AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MAY 29, 2003
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED FEBRUARY 28, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
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COMMISSION FILE NUMBER: 1-15045
INTERVOICE, INC.
(Exact name of registrant as specified in its charter)
TEXAS 75-1927578
(State of Incorporation) (I.R.S. Employer
Identification Number)
17811 WATERVIEW PARKWAY 75252
DALLAS, TEXAS (Zip Code)
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(972) 454-8000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
TITLE OF EACH CLASS
Common Stock, No Par Value
Preferred Share Purchase Rights
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Aggregate Market Value of Common Stock held by Nonaffiliates as of May 13,
2003: $88,006,641
Number of Shares of Common Stock Outstanding as of May 13, 2003: 34,111,101
DOCUMENTS INCORPORATED BY REFERENCE
Listed below are documents parts of which are incorporated herein by
reference and the part of this Report into which the document is incorporated:
(1) Proxy Statement for the 2003 Annual Meeting of Shareholders -- Part
III.
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TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business.................................................... 2
Overview.................................................... 2
Markets..................................................... 3
Products and Services....................................... 4
Competition................................................. 6
Sales and Marketing......................................... 7
Strategic Alliances......................................... 7
Backlog..................................................... 8
Research and Development.................................... 8
Proprietary Rights.......................................... 8
Manufacturing and Facilities................................ 9
Employees................................................... 10
Merger with Brite Voice Systems, Inc........................ 10
Availability of Company Filings with the SEC................ 10
Item 2. Properties.................................................. 10
Item 3. Legal Proceedings........................................... 10
Item 4. Submission of Matters to a Vote of Security Holders......... 13
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 13
Item 6. Selected Financial Data..................................... 14
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 15
Item 7A. Quantitative and Qualitative Disclosures about Market
Risk........................................................ 36
Item 8. Financial Statements and Supplementary Data................. 37
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 75
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 75
Item 11. Executive Compensation...................................... 75
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 75
Item 13. Certain Relationships and Related Transactions.............. 75
Item 14. Controls and Procedures..................................... 75
Item 15. Principal Accountant Fees and Services...................... 75
PART IV
Item 16. Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 75
1
PART I
ITEM 1. BUSINESS
OVERVIEW
Intervoice, Inc. is a world leader in providing converged voice and data
solutions for the telecommunication carrier (network) and enterprise markets.
Intervoice offers enterprises and network carriers a flexible, scalable
integration platform, a powerful application development environment and
comprehensive services. Founded in 1983, the Company is celebrating 20 years of
innovation this year. Over the years, Intervoice has introduced a series of
product advancements that have helped application developers, enterprises and
carriers worldwide connect people and information.
With the experience gained from the deployment of more than 22,000 systems
around the globe and through continuously applying current technologies,
Intervoice has created compelling business solutions that promote customer
profitability and satisfaction with demonstrable return on investment.
Intervoice is headquartered in Dallas with offices in Europe, the Middle East,
South America, and Asia Pacific. For the fiscal year ended February 28, 2003,
the Company reported revenues of approximately $156.2 million, with systems and
services sales representing approximately 54% and 46% of revenues, respectively.
Omvia(TM), the Company's open, standards-based product suite, offers
speech-enabled Interactive Voice Response ("IVR") applications, multimedia and
network-grade portals and enhanced telecommunications applications such as
unified messaging, short messaging services (SMS), voicemail, prepaid services
and interactive alerts. Services provided include maintenance, implementation,
and business and technical consulting services. When capital funding is scarce,
the Company's managed services provide an important alternative for its
customers to realize the strategic deployment of services that will promote
profitability and improve market differentiation and competitive advantage while
avoiding the up front costs of capital investment.
For enterprises, Intervoice offers Omvia(TM) software, tools and
infrastructure supporting speech-activated and Web-based self-service
applications, wireless Internet services and multimedia portals. Representative
customers across multiple industries include: AdvancePCS, Ameritrade, Amtrak,
Bank of America, CIBC, Citigroup, Continental Airlines, E*Trade, FedEx,
Fidelity, Fleet/FirstBoston, Ford Motor Company, General Motors, HCA Healthcare,
Idaho Power, J.P. Morgan Chase, Merck-Medco, Michigan Department of Treasury,
Nissan, Pitney Bowes, Sears, Travelocity, United Airlines, Washington Mutual and
Wells Fargo.
Revenues from the enterprise market are primarily attributable to domestic
activities, with approximately 89% coming from North America customers. Products
and services for the enterprise sector accounted for approximately 57% of the
Company's total revenue in fiscal 2003. Of the Company's total revenue within
the enterprise market, approximately 59% was derived from systems sales and
approximately 41% was derived from the sale of services.
For network operators, Intervoice offers robust and scalable telco-grade
platforms and an integrated suite of Omvia(TM) network applications enabling
prepaid and post-paid services, network portals, voicemail and unified messaging
services. International sales represented approximately 81% of total
network-specific revenue in fiscal 2003. Intervoice products and services sold
to network markets accounted for approximately 43% of the Company's total
revenue in fiscal 2003. Of Intervoice's total network sector revenue,
approximately 48% was derived from systems sales and approximately 52% was
derived from the sale of services.
To date, Intervoice has deployed enhanced network systems and services in
over 50 countries to over 200 service providers including British Telecom
(including BT Cellnet, now O2), Deutsche Telecom (Germany), ETB (Colombia),
VAR-Tec (U.S.), Fiji Telecom (Australia), MMO/Vodafone (Germany), Orange
(India), Qwest (U.S.), Rogers AT&T (Canada), Safaricom (Kenya), SBC (U.S.),
Smartcom (Chile), STC (Saudi Arabia), Stet Hellas (Greece), SwissCom
(Switzerland), Turkcell (Turkey), and Verizon International (Mexico, Puerto Rico
and Venezuela).
2
By incorporating the industry-leading features of the Intervoice enterprise
platform, Omvia is becoming an open, highly scalable, universal architecture
with flexible configuration options suitable for deployment in enterprises of
all sizes and in the world's largest networks. A standards-based development
environment is part of Intervoice's product strategy. Intervoice product
roadmaps are designed to ensure an open, standards-based architecture that will
be increasingly important for the voice and data solutions of the future.
Intervoice supports standards including VoiceXML and SALT (Speech Application
Language Tags) specifications for voice-enabled web applications, and J2EE and
..NET for enterprise software architectures. The Company is a member of the
World-Wide Web Consortium and participates in the SALT Forum. Intervoice also
participates in network-focused organizations such as the 3GPP and the GSM
Association.
Omvia solutions are enabled by patented Intervoice technologies, as well as
best-of-breed products and services supplied by industry-leading Omvia partners.
Intervoice is a partner to companies that include providers of speech
technologies, platform technologies, softswitches and operating systems.
Intervoice has alliances with leading speech technology providers including
Microsoft, Nuance, ScanSoft and SpeechWorks for speech recognition and
text-to-speech solutions. Through a strategic alliance with Microsoft,
Intervoice hopes to make it faster, easier and more economical to build and
deliver open, standards-based enterprise telephony and multimodal speech
solutions based on SALT standards.
Intervoice expects to see impressive growth in subscribers to wireless
communication and Internet-based services. Wireless and Web technologies have
created diverse, related markets that are still emerging and evolving. These
developments have blurred the line that once clearly separated the enterprise
from connecting network environments. Intervoice is enhancing its products to
make the most of wireless and Web technology trends and emerging open standards.
The Company continually refines its product and service solutions to keep its
customers on the leading edge of performance while leveraging its existing voice
and data infrastructures.
MARKETS
Intervoice operates in two broad market categories: the enterprise market
and the telecommunications carrier, or network, market. In addition, the Company
is beginning to see increasing opportunities in a third market that is more
narrowly defined, yet crosses both the enterprise and carrier markets -- the
developer market.
The enterprise market is characterized by a business environment that has
goals to improve customer communication and personalization as well as reduce
the costs of customer contact, a historically time-and-money intensive
operation. Furthermore, consumers are increasingly taking charge of this
important interaction between enterprise and consumer; deciding where, when and
how they want this communication. To address this new business paradigm,
enterprises are increasingly applying innovative wireless, speech and web
technologies to leverage existing customer service infrastructures in the
creation of interactive, self-directed service applications. These new
applications are designed to put the customer in control of the delivery of the
information while allowing the enterprise control of the data. This serves to
address the enterprise's objectives of improving the customer experience and
reducing operating costs.
The network market is also characterized by the competing objectives of
limiting capital expenditures while introducing innovative new services to
enhance differentiation in an increasingly competitive and commoditized business
landscape. Already battered by declining growth, risk-averse carriers are
looking for proven services and a clear, near-term return on investment ("ROI")
to shore up declining subscriber growth and maintain their existing subscriber
base. Enhanced services such as voicemail, text messaging, multimedia messaging,
information portals and personal alerts are seen by carriers as opportunities to
earn incremental revenue, as are services such as prepaid, which help to address
new market niches. In looking to these services, network carriers are also
looking to maximize the return from their past equipment investments. This
requires that vendors not only provide the applications required by the
carriers, but also provide them in such a way as to leverage the existing
infrastructure investments that came with the optimistic build-out of the late
1990s. In addition, as a result of carrier downsizing in recent years, network
carriers are looking to the vendors themselves to provide professional services
toward deploying and managing the services built on their systems.
