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| CAPA > SEC Filings for CAPA > Form 10-Q on 31-Oct-2008 | All Recent SEC Filings |
31-Oct-2008
Quarterly Report
This discussion and analysis should be read in conjunction with our unaudited consolidated financial statements and accompanying notes included in this document and our 2007 audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 17, 2008 and amended on April 29, 2008.
This Quarterly Report on Form 10-Q contains forward-looking statements. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as "may," "should," "expect," "plan," "intend," "anticipate," "believe," "estimate," "predict," "potential," "continue," "could," "future," "seek," "target" or the negative of these terms or other terminology. These statements are only predictions. Actual events or results may differ materially. In evaluating these statements, you should specifically consider various factors, including the risks outlined at the beginning of this report under "Forward-Looking Statements," in Part I, Item 1A of our most recent Annual Report on Form 10-K and in Part II, Item 1A of our Quarterly Reports on Form 10-Q. These factors may cause our actual results to differ materially from any forward-looking statements. Except as required by law, we undertake no obligation to publicly release any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
Overview
Founded in 1982, Captaris, Inc., ("we", "us", "our") is a provider of computer products that automate document-centric business processes. With a comprehensive suite of software, hardware and services, we help organizations gain control over many processes that include the need to integrate documents more securely and efficiently. Our solutions also provide interoperability between documents and business applications and technology platforms.
We develop products and services for document capture, intelligent document recognition and classification, routing, workflow, document management and document delivery. Our product lineup includes the brand names RightFax, FaxPress, Captaris Workflow, Alchemy, Single Click Entry, DOKuStar and RecoStar.
Our products are distributed and supported through a global network of technology partners. This distribution system consists of business partners from all levels of the information technology ("IT") spectrum: value-added resellers, original equipment manufacturers ("OEMs"), system integrators, distributors, mass market resellers, online retailers, office equipment dealers, and independent software vendors ("ISVs"). We believe the use of multiple distribution channels increases the likelihood that our products will be sold to more customers.
We have a large installed base of customers that includes, as of the date of this report, the entire Fortune 100, the majority of the Global 2000 companies, and thousands of mid-sized enterprises. Our customers use our products to reduce costs, comply with regulations, increase the performance and productivity of critical business processes, and leverage their IT system investments.
In July 2007, we bolstered our product portfolio, customer base, and distribution capabilities by acquiring Castelle, a provider of "all-in-one" network fax appliance solutions for businesses and enterprises. Castelle FaxPress products are designed to be easily deployed and maintained and are generally intended for lower volume use at lower price points than our RightFax product offerings. FaxPress provides Captaris with a fax server product that can be positioned in the tier below RightFax for customers looking for basic fax services that are low cost and easily deployable. The FaxPress products are available through a worldwide network of distributors, resellers, and online retailers.
Included in our single business segment, Castelle's expertise in building "all-in-one" network appliance solutions facilitates our plan to broaden our offerings in the areas of document capture, routing and management. The network appliance design combines software and hardware into a "plug and play" device, and we believe this design is particularly well suited to support our focus on achieving synergies with multi-function product manufacturers and their dealer networks.
We further increased our product portfolio, customer base and distribution capabilities with the acquisition of Oc? Document Technologies GmbH ("ODT") in January 2008. ODT is a provider of software and solutions for document capture, text recognition, and document classification. On an unaudited basis, ODT's revenue was approximately €22.5 million for the 12 months ended November 30, 2007 and their gross margin was approximately 65%. ODT's revenue includes software licenses, maintenance and support, hardware and professional services. In contrast to our business prior to the acquisition, ODT's revenue includes a higher percentage of professional services and a larger portion of their sales are made directly rather than through partners. As a result of these factors, and a smaller revenue and customer base, ODT has a lower gross margin and more revenue variability.
