Document/Exhibit Description Pages Size
1: 10-K Annual Report 59 349K
2: EX-4.01 Instrument Defining the Rights of Security Holders 2 10K
3: EX-10.20 Material Contract 2 11K
4: EX-10.21 Material Contract 2 13K
5: EX-21 Subsidiaries of the Registrant 1 5K
6: EX-23.1 Consent of Experts or Counsel 1 8K
7: EX-23.2 Consent of Experts or Counsel 1 7K
8: EX-27 Financial Data Schedule (Pre-XBRL) 2 9K
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(MARK ONE)
/X/ ANNUAL REPORT Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
FOR FISCAL YEAR ENDED MARCH 31, 1999 or
/ / Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 (no fee required)
For the transition period from ______________ to ______________.
COMMISSION FILE NUMBER: 0-14713
INTERLEAF, INC.
(Exact Name of Registrant as Specified in Its Charter)
[Download Table]
DELAWARE 04-272042
(State or Other (I.R.S. Employer Identification No.)
Jurisdiction of
Incorporation or
Organization)
62 FOURTH AVENUE 02451
WALTHAM, MASSACHUSETTS
(Address of Principal (Zip Code)
Executive Offices)
(781) 290-0710
(Registrant's Telephone Number,
Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.01 PAR VALUE
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 ______
Indicate by check mark if disclosure of delinquent filers pursuant to Rule
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to the
Form 10-K. [ ]
The aggregate market value of the registrant's Common Stock, $.01 par value,
held by non-affiliates of the registrant as of June 23, 1999 was $67,226,377,
based on the last reported sale price of $6.25 on the Nasdaq National Market on
that date. As of June 23, 1999, 11,230,720 shares of the registrant's Common
Stock, $.01 par value, were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Proxy Statement involving the election of
directors, which is expected to be filed within 120 days after the end of the
registrant's fiscal year, are incorporated by reference in Part III of this
Report (Items 10, 11 and 12).
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FORWARD LOOKING INFORMATION
Some of the statements contained in this Annual Report and in the documents
incorporated by reference are forward-looking. The following and similar
expressions identify forward-looking statements:
- expects;
- anticipates; and
- estimates.
Forward-looking statements include, but are not limited to, statements
related to:
- Interleaf's plans, objectives, expectations and intentions;
- the timing of, availability and functionality of products under
development or recently introduced; and
- general economic conditions.
Actual results may differ materially from those suggested by the
forward-looking statements for various reasons, including those discussed under
"Risk Factors." These forward-looking statements speak only as of the date of
this Annual Report, or in the case of forward-looking statements in documents
incorporated by reference, as of the dates of those documents.
* * *
Effective December 31, 1998, the Company declared a 1 for 3 reverse split of
its common stock. Par value did not change as a result, and all share, per share
data and other information in this Annual Report is presented giving effect to
the 1 for 3 reverse split.
* * *
Interleaf-Registered Trademark- and Panorama-Registered Trademark- are
registered trademarks of Interleaf, Inc., and BladeRunner(TM), I5(TM), I6(TM),
I7(TM), E-content(TM), E-publishing(TM), Information Manager(TM), Worldview(TM),
WordView Press(TM), RDM(TM), RDM-X(TM,) BusinessWeb(TM) and BUSINESSWEB PLUS(TM)
are trademarks of Interleaf, Inc. Microsoft-Registered Trademark- Word(TM) is a
trademark of Microsoft Corporation. Other company and product names may be
trademarks of the respective companies.
-C- 1999 Interleaf, Inc. All rights reserved.
PART I
ITEM 1. BUSINESS
OVERVIEW
Interleaf and its subsidiaries ("Interleaf" or the "Company") develop and
market software products and services which address two distinct markets,
referred to as "E-publishing" and "E-content". The Company's traditional
solutions, which are used in the creation, publication, management and
distribution of electronic and paper documents are targeted to the E-publishing
market. The Company's traditional E-publishing software products enable
customers to compose, edit, view and print documents and to control, manage and
distribute those documents, thereby enabling the Company to offer its customers
a cost-effective and efficient means of maximizing the value from their
information assets.
Interleaf's E-content solutions are comprised of a new software product
called BladeRunner and related services, and are targeted at a market called
"Enterprise Content Management". BladeRunner, enables customers to create,
manage and re-use information at a level of detail determined by the customer,
using eXtensible Markup Language ("XML") as its technology backbone and
Microsoft Word for content creation. Customers are able to:
- seamlessly integrate the "information chain"--connecting customers with
their suppliers, customers and other members of their extended enterprise
- apply intelligence, structure and style to corporate information
- generate output in a variety of formats, and
- dynamically integrate that information with other electronic and business
processes in support of their E-business initiatives.
BladeRunner enables organizations to realize improved time to market,
increase revenues and gain competitive advantage by providing a solution
designed to leverage information content and facilitate business transactions
throughout the information value chain.
While the Enterprise Content Management market and E-content solutions are
new for the Company, they represent the logical progression of Interleaf's
traditional business. During fiscal 1999, Interleaf realized that its
E-publishing and E-content solutions require different resources, strategies and
investments in order to be successful, and that the measurement of success is
very different for each. As a result, during the first quarter of fiscal 2000
the Company has dedicated separate management, development, sales and support
resources to its E-publishing and E-content solutions. The Company intends to
change its reporting segments for fiscal year 2000 to separately reflect results
from its E-publishing and E-content operations. However, this Annual Report
continues to reflect operations segmented by geography, and revenues segmented
between product, maintenance and services.
TRADITIONAL E-PUBLISHING PRODUCTS
Since its inception, Interleaf has primarily focused on the development and
marketing of electronic publishing software, traditionally used for the
authoring and publication of technical documentation. The Company expanded its
product line to include a document management system which provides document
storage in and retrieval from a robust repository. Additional products have
provided demand print, document collections and viewing, intranet publishing and
ancillary functionality. These products were initially developed for Unix
workstations, and in fiscal 1996 certain products were released for personal
computers ("PCs") running Microsoft Windows and Windows NT. The Company released
the latest version of its flagship E-publishing product, Interleaf 7 ("I7"), in
the fourth quarter of fiscal 1999, with additional functionality, improved user
interface and enhanced performance.
1
Interleaf provides its traditional, high-end technical publishing software
and services to many of the world's largest manufacturing, industrial, utility,
transportation and financial services companies, and the Company realized a
strong revenue stream from this market in prior years. However, the technical
publishing software market is largely saturated, the customer base is
consolidating due to global mergers and acquisitions among the Company's largest
corporate customers and competition is increasing from the steadily-improving
functionality of low-end PC-based products, such as Microsoft Word. This
consolidation and increased competition has had a negative impact on Interleaf's
E-publishing revenue and business (See Item 7, Management's Discussion and
Analysis of Financial Condition and Results of Operations).
The Company is attempting to offset this downward pressure on its
traditional product revenue in two ways. First, the Company has released new
versions of its traditional products, providing additional functionality,
enhanced performance, Year 2000 compliance and error corrections. Second,
Interleaf intends to emphasize the delivery of its products and consulting
services as an integrated package, and the Company is adopting an outsourcing
approach to sales, where Interleaf would take responsibility for all aspects of
its traditional customers' technical document production process.
NEW E-CONTENT PRODUCT DEVELOPMENT
The software industry is characterized by rapid technological change, which
requires the continuing enhancement of existing products and development of new
products. After extensive market research and planning, Interleaf has shifted
its corporate strategy and is focusing on the emerging Enterprise Content
Management market. Enterprise Content Management solutions enable a customer to
break down its information into reusable units, and to re-use and re-purpose
those information units in its documents (both electronic and paper) using
structure and intelligence which reflect the needs and business processes of the
customer and its extended enterprise. Interleaf believes that it has a foothold
in this market, by virtue of its technology expertise (including technology
developed in its former Xtreme product line), custom application development
experience and large customer base.
As the Company expected, XML is emerging as a de facto technology standard
for web-based information publishing. XML adds structure to information at
whatever level is required, and separates and allows control of that structure,
so that the information can be easily distilled, cataloged and reused within
companies and between business partners. XML will enable the delivery of
just-in-time, customized documents through the assembly of small,
easily-identifiable and compatible information components, or elements. XML also
enables document-to-document information processing, which will facilitate
electronic commerce.
In early 1998, Interleaf announced the development of BladeRunner, which
will support Microsoft Word as the primary user authoring environment (along
with I7 and other authoring products), and enable the creation and sharing of
XML document elements without requiring a technical knowledge of XML. These
features are critical to the wide adoption of BladeRunner and Interleaf's
Enterprise Content Management solution, because users will expect to create new
content and assemble custom documents within a familiar authoring environment.
During the second quarter of fiscal 1999, a non-commercial version of
BladeRunner was released, and licensed to several companies as part of
Interleaf's "Early Adopter Program", or "EAP". These companies each purchased
BladeRunner, together with Interleaf consulting services, in order to test the
technology and develop a pilot application as a first step towards implementing
a full-scale Enterprise Content Management solution.
BladeRunner was made commercially available on schedule in June of 1999.
Successive versions have been scheduled for release later in fiscal year 2000.
2
CONSULTING AND OUTSOURCING.
The Interleaf Professional Services Group (IPSG) provides software
installation, custom application development, implementation and other
consulting services. Engagements for both the E-publishing and E-content
solutions typically run from a few days to help a customer scope and plan its
Interleaf-based application project, to several months for a turnkey delivery of
a custom application.
Interleaf's solutions-based approach to sales is also a key aspect of the
Company's Enterprise Content Management strategy. The Company believes that, due
to the complexity of its E-content solutions and the early stage of the
Enterprise Content Management market and its technology and standards, the
successful implementation of an Enterprise Content Management solution will
necessarily require a relatively large component of services.
PRODUCTS
E-CONTENT PRODUCT
BLADERUNNER. BladeRunner is the Company's comprehensive, XML-based
E-content software product, and operates on Windows NT for the server and
publishing client and on any Microsoft Windows configuration supporting MS-Word
for the authoring client. BladeRunner is the first complete Enterprise Content
Management solution that harnesses industry standards such as XML and Microsoft
Word to deliver the reusability benefits of structured information in
content-critical business solutions. BladeRunner enables organizations to
design, create, manage and publish business information throughout the
information value chain that connects BladeRunner customers with their
customers, suppliers and distributors. BladeRunner consists of four modules,
with the features indicated:
THE CONTENT DESIGN MODULE: aids in the analysis of the information
requirements of the customer's applications, graphically depicts the
relationships among the detailed information components, and translates
information component relationships into Document Type Definitions ("DTDs").
THE CONTENT CREATION MODULE: generates valid XML using Microsoft Word as
the author interface, captures content from any authoring tool that produces
valid XML, validates content at the author's desktop, and allows the
creation of content locally, or remotely across the extended enterprise.
THE CONTENT MANAGEMENT MODULE: allows the user to define the level of
granularity at which the content will be tagged, stored and managed. This
module stores and manages all related elements and meta-data, validates the
content validation against a DTD, and provides workflow design and
management. This module includes an open object oriented repository, and due
to its open, standards-based architecture, it will work with both object
oriented and relational databases. Data adaptors will connect the repository
with ERP, ERM and other enterprise applications.
THE CONTENT PUBLISHING MODULE: enables business rules-based and
media-aware conditional presentation with eXtensible Style Language ("XSL"),
resulting in content re-use and re-purpose for multiple media. The user's
content is selected, sequenced, organized and prepared for styling and
rendering, and then published dynamically to paper, CD-ROM and electronic
output for Web and corporate intranets, in output formats such as XML, HTML,
Postscript, PDF and Interleaf formats.
RDM-X. RDM-X will be a comprehensive migration solution for customers of
Interleaf's traditional document management system (RDM) to upgrade to
BladeRunner. RDM-X is designed to leverage customers' investment in their
document management solution while enabling them to implement the benefits of
content management and of the emerging XML and XSL information standard.
RDM-X will be available as a phased approach enabling a seamless upgrade
path for RDM customers to move to an XML-based E-content solution. RDM customers
will initially receive BladeRunner's authoring and publishing capabilities
integrated with the RDM repository, providing the ability to create
3
XML, store the files in the RDM repository, and begin publishing XML to multiple
formats using XSL. Ultimately these customers may purchase BladeRunner's
repository to implement a complete XML-based E-content solution.
INFORMATION MANAGER. Information Manager, purchased from Texcel
International AB in fiscal 2000, is an XML and Standard Generalized Markup
Language ("SGML") E-content repository and system that provides a Web-based
client, workflow, version management, queries, electronic review and dynamic
document assembly for multi-user authoring and editing environments. Customers
use Information Manager to create intelligent, content-driven applications such
as interactive electronic technical manuals, Web- and CD-ROM-based reference
materials and on-demand research reports, as well as printed product and
maintenance documentation. Information Manager is a client/server system with a
Windows client and a Windows NT or UNIX server.
This technology has been incorporated into BladeRunner. Interleaf will
continue to support Information Manager for existing customers, and offer an
upgrade path to BladeRunner to enable those customers to benefit from
BladeRunner's additional functionality.
E-PUBLISHING PRODUCTS
The Company currently markets a broad suite of software products which are
sold both individually and as parts of an integrated solution. These products
include I7 for publishing, WorldView for on-line distribution of document
collections, RDM for document management, BusinessWeb Plus for intranet
publishing of Interleaf-based documents, Panorama for distribution of SGML
documents, and CD Web Publisher for publishing information on CD media. The
Company also markets consulting and training services and provides technical
support to enable its customers to reap the maximum benefit from their
investment in Interleaf tools and applications.
INTERLEAF 7. Interleaf 7, or I7, is the Company's flagship E-publishing
product. I7 is a complex authoring and publishing engine, which operates on UNIX
workstations, Windows NT and Windows operating systems. Information-driven and
collaborative publishing processes require a publishing engine such as I7 to
assimilate information from documents originating from a variety of sources
(i.e. either a single document containing thousands of pages or a collection or
library of interrelated documents). I7 enables customers to reuse this
information and re-purpose it for different distribution media: paper, Internet,
intranet, local area network ("LAN"), wide area network ("WAN"), CD-ROM or for
On-Demand Printing. These documents share common characteristics such as
multiple authors, controlled revisions and long life cycles. I7 automates
complex document processes by providing tools for creating and maintaining
documentation. By leveraging 32-bit operating environments, I7 can execute rapid
changes across large document collections, maintaining cross references,
autonumbering and pagination.
WORLDVIEW. WorldView is an I7-based application suite for electronic
document distribution, which enables customers to transform various types of
electronic data into collections of interrelated information for distribution
online, by CD-ROM, diskette and other media types. Customers may merge and
assimilate documents ranging from single page reports to thousands of pages of
documentation that may originate in different formats and different applications
throughout an organization.
RDM. RDM is a robust document management solution designed for large,
complex and dynamic documentation. RDM manages document objects from a variety
of sources such as I7, Microsoft Word and other text, CAD drawings,
spreadsheets, graphics and audio clips. RDM manages document workflow revision
cycles and serves as the basis for online publishing and document collection
updates. RDM runs on UNIX and Microsoft Windows 95 and NT.
BUSINESSWEB PLUS. BusinessWeb Plus combines WorldView functionality with
the Company's Java viewing technology to provide a solution for Internet or
intranet access to RDM-managed knowledge repositories and Worldview Press
collections. BusinessWeb Plus enables users to immediately access their
4
documents through a web-browser without having to do any conversion or
reformatting. This enables corporations to rapidly exploit the advantages of the
wide reach and simple management of Internet-based information.
SERVICES
CONSULTING AND OUTSOURCING. The Interleaf Professional Services Group
(IPSG) has been particularly active in building sophisticated E-publishing
applications in the manufacturing, transportation and financial services
markets. As a strategy to increase revenue from sales of its traditional
products, the Company is increasing its promotion of turnkey solutions.
Interleaf is also considering an outsourcing model for the E-publishing market,
where Interleaf would take responsibility for all aspects of the technical
document production process. The Company is currently establishing an
outsourcing capability to offer to its customers, and may consider seeking
partnership opportunities with established outsourcing companies.
In the new E-content business, IPSG is instrumental in insuring that the
initial BladeRunner customers understand the new system and are successful in
deriving value and meeting their goals. The Company offers packages of IPSG
services and BladeRunner software designed to enable customers meet well-defined
and manageable objectives, starting with pilot projects, continuing with
enterprise-wide system design, planning and development, and continuing through
a complete Enterprise Content Management system implementation. An example of
this type of packaging is the Company's E-Base solution, which delivers an
XML-based E-content foundation in just two weeks. This package includes 1 day of
implementation, 2 days of training, 7 days of consulting, and a BladeRunner
license limited to permit the development, testing and use of one pilot content
management application.
TECHNICAL SUPPORT AND TRAINING. Interleaf offers its customers maintenance
contracts that currently provide them with software upgrades, bug fixes and
technical support. Interleaf operates two main technical support centers--one at
its corporate headquarters in the United States and the other, providing
European-wide support, in Germany. Smaller support centers are also located in
Australia and Japan.
The Company also markets a wide variety of training courses to help
customers use the Interleaf tools quickly and effectively. Training is performed
on a global basis at Interleaf facilities, satellite locations and customer
sites.
MARKETS AND CUSTOMERS
Interleaf's E-publishing solutions have historically targeted the technical
documentation segment of the electronic publishing market. Its customers are
among the largest and most highly-regarded companies in a wide range of markets,
including process manufacturing, discrete manufacturing, financial services,
government and transportation. The Company has decided to closely focus in the
future on selected vertical markets, including manufacturing and the financial
services market.
The Company's installed-base of E-publishing customers provides a strong
point of departure as Interleaf moves to establishing itself as a leading
supplier of Enterprise Content Management solutions to companies in the
manufacturing and financial services segments of this market.
Interleaf's E-content solutions are targeted to large organizations
undergoing extensive E-Business initiatives, such as the following two examples.
BladeRunner is targeted to product manufacturers who have short development
cycles, where products/product information frequently changes, and where the re-
use and publishing simplicity of business content are key drivers. BladeRunner
is also targeted to information providers, including commercial publishers,
training companies and organizations, financial services, healthcare, government
agencies and technology companies where the abilities to customize, personalize,
re-use and re-purpose business information are key drivers.
5
SALES AND DISTRIBUTION
UNITED STATES. In the United States, Interleaf distributes its software
products and consulting services primarily through direct field sales and
telesales representatives to large corporations.
DIRECT CHANNEL. Currently, the Company sells its software products and
consulting services to large organizations primarily through a direct field
sales force assigned to regional and named-account territories, and through a
telesales operation that supports the direct sales force. In fiscal 2000,
Interleaf plans to focus much of its direct sales force on selling to large
manufacturers, which make up the largest portion of its installed base. The
Company also operates a dedicated telesales organization to market its complex
publishing products and maintenance services to its installed base of customers.
Interleaf maintains sales and service offices in five United States locations.
ALTERNATE CHANNELS. The Company has agreements with a limited number of
value-added resellers (VARs) to market and distribute its software products.
During the past three fiscal years, domestic revenues attributable to VAR sales
were not significant. As part of its E-content strategy moving forward, the
Company will actively pursue distribution partnerships with solution providers
who offer domain knowledge, have vertical market application expertise and have
an established market presence in their area of concentration. In addition, the
Company is seeking to create business partnerships with large system integrators
such as IBM, SAIC, Ernst & Young or Andersen Consulting, in order to extend
BladeRunner's market exposure and penetration.