3
The emerging developer market is built on the premise that the advanced
speech technologies which are increasingly core to the solutions used by the
enterprise and network markets will soon be available to businesses of all sizes
as a result of the increasing acceptance of the standards on which they are
built. The advent of these industry standards, of which VoiceXML and more
recently, SALT, are the most widely known, are being strongly promoted by
industry leaders such as IBM and Microsoft. Just as HTML spawned a number of
service creation environments (SCEs) for web development, the movement toward
open standards to deliver speech and multi-modal solutions will spawn SCEs and
associated toolsets to simplify development of these expanded modes of
communication among millions of developers worldwide.
PRODUCTS AND SERVICES
Intervoice builds and delivers the Company's products and services around
four core strengths and a single value proposition. The four core strengths are
technology, tools and components, applications and services. Together, these
four strengths deliver on our value proposition which provides the services,
applications, tools and technology that enable developers, enterprises and
carriers to connect people with information to promote profitability and
customer satisfaction.
ENTERPRISE SOLUTIONS
Enterprise Technology
The Company's strengths and the value proposition they support are
reflected in the enterprise market as part of a suite of offerings that can be
delivered as components or as part of a total, turnkey solution. These IVR
solutions use the latest in speech recognition technology to allow enterprises
to automate increasingly complex interactions, enabling businesses to provide
quick and timely communications with customers and business partners. Such
technology enables enterprises to communicate with their customers through
voice, web, e-mail, facsimile and other forms of communication on a variety of
devices, including telephones, PCs, mobile phones and personal digital
assistants ("PDAs").
In utilizing such a sophisticated automated solution, enterprises realize
rapid ROI of as little as three months through the resulting reduction of
operational costs and, at the same time, realize improved customer satisfaction,
and improved product and service differentiation.
Enterprise Tools and Components
The creation of these solutions is enhanced through a market-leading SCE
called InVision(R). Using an intuitive interface designed to complement a
familiar Windows(R)-based interface, InVision(R) allows drag-and-drop
development of menus and call flows using predefined software modules. In
addition, the Company offers a number of other features and tools for measuring
and monitoring installed systems, allowing businesses to continue to review and
refine the performance of their systems in order to maximize the return on their
investment and optimize customer satisfaction. With the move to open systems and
standards, the Company is unbundling its traditional products to address new
emerging market segments. These unbundled components can be used by developers,
system integrators or other technology companies to create customer solutions.
Enterprise Applications
In the enterprise space, Intervoice has the single largest market share in
IVR systems shipped. With a base of over 1,600 customers worldwide, the Company
is represented across a number of different industries. The most prominent of
these vertical segments is the banking and financial services market where
Intervoice's customers include 46 of the 50 largest U.S. bank holding companies.
The Company also has a significant share of the transportation and hospitality
(travel) industries.
Providing customer access to information when, where, and how they want it
is at the core of Intervoice IVR and speech-enabled IVR systems. As speech
recognition and text-to-speech technologies are added as natural user
interfaces, these systems evolve to allow for the automation of interactions
previously seen as too complex for a traditional DTMF (touch-tone) interface.
Businesses now use these systems to automate access
4
to account information, allow secure access to sensitive information through
voice verification, change or correct name and address information, receive
stock quotes and execute securities trades. Applications also enable customer
access to order products, pay bills, enroll for college courses, apply for jobs
and many other routine and complex interactions.
Enterprise Services
In order to assure the best response from an IVR solution, Intervoice
offers its customers a single source for system implementation and ongoing
system support to design, deploy and maintain an advanced automated IVR system.
The Company's services include identifying and designing appropriate customer
applications, complete project management of a customer application, adjustments
to user interfaces and vocabularies (of speech-driven applications), customer
application specification development and consulting, installation services,
technical and maintenance support, and customer training.
Intervoice also offers its systems solutions on a managed services basis to
enterprises that wish to outsource voice-enabled solutions for call center
applications and web infrastructure. By handling the creation, delivery,
management and monitoring of advanced speech and interactive voice applications
and equipment, Intervoice allows enterprises to shorten time to market, reduce
the demand for skilled IT personnel and enhance their business continuity
strategy with overflow or disaster recovery services, all while avoiding the
need for a significant capital investment.
NETWORK SOLUTIONS
Network Technology
The Company's carrier class products are network grade platforms designed
to support a range of network implementations from thousands of subscribers for
a pilot exercise, to millions of users in a globally distributed deployment.
These systems have attributes such as redundancy, scalability, reliability and
installation environment that are necessary in this market. In order to serve
carriers at different stages in their network evolution, the Company's products
are designed for, and deployed in, Intelligent Network (IN), 2.5G Wireless, 3G
Wireless and SIP based VoIP networks as well as legacy PSTN, SS7 and cellular
networks. The network product strategy relies on architecture standards such as
LDAP, XML and VoiceXML to achieve this interoperability at the subscriber level.
At the network level, application standards like SNMP, CORBA, Parlay, SOAP,
IMAP4 and VPIM ensure compatibility with legacy systems previously deployed in
the carrier's network.
Network Tools and Components
With the demanding requirements of a quickly evolving competitive
landscape, carriers must have the capability to change and update applications
in a fast and cost efficient manner. Intervoice supplies a comprehensive suite
of tools for the carrier including a SCE that generates both a proprietary
application script and scripts based on the open standard VoiceXML, essentially
offering the carrier the best of both worlds. The Company also offers Media
Manager, a prompt and application distribution tool that increases customer
efficiency by automating the process of updating network based application
services.
Network Applications
Intervoice offers payment, messaging and portal applications for network
carriers. Payment products and services enable carriers to bill users on a
prepaid or postpaid basis. Prepaid payment gives carriers the ability to offer
advance payment for telephony services as well as for a wide range of
transaction-based events. Prepaid systems have been a large growth product for
the Company in developing countries where carriers face customer collection
issues, as well as in developed countries where carriers look to serve new niche
markets. Prepaid payment services include prepaid wireless, prepaid calling
cards, residential prepaid and automated operator services. Postpaid systems
enable network operators to offer privately branded long-distance calling
services to wholesale and retail customers, and allow callers to charge calls to
credit/debit cards or calling cards and make collect calls.
5
The Intervoice messaging suite of products allows subscribers to
collaborate and communicate more effectively through a variety of services,
including voicemail, unified messaging, call notification and short message
services. Voicemail features include conditional personal greeting, intelligent
call return, mailbox-to-mailbox messaging and multi-network mailboxes. Unified
Messaging provides a universal mailbox for management of all voice, fax and
e-mail messages. Call Notify offers a simple and cost-effective missed call
notification service for wireless market segments not using voice-messaging
services. Short Message Services, increasingly popular worldwide, allow text
messages to be transmitted via telephony networks.
Intervoice portal systems are speech-enabled and interface to live or
stored multimedia content such as consumer services (news, sports, weather,
etc.), directory assistance, subscriber self-service and secure commerce
transactions. Portal products can also be used to enable automation of self-help
applications in the carrier environment such as directory assistance and
automated customer service.
Network Services
Intervoice offers a suite of professional services to assist the carrier in
the planning, deployment and ongoing maintenance of value-added network
services. Consulting and business services include business planning, marketing,
technical consulting and service planning. Technology services provide
customization of the Company's products and integration with third party or
partner products. Intervoice also operates a portfolio of operations support
services, including maintenance programs, technical support, monitoring and
surveillance and disaster recovery services. In addition to systems sales, the
Company also offers its products and services on a hosted basis as a Managed
Service. The Managed Service model is an outsourcing alternative to carriers
that are faced with rapidly changing technologies, scarce capital, uncertain
returns on investment and a lack of core competencies to deploy and manage
complex services. Intervoice currently serves over 1.5 million carrier end-users
on an ASP (managed service) basis from its four secure hosting locations in
Cambridge and Manchester in the U.K., and Orlando, Florida and Dallas, Texas in
the U.S.
Concentration of Revenue
The Company has historically made significant sales of network systems,
customer services and managed services to British Telecom and its affiliate BT
Cellnet (together "BT"). In November 2001, BT Cellnet was separated from the
British Telecom consolidated group and became O2. Sales to a combination of the
BT and O2 entities accounted for 11%, 15% and 19% of the Company's total
revenues during fiscal 2003, 2002 and 2001, respectively. Sales under a single
managed services contract with BT Cellnet and subsequently with O2 accounted for
8%, 12% and 13% of the Company's total revenues for such years. Monthly minimum
managed service revenues under this managed services contract declined during
fiscal 2002 from a fiscal 2002 high of approximately $2.6 million per month in
March 2001 to a fixed fee of approximately $0.9 million per month as of January
2002 in accordance with the terms of the customer contract. Beginning in June
2003, in conjunction with a contract amendment that extends the term of the
managed services agreement for two years to June 2005, the fixed fee will be
further reduced to approximately $0.7 million per month. The Company expects its
cost of providing services under this contract to rise slightly during the
extension period. No other customer accounted for 10% or more of the Company's
sales during fiscal 2003, 2002, or 2001.