After the acquisition, we re-named ODT to Captaris Document Technologies GmbH ("CDT"). CDT develops intelligent document and character recognition technologies that can read and extract the important information from documents needed to drive business processes and decisions. CDT products include RecoStar, DOKuStar and Single Click Entry. CDT customers include some large ISVs and OEMs with capture offerings, as well as blue chip end-user accounts in Germany. CDT's expertise in intelligent document recognition supports our vision of fully enabling document capture, collaboration and workflow. As we continue to merge our products, we anticipate leveraging CDT's technology to enhance capture and routing in both the RightFax and Alchemy platforms. The ability to classify documents and extract critical meta-data will also enable deeper integrations with line of business applications and business process management.
Executive Summary
We derive net revenue primarily from licensing software as well as follow-on sales of add-on software modules, incremental capacity and the sale of maintenance, support and service agreements, professional services, appliances and the resale of fax boards.
We work with resellers and distributors located throughout the world. These resellers and distributors sell and install our products and they receive discounts based on the volume of sales. Within our selling and marketing groups, we dedicate significant resources to monitor our resellers and distributors and to generate demand and provide market positioning and support.
We believe that utilizing an indirect channel approach provides several advantages, including minimizing our investment in office facilities and personnel in field locations and applying greater resources to sales and implementation efforts. However, with a channel sales model, we have more difficulty tracking the number and location of all end-users utilizing our products. This also limits our ability to capture information around product usage, system integration characteristics, and deployment satisfaction directly from our customers' perspective in order to enhance or build new products, solutions and services.
We have extensive service offerings that are sold in conjunction with our products, including: maintenance, support, professional services and solutions. All of these offerings are designed to help customers protect and extend their software investment.
Our $11.2 million and $27.8 million revenue increase for the quarter and nine months ended September 30, 2008 compared to the same periods in 2007, was primarily attributable to the inclusion of CDT in our results of operations and the continuing growth of our traditional maintenance, support and service revenue. In comparison to the year ended December 31, 2007, we expect revenue increases in our software, appliances, and services categories for the year ending December 31, 2008. This expectation is based on including in our 2008 results of operations revenue from CDT as discussed in the "Acquisition" section below, as well as increased customer demand for existing products resulting from increased investment in our sales organization. We expect hardware revenue will be relatively flat compared to 2007 and a smaller percentage of total revenue due to market shifts to software-based fax over Internet protocol, which does not rely on fax hardware in many Internet protocol environments. We also expect a significant shift in our revenue distribution on a geographic basis. As a result of the acquisition of CDT, with operations primarily in Europe, and increased investment in our sales organization in international markets, we anticipate significantly higher revenue in 2008 from international markets, compared to 2007. During the quarter ended September 30, 2008, one customer accounted for 14.3% of our net revenue. No single customer represented more than 10% of our net revenue for the quarter ended September 30, 2007 and for the nine months ended September 30, 2008 and 2007, respectively.
Our gross profit is the selling price of our products, net of estimated returns, less cost of revenue. Our cost of revenue includes fax boards, manufacturing and distribution costs, royalties for licensed products, amortization of acquired technology, product warranty costs, operation costs related to product support and costs associated with the delivery of professional services.
Gross profit increased by $6.9 million and $16.5 million, respectively, during the quarter and nine months ended September 30, 2008 compared to the same periods in 2007. This was primarily attributable to the inclusion of CDT in our results of operations and the continuing growth of our traditional maintenance, support and service revenue. We expect our gross profit will increase in 2008 due to anticipated increases in revenue mentioned above. We expect gross profit as a percentage of revenue to decline in 2008 compared to 2007 for two reasons. First, CDT has traditionally recorded lower gross margins than Captaris primarily because of a higher portion of professional services; therefore including CDT in our results of operations will have the effect of reducing our overall gross profit as a percentage of revenue. Second, amortization expense of $569,000 and $1.8 million related to the technology acquired from CDT is recorded in cost of revenue during the quarter and nine months ended September 30, 2008, respectively. Also, in some cases, CDT will sell hardware at low margins as part of a larger solution.