INTERNATIONAL. The Company primarily markets its software products and
services in Canada, Europe and Asia through its wholly-owned subsidiaries in
Australia, Canada, France, Germany, Japan and the United Kingdom. In Italy,
Interleaf products were sold exclusively through Interleaf Italia S.r.l., in
which Interleaf held a 31% capital interest. During fiscal 1999, Interleaf
purchased the remaining 69% of capital in Interleaf Italia, which is now a
wholly-owned subsidiary of the Company. From 1989 through June, 1997, Interleaf
had been selling its products in Latin America through an exclusive distributor.
The Company has repurchased the distribution rights and is now selling directly
in Latin America. The revenues from Latin America have been insignificant.
Interleaf's operations in Japan and Australia have experienced a decrease in
revenue, which is due in part to the general economic downturn in Japan and the
Asia-Pacific region. This economic downturn has affected the purchasing power
and patterns of Interleaf's customers, which in turn affects Interleaf's revenue
in the region.
MANUFACTURING
The Company outsources its manufacturing operations, which include the
duplication of tapes, diskettes, CDs, and printed documents, assembling, and
final packaging. The Company's outsourcing vendor is reliable, and alternative
vendors are readily available.
BACKLOG
The Company generally manufactures its software on the basis of its forecast
of near-term demand and generally ships to end users within thirty (30) days
after receipt of the order. Consequently, the Company's product backlog is not
indicative of future sales levels, or material to an understanding of its
business. The Company does have a material backlog in consulting services, which
represents projects which are underway or scheduled for commencement in the
future.
6
COMPETITION
The electronic publishing, distribution, viewing and document management
markets are highly competitive. Some of the competitors in those markets are
larger and have greater resources than the Company. The introduction and market
acceptance of new technologies, such as the Internet and Intranet, have also
offered new forms of opportunity and competition for the Company's existing
products.
In the electronic publishing and viewing segments of the E-publishing
market, the Company competes primarily with Adobe Systems Inc. In the document
management market segment, the Company competes with numerous companies,
including Documentum, Inc. and PC Docs, Inc. Principal competitive factors in
these markets include product functionality, custom application development
expertise, customer support, ease of use, integration, and price.
The Company's products, integrated with each other, blended with specialized
services, and used across different hardware platforms, are its principal
competitive advantages in a market that is fragmented, with many companies
offering only separate parts of a solution. The Company also believes that its
ability to provide Enterprise Content Management solutions for customer-specific
business problems will increasingly distinguish the Company from its competitors
in the E-publishing market.
In the Enterprise Content Management market, the Company competes primarily
with Inso Corporation. Certain companies, such as Chrystal Software,
Incorporated and ArborText, Inc., offer partial solutions to customers, and they
may jointly market their products in order to provide a more complete solution
such as that offered by Interleaf. Principal competitive factors in these
markets include the use of a non-proprietary authoring tool, the ability to use
and exploit XML as a new technology, product functionality, custom application
development expertise, customer support, ease of use, integration, and price.
The Company believes that BladeRunner's ability to use Microsoft Word as an
authoring front-end, and the end-to-end breadth of its solution (particularly
its extensive publishing capabilities) will distinguish BladeRunner from its
competitors and enable the Company to emerge as a leader in this market.
RESEARCH AND DEVELOPMENT
The Company spent $8.9 million on research and development in fiscal 1999,
including $1.4 million of capitalized software development costs, $8.9 million
in fiscal 1998 and $15.0 million in fiscal 1997. During 1998 and 1997 these
amounts were spent largely on the continued enhancement of the Company's
existing E-publishing products, and on development of new technology such as the
Company's Java-based viewing software. During fiscal 1999, much of the Company's
R&D efforts were concentrated on the development of BladeRunner.
EMPLOYEES
As of March 31, 1999, the Company employed 338 full-time employees
worldwide, of whom 55 were employed in research and development, which includes
quality assurance and technical documentation, 134 in domestic sales operations,
including services, 35 in domestic customer support, 8 in corporate marketing,
36 in finance and administration, and 70 in the Company's international
operations. The Company's success will depend in large part on its ability to
attract and retain qualified personnel, who are in demand throughout the
industry. None of the Company's employees are represented by a labor union.
Interleaf believes that its employee relations are good.
PRODUCT PROTECTION
The Company relies on a combination of copyright, trade secret, patent and
trademark laws, license agreements and technical measures to protect its rights
in and to its software and its product names. However, for the reasons discussed
below under "Risk Factors--Dependence on Proprietary Technology; Risks of
Infringement", and due to rapid technological change in the software industry,
the Company
7
believes that patent, trade secret and copyright protection are less significant
than factors such as the knowledge, ability and experience of employees as well
as product and company name recognition.
The Company relies primarily on copyright laws of the United States and
other jurisdictions and on written software license agreements to protect its
intellectual property rights in its software products. Although the Company's
license agreements prohibit both the unauthorized use, copying or distribution
of the Company's products, and the disclosure of the proprietary aspects of its
products, it is technically possible for competitors to copy aspects of its
products in violation of the Company's rights.
In addition, the Company has obtained a U.S. patent which provides the
Company with exclusive rights to certain inventions embodied in its I7 and RDM
products. The Company has applied for another patent covering its Java-based
viewing technology, and it may apply for additional patents in the future.
The Company has obtained trademark registrations of INTERLEAF and PANORAMA
in the United States and certain foreign jurisdictions. In addition, E-CONTENT,
E-PUBLISHING, I5, I6, I7, BLADERUNNER, WORLDVIEW, WORLDVIEW PRESS, RDM, RDM-X,
BUSINESSWEB, PANORAMA, CD WEB PULISHER, and INFORMATION MANAGER are trademarks
of the Company.
ITEM 2. PROPERTIES
The Company's principal executive, administrative and research and
development operations are located in two buildings in Waltham, Massachusetts,
cumulatively totaling approximately 40,900 square-feet, which the Company
occupies under leases expiring in December 2001 and December 2002, respectively.
The Company also leases sales and support offices in ten locations in the
United States and seven foreign locations for its subsidiaries.
ITEM 3. LEGAL PROCEEDINGS
There are no material legal proceedings to which the Company is a party or
to which any of its property is subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS
The Company's common stock is listed on the Nasdaq National Market of The
NASDAQ Stock Market, Inc. ("NASDAQ") under the symbol LEAF. On June 23,1999
there were 800 holders of record of the Company's common stock. This number does
not reflect persons or entities who hold their stock in nominee or "street name"
through various brokerage firms. The high and low closing sale prices for the
common stock for the last two fiscal years are as follows:
FISCAL 1999:
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QUARTER ENDED JUNE 30 SEPTEMBER 30 DECEMBER 31 MARCH 31
-------------------------------------------- ----------- ----------------- --------------- -----------
High........................................ 10 5/16 5 5/8 3 3/16 4 3/16
Low......................................... 5 5/8 2 1/4 1 11/16 1 3/4
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FISCAL 1998
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QUARTER ENDED JUNE 30 SEPTEMBER 30 DECEMBER 31 MARCH 31
-------------------------------------------- ----------- --------------- ------------- -------------
High........................................ 5 1/16 10 1/2 11 29/32 11 1/4
Low......................................... 2 23/32 4 5/16 7 7/8 8 1/4
Through the end of its 1999 fiscal year, the Company has never paid cash
dividends on its common stock.
In the fourth quarter of fiscal 1999, the Company received net proceeds of
$3.9 million from a private placement financing. Those such proceeds were used
to redeem and convert the Series C Stock and Series D Stock, respectively. See
Item 7, Management's Discussion and Analysis of Financial Condition and Results
of Operations.
ITEM 6. SELECTED FIVE-YEAR FINANCIAL DATA
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YEAR ENDED MARCH 31 1999A 1998 1997B 1996C 1995D
--------------------------------------------------------- --------- --------- ---------- --------- ----------
(IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
Total revenues........................................... $ 45,194 $ 52,577 $ 64,823 $ 88,557 $ 87,856
--------- --------- ---------- --------- ----------
Net income (loss)........................................ $ (1,125) $ 2,436 $ (29,550) $ 311 $ (48,362)
--------- --------- ---------- --------- ----------
Net income (loss) applicable to common stockholders:
Basic................................................ $ 7,081 $ 1,978 $ (29,550) $ 311 $ (48,362)
Diluted.............................................. $ (1,198) $ 2,208 $ (29,550) $ 311 $ (48,362)
--------- --------- ---------- --------- ----------
Net income (loss) per share:
Basic................................................ $ 1.01 $ 0.33 $ (5.11) $ 0.06 $ (10.41)
Diluted.............................................. $ (.14) $ 0.27 $ (5.11) $ 0.05 $ (10.41)
--------- --------- ---------- --------- ----------
Shares used in computing net income (loss) per share:
Basic................................................ 7,019 5,952 5,781 5,186 4,646
Diluted.............................................. 8,687 8,269 5,781 6,165 4,646
--------- --------- ---------- --------- ----------
Total assets............................................. $ 37,812 $ 39,388 $ 37,900 $ 48,916 $ 50,793
--------- --------- ---------- --------- ----------
Long-term obligations.................................... $ 1,234 $ 2,063 $ 2,955 $ 773 $ 625
--------- --------- ---------- --------- ----------
Total shareholders' equity (deficit)..................... $ 9,229 $ 9,310 $ (772) $ 15,419 $ 10,615
--------- --------- ---------- --------- ----------
Common shares outstanding................................ 10,382 6,052 5,820 5,566 4,735
--------- --------- ---------- --------- ----------
------------------------
a. Fiscal 1999 results include a charge of $.6 million for purchased
in-process research and development.
b. Fiscal 1997 results include $10.9 million of restructuring charge for
restructuring of the Company's worldwide operations, a $2.3 million
write-off of intangible assets, and a $2.5 million write-off of
capitalized software, inventory and prepaid royalties.
c. Fiscal 1996 results include a $1.2 million benefit from the settlement
of a dispute with a joint venture partner.
d. Fiscal 1995 results include a $15.2 million write-off of goodwill
related to the acquisition of distributorships in Canada, France and
Germany, a $7.1 million charge for restructuring the Company's worldwide
operations, a $2.0 million write-off of capitalized software development
costs, and a $1.9 million charge for revaluation of the Company's
deferred tax asset.
9
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company reported a net loss of $1.1 million on revenues of $45.2 million
in fiscal 1999 compared with net income of $2.4 million on revenues of $52.6
million in fiscal 1998 and a net loss of $29.6 million on revenues of $64.8
million in fiscal 1997. Much of the decline in revenue is due to a decrease in
product revenue and the related decline in maintenance and service revenue
caused by the continuing saturation and consolidation of the market for complex
authoring products and the increasing popularity of low-end versions of
Windows-based authoring software. The Company has continued to develop
BladeRunner, Interleaf's new Enterprise Content Management product targeted to
its customers' extended enterprises.
IMPACT OF CERTAIN REDEMPTIONS. The Company has recorded preferred stock
dividends of $.6 million in deriving net income applicable to common
shareholders for basic earnings per share in fiscal 1999. Additionally, for
purposes of calculating basic earnings per share, the Company recorded gains on
the redemption of all outstanding shares of its Series C Stock and conversion of
79% of its Series D Stock aggregating $8.8 million. Therefore, the Company's net
income applicable to common shareholders was $7.1 million in fiscal 1999 for
purposes of basic earnings per share. For purposes of calculating diluted
earnings per share, all of the gains on redemption of outstanding shares of
Series C Stock and conversion of Series D Stock have been excluded in the
calculation and only the dividends on shares of Series C Stock and Series D
Stock redeemed and converted, respectively, in fiscal 1999 were included in the
calculation of diluted earnings per share for fiscal 1999. For purposes of
diluted earnings per share, the Company had a net loss applicable to common
shareholders of $1.2 million in fiscal 1999. In fiscal 1998, for purposes of
calculating basic earnings per share, the Company recorded dividends on its
Series C Stock and Series D Stock outstanding of $.5 million, resulting in net
income applicable to common shareholders of $2.0 million. For purposes of
calculating diluted earnings per share, only dividends on the Series C stock
were included. Therefore, net income applicable to common shareholders for
purposes of diluted earnings per share was $2.2 million in fiscal 1998.
IMPACT OF CERTAIN ACQUISITIONS. Effective August 31, 1998, the Company
purchased 100% of the outstanding common shares of PDR Automated Systems and
Publications, Inc. ("PDR"). PDR provides subcontracting and outsourcing services
for the development, management and distribution of information, and has
developed certain technology surrounding image processing. The acquisition has
been accounted for as a purchase business combination and, therefore, the
operating results of PDR have been included in the Consolidated Statement of
Operations since the date of acquisition. The Company paid cash of $2.9 million
and depending upon certain financial contingencies, may be obligated to pay an
additional $3.0 million or more, payable in stock, except that the Company may
pay in cash under certain circumstances. Of this $3.0 million additional amount,
$.7 million is guaranteed and was accrued in the second quarter of fiscal 1999.
The Company recorded costs associated with the acquisition of $.1 million
related to valuation services, legal and audit fees.
During the second quarter of fiscal 1999, the purchase price was allocated
to the net tangible and intangible assets of PDR as follows (net of negative
goodwill of $1.4 million):
[Enlarge/Download Table]
(AMOUNTS IN MILLIONS)
-----------------------
Net tangible assets acquired............................................. $ 1.3
Outsourcing operations................................................... 1.4
Core technology.......................................................... .5
Acquired in-process research and development............................. .3
Assembled workforce...................................................... .2
---
$ 3.7
---
---
10
During the fourth quarter of fiscal 1999, the Company paid the first $1.5
million installment payment in stock upon the achievement of the specified
revenue levels. That common stock has been classified as redeemable common stock
at March 31, 1999 due to certain redemption rights of the holders. This payment,
$.7 million of which was previously accrued, was allocated as follows: $.4
million to outsourcing operations, $.2 million to core technology, $.1 million
to acquired in-process research and development and $.1 million to assembled
workforce. The Company may still be obligated to pay an additional $1.5 million
or more upon successful achievement of certain additional financial
contingencies.
It has been determined that technological feasibility of the in-process
research and development ("IPR&D") purchased from PDR has not been established
and that the technology has no alternative future use. Therefore, in accordance
with generally accepted accounting principles, the Company has expensed the
amount of the purchase price allocated to purchased IPR&D of approximately $.4
million. The intangible assets will be amortized on a straight line basis over
estimated useful lives ranging up to ten years.
In connection with the acquisition of PDR, the Company initially recorded
$.8 million of purchased IPR&D during the second quarter of fiscal 1999. While
the Company had obtained a valuation from an independent appraiser supporting
the amount, consideration of evolving practice surrounding the valuation of
IPR&D resulted in an adjustment to reduce such charge from $.8 million to $.3
million during the second quarter of fiscal 1999. The Company has restated its
second and third quarter financial results to reflect that adjustment. The
effect of the restatement was to decrease the charge for acquired IPR&D from $.8
million to $.3 million, increase core technology from zero to $.5, decrease
assembled workforce from $.3 million to $.2 million and increase outsourcing
operations from $1.3 million to $1.4 million. As a result of these changes, the
net loss for the quarter ended September 30, 1998 decreased to $2.1 million from
$2.6 million and basic and diluted net loss per share for the quarter ended
September 30, 1998 decreased to $(0.42) per share from $(0.49) per share. The
net income for the quarter ended December 31, 1998 was not significantly
impacted by the restatement.
The valuation of acquired IPR&D was based on management's projections of the
after tax net cash flows attributable to the IPR&D. Specifically, the valuation
considers the following: (i) a fair market value premise; (ii) comprehensive due
diligence concerning all potential intangible assets including trademarks and
tradenames, patents, copyrights, non-compete agreements, assembled workforce and
customer relationships and sales channel relationships; (iii) the value
contribution of core technology to the acquired in-process technology, with a
view toward ensuring the relative allocations to core technology and acquired
in-process research and development were consistent with the relative
contributions of each to the final product; and (iv) the calculation used to
determine the value allocated to acquired in-process research and development
considered only the efforts completed as of the transaction date and only the
cash flow associated with said completed efforts for one generation of the
product development efforts in-process at the acquisition date. The charge for
acquired IPR&D relates to one development project in process at the date of the
acquisition that had not reached technological feasibility, had no alternative
future use, and for which ultimate successful development was uncertain. The
conclusion that the development efforts in-process, or any material
sub-component, had no alternative future use was reached in consultation with
engineering personnel from PDR as well as the Company's valuation advisors.
The in-process project consists of the development of PDR's existing Check
Image Processing ("CIP") product, which will allow users to operate the CIP
product on varied operating platforms. The primary project tasks open at the
time of acquisition included completion of porting to various platforms, Year
2000 compliance, enhancing graphics and quality testing. At the time of
acquisition, additional development remained on all tasks (management estimated
that the project was approximately 45% complete) and costs to complete were
estimated to total approximately $200,000. At the time of the acquisition,
management believed that the product being developed would become available for
sale late in fiscal 2000. Interleaf will begin to benefit from the acquired
IPR&D once completed product is sold. Failure to reach successful completion of
this project may result in impairment of the associated capitalized intangible
11
assets, i.e. goodwill and core technology, and/or may require the Company to
accelerate the time period over which the intangibles are being amortized, which
may have a material adverse effect on the Company's results of operations and
financial condition.
Significant assumptions used to determine the value of the acquired IPR&D
included several factors. The first was a forecast of net cash flows that were
expected to result from the in-process development effort using projections
prepared by Interleaf management. Net cash flow projections included projected
revenue growth and trends in profit margins and selling, general and
administrative expense that were consistent with recent historical trends prior
to the acquisition. Second, a percentage complete of 45% for the project
estimated by considering the costs invested to date relative to the expected
total cost of the development effort, supported by the amount of technological
progress completed as of the transaction date relative to the overall
technological achievements required to achieve the intended functionality of the
eventual product. The technological issues were addressed primarily by
engineering representatives from PDR along with the Company's independent
valuation advisors. Third, a 30% discount rate, which represents a rate
equivalent to that which would be employed in a fair value analysis, i.e., one
that considers all cash flows associated with the project and resulting product,
and therefore represents a blended rate of all the risks associated with the
product. Lastly, a core technology charge reflected as one third of after tax
net income related to the in-process project was utilized. This rate represents
an amount that the Company would be required to pay in royalties assuming it had
licensed the products expected to be derived from the acquired in-process
development efforts.
As of March 31, 1999, the technological feasibility of the project had not
yet been reached and no significant departures from the assumptions included in
the valuation analysis have occurred.
Effective September 11, 1998, the Company acquired the Panorama and CD Web
Publishing product lines from Softquad Inc. for $.4 million. The acquisition
provides the Company with products which are complementary to its existing
complex publishing product line and in-process technologies which are expected
to contribute to the development of the Company's new E-content products. The
total fair value of the net assets acquired was approximately $.1 million.
In connection with this acquisition, it has been determined that
technological feasibility of the purchased IPR&D has not been established and
the technology has no alternative future use. Therefore, in accordance with
generally accepted accounting principles, the Company has expensed the amount of
the purchase price allocated to purchased IPR&D of $.2 million. The excess of
purchase price over the fair value of the assets acquired ($.1 million) has been
recorded as goodwill, and will be amortized on a straight line basis over five
years. This acquisition is not considered material to the Company's financial
position or results of operation.
Effective January 1, 1999, the Company acquired 69% of the outstanding
common stock of Interleaf Italia, S.R.L. ("Interleaf Italia"). The Company
previously owned 31% of Interleaf Italia. Interleaf Italia provides
distribution, support and consulting services for Interleaf products in Italy.
The acquisition has been accounted for as a purchase business combination and,
therefore, the operating results of Interleaf Italia have been included in the
Consolidated Statement of Operations since January 1, 1999. The Company paid
cash of $.4 million, issued .3 million shares of common stock valued at $.6
million, warrants to purchase .2 million shares of common stock valued at $.1
million and two future payments of $.2 million each, payable in 12 and 24
months. In connection with the acquisition, the acquired net tangible assets of
Interleaf Italia were recorded at $.3 million, which approximates fair value.