COMPETITION
The enterprise market is fragmented and highly competitive. The Company's
major competitors in this market are Avaya, IBM, Nortel, Aspect Communications
and Security First (formerly Edify). The principal competitive factors in this
market include breadth and depth of solution, product features, product
scalability and reliability, client services, the ability to implement
solutions, and the creation of a referenceable customer base. The Company
believes that its product line of speech-enabled solutions, combined with its
professional and technical services and its extensive customer base, allow it to
compete favorably in this market. However, the market is evolving rapidly, and
the Company anticipates intensified competition not only from traditional IVR
vendors but also from emerging vendors with non-traditional technologies and
solutions.
6
Competition in the enhanced network services market ranges from large
telecommunication suppliers offering turnkey, multi-application solutions to
"niche" companies that specialize in a particular enhanced service such as
prepaid or voicemail. The Company's primary competitors in this market are
suppliers such as Comverse Technology, UNISYS and Lucent Technologies that
provide a suite of enhanced services. Smaller niche players that compete with
the Company in various geographies and/or products include GlenAyre, Tecnomen,
Boston Communications Group and Huawei. The Company believes that, with its
current suite of integrated and interoperable payment, messaging and portal
services, its flexible business models, and its professional and technical
service offerings, it compares favorably with its competition. However, the
Company anticipates that competition will continue from existing and new
competitors, some of which have greater financial, technological and marketing
resources and greater market share than the Company.
SALES AND MARKETING
Intervoice markets its products directly, with a global sales force, and
through more than 70 domestic and international distributors. The Company enters
into arrangements with distributors to broaden distribution channels, to
increase its sales penetration to specific markets and industries and to provide
certain customer services. Distributors are selected based on their access to
the markets, industries and customers that are candidates for Intervoice
products. The Intervoice direct sales force consists of approximately 70 sales
directors and representatives worldwide. During fiscal 2003, approximately 72%
and 28% of total Company system revenue were attributable to direct sales to
end-users and to sales to distributors, respectively.
Major domestic distributors include Aurum Technology, Liberty/FiTech, EDS,
Fiserv, Nextira One, Norstan, Siemens Business Communications, Sprint and
Symitar Systems. Major international distributors include Adamnet (Japan), IVRS
(Hong Kong, China), Loxbit (Thailand), Norstan (Canada), Promotora Kranon
(Mexico), Siemens AG (Worldwide), Switch (Chile), Tatung (Taiwan) and Telia
Promotor (Sweden).
Subsidiaries of the Company maintain offices in the U.K., Germany,
Switzerland, the Netherlands, the United Arab Emirates, and South Africa to
support sales throughout Europe, the Middle East and Africa. A company office
located in Singapore supports sales in the Pacific Rim. Latin American sales are
supported from the Company's Dallas headquarters and through a regional office
in Brazil.
International revenues were 41%, 44% and 48% of total revenues in fiscal
2003, 2002 and 2001, respectively. See "Cautionary Disclosures To Qualify
Forward-Looking Statements" under Item 7 -- Management's Discussion and Analysis
of Financial Condition and Results of Operations for a discussion of risks
attendant to the Company's international operations.
See "Sales" in Item 7 -- Management's Discussion and Analysis of Financial
Condition and Results of Operations for additional information on sales by
market and geographic area and concentration of revenue.
STRATEGIC ALLIANCES
The Company actively seeks strategic relationships with companies to build
its developing partner ecosystem. The partner ecosystem is built by establishing
relationships in three basic areas consisting of software and technology
solution partners, system integration partners and niche market partners. These
relationships will enhance the Company's technological strength, improve its
market position, facilitate shorter time-to-market, enhance its ability to
deliver end-to-end solutions, and broaden its market coverage.
During the third quarter of fiscal year 2003 Intervoice entered into a new
strategic alliance agreement with Microsoft. The alliance is multi-faceted,
encompassing joint technology initiatives, joint-marketing strategies and joint
go-to-market initiatives. The partnership was formed to help make speech
recognition solutions mainstream through the implementation of SALT standards
based solutions incorporated in Microsoft's Operating Software. The two
companies will collaborate and integrate technology, and Intervoice will build
some of its voice solutions based on the combined technology. Intervoice is
actively seeking additional relationships with partners for the delivery of
solutions based on additional emerging open, standards-based solutions.
7
The Company also has relationships with several speech technology leaders,
including Nuance, ScanSoft and SpeechWorks. These relationships allow Intervoice
to integrate speech recognition technologies with core Intervoice technologies
to implement fully integrated speech solutions. Intervoice maintains an active
relationship with Sun Microsystems for the delivery of its products targeted to
the network operators and has also established a relationship with HP for server
technology to support the Omvia Media Server product line. In addition, during
fiscal 2003 Intervoice also established a relationship with BEA, one of the
leading J2EE application server suppliers, for the advancement of VoiceXML based
speech recognition solutions. These relationships and others allow Intervoice to
act as a complete systems integrator for the voice solutions marketplace.
The Company also has strategic relationships with major telecommunications
equipment suppliers such as Ericsson and Siemens who participate in joint sales
opportunities around the world.
BACKLOG
The Company's systems backlog at February 28, 2003, 2002 and 2001, which
does not include the contracted value of future maintenance and managed services
to be recognized by the Company, was approximately $37 million, $26 million and
$35 million, respectively. The Company expects all existing backlog to be
delivered within fiscal 2004. Due to customer demand, some of the Company's
sales are completed in the same fiscal quarter as ordered. Thus, the Company's
backlog at any particular date may not be indicative of actual sales for any
future period.
RESEARCH AND DEVELOPMENT
Research and development expenses were approximately $23 million, $29
million and $35 million during fiscal 2003, 2002 and 2001, respectively, and
included the design of new products and the enhancement of existing products.
The Company's research and development spending is focused in four key
areas. First, software tools are being developed to aid in the development,
deployment and management of customer applications incorporating speech
recognition and text to speech technologies. Next, hardware and software
platforms are being developed which interface with telephony networks and an
enterprise's internal data network. Such platforms are being developed to
operate in traditional enterprise networks as well as newer network environments
such as J2EE and Microsoft's .NET. Third, "voice browsers" based on open
standards such as SALT and VoiceXML are being developed. Voice browsers
incorporate speech recognition technologies and perform the task of formatting a
user's verbal query into an inquiry that can be acted upon and/or responded to
by an enterprise system. Finally, research and development activities are
focusing on modularization of key hardware and software elements. This is
increasingly important in a standards-based, open systems architecture as
modularization will allow for interchange of commodity elements to reduce
overall systems cost and for the Company's best of breed and core technology
strengths to be leveraged into new applications and vertical markets.
The Company expects to maintain a strong commitment to research and
development to remain at the forefront of technology development in its markets,
which is essential to the continued improvement of the Company's position in the
industry.
PROPRIETARY RIGHTS
The Company believes that its existing patent, copyright, license and other
proprietary rights in its products and technologies are material to the conduct
of its business. To protect these proprietary rights, the Company relies on a
combination of patent, trademark, trade secret, copyright and other proprietary
rights laws, nondisclosure safeguards and license agreements. As of February 28,
2003, the Company owned 62 patents and had 27 pending applications for patents
in the United States. In addition, the Company has registered "Intervoice" as a
trademark in the United States. Currently, in the United States, the Company has
25 registered trademarks and service marks and three pending applications for
such marks. Some of the Company's patents and marks are also registered in
certain foreign countries. The Company also has four
8
registered copyrights and one pending application for a copyright in the United
States. The Company's software and other products are generally licensed to
customers pursuant to a nontransferable license agreement that restricts the use
of the software and other products to the customer's internal purposes. Although
the Company's license agreements prohibit a customer from disclosing proprietary
information contained in the Company's products to any other person, it is
technologically possible for competitors of the Company to copy aspects of the
Company's products in violation of the Company's rights. Furthermore, even in
cases where patents are granted, the detection and policing of the unauthorized
use of the patented technology is difficult. Moreover, judicial enforcement of
copyrights may be uncertain, particularly in foreign countries. The occurrence
of the unauthorized use of the Company's proprietary information by the
Company's competitors could have a material adverse effect on the Company's
business, operating results and financial condition.
The Company provides its customers a qualified indemnity against the
infringement of third party intellectual property rights. From time to time
various owners of patents and copyrighted works send the Company or its
customers letters alleging that the Company's products do or might infringe upon
the owners' intellectual property rights, and/or suggesting that the Company or
its customers should negotiate a license or cross-license agreement with the
owner. The Company's policy is to never knowingly infringe upon any third
party's intellectual property rights. Accordingly, the Company forwards any such
allegation or licensing request to its outside legal counsel for their review
and opinion. The Company generally attempts to resolve any such matter by
informing the owner of its position concerning non-infringement or invalidity,
and/or, if appropriate, negotiating a license or cross-license agreement. Even
though the Company attempts to resolve these matters without litigation, it is
always possible that the owner of the patent or copyrighted works will institute
litigation. Owners of patent(s) and/or copyrighted work(s) have previously
instituted litigation against the Company alleging infringement of their
intellectual property rights, although no such litigation is currently pending
against the Company. As noted above, the Company currently has a portfolio of 62
patents, and it has applied for and will continue to apply for and receive a
number of additional patents to reflect its technological innovations. The
Company believes that its patent portfolio could allow it to assert
counterclaims for infringement against certain owners of intellectual property
rights if those owners were to sue the Company for infringement. In certain
situations, it might be beneficial for the Company to cross-license certain of
its patents for other patents which are relevant to the call automation
industry. See Item 3. -- Legal Proceedings for a discussion of certain patent
matters.
