Item 1. BUSINESS
General
Periphonics Corporation (the "Company") was originally incorporated in Delaware in December 1969. On January 31, 1983, the Company was dissolved and operated as a division of Gilbarco, Inc., a wholly-owned subsidiary of Exxon Corporation. On July 26, 1984, the Company was reincorporated in Delaware and in 1986, 4000 VMH Corp., a company owned by persons who were then senior executives of the Company, purchased all of the outstanding Common Stock of the Company from Exxon Corporation. In March 1995, the Company completed an initial public offering ("IPO") of its Common Stock. Effective upon the closing of the IPO, 4000 VMH Corp. was merged with and into the Company.
The Company develops, markets and supports high performance interactive voice response ("IVR") systems, based on industry standard, open architecture computer hardware and operating system software, in combination with its own proprietary IVR technology. The nature of the Company's business, and the way many people view the market, is gradually broadening to encompass more than basic IVR - and is now more appropriately described as: development, marketing and support of products and services for Computer Telephony Integration ("CTI") and for Telecom Enhanced Network Services using technologies such as IVR, speech input, messaging, fax and web browsers. The Company's products and services automate call and transaction processing, increase call center agent productivity, and can create new revenue for our customers.
The Company is a leading supplier of mid-to-large scale systems - systems handling hundreds to thousands of simultaneous telephone calls. Systems have been installed in more than 50 countries. Our staff of 733 employees (May 1997) serves customers from Periphonics offices in Canada, Germany, Hong Kong, Mexico, Singapore, the United Kingdom and the USA.
The Market
The Company's products and services represent an important element in the telecommunications and data processing infrastructure of many customer service-oriented organizations. Typical systems enable callers to use a touch-tone telephone or speech input to access information in an organization's computer database and to receive that information verbally via high quality digitally-stored or synthesized speech or via facsimile. In addition, these systems enable customers to execute certain transactions on-line without the intervention of customer service personnel. As a result, these systems permit businesses and other organizations in both the public and private sectors to better utilize the capabilities of their telephone and computer systems, to provide new revenue generating services, to increase the productivity of their customer support staff, and to offer more services to customers in less time and at lower cost. These systems are used for a variety of transaction specific applications including accessing data regarding bank, mutual fund or brokerage accounts; checking the status of insurance claims or tax filings; obtaining loan or credit card balances and/or rates; registering for college courses; and retrieving descriptions of particular products or services.
IVR systems constitute a specialized segment of the overall voice processing/call processing market, which also includes voice messaging/voice mail systems, automated attendant systems, automated call distribution systems and outbound predictive dialing systems. The Company believes that the increased use of those systems has been due to several factors, including industry-wide improvements in product features, public acceptance of automated systems to obtain information or execute transactions and competitive pressures on organizations to offer improved customer services at lower costs.
International sales constitute an important element of Periphonics' business, and Periphonics believes that international markets will continue to offer attractive growth potential. See Note 12 of Notes to Consolidated Financial Statements for information concerning the Company's operations by geographic area.
Principal Markets, Customers and Applications
Periphonics has manufactured and delivered systems to customers in the U.S. and in more than 50 other countries. Based on its installed customer base, the Company believes it is a leading supplier of mid-size and large-scale IVR systems. In each of fiscal, 1995, 1996 and 1997, no single customer accounted for as much as 10% of the Company's total revenues. In fiscal 1997, the Company's top ten customers (two of which were new customers) accounted for approximately 36% of total revenues. Six of these top ten customers were telecommunications companies, three of them were financial services companies and one was a government customer. The Company's system sales to customers outside the U.S. contributed approximately 37% of total system sales in fiscal 1997.
Although the Company is broadening its vertical market focus to include additional industries such as government, higher education, healthcare services, transportation, electric and water utilities and distribution companies, it expects that it will continue to derive a substantial percentage of its system sales from telecommunications and financial services businesses. Accordingly, unfavorable economic conditions or factors that relate to these industries, particularly any such conditions that might result in reductions in capital expenditures by the Company's target customers, could have a material adverse affect on the Company's results of operations. The Company believes that in recent periods certain of its competitors have experienced results below their expectations particularly with respect to certain of their telecommunications customers. There can be no assurance that the Company will not experience similar difficulties with its telecommunications or other vertical market customers.
Some of the representative markets using Periphonics' systems and typical customer applications in these markets are described below:
Product Technology
The Company's products generally consist of the following major elements: (i) an application processor platform with one or more SPARC-based RISC processors; (ii) a proprietary voice subsystem that contains one or more telephony interface boards, voice storage, and one or more tone- detection modules, (iii) Company-designed transaction processing software modules and (iv) optional application development tools.
The main attributes of the products' architecture include its internally distributed client/server processing structure and function specific processing via dedicated microprocessors. The major advantage of this approach is two fold: first, it allows for more effective system implementation by tailoring each function as required; second, it allows for incorporation of new technology in each function as it becomes available, which is beneficial since technology relating to different functions improves at different rates over time. The result of the architecture is a system that can be tailored for many configurations and adapted to newer technologies in telephony and transaction processing. By maintaining an unmodified UNIX kernal and standard UNIX file system, the Company's system software delivers an open and scalable client/server implementation which can be easily migrated to new UNIX versions or to other hardware platforms. The architecture has been designed to provide a systems platform that supports capacity growth and technological evolution with modular upgrades.
The products, like those of several other competitors (such as Lucent Technologies, formerly part of AT&T, IBM and InterVoice), utilize internally developed telephony interfaces and speech processing modules. Many other competitors rely on telephony interface and other modules purchased from third party component suppliers (such as Dialogic Corporation or Natural Microsystems, Inc.). The Company believes that designing its own telephone and speech processing modules gives it an advantage in evolving and upgrading its systems in a logical and compatible manner, thus preserving the customer's investment in the system over a longer period of time.
The Company's VPS Series products offer a wide range of telephone interface and data connectivity options. The telephone interface options supported by the system include standard digital (including ISDN support for countries including the U.S., Canada and Germany) and analog connections to public switched networks and to a variety of PBX/ACD systems from vendors including Lucent Technologies, Northern Telecom, Rolm/Siemens, Rockwell, Aspect, NEC, Fujitsu, Hitachi, Ericsson and Alcatel. The data connectivity options supported by the system include interfaces for mainframe-based legacy systems as well as LAN-based systems. These interfaces can support a variety of databases and Application Programming Interfaces ("APIs").
Products
The Company's products include a family of scalable interactive transaction processing systems, called the VPS Series, which can be configured for small (8-24 ports), mid-size (24 to 120 ports), or large scale installations, including a network of multiple systems to handle thousands of telephone ports. The Company also develops and sells software application products and application development tools that provide customers with various administrative, systems management and application development capabilities for their systems.
All of the products in the VPS Series share an open, flexible, modular architecture, and the same system software which allows application software developed for any system to operate across the Company's entire range of system configurations. The Company provides periodic software upgrades for its systems to deliver enhanced features and maintenance updates. The current VPS Series system software release version is 5.2 and has been available since March 1997. Periphonics' IVR systems are listed below:
Year of Port Model Introduction Capacity
VPS/is (digital) 1995 24/30-96/120
VPS/is (analog) 1995 8-120
VPS/mcp 1996 192/240 - 384/480
VPS/is. This model provides enhanced client/server capabilities within a UNIX Software architecture that features parallel functional processing with flexible scalability. The VPS/is system is designed to handle applications, even at peak loads, and accommodates new feature and performance upgrades through incremental enhancements.
VPS/mcp. This model provides higher density systems that are optimized for high volume calling services. The system and application software for these models are fully compatible with VPS/is systems.
Depending on system configuration, optional features and custom programming, prices for the Company's systems can range from less than $1,000 per port to more than $4,000 per port, and individual systems can be purchased for as little as $18,000 to more than $1 million.
Periphonics provides a number of optional features to enhance its systems capabilities. Most of these option features are configured as shared-system resources and are utilized only when needed, thus providing a cost-effective implementation that is scalable to the capacity needs. Each of the optional features is available for use on each of the VPS Series products, where appropriate. These features include:
Basic Speech Recognition Devices. This option offers recognition of spoken numbers and control words by callers along with standard touch-tone input. In addition, some versions of this option can recognize individual spoken words or continuous numbers or multilingual speech.