The Company also recorded $1.2 million of goodwill which will be amortized on a
straight line basis over an estimated useful life of seven years.
12
RESULTS OF OPERATIONS
REVENUES
PRODUCT: In the fiscal years ended March 31, 1999, 1998 and 1997, worldwide
product revenues were $9.5 million, $13.3 million and $18.8 million,
respectively, representing 21%, 25% and 29%, respectively, of the Company's
total revenues. There was a decrease in total product revenue of $3.8 million
(29%) in fiscal 1999 from fiscal 1998, and a decrease of $5.5 million (29%) in
fiscal 1998 from fiscal 1997. In fiscal 1999, revenue declined in the Americas
and Asia Pacific segments and increased in Europe in comparison with fiscal
1998. The increase in Europe was mainly attributable to one large order of
approximately $1.0 million and to the acquisition of Interleaf Italia, neither
of which affected fiscal 1998. In fiscal 1998, revenue declined in all
geographic regions in comparison with 1997. The continued decline in product
license revenue was due to several factors. The first factor was the saturation
of the market for high-end authoring software. Second, there was considerable
consolidation in the aerospace/defense industry, where the Company had
historically derived most of its authoring product license revenue. Third,
Windows-based publishing software has become increasingly popular and powerful,
performing an increasing proportion of the complex authoring functions
previously performed only by those products of Interleaf and its complex
authoring competitors.
The Company has refocused its business strategy on providing a new family of
Enterprise Content Management products targeted toward specific vertical
markets. While the Company has built well-accepted integrated document
publishing solutions for individual customers, it has not yet demonstrated the
ability to develop, market and sell Enterprise Content Management products.
There is no assurance that the Company will be successful in implementing this
strategy. In fiscal 1999, the Company made a pre-release version of its
BladeRunner product available through an Early Adopter Program ("EAP").
Additionally, since the Company's services and maintenance revenues are largely
dependent on new product licenses, these revenue components have also
experienced downward pressure, which may continue.
MAINTENANCE: In the fiscal years ended March 31, 1999, 1998 and 1997,
worldwide maintenance revenues were $21.3 million, $26.1 million and $29.0
million, respectively, representing 47%, 50% and 45%, respectively, of the
Company's total revenues. There was a decrease in total maintenance revenue of
$4.8 million (18%) in fiscal 1999 from fiscal 1998, and a decrease of $2.9
million (10%) in fiscal 1998 from fiscal 1997. Future maintenance revenue is
dependent on the Company's ability to maintain its existing customer base, to
release new versions of its traditional products, and to increase maintenance
contract volume related to the new content management products.
SERVICES: Services revenue consists of revenue from consulting, technical
document outsourcing and customer training. During the fiscal years ended March
31, 1999, 1998 and 1997, worldwide revenues from services were approximately
$14.4 million, $13.2 million and $17.0 million, respectively, representing
approximately 32%, 25% and 26% respectively, of the Company's total revenues.
There was an increase in services revenue of $1.2 million (9%) in fiscal 1999
from fiscal 1998, and a decrease of $3.8 million (22%) in fiscal 1998 from
fiscal 1997. The increase in services revenue is mainly attributable to the
operations of PDR, which generated $3.3 million of revenue from date of
acquisition, partially offset by the continuing decrease in services related to
the Company's complex publishing products. The decrease in services revenue in
fiscal 1998 compared with fiscal 1997 is attributable to a decrease in product
revenues due to the maturation of the market for complex authoring products.
Future services revenue is dependent on the Company's ability to maintain its
existing customer base and to increase consulting, technical document
outsourcing and training contracts based on the successful introduction of new
products and growth of its newly acquired technical document outsourcing
business.
13
SOFTWARE AND SERVICES
AMERICAS: Revenues in the Americas were approximately $27.3 million (60%),
$37.3 million (71%) and $41.3 million (64%) of total revenues during fiscal
1999, 1998, and 1997, respectively. The declines in fiscal 1999 and 1998 were
primarily due to a decrease in product license revenue and the related impact on
maintenance and consulting revenues partially offset by revenues from the
acquisition of PDR.
EUROPE: Revenues from the Company's European operations were approximately
$13.5 million (30%), $12.6 million (24%) and $20.2 million (31%) during fiscal
1999, 1998, and 1997, respectively. The increase in revenues in fiscal 1999
compared with fiscal 1998 is primarily attributable to a large order of
approximately $1.0 million and to the previously discussed acquisition of
Interleaf Italia. The decrease in fiscal 1998 compared with fiscal 1997 was
mainly due to lower product revenue and related impact on maintenance and
services revenues.
ASIA/PACIFIC: Revenues from the Company's Asia/Pacific operations were $1.1
million (2%), $2.7 million (5%) and $3.3 million (5%) in fiscal 1999, 1998 and
1997, respectively. The declines in revenues for 1999 and 1998 are attributable
to lower product license revenues and the related impact on maintenance and
service revenue.
OUTSOURCING
AMERICAS: Revenues from outsourcing in fiscal 1999 are comprised solely of
the results of PDR from the date of acquisition, August 31, 1999. As the
acquisition was accounted for as a purchase, there are no comparable amounts
reflected in the financial statements from fiscal 1998 and 1997.
FISCAL 2000
During fiscal 2000 the Company will release its E-content products and
services, which are designed to create, store, manage, reuse and re-purpose
information in the Enterprise Content Management marketplace. To enhance the
functionality of its E-content products, in the first quarter of fiscal 2000 the
Company acquired certain assets and technology of Texcel International A.B., a
former competitor in the Enterprise Content Management marketplace.
During fiscal 2000, the Company plans to continue to develop and release
upgrades to its traditional E-publishing products. The Company has decided to
dedicate separate resources to the development, marketing and support of its
E-publishing and E-content solutions, bringing increased focus and concentrated
efforts to bear on each of these two markets. The Company also plans to continue
to develop E-content product offerings which are focused on at least two
vertical segments of the Enterprise Content Management market.
Growth in revenues during fiscal 2000 will be largely dependent on the
introduction and customer acceptance of the new and enhanced software to be
released in fiscal 2000. Leveraging software products with services to provide
web-based Enterprise Content Management solutions to its customers, improving
sales force productivity and the effectiveness of the Company's investment in
marketing and lead generation programs as well as the ability to grow its
technical document outsourcing business will be key to the Company's ability to
grow.
COSTS OF REVENUES
Cost of product revenues includes amortization of capitalized software
development costs, product media, documentation materials, packaging and
shipping costs, and royalties paid for licensed technology. In the fiscal years
ended March 31, 1999, 1998 and 1997, worldwide cost of product revenues were
$2.6 million, $4.0 million and $7.5 million, respectively, representing 27%, 30%
and 40%, respectively, of
14
the Company's total product revenues. Total cost of product revenue decreased by
$1.4 million (35%) in fiscal 1999 from fiscal 1998 and $3.5 million (47%) in
fiscal 1998 from fiscal 1997. Decreases in the cost of product revenues are
directly attributable to the decreases in product revenue.
In the fiscal years ended March 31, 1999, 1998 and 1997, worldwide cost of
maintenance revenues were $3.0 million, $3.7 million and $4.6 million,
respectively, representing 14%, 14% and 16%, respectively, of the Company's
total maintenance revenues. Total cost of maintenance revenue decreased by $.7
million (19%) in fiscal 1999 from fiscal 1998 and $.9 million (20%) in fiscal
1998 from fiscal 1997. The major reason for the decreases was a reduction in
customer support personnel associated with the fiscal year 1995 and 1997
restructuring.
In fiscal years 1999, 1998 and 1997 worldwide cost of services revenue was
$13.1, $11.3 and $16.0 million, respectively, representing 91%, 86% and 94%,
respectively, of the Company's services revenue. The increase of $1.8 million in
fiscal 1999 is mainly attributable to the acquisition of PDR and additional
service revenues compared with fiscal 1998. The increase in cost of services as
a percentage of revenues reflects the pricing pressure in the Company's
consulting service business coupled with increasing salary and related costs of
consultants. The decrease of $4.7 million in 1998 compared with 1997 is due to a
decline in product and services revenue and to the fiscal 1997 restructuring.
OPERATING EXPENSES
SELLING, GENERAL AND ADMINISTRATIVE ("SG&A"): SG&A expenses decreased by
$2.4 million in fiscal 1999 compared with fiscal 1998 and by $14.8 million in
fiscal 1998 compared with fiscal 1997. The decrease in fiscal 1999 compared with
fiscal 1998 is primarily due to a continued focus on stringent cost controls by
management, including an expense reduction initiative which began in September
1998. Additionally, SG&A expense was reduced by $.2 million as a result of the
adjustment of certain accrued expenses for which it was determined an accrual
was no longer necessary. The decrease in fiscal 1998 compared with fiscal 1997
was primarily due to significant personnel and facilities expense reductions
related to the Company's fiscal 1995 and 1997 restructurings.
RESEARCH AND DEVELOPMENT ("R&D"): R&D expenses consist primarily of
personnel expenses to support product development, net of capitalized software
development costs. In fiscal 1999, the Company's total product development and
engineering expenses including capitalized software development costs, were $8.9
million representing 20% of total revenues. The total investment in R&D includes
$7.5 million charged to R&D expense and $1.4 million of capitalized software
development costs. During the fiscal years ended March 31, 1998 and 1997, the
Company's product development and engineering expenses, were approximately $8.9
million and $15.0 million, respectively, representing 17% and 23%, respectively,
of the Company's total revenues. There were no software development costs
capitalized in fiscal 1998. After consideration of $1.4 million of capitalized
software costs, R&D expense in fiscal 1999 was comparable with fiscal 1998. In
fiscal 1999 the Company focused its R&D activities in the development of content
management products and a successful release of its flagship complex publishing
software, Interleaf 7, while benefiting from a focus on expense control. R&D
expenses decreased by $6.1 million (41%) in fiscal 1998 from fiscal 1997. The
decrease in R&D expenses in fiscal 1998 compared with fiscal 1997 is due to a
decrease in personnel costs resulting from the 1997 restructuring.
15
INCOME TAXES
In fiscal 1999, the tax provision consists mainly of taxes payable in Italy
and a U.S. Federal alternative minimum tax. In fiscal 1998, an alternative
minimum tax provision was provided. For fiscal year 1997, no tax provision was
required due to the losses sustained during the year.
The Company has net operating loss carryforwards of approximately $49
million in several tax jurisdictions to offset future taxable income. In
addition, the Company has tax credit carryforwards of approximately $11 million
to offset federal and state income tax liabilities. Therefore, the Company
expects to pay minimal income taxes for the foreseeable future.
LIQUIDITY AND CAPITAL RESOURCES
SOURCES AND USES
The Company had $16.5 million of cash and cash equivalents at March 31,
1999, a decrease of $4.6 million from March 31, 1998. The decrease in cash is
mainly attributable to the following:
[Enlarge/Download Table]
(AMOUNT IN
MILLIONS)
-------------
Sources of Cash
Private placement proceeds......................................................................... $ 3.9
Cash generated by operations....................................................................... .5
Effect of exchange rate changes on cash............................................................ .1
-----
4.5
-----
Uses of Cash
Redemption of the Company's Series C and Series D preferred stock $ (3.8)
Acquisitions....................................................................................... (2.7)
Capitalized software costs......................................................................... (1.4)
Capital expenditures............................................................................... (.9)
Dividend payments.................................................................................. (.3)
-----
(9.1)
-----
Net Change........................................................................................... $ (4.6)
-----
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During the third quarter of fiscal 1999, the Company redeemed 100% of its
Series C Convertible Preferred Stock ("Series C Stock") for $1.6 million.
Additionally, dividends on the Series C Stock accrued at September 30, 1998
totaling $.2 million were waived and will not be paid. For purposes of the 1999
basic earnings per share calculation, this redemption resulted in $8.1 million
being added to net income to arrive at net income available to common
shareholders. The $8.1 million represents the excess of the carrying amount of
the Series C Stock over the fair value of the consideration paid by the Company.
On September 30, 1997, the Company completed a private placement resulting
in net proceeds to the Company of $6.8 million from the issuance of 7,625 shares
of 6% Convertible Preferred Stock ("Series D Stock") and placement agent
warrants to purchase 763 additional shares of Series D Stock.
On November 4, 1998, the Company reached agreement with the holders of 79%
of its Series D Stock outstanding, pursuant to which all of the Series D Stock
held by such persons (5,487 shares out of 6,987 outstanding) was converted into
a total of approximately $2.2 million in cash and approximately 1.2 million
shares of Common Stock. This conversion occurred on November 18, 1998. The
shares of Common Stock issued to the former holders of Series D Stock are held
subject to the restrictions on re-sale, prohibitions against short-selling and
the other terms and conditions of the Preferred Stock Investment Agreement under
which the Series D Stock was originally issued. For purposes of the 1999 basic
earnings per share calculation, this conversion resulted in $.7 million being
added to net income to arrive at net income
16
available to common shareholders. The $.7 million represents the excess of the
carrying amount of Series D Stock over the fair value of consideration paid by
the Company.
Subsequent to March 31, 1999, the holder of all remaining outstanding shares
of Series D Stock converted all of such shares into common stock.
The Company financed the redemption of the Series C Stock and the cash
portion of the conversion of the Series D Stock out of its existing working
capital and the sale of Common Stock to investors in a private placement
described below.
Between November 18 and December 15, 1998, the Company entered into
agreements with certain officers, directors and existing stockholders of the
Company under which each of them granted to the Company an option to require
each to purchase a specified number of shares of Common Stock, up to an
aggregate maximum of 1,761,167 shares if Interleaf exercised its option in full,
at an exercise price of $2.40 per share. On February 11, 1999, the Company
exercised its option in full and the 1,761,167 shares were issued on February
16, 1999 and the Company received $3.9 million in cash proceeds, net of issuance
costs.
For the year ended March 31, 1999, the Company paid approximately $2.0
million, net of sublease receipts, related to the fiscal 1997 and 1995
restructurings, compared to $3.1 million paid during the same period in fiscal
1998. Cash payments related to these restructurings, the majority of which are
related to operating lease payments, net of subleases, are anticipated to
continue until December 2000. All significant vacant space under lease has been
subleased.
At March 31, 1999, the Company had outstanding letters of credit aggregating
$.9 million which expire between July 31, 1999 and October 31, 2001. These
letters of credit guarantee payments on two leases and the future amounts
payable for the acquisition of Interleaf Italia (see Note 3 to Financial
Statement). The letters of credit are secured by equal amounts of cash and are
reduced by the amount of the respective payments.
At March 31, 1999 and March 31, 1998, the Company had approximately $1.1
million of cash restricted for potential payment of a withholding tax assessment
on its German subsidiary related to payments remitted to the United States from
Germany in 1990. The Company is appealing this assessment.
The Company believes its current cash balances and cash generated from
operations, combined with the cash proceeds from the private placement
(previously discussed), offset by restructuring payments, will be sufficient to
meet the Company's liquidity needs for fiscal 2000 and the foreseeable future.
However, the Company may determine that it needs to increase its investment in
the development, marketing and promotion of its E-content solutions, and in such
event it would be necessary for the Company to raise additional capital. The net
tangible asset listing criteria for the NASDAQ National Market and the Company's
financial condition may necessitate that any such financing be an equity
financing. The Company cannot guaranty that such financing can be obtained or
that it can be obtained on commercially reasonable terms or without incurring
substantial dilution to existing stockholders.
EFFECTS OF INFLATION AND FOREIGN EXCHANGE
Although the Company cannot accurately determine the precise effect of
inflation on its operations, it does not believe inflation has had a material
effect on its revenues or its results of operations. Management does not expect
inflation to have a significant impact on operations in the foreseeable future.
The Company maintains development and sales and support facilities in
several locations worldwide, including, Belgium, England, France, Germany,
Italy, Australia and Japan, among others. A significant amount of the Company's
business is conducted with companies located in these and other countries and
certain transactions may be denominated in currencies other than the U.S.
dollar. As a result, the Company may experience transaction gains and losses as
a result of currency fluctuations. In order to minimize its exposure to loss
from changes in foreign currency exchange rates, the Company's subsidiaries
17
pay foreign denominated liabilities, mainly denominated in U.S. dollars, as soon
as is practicable. The Company traditionally has not hedged its foreign currency
exposure; however, it is not precluded from using forward exchange contracts in
the future if the need arises.
The Company may be subject to losses resulting from unanticipated changes in
foreign currency exchange rates. The market factors that expose the Company in
this regard include economic conditions in which the Company conducts business.
The Company expects to continue to engage in practices to minimize transaction
gains and losses as a result of currency fluctuations in the future, to the
extent appropriate. Historically, actual results of the Company's foreign
currency risk management procedures have been in line with management's
expectations and have not resulted in significant gains or losses; however, the
Company cannot guaranty that it will not experience significant gains or losses
from currency exchange in the future.
IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
COMPREHENSIVE INCOME. In June 1997, the Financial Accounting Standards
Board ("FASB") issued Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income" ("SFAS 130"). This Statement requires
disclosure of comprehensive income, as defined, and its components in interim
and annual financial statements. Components of comprehensive income include any
changes in equity during a period that are not the result of transactions with
owners including cumulative foreign currency translation adjustments and minimum
pension liabilities, if any. The Company adopted SFAS 130 during fiscal 1999.
The adoption of SFAS 130 pertains to disclosure only and, accordingly, had no
impact on the Company's consolidated financial position or results of
operations.
SEGMENT REPORTING. In June 1997, the FASB issued Statement of Financial
Accounting Standards No. 131, "Disclosure about Segments of an Enterprise and
Related Information" ("SFAS 131"). SFAS 131 requires an enterprise to report
financial and descriptive information about its reportable operating segments.
Operating segments are components that were reviewed regularly by chief
operating decision makers, as defined, in determining resource allocations and
in assessing performance. SFAS 131 requires a business enterprise to report a
measure of segment profit or loss, certain specific revenue expense items
(including interest, depreciation, and income taxes, if utilized by management),
and segment assets if utilized by management in a decision making capacity. It
also established standards for related disclosures about products and services,
geographic areas, and major customers. The Company adopted SFAS 131 in fiscal
1999. The adoption of SFAS 131 pertains to disclosure only and, accordingly, had
no impact on the Company's consolidated financial position or results of
operations.
FINANCIAL INSTRUMENTS. On June 15, 1998, the FASB issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). This Statement is effective for all fiscal
quarters of all fiscal years beginning after June 15, 1999 (April 1, 2000 for
the Company) and requires that all derivative instruments be recorded on the
balance sheet at their fair value. Changes in the fair value of derivatives are
recorded each period in current earnings or other comprehensive income,
depending on whether a derivative is designated as part of a hedge transaction
and, if it is, the type of hedge transaction. The Company believes the adoption
of SFAS 133 will have no material impact to its operating results or financial
position.
YEAR 2000
BACKGROUND
Some computers, software, and other equipment include programming code in
which calendar year data is abbreviated to only two digits. As a result of this
design decision, some of the systems do not properly recognize a year that
begins with "20" instead of "19". These problems are widely expected to
18
increase in frequency and severity as the year 2000 approaches, and are commonly
referred to as the "Millenium Bug" or "Year 2000 problem".
INTERLEAF APPROACH
Interleaf established a Year 2000 project team to address all aspects of the
Year 2000 problem in each area of its business. The project team has four areas
of focus, each with its own project manager. These four areas are: (1) the
software that is created by Interleaf and sold to customers; (2) internal
business systems; (3) the hardware and operating system software used by
employees; and (4) facilities and critical vendors other than computer
suppliers.