The Company believes that software and technology companies, including the
Company and others in the Company's industry, increasingly may become subject to
infringement claims. Such claims may require the Company to enter into costly
license agreements, or result in even more costly litigation. To the extent the
Company requires a licensing arrangement, the arrangement may not be available
at all, or, if available, may be very expensive or even prohibitively expensive.
As with any legal proceeding, there is no guarantee that the Company will
prevail in any litigation instituted against the Company asserting infringement
of intellectual property rights. To the extent the Company suffers an adverse
judgment, it might have to pay substantial damages, discontinue the use and sale
of infringing products, repurchase infringing products from the Company's
customers pursuant to indemnity obligations, expend significant resources to
acquire non-infringing alternatives, and/or obtain licenses to the intellectual
property that has been infringed upon. As with licensing arrangements,
non-infringing substitute technologies may not be available, and if available,
may be very expensive, or even prohibitively expensive, to implement.
Accordingly, for all of the foregoing reasons, a claim of infringement could
ultimately have a material adverse effect on the Company's business, financial
condition and results of operations.
MANUFACTURING AND FACILITIES
The Company's manufacturing operations consist primarily of the final
assembly, integration and extensive testing and quality control of
subassemblies, host computer platforms, operating software and the Company's run
time software. The Company currently uses third parties to perform printed
circuit board assembly, sheet metal fabrication and customer-site service and
repair. Although the Company generally uses standard parts and components for
its products, some of its components, including semi-conductors and, in
9
particular, digital signal processors manufactured by Texas Instruments and AT&T
Corp., are available only from a small number of vendors. Likewise, the Company
licenses speech recognition technology from a small number of vendors. As the
Company continues to migrate to open, standards-based systems, it will become
increasingly dependent on its component suppliers and software vendors. To date,
the Company has been able to obtain adequate supplies of needed components and
licenses in a timely manner. If the Company's significant vendors are unable or
cease to supply components or licenses at current levels, the Company may not be
able to obtain these items from another source or at historical prices.
Consequently, the Company would be unable to provide products and to service its
customers or generate historical operating margins, which would negatively
impact its business and operating results.
EMPLOYEES
As of May 13, 2003, the Company had 719 employees.
MERGER WITH BRITE VOICE SYSTEMS, INC.
On May 3, 1999, the Company, through a wholly-owned subsidiary, commenced
an all cash tender offer (the "Offer") for the purchase of 75% of the
outstanding common stock of Brite Voice Systems, Inc. ("Brite"), at a price of
$13.40 per share. The Offer was fully subscribed and expired on June 1, 1999. On
August 12, 1999 the remaining 25% of Brite shares were exchanged for the
Company's shares to complete the merger. The Company entered into a $125 million
term loan and borrowed an additional $10 million under a related revolving
credit facility to finance the merger. At February 28, 2002 the Company had $30
million of this indebtedness still outstanding. Such amount was refinanced in
full during fiscal 2003. See "Liquidity" in Part II, Item 7 -- Management's
Discussion and Analysis of Financial Condition and Results of Operations for a
discussion of the Company's current credit facilities.
AVAILABILITY OF COMPANY FILINGS WITH THE SEC
The Company's Internet website is www.intervoice. com. The Company makes
available through its Internet website its annual report on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K and amendments to those
reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 as soon as reasonably practicable after it electronically
files such material with, or furnishes it to, the Securities and Exchange
Commission (SEC).
ITEM 2. PROPERTIES
The Company owns approximately 225,000 square feet of manufacturing and
office facilities in Dallas, Texas. The Company leases approximately 221,000
square feet of office space as follows:
SQUARE FEET
-----------
Allen, Texas................................................ 130,000
Orlando, Florida............................................ 34,000
Manchester, United Kingdom.................................. 27,000
Cambridge, United Kingdom................................... 12,000
Other domestic and international locations.................. 18,000
During the fourth quarter of fiscal 2002, the Company announced that it
would forego expansion into existing leased space in Allen, Texas, and is
attempting to sublease the space for the remaining lease term.
ITEM 3. LEGAL PROCEEDINGS
INTELLECTUAL PROPERTY MATTERS
From time to time Ronald A. Katz Technology Licensing L.P. ("RAKTL") has
sent letters to certain customers of the Company suggesting that the customer
should negotiate a license agreement to cover the practice of certain patents
owned by RAKTL. In the letters, RAKTL has alleged that certain of its patents
10
pertain to certain enhanced services offered by network providers, including
prepaid card and wireless services and postpaid card services. RAKTL has further
alleged that certain of its patents pertain to certain call processing
applications, including applications for call centers that route calls using a
called party's DNIS identification number. As a result of the correspondence, an
increasing number of the Company's customers have had discussions, or are in
discussions, with RAKTL. Certain products offered by the Company can be
programmed and configured to provide enhanced services to network providers and
call processing applications for call centers. The Company's contracts with
customers usually include a qualified obligation to indemnify and defend
customers against claims that products as delivered by the Company infringe a
third party's patent.
None of the Company's customers have notified the Company that RAKTL has
claimed that any product provided by the Company infringes any claims of any
RAKTL patent. Accordingly, the Company has not been required to defend any
customers against a claim of infringement under a RAKTL patent. The Company has,
however, received letters from customers notifying the Company of the efforts by
RAKTL to license its patent portfolio and reminding the Company of its potential
obligations under the indemnification provisions of the applicable agreements in
the event that a claim is asserted. In response to correspondence from RAKTL, a
few customers have attempted to tender to the Company the defense of its
products under contractual indemnity provisions. The Company has informed these
customers that while it fully intends to honor any contractual indemnity
provisions, it does not believe it currently has any obligation to provide such
a defense because RAKTL does not appear to have made a claim that a Company
product infringes a patent. Some of these customers have disagreed with the
Company and believe that the correspondence from RAKTL can be construed as
claim(s) against the Company's products. An affiliate of Verizon Communications,
Inc., Cellco Partnership d/b/a Verizon Wireless, recently settled all claims of
patent infringement asserted against it in the matter of RAKTL v. Verizon
Communications, Inc. et al, No. 01-CV-5627, in U.S. District Court, Eastern
District of Pennsylvania. Verizon Wireless had previously notified the Company
of the lawsuit and referenced provisions in a contract for prepaid services
which required a wholly owned subsidiary of the Company, Brite Voice Systems
Inc., to indemnify Verizon Wireless against claims that its services infringe
patents. The clams in the lawsuit made general reference to prepaid services and
a variety of other services offered by Verizon Wireless and its affiliates but
did not refer to Brite's products or services. The Company had informed Verizon
Wireless that it could find no basis for an indemnity obligation under the
expired contract and, accordingly, the Company did not participate in the
defense or settlement of the matter.
Even though RAKTL has not alleged that a product provided by the Company
infringes a RAKTL patent, it is always possible that RAKTL may do so. In the
event that a Company product becomes the subject of litigation, a customer could
attempt to invoke the Company's indemnity obligations under the applicable
agreement. As with most sales contracts with suppliers of computerized
equipment, the Company's contractual indemnity obligations are generally limited
to the products and services provided by the Company, and generally require the
customer to allow the Company to have control over any litigation and settlement
negotiations with the patent holder. The customers who have received letters
from RAKTL generally have multiple suppliers of the types of products that might
potentially be subject to claims by RAKTL.
Even though no claims have been made that a specific product offered by the
Company infringes any claim under the RAKTL patent portfolio, the Company has
received opinions from its outside patent counsel that certain products and
applications offered by the Company do not infringe certain claims of the RAKTL
patents. The Company has also received opinions from its outside counsel that
certain claims under the RAKTL patent portfolio are invalid or unenforceable.
Furthermore, based on the reviews by outside counsel, the Company is not aware
of any valid and enforceable claims under the RAKTL portfolio that are infringed
by the Company's products. If the Company does become involved in litigation in
connection with the RAKTL patent portfolio, under a contractual indemnity or any
other legal theory, the Company intends to vigorously contest the claims and to
assert appropriate defenses. An increasing number of companies, including some
large, well known companies and some customers of the Company, have already
licensed certain rights under the RAKTL patent portfolio. RAKTL has previously
announced license agreements with, among others, AT&T Corp., Microsoft
Corporation and International Business Machines Corporation.
In the matter of Aerotel, Ltd. et al, v. Sprint Corporation, et al, Cause
No. 99-CIV-11091 (SAS), pending in the United States District Court, Southern
District of New York, Aerotel, Ltd., has sued Sprint
11
Corporation alleging that certain prepaid services offered by Sprint are
infringing Aerotel's U.S. Patent No. 4,706,275 ("275 patent"). According to
Sprint, the suit originally focused on land-line prepaid services not provided
by the Company. As part of an unsuccessful mediation effort, Aerotel also sought
compensation for certain prepaid wireless services provided to Sprint PCS by the
Company. As a result of the mediation effort, Sprint has requested that the
Company provide a defense and indemnification to Aerotel's infringement claims,
to the extent that they pertain to any wireless prepaid services offered by the
Company. In response to this request, the Company offered to assist (and has in
fact been assisting) Sprint's counsel in defending against such claims, to the
extent they deal with issues unique to the system and services provided by the
Company. Sprint has asserted, among other things, that Intervoice should
reimburse Sprint for legal expenses Sprint incurs in connection with defending
the wireless services. The trial court, which had temporarily stayed
proceedings, recently recommenced proceedings following certain rulings from the
United States Patent and Trademark Office. The Company has received opinions
from its outside patent counsel that the wireless prepaid services offered by
the Company do not infringe the "275 patent". Aerotel has filed expert reports
that assert that wireless services provided by the Company are covered under
Claim 23 of the "275 patent". Sprint has filed its own expert report rebutting
Aerotel's expert.