Large Vocabulary Recognition Devices. This option offers recognition of hundreds to thousands of spoken words along with standard touch-tone input. In addition, recognition results can be combined with natural language processing to allow a very simple and intuitive caller interface for a wide range of automated interactive services.
Caller Message Recording. This option allows the system to record spoken information such as names and addresses from callers and link it with touch-tone information from the same caller and with data retrieved from a host computer for later transcription by the system operator.
Message Transfer Server. This option offers centralized speech storage and retrieval for a cluster of systems. It includes a highly available and scalable configuration with fault-tolerant disk storage (using RAID) and redundant LAN based message storage and playback.
Facsimile Interface. This option allows the system to provide a paper response, such as a confirmation letter or account statement, via facsimile transmission, as part of an interactive transaction. The VPS Series digitally stores graphical fax images, which are dynamically combined with caller-supplied information and host database information and transmitted to the caller's facsimile machine under application control.
Text-to-Speech. This option allows VPS Series products to convert textual data obtained from a database into synthesized speech.
PeriWeb. A software option that permits Periphonics' systems to support a user's web browser in order to accomplish World Wide Web-based transactions; instead of a voice greeting, the response is provided via a dynamic visual hypertext display.
Periphonics also develops, markets and supports CTI Products including:
CallSponsor. A CTI server product that integrates one or more PBX/ACD systems, IVR systems and desktop applications to enable a more productive environment for call center agents. CallSponsor provides call/data tracking and delivery of simultaneous voice and data ("screen pop") to the agent desktops.
CallView. A CTI desktop client software product that interfaces with CallSponsor and enables integration with other desktop applications to provide seamless call transfers and software based control of PBX/ACD telephone functions.
Periphonics also develops, markets and supports products for Telecom Enhanced Network Services including:
Periphonics Calling Card Platform ("PCCP"). This application software product includes a replicated Oracle database and a wide range of configuration options that are activated through easily set parameters. It is scalable over a wide range of sizes - from sizes suitable for small countries as well as large countries.
Voice Activated Dialing ("VAD"). This application software product includes speaker dependent recognition technology that is combined with a highly adaptive application to meet the needs of telecom service providers in a wide range of configuration.
Common Channel Signaling Service ("CCSS"). This option allows a cluster of systems to interface to a switching network via SS7 or C7 signaling protocol. These protocols are used by network service providers to connect enhanced service equipment with more flexibility. The CCSS includes a highly available and scalable configuration with redundant servers.
Periphonics also develops, markets and supports optional system management and application software development tools including:
PeriView. A network management system that facilitates control, administration and monitoring of multiple VPS/is systems from designated common points in the network.
PeriProducer. An icon-based visual software development tool that application developers can utilize to construct full-function production applications for VPS Series systems without the need for extensive programming experience or the use of conventional computer languages.
PeriStudio. A tool that allows users to create, manage, and edit vocabulary elements for VPS Series systems. PeriStudio employs a graphical user interface with point-and-click operation. PeriStudio also supports file interchange with Microsoft Windows, Apple and Sun Microsystems speech file formats.
Product Development
Recent product development efforts have resulted in the introduction of new speech recognition features, new CTI features to increase agent productivity, Periphonics Calling Card Platform and VAD applications. The Company's present product development activities include integration of new features for speech recognition and other voice processing functions; development of additional graphical management tools; interfaces to additional computer and telephone systems; additional application software products; and cost reducing design enhancements.
The Company's research and development ("R&D") management is customer oriented and regularly interacts with its major customers. The Company monitors applicable industry technology developments, including proposals for new standards from industry groups (such as TSAPI and TAPI) as part of its product development efforts to provide state-of-the-art systems and related features.
During fiscal, 1995, 1996 and 1997, the Company spent $5.8 million, $7.9 million and $10.7 million, respectively, on R&D. The Company anticipates that R&D expenditures will continue to represent a significant expense to the Company on an ongoing basis.
Customer Application Programming Services
Implementing an IVR or CTI project usually requires the creation of a script, recording and digitizing the appropriate words and phrases, and writing custom application software for the system that links the script and the telephone network interface and provides access to the appropriate database information. Periphonics has established customer project implementation groups that provides customer-specific programming and project management services for turnkey projects based in the United States (Bohemia, New York, and Pleasanton, California), Mexico, the United Kingdom, Germany and Singapore.
The Company licenses its application software development tools to those customers who prefer to carry out this implementation work themselves, and provides software support, detailed documentation, and a comprehensive hands-on training program to such customers.
Support Services; Maintenance
The Company generally offers 24-hour direct support to its customers. The Company's technical support specialists can access a customer's system via dial-up modem access and utilize various remote diagnostic and trace functions which are built into the Company's systems. In addition, the technical support staff also assists the Company's field service staff in resolving installation and maintenance issues relating to the Company's products. Field service staff are based at many locations around the United States, Canada, Mexico, the United Kingdom, Germany, Singapore and Hong Kong. Technical support specialists are based in the United States (Bohemia, New York and Pleasanton, California), Mexico, the United Kingdom, Germany, Singapore and Hong Kong.
In certain instances, technical support and maintenance for international customers is provided by the Company's distributors.
Periphonics' products and services are sold with limited warranties, generally for 60 days. After the expiration of the warranty, customers may purchase a renewable 12-month maintenance contract. Under these contracts, the Company agrees to provide upgrades of standard system software, on-site repair or replacement of system hardware that does not perform in accordance with specifications, and telephone consultation.
Sales and Marketing
The Company's sales, marketing and pre-sales technical support personnel are located in 17 cities in the U.S.A. and in Canada, United Kingdom, Germany, Hong Kong, Mexico and Singapore. The Company also has agreements with VARs and OEMs who purchase the Company's systems for integration into larger systems as well as with local distributors and independent sales representatives in a number of overseas markets.
The Company's marketing and sales efforts also utilize direct mail, participation in numerous trade shows, an active telemarketing program, and trade publication advertising.
The following table illustrates the respective amounts of the Company's system sales contributed by U.S. and international based customers:
The following table illustrates the respective amounts of the Company's total revenue contributed by U.S. and international based customers:
Manufacturing
The Company's manufacturing activities, which consist primarily of production planning, purchasing, module assembly and testing, system assembly and quality assurance, are conducted at its Bohemia, New York facility and, for European, Middle Eastern and African sales, at its facility in Camberley, U.K.
Variability of Quarterly Results; Limited Backlog
The Company's quarterly operating results may fluctuate as a result of a variety of factors, including the length of the sales cycle, the timing of orders from and shipments to customers, delays in development and customer acceptance of custom software applications, product development expenses, new product introductions or announcements by the Company or its competitors, levels of market acceptance for new products and the hiring and training of additional staff as well as general economic conditions. Historically, the size and timing of the Company's sales transactions, including international sales, have varied substantially from quarter to quarter with a substantial percentage of orders and deliveries occurring in the final weeks of a quarter, and the Company expects such variations to continue in future periods. The Company is typically able to deliver systems within 60 days of receipt of the order and therefore, does not customarily have a significant long-term backlog. Because a significant portion of the Company's overhead is fixed in the short-term, the Company's results of operations may be materially adversely affected if revenues fall below the Company's expectations. During the fiscal year ended May 31, 1997, 26.7% of the Company's sales from IVR systems and 33.1% of the Company's net earnings occurred in the Company's fourth fiscal quarter. Generally, the Company's inventory of computer hardware is determined by the Company's forecasts of sales during future periods. If management's forecasts of product sales and product mix prove to be substantially inaccurate, the Company may not have the necessary inventory available to deliver systems in a timely manner which may have a material adverse effect on the Company's results of operations during such period.
Risk of Rapid Technological Change and New Product Introduction
The market for IVR, CTI and automated transaction processing systems is characterized by rapid continual technological change and improvements in hardware and software technology and in the features and capabilities of these systems. The Company's future success depends upon its ability to introduce new products and to add new features and enhancements to its existing systems that keep pace with technological and market developments, and that address the increasingly sophisticated and demanding needs of its customers. In order to remain competitive, the Company expects to continue to expend significant resources for research and development. There can be no assurance that the Company will be successful in developing and marketing, on a timely basis, product modifications or enhancements or new products that respond to technological advances by others, or that such new or enhanced products or features will adequately and competitively address the needs of the marketplace. In addition, there can be no assurances that the Company will properly estimate costs under fixed price contracts in developing application software and otherwise tailoring its systems to customer-specific requests.