INTERLEAF CREATED PRODUCTS
Assessment:
In 1997 Interleaf began to focus on the Year 2000 problem regarding its
software products created for sale to customers. Products that generate the most
revenue or create the highest risk were prioritized for testing and repair. The
assessment of these products was completed in early 1998 and the repair process
begun. The Company made the decision to discontinue sales and support for
certain low volume products and computer platforms.
Customer Communications:
The Company sent a description of its Year 2000 product strategy to all of
its maintenance customers. It created and is maintaining a Year 2000 product
status page as part of its web site. Interleaf distributed another mailing to
the entire maintenance base describing the status of the year 2000 releases and
a list of retired products and platforms, in the fourth quarter of calendar year
1998.
Status:
Most major products have been tested and modified for most of the computer
platforms that will be supported beyond the year 2000. Upgrades which correct
any known Year 2000 problems with those products are available at no extra
charge to the customers with current maintenance contracts. Year 2000 upgrades
were all completed for supported products by the end of the second calendar
quarter of 1999 for all major products and platforms. The extent of the changes
required ranges from simple recompilation with Year 2000 compliant operating
systems to extensive modifications.
Testing and repair of layered applications and low volume products has begun
and will be completed by the end of September, 1999. The Company expects that
the layered applications will not require significant modifications, since
initial analysis has indicated that there is no date handling performed by these
products. Moreover, in many instances the Company created layered applications
under specific contracts with specific customers, and not for general re-sale.
The Company believes that it has no obligation to modify those applications to
address the Year 2000 problem, unless the particular customers engage Interleaf
to fix those problems. All products under development are being developed to be
Year 2000 compliant. The Company has received notices from a small number of
customers regarding non-compliance of unsupported products, and to date the
Company has successfully resolved those issues without material cost. The
Company cannot predict whether or not claims may be asserted with respect to
non-supported products, either due to a breakdown in the customer communications
process, to contractual obligations not understood by its customer or by
Interleaf, or for other reasons.
INTERNAL BUSINESS SYSTEMS
In the United States, Interleaf contracted an independent third party to
perform Year 2000 compliance testing on its critical internal business systems.
Some problems were identified and appropriate modifications were made. The
systems were then re-tested and performed successfully. The software vital
19
to corporate operations has been proven by the independent third party to
function without problems related to the millenium change. The Company has
investigated and received assurances from the vendors that all critical internal
business software in North America and Europe is Year 2000 ready.
The assessment phase is now underway for business software used in Japan and
Australia. The Company intends to have compliance assured by October 1999.
HARDWARE AND OPERATING SYSTEMS SOFTWARE
Assessment of the systems used by employees began in early 1997 and has been
completed. The Company has developed a plan to upgrade or replace all critical
systems used by employees, including all hardware in the enterprise from servers
to laptops. The upgrade/replacement process began in early 1998 and is
approximately 70% complete. The entire process is to be complete by the end of
September 1999.
FACILITIES AND CRITICAL VENDORS
In the fourth calendar quarter of 1998 Interleaf began discussions with
facility management of its leased office spaces to ensure that the proper
actions are taken to avoid disruption of productivity in all Interleaf
facilities. Two major elements of Interleaf's business, payroll and
manufacturing, are outsourced. Interleaf has been assured by those service
providers that operation of these critical business areas will not be affected
by the Millenium change.
COST
The costs of the Interleaf Year 2000 efforts are being funded out of cash
flow from operations. The total cost associated with the required modifications
and upgrades associated with the Year 2000 projects is not expected to be
material to the Company's financial position. The process of repairing and
testing the software that Interleaf creates for sale has been done with existing
personnel. The Year 2000 testing equipment and lab environment have been created
using existing equipment and space. The capital costs associated with the
upgrade and replacement of corporate and field office computing environments is
expected to be $400,000. These expenditures began in late 1997 and will continue
through the third calendar quarter of 1999. Software maintenance costs
attributable to the Year 2000 process will be approximately $50,000. Labor
associated with this process of implementing the internally used systems was
provided by existing budgeted personnel.
RISK
Interleaf has made a significant effort to address its Year 2000 issues. At
this time, there are no identifiable significant risks associated with its Year
2000 readiness, although there is a risk that unanticipated problems may arise.
The Company has prepared a contingency plan to address reasonably likely worst
case business operations scenarios.
RISK FACTORS
The following risk factors should be carefully considered in evaluating the
Company and its business.
INTERLEAF IS DEPENDENT ON THE SUCCESS OF ITS NEW E-CONTENT PRODUCTS AND
SERVICES.
Interleaf's strategy for future growth depends upon the successful
development, introduction and customer acceptance of new and improved products
and services such as its Enterprise Content Management products and services.
Enterprise Content Management refers to processes and technology which enable a
business enterprise to create and package information content (such as text,
graphics, documents and hyperlinks) from throughout an organization and its
business partners as part of a dynamic, integrated web-based solution. There is
a risk that the market for Enterprise Content Management products and
20
services may not grow, that Interleaf may not be successful in developing
Enterprise Content Management software, or that the marketplace may not accept
Interleaf's software. Interleaf's new products are based on the "XML" language
(eXtensible Markup Language). There are risks that this new technology will
change, and as a result the new products when released will not meet market and
customer requirements. There is also a risk that XML will be supplanted as the
de facto standard in the Enterprise Content Management market, and that
BladeRunner will become obsolete or the Company will be forced to migrate the
product to a new technology.
INTERLEAF'S QUARTERLY OPERATING RESULTS MAY FLUCTUATE.
Interleaf believes that period-to-period comparisons of its results of
operations are not necessarily meaningful and that investors should not rely on
them as indications of future performance because of the following factors:
- Interleaf typically ships a substantial amount of its products in the
final weeks, or even the final days, of each quarter;
- The length of Interleaf's sales cycle makes it difficult to predict when
Interleaf will receive license revenue; and
- Any shortfall or delay in the recognition of revenue from even a limited
number of license transactions could cause significant variations in
Interleaf's operating results from quarter to quarter because Interleaf's
expenses are relatively fixed.
These factors also increase the risk that Interleaf's results in some
quarters will be below the expectations of stock analysts or investors. Such an
"earnings surprise" frequently will result in a drop in the market price of a
company's stock.
THERE IS INTENSE COMPETITION IN INTERLEAF'S TECHNICAL DOCUMENTATION AND
ENTERPRISE CONTENT MANAGEMENT MARKETS.
The market for Interleaf's existing technical documentation products is very
competitive, subject to rapid change and significantly affected by activities of
other industry participants. Several competitors in that market have greater
market penetration, greater name recognition, a larger installed base of
customers and significantly greater financial, technical and marketing resources
than Interleaf.
While Interleaf has identified its primary existing competitors in the
Enterprise Content Management market, this market is still developing and
subject to rapid change. As a result, new competitors may emerge very quickly,
or very large companies such as Microsoft Corporation may decide to enter the
market, presenting significant competitive challenges and causing confusion and
turmoil in the market.
INTERLEAF NEEDS TO MAINTAIN A GOOD WORKING RELATIONSHIP WITH MICROSOFT, AND TO
DEVELOP NEW RELATIONSHIPS WITH OTHER COMPANIES.
Interleaf also needs to maintain a good working relationship with Microsoft
Corporation, since many of Interleaf's products are designed to be accessed
using Microsoft software such as Microsoft Word, Office, SQL Server and NT.
Interleaf believes that market penetration and acceptance of its new Enterprise
Content Management products will depend significantly on developing
relationships with companies that will promote, market, re-sell and integrate
BladeRunner, including relationships with third party resellers, system
integrators and other companies. Interleaf cannot guaranty that it will be able
to develop and maintain these relationships.
21
INTERLEAF'S INTELLECTUAL PROPERTY HAS LIMITED PROTECTION; OTHERS COULD
MISAPPROPRIATE INTERLEAF'S INTELLECTUAL PROPERTY AND INTERLEAF MAY NOT BE ABLE
TO ENFORCE ITS RIGHTS; INTERLEAF'S INTELLECTUAL PROPERTY COULD INFRINGE ON
RIGHTS OF OTHERS.
Interleaf's success is heavily dependent upon the protection of its
proprietary technology through a combination of copyrights, trademarks, patents,
trade secrets and technical measures. There is the risk that Interleaf's
attempts to protect its rights will not be adequate and that competitors may
independently develop similar technology. Interleaf seeks to protect its
software, documentation and other written materials primarily under trade secret
and copyright laws, which afford only limited protection. The laws of some
foreign countries do not provide the same level of protection to Interleaf's
proprietary rights as do the laws of the United States. Policing unauthorized
use of Interleaf's products is difficult. While Interleaf cannot determine the
extent to which piracy of its software products exists, some software piracy can
be expected.
Interleaf is not aware that any of its products infringe the proprietary
rights of third parties. However, in the future, third parties may claim that
Interleaf's current or future products infringe on their proprietary rights.
Claims of this type could be very time-consuming, result in costly litigation,
cause product shipment delays or require Interleaf to enter into costly royalty
or licensing agreements.
INTERLEAF'S FOREIGN SALES AND FINANCIAL RESULTS MAY FLUCTUATE BECAUSE OF
CURRENCY EXCHANGE RATE FLUCTUATIONS.
Interleaf generates sales primarily in U.S. dollars, British pounds, and
Euros and incurs expenses principally in the same currencies. Fluctuations in
the value of the U.S. dollar and foreign currencies have caused, and are likely
to continue to cause, amounts translated into U.S. dollars to fluctuate in
comparison with previous periods. Interleaf generally has not attempted to limit
its foreign currency exposure through foreign currency exchange rate hedging
transactions. Exchange rate fluctuations or other risks associated with
international operations may have a material adverse affect on Interleaf's
business, financial condition and results of operations. Interleaf's worldwide
business operations also may be affected by changes in demand resulting from
these currency exchange rate fluctuations, as well as by governmental controls
and other risks associated with international sales (such as changes in various
regulatory requirements, political and economic changes and disruptions,
export/import controls, tariff regulations, difficulties in staffing and
managing foreign sales and support operations, greater difficulties in trade
accounts receivable collection, and possibly adverse tax consequences).
YEAR 2000 PROBLEMS COULD AFFECT INTERLEAF'S BUSINESS.
Some computers, software, and other equipment include programming code in
which calendar year data is abbreviated to only two digits. As a result of this
design decision, some of the systems do not properly recognize a year that
begins with "20" instead of "19". These problems are widely expected to increase
in frequency and severity as the year 2000 approaches, and are commonly referred
to as the "Millennium Bug" or "Year 2000 problem". Interleaf has made
significant efforts to address its Year 2000 issues, as described above. At this
time, there are no identifiable significant risks associated with its Year 2000
readiness, although there is a risk that unanticipated problems may arise. Any
costs, which are not expected to be material, that are associated with
compliance efforts are being funded out of cash flow from operations.
RECENT ACQUISITIONS HAVE RISKS.
As part of its business strategy to acquire and develop new products and
services, Interleaf acquired PDR and the remaining outstanding capital of
Interleaf Italia Srl and certain assets of Softquad and Texcel International AB
during the last year. The risks related to these acquisitions include, among
others, the difficulty of assimilating the operations, information systems and
personnel of the acquired businesses;
22
difficulties in assimilating the acquired products into Interleaf's current and
future products, sales force and sales channels; the risk that customers of the
acquired businesses will react unfavorably to the acquisition and as a result
Interleaf will not reap the benefits that it had expected; and difficulties in
retaining and integrating employees of the acquired businesses.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INTERLEAF, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
The following consolidated financial statements and schedules of Interleaf,
Inc. and subsidiaries, and report, are included herein:
[Enlarge/Download Table]
DESCRIPTION PAGE
----------------------------------------------------------------------------------------------------------- -----
Report of Management....................................................................................... 24
Consolidated Statement of Operations for the Years Ended March 31, 1999, 1998, and 1997.................... 25
Consolidated Balance Sheet at March 31, 1999 and 1998...................................................... 26
Consolidated Statement of Changes in Shareholders' Equity (Deficit) for the Years Ended March 31, 1999,
1998, and 1997........................................................................................... 27
Consolidated Statement of Cash Flows for the Years Ended March 31, 1999, 1998, and 1997.................... 28
Notes to Consolidated Financial Statements................................................................. 29
Report of Independent Accountants.......................................................................... 50
Report of Independent Auditors............................................................................. 51
Schedule II--Valuation and Qualifying Accounts............................................................. 52
All other schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable, and therefore have been omitted.
23
REPORT OF MANAGEMENT
The financial statements, including all related financial information
presented in the Annual Report, were prepared by management, and management is
responsible for their fairness, integrity and objectivity. These statements have
been prepared in accordance with generally accepted accounting principles, and
include amounts that are based on management's best estimates and judgement and
incorporate accounting policies that are reasonable and prudent for the
Company's business environment. The financial statements as of March 31, 1999
and for the year then ended have been audited by our independent public
accountants, PricewaterhouseCoopers, and their report is included elsewhere
herein. The financial statements as of March 31, 1998 and for the two years then
ended were audited by Ernst & Young and their report is included elsewhere
herein.
The Company maintains accounting and control systems and believes the
internal control systems in use are sufficient to provide reasonable assurance
that assets are safeguarded against material loss and are properly accounted
for, and that transactions are properly recorded in the financial records used
in preparing the financial statements.
The Company has distributed throughout the organization its policies for
financial control. Management believes that its policies and the monitoring of
compliance with these policies provide reasonable assurance that its operations
are adhering to prescribed financial policy.
The Board of Directors carries out its responsibility for these financial
statements through its Audit Committee, composed of non-employee directors. The
Audit Committee reviews the financial statements before they are released for
publication. The Audit Committee meets periodically with the senior financial
officers and PricewaterhouseCoopers. It reviews the audit scope, significant
financial transactions, major accounting issues and recommendations of
PricewaterhouseCoopers. PricewaterhouseCoopers has full and free access to the
Audit Committee and meets with its members, with and without management being
present, to discuss internal control, auditing and financial reporting matters.
/s/ JAIME W. ELLERTSON
-------------------------------------------
Jaime W. Ellertson
President and Chief Executive Officer
/s/ PETER J. RICE
-------------------------------------------
Peter J. Rice
Vice President
24
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED STATEMENT OF OPERATIONS
[Enlarge/Download Table]
YEAR ENDED MARCH 31
1999 1998 1997
--------- --------- ---------
(IN THOUSANDS, EXCEPT FOR PER
SHARE AMOUNTS)
Revenues:
Products.............................................................................. $ 9,451 $ 13,335 $ 18,821
Maintenance........................................................................... 21,295 26,083 28,972
Services.............................................................................. 14,448 13,159 17,030
--------- --------- ---------
Total revenues........................................................................ 45,194 52,577 64,823
--------- --------- ---------
Costs of Revenues:
Products.............................................................................. 2,582 3,966 7,502
Maintenance........................................................................... 3,018 3,747 4,561
Services.............................................................................. 13,118 11,324 16,041
--------- --------- ---------
Total costs of revenues............................................................... 18,718 19,037 28,104
--------- --------- ---------
Gross margin.......................................................................... 26,476 33,540 36,719
--------- --------- ---------
Operating Expenses:
Selling, general and administrative................................................... 19,834 22,281 37,114
Research and development.............................................................. 7,487 8,897 14,994
Purchased in-process research and development......................................... 611 -- --
Write-down of intangible assets....................................................... -- -- 2,288
Restructuring charge.................................................................. -- -- 10,942
--------- --------- ---------
Total operating expenses.............................................................. 27,932 31,178 65,338
--------- --------- ---------
Income (loss) from operations......................................................... (1,456) 2,362 (28,619)
Other income (expenses)............................................................... 537 153 (931)
--------- --------- ---------
Income (loss) before income taxes..................................................... (919) 2,515 (29,550)
Provision for income taxes............................................................ 206 79 --
--------- --------- ---------
Net income (loss)..................................................................... (1,125) 2,436 (29,550)
Dividends on Preferred Stock.......................................................... (565) (458) --
Gain on preferred stock redemption.................................................... 8,771 -- --
--------- --------- ---------
Net income applicable to common shareholders- basic earnings per share................ 7,081 1,978 (29,550)
Effect of dilutive securities
Dividends on preferred stock........................................................ 492 230 --
Gain on preferred stock redemption.................................................. (8,771) -- --
--------- --------- ---------
Net income (loss) applicable to common shareholders- diluted earnings per share....... $ (1,198) $ 2,208 $ (29,550)
--------- --------- ---------
--------- --------- ---------
INCOME PER SHARE:
Basic................................................................................. $ 1.01 $ 0.33 $ (5.11)
--------- --------- ---------
--------- --------- ---------
Diluted............................................................................... $ (0.14) $ 0.27 $ (5.11)
--------- --------- ---------
--------- --------- ---------
Shares used in computing income per share
Basic................................................................................. 7,019 5,952 5,781
--------- --------- ---------
--------- --------- ---------
Diluted............................................................................... 8,687 8,269 5,781
--------- --------- ---------
--------- --------- ---------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS
25
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED BALANCE SHEET
[Enlarge/Download Table]
MARCH 31,1999 MARCH 31, 1998
------------- --------------
IN THOUSANDS, EXCEPT FOR
SHARE AND PER SHARE AMOUNTS
ASSETS
Current assets
Cash and cash equivalents......................................................... $ 16,479 $ 21,112
Accounts receivable, net of reserve for doubtful accounts of $1,123 at March 31,
1999 and $1,364 at March 31, 1998............................................... 12,008 12,706
Prepaid expenses and other current assets......................................... 1,541 838
------------- --------------
Total Current Assets.............................................................. 30,028 34,656
Property and equipment, net....................................................... 2,120 3,321
Intangible assets, net............................................................ 5,222 583
Other assets...................................................................... 442 828
------------- --------------
Total Assets...................................................................... $ 37,812 $ 39,388
------------- --------------
------------- --------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable.................................................................. $ 2,224 $ 2,079
Accrued expenses.................................................................. 11,184 11,657
Unearned revenue.................................................................. 11,492 12,136
Accrued restructuring............................................................. 953 2,143
------------- --------------
Total Current Liabilities......................................................... 25,853 28,015
Long-term restructuring........................................................... 1,234 2,063
------------- --------------
Total Liabilities................................................................. 27,087 30,078
------------- --------------
Redeemable common stock, shares issued and outstanding, 469,093 at March 31,1999
and none at March 31, 1998...................................................... 1,496 --
------------- --------------
Shareholders' Equity
Preferred stock, par value $.10 per share, authorized 5,000,000 shares:
Series A Junior Participating, none issued and outstanding........................
Senior Series B Convertible, shares issued and outstanding, 726,003 at March 31,
1999 and 861,911 at March 31, 1998.............................................. 73 86
Series C Convertible, shares issued and outstanding, none at March 31, 1999 and
1,010,348 at March 31, 1998..................................................... -- 101
6% Convertible, shares issued and outstanding, 1,050 at March 31, 1999 and 7,625
at March 31, 1998............................................................... -- 1
Common stock, par value $.01 per share, authorized 50,000,000 shares, issued and
outstanding, 9,913,209 at March 31, 1999 and 6,051,770 at March 31, 1998........ 99 61
Additional paid-in capital........................................................ 94,795 93,490
Retained earnings (accumulated deficit)........................................... (85,197) (84,072)
Accumulated other comprehensive loss.............................................. (541) (357)
------------- --------------
Total Shareholders' Equity........................................................ 9,229 9,310
------------- --------------
Total Liabilities and Shareholders' Equity........................................ $ 37,812 $ 39,388
------------- --------------
------------- --------------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS
26
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT)
[Enlarge/Download Table]
PREFERRED
PREFERRED STOCK PREFERRED ADDITIONAL RETAINED
STOCK SENIOR SENIOR STOCK 6% COMMON PAID-IN EARNINGS
SERIES B SERIES C CONVERTIBLE STOCK CAPITAL (DEFICIT)
------------- ----------- --------------- ------------- ----------- ---------
(IN THOUSANDS)
Balances at March 31, 1996.................... 92 -- -- 57 72,458 (56,958)
Net Loss...................................... -- -- -- -- -- (29,550)
Cumulative translation adjustment............. -- -- -- -- -- --
Comprehensive loss............................