PENDING LITIGATION
David Barrie, et al., on Behalf of Themselves and All Others Similarly
Situated v. InterVoice-Brite, Inc., et al.; No. 3-01CV1071-D, pending in the
United States District Court, Northern District of Texas, Dallas Division:
Several related class action lawsuits were filed in the United States
District Court for the Northern District of Texas on behalf of purchasers of
common stock of the Company during the period from October 12, 1999 through June
6, 2000 (the "Class Period"). Plaintiffs have filed claims, which were
consolidated into one proceeding, under sec.sec. 10(b) and 20(a) of the
Securities Exchange Act of 1934 and the Securities and Exchange Commission Rule
10b-5 against the Company as well as certain named current and former officers
and directors of the Company on behalf of the alleged class members. In the
complaint, Plaintiffs claim that the Company and the named current and former
officers and directors issued false and misleading statements during the Class
Period concerning the financial condition of the Company, the results of the
Company's merger with Brite and the alleged future business projections of the
Company. Plaintiffs have asserted that these alleged statements resulted in
artificially inflated stock prices.
The Company believes that it and its officers complied with their
obligations under the securities laws, and intends to defend the lawsuit
vigorously. The Company responded to this complaint by filing a motion to
dismiss the complaint in the consolidated proceeding. The Company asserted that
the complaint lacked the degree of specificity and factual support to meet the
pleading standards applicable to federal securities litigation. On this basis,
the Company requested that the United States District Court for the Northern
District of Texas dismiss the complaint in its entirety. Plaintiffs responded to
the Company's request for dismissal. On August 8, 2002, the Court entered an
order granting the Company's motion to dismiss the class action lawsuit. In the
order dismissing the lawsuit, the Court granted plaintiffs an opportunity to
reinstate the lawsuit by filing an amended complaint. Plaintiffs filed an
amended complaint on September 23, 2002. The Company has filed a motion to
dismiss the amended complaint, and plaintiffs have filed a response in
opposition to the Company's motion to dismiss. The Court has ordered the parties
to attend a mediation with a neutral third-party mediator during June 2003. All
discovery and other proceedings not related to the dismissal have been stayed
pending resolution of the Company's request to dismiss the amended complaint.
Telemac Arbitration
On March 28, 2003 the Company announced a settlement of an arbitration
proceeding in the Los Angeles, California, office of JAMS initiated by Telemac
Corporation ("Telemac") against the Company, InterVoice Brite Ltd. and Brite
Voice Systems, Inc., JAMS Case No. 1220026278. Telemac's allegations arose out
of the negotiation of an Amended and Restated Prepaid Phone Processing Agreement
between Telemac and Brite Voice Systems Group, Ltd., and certain amendments
thereto, under which Telemac licensed prepaid wireless software for use in the
United Kingdom under agreement with O2, formerly
12
BT Cellnet, a provider of wireless telephony in the United Kingdom. The terms of
the settlement included a cash payment to Telemac, which was not significant to
the Company's consolidated financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
COMMON STOCK
The Company's outstanding shares of common stock are quoted on the Nasdaq
National Market under the symbol INTV. The Company has not paid any cash
dividends since its incorporation. The definitive loan documentation evidencing
the Company's debt facilities contains a contractual limitation on the Company
which restricts its ability to pay a dividend in cash or property, although the
Company is permitted to pay stock dividends. The Company does not anticipate
paying cash dividends in the foreseeable future.
High and low share prices as reported on the Nasdaq National Market are
shown below for the Company's fiscal quarters during fiscal 2003 and 2002.
FISCAL 2003 QUARTER HIGH LOW
------------------- ------ ------
1st......................................................... $ 6.40 $ 3.06
2nd......................................................... $ 3.09 $ 0.98
3rd......................................................... $ 2.30 $ 1.30
4th......................................................... $ 3.19 $ 1.66
FISCAL 2002 QUARTER HIGH LOW
------------------- ------ ------
1st......................................................... $12.49 $ 7.25
2nd......................................................... $13.45 $10.36
3rd......................................................... $15.67 $ 9.85
4th......................................................... $17.99 $ 4.98
On May 13, 2003, there were 814 shareholders of record and approximately
11,300 beneficial shareholders of the Company. The closing price of the Common
Stock on that date was $2.58.
Information regarding securities authorized for issuance under the
Company's equity compensation plans is incorporated by reference to Item 12 of
this Form 10-K, which in turn incorporates by reference a section of the
Company's definitive proxy statement.
13
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with the Company's consolidated financial statements and related
notes included elsewhere herein and in conjunction with "Management's Discussion
and Analysis of Financial Condition and Results of Operations" set forth in Item
7.
FISCAL YEAR ENDED FEBRUARY 28 OR 29
---------------------------------------------
2003* 2002** 2001*** 2000**** 1999
------ ------ ------- -------- ------
(IN MILLIONS, EXCEPT PER SHARE DATA)
Sales............................................ $156.2 $211.6 $274.7 $286.2 $136.9
Income (Loss) from Operations.................... (44.1) (51.6) 0.4 0.3 29.1
Income (Loss) Before the Cumulative Effect of a
Change in Accounting Principle................. (50.6) (44.7) 9.5 (14.8) 20.2
Net Income (Loss)................................ (66.4) (44.7) (2.3) (14.8) 20.2
Total Assets..................................... 101.0 175.4 256.8 303.0 111.5
Current Portion of Long Term Debt................ 3.3 6.0 18.5 25.0 --
Long Term Debt, Net of Current Portion........... 15.8 24.0 31.1 75.0 5.0
Per Diluted Common Share:
Income (Loss) Before the Cumulative Effect of a
Change in Accounting Principle.............. (1.49) (1.34) 0.28 (0.49) 0.68
Net Income (Loss).............................. (1.95) (1.34) (0.07) (0.49) 0.68
Shares Used in Per Diluted Common Share
Calculation.................................... 34.0 33.4 34.3 30.5 29.8
---------------
* The fiscal 2003 loss from operations was impacted by special charges of
$34.3 million related to staffing reductions, facilities closures, the
write down of excess inventories, costs associated with loss contracts,
loss on early extinguishment of debt, and impairment of certain intangible
assets. (See "Special Charges" and "Amortization and Impairment of Goodwill
and Acquired Intangible Assets" under Item 7.) The fiscal 2003 net loss was
also increased as a result of a $15.8 million charge for the cumulative
effect of a change in accounting principle associated with the Company's
adoption of Statement of Financial Accounting Standards No. 142 "Accounting
for Goodwill and Other Intangible Assets". Fiscal 2003 results benefited
from a change in the U.S. federal tax law that allowed the Company to
recognize net tax benefits of approximately $3.0 million.
** The fiscal 2002 loss from operations was impacted by special charges of
$33.4 million related to the streamlining of product lines, the write down
of excess inventories and non-productive assets, the closure of certain
facilities, and staffing reductions (see "Special Charges" under Item 7).
The classification of debt outstanding at February 28, 2002 was based on
refinancing transactions completed subsequent to February 28, 2002.
*** The fiscal 2001 loss from operations was impacted by special charges of
$8.2 million related to changes in the Company's organizational structure
and product offerings (see "Special Charges" under Item 7). Income before
the cumulative effect of a change in accounting principle was impacted by
these special charges of $8.2 million ($5.4 million net of taxes) and by a
$21.4 million ($13.8 million net of taxes) gain on the sale of SpeechWorks
International, Inc. common stock (see "Other Income (Expense)" under Item
7). Sales, income from operations, income before the cumulative effect of a
change in accounting principle and net loss also were affected by a change
in the Company's method of accounting for revenue recognition. (See "Sales"
and "Income (Loss) From Operations and Net Income (Loss)" under Item 7).
**** Fiscal 2000 income from operations and net loss were impacted by special
charges of $15.0 million relating to the establishment of a comprehensive
cross-license agreement with an affiliate of Lucent Technologies, Inc.,
provisions for inventories and certain intangible assets made obsolete by
the Company's merger with Brite, severance payments to employees of the
Company made redundant as a result of the merger with Brite, and charges to
bad debts relating to the impairment of certain foreign
14
accounts receivables, and the cancellation of certain customer trade-in
obligations. The Company also wrote off $30.1 million of the acquisition
cost for Brite as in-process research and development.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
CAUTIONARY DISCLOSURES TO QUALIFY 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,
without limitation, statements contained in this "Management's Discussion and
Analysis of Financial Condition and Results of Operations" 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 to be correct. In addition to
important factors described elsewhere in this report, the Company cautions
current and potential investors that the following important risk factors, among
others, sometimes have affected, and in the future could affect, the Company's
actual results and could cause such results during fiscal 2004, and beyond, to
differ materially from those expressed in any forward-looking statements made by
or on behalf of the Company:
- The Company has experienced recent operating losses and may not operate
profitably in the future. The Company incurred net losses of
approximately $66.4 million, $44.7 million and $2.3 million in fiscal
2003, 2002 and 2001, respectively. The Company may continue to incur
losses, which could hinder the Company's ability to operate its current
business. The Company may not be able to generate sufficient revenues
from its operations to achieve or sustain profitability in the future.