A portion of sales of the Company's systems depend, in part, upon customers' belief that the Company's UNIX and RISC-based systems offer more performance, features and benefits than PC-based systems offered by certain of the Company's competitors. As PC hardware and operating software become more powerful, however, the capabilities of PC-based systems are likely to increase and may become increasingly competitive alternatives to the Company's products in mid-size and large scale installations.
The Company's software products, like software programs generally, may contain undetected errors or bugs when introduced, or as new versions are released. While the Company's current products have not experienced post-release software errors that have had a significant financial or operational impact on the Company, there can be no assurance that such problems will not occur in the future, particularly as the Company's systems continue to become more complex and sophisticated. Such defective software may result in loss of or delay in market acceptance of the Company's products, warranty liability or product recalls.
Highly Competitive Market Environment
The market for IVR, CTI and automated transaction processing systems in the U.S. and internationally is highly competitive and competition may intensify from existing suppliers and new market entrants. Certain of the Company's competitors have substantially greater financial, technical, marketing and sales resources than the Company. There can be no assurance that the Company's present or future competitors will not exert increased competitive pressures on the Company. In particular, the Company may in the future experience pricing pressures as the markets in which it competes mature, as new technologies are introduced or for other reasons, and such price competition could adversely affect the Company's market share and results of operations.
In addition, many suppliers of voice mail systems and telecommunications systems have added IVR capabilities to some of their product offerings and offer IVR systems as a component or add-on of an overall sale of a voice mail system or a telecommunications switch. As internet-based systems are enhanced for transaction processing applications, they may provide an alternative means of allowing customers to interact with computer-based information, thereby reducing the need for IVR. Although the Company believes it has certain marketing, technical and other advantages over many of its competitors, maintaining such advantages will require continued investment by the Company in product innovation and development, as well as in sales, marketing and customer support. There can be no assurance that the Company will be successful in such efforts. If the Company is unable to maintain such advantages, it may have a material adverse effect on the Company's results of operations.
Periphonics' principal competitors in the U.S. include Brite Voice Systems, Inc., InterVoice and Syntellect, Inc., whose businesses are substantially focused on sales of IVR systems, and large, diversified companies such as Lucent Technologies, and IBM for whom IVR and CTI is a small portion of their overall business. In certain specific vertical markets, such as higher education or employee-benefit information systems, the Company faces specialized competition from one or two smaller companies.
Competition for small IVR systems (4-16 ports) is expected to increase over the next several years from a range of companies offering PC-based systems. This trend could extend to mid-size and large-scale systems.
In international markets, Periphonics faces competition primarily from its U.S. competitors and several locally based companies. Periphonics believes that the principal competitive factors are supplier and product reputation and reliability, system features, customer service, price and the effectiveness of marketing and sales efforts. Although certain of the Company's competitors have considerably greater financial, technical and sales and marketing resources than the Company, the Company believes that it competes favorably with respect to each of these factors.
International Sales
System sales to customers outside the U.S. accounted for approximately 35%, 36%, and 37% of the Company's total system sales in the fiscal years ended May 31, 1995, 1996 and 1997, respectively. Systems sales to customers outside the United States, as a percentage of the Company's overall sales, may fluctuate on a quarterly basis, and the percentage of such sales in a particular quarter are not indicative of the percentage of international sales at the end of the fiscal year.
The Company's international business is subject to a number of risks, including compliance with special national telecommunications standards and regulatory requirements, export regulations, currency exchange rates, tariffs and other barriers, difficulties in staffing and managing foreign subsidiary operations, potentially adverse tax consequences, longer payment cycles, greater difficulty in accounts receivable collections and specialized inventory requirements applicable to particular foreign countries. There can be no assurance that these factors will not have an adverse impact on the Company's future international sales or operating results. The Company does not currently engage in international currency hedging transactions. To the extent the Company is unable to match revenue received in foreign currencies with expenses paid in the same currency, it is exposed to possible losses on international currency transactions.
Dependence on Suppliers
Most of the components and parts used in the Company's products are available from more than one supplier. Certain components that are purchased from one source can generally be replaced with parts available from other sources, after some re-engineering or design changes.
In certain instances, despite the availability of multiple supply sources, the Company elects to procure certain components or parts from a single source to maintain quality control or to develop a strategic relationship with a supplier. Although the Company has entered into long-term supply contracts with certain of its vendors, the Company has no assurance that components and parts will be available as required, or that prices of such components and parts will not increase. In certain instances the manufacture of components used by the Company in its products has been discontinued by suppliers and the Company has been required to seek functionally similar substitutes or substantially increase its inventories of these discontinued components for its future use. To date, when components have become unavailable, the Company has been able to obtain either sufficient inventory for its own use or other functionally similar substitutes and to accomplish any necessary redesign without a material interruption in production, although there can be no assurance that this will remain the case in the future. If the Company were to experience significant delays, interruptions, discontinuations or reductions in the supply of certain components and parts purchased from suppliers, the Company's results of operations could be materially adversely affected.
Limited Protection of Proprietary Technology
The Company's success is heavily dependent upon its proprietary software technology. The Company has no patents; consequently it relies on a combination of copyright, trademark and trade secret laws, employee and third-party non-disclosure agreements, and license agreements to protect its proprietary software technology. Nonetheless, there can be no assurance that the steps taken by the Company to protect its proprietary rights will be adequate to prevent misappropriation of such rights or that third parties will not independently develop functionally equivalent or superior software technology. The Company from time to time receives correspondence alleging that its products may infringe patents held by third parties. The Company believes that its products and other proprietary rights do not infringe the proprietary rights of third parties. There can be no assurance, however, that third parties will not assert infringement claims against the Company in the future or that any such claims will not require the Company to enter into license arrangements or result in protracted and costly litigation, regardless of the merits of such claims. There also can be no assurance that the Company will be able to obtain licenses to disputed third party technology or that such licenses, if available, would be available on commercially reasonable terms. The Company is aware that certain segments of the voice processing industry, particularly voice mail/voice messaging systems, are affected by active and costly litigation. There can be no assurance that as the Company's interactive transaction processing systems evolve and provide features which extend their uses and capabilities, possibly to include certain voice mail/voice messaging and/or additional internet-related features, the Company will not become involved in, or otherwise be affected by, litigation which may or may not be meritorious.
The Company believes that due to the rapid pace of innovation within the telecommunications industry (including the IVR and CTI segments of the market), factors such as technological and creative skill of personnel, knowledge and experience of management, reputation, maintenance and support and the ability to develop and enhance systems, software products and services are more important for establishing and maintaining a competitive position within the industry than are patent, copyright and other legal protections for its technology.
Dependence on Key Personnel
The Company's success during the foreseeable future will depend largely upon the continued services of its executive officers, each of whom has entered into an employment agreement with the Company. Each employment agreement contains non-competition covenants that extend for a period of up to two years following termination of employment. The Company does not have key-man life insurance on its executive officers. The Company's success also depends in part on its ability to attract and retain qualified managerial, technical and sales and marketing personnel in a timely fashion. The Company's results of operations could be materially adversely affected if the Company were unable to attract, hire, assimilate and train these personnel in a timely manner.
Anti-Takeover Provisions and Rights Plan
Certain "anti-takeover" provisions of the Delaware General Corporation Law, among other matters, restrict the ability of certain stockholders to effect a merger or business combination or obtain control of the Company. In addition, the Company's By-Laws provide for a classified Board of Directors with staggered three-year terms. The Company has an authorized class of 1,000,000 shares of preferred stock, which may be issued by the Board of Directors on such terms and with such rights, preferences and designations as the Board of Directors may determine, without further stockholder action. Issuance of such preferred stock, depending upon the rights, preferences and designations thereof, may have the effect of delaying, deferring or preventing a change in control of the Company. On July 15, 1996, the Board of Directors of the Company approved a Rights Plan designed to protect stockholders in the event of an unsolicited attempt to acquire the Company, including a gradual accumulation of shares in the open market, a partial or two-tier tender offer that does not treat all stockholders equally, and other takeover tactics which the Board of Directors believes may be abusive and not in the best interests of stockholders. The implementation of the Rights Plan increases the Board of Directors' power in the event of an unsolicited proposal by giving the Board of Directors more time and the opportunity to evaluate an offer and exercise its good faith business judgment to take appropriate steps to protect and advance stockholder interests by negotiating with the bidder, auctioning the Company, implementing a recapitalization or restructuring designed as an alternative to the offer, or taking other action.