Conversion of Senior Series B Convertible
Preferred stock into common stock........... (6) -- -- -- 6 --
Issuance and obligations of Series C
Convertible Preferred stock................. -- 101 -- -- 9,289 --
Common stock issued in connection with stock
options exercised by employees.............. -- -- -- -- 449 --
Common stock issued in connection with
employee stock purchase plan................ -- -- -- 739 --
Common stock issued in connection with
acquisition................................. -- -- -- 1 2,689 --
--- --- --- --- ----------- ---------
Balances at March 31, 1997.................... 86 101 -- 58 85,630 (86,508)
Net Income.................................... -- -- -- -- -- 2,436
Cumulative translation adjustment............. -- -- -- -- -- --
Comprehensive income..........................
Common stock issued in connection with stock
options exercised by employees.............. -- -- -- 2 1,273 --
Issuance of Series C Convertible Preferred
Stock....................................... -- -- -- -- 29 --
Common stock issued in connection with
employee stock purchase plan................ -- -- -- 1 220 --
Issuance of 6% Convertible Preferred Stock.... -- -- 1 -- 6,796 --
Dividends on Preferred Stock.................. -- -- -- -- (458) --
--- --- --- --- ----------- ---------
Balances at March 31, 1998.................... 86 101 1 61 93,490 (84,072)
Net Loss...................................... -- -- -- -- -- (1,125)
Cumulative translation adjustment............. -- -- -- -- -- --
Comprehensive (loss)..........................
Conversion of Senior Series B Convertible and
6% Convertible preferred stock into common
stock....................................... (13) -- -- 5 8 --
Dividends on Preferred Stock.................. -- -- -- -- 105 --
Common stock issued in connection with stock
options exercised by employees.............. -- -- -- -- 40 --
Common stock issued in connection with
employee stock purchase plan................ -- -- -- 1 293 --
Redemption of Series C and 6% Convertible
preferred stock............................. -- (101) (1) 11 (3,700) --
Common stock issued in connection with
acquisitions................................ -- -- -- 3 700 --
Common stock issued in connection with private
placement................................... -- -- -- 18 3,859 --
--- --- --- --- ----------- ---------
Balance at March 31, 1999..................... $ 73 -- -- $ 99 $ 94,795 $ (85,197)
--- --- --- --- ----------- ---------
ACCUMULATED TOTAL
OTHER SHAREHOLDERS'
COMPREHENSIVE EQUITY
INCOME (LOSS) (DEFICIT)
--------------- -------------
Balances at March 31, 1996.................... (230) 15,419
-------------
Net Loss...................................... -- (29,550)
Cumulative translation adjustment............. 91 91
-------------
Comprehensive loss............................ (29,459)
-------------
Conversion of Senior Series B Convertible
Preferred stock into common stock........... -- --
Issuance and obligations of Series C
Convertible Preferred stock................. -- 9,390
Common stock issued in connection with stock
options exercised by employees.............. -- 449
Common stock issued in connection with
employee stock purchase plan................ -- 739
Common stock issued in connection with
acquisition................................. -- 2,690
----- -------------
Balances at March 31, 1997.................... (139) (772)
-------------
Net Income.................................... -- 2,436
Cumulative translation adjustment............. (218) (218)
-------------
Comprehensive income.......................... 2,218
-------------
Common stock issued in connection with stock
options exercised by employees.............. -- 1,275
Issuance of Series C Convertible Preferred
Stock....................................... -- 29
Common stock issued in connection with
employee stock purchase plan................ -- 221
Issuance of 6% Convertible Preferred Stock.... -- 6,797
Dividends on Preferred Stock.................. -- (458)
----- -------------
Balances at March 31, 1998.................... (357) 9,310
-------------
Net Loss...................................... -- (1,125)
Cumulative translation adjustment............. (184) (184)
-------------
Comprehensive (loss).......................... (1,309)
-------------
Conversion of Senior Series B Convertible and
6% Convertible preferred stock into common
stock....................................... -- --
Dividends on Preferred Stock.................. -- 105
Common stock issued in connection with stock
options exercised by employees.............. -- 40
Common stock issued in connection with
employee stock purchase plan................ -- 294
Redemption of Series C and 6% Convertible
preferred stock............................. -- (3,791)
Common stock issued in connection with
acquisitions................................ -- 703
Common stock issued in connection with private
placement................................... -- 3,877
----- -------------
Balance at March 31, 1999..................... $ (541) $ 9,229
----- -------------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS
27
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED STATEMENT OF CASH FLOWS
[Enlarge/Download Table]
YEAR ENDED MARCH 31
1999 1998 1997
--------- --------- ---------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss).................................................................. $ (1,125) $ 2,436 $ (29,550)
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Write-off of intangible assets................................................... -- -- 2,288
Restructuring charge............................................................. -- -- 10,942
Depreciation and amortization expense............................................ 2,680 4,174 9,706
Purchased in-process research & development...................................... 611 -- --
Loss from disposal of property and equipment..................................... -- -- 212
Changes in assets and liabilities, net of acquired amounts: (Increase) decrease in
accounts receivable, net......................................................... 3,120 (1,712) 8,126
(Increase) decrease in other assets.............................................. 51 (322) 309
Decrease in accounts payable and accrued expenses................................ (2,054) (1,519) (172)
Decrease in unearned revenue..................................................... (1,037) (2,737) (730)
Decrease in other liabilities.................................................... (1,731) (2,970) (4,379)
Other, net....................................................................... 45 -- 410
--------- --------- ---------
Net cash provided by (used in) operating activities................................ 560 (2,650) (2,838)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures............................................................... (903) (1,151) (1,816)
Acquisitions net of cash acquired.................................................. (2,741) -- --
Capitalized software development costs............................................. (1,401) -- (1,113)
--------- --------- ---------
Net cash used in investing activities.............................................. (5,045) (1,151) (2,929)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from issuance of preferred stock...................................... -- -- 9,390
Net proceeds from issuance of 6% preferred stock................................... -- 6,796 --
Net proceeds from issuance of common stock......................................... 3,877 1,496 1,250
Dividends paid..................................................................... (251) -- --
Redemption of preferred stock...................................................... (3,824) -- --
Repayment of long-term debt and capital leases..................................... -- (6) (18)
--------- --------- ---------
Net cash provided by (used in) financing activities................................ (198) 8,286 10,622
--------- --------- ---------
Effect of exchange-rate changes on cash............................................ 50 (722) (231)
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents............................... (4,633) 3,763 4,624
Cash and cash equivalents at beginning of year..................................... 21,112 17,349 12,725
--------- --------- ---------
Cash and cash equivalents at end of year........................................... $ 16,479 $ 21,112 $ 17,349
--------- --------- ---------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS
28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 THE COMPANY
Interleaf, Inc. and its subsidiaries (the "Company") develop and market
software for the electronic assembly, management, retrieval, publishing and
distribution of business-critical documents and information, and it is focusing
its efforts for growth on Enterprise Content Management software and services.
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION. The consolidated financial statements include
the accounts of Interleaf, Inc. and its subsidiaries. All significant
intercompany balances and transactions have been eliminated in consolidation.
REVENUE RECOGNITION. Revenue from the license of software products is
recognized when the products are shipped, provided there are no vendor
obligations remaining and collection of the receivable is considered probable.
The Company also maintains a reserve for sales allowances to provide for
possible product returns or allowances resulting from a lack of sell through of
products by resellers. In the fourth quarter of fiscal 1997, the Company
recorded a charge of $1.5 million to provide for anticipated allowances expected
to be granted. Maintenance revenue is recognized ratably over the contract
period. Services revenue is recognized as the related services are performed on
either a time and materials basis or pro-rata based on project or contract
completion. Unearned revenue represents the remaining amount of revenue to be
recognized in future periods primarily related to maintenance and service
contracts.
CASH AND CASH EQUIVALENTS. Cash equivalents, consisting primarily of
commercial paper and treasury bills, represent highly liquid investments with
maturities at date of purchase of three months or less. These investments are
stated at cost, which approximates market value. See Note 13 on restricted cash.
PROPERTY AND EQUIPMENT. Property and equipment are stated at cost.
Depreciation and amortization are determined on the straight-line method over
the estimated useful lives of the related assets. The estimated useful lives
generally range from 3 to 5 years. Expenditures for repairs and maintenance are
charged to operations as incurred.
CAPITALIZED SOFTWARE DEVELOPMENT COSTS. Costs incurred in the research,
design and development of software for sale to others are charged to expense
until technological product feasibility is established, after which remaining
software development costs are capitalized. These costs are amortized as part of
the cost of revenue beginning when the product is available for general release
to customers. Such amounts are amortized over the estimated remaining useful
life of the product not to exceed three years. The Company continually compares
the unamortized portion of capitalized software development costs to the net
realizable value of the related product. The net realizable value is the
estimated future gross revenues from that product reduced by the estimated
future costs of completing and disposing of that product. The amount by which
the unamortized capitalized costs exceed the net realizable value is
written-off. See Note 5 for discussion of Intangible Assets and write-downs
recorded during fiscal 1997.
FOREIGN CURRENCY TRANSLATION. The translation of assets and liabilities of
foreign subsidiaries is made at year-end rates of exchange, and revenues and
expenses are recorded at average rates of exchange. The resulting translation
adjustments are excluded from net income and are accumulated as a separate
component of accumulated other comprehensive income (loss). Realized and
unrealized exchange gains or losses from foreign currency transactions are
reflected in the statements of operations. The exchange loss for fiscal year
1999 was not material and for fiscal years 1998 and 1997 was $180,000 and
$531,000, respectively.
29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
COMPREHENSIVE INCOME. Comprehensive income includes the effect of changes
in equity not resulting from transactions with owners, including foreign
currency translation adjustments, which have no income tax impact to the
Company.
STOCK-BASED COMPENSATION. Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" ("SFAS 123") encourages but does
not require companies to record compensation cost for stock-based employee
compensation plans at fair value. The Company has chosen to continue to account
for stock-based employee compensation using the intrinsic value method
prescribed in Accounting Principles Board (APB) Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25") and related interpretations. Accordingly,
compensation cost for stock options granted to employees is measured as the
excess, if any, of the quoted market price of the Company's stock at the date of
the grant over the amount an employee must pay to acquire the stock.
CONCENTRATIONS OF CREDIT RISK. Financial instruments which potentially
subject the Company to concentrations of credit risk consist principally of cash
investments and accounts receivable. The Company places its cash investments in
investment grade instruments with maturities of three months or less and limits
the amount of investment with any one financial institution. The credit risk
associated with accounts receivable is limited due to the Company's credit
evaluation process and the large number of customers and their dispersion over
different industries and geographic areas.
USE OF ACCOUNTING ESTIMATES. The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that effect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Significant estimates include adequacy of
restructuring accruals, collectibility of accounts receivable, and
recoverability of depreciable assets and intangible assets. Actual results could
differ from these estimates.
BASIS OF PRESENTATION. The accompanying financial statements have been
presented assuming that the Company will continue as a going concern. During
1997, the Company experienced a substantial decline in revenues and a
substantial loss from operations, resulting in a shareholders' deficit at March
31, 1997. In response to these matters, the Company developed detailed plans
relating to its fiscal 1998 operations which restored the Company to profitable
operations despite a continued decline in revenues. In 1999, the Company
incurred a loss in the second quarter, as well as for the entire year. In the
third quarter of fiscal 1999, the Company redeemed its Series C Stock and 79% of
its outstanding Series D Stock. These redemptions, coupled with the loss
recorded in the second quarter (and for fiscal year 1999), required the Company
to raise additional capital during the fourth quarter of fiscal 1999 to maintain
its common stock listing on the NASDAQ National Market. Subsequent to the second
quarter, increased revenue and continued focus on cost control returned the
Company to profitability. Management is committed to continue taking all
appropriate and necessary actions to effect timely cost reductions in the event
that anticipated revenue levels are not achieved during fiscal 2000. In the
event such actions are not successful in achieving breakeven or profitable
operations, additional financing will be needed. Under such circumstances, the
Company cannot guaranty that such financing could be obtained or that it could
be obtained at commercially reasonable terms or without incurring substantial
dilution to existing shareholders. The financial statements do not include any
adjustments to reflect the possible effects of these uncertainties. Management
believes that, based on its fiscal 2000 operating plan and existing cash
balances, the Company will have sufficient cash to support operations during
fiscal 2000 and the foreseeable future. However, the Company may determine that
it needs to increase its investment in the development, marketing and promotion
of its E-content solutions, and in such event it would be necessary for the
Company to raise
30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
additional capital. The net tangible asset listing criteria for the NASDAQ
National Market and the Company's financial condition may necessitate that any
such financing be an equity financing. The Company cannot guaranty that such
financing can be obtained or that it can be obtained on commercially reasonable
terms or without incurring substantial dilution to existing stockholders.
NOTE 3 ACQUISITIONS
Effective August 31, 1998, the Company purchased 100% of the outstanding
common shares of PDR Automated Systems and Publications, Inc. ("PDR"). PDR
provides subcontracting and outsourcing services for the development, management
and distribution of information, and has developed certain technology
surrounding image processing. The acquisition has been accounted for as a
purchase business combination and, therefore, the operating results of PDR have
been included in the Consolidated Statement of Operations since the date of
acquisition. The Company paid cash of $2.9 million and depending upon certain
financial contingencies, may be obligated to pay an additional $3.0 million or
more, payable in stock, except that the Company may pay in cash under certain
circumstances. Of this $3.0 million additional amount, $.7 million is guaranteed
and was accrued in the second quarter of fiscal 1999. The Company recorded costs
associated with the acquisition of $.1 million related to valuation services,
legal and audit fees.
During the second quarter of fiscal 1999, the purchase price, was allocated
to the net tangible and intangible assets of PDR as follows (net of negative
goodwill of $1.4 million):
[Enlarge/Download Table]
(AMOUNTS IN MILLIONS)
-----------------------
Net tangible assets acquired............................................ $ 1.3
Outsourcing operations.................................................. 1.4
Core technology......................................................... .5
Acquired in-process research and development............................ .3
Assembled workforce..................................................... .2
---
$ 3.7
---
---
During the fourth quarter of fiscal 1999, the Company paid the first $1.5
million installment payment in stock upon the achievement of the specified
revenue levels. That common stock has been classified as redeemable common stock
at March 31, 1999 due to certain redemption rights of the holders. This payment,
$.7 million of which was previously accrued, was allocated as follows: $.4
million to outsourcing operations, $.2 million to core technology, $.1 million
to acquired in-process research and development and $.1 million to assembled
workforce. The Company may still be obligated to pay an additional $1.5 million
or more upon successful achievement of certain additional financial
contingencies.
It has been determined that technological feasibility of the in-process
research and development ("IPR&D") purchased from PDR has not been established
and that the technology has no alternative future use. Therefore, in accordance
with generally accepted accounting principles, the Company has expensed the
amount of the purchase price allocated to purchased IPR&D of approximately $.4
million. The intangible assets will be amortized on a straight line basis over
estimated useful lives ranging up to ten years.
In connection with the acquisition of PDR, the Company initially recorded
$.8 million of purchased IPR&D during the second quarter of fiscal 1999. While
the Company had obtained a valuation from an
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3 ACQUISITIONS (CONTINUED)
independent appraiser supporting the amount, consideration of evolving practice
surrounding the valuation of IPR&D resulted in an adjustment to reduce such
charge from $.8 million to $.3 million during the second quarter of fiscal 1999.
The Company has restated its second and third quarter financial results to
reflect that adjustment. The effect of the restatement was to decrease the
charge for acquired IPR&D from $.8 million to $.3 million, increase core
technology from zero to $.5, decrease assembled workforce from $.3 million to
$.2 million and increase outsourcing operations from $1.3 million to $1.4
million. As a result of these changes, the net loss for the quarter ended
September 30, 1998 decreased to $2.1 million from $2.6 million and basic and
diluted net loss per share for the quarter ended September 30, 1998 decreased to
$(0.42) per share from $(0.49) per share. The net income for the quarter ended
December 31, 1998 was not significantly impacted by the restatement.
The valuation of acquired IPR&D was based on management's projections of the
after tax net cash flows attributable to the IPR&D. Specifically, the valuation
considers the following: (i) a fair market value premise; (ii) comprehensive due
diligence concerning all potential intangible assets including trademarks and
tradenames, patents, copyrights, non-compete agreements, assembled workforce and
customer relationships and sales channel relationships; (iii) the value
contribution of core technology to the acquired in-process technology, with a
view toward ensuring the relative allocations to core technology and acquired
in-process research and development were consistent with the relative
contributions of each to the final product; and (iv) the calculation used to
determine the value allocated to acquired in-process research and development
considered only the efforts completed as of the transaction date and only the
cash flow associated with said completed efforts for one generation of the
product development efforts in-process at the acquisition date. The charge for
acquired IPR&D relates to one development project in process at the date of the
acquisition that had not reached technological feasibility, had no alternative
future use, and for which ultimate successful development was uncertain. The
conclusion that the development efforts in-process, or any material
sub-component, had no alternative future use was reached in consultation with
engineering personnel from PDR as well as the Company's valuation advisors.
The in-process project consists of the development of PDR's existing Check
Image Processing ("CIP") product, which will allow users to operate the CIP
product on varied operating platforms. The primary project tasks open at the
time of acquisition included completion of porting to various platforms, Year
2000 compliance, enhancing graphics and quality testing. At the time of
acquisition, additional development remained on all tasks (management estimated
that the project was approximately 45% complete) and costs to complete were
estimated to total approximately $200,000. At the time of the acquisition,
management believed that the product being developed would become available for
sale late in fiscal 2000. Interleaf will begin to benefit from the acquired
IPR&D once completed product is sold. Failure to reach successful completion of
this project may result in impairment of the associated capitalized intangible
assets, i.e. goodwill and core technology, and/or may require the Company to
accelerate the time period over which the intangibles are being amortized, which
may have a material adverse effect on the Company's results of operations and
financial condition.
Significant assumptions used to determine the value of the acquired IPR&D
included several factors. The first was a forecast of net cash flows that were
expected to result from the in-process development effort using projections
prepared by Interleaf management. Net cash flow projections included projected
revenue growth and trends in profit margins and selling, general and
administrative expense that were consistent with recent historical trends prior
to the acquisition. Second, a percentage complete of 45% for the project
estimated by considering the costs invested to date relative to the expected
total cost of the development effort, supported by the amount of technological
progress completed as of the transaction date relative to the overall
technological achievements required to achieve the intended functionality of
32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3 ACQUISITIONS (CONTINUED)
the eventual product. The technological issues were addressed primarily by
engineering representatives from PDR along with the Company's independent
valuation advisors. Third, a 30% discount rate, which represents a rate
equivalent to that which would be employed in a fair value analysis, i.e., one
that considers all cash flows associated with the project and resulting product,
and therefore represents a blended rate of all the risks associated with the
product. Lastly, a core technology charge reflected as one third of after tax
net income related to the in-process project was utilized. This rate represents
an amount that the Company would be required to pay in royalties assuming it had
licensed the products expected to be derived from the acquired in-process
development efforts.