- The Company is obligated to make periodic payments of principal and
interest under its financing agreements. The Company has material
indebtedness outstanding under a mortgage loan secured by the Company's
office facilities in Dallas, Texas and under a senior secured term loan
facility. The Company is required to make periodic payments of interest
under each of these financing agreements and, in the case of the term
loan, periodic payments of principal. The Company may, from time to time,
have additional indebtedness outstanding under its revolving credit
facility. If the Company at any time defaults on any of its payment
obligations or other obligations under any financing agreement, the
creditors under the applicable agreement will have all rights available
under the agreement, including acceleration, termination and enforcement
of security interests. The financing agreements also have certain
qualified cross-default provisions, particularly for acceleration of
indebtedness under any one of the financing agreements. Under such
circumstances, the Company's cash position and liquidity would be
severely impacted, and it is possible the Company would not be able to
pay its debts as they come due.
- The Company's financing agreements include significant financial and
operating covenants and default provisions. In addition to the payment
obligations, the Company's senior secured term loan and revolving credit
facility and its mortgage loan facility contain significant financial
covenants, operating covenants and default provisions. If the Company
does not comply with any of these covenants and default provisions, the
Company's secured lenders can accelerate all indebtedness outstanding
under the facilities and foreclose on substantially all of the Company's
assets. In order for the Company to comply with the escalating minimum
EBITDA requirements in its senior secured credit facility, the Company
will have to continue to increase revenues and/or lower expenses in
future quarters.
- General business activity has declined. The Company's sales are largely
dependent on the strength of the domestic and international economies
and, in particular, on demand for telecommunications equipment,
computers, software and other technology products. The market for
telecommunications equipment has declined sharply over the last three
years, and the markets for computers, software and other technology
products also have declined. In addition, there is concern that demand
for the types of
15
products offered by the Company will remain soft for some period of time
as a result of domestic and global economic and political conditions.
- The Company is prone to quarterly sales fluctuations. Some of the
Company's transactions are completed in the same fiscal quarter as
ordered. The quantity and size of large sales (sales valued at
approximately $2.0 million or more) during any quarter can cause wide
variations in the Company's quarterly sales and earnings, as such sales
are unevenly distributed throughout the fiscal year. The Company's
accuracy in estimating future sales is largely dependent on its ability
to successfully qualify, estimate and close system sales from its
"pipeline" of sales opportunities during a quarter. No matter how
promising a pipeline opportunity may appear, there is no assurance it
will ever result in a sale. Accordingly, the Company's actual sales for
any fiscal reporting period may be significantly different from any
estimate of sales for such period. See the discussion entitled "Sales" in
this Item 7 for a discussion of the Company's system for estimating sales
and trends in its business.
- The Company is subject to potential and pending lawsuits and other
claims. The Company is subject to certain potential and pending lawsuits
and other claims discussed in Item 3 "Legal Proceedings". The Company
believes that each of the pending lawsuits to which it is subject is
without merit and intends to defend each matter vigorously. The Company
may not prevail in any or all of the litigation or other matters. An
adverse judgment in any of these matters, as well as the Company's
expenses relating to its defense of a given matter, could have
consequences materially adverse to the Company.
- The Company faces intense competition based on product capabilities and
experiences ever increasing demands from its actual and prospective
customers for its products to be compatible with a variety of rapidly
proliferating computing, telephony and computer networking technologies
and standards. The ultimate success of the Company's products is
dependent, to a large degree, on the Company allocating its resources to
developing and improving products compatible with those technologies,
standards and functionalities that ultimately become widely accepted by
the Company's actual and prospective customers. The Company's success is
also dependent, to a large degree, on the Company's ability to implement
arrangements with other vendors with complementary product offerings to
provide actual and prospective customers greater functionality and to
ensure that the Company's products are compatible with the increased
variety of technologies and standards. The principal competitors for the
Company's systems include Avaya, IBM, Nortel, Aspect Communications,
Security First, Comverse Technology, Lucent Technologies and UNISYS. Many
of the Company's competitors have greater financial, technological and
marketing resources than the Company has. Although the Company has
committed substantial resources to enhance its existing products and to
develop and market new products, it may not be successful.
- The Company may not be able to retain its customer base and, in
particular, its more significant customers, such as O2. The Company's
success depends substantially on retaining its significant customers. The
loss of one of the Company's significant customers could negatively
impact the Company's results of operations. The Company's installed base
of customers generally is not contractually obligated to place further
systems orders with the Company or to extend their services contracts
with the Company at the expiration of their current contracts. Sales to
O2, formerly BT Cellnet, which purchases both systems and managed
services from the Company, accounted for approximately 11%, 15% and 19%
of the Company's total sales during fiscal 2003, 2002 and 2001,
respectively. Under the terms of its recently extended managed services
contract with O2 and at current exchange rates, the Company will
recognize revenues of approximately $0.9 million per month through July
2003, and $0.7 million per month from August 2003 through the end of the
contract in July 2005. The amounts received under the agreement may vary
based on future changes in the exchange rate between the dollar and the
British pound.
- The Company may not be successful in transitioning its products and
services to an open, standards-based business model. The Company has
historically provided complete, bundled hardware and software systems
using internally developed components to address its customers' total
business needs. Increasingly, the markets for the Company's products are
requiring a shift to the development of
16
products and services based on an open, standards-based architecture such
as the J2EE and Microsoft's(R).NET environments utilizing VoiceXML and/or
SALT standards. Such an open, standards-based approach allows customers
to independently purchase and combine hardware components, standardized
software modules, and customization, installation and integration
services from individual vendors deemed to offer the best value in the
particular class of product or service. In such an environment, the
Company believes it may sell less hardware and fewer bundled systems and
may become increasingly dependent on its development and sale of software
application packages, customized software and consulting and integration
services. This shift will place new challenges on the Company's
management to transition its products and to hire and retain the mix of
personnel necessary to respond to this business environment, to adapt to
the changing expense structure that the new environment may tend to
foster, and to increase sales of services, customized software and
application packages to offset reduced sales of hardware and bundled
systems. If the Company is unsuccessful in resolving one or more of these
challenges, the Company's revenues and profitability could decline.
- The Company will incur substantial expenses to transition its products
and services to an open, standards-based business model. The Company
anticipates that it will incur substantial research and development
expenses and other expenses to adapt its organization and product and
service offerings to an open, standards-based business model. If the
Company is unable to accurately estimate the future expenses associated
with these strategic initiatives, or if the Company must divert its
resources to fund other strategic or operational obligations, the
Company's ability to fund the strategic initiatives and to operate
profitably will be adversely affected.
- The Company's reliance on significant vendor relationships could result
in significant expense or an inability to serve its customers if it loses
these relationships. Although the Company generally uses standard parts
and components for its products, some of its components, including
semi-conductors and, in particular, digital signal processors
manufactured by Texas Instruments and AT&T Corp., are available only from
a small number of vendors. Likewise, the Company licenses speech
recognition technology from a small number of vendors. As the Company
continues to migrate to open, standards-based systems, it will become
increasingly dependent on its component suppliers and software vendors.
To date, the Company has been able to obtain adequate supplies of needed
components and licenses in a timely manner. If the Company's significant
vendors are unable or cease to supply components or licenses at current
levels, the Company may not be able to obtain these items from another
source or at historical prices. Consequently, the Company would be unable
to provide products and to service its customers or to generate
historical operating margins, which would negatively impact its business
and operating results.
- If third parties assert claims that the Company's products or services
infringe on their technology and related intellectual property rights,
whether the claims are made directly against the Company or against the
Company's customers, the Company could incur substantial costs to defend
these claims. If any of these claims is ultimately successful, a third
party could require the Company to pay substantial damages, discontinue
the use and sale of infringing products, expend significant resources to
acquire non-infringing alternatives, and/or obtain licenses to use the
infringed intellectual property rights. Moreover, where the claims are
asserted with respect to the Company's customers, additional expenses may
be involved in indemnifying the customer and/or designing and providing
non-infringing products. See Item 3 "Legal Proceedings" for a discussion
of certain pending and potential claims of infringement.
- The Company is exposed to risks related to its international operations
that could increase its costs and hurt its business. The Company's
products are currently sold in more than 75 countries. The Company's
international sales, as a percentage of total Company sales, were 41%,
44% and 48% in fiscal 2003, 2002 and 2001, respectively. International
sales are subject to certain risks, including:
- fluctuations in currency exchange rates;
- the difficulty and expense of maintaining foreign offices and
distribution channels;
17
- tariffs and other barriers to trade;
- greater difficulty in protecting and enforcing intellectual property
rights;
- general economic and political conditions in each country;
- loss of revenue, property and equipment from expropriation;
- import and export licensing requirements; and
- additional expenses and risks inherent in conducting operations in
geographically distant locations, including risks arising from
customers speaking different languages and having different cultural
approaches to the conduct of business.