Our operating expenses were $23.2 million and $17.9 million for the quarters ended September 30, 2008 and 2007, respectively. Our operating expenses were $76.1 million and $50.0 million for the nine months ended September 30, 2008 and 2007, respectively. The increase in the quarter ended from September 30, 2007 to 2008 was due primarily to the inclusion of CDT in our operating results. The increase for the nine months ended from September 30, 2007 to 2008 was due primarily to the inclusion of Castelle and CDT in our operating results. CDT's operating expenses were $5.5 million and $18.9 million for the quarter and nine months ended September 30, 2008, respectively. Castelle's operating expenses were $3.6 million for the nine months ended September 30, 2008.
Our principal sources of liquidity are cash and cash equivalents and our $20.0 million Credit Facility described below under "Liquidity and Capital Resources". The balance of cash, cash equivalents, restricted cash and short- and long-term investments at
September 30, 2008 totaled $28.1 million compared to $47.2 million at December 31, 2007. The decrease in cash, cash equivalents, restricted cash and short and long-term investments from 2007 to 2008 was primarily due to the CDT acquisition of $17.9 million, capital purchases of $4.2 million and cash used in our operating activities of $6.4 million (which includes a $3.1 million realized loss related to a foreign exchange forward contract that was settled on April 4, 2008 with the bank). These decreases were partially offset by net proceeds drawn from our Credit Facility of $8.3 million. Capital expenditures during the nine months ended September 30, 2008 consisted primarily of leasehold improvements and furniture and fixtures related to our new offices in Bellevue, Washington and Tucson, Arizona.
Acquisition
On January 4, 2008, our wholly-owned subsidiary, Captaris Verwaltungs GmbH, a German limited liability company ("CVG"), acquired ODT, pursuant to a Sale and Purchase Agreement (the "SPA") by and between CVG and Océ Deutschland Holding GmbH & Co. KG, a German limited partnership (the "Seller"), dated December 20, 2007. Under the terms of the SPA, CVG acquired all of the outstanding equity of ODT from the Seller, and ODT became a wholly-owned subsidiary of CVG and an indirect wholly-owned subsidiary of Captaris. After our acquisition, we re-named ODT to CDT. We combined CDT in our single business segment and our results of operations include CDT's results of operations for the period from January 4, 2008 to September 30, 2008.
Under the terms of the SPA, CVG acquired CDT for a purchase price of approximately $17.9 million, net of CDT's cash balance as of the closing of approximately $32.0 million, including transaction costs of $2.8 million plus assumed liabilities of $30.2 million. The assumed liabilities include $18.1 million in future retirement and employee benefit obligations, deferred revenue of $1.8 million and accounts payable and accrued liabilities of $10.3 million. At the closing, €2.0 million ($3.0 million) of the purchase price was deposited in a third-party escrow account for 12 months as security for any post-closing purchase price adjustments and, subject to certain limitations, for indemnification claims against the Seller; however, we released the full amount of the escrow to the Seller in connection with the resolution of a post-closing dispute with the Seller during the first quarter of 2008. The acquisition of CDT has been accounted for as a purchase. We recognized a charge of $1.3 million for acquired in-process research and development. See Note 8 to our unaudited consolidated financial statements.
In January 2008, we loaned CVG, €31.6 million to finance the acquisition of CDT as well as pay on behalf of CDT approximately €3.1 million of profit-sharing CDT owed to its former owner. The loan accrues interest at a rate equal to the three months EURIBOR rate plus 2.75% per annum. Since the acquisition, and through the date of this report, the majority of our consolidated cash is held by CDT in Germany. See "Liquidity and Capital Resources" below.
Critical Accounting Judgments and Estimates
The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of our financial statements and the reported amounts of revenue and expenses during the reporting period. We base our estimates on historical experience, current conditions and various other assumptions we believe to be reasonable under the circumstances. Our estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources, as well as identifying and assessing our accounting treatment with respect to commitments and contingencies. Actual results may differ significantly from these estimates. To the extent that there are material differences between these estimates and actual results, the presentation of our financial condition or results of operations may be affected.