As of March 31, 1999, the technological feasibility of the project had not
yet been reached and no significant departures from the assumptions included in
the valuation analysis have occurred.
The following unaudited pro forma financial information presents the
combined results of operations of Interleaf and PDR as if the acquisition had
occurred at the beginning of fiscal 1999 and 1998, respectively, after giving
effect to the amortization of intangible assets and the charge for purchased
IPR&D. The per share impact of the purchased IPR&D charge totals $(.07) and
$(.05) for basic and diluted earnings per share, respectively, in fiscal 1999
and $(.08) and $(.06) for basic and diluted earnings per share, respectively, in
fiscal 1998. This unaudited pro forma financial information is presented for
illustrative purposes only and is not necessarily indicative of the results of
operations that actually would have been realized had the Company and PDR been a
combined company during the specified periods. Additionally, they are not
indicative of the results of future combined operations.
[Enlarge/Download Table]
UNAUDITED
YEAR ENDED
AMOUNTS IN THOUSANDS, EXCEPT ------------------------------
PER SHARE AMOUNTS MARCH 31, 1999 MARCH 31, 1998
--------------------------------------------------------------------------------- -------------- --------------
Revenue.......................................................................... $ 47,676 $ 58,941
------- -------
------- -------
Net Income (loss) applicable to common stockholders:
Basic........................................................................ $ 7,242 $ 2,083
------- -------
------- -------
Diluted...................................................................... $ (1,037) $ 2,313
------- -------
------- -------
Earnings per share:
Basic........................................................................ $ 1.03 $ .35
------- -------
------- -------
Diluted...................................................................... $ (.12) $ .28
------- -------
------- -------
Effective September 11, 1998, the Company acquired the Panorama and CD Web
Publishing product lines from Softquad Inc. for $.4 million. The acquisition
provides the Company with products which are complementary to its existing
complex publishing product line and in-process technologies which are expected
to contribute to the development of the Company's new E-content products. The
total fair value of the net assets acquired was approximately $.1 million.
In connection with this acquisition, it has been determined that
technological feasibility of the purchased IPR&D has not been established and
the technology has no alternative future use. Therefore, in accordance with
generally accepted accounting principles, the Company has expensed the amount of
the purchase price allocated to purchased IPR&D of $.2 million. The excess of
purchase price over the fair value of the assets acquired ($.1 million) has been
recorded as goodwill, and will be amortized on a straight line basis over five
years. This acquisition is not considered material to the Company's financial
position or results of operation.
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3 ACQUISITIONS (CONTINUED)
Effective January 1, 1999, the Company acquired 69% of the outstanding
common stock of Interleaf Italia, S.R.L. ("Interleaf Italia"). The Company
previously owned 31% of Interleaf Italia. Interleaf Italia provides
distribution, support and consulting services for Interleaf products in Italy.
The acquisition has been accounted for as a purchase business combination and,
therefore, the operating results of Interleaf Italia have been included in the
Consolidated Statement of Operations since January 1, 1999. The Company paid
cash of $.4 million, issued .3 million shares of common stock valued at $.6
million, warrants to purchase .2 million shares of common stock valued at $.1
million and two future payments of $.2 million each, payable in 12 and 24
months. In connection with the acquisition, the acquired net tangible assets of
Interleaf Italia were recorded at $.3 million, which approximates fair value.
The Company also recorded $1.2 million of goodwill which will be amortized on a
straight line basis over an estimated useful life of seven years.
On May 1, 1996, the Company purchased all of the outstanding equity
securities of The Learning Alliance, Inc. ("TLA") for 113,834 shares of common
stock, valued at $2.7 million. TLA provided sales training services and develops
and markets related software for the sales force automation and integration
marketplace. The acquisition was accounted for using the purchase method of
accounting, whereby the purchase price was allocated to the assets acquired and
liabilities assumed based on their respective estimated fair values. The
acquisition resulted in goodwill of approximately $2.6 million. In December
1996, in order to allow the Company's management to focus on development of its
core businesses, the Company decided to divest itself of TLA. TLA was sold in
January 1997 for future royalty considerations and foregone severance payments.
As a result of this decision, in December 1996 the Company recorded a write-down
of approximately $2.3 million of goodwill which had been recorded in connection
with the acquisition. The operating results of TLA, which were not material,
have been included in the consolidated financial statements from the date of the
acquisition to the date of disposition. Pro forma presentations have not been
included as the acquisition was not material to the results of operations of the
Company.
NOTE 4 PROPERTY AND EQUIPMENT
Property and Equipment at March 31 consisted of the following:
[Enlarge/Download Table]
1999 1998 1997
--------- --------- ---------
(IN THOUSANDS)
Office, demonstration and other equipment......................................... $ 7,702 $ 27,252 $ 27,739
Development equipment............................................................. 960 12,815 12,654
Furniture......................................................................... 909 3,740 3,799
Leasehold improvements............................................................ 1,543 1,819 1,637
--------- --------- ---------
11,114 45,626 45,829
Less allowances for depreciation and amortization................................. 8,994 42,305 40,866
--------- --------- ---------
$ 2,120 $ 3,321 $ 4,963
--------- --------- ---------
--------- --------- ---------
NOTE 5 INTANGIBLE ASSETS
The Company's intangible assets have historically consisted of purchased
goodwill and capitalized software development costs. The Company's policy is to
amortize purchased goodwill to selling, general and administrative expense, and
to amortize capitalized software development costs to cost of revenue. In fiscal
1999, upon achieving technological feasibility, the Company capitalized $1.4
million of software development costs related to two development projects. Upon
availability for general release these
34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5 INTANGIBLE ASSETS (CONTINUED)
amounts will be amortized to cost of revenue over the estimated useful life of
the product. As a result of a strategic product review, in fiscal year 1997 the
Company wrote off capitalized software development costs of $2.0 million which
were associated with discontinued products or products with limited future
revenue potential. The unamortized portion of capitalized software development
costs was $1.4 million and $0.6 million at March 31, 1999 and 1998,
respectively. Amortization and write-downs to net realizable value of
capitalized software development costs were approximately $.6 million, $1.7
million and $5.0 million, during fiscal 1999, 1998, and 1997, respectively. In
connection with the acquisitions discussed in Note 3, the Company recorded
goodwill and other intangible assets of $4.1 million during fiscal 1999.
Amortization expense related to these assets totaled $.2 million in fiscal 1999.
There was no goodwill or intangible asset amortization in fiscal 1998. In fiscal
year 1997, the Company wrote off goodwill of approximately $2.3 million related
to the acquisition of The Learning Alliance (see Note 3).
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6 CREDIT AGREEMENT
At March 31, 1999, the Company has outstanding letters of credit aggregating
$.9 million which expire between July 31, 1999 and October 31, 2001. These
letters of credit guarantee payments on two leases and the future amounts
payable for the acquisition of Interleaf Italia (see Note 3). The letters of
credit are secured by equal amounts of cash and are reduced by the amount of the
respective payments.
NOTE 7 ACCRUED EXPENSES
Accrued expenses at March 31 consisted of the following:
[Enlarge/Download Table]
1999 1998
--------- ---------
(IN THOUSANDS)
Accrued compensation and related items.................................. $ 2,940 $ 3,159
Taxes, other than income................................................ 2,148 754
Royalties............................................................... 462 1,255
Other................................................................... 5,634 6,489
--------- ---------
$ 11,184 $ 11,657
--------- ---------
--------- ---------
NOTE 8 LEASE COMMITMENTS
The Company leases its headquarters and sales offices, and certain equipment
under various operating leases, which expire through the year 2005. Rent expense
amounted to approximately $3.0, $2.9 million and $5.1 million during fiscal
1999, 1998, and 1997, respectively.
Future minimum lease commitments on noncancelable operating leases and
sublease income are as follows:
[Enlarge/Download Table]
YEAR ENDED MARCH 31
--------------------------------------------------------------------
2000 2001 2002 2003 2004 THEREAFTER
--------- --------- --------- --------- --------- -------------
(IN THOUSANDS)
Future minimum lease commitments on
noncancelable leases.......................... $ 6,492 $ 4,938 $ 492 $ 380 $ 32 $ 11
Future minimum sublease income.................. $ 3,947 $ 2,976 $ 38 $ -- $ -- $ --
These future minimum lease commitments include approximately $1.6 million,
net of sublease income, related to facilities the Company has elected to abandon
or downsize in connection with the restructuring and acquisition-related
initiatives.
NOTE 9 RESTRUCTURINGS
Restructuring charges include costs associated with employee termination
benefits and facility closures and related costs. Employee termination benefits
include severance, wage continuation, notice pay and related fringe benefits.
Facility closure and related costs include lease payments, lease buyout costs,
disposal of property and equipment, and related costs.
In connection with the Company's restructuring initiatives, the Company paid
approximately $.2 million, $.6 million and $2.7 million for employee termination
benefits during fiscal 1999, 1998, and 1997, respectively. Payments for facility
closures and related costs, net of sublease receipts, were approximately $1.8
million, $1.9 million and $1.4 million during fiscal 1999, 1998, and 1997,
respectively. Expenditures for
36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9 RESTRUCTURINGS (CONTINUED)
facility closures, primarily lease payments, are anticipated to continue through
the fiscal year 2001. The Company continues to monitor its cost structure in
light of current and future revenue levels.
In the second quarter of fiscal 1997, as a result of a significant decline
in product revenue, the Company announced a restructuring plan and recorded a
charge of $4.8 million to reduce employment by approximately 75 people, to close
or reduce space in seven sales offices, and to implement the second and final
stage of relocating corporate headquarters to smaller and less expensive space.
The employee terminations affected all groups throughout the organization.
Approximately $1.3 million of the restructuring charge was for employee
termination benefits and $3.5 million for facility closures and related costs.
In the third quarter of fiscal 1997, the Company announced another
restructuring plan and recorded a charge of $3.7 million to further reduce
employment by approximately 100 people at a cost of $1.8 million and to close or
reduce space in six sales offices at a cost of $1.9 million. The employee
terminations affected all groups throughout the organization. In the fourth
quarter of fiscal 1997, the Company recorded an additional charge of $2.4
million to reflect changes in cost and timing assumptions relating to previously
restructured facilities.
NOTE 10 INCOME TAXES
The provision for income taxes is composed of the following:
[Enlarge/Download Table]
1999 1998 1997
--------- ----- ---------
(IN THOUSANDS)
Current:
Federal.............................................................. $ 25 $ 79 $ --
State................................................................ -- -- --
Foreign.............................................................. 181 -- --
--------- --- ---------
Total Current.......................................................... 206 79 --
Deferred:
Federal.............................................................. -- -- --
State................................................................ -- -- --
--------- --- ---------
Total Deferred......................................................... -- -- --
--------- --- ---------
$ 206 $ 79 $ --
--------- --- ---------
The provision for income taxes is based on the following amounts of income
(loss) before income taxes:
[Enlarge/Download Table]
1999 1998 1997
--------- --------- ----------
(IN THOUSANDS)
Domestic:...................................................... $ 112 $ 4,537 $ (21,586)
Foreign........................................................ (1,031) (2,022) (7,964)
--------- --------- ----------
$ (919) $ 2,515 $ (29,550)
37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10 INCOME TAXES (CONTINUED)
Total income taxes reported are different from the amount that would have
been computed applying the federal statutory tax rate to income before income
taxes. The difference is attributable to the following:
[Enlarge/Download Table]
1999 1998 1997
--------- --------- ----------
(IN THOUSANDS)
Computed at federal statutory rate............................... $ (312) $ 814 $ (10,047)
Loss for which no tax benefit was realized....................... 482 -- 9,151
Nondeductible write-downs........................................ -- -- 778
Non-deductible acquired in-process research & development........ 208 -- --
Other nondeductible expenses..................................... 33 102 118
Benefit of net operating loss carryforwards...................... (205) (837) --
--------- --------- ----------
$ 206 $ 79 $ --
Deferred taxes result from temporary differences in the recognition of
revenues and expenses for tax and financial reporting purposes. The components
of the Company's deferred tax assets and liabilities as of March 31 are as
follows:
[Enlarge/Download Table]
1999 1998 1997
--------- --------- ---------
(IN THOUSANDS)
Deferred tax assets
Net operating loss carryforwards................................................. $ 18,891 $ 24,138 $ 22,897
Tax credit carryforwards......................................................... 10,837 7,376 7,150
Accrued rent..................................................................... 229 344 473
Reserve for doubtful accounts receivable, intangible asset amortization, vacation
and other accruals............................................................. 1,612 950 864
Restructuring.................................................................... 940 1,384 2,555
--------- --------- ---------
Total deferred tax assets........................................................ 32,509 34,192 33,939
Deferred tax asset valuation allowance........................................... (31,961) (34,079) (33,619)
--------- --------- ---------
548 113 320
Deferred tax liabilities:
Capitalized software development costs........................................... (521) (113) (320)
Other............................................................................ (27) -- --
--------- --------- ---------
Total deferred tax liabilities................................................... (548) (113) (320)
--------- --------- ---------
Net deferred tax asset........................................................... $ -- $ -- $ --
--------- --------- ---------
Realization of total deferred tax assets is contingent upon future taxable
income. A 100% valuation allowance of net deferred tax assets has been
established due to the uncertainty of realization of these tax benefits. The
deferred tax asset valuation allowance decreased $2.1 million and increased $0.5
million during fiscal 1999 and 1998, respectively.
At March 31, 1999, the Company and its subsidiaries had net operating loss
carryforwards of approximately $49 million that are available to offset future
taxable income. The loss carryforwards are attributable to operations in several
tax jurisdictions and expire in fiscal 2000 and thereafter. In addition,
38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10 INCOME TAXES (CONTINUED)
the Company has research and development and other tax credit carryforwards of
approximately $11 million, which are available to reduce future federal and
state income tax liabilities. The tax credit carryforwards expire over time,
commencing in fiscal 2000. No tax payments were made in fiscal 1998 or fiscal
1997. In fiscal 1999, the Company made tax payments of $.2 million related to
alternative minimum taxes and certain state income taxes which were previously
accrued.
NOTE 11 SHAREHOLDERS' EQUITY
Effective December 31, 1998, the Company declared a 1 for 3 reverse split of
its common stock. Par value did not change as a result, and all share and per
share data have been restated to give effect to the 1 for 3 reverse split.
SERIES A
On July 15, 1988, the Company declared a dividend distribution of one
Preferred Stock Purchase Right (a Right) for each outstanding share of the
Company's common stock to shareholders of record on July 25, 1988 and for shares
of the Company's common stock issued and outstanding thereafter. The Rights were
non-voting and expired by their terms on July 15, 1998. Each Right entitled the
holder to purchase a unit consisting of one-hundredth of a share (a Unit) of
Series A Junior Participating Preferred Stock, $.10 par value ("Series A"), at a
purchase price of $65.00 in cash. The Rights initially traded with the shares of
common stock and were not exercisable. The Rights would separate from the common
stock and become exercisable only upon the happening of certain events.
Thereafter, in the event that the Company were not the surviving corporation in
a merger with an Acquiring Person, or the acquisition of 25% of common stock by
any person (except pursuant to a tender offer for all shares of common stock
determined to be fair by certain directors of the Company), or upon certain
self-dealing transactions or increases in an Acquiring Person's ownership of
common stock, each holder of an outstanding Right other than an Acquiring Person
would have been entitled to receive, upon exercise of a Right, the number of
shares of the Company's common stock that equals the exercise price of the Right
divided by one half of the current market price of the Company's common stock.
In the event that the Company were not the surviving corporation in a merger, or
if more than 50% of its assets or earning power is sold or transferred after any
person has become an Acquiring Person, each holder of an outstanding Right other
than any Acquiring Person would receive, upon exercise of a Right, the number of
shares of common stock of the acquiring Company that equals the exercise price
of the Right divided by one half of the current market price of the acquiring
Company's common stock. The Rights were allowed to expire on July 15, 1998
without ever having become exercisable, and they have no further effect.
SERIES B
In September 1989, the Company issued 2,142,857 shares of its Senior Series
B Convertible Preferred Stock ("Series B Stock"), at a price of $7.00 per share.
Under the terms of the Series B Stock, the holders have a liquidation preference
of $7.00 per share over the holders of Common Stock. After the payment of
liquidation preferences to any class or series of stock superior to the Series B
Stock (such as the Series C Stock and the Series D Stock), and payment of the
Series B liquidation preference, all other shareholders are entitled to receive,
on a per share basis, an amount equal to the total amount of the preference paid
at $7 per share as stated above, divided by the total number of shares of common
stock that the holders of Series B Stock would have been entitled to receive
upon conversion. Finally, the holders of Series B Stock and common stock share
ratably in the remainder, if any, with each share of Series B Stock being deemed
to have been converted to common stock. Holders of Series B Stock are entitled
to vote as a single class on
39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11 SHAREHOLDERS' EQUITY (CONTINUED)
all matters submitted to the common shareholders, receiving the number of votes
equal to the number of shares of common stock that they would have received upon
conversion, except that the holders of Series B Stock, voting as a separate
class, are entitled to elect one director, and the Company needs the approval of
the holders of a majority of the Series B Stock on certain significant events.
Each share of Series B Stock is convertible into .447917 shares of common
stock. The holders of Series B Stock converted 135,908, 0 and 61,393 shares of
Series B Stock into shares of the Company's common stock during fiscal 1999,
1998 and 1997, respectively.
The Series B stock may be redeemed at any time by the Company at $21.00 per
share, provided at least 20% of the shares of Series B Stock then outstanding
are redeemed. Holders of Series B Stock shall share ratably in any dividends
declared on the common stock as if each share of Series B Stock had been
converted to common stock.
SERIES C
On October 15, 1996, the Company issued 1,004,904 shares of newly authorized
Series C Convertible Preferred Stock ("Series C Stock") at a price of $9.9512
per share, receiving net proceeds of $9.4 million. In accordance with the
investment agreement under which the Series C Stock was sold, the Company issued
an additional 5,444 shares of Series C Stock. Each share of Series C Stock was
initially convertible into 1.33 shares of common stock, and the conversion ratio
was adjustable upon certain issuances of common stock by the Company. Dividends
of $0.24878 per share were payable on April 15, 1998 and October 15, 1998, and
$0.49756 per share on each April 15 and October 15 thereafter.
During the third quarter of fiscal 1999, the Company redeemed all of the
Series C Stock for $1.6 million. Additionally, dividends accrued at September
30, 1998 totaling $.2 million were waived and not paid. For purposes of the 1999
basic earnings per share calculation, this redemption resulted in $8.1 million
being added to net income to arrive at net income available to common
shareholders. The $8.1 million represents the excess of the carrying amount of
the Series C Stock over the fair value of the consideration paid by the Company.
SERIES D
On September 30, 1997, the Company sold 7,625 shares of Series 6%
Convertible Preferred Stock ("Series D Stock") at a price of $1,000 per share in
a private placement. The Company received proceeds of $6.8 million, net of
placement agent fees and transaction costs. In addition, the Company issued to
the placement agent warrants to purchase 763 shares of Series D Stock at an
exercise price of $1,000 per share. These warrants are exercisable for a period
of five years commencing September 30, 1997.
Each share of Series D Stock was entitled to receive dividends, payable
annually on September 30 of each year, when and as declared by the Company's
Board of Directors, at the rate of 6% per annum in preference to any payment
made on any shares of Common Stock or any other class or series of capital stock
of the Company other than the Series C Stock, which had rights to dividends PARI
PASSU with the Series D Stock. The dividends on the Series D Stock accrued from
day to day whether or not earned or declared. Any dividend payable after the
date of issuance of the Series D Stock could be paid (i) in additional shares of
Series D Stock valued at $1,000.00 per share, or (ii) upon proper notice, in
cash. Each share of Series D Stock was also entitled to a liquidation preference
of $1,000.00 per share, plus any accrued but unpaid dividends, in preference to
any other class or series of capital stock of the Company
40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11 SHAREHOLDERS' EQUITY (CONTINUED)
(except shares of Series C Stock, which were PARI PASSU with the Series D
Stock). Except as otherwise provided by applicable law, holders of Series D
Stock had no voting rights.