Potential Volatility of Stock Price
The market price of the shares of the Company's Common Stock may be highly volatile. Factors such as fluctuations in the Company's quarterly operating results, announcements of technological innovations or new commercial products by the Company or its competitors, and conditions in the markets in which the Company and its customers compete may have a significant effect on the market price and marketability of the Common Stock. Prices for many technology company stocks, including the Common Stock, may fluctuate widely as a result of the factors cited above or for reasons that are not directly related to the operating performance of such companies, including general fluctuations in stock prices and changes in earnings estimates or recommendations by securities analysts. See "Price Range of Common Stock."
Employees
As of May 31, 1997, Periphonics employed 733 persons. Approximately 100 employees are located outside the U.S. None of the Company's employees is covered by collective bargaining agreements. The Company considers relations with its employees in general to be excellent.
Disclosures Regarding Forward Looking Statements
This report on Form 10-K includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical facts included in this Form 10- K including, but not limited to, statements contained in this "Business," "Management's Discussion and Analysis" and "Notes to Consolidated Financial Statements," located elsewhere herein regarding the Company's financial position, business strategy, plans and objectives of management of the Company for future operations, and industry conditions, are forward-looking statements. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove correct.
Item 2.
Item 2. Properties
The Company's corporate headquarters and manufacturing facility is located in Bohemia, New York, a New York City suburb. This facility consists of a Company-owned 65,000 square-foot building located on a 3.9 acre site and 89,000 square feet leased in two nearby buildings (including an additional 7,000 square feet which the Company leased during August 1997). The headquarters contain the Company's manufacturing, development, service and administration departments, as well as a professional-quality recording studio. The Company also owns approximately 3.4 acres of vacant land for future development adjacent to its headquarters. The Company believes that suitable additional space will be available in the area as needed in the future on commercially reasonable terms.
In addition, the Company has leased regional sales offices in Atlanta, Charlotte, Chicago, Dallas, Denver, Grand Rapids, Los Angeles, Minneapolis, Ontario, Pleasanton, Providence, San Francisco, Seattle, Tampa, Toronto and Washington D.C.
The Company's European headquarters in Camberley, U.K. is housed in a 17,000 square-foot leased space in two adjacent buildings. The Company also leases a maintenance support office of approximately 1,500 square feet nearby Manchester, England. Sales, custom application development and on-going maintenance staff operates out of leased offices in Germany, Hong Kong, Mexico and Singapore.
Item 3.
Item 3. Legal Proceedings
The Company is not a party to any litigation that it believes could have a material adverse effect on the Company or its business.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
None
PART II
Item 5.
Item 5. Market for Common Equity and Related Stockholder Matters
The Company's Common Stock, par value $.01 per share (the "Common Stock"), trades on the NASDAQ Stock Market under the symbol PERI. The following table sets forth for each period indicated the high and low closing prices for the Common Stock for the period March 31, 1995, the date of the Company's initial public offering, through May 31, 1997, as reported by NASDAQ:
The foregoing over-the-counter market quotations represent inter-dealer prices, without retail mark-up, markdown or commission and may not represent actual transactions.
Prices for the shares have been adjusted to reflect a two for one split of the Company's Common Stock effected as a stock dividend paid on October 31, 1996.
(b) The number of recordholders of the Common Stock as of August 26, 1997 is approximately 349. The Company believes that there are a substantially greater number of beneficial owners of shares of its Common Stock.
(c) The Company currently intends to retain all future earnings for use in the operations of its business and, therefore, does not anticipate paying cash dividends on its Common Stock in the foreseeable future. The payment of dividends is within the discretion of the Board of Directors and will be dependent, among other things, upon earnings, capital requirements, financing agreement covenants, the financial condition of the Company and applicable law.
Item 6.
Item 6. Selected Financial Data
The following selected consolidated financial data as of and for each of the five fiscal years in the period ended May 31, 1997 has been derived from the consolidated financial statements of the Company, which have been audited by Deloitte & Touche LLP, independent auditors, whose report as of May 31, 1997 and 1996, and for each of the three years in the period ended May 31, 1997 is included elsewhere herein. The selected consolidated financial data should be read in conjunction with and is qualified in its entirety by the Company's consolidated financial statements, related notes and other financial information included elsewhere herein.
Fiscal Year Ended May 31, (in thousands except share and per share data)
(1) On February 1, 1995, the Company accelerated the vesting of all outstanding stock options under its 1986 Incentive Stock Option Plan (the "1986 Plan"), thereby allowing all such options to be fully vested at such date. The Company also relinquished its right to repurchase shares obtained by employees under the 1986 Plan. As a result, the Company recorded a non-recurring, noncash compensation charge of approximately $1.25 million, or $0.13 per share. See Note 10 of notes to consolidated financial statements.
(2) During fiscal 1994, the Company changed its method of accounting for income taxes to conform to Statement of Financial Accounting Standards No. 109.
(3) Earnings per common and common equivalent share has been computed by dividing net earnings, after reduction for preferred stock dividends, when applicable, by the weighted average number of common shares and common equivalent shares outstanding. Common equivalent shares included in the computation represent common equivalent shares from convertible preferred stock, when applicable, and dilutive common equivalent shares from stock options (using the treasury stock method). See Note 2 of notes to consolidated financial statements.
Item 7.
Item 7. Management's Discussion and Analysis
Overview
Disclosures Regarding Forward Looking Statements
This report on Form 10-K includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical facts included in this Form 10- K including, but not limited to, statements contained in this "Management's Discussion and Analysis," "Business" and "Notes to Consolidated Financial Statements," located elsewhere herein regarding the Company's financial position, business strategy, plans and objectives of management of the Company for future operations, and industry conditions, are forward-looking statements. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove correct.
Fiscal Years Ended May 31, 1996 and 1997
Total Revenues. Total revenues increased by 25.3%, from $88.8 million in fiscal 1996 to $111.2 million in fiscal 1997. System sales increased by 20.0%, from $71.8 million in fiscal 1996 to $86.1 million in fiscal 1997. The increase in system sales was due to a 18.6% increase in domestic sales and a 22.4% increase in international sales primarily due to continued growth in new and upgraded system requirements. The increase in system sales was primarily due to increases in unit sales volume. Service revenues increased by 47.6%, from $17.0 million in fiscal 1996 to $25.1 million in fiscal 1997, primarily due to the addition of units to the service base, as well as an increase in installation revenues.
Gross Profit. The Company's gross profit increased by $12.4 million from $45.0 million in fiscal 1996 to $57.5 million in fiscal 1997. Gross profit as a percentage of total revenues increased from 50.7% in fiscal 1996 to 51.7% in fiscal 1997. Gross profit on system sales increased by $8.3 million, or 21.2%, from $39.0 million in fiscal 1996 to $47.3 million in fiscal 1997. Gross margin on system sales increased from 54.3% in fiscal 1996 to 54.9% in fiscal 1997. Gross profit on service revenues increased by $4.1 million, or 68.3%, from $6.0 million in fiscal 1996 to $10.2 million in fiscal 1997. Gross margin on service revenues was 35.6% and 40.5% in fiscal years 1996 and 1997, respectively.
Selling, General and Administrative Expenses. Selling, general and administrative ("SG&A") expenses were $22.6 million and $27.7 million for fiscal 1996 and 1997, respectively, or 25.4% and 24.9% of total revenues, respectively. The increase in the dollar amount of the SG&A expenses was primarily due to expansion of the sales effort in both domestic and international markets, increased sales commissions due to higher revenues and increases in expenses to support the increased level of sales. SG&A expenses decreased as a percentage of total revenues due to the Company's ability to leverage certain fixed expenses over its growing revenue base.