On an ongoing basis, we evaluate our estimates used, including those related to the valuation of stock options, valuation of goodwill and other intangible assets, valuation of derivative instruments, useful lives of intangible assets and equipment and leasehold improvements, inventory valuation allowances, revenue recognition, the estimated allowances for sales returns and doubtful accounts and income tax accruals. We believe that the following accounting policies are critical to understanding our historical and future performance, as these policies may involve a higher degree of judgment and complexity than others. For a detailed discussion on the application of these and other accounting policies, see Note 1 in Notes to Consolidated Financial Statements in Item 8 of our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 17, 2008.
Our most critical accounting judgments and estimates relate to the following areas:
• Revenue recognition;
• Allowances for sales returns and doubtful accounts;
• Valuation of inventory at lower of cost or market value;
• Classification of investments and assessment of related unrealized losses;
• Valuation of acquired businesses, assets and liabilities;
• Impairment of goodwill;
• Useful lives of equipment, leasehold improvements and intangible assets;
• Valuation of derivative instruments
• Contingencies;
• Stock-based compensation plans; and
• Accounting for income taxes.
Revenue recognition. Our revenue recognition policies follow the guidelines of the American Institute of Certified Public Accountants ("AICPA") Statement of Position ("SOP") No. 97-2, Software Revenue Recognition, as amended. We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed or determinable and collection is reasonably assured.
We sell products through resellers, Original Equipment Manufacturers ("OEM") and other channel partners, as well as directly to end-users. Generally our resellers do not stock product, and except for OEM sales described below, we recognize product revenue upon shipment, net of estimated returns, provided that collection is determined to be probable and no significant obligations remain. If a reseller does stock product, we defer this revenue until the reseller sells the product through to end-users.
Sales of our appliance products are made through stocking distributors. For sales to distributors, we recognize revenues on either the sell-through or sell-in method of revenue recognition as determined by the contractual arrangement with each distributor. When the distributor is entitled to stock rotation rights, we recognize revenue upon delivery of the appliances to the distributor less a provision for an estimate of those rights (the "sell-in" method). Otherwise, revenue is recognized upon delivery of the appliances to the end-user (the "sell-through" method).
Revenue from perpetual software licenses is recognized when the software has been shipped, provided that collection for such revenue is deemed probable. Revenue from term software licenses is recognized over the term of the license, generally 12 months.
Whenever a software license, hardware, installation and post-contract customer support ("PCS") elements are sold together, we allocate the total arrangement fee among each element based on its respective fair value, which is the price charged when that element is sold separately. The amount of revenue assigned to each element is impacted by our judgment as to whether an arrangement includes multiple elements and, if so, whether vendor-specific objective evidence ("VSOE") of fair value exists for those elements. Changes to the elements in an arrangement and our ability to establish VSOE for those elements could affect the timing of revenue recognition for these elements. Revenue for PCS is recognized on a straight-line basis over the service contract term, ranging from one to five years. PCS includes rights to unspecified upgrades and updates, when and if available, and bug fixes.
Installation revenue is recognized when the product has been installed at the customer's site and accepted by the customer. Recognition of revenue from software sold with installation services is recognized either when the software is shipped or when the installation services are completed, depending on our agreement with the customer and whether the installation services are integral to the functionality of the software.
We have entered into agreements with certain OEMs from which we receive royalty payments periodically. Under the terms of the OEM license agreements, each OEM will qualify our software on their hardware and software configurations. Once the software has been qualified, the OEM will begin to ship products and report net sales to us. Most OEMs pay a license fee based on the number of copies of licensed software included in the products sold to their customers. These OEMs pay fees on a per-unit basis and we record associated revenue when we receive notification of the OEMs' sales of the licensed software to an end-user. The terms of the license agreements generally require the OEMs to notify us of sales of our products within 30 to 45 days after the end of the month or quarter in which the sales occur. As a result, we recognize the revenue in the month or quarter following the sales of the product to these OEMs' customers.