- The Company's inability to properly estimate costs under fixed price
contracts could negatively impact its profitability. Some of the
Company's contracts to develop application software and customized
systems provide for the customer to pay a fixed price for its products
and services regardless of whether the Company's costs to perform under
the contract exceed the amount of the fixed price. If the Company is
unable to estimate accurately the amount of future costs under these
fixed price contracts, or if unforeseen additional costs must be incurred
to perform under these contracts, the Company's ability to operate
profitably under these contracts may be adversely affected. The Company
has realized significant losses under certain customer contracts in the
past and may experience similar significant losses in the future.
- The Company's inability to meet contracted performance targets could
subject it to significant penalties. Many of the Company's contracts,
particularly for managed services, foreign contracts and contracts with
telecommunication companies, include provisions for the assessment of
liquidated damages for delayed project completion and/or for the
Company's failure to achieve certain minimum service levels. The Company
has had to pay liquidated damages in the past and may have to pay
additional liquidated damages in the future. Any such future liquidated
damages could be significant.
- Increasing consolidation in the telecommunications and financial
industries could affect the Company's revenues and profitability. The
majority of the Company's significant customers are in the
telecommunications and financial industries, which are undergoing
increasing consolidation as a result of merger and acquisition activity.
This activity involving the Company's significant customers could
decrease the number of customers purchasing the Company's products and/or
delay purchases of the Company's products by customers that are in the
process of reviewing their strategic alternatives in light of a pending
merger or acquisition. If the Company has fewer customers or its
customers delay purchases of the Company's products as a result of merger
and acquisition activity, the Company's revenues and profitability could
decline.
- Any failure by the Company to satisfy its registration, listing and other
obligations with respect to the common stock underlying certain warrants
could result in adverse consequences. Subject to certain exceptions, the
Company is required to maintain the effectiveness of the registration
statement that became effective June 27, 2002 covering the common stock
underlying certain warrants to purchase up to 621,304 shares of the
Company's common stock at a price of $4.0238 per share until the earlier
of the date the underlying common stock may be resold pursuant to Rule
144(k) under the Securities Act of 1933 or the date on which the sale of
all the underlying common stock is completed. The Company is subject to
various penalties for failure to meet its registration obligations and
the related stock exchange listing for the underlying common stock,
including cash penalties. The warrants are also subject to anti-dilution
adjustments.
- The occurrence of force majeure events could impact the Company's results
from operations. The occurrence of one or more of the following events
could potentially cause the Company to incur significant losses: acts of
God, war, riot, embargoes, acts of civil or military authorities, acts of
terrorism or sabotage, shortage of supply or delay in delivery by
Intervoice's vendors, the spread of SARS or other diseases, fire, flood,
explosion, earthquake, accident, strikes, radiation, inability to secure
transportation, failure of communications, failure of utilities or
similar events.
18
RESULTS OF OPERATIONS
The following table presents certain items as a percentage of sales for the
Company's last three fiscal years.
YEAR ENDED FEBRUARY 28
------------------------
2003* 2002** 2001***
----- ------ -------
Sales....................................................... 100% 100.0% 100.0%
Cost of Goods Sold.......................................... 56.3 59.3 50.9
----- ----- -----
Gross Margin................................................ 43.7 40.7 49.1
----- ----- -----
Research and Development Expenses........................... 14.5 13.8 12.6
Selling, General and Administrative Expenses................ 42.2 39.4 31.4
Amortization of Goodwill and Acquisition Related Intangible
Assets.................................................... 4.5 6.3 5.0
Impairment of Goodwill and Acquisition Related Intangible
Assets.................................................... 10.7 5.5 --
----- ----- -----
Operating Income (Loss)..................................... (28.2) (24.3) 0.1
Other Income (Expense), Net................................. (4.6) (1.7) 5.2
----- ----- -----
Income (Loss) Before Income Taxes and the Cumulative Effect
of a Change in Accounting Principle....................... (32.8) (26.0) 5.3
Income Taxes (Benefit)...................................... (0.5) (4.9) 1.9
----- ----- -----
Income (Loss) Before the Cumulative Effect of a Change in
Accounting Principle...................................... (32.3) (21.1) 3.4
===== ===== =====
---------------
* The fiscal 2003 loss from operations was impacted by special charges of
$34.3 million (22.0% of sales) related to staffing reductions, facilities
closures, the write down of excess inventories, costs associated with loss
contracts, loss on early extinguishment of debt, and impairment of certain
intangible assets. (See "Special Charges" and "Amortization and Impairment
of Goodwill and Acquired Intangible Assets" under Item 7.) Fiscal 2003
results benefited from a change in the U.S. federal tax law that allowed it
to recognize net tax benefits of approximately $3.0 million (1.9% of sales).
** The fiscal 2002 loss from operations was impacted by special charges of
$33.4 million (15.8% of sales) related to the streamlining of product lines,
the write down of excess inventories and non-productive assets, the closure
of certain facilities, and staffing reductions (see "Special Charges" under
Item 7).
*** The fiscal 2001 loss from operations was impacted by special charges of $8.2
million (3.0% of sales) related to changes in the Company's organizational
structure and product offerings (see "Special Charges" under Item 7). Income
before the cumulative effect of a change in accounting principle was
impacted by these special charges of $8.2 million ($5.4 million or 2.0% of
sales, net of taxes) and by a gain on the sale of SpeechWorks International,
Inc. common stock of $21.4 million ($13.8 million or 5.0% of sales, net of
taxes). See "Other Income (Expense)" under Item 7.
CRITICAL ACCOUNTING POLICIES
In preparing its consolidated financial statements in conformity with
accounting principles generally accepted in the United States, the Company uses
statistical analyses, estimates and projections that affect the reported amounts
and related disclosures and that may vary from actual results. The Company
considers the following accounting policies to be both those most important to
the portrayal of its financial condition and those that require the most
subjective judgment. If actual results differ significantly from management's
estimates and projections, there could be a material effect on the company's
financial statements.
REVENUE RECOGNITION
The Company recognizes revenue from the sale of hardware and software
systems, from the delivery of maintenance and other customer services associated
with installed systems and from the provision of its
19
enhanced telecommunications services and IVR applications on an ASP (managed
service) basis. The Company's policies for revenue recognition follow the
guidance in Statement of Position No. 97-2 "Software Revenue Recognition," as
amended (SOP 97-2), and SEC Staff Accounting Bulletin No. 101 (SAB 101). The
Company adopted SAB 101 effective March 1, 2000. See Item 8, Note D -- Change in
Accounting Principle for Revenue Recognition which describes the impact of that
change on the fiscal 2001 operating results. If contracts include multiple
elements, each element of the arrangement is separately identified and accounted
for based on the relative fair value of such element. Revenue is not recognized
on any element of the arrangement if undelivered elements are essential to the
functionality of the delivered elements.
Sale of Hardware and Software Systems: Many of the Company's sales are of
customized software or customized hardware/software systems. Such systems
incorporate newly designed software and/or standard building blocks of hardware
and software which have been significantly modified, configured and assembled to
match unique customer requirements defined at the beginning of each project.
Sales of these customized systems are accounted for using contract accounting
principles under either the percentage of completion (POC) or completed contract
methodology as further described below. In other instances, particularly in
situations where the Company sells to distributors or where the Company is
supplying only additional product capacity (i.e., similar hardware and software
systems to what is already in place) for an existing customer, the Company may
sell systems that do not require significant customization. In those situations,
revenue is recognized when there is persuasive evidence that an arrangement
exists, delivery has occurred, the fee is fixed or determinable, and
collectibility is probable. Typically, this is at shipment when there is no
installation obligation or at the completion of minor post-shipment installation
obligations.
Generally, the Company uses POC accounting for its more complex custom
systems. In determining whether a particular sale qualifies for POC treatment,
the Company considers multiple factors including the value of the contract, the
anticipated duration of the contract performance period, and the degree of
customization inherent in the project. Projects normally must have an aggregate
value of more than $500,000 to qualify for POC treatment. For a project
accounted for under the POC method, the Company recognizes revenue as work
progresses over the life of the project based on a comparison of actual labor
inputs (labor hours worked) to current estimates of total labor inputs required
to complete the project. Project estimates are reviewed and updated on a
quarterly basis.
The terms of most POC projects require customers to make interim progress
payments during the course of the project based on the Company's completion of
contractually defined milestones. Such payments and a written customer
acknowledgement at the completion of the project, usually following a final
customer test phase, document the customer's acceptance of the project. In some
circumstances, the passage of a contractually defined time period or the
customer's use of the system in a live operating environment may also constitute
final acceptance of a project.
The Company uses completed contract accounting for smaller custom projects
not meeting the POC thresholds described above. The Company also uses completed
contract accounting in situations where the technical requirements of a project
are so complex or are so dependent on the development of new technologies or the
unique application of existing technologies that the Company's ability to make
reasonable estimates is in doubt or where a sale is subject to unusual "inherent
hazards" that make the Company's estimates doubtful. Such hazards are unrelated
to, or only incidentally related to, the Company's typical activities and
include situations where the enforceability of a contract is suspect, completion
of the contract is subject to pending litigation, or where the systems produced
are subject to condemnation or expropriation risks. These latter situations are
extremely rare. For all completed contract sales, the Company recognizes revenue
upon customer acceptance as evidenced by a written customer acknowledgement, the
passage of a contractually defined time period or the customer's use of the
system in a live operating environment.