Research and Development Expenses. Research and development ("R&D") expenses were $7.9 million and $10.7 million for fiscal 1996 and 1997, respectively, or 8.9% and 9.6% of total revenues, respectively. The increase in the dollar amount of research and development expense reflects the continued expansion of the Company's R&D staff which increased from 101 to 128 between May 31, 1996 and 1997. R&D expenses are charged to operations as incurred, and software development costs have not been capitalized. The Company expects such expenditures to continue to increase, although such expenses as a percentage of total revenues may vary from period to period.
Other Income (Expense). Other income was $1.2 million for fiscal 1997 as compared to $0.5 million in fiscal 1996. Interest income was $0.9 million and $1.2 million in fiscal 1996 and fiscal 1997, respectively. Foreign exchange gain (loss) decreased from a loss of $0.4 million in fiscal 1996 to no loss in fiscal 1997.
Income Taxes. Variations in the customary relationship between the provision for income taxes and the statutory income tax rate during the past two years primarily resulted from the utilization of research and development tax credits, state and local income taxes and exempt income of the Company's foreign sales corporation. The Company's effective income tax rates were 38.8% and 37.5% for fiscal 1996 and fiscal 1997, respectively.
Foreign Operations. The Company's European subsidiary had an operating profit of $0.4 million during fiscal 1997 as compared to an operating profit of $0.8 million during fiscal 1996 (see Note 12 of notes to consolidated financial statements). The decline in profitability was primarily due to lower gross margins on system sales and higher SG&A expenses associated with infrastructure growth. Transfers from the Company's North American operations to its European subsidiary are accounted for at cost, plus a reasonable profit. The cost of revenues for the Company's European subsidiary includes approximately $0.6 million of intercompany gross profit earned by the Company's North American operations on system sales by the European subsidiary to third parties during both fiscal 1996 and fiscal 1997, respectively.
Fiscal Years Ended May 31, 1995 and 1996
Total Revenues. Total revenues increased by 37.1%, from $64.8 million in fiscal 1995 to $88.8 million in fiscal 1996. System sales increased by 38.8%, from $51.7 million in fiscal 1995 to $71.8 million in fiscal 1996. The increase in system sales was due to a 35.8% increase in domestic sales and a 44.5% increase in international sales and was in part related to the introduction of the VPS/is system, a new RISC and UNIX based product. The increase in system sales was primarily due to increases in unit sales volume. Service revenues increased by 30.5%, from $13.0 million in fiscal 1995 to $17.0 million in fiscal 1996, primarily due to the addition of units to the service base, as well as an increase in installation revenues.
Gross Profit. The Company's gross profit increased by $12.3 million from $32.7 million in fiscal 1995 to $45.0 million in fiscal 1996. Gross profit as a percentage of total revenues increased from 50.5% in fiscal 1995 to 50.7% in fiscal 1996. Gross profit on system sales increased by $10.9 million, or 39.0%, from $28.1 million in fiscal 1995 to $39.0 million in fiscal 1996. Gross margin on system sales increased from 54.2% in fiscal 1995 to 54.3% in fiscal 1996. Gross profit on service revenues increased by $1.4 million, or 30.2%, from $4.6 million in fiscal 1995 to $6.0 million in fiscal 1996. Gross margin on service revenues was 35.6% in both fiscal 1995 and fiscal 1996.
Selling, General and Administrative Expenses. Selling, general and administrative ("SG&A") expenses were $18.7 million and $22.6 million for fiscal 1995 and 1996, respectively, or 28.9% and 25.4% of total revenues, respectively. The increase in the dollar amount of the SG&A expenses was primarily due to expansion of the sales effort in both domestic and international markets, increased sales commissions due to the significant increase in revenues and increases in expenses to support the increased level of sales. SG&A expenses decreased as a percentage of total revenues due to the Company's ability to leverage certain fixed expenses over its growing revenue base.
Research and Development Expenses. Research and development ("R&D") expenses were $5.8 million and $7.9 million for fiscal 1995 and 1996, respectively, or 9.0% and 8.9% of total revenues, respectively. The increase in the dollar amount of research and development expense reflects the continued expansion of the Company's R&D staff which increased from 69 to 101 between May 31, 1995 and 1996. R&D expenses are charged to operations as incurred, and software development costs have not been capitalized. The Company expects such expenditures to continue to increase, although such expenses as a percentage of total revenues may vary from period to period.
Non-recurring Noncash Stock Option Compensation Expense. On February 1, 1995, the Company accelerated the vesting on all outstanding stock options under its 1986 Incentive Stock Option Plan ("the 1986 Plan"), thereby allowing all such options to be fully vested at such date. The Company also relinquished its right to repurchase shares obtained by employees under the 1986 Plan. As a result, the Company recorded a non-recurring noncash compensation charge of approximately $1.25 million, equal to the difference between the formula price as of February 1, 1995 (which was calculated utilizing a formula based upon the book value of the Company's Common Stock) of all outstanding stock options issued subsequent to January 28, 1988 and their estimated value on February 1, 1995 (based upon the initial public offering price of the Company's Common Stock).
Other Income (Expense). Other income was $0.5 million for fiscal 1996 as compared to other expense of $0.7 million in fiscal 1995. Interest expense decreased from $1.0 million in fiscal 1995 to $0 in fiscal 1996, due to the elimination of debt by the use of proceeds from the Company's initial public offering. Interest income was $0.2 million and $0.9 million in fiscal 1995 and fiscal 1996. Foreign exchange gain (loss) decreased from a gain of $0.1 million in fiscal 1995 to a loss of $0.4 million in fiscal 1996.
Income Taxes. Variations in the customary relationship between the provision for income taxes and the statutory income tax rate primarily result from foreign subsidiaries' net operating losses which did not produce current tax benefits, the utilization of research and development tax credits and state and local income taxes. The Company's effective income tax rates were 48.1% and 38.8% for fiscal 1995 and fiscal 1996, respectively. Excluding the effect of the non-recurring noncash compensation charge the effective income tax rate for fiscal 1995 would have been 40.0%. See Note 8 of notes to consolidated financial statements.
Foreign Operations. The Company's European subsidiary had an operating profit of $0.8 million during fiscal 1996 as compared to an operating loss of $0.2 million during fiscal 1995 (see Note 12 of notes to consolidated financial statements). The increase in profitability was primarily due to an increase in the gross margin on increased system sales. Transfers from the Company's North American operations to its European subsidiary are accounted for at cost, plus a reasonable profit. The cost of revenues for the Company's European subsidiary includes approximately $0.9 million and $0.6 million of intercompany gross profit earned by the Company's North American operations on system sales by the European subsidiary to third parties during fiscal 1995 and fiscal 1996, respectively.
Liquidity and Capital Resources
The Company's principal cash requirement to date has been to fund working capital and capital expenditures in order to support the growth of revenues. Historically, the Company has primarily financed this requirement through cash flow from operations and bank borrowings and two Public Offerings of the Company's Common Stock in 1995, which resulted in an aggregate of $41.1 million of net proceeds to the Company. Cash flow from operations was $0.2 million, $9.6 million and $7.3 million in fiscal 1995, 1996 and 1997, respectively. At May 31, 1997, the Company had working capital of $55.2 million, including $25.1 million of cash and cash equivalents. The Company expects its working capital needs to increase along with future revenue growth.
At May 31, 1997, current assets increased by $11.9 million while current liabilities increased by $5.1 million as compared to May 31, 1996. Current assets increased principally as a result of increases in inventories and accounts receivable due to higher operating levels.
The average days' sales outstanding (calculated by dividing the net accounts receivable at the balance sheet date) were approximately 98 days, 83 days and 111 days at May 31, 1995, 1996 and 1997, respectively.
In January 1995, the Company increased its line of credit to $8.0 million with interest charged at the prime rate plus 0.25%. The line of credit expires on November 30, 1997. As of May 31, 1997, the Company had no borrowings under this line of credit
The Company made capital expenditures totalling $2.4 million, $5.9 million and $10.3 million during fiscal 1995, 1996 and 1997, respectively.
The Company believes that its existing sources of working capital and borrowings available under its revolving line of credit will be sufficient to fund its operations and capital expenditures for at least 12 months.
Recent Financial Accounting Standards Board Statements
Recent pronouncements of the Financial Accounting Standards Board ("FASB") which are not required to be adopted at this date include, Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information ("SFAS 131"), Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"), Statement of Financial Accounting Standards No. 129, "Disclosure of Information about Capital Structure" ("SFAS 129"), and Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"). SFAS 131 and SFAS 130 are effective for fiscal years beginning after December 15, 1997 and SFAS 129 and 128 are effective for fiscal years ending December 31, 1997. The adoption of these pronouncements is not expected to have a material impact on the Company's consolidated financial statements.