We provide allowances for estimated returns, and return rights that exist for some customers. In general, customers are not granted return rights at the time of sale. However, we have historically accepted returns and therefore, reduce revenue recognized for estimated product returns. For those customers to whom we do grant return rights, we reduce revenue by an estimate of these returns. If we cannot reasonably estimate these returns, we defer the revenue until the return rights lapse. For software sold to resellers for which we have granted exchange rights, we defer the revenue until the reseller sells the software through to end-users. When customer acceptance provisions are present and we cannot reasonably estimate returns, we recognize revenue upon the earlier of customer acceptance or expiration of the acceptance period.
Professional services are customarily billed at fixed rates, plus out-of-pocket expenses and revenue is recognized when the service has been completed. However, if it is determined that a consulting engagement will be unprofitable, we recognize the loss at the time of such determination. Training revenue is recognized when the training is completed.
Allowance for sales return. We estimate potential future product returns related to current period revenue based on our historical returns, current economic trends, changes in customer demand and acceptance of our products. We periodically review the adequacy of our
sales returns allowance and underlying assumptions. If the assumptions we use to calculate the estimated sales returns do not properly reflect future returns, a change in accruals for sales returns would be made in the period in which such a determination was made. Historically, our accruals for sales returns have been adequate.
Allowance for doubtful accounts. We make ongoing assumptions as to the collectibility of our accounts receivable in our calculation of the allowance for doubtful accounts. In determining the amount of the allowance, we make estimates based on our historical bad debts, the aging of customer accounts, customer concentrations, customer credit-worthiness, current economic trends and changes in our customer payment patterns. Our reserves historically have been adequate to cover our actual credit losses. However, if actual credit losses were to fluctuate significantly from the reserves we have established, our general and administrative expenses could be adversely affected.
Valuation of inventory at lower of cost or market value. Due to rapid changes in technology, it is possible that older products in inventory may become obsolete or that we may sell these products below cost. When we determine that the carrying value of inventories is not recoverable, we write-down inventories to market value. If actual market conditions are less favorable than we project, inventory write-downs may be required, which may have a material adverse effect on our financial results.
Valuation of acquired businesses, assets and liabilities. Our business acquisitions typically result in goodwill and other intangible assets, and the recorded values of those assets may become impaired in the future. As of September 30, 2008, our goodwill and intangible assets, net of accumulated amortization, were $80.8 million. The determination of the fair value of such intangible assets and goodwill is a critical and complex consideration that involves significant assumptions and estimates. These assumptions and estimates are based on our best judgments and could materially affect our financial condition and results of operations.
Impairment of goodwill. Our judgments regarding the existence of impairment indicators include our assessment of the impacts of legal factors; market and economic conditions; the results of our operational performance and strategic plans; competition and market share; and any potential for the sale or disposal of a significant portion of our principal operations. If we conclude that indicators of impairment exist, we then assess the fair value of goodwill. Our valuation process provides an estimate of a fair value of goodwill using a discounted cash flow model and includes many assumptions and estimates. We test goodwill for impairment on an annual basis in the first quarter of the year, and on an interim basis in certain circumstances. We conducted our annual assessment during the first quarter of 2008 and determined our goodwill at March 31, 2008 was not impaired. In the event that, in the future, we conclude that our goodwill or our amortizable intangible assets are impaired, we would be required to record a charge to earnings in our financial statements and that charge may significantly decrease our results of operations.
Impairment of equipment, leasehold improvements, long-lived assets and other intangible assets. We periodically review long-lived assets, other intangibles and product lines that we may sell or otherwise dispose of before the end of the asset's previously estimated useful life to determine if there is any impairment of these assets. We assess the impairment of these assets, or the need to accelerate amortization, whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Our judgments regarding the existence of impairment indicators are based on legal factors, market conditions and operational performance of our long-lived assets and other intangibles. Future events could cause us to conclude that impairment indicators exist and that the assets should be reviewed to determine their fair value. We assess the assets for impairment based on the estimated future undiscounted cash flows expected to result from the use of the assets and their eventual disposition. If the carrying amount of an asset exceeds its estimated future undiscounted cash flows, an impairment loss is recorded for the excess of the asset's carrying amount over its fair value. Fair value is generally determined based on a valuation process that provides an estimate of a fair value of these assets . . .
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