, Inc. and the Registrant.
10.11   (9)    Lease for New Principal Facilities.
10.12   (10, #)    Form of Stock Option Agreement Used in Connection with the Registrant’s 2004 Stock Incentive Plan.
10.13   (11, #)    John L. McGannon Employment Agreement.
10.14   (11, #)    Daniel Fregeau Employment Agreement.
10.15   (11, #)    Nasser Barghouti Employment Agreement.
10.16   (11, #)    Peter Riccio Employment Agreement.
10.17   (11, #)    J. Douglas Winter Employment Agreement.
10.18   (11, #)    Tao Ye Employment Agreement.
31.1   (*)    Certification of CEO/CFO Pursuant to Rules 13a-14 and 15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1   (*)    Certification of CEO/CFO Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(1) Previously filed as an exhibit to the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on May 20, 2004.

 

(2) Previously filed as exhibits to Registration Statement on Form S-1 Registration Number 333-06344 filed with the Securities and Exchange Commission on June 20, 1996.

 

(3) Previously filed as exhibits to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.

 

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(4) Previously filed as exhibits to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1998.

 

(5) Previously filed as an exhibit to the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 20, 2003.

 

(6) Previously filed as exhibits to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003.

 

(7) Previously filed as Appendix A to the Registrant’s Proxy Statement on Schedule 14A filed with the Securities and Exchange Commission on March 29, 2004.

 

(8) Previously filed as an exhibit to the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 4, 2004.

 

(9) Previously filed as an exhibit to the Registrant’s Current Report on Form 8-K with the Securities and Exchange Commission on March 2, 2005.

 

(10) Previously filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004.

 

(11) Previously filed as exhibits to the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 14, 2005.

 

(#) Indicates management compensatory plan, contract or arrangement.

 

(*) Filed herewith.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

        DOCUMENT SCIENCES CORPORATION

Date: November 14, 2005

     

/s/ John L. McGannon

       

John L. McGannon

       

President, Chief Executive Officer and

Chief Financial Officer

(Principal Executive Officer and

Principal Financial Officer)

 

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EXHIBIT INDEX

 

Exhibit

Number


 

Exhibit Description


   Page

  3.1   (1)   Amended and Restated Certificate of Incorporation.     
  3.2   (1)   Amended and Restated Bylaws.     
  4.1   (2)   Specimen Stock Certificate.     
  4.2   (3)   Rights Agreement between the Registrant and U.S. Stock Transfer Corporation, as Rights Agent, dated May 11, 2001, which includes as Exhibit A thereto the form of Rights Certificate to be Distributed to Holders of Rights after the Distribution Date (as that term is defined in the Rights Agreement).     
10.1   (2, #)   Form of Indemnity Agreement Between the Registrant and each of its Officers and Directors.     
10.2   (3)   Form of Software License and Software Support Agreement.     
10.3   (3)   Form of Professional Services Agreement.     
10.4   (3)   Form of Value Added Reseller Agreement.     
10.5   (4, #)   1997 Employee Stock Purchase Plan, as Amended.     
10.6   (4)   Lease for Principal Facilities, as Amended, and Assignment of Lease.     
10.7   (5)   Stock Repurchase Agreement Between Xerox and the Registrant.     
10.8   (6)   Development Services and Referral Agreement Between Objectiva Software Solutions, Inc. and the Registrant dated January 16, 2004.     
10.9   (7)   2004 Stock Incentive Plan.     
10.10   (8)   Stock Purchase Agreement Between Objectiva Software Solutions, Inc. and the Registrant.     
10.11   (9)   Lease for New Principal Facilities.     
10.12   (10, #)   Form of Stock Option Agreement Used in Connection with the Registrant’s 2004 Stock Incentive Plan.     
10.13   (11, #)   John L. McGannon Employment Agreement.     
10.14   (11, #)   Daniel Fregeau Employment Agreement.     
10.15   (11, #)   Nasser Barghouti Employment Agreement.     
10.16   (11, #)   Peter Riccio Employment Agreement.     
10.17   (11, #)   J. Douglas Winter Employment Agreement.     
10.18   (11, #)   Tao Ye Employment Agreement.     
31.1   (*)   Certification of CEO/CFO Pursuant to Rules 13a-14 and 15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.     
32.1   (*)   Certification of CEO/CFO Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.     

(1) Previously filed as an exhibit to the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on May 20, 2004.

 

(2) Previously filed as exhibits to Registration Statement on Form S-1 Registration Number 333-06344 filed with the Securities and Exchange Commission on June 20, 1996.

 

(3) Previously filed as exhibits to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.

 

(4) Previously filed as exhibits to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1998.

 

(5) Previously filed as an exhibit to the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 20, 2003.

 

(6) Previously filed as exhibits to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003.

 

(7) Previously filed as Appendix A to the Registrant’s Proxy Statement on Schedule 14A filed with the Securities and Exchange Commission on March 29, 2004.

 

(8) Previously filed as an exhibit to the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 4, 2004.

 

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(9) Previously filed as an exhibit to the Registrant’s Current Report on Form 8-K with the Securities and Exchange Commission on March 2, 2005.

 

(10) Previously filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004.

 

(11) Previously filed as exhibits to the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 14, 2005.

 

(#) Indicates management compensatory plan, contract or arrangement.

 

(*) Filed herewith.

 

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