Foreign Currency Transaction
The Company does not currently engage in international currency hedging transactions to mitigate its foreign currency exposure. Included in the foreign exchange gain (loss) are unrealized foreign exchange gains and losses resulting from the currency remeasurement of the financial statements (primarily inventories, accounts receivable and intercompany debt) of the foreign subsidiaries of the Company into U.S. dollars. To the extent the Company is unable to match revenue received in foreign currencies with expenses paid in the same currency, it is exposed to possible losses on international currency transactions.
Inflation
In the opinion of management, inflation has not had a material effect on the operations of the Company.
Item 8.
Item 8. Consolidated Financial Statements
The information is contained on Pages through hereof.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedule and reports on Form 8-K
- ---------------
*Incorporated by reference to the Registrant's Registration Statement on Form S-1, Registration Number 33-89294.
(b)(1) REPORTS ON FORM 8-K
The Registrant did not file any reports on Form 8-K during the last quarter of its fiscal year ended May 31, 1997.
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.
PERIPHONICS CORPORATION Registrant
By: /s/Peter J. Cohen -------------------------------- Peter J. Cohen, President
Dated: August 28, 1997
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.
PERIPHONICS CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of Periphonics Corporation Bohemia, New York
We have audited the accompanying consolidated balance sheets of Periphonics Corporation and subsidiaries as of May 31, l997 and 1996, and the related consolidated statements of earnings, stockholders' equity and cash flows for each of the three years in the period ended May 31, 1997. Our audits also included the financial statement schedule listed in the Index at item 14(a)2. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Periphonics Corporation and subsidiaries as of May 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended May 31, 1997 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
DELOITTE & TOUCHE LLP
Jericho, New York July 14, 1997
PERIPHONICS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share data)
See notes to consolidated financial statements.
PERIPHONICS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS (In thousands)
See notes to consolidated financial statements.
PERIPHONICS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands, except share data)
See notes to consolidated financial statements.
PERIPHONICS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
See notes to consolidated financial statements.
PERIPHONICS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED MAY 31, 1997, 1996 AND 1995 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
1. DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION AND INITIAL PUBLIC OFFERING
Periphonics Corporation and subsidiaries (the "Company") develops, markets and supports high performance interactive voice response ("IVR") systems, based on industry-standard, open architecture hardware and operating system software, in combination with its own proprietary IVR technology that address the needs of mid-size and large-scale customer installations. During 1986, the Company became a wholly-owned subsidiary of 4000 VMH Corp. as a result of the purchase of all of the Company's outstanding common stock from Exxon Corporation ("Exxon") by 4000 VMH Corp. The transaction was accounted for using the purchase method of accounting. The aggregate purchase price of $5,542 approximated the net assets of the Company at the closing date. Effective March 30, 1995, 4000 VMH Corp. was merged into the Company (the "Merger"). The accompanying consolidated financial statements have been prepared giving effect to the Merger. The financial position and results of operations of 4000 VMH Corp. are not material to the accompanying consolidated financial statements.
On March 30, 1995, the Company consummated an initial public offering of common stock (the "Public Offering"). In the Public Offering, the Company sold 4,300,000 shares of common stock and selling stockholders sold 1,200,000 shares of common stock at $7.00 per share. The Company did not receive any of the proceeds from the sale of common stock by the selling stockholders. Net proceeds of $27,104 (after underwriters discounts of $2,107 and offering expenses of $889) were received by the Company and were used to repay borrowings totaling $14,248 pursuant to various credit agreements and to reacquire 1,500,000 shares of its common stock from Exxon for approximately $8,789 (plus the payment to Exxon of approximately $207 of accumulated dividends) with the balance of $3,860 to be used for general corporate purposes.
In April 1995, the underwriters exercised their over-allotment option to purchase an additional 825,000 shares from the selling stockholders. The Company did not receive any of the proceeds.
On November 17, 1995, the Company consummated a secondary public offering of common stock (the "Secondary Offering"). In the Secondary Offering, the Company sold 1,200,000 shares of common stock and selling stockholders sold 1,310,000 shares of common stock at $12.75 per share. The Company did not receive any of the proceeds from the sale of common stock by the selling stockholders. Net proceeds of approximately $13,959 (after underwriting discounts of $876 and offering expenses of $465) were received by the Company and are to be used for general corporate purposes, including working capital, facilities expansion, and possible acquisitions of businesses,
products, or technologies complementary to the Company's business.
On November 22, 1995, the underwriters exercised their over-allotment option to purchase an additional 376,500 shares from the selling shareholders. The Company did not receive any of the proceeds.
Amounts of shares and per share amounts in this note have been adjusted to reflect the stock split (See Note 10c).
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a. Principles of consolidation - The consolidated financial statements include the accounts of Periphonics Corporation and subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
b. Revenue recognition - Sales of standard products are recognized when products are shipped. Sales of custom software (either as a portion of system orders or as add-on orders) are recognized upon customer acceptance. For both standard products and custom software, sales are recorded only after it is determined that the Company has no significant remaining obligations and collectibility of the resulting receivable is probable. Service revenues (including postcontract customer support) and other revenues (including revenues relating to insignificant obligations at the time sales are recorded) are recognized ratably over applicable contractual periods or as service is performed.
Standard products and custom software are sold with limited warranties, generally for 60 days. Warranty expense for the fiscal years ended May 31, 1997, 1996 and 1995 was not material.
c. Inventories - Inventories are valued at the lower of cost (first-in, first-out method) or market. Reserves are established to record provisions for excess and obsolete inventories in the period in which it becomes reasonably evident that the product is not saleable or the market value is less than cost.
d. Cash and cash equivalents - The Company considers all cash and investments with original maturity dates of three months or less to be components of cash and cash equivalents.
e. Investments - The Company follows the provisions of Statement of Financial Accounting Standards No. 115, "Accounting For Certain Investments In Debt and Equity Securities". At May 31, 1996, the Company's investments consisted of U.S. Government and Agency bonds with original maturities of greater than three months and remaining maturities of less than six months. Such debt securities are classified as held-to-maturity because the Company has the positive intent and ability to hold the investments to maturity. Held-to-maturity investments are stated at amortized cost, adjusted for amortization of premiums and accretion of discounts.
f. Property, plant and equipment - Property, plant and equipment is stated at cost less accumulated depreciation and is depreciated on the straight-line method over the estimated useful lives of related assets. Leasehold improvements are amortized over
the life of the lease or the estimated life of the asset, whichever is less.
g. Software development costs - The development of new software products and enhancements to existing products are expensed as incurred until technological feasibility has been established. After technological feasibility is established, any additional costs would be capitalized in accordance with Statement of Financial Accounting Standards No. 86, "Accounting For the Cost of Computer Software To Be Sold, Leased or Otherwise Marketed." To date, no internal software development costs have been capitalized as the Company believes its current process for developing this software is essentially completed concurrently with the establishment of technological feasibility.
h. Impairment of Long-Lived Assets - In accordance with Statement of Financial Accounting Standards No. 121 ("SFAS 121"), "Accounting For the Impairment of Long-Lived Assets and For Long-Lived Assets To Be Disposed Of", the Company reviews its long-lived assets, including property, plant and equipment, identifiable intangibles and software development costs for impairment whenever events or changes in circumstances indicate that the carrying amounts of the assets may not be fully recoverable. To determine recoverability of its long-lived assets, the Company evaluates the probability that future undiscounted net cash flows, without interest charges, will be less than the carrying amount of the assets. Impairment is measured at fair value. SFAS 121 had no effect on the Company's consolidated financial statements.
i. Foreign currency translation - The functional currency of the Company's foreign subsidiaries is the US dollar. Therefore, assets and liabilities of the foreign subsidiaries are remeasured using a combination of current and historical rates. Income and expense accounts are remeasured primarily using average rates in effect during the year. Unrealized foreign exchange gains and losses resulting from the remeasurement of these entities are included in the results of operations. The Company does not currently engage in international currency hedging transactions.
j. Income taxes - The Company follows the provisions of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS 109") which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the Company's financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial accounting and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Tax credits are accounted for under the flow-through method.
k. Earnings per common and common equivalent share - Earnings per common and common equivalent share has been computed by dividing net earnings by the weighted average number of common shares and common share equivalents outstanding. Common share equivalents included in the computation represent common share equivalents from convertible preferred stock, when applicable, and dilutive common equivalent shares from stock options (using the treasury stock method).
l. Use of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities 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. Actual results could differ from those estimates.
m. Fair Value of Financial Instruments - Financial instruments consist primarily of investments in cash equivalents, short-term investments, trade accounts receivable, and accounts payable. At May 31, 1997 and 1996, the fair value of the Company's financial instruments approximated the carrying value.
n. Stock-based Compensation - The Company accounts for stock-based awards to employees using the intrinsic value method in accordance with APB No. 25, "Accounting for Stock Issued to Employees" ("APB 25").