Commencing on December 29, 1997, at least 10% and up to 25% (depending upon
the price at which the Common Stock was trading) of the number of shares of
Series D Stock held of record by each holder on such day became convertible into
shares of Common Stock, and thereafter on the successive monthly anniversaries
of such day additional shares of Series D Stock became convertible (with the
additional amount varying from 10% to 25% of the number of shares of Series D
Stock held of record by such holder on such day depending upon the price at
which Common Stock was trading) except that in any month when the highest of the
Common Stock's daily low trading prices was $7.50 or less, not more than 10% of
each holder's shares of Series D Stock held of record on such day became
convertible.
The number of shares of Common Stock issuable upon conversion of shares of
Series D Stock was equal to the liquidation preference of the shares being
converted, divided by the then-effective conversion price (the "Conversion
Price"). The Conversion Price through April 30, 1998 was $5.50. The Conversion
Price between May 1, 1998 and January 31, 1999 was the lowest trading price of
the Common Stock during the twenty-two (22) consecutive trading days immediately
preceding the date of conversion, reduced by the Applicable Percentage,
described below, except that the Conversion Price could not be not less than
$1.50 prior to November 1, 1998. The "applicable percentage" was dependent upon
the time which has passed from original issuance to the date of measurement,
being 9.8% starting on May 1, 1998 and increasing in each subsequent month to
11.1%, 12.4%, 13.7%, and 15%. At any date after February 1, 1999, the Conversion
Price would be the lesser of (a) 85% of the average of low daily trading price
of the Common Stock for all the trading days during November 1998 through
January 1999 (provided that in no event shall this amount be less than $8.449),
or (b) 85% of the average of the lowest daily trading price of the Common Stock
during the twenty-two (22) consecutive trading days immediately preceding the
date of conversion (the "Conversion Cap"). The Conversion Price is at all times
also subject to adjustment for customary anti-dilution events such as stock
splits, stock dividends, reorganizations and certain mergers affecting the
Common Stock. On September 30, 2003, all of the then outstanding shares of
Series D Stock would be automatically converted into shares of Common Stock at
the then-applicable Conversion Price. No holder of shares of Series D Stock
would be entitled to convert any shares of Series D Stock into shares of Common
Stock if, following such conversion, the holder and its affiliates (within the
meaning of the Securities Exchange Act of 1934) would be the beneficial owners
(as defined in Rule 13d-3 thereunder) of 10% or more of the outstanding shares
of Common Stock.
On November 4, 1998, the Company reached agreement with the holders of 79%
of its outstanding Series D Stock, pursuant to which all of the shares of Series
D Stock held by those persons (5,487 shares out of 6,987 outstanding) was
converted into a total of approximately $2.2 million in cash and approximately
1.2 million shares of common stock. This conversion occurred on November 18,
1998. The shares of Common Stock issued to the former holders of Series D Stock
are held subject to the restrictions on re-sale, prohibitions against
short-selling and the other terms and conditions of the Preferred Stock
Investment Agreement under which the Series D was originally issued.
Specifically, the holders of those shares of Common Stock agreed to be limited
on resales of such shares to the greatest of: (i) 10% of the average daily
trading volume of the Common Stock for the five trading days preceding any such
sales; (ii) 12,000 shares; or (iii) 10% of the trading volume for the Common
Stock on the date of any such sale. For purposes of the 1999 basic earnings per
share calculation, this conversion resulted in $.7 million being added to net
income to arrive at net income available to common shareholders. The $.7 million
represents the excess of the carrying amount of Series D Stock over the fair
value of consideration paid by the Company.
41
NOTE 11 SHAREHOLDERS' EQUITY (CONTINUED)
STOCK OPTION PLANS
The Company has five separate stock option plans that provide for the
granting of non-qualified and incentive stock options to employees, consultants,
officers and directors. The Board of Directors determines the option price, the
option term, and the vesting period for options granted. Incentive stock options
are granted at a price not less than the fair market value on the date of grant.
In June 1993, the Board of Directors adopted the 1993 Stock Option Plan (the
"1993 Plan"), which initially provided for a maximum of 250,000 shares of common
stock to be issued and sold under the plan. In August 1995, August 1997 and
February 1998 the Board of Directors approved amendments to the 1993 Plan to
increase the number of shares available for issuance under the plan by 250,000,
200,000 and 433,000 shares, respectively. On July 14, 1994, the Board of
Directors adopted the 1994 Employee Stock Option Plan (the "1994 Plan"), which
initially provided for a maximum of 250,000 shares of common stock to be issued
and sold under that plan. In May 1996 and October 1996 the Board of Directors
approved amendments to the 1994 Plan to increase the number of shares available
for issuance under the plan by 250,000 and 333,000 shares, respectively. In
February 1998, the Board of Directors determined that no additional shares would
be issued under the 1994 Plan, that all future option grants would be issued
under the 1993 Plan, and that the 1993 Plan would be administered in a broadly
based fashion. The Board also increased the number of shares available for
issuance under the 1993 Plan by 433,000 shares. In January 1997 and February
1998 the Company adopted the 1997 Key Man Stock Option Plan and Agreement ("1997
Key Man Plan"), and the 1998 Key Man Stock Option Plan and Agreement ("1998 Key
Man Plan"), respectively. These two plans provided for a maximum of 317,000
shares of common stock to be issued and sold to two senior executives. As of
March 31, 1999, options to purchase the entire 317,000 shares authorized under
those two plans had been granted, and no further shares were available for
grant.
On September 12, 1996, the Board of Directors authorized a repricing program
which allowed employees to elect to reprice all or some of their outstanding
options, ranging in exercise price from $8.25 to $32.25 per share, to the
September 12, 1996 closing price of $7.69. Any options repriced may not be
exercised until March 12, 1997. Options for approximately .7 million shares were
repriced. On June 20, 1997, the Board of Directors authorized a repricing
program which allowed employees to elect to reprice all or some of their
outstanding options, ranging in price from $6.00 to $24.75 per share, to the
June 20, 1997 closing price of $3.75. Approximately .4 million shares were
repriced. On December 15, 1998 the Board of Directors authorized a repricing
program which allowed employees to elect to reprice all or some of their
outstanding options, ranging in price from $2.82 to $22.11 per share to the
December 15, 1998 closing price of $1.97. Any options repriced on that date may
not be exercised until December 15, 1999. Options for 1.0 million shares were
repriced.
42
NOTE 11 SHAREHOLDERS' EQUITY (CONTINUED)
A summary of activity for these stock option plans is as follows:
[Enlarge/Download Table]
PRICE RANGE WEIGHTED AVERAGE
NUMBER OF SHARES OF SHARES PRICE PER SHARE
------------------- -------------- -----------------
(IN THOUSANDS, EXCEPT PRICE RANGE OF SHARES)
Outstanding at March 31, 1996............................... 607 $ 8.25-32.25 $ 13.50
Granted..................................................... 938 6.15- 7.68 7.32
Exercised................................................... (52) 8.25-13.50 8.70
Cancelled................................................... (513) 7.50-31.89 17.85
----- -------------- ------
Outstanding at March 31, 1997............................... 980 6.09-32.25 $ 8.25
Granted..................................................... 761 2.82-10.89 6.51
Exercised................................................... (150) 2.82-16.50 8.46
Cancelled................................................... (314) 2.82-32.25 9.75
----- -------------- ------
Outstanding at March 31, 1998............................... 1,277 $ 2.82-22.11 $ 9.21
Granted..................................................... 464 $ 1.97- 8.44 2.28
Exercised................................................... (10) 2.82- 3.75 3.57
Canceled.................................................... (381) 1.97-22.11 11.21
----- -------------- ------
Outstanding at March 31, 1999............................... 1,350 $ 1.97- 8.44 $ 2.10
At March 31, 1999, there were approximately 375,000 shares available for
grant under the 1993 Plan. Options exercisable at March 31, 1999, 1998, and 1997
under the 1993 Plan, 1994 Plan, 1997 Key Man Plan and the 1998 Key Man Plan were
in the aggregate approximately 554,000, 112,000 and 413,000, respectively.
In September 1993, the Company adopted a 1993 Director Stock Option Plan
(the "Director Plan"), under which non-employee directors may receive options.
Under that plan, each non-employee director received a grant of 1,700 options
at the inception of the Director Plan, and each newly elected non-employee
director received a grant of 1,700 options as of the date of his or her first
election as a director. Every April 1, each non-employee director automatically
received a grant of 1,700 additional options. In December 1997, the Board of
Directors amended the Director Plan to provide that newly elected non-employee
directors will receive a grant of 8,300 shares, and on each April 1 each
non-employee director will automatically receive a grant of an additional 2,500
shares. During fiscal 1999, 1998 and 1997, no options were exercised. At March
31, 1999, there were options outstanding to purchase 113,000 shares under the
Director Plan and no shares were available for grant. Options exercisable under
the Director Plan at March 31, 1999, 1998, and 1997 were 68,000, 5,000 and
23,000, respectively.
PRO FORMA DISCLOSURE OF THE EFFECTS OF STOCK-BASED COMPENSATION PLANS: The
Company accounts for stock-based compensation using the method prescribed in APB
25. The Company has adopted the disclosure-only provisions of SFAS 123.
Accordingly, no compensation cost has been recognized for the Company's stock
option plans and employee stock purchase plan.
43
NOTE 11 SHAREHOLDERS' EQUITY (CONTINUED)
Had compensation cost been determined based on the fair value at the grant
dates for awards under those plans in fiscal 1999, 1998 and 1997 on a basis
consistent with the provisions of SFAS No. 123, the Company's net income and
earnings per share on a diluted basis would have been as indicated below:
[Enlarge/Download Table]
1999 1998 1997
--------- ------------- ----------
(IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
Net income (loss)--as reported.............................................. $ (1,125) $ 2,436 $ (29,550)
Net income (loss)--pro forma................................................ (3,186) 1,651 (29,858)
Earnings (loss) per share--as reported--Basic............................... 1.01 .33 (5.11)
Earnings (loss) per share--pro forma--Basic................................. .72 .20 (5.16)
As reported--diluted (except when anti-dilutive)............................ (.14) .27 (5.11)
Pro forma-diluted (except when anti-dilutive)............................... (.38) .17 (5.16)
Because SFAS No. 123 is only applicable to options granted subsequent to
March 31, 1995, its pro forma effects are not fully reflected in the above
table. The fair value of options at date of grant was estimated using the
Black-Scholes option pricing model with the following weighted average
assumptions:
Expected life (years)....................................................... 4 4 4
Risk-free interest rate..................................................... 4.66% 5.47%-6.83% 6.38%
Volatility.................................................................. 79.4% 78.9% 73.8%
Dividend yield.............................................................. -- -- --
The weighted-average grant-date fair value of options granted during fiscal
1999, 1998 and 1997 was $.46, $3.33 and $5.52, respectively. The following table
summarizes information about stock options outstanding at March 31, 1999:
[Enlarge/Download Table]
OPTIONS OUTSTANDING
------------------------------------ OPTIONS EXERCISABLE
WEIGHTED AVERAGE --------------------------------------
NUMBER REMAINING NUMBER
OUTSTANDING AT CONTRACTUAL LIFE WEIGHTED AVERAGE EXERCISABLE AT WEIGHTED AVERAGE
RANGE OF EXERCISE PRICE 3/31/99 (IN YEARS) EXERCISE PRICE 3/31/99 EXERCISE PRICE
---------------------------- ----------------- ----------------- ----------------- ----------------- -------------------
(IN THOUSANDS, EXCEPT PRICE RANGE OF SHARES)
$.00-1.97................... 942 8.0 $ 1.97 490 1.97
$1.98-2.05.................. 357 9.6 $ 2.03 34 2.03
$2.06-4.00.................. 34 8.0 $ 3.75 18 3.75
$4.01-8.45.................. 17 5.7 $ 8.25 12 7.96
EMPLOYEE STOCK PURCHASE PLAN: The Company's 1987 Employee Stock Purchase
Plan allowed eligible officers and employees to withhold up to 10% of their
total compensation to purchase shares of the Company's common stock. The
purchase price is 85% of the fair market value of the stock on the date a
one-year offering commences or the date an offering terminates, whichever is
lower. On April 9, 1998, this plan was amended by the Board of Directors to
provide that the final offering period would terminate on November 5, 1998,
rather than April 30, 1999 as originally provided. Shares issued to employees
during fiscal 1999, 1998, and 1997 were approximately 125,000, 84,000 and
61,000, respectively. On June 15, 1998, the Company adopted the new 1998
Employee Stock Purchase Plan, providing essentially the same benefits as the
1987 Employee Stock Purchase Plan, having 20 offering periods of six months
each, and a term of ten years. There are 833,333 shares of common stock reserved
for issuance pursuant to this plan.
At March 31, 1999, approximately 4,847,000 shares of common stock were
reserved for issuance for various purposes, primarily for issuance upon
conversion of the Series B Stock and Series D Stock,
44
NOTE 11 SHAREHOLDERS' EQUITY (CONTINUED)
issuance upon exercise of options granted under the various stock option plans,
issuance upon exercise of certain outstanding warrants, and issuance under the
1998 Employee Stock Purchase Plan.
NOTE 12 EMPLOYEE BENEFIT PLANS
The Company's retirement savings plan (401(k) plan) allows eligible
employees to make tax-deferred contributions. Participants in the 401(k) plan
may contribute up to 15% of their total annual compensation, not to exceed the
specified statutory limit. Participants are 100% vested in their own
contributions. The 401(k) plan permits, but does not require, the Company to
make contributions to the 401(k) plan. The Company made contributions of $25,000
during fiscal 1999 and made no contributions during fiscal 1998 and 1997.
NOTE 13 CONTINGENCIES
In the ordinary course of its business activities, the Company is subject to
various investigations, claims and legal proceedings. Each of these matters is
subject to various uncertainties, and it is possible that some of these matters
may be resolved unfavorably to the Company. Management believes that the
ultimate resolution of these matters will not have a material adverse effect on
the financial position or results of operations of the Company.
Interleaf's German subsidiary, Interleaf GmbH, has been notified that it is
liable for certain German withholding taxes related to payments remitted to the
United States from Germany. The Company is appealing this assessment; however,
approximately $1.1 million of the cash and cash equivalents balance at March 31,
1999 and 1998 has been restricted for potential payment of the German
withholding taxes. Additionally, the Company has been assessed $.7 million for a
German Trade Tax. The Company intends to dispute this claim. The Company
believes the final outcome will not have a material adverse effect on the
financial position or results of operations of the Company.
NOTE 14 INDUSTRY SEGMENT AND GEOGRAPHIC INFORMATION
The Company's four reportable segments provide software and related services
in three geographic regions and a technical document outsourcing business. The
outsourcing business is represented by PDR, acquired August 31, 1998, and
operates solely in the Americas region. Reported segment income is comprised of
external customer revenue less operating expenses incurred by the segment.
Intercompany revenues and expenses, comprised mainly of software royalty income
and expense, have been eliminated. Segment assets are all assets directly
attributable to a particular segment. Intangible assets are included in the
Americas region software and services segment and are not allocated to other
segments. The accounting policies for the segments are the same as those
described in Note 2.