3. ACCOUNTS RECEIVABLE
1997 1996 ---- ---- Billed $ 27,003 $ 16,055 Unbilled 8,732 7,774 ---------- ---------- $ 35,735 $ 23,829 ========== ==========
Unbilled receivables primarily relate to sales recorded on standard products which have been shipped, but have not yet been finally accepted by the customer. The Company has no significant remaining obligations relating to these unbilled receivables and collectibility is probable (see Note 2b). Substantially all unbilled receivables as of May 31, 1996 were collected during fiscal 1997. All unbilled receivables as of May 31, 1997 are expected to be collected in less than one year.
4. INVENTORIES
1997 1996 ---- ---- Raw materials $ 7,624 $ 6,218 Work-in-process 5,234 4,879 ---------- --------- $ 12,858 $ 11,097 ========== =========
5. PROPERTY, PLANT AND EQUIPMENT, net
Depreciation expense relating to property, plant and equipment amounted to approximately $3,702, $2,833 and $2,063 for the years ended May 31, 1997, 1996 and 1995, respectively.
6. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
7. LINE OF CREDIT
The Company has an $8,000 unsecured line of credit with a bank which expires on November 30, 1997. There were no borrowings against such line of credit at May 31, 1997 or 1996. Any borrowings on this line of credit will bear interest at the prime rate (8.50 percent at May 31, 1997) plus one-quarter percent.
8. INCOME TAXES
The provision for income taxes consists of the following:
The difference between the statutory Federal tax rate and the Company's effective tax rate is as follows (as a percentage of pretax earnings):
At May 31, 1997, 1996 and 1995, the deferred tax assets and liabilities consisted of:
The valuation allowance decreased by approximately $52 and $298 during fiscal 1997 and 1996, respectively, primarily as a result of the utilization of net operating loss carryforwards of foreign subsidiaries.
9. REDEEMABLE CUMULATIVE CONVERTIBLE PREFERRED STOCK
a. Series A Preferred Stock Issued to Exxon - In May 1994, the Company and Exxon, the former holder of the Company's Series A Preferred Stock (the "Preferred Stock"), entered into an agreement which restructured certain conversion, dividend and redemption rights relating to the Preferred Stock. Pursuant to the terms of such agreement, the Company was required to pay all unpaid accrued cumulative dividends as of May 31, 1994 ($1,035) in five quarterly installments of $207 beginning June 1, 1994 and to pay all future dividends as they are incurred. The redemption price, as well as liquidation value, of the Preferred Stock under the agreement was $1,000 per share. Dividends on this Preferred Stock, which were cumulative, were payable at $10 per share per quarter.
On March 30, 1995, the effective date of the Public Offering, the Company and Exxon executed a Stock Redemption Agreement pursuant to which (i) the Company paid Exxon approximately $207 in accumulated dividends on the Preferred Stock; (ii) Exxon converted all of its shares of Preferred stock into 1,500,000 shares of the Company's Common Stock pursuant to existing conversion rights; and (iii) the Company reacquired such shares of Common Stock at a price equal to $5.86 per share. The Stock Redemption Agreement further provided that upon the completion of the Company's reacquisition of the Common Stock held by Exxon, all of Exxon's rights as a stockholder of the Company were terminated and the Company and Exxon released and discharged all obligations to the other party arising out of Exxon's ownership of the Preferred Stock.
b. Preferred Stock Issued By Subsidiary - The Company had preferred stock issued by a subsidiary of the Company, which consisted of 900,000 authorized shares, 625,999 shares of which were issued in conjunction with the purchase of certain assets of Autophon U.K. in July 1990. This preferred stock was stated at $1,215 based upon the fair market value of the assets acquired. The preferred stock was convertible into either common stock of Periphonics Voice Processing Systems Limited (a subsidiary of the Company) at a ratio of 1,000 to 1, or into 78,250 shares of common stock of the Company through the exercise of a warrant. Effective May 31, 1996, the holder of this preferred stock exercised the warrant to convert such shares into 78,250 shares of common stock of the Company.
10. STOCKHOLDERS' EQUITY
a. Stock option plans - The l986 Incentive Stock Option Plan (the "1986 Plan") allowed for the issuance of options to purchase 1,000,000 shares of common stock by employees. Options were issued at an exercise price which was calculated utilizing a formula based upon the book value of the Company's common stock at the date of grant (the "Formula Price"). Options under the 1986 Plan are exercisable in 25 percent increments beginning one year after the date of grant and expire up to ten years after the date of grant. While the Company was privately held, it maintained the right, under certain conditions, to repurchase shares obtained by employees under the 1986 Plan at the Formula Price calculated at the date of repurchase. As of the date of the Public Offering, the Company no longer has the right to repurchase such shares. The Company's Board of Directors (the "Board") has determined not to make further grants under the 1986 Plan and to make any future grants from the 1995 Stock Option Plan (the "1995 Plan").
For those options issued under the 1986 Plan subsequent to January 28, 1988, compensation expense has been recognized for the difference in the Formula Price at the date of grant and the Formula Price calculated at the end of each reporting period through February 1, 1995. Such compensation expense was $24 for the year ended May 31, 1995, and is included in selling, general and administrative expenses on the accompanying consolidated statements of operations. On February 1, 1995, the Company accelerated the vesting on all outstanding stock options under the 1986 Plan thereby allowing all such options to be fully vested at such date. The Company also relinquished its right to repurchase shares obtained by employees under the Plan. As a result, the Company recorded a nonrecurring, non-cash compensation charge of approximately $1,250, equal to the difference between the Formula Price of all outstanding stock options issued subsequent to January 28, 1988 and their estimated value on February 1, 1995 (based upon the expected initial public offering price).
The 1995 Plan has 1,200,000 shares of common stock reserved for issuance upon the exercise of options designated as either [i] incentive stock options ("ISOs") under the Internal Revenue Code, or [ii] non-qualified options. ISOs may be granted under the 1995 Plan to employees and officers of the Company. Non-qualified options may be granted to consultants, directors (whether or not they are employees), employees or officers of the Company. Each option vests in four annual installments of 25 percent
each on the first, second, third and fourth anniversary of the date of grant. Options granted under the 1995 Option Plan may not be granted at a price less than the fair market value of the Company's common stock on the date of grant (or 110 percent of fair market value in the case of persons holding 10 percent or more of the voting stock of the Company) and expire not more than ten years from the date of grant (five years in the case of ISOs granted to persons holding 10 percent or more of the voting stock of the Company).
There are 591,000 shares available for future grant under the 1995 plan.
In February 1995, the Board adopted and the stockholders approved, a Non-Employee Director Stock Option Plan (the "Directors Plan"). The Directors Plan has 200,000 shares of common stock reserved for issuance from which grants of non-qualified
stock options covering 15,000 shares and 10,000 shares of common stock are automatically made on the election of a non-employee Director to the Board and the date of each annual meeting of shareholders to certain non-employee Directors of the Company, respectively. The exercise price under each option is the fair market value of the Company's common stock on the date of grant. Each option has a five-year term and vests in four annual installments of 25 percent each on the first, second, third and fourth anniversary of the date of grant. The non-vested portion of an option terminates if the Director ceases to be a member of the Board.
There are 130,000 shares available for future grants under the Directors Plan. No options have been canceled under this plan.
b. Additional Stock Plan Information - As discussed in Note 2, the Company continues to account for its stock-based awards using the intrinsic value method in accordance with APB 25 and its related interpretations. Accordingly, no compensation expense has been recognized in the financial statements for employee stock arrangements.
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation", ("SFAS 123") requires the disclosure of pro forma net income and earnings per share had the Company adopted the fair value method as of the beginning of fiscal 1996. Under SFAS 123, the fair value of stock-based awards to employees is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company's stock options awards. These models also require
subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The Company's calculations were made using the Black-Scholes option pricing model with the following weighted average assumptions for 1996 and 1997: expected life, 1.25 years following vesting; stock volatility, 78 percent, risk free interest rate of 6.0 percent and no dividends during the expected term. The Company's calculations are based on a multiple option valuation approach and forfeitures are recognized as they occur. The weighted average fair value of options granted during 1997 and 1996 were $9.22 and $5.43, per option, respectively. If the computed fair values of the 1997 and 1996 awards had been amortized to expense over the vesting period of the awards, pro forma net income would have been approximately $11,872 ($0.85 per share) and $8,927 ($0.67 per share), respectively. However, the impact of outstanding non-vested stock options granted prior to June 1, 1995 has been excluded from the pro forma calculation; accordingly, the 1996 and 1997 pro forma adjustments are not indicative of future period pro forma adjustments, when the calculation will apply to all applicable stock options.
c. Stock Split and Changes in Authorized Capital - On September 20, 1996, the Board of Directors approved a two-for-one split of its common stock effected as a stock dividend on October 31, 1996 to shareholders of record at the close of business on October 15, 1996. All historical share and per share data appearing in the consolidated financial statements and notes thereto have been retroactively adjusted for the stock split, unless otherwise noted.
Also, on September 20, 1996, the Board of Directors determined it advisable to amend the Company's Certificate of Incorporation to increase the number of authorized shares of Common Stock from 15,000,000 shares to 30,000,000 shares. The proposed amendment to the Amended and Restated Certificate of Incorporation was submitted for shareholder approval. Shareholder approval was announced on November 8, 1996 at the 1996 Annual Meeting of Stockholders.
d. Employee Stock Purchase Plan - During 1996, the Company adopted an Employee Stock Purchase Plan to provide eligible employees an opportunity to purchase shares of its common stock through payroll deductions during two offering periods, December 1 thru May 31 and June 1 thru November 30. The purchase price is an amount equal to 85% of the fair market value of a share of common stock on the first or last day of the offering period, whichever is lower. The aggregate number of shares purchased by an employee may not exceed a number of shares determined by dividing $12,500 by the fair market value of a share of the Company's common stock on the first day of the offering period. The stock purchase plan expires on August 10, 2005. A total of 400,000 shares are available for purchase under the plan. 14,744 shares were issued under the plan during fiscal 1997 at $14.24.
e. Stock Purchase Rights - In July 1996, the Company adopted a Stockholder Rights Plan (the "Plan") and declared a dividend distribution of one preferred share purchase right (the "Right") at the rate of one Right for each share of common stock held as of the close of business on July 31, 1996. Each Right entitles the holder to purchase from the Company one one-hundredth of a share of Series A Junior Participating Preferred Stock, par value $0.01 per share, at a price of $100 per one one-hundredth
of a preferred share. The Rights are not exercisable until certain events occur, as defined in the Plan, and expire on July 31, 2006. The Rights are also redeemable, under certain circumstances, by the Board of Directors at a price of $0.01 per Right.
11. COMMITMENTS AND CONTINGENCIES
a. Deferred compensation plan - The Company maintains a 40l(k) deferred compensation plan for all employees meeting certain service requirements. The Company has made no matching contribution to amounts deferred by employees. The Company pays the administrative costs of the plan.
b. Employment contracts - The Company had entered into employment contracts with seven officers expiring through December 31, 1996. These agreements allowed for aggregate annual base compensation of $1,698 as well as bonuses based primarily on the profit growth of the Company, as defined in the Company's performance incentive plan. On March 30, 1995, the Company terminated certain of the employment contracts and replaced them with revised contracts. The revised contracts terminate on May 31, 1998 and allow for aggregate annual base compensation consistent with the previous agreements as well as annual bonuses to be determined in accordance with the provisions of the Company's performance incentive plan. In addition, these revised employment contracts automatically self renew for consecutive two year terms unless at least one year prior to the expiration of the existing term either party gives notice of cancellation.
c. Stock repurchase agreements - The Company had entered into stock repurchase agreements with the stockholders of 4000 VMH Corp. The agreements required the Company to repurchase, from the estate of a deceased stockholder or from a disabled stockholder, all of the shares owned by the stockholder. The purchase price for the shares would be determined and paid as provided for in the agreements. To fully fund its obligations under these agreements, the Company had acquired certain disability income and life insurance policies on its stockholders. On March 30, 1995, the Company terminated the agreements. The Company entered into new agreements with certain stockholders of the Company. The new agreements require the Company to maintain life insurance on the life of each of the specified stockholders in amounts as defined in the agreement and grant the estate of a deceased stockholder a put option which would require the Company to redeem a portion of the shares of common stock owned by the estate. The maximum number of such shares to be redeemed shall be determined by dividing the fair market value of a share on the date of death into the net life insurance proceeds received by the Company upon the death of such deceased stockholder.
d. Legal matters - The Company is involved in certain legal matters in the normal course of business. The Company's management does not believe that resolution of these matters will have a materially adverse effect on the Company's consolidated financial statements.
e. Concentration of industry and credit risk - The Company grants credit to geographically diversified customers primarily in the telecommunications and financial services industry. The Company is broadening its vertical market focus to include additional industries such as government, higher education, healthcare services, transportation, electric and water utilities and distribution companies. No one customer accounted for more than 10 percent of total revenues during fiscal 1997, 1996 and 1995.
f. Lease agreements - The Company has entered into operating leases for certain sales and service locations, automobiles and office equipment. Future minimum annual lease payments under noncancellable operating leases are:
Year Ending May 31, 1998 $ 2,336 1999 1,763 2000 979 2001 379 2002 344 Thereafter 2,980 -------- $ 8,781 ========
Rental expense was $2,003, $1,045 and $740 during the years ended May 31, 1997, 1996 and 1995, respectively.
12. OPERATIONS BY GEOGRAPHIC AREA
The Company is engaged in only one segment and line of business, the design, manufacture and service of interactive voice response systems.
Year Ended May 31, 1997 1996 1995 ---- ---- ---- System Sales and Service Revenues: Sales to unaffiliated customers from: North America $ 99,895 $ 79,997 $ 57,488 Europe 11,349 8,806 7,289 --------- --------- --------- Total revenues to unaffiliated customers 111,244 88,803 64,777 --------- --------- --------- Transfers between geographic areas from: North America 3,815 3,665 2,635 Europe - - - --------- --------- --------- Total transfers between geographic areas 3,815 3,665 2,635 --------- --------- ---------- Eliminations (3,815) (3,665) (2,635) --------- --------- --------- Total revenues $ 111,244 $ 88,803 $ 64,777 ========= ========= ========== Earnings from Operations: North America $ 18,686 $ 13,696 $ 6,791 Europe 428 840 (256) Eliminations (87) (7) 339 --------- --------- -------- Total earnings from operations $ 19,027 $ 14,529 $ 6,874 ========= ========= ========= Identifiable Assets: North America $ 99,038 $78,393 $ 50,778 Europe 10,279 8,051 5,580 Eliminations (15,734) (11,341) (8,636) --------- --------- --------- Total identifiable assets $ 93,583 $ 75,103 $47,722 ========= ========= ==========
The activities of the Company's Mexican operation, which are not material for separate disclosure, are included in North America.
Transfers between geographic areas are accounted for at cost, plus a reasonable profit. European cost of revenues for the years ended May 31, 1997, 1996 and 1995 includes approximately $589, $565 and $928, respectively, of intercompany gross profit earned by North America on system sales by Europe to third parties.
Total revenues to customers outside the U.S. were $36,380, $28,242 and $20,020 for the years ended May 31, 1997, 1996, and 1995, respectively.
Export sales from the Company's United States operations to unaffiliated customers were as follows:
* * * * *
SCHEDULE II
PERIPHONICS CORPORATION AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (In thousands)
(1) Amounts written off or disposed of.