Summarized financial information concerning the Company's reportable
segments is shown in the following tables:
45
NOTE 14 INDUSTRY SEGMENT AND GEOGRAPHIC INFORMATION (CONTINUED)
The following table sets forth the computation of basic and diluted income
(loss) per share:
[Enlarge/Download Table]
SOFTWARE AND SERVICES OUTSOURCING
---------------------------------- -----------
AMERICAS EUROPE ASIA/PACIFIC AMERICAS
---------- --------- ----------- ----------- TOTAL
----------
YEAR ENDED MARCH 31, 1999
Product........................................... $ 4,752 $ 4,376 $ 323 $ -- $ 9,451
Maintenance....................................... 13,780 6,857 658 -- 21,295
Services.......................................... 8,762 2,233 161 3,292 14,448
---------- --------- ----------- ----------- ----------
Total revenue..................................... $ 27,294 $ 13,466 $ 1,142 $ 3,292 $ 45,194
---------- --------- ----------- ----------- ----------
---------- --------- ----------- ----------- ----------
Amortization...................................... $ 806 $ -- $ -- $ -- $ 806
---------- --------- ----------- ----------- ----------
---------- --------- ----------- ----------- ----------
Depreciation...................................... $ 1,454 $ 386 $ 27 $ 7 $ 1,874
---------- --------- ----------- ----------- ----------
---------- --------- ----------- ----------- ----------
Segment operating income(loss).................... $ (5,330) $ 4,039 $ (425) $ 260 $ (1,456)
---------- --------- ----------- ----------- ----------
---------- --------- ----------- ----------- ----------
YEAR ENDED MARCH 31, 1998
Product........................................... $ 8,476 $ 3,775 $ 1,084 $ -- $ 13,335
Maintenance....................................... 18,167 6,735 1,181 -- 26,083
Services.......................................... 10,668 2,055 436 -- 13,159
---------- --------- ----------- ----------- ----------
Total revenue..................................... $ 37,311 $ 12,565 $ 2,701 $ -- $ 52,577
---------- --------- ----------- ----------- ----------
---------- --------- ----------- ----------- ----------
Amortization...................................... $ 1,697 $ -- $ -- $ -- $ 1,697
---------- --------- ----------- ----------- ----------
---------- --------- ----------- ----------- ----------
Depreciation...................................... $ 1,828 $ 488 $ 161 $ -- $ 2,477
---------- --------- ----------- ----------- ----------
---------- --------- ----------- ----------- ----------
Segment operating income(loss).................... $ 474 $ 2,465 $ (577) $ -- $ 2,362
---------- --------- ----------- ----------- ----------
---------- --------- ----------- ----------- ----------
YEAR ENDED MARCH 31, 1997
Product........................................... $ 8,555 $ 8,240 $ 2,026 $ -- $ 18,821
Maintenance....................................... 20,254 7,785 933 -- 28,972
Services.......................................... 12,493 4,165 372 -- 17,030
---------- --------- ----------- ----------- ----------
Total revenue..................................... $ 41,302 $ 20,190 $ 3,331 $ -- $ 64,283
---------- --------- ----------- ----------- ----------
---------- --------- ----------- ----------- ----------
Amortization...................................... $ 5,855 $ -- $ -- $ -- $ 5,855
---------- --------- ----------- ----------- ----------
---------- --------- ----------- ----------- ----------
Depreciation...................................... $ 3,074 $ 588 $ 189 $ -- $ 3,851
---------- --------- ----------- ----------- ----------
---------- --------- ----------- ----------- ----------
Segment operating income(loss).................... $ (19,286) $ 2,294 $ (685) $ -- $ (17,677)
---------- --------- ----------- ----------- ----------
---------- --------- ----------- ----------- ----------
THE FOLLOWING ARE RECONCILIATIONS TO CORRESPONDING TOTALS IN THE ACCOMPANYING
CONSOLIDATED STATEMENTS:
[Enlarge/Download Table]
1999 1998 1997
--------- --------- ----------
Income (loss) for reportable segments........................ $ (1,456) $ 2,362 $ (17,677)
Restructuring charges........................................ -- -- (10,942)
Non-operating income/(expense)............................... 2 (84) (1,061)
Interest income, net......................................... 535 237 130
--------- --------- ----------
Income (loss) before taxes................................... $ (919) $ 2,515 $ (29,550)
--------- --------- ----------
--------- --------- ----------
46
NOTE 14 INDUSTRY SEGMENT AND GEOGRAPHIC INFORMATION (CONTINUED)
THE FOLLOWING TABLE INCLUDES ASSETS ATTRIBUTABLE TO EACH SEGMENT:
[Enlarge/Download Table]
1999 1998 1997
--------- --------- ---------
SOFTWARE AND SERVICES
Americas................................................... $ 20,036 $ 24,059 $ 19,811
Europe..................................................... 14,991 14,003 16,387
Asia/Pacific............................................... 817 1,326 1,702
OUTSOURCING 1,968 -- --
--------- --------- ---------
Total assets............................................... $ 37,812 $ 39,388 $ 37,900
--------- --------- ---------
--------- --------- ---------
THE GEOGRAPHIC AREAS OF THE COMPANY'S SALES FOR THE YEARS ENDED MARCH 31 AND THE
LONG-LIVED ASSETS AT MARCH 31 ARE AS FOLLOWS:
[Enlarge/Download Table]
1999 1998 1997
--------- --------- ---------
REVENUE
United States.............................................. $ 28,346 $ 35,085 $ 40,042
International.............................................. 16,848 17,492 24,781
--------- --------- ---------
Total...................................................... $ 45,194 $ 52,577 $ 64,283
--------- --------- ---------
--------- --------- ---------
Long-lived assets
United States.............................................. $ 7,014 $ 3,355 $ 5,666
International.............................................. 770 1,377 2,022
--------- --------- ---------
Total...................................................... $ 7,784 $ 4,732 $ 7,688
--------- --------- ---------
--------- --------- ---------
47
NOTE 15 INCOME (LOSS) PER SHARE
The following table sets forth the computation of basic and diluted income
(loss) per share:
[Enlarge/Download Table]
1999 1998 1997
--------- --------- ----------
IN THOUSANDS, EXCEPT FOR PER
SHARE AMOUNTS
NUMERATOR:
Net income....................................................................... $ (1,125) $ 2,436 $ (29,550)
Preferred stock dividends
Senior series C convertible.................................................... (283) (230) --
Senior series D convertible-redeemed........................................... (209) (228) --
Senior series D convertible-outstanding........................................ (73) -- --
--------- --------- ----------
(565) (458)
--------- --------- ----------
Gains on redemption
Senior series C convertible.................................................... 8,100 -- --
Senior series D convertible.................................................... 671 -- --
--------- --------- ----------
8,771 -- --
--------- --------- ----------
Numerator for basic income (loss) per share
Income loss available to common shareholders................................... 7,081 1,978 (29,550)
--------- --------- ----------
EFFECT OF DILUTIVE SECURITIES
Preferred stock dividends
Senior series C convertible.................................................... 283 230 --
Senior series D convertible-redeemed........................................... 209 -- --
Senior series D convertible-outstanding........................................ -- -- --
--------- --------- ----------
492 230 --
--------- --------- ----------
Gains on redemption
Senior series C convertible.................................................... (8,100) -- --
Senior series D convertible.................................................... (671) -- --
--------- --------- ----------
(8,771) -- --
--------- --------- ----------
Numerator for diluted income (loss) per share
Income (loss) available to common shareholders................................. $ (1,198) $ 2,208 $ (29,550)
--------- --------- ----------
--------- --------- ----------
DENOMINATOR:
Denominator for basic earnings per share
Weighted average shares.......................................................... 7,019 5,952 5,781
--------- --------- ----------
Effect of dilutive securities
Series B convertible preferred stock........................................... -- 386 --
Series C convertible preferred stock........................................... 756 1,344 --
Series D convertible preferred stock........................................... 912 -- --
Stock options.................................................................. -- 549 --
Stock purchase plan............................................................ -- 34 --
Warrants....................................................................... -- 4 --
--------- --------- ----------
Dilutive potential common shares................................................. 1,668 2,317 --
--------- --------- ----------
Denominator for diluted earnings per share
Adjusted weighted average shares and assumed conversions......................... 8,687 8,269 5,781
--------- --------- ----------
--------- --------- ----------
Basic earnings (loss) per share.................................................. $ 1.01 $ 0.33 $ (5.11)
--------- --------- ----------
--------- --------- ----------
Diluted earnings (loss) per share................................................ $ (0.14) $ 0.27 $ (5.11)
--------- --------- ----------
--------- --------- ----------
48
NOTE 15 INCOME (LOSS) PER SHARE (CONTINUED)
For additional disclosures regarding outstanding preferred stock, employee
and director stock options, the employer stock purchase plan and warrants, see
Note 11. In 1999, stock options, conversion of Series B Stock and conversion of
outstanding Series D Stock at March 31, 1999, all of which aggregated 1,181,000
common shares, were not included in the computation of diluted earnings per
share because the effect would have been anti-dilutive. In 1998, options to
purchase 728,000 shares of common stock were outstanding at March 31, 1998, but
were not included in the computation of the diluted earnings per share because
the options' exercise prices were greater than the average market price of the
common shares and, therefore, the effect would be anti-dilutive. In 1997, no
dilutive securities were included in the computation of diluted earnings per
share because the Company had a net loss, and the effect would have been
anti-dilutive.
NOTE 16 SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following summarizes unaudited selected quarterly results of operations
for the years ended March 31, 1999 and 1998 and the market range for the
Company's common stock for those periods:
[Enlarge/Download Table]
QUARTER ENDED JUNE 30 SEPTEMBER 30(A) DECEMBER 31(A) MARCH 31 YEAR
---------------------------------------------- --------- --------------- -------------- ----------- ---------
(IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS)
FISCAL 1999
Revenues...................................... $ 11,008 $ 10,010 $ 11,636 $ 12,540 $ 45,194
--------- ------- ------- ----------- ---------
Gross Margin.................................. $ 6,850 $ 5,653 $ 6,967 $ 7,006 $ 26,476
--------- ------- ------- ----------- ---------
Net income (loss)............................. $ 254 $ (2078) $ 241 $ 458 $ (1,125)
--------- ------- ------- ----------- ---------
Net income (loss) per share:
Basic....................................... $ (0.05) $ (0.42) $ 1.30 $ .05 $ 1.01
Diluted..................................... $ (0.05) $ (0.42) $ .03 $ .04 $ (.14)
--------- ------- ------- ----------- ---------
Common stock prices:
High........................................ 10 5/16 5 5/8 3 3/16 4 3/16
Low......................................... 5 5/8 2 1/4 1 11/16 1 3/4
--------- ------- ------- -----------
FISCAL 1998
Revenues...................................... $ 12,826 $ 13,118 $ 13,424 $ 13,209 $ 52,577
--------- ------- ------- ----------- ---------
Gross Margin.................................. $ 8,311 $ 8,277 $ 8,440 $ 8,512 $ 33,540
--------- ------- ------- ----------- ---------
Net income.................................... $ 386 $ 449 $ 726 $ 875 $ 2,436
--------- ------- ------- ----------- ---------
Net income per share:
Basic....................................... $ 0.07 $ 0.08 $ 0.12 $ 0.10 $ 0.33
Diluted..................................... $ 0.05 $ 0.05 $ 0.10 $ 0.09 $ 0.27
--------- ------- ------- ----------- ---------
Common stock prices:
High........................................ 5 1/16 10 1/2 11 29/32 11 1/4
Low......................................... 2 23/32 4 5/16 7 7/8 8 1/4
--------- ------- ------- -----------
------------------------
a. The second and third quarter 1999 net income (loss) and earnings per share
have been restated to reflect an adjustment to the charge taken for
purchased IPR&D as discussed in Note 3.
49
REPORT OF INDEPENDENT ACCOUNTANTS
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF
INTERLEAF, INC.
In our opinion, the consolidated financial statements listed in the
accompanying index on page 23 present fairly, in all material respects, the
financial position of Interleaf, Inc. and its subsidiaries at March 31, 1999,
and the results of their operations and their cash flows for the year then
ended, in conformity with generally accepted accounting principles. In addition,
in our opinion, the financial statement schedule listed in the accompanying
index, for the year ended March 31, 1999, presents fairly, in all material
respects, the information set forth therein when read in conjunction with the
related consolidated financial statements. These financial statements and
financial statement schedule are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audit. We conducted our audit of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Boston, Massachusetts
May 6, 1999
50
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors
Interleaf, Inc.
We have audited the accompanying consolidated balance sheet of Interleaf,
Inc. as of March 31, 1998, and the related consolidated statements of
operations, changes in shareholders' equity (deficit), and cash flows for each
of the two years in the period ended March 31, 1998. Our audits also included
the financial statement schedule listed in the Index at Item 14(a). These
financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Interleaf, Inc. at March 31, 1998, and the consolidated results of its
operations and its cash flows for each of the two years in the period ended
March 31, 1998, in conformity with generally accepted accounting principles.
Also, in our opinion, the related financial statement schedule, when considered
in relation to the basic financial statements taken as a whole, presents fairly
in all material respects the information set forth therein.
Ernst & Young, LLP
Boston, Massachusetts
May 13, 1998
51
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
[Enlarge/Download Table]
COL. B COL. C.
------------- ------------- COL. E COL. F
COL. A BALANCE AT ADDITIONS TO ------------- -------------
---------------------------------------------------------- BEGINNING OF COSTS AND DEDUCTIONS BALANCE AT
DESCRIPTION PERIOD EXPENSES DESCRIBE (1) END OF PERIOD
---------------------------------------------------------- ------------- ------------- ------------- -------------
Year ended March 31, 1997:
Deducted from asset accounts
Allowance for doubtful accounts......................... $ 1,695 $ 304 $ (628) $ 1,371
------ ----- ----- ------
------ ----- ----- ------
Year ended March 31, 1998:
Deducted from asset accounts
Allowance for doubtful accounts......................... $ 1,371 $ 224 $ (231) $ 1,364
------ ----- ----- ------
------ ----- ----- ------
Year ended March 31, 1999:
Deducted from asset accounts
Allowance for doubtful accounts......................... $ 1,364 $ 259 $ (500) $ 1,123
------ ----- ----- ------
------ ----- ----- ------
------------------------
(1) Write-off of uncollectable accounts receivable and effect of foreign
exchange rate fluctuations
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is contained in part under the caption
"Executive Officers of the Company" in Part I hereof and the remainder is
incorporated herein by reference to "Election of Directors" (except for the
information contained under the subheadings "Compensation Committee Report" and
"Stock Performance Graph") in the Company's Proxy Statement for the Company's
Annual Meeting of Shareholders to be held on September 8, 1999 (the "1999 Proxy
Statement") to be filed with the SEC within 120 days from fiscal year end.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated herein by reference to
"Executive Compensation," "Severance Plan and Change in Control," and
"Directors' Compensation" contained in the 1999 Proxy Statement to be filed with
the SEC within 120 days from fiscal year end.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated herein by reference to
information contained in the table appearing under the heading "Principal
Shareholders" contained in the 1999 Proxy Statement to be filed with the SEC
within 120 days from fiscal year end.
52
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated herein by reference to
"Certain Relationships and Related Transactions" contained in the 1999 Proxy
Statement to be filed with the SEC within 120 days from fiscal year end.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)
1. Financial Statements. The financial statements are listed in the Index
to Consolidated Financial Statements and Financial Statement Schedule
filed as part of this Annual Report on Form 10-K.
2. Financial Statement Schedule. The financial statement schedule is listed
in the Index to Consolidated Financial Statements and Financial Statement
Schedule filed as part of this Annual Report on Form 10-K.
3. Exhibits. The exhibits listed in the accompanying Exhibit Index are
filed as part of this Annual Report on Form 10-K.
(b) Reports on Form 8-K
On March 16, 1999, the Company filed a Current Report on Form 8-K (File No.
0-14713) attaching as an Exhibit financial statements reflecting the effect of
the Company's February, 1999 private placement, and its resulting compliance
with NASDAQ's minimum net tangible asset continued listing criteria.
53
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
[Download Table]
INTERLEAF, INC.
By: /s/ JAIME W. ELLERTSON
----------------------------------------
Jaime W. Ellertson,
PRESIDENT AND CHIEF EXECUTIVE OFFICER
Dated: June 29, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
[Download Table]
SIGNATURE CAPACITY DATE
------------------------------ -------------------------- -------------------
President and Chief
/s/ JAIME W. ELLERTSON Executive Officer and a
------------------------------ Director (Principal June 29, 1999
Jaime W. Ellertson Executive Officer)
Vice President of Finance
and Administration Chief
/s/ PETER J. RICE Financial Officer and
------------------------------ Treasurer (Principal June 29, 1999
Peter J. Rice Financial and Accounting
Officer)
/s/ RORY J. COWAN
------------------------------ Chairman of the Board of June 29, 1999
Rory J. Cowan Directors
/s/ FREDERICK B. BAMBER
------------------------------ Director June 29, 1999
Frederick B. Bamber
/s/ DAVID A. BOUCHER
------------------------------ Director June 29, 1999
David A. Boucher
/s/ MARCIA J. HOOPER
------------------------------ Director June 29, 1999
Marcia J. Hooper
/s/ JOHN A. LOPIANO
------------------------------ Director June 29, 1999
John A. Lopiano
54
EXHIBIT INDEX
[Enlarge/Download Table]
EXHIBIT METHOD OF
NUMBER DESCRIPTION FILING
--------- ------------------------------------------------------------------------------------------- ----------
3.01 Restated Articles of Organization of the Company, as amended [A]
3.02 By-Laws of the Company, as amended [B]
4.01 Specimen Certificate for Shares of the Common Stock Included
10.01 1989 Officer and Employee Severance Benefit Plans [C]
10.02 1993 Director Stock Option Plan [B]
10.03 1993 Stock Option Plan, as amended [D]
10.04 1994 Employee Stock Option Plan, as amended [E]
10.05 1998 Employee Stock Purchase Plan [F]
10.06 1997 Key Man Stock Option Plan and Agreement dated January 10, 1997 [G]
10.07 1998 Key Man Stock Option Plan and Agreement dated February 23, 1998 [G]
10.08 Preferred Stock Purchase Agreement, for the issuance of 2,142,857 shares of the Company's [H]
Senior Series B Convertible Preferred Stock, dated September 29, 1989
10.09 Letter Agreement among Interleaf, Inc., the Lindner Growth Fund and the Lindner Dividend [I]
Fund dated as of August 19, 1998, as amended by Letter Agreement dated October 26, 1998,
pursuant to which the Company redeemed 100% of the Series C Stock
10.10 Form of Letter Agreements among Interleaf, Inc., and certain holders of the 6% Convertible [I]
Preferred Stock, dated as of October 27, 1998, and Form of Closing Letter dated November 4,
1998 with respect to the conversion of 6% Convertible Preferred Stock
10.12 Form of Common Stock Purchase Agreement between the Company and each of the participants in [J]
the March 1999 Private Placement.
10.13 Lease of Prospect Place, Waltham, MA, between Prospect Place Limited Partnership and [K]
Interleaf, Inc., and related Agreements, dated March 30, 1990.
10.14 Sublease, dated September 15, 1995, between Parametric Technology Corporation and the [L]
Company
10.15 Net Lease, dated August 14, 1995, between Principal Mutual Insurance Company and the [L]
Company
10.16 Offer Letter and Acceptance between Jaime W. Ellertson, the Company's President and Chief [M]
Executive Officer, and the Company, dated January 9, 1997.
10.17 Offer Letter and Acceptance between Craig Newfield, the Company's Vice President, General [N]
Counsel and Clerk, and the Company, dated October 3, 1997
10.18 Offer Letter and Acceptance between Peter J. Rice, the Company's Vice President, Chief [N]
Financial Officer and Treasurer, and the Company, dated February 23, 1998.
10.19 Letter Agreement between the Company and Amanda Radice dated November 2, 1998, regarding [I]
the employment of Ms. Radice by the Company
10.20 Letter Agreement between the Company and Barry Briggs dated May 3, 1999, regarding the Included
employment of Mr. Briggs by the Company
[Enlarge/Download Table]
EXHIBIT METHOD OF
NUMBER DESCRIPTION FILING
--------- ------------------------------------------------------------------------------------------- ----------
10.21 Letter Agreement between the Company and Graham Marshall dated May 10, 1999, regarding the Included
employment of Mr. Marshall by the Company
10.22 Stock Purchase Agreement by and among Interleaf, Inc., PDR Automated Systems and [O]
Publications, Inc. and Dona D. Ray, with variable information for otherwise identical
agreements with Messrs. Marksbury and Kloiber
10.23 Stock Purchase Agreement dated February 25, 1999 between the Company and Finpiave, S.p.A. [P]
regarding the purchase by Interleaf of 69% of the capital of Interleaf Italia S.r.l.
10.24 Asset Purchase Agreement dated April 7, 1999 by and among Interleaf, Inc., Texcel [Q]
International AL, Texcel Research, Inc. and Texcel (UK) Limited
21 Subsidiaries of the Company Included
23.1 Consent of Independent Auditors Included
23.2 Consent of Independent Accountants Included
27 Financial Data Schedule Included
------------------------
A Incorporated herein by reference are the applicable Exhibit to Company's
Report on Form 10-Q for the quarter ended December 31, 1996, File Number
0-14713; and Appendix A to the Proxy Statement filed December 2, 1998, File
Number 0-14713.
B Incorporated herein by reference is the applicable Exhibit to Company's
Annual Report on Form 10-K for the year ended March 31, 1994, File Number
0-14713.
C Incorporated herein by reference is the applicable Exhibit to Company's
Annual Report on Form 10-K for the year ended March 31, 1989, File Number
0-14713.
D Incorporated herein by reference is the applicable Exhibit to Company's
Annual Report on Form 10-K for the year ended March 31, 1995, File Number
0-14713.
E Incorporated herein by reference is the applicable Exhibit to Company's
Report on Form 10-Q for the quarter ended September 30, 1996, File Number
0-14713.
F Incorporated herein by reference is Exhibit A to the Company's Proxy
Statement for 1998 Annual Meeting of Stockholders July 28, 1998, File Number
333-77907.
G Incorporated herein by reference is the applicable Exhibit to the Company's
Registration Statement on Form S-8, filed June 5, 1998, File Number
333-56145.
H Incorporated herein by reference is the applicable Exhibit to Company's
Annual Report on Form 10-K for the year ended March 31, 1990, File Number
0-14713.
I Incorporated herein by reference is the applicable Exhibit to Company's
Report on Form 10-Q for the quarter ended September 30, 1998, File Number
0-14713.
J Incorporated herein by reference is Exhibit 10 to the Company's Current
Report on Form 8-K dated November 27, 1998, File Number 0-14713.
K Incorporated herein by reference is the applicable Exhibit to Company's
Report on Form 8-K filed April 13, 1990, File Number 0-14713.
L Incorporated herein by reference is the applicable Exhibit to Company's
Registration Statement on Form S-2, File Number 33-63785.
M Incorporated herein by reference is the applicable Exhibit to Company's
Report on Form 10-Q for the quarter ended December 31, 1996, File Number
0-14713.
N Incorporated herein by reference is the applicable Exhibit to Company's
Annual Report on Form 10-K for the year ended March 31, 1998, File Number
0-14713.
O Incorporated herein by reference is Exhibit 10.1 to the Company's Current
Report on Form 8-K dated September 24, 1998, File Number 0-14713.
P Incorporated herein by reference is Exhibit 4.2 to the Company's Registration
Statement on Form S-3 dated May 6, 1999, File Number 333-77907.
Q Incorporated herein by reference is Exhibit 4.3 to the Company's Registration
Statement on Form S-3 dated May 6, 1999, File Number 333-77907.
Dates Referenced Herein and Documents Incorporated by Reference
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