The Company generates a significant percentage of its sales, particularly
sales of enhanced telecommunications services systems, outside the United
States. Customers in certain countries are subject to significant economic and
political challenges that affect their cash flow, and many customers outside the
United States are generally accustomed to vendor financing in the form of
extended payment terms. To remain competitive in markets outside the United
States, the Company may offer selected customers such payment terms. In all
20
cases, however, the Company only recognizes revenue at such time as its system
or service fee is fixed or determinable, collectibility is probable and all
other criteria for revenue recognition have been met. In some limited cases,
this policy may result in the Company recognizing revenue on a "cash basis",
limiting revenue recognition on certain sales of systems and/or services to the
actual cash received to date from the customer, provided that all other revenue
recognition criteria have been satisfied.
Sale of Maintenance and Other Customer Services: The Company recognizes
revenue from maintenance and other customer services when the services are
performed or ratably over the related contract period. All significant costs and
expenses associated with maintenance contracts are expensed as incurred. This
approximates a ratable recognition of expenses over the contract period.
Sale of Managed Services: The Company can provide enhanced communications
solutions to customers on an outsourced basis through its ASP (managed service)
business. While specific arrangements can vary, the Company generally builds a
customized computer system to address a specific customer's business need and
then owns, monitors, and maintains that system, ensuring that it processes the
customer's business transactions in accordance with defined specifications. For
its services, the Company generally receives a one-time setup fee paid at the
beginning of the contract and a service fee paid monthly over the life of the
contract. Most contracts range from 12 to 36 months in length.
The Company combines the setup fee and the total service fee to be received
from the customer and recognizes revenue ratably over the term of the ASP
contract. The Company capitalizes the cost of the computer system(s) used to
provide the service and depreciates such systems over the contract life (for
assets unique to the individual contract) or the life of the equipment (for
assets common to the general managed service operations). All labor and other
period costs required to provide the service are expensed as incurred.
Loss Contracts: The Company updates its estimates of the costs necessary
to complete all customer contracts in process on a quarterly basis. Whenever
current estimates indicate that the Company will incur a loss on the completion
of a contract, the Company immediately records a provision for such loss as part
of the current period cost of goods sold.
INVENTORIES
Inventories are valued at the lower of cost or market. Inventories are
recorded at standard cost which approximates actual cost determined on a
first-in, first-out basis. The Company periodically reviews its inventories for
unsaleable or obsolete items and for items held in excess quantities based on
current and projected usage. Adjustments are made where necessary to reduce the
carrying value of individual items to reflect the lower of cost or market, and
any such adjustments create a new carrying value for the affected items.
INTANGIBLE ASSETS AND GOODWILL
Intangible Assets: Intangible assets are comprised of separately
identifiable intangible assets arising out of the Company's fiscal 2000
acquisition of Brite Voice Systems, Inc., and certain capitalized purchased
software. Intangible assets are being amortized using the straight-line method
over each asset's estimated useful life. Such lives range from five to twelve
years. In accordance with the provisions of Statement of Financial Accounting
Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets (SFAS No. 144), which the Company adopted on March 1, 2002, and Statement
of Financial Accounting Standards No. 121, which was effective for the Company's
fiscal years 2002 and 2001, the Company reviews its intangible assets for
possible impairment when events and circumstances indicate that the assets might
be impaired and the undiscounted projected cash flows associated with such
assets are less than the carrying amounts of the assets. In those situations,
the Company recognizes an impairment loss on the intangible asset equal to the
excess of the carrying amount of the asset over the asset's fair value,
generally determined based upon discounted estimates of future cash flows.
The cost of internally developed software products and substantial
enhancements to existing software products for sale are expensed until
technological feasibility is established, at which time any additional costs
21
would be capitalized in accordance with Statement of Financial Accounting
Standards (SFAS) No. 86. Technological feasibility of a computer software
product is established when the Company has completed all planning designing,
coding, and testing activities that are necessary to establish that the product
can be produced to meet its design specifications including functions, features,
and technical performance requirements. No costs have been capitalized to date
for internally developed software products and enhancements as the Company's
current process for developing software is essentially completed concurrently
with the establishment of technological feasibility. The Company capitalizes
purchased software upon acquisition when such software is technologically
feasible or if it has an alternative future use, such as use of the software in
different products or resale of the purchased software.
Goodwill: The Company's goodwill also results from its fiscal 2000
purchase of Brite Voice Systems, Inc. Under the provisions of SFAS No. 141,
Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets,
which the Company adopted on March 1, 2002, goodwill is presumed to have an
indefinite life and is not subject to annual amortization. Goodwill is
subjected, however, to tests for impairment on at least an annual basis and more
frequently if triggering events are identified on an interim basis. The
impairment review follows the two-step approach defined in SFAS No. 142. The
first step compares the fair value of the Company, with its carrying amount,
including goodwill. If the fair value exceeds the carrying amount, goodwill is
considered not impaired. If the carrying amount exceeds fair value, the Company
must compare the implied fair value of goodwill with the carrying amount of that
goodwill. If the carrying amount of goodwill exceeds the implied fair value of
that goodwill, an impairment loss is recognized in an amount equal to the lesser
of that excess or the carrying amount of goodwill.
INCOME TAXES
Deferred income taxes are recognized using the liability method and reflect
the tax impact of temporary differences between the amounts of assets and
liabilities for financial reporting purposes and such amounts as measured by tax
laws and regulations. The Company provides a valuation allowance for deferred
tax assets in circumstances where it does not consider realization of such
assets to be more likely than not.
SALES
The Company is a leader in providing converged voice and data solutions for
the network and enterprise markets. The Company operates as a single, integrated
business unit focusing on these two major markets. The Company's sales to the
network market focus on products and services that are designed to create
opportunities for network carriers and service providers to increase revenue
through value-added services and/or reduce costs through automation. Sales to
the enterprise market focus on providing automated customer service and
communications systems that reduce costs and improve customer service levels
through enabling accurate and efficient communication and transactions between
an enterprise, its customers and its business partners. In both markets, the
Company provides a suite of professional services that supports its installed
systems including maintenance, implementation, and business and technical
consulting services. To further leverage the strong return on investment offered
by its systems offerings, the Company also offers enhanced communications
solutions to network and enterprise customers on an outsourced basis as an
Application Service Provider, or ASP.
22
The Company's sales by market for fiscal 2003, 2002 and 2001, were as
follows (in millions):
2003 2002 2001
------ ------ ------
Enterprise Systems Sales.................................... $ 52.4 $ 77.6 $ 95.8
Enterprise Services Sales................................... 35.9 30.8 25.6
------ ------ ------
Enterprise Total Sales...................................... 88.3 108.4 121.4
------ ------ ------
Network Systems Sales....................................... 32.3 48.8 86.9
Network Services Sales...................................... 35.6 54.4 66.4
------ ------ ------
Network Total Sales......................................... 67.9 103.2 153.3
------ ------ ------
Total Company Systems Sales................................. 84.7 126.4 182.7
Total Company Services Sales................................ 71.5 85.2 92.0
------ ------ ------
Total Company Sales......................................... $156.2 $211.6 $274.7
====== ====== ======
The Company assigns revenues to geographic locations based on the location
of the customer. The Company's net sales by geographic area for fiscal years
2003, 2002 and 2001 were as follows (in millions):
2003 2002 2001
------ ------ ------
North America............................................... $ 91.5 $118.8 $141.6
Central and South America................................... 6.1 7.4 14.9
Pacific Rim................................................. 2.9 5.5 11.6
Europe, Middle East and Africa.............................. 55.7 79.9 106.6
------ ------ ------
Total..................................................... $156.2 $211.6 $274.7
====== ====== ======
International sales constituted 41%, 44% and 48% of total Company sales in
fiscal 2003, 2002 and 2001, respectively.
Effective March 1, 2000, the Company changed its method of accounting for
revenue recognition in accordance with SAB No. 101, "Revenue Recognition in
Financial Statements". The cumulative effect of this change in accounting has
been reflected as a charge to fiscal 2001 operations and is discussed below in
"Income (Loss) from Operations and Net Income (Loss)". As a result of the
change, the Company recognized as part of fiscal 2001 sales $22.4 million of
revenue whose contribution to income is included in the cumulative effect
adjustment and did not recognize $2.8 million of 2001 sales whose contribution
to income would have been recognized had the change in accounting policy not
been adopted.
Total Company sales declined 26% in fiscal 2003 and 23% in fiscal 2002 when
compared to sales of the preceding year. The decrease in sales in fiscal 2003
was comprised of decreases in systems sales of approximately 33% in both of the
Company's primary markets and a 35% decline in services sales to the network
market, partially offset by a 17% increase in services sales to the enterprise
market. The reduced levels of systems sales continue to reflect the previously
reported sharp declines in the Company's primary markets over the past two
years. The Company believes that its major markets will remain soft through
fiscal 2004. The decline in services sales to the networks sector is primarily
attributable to decreased managed service revenues resulting from a decrease in
the volume of activity processed under certain of the Company's contacts,
including, particularly, its contract with O2 as further described below. The
increase in services sales to the enterprise sector is attributable to 10%
growth in the sale of customer support services and growth in the managed
services customers base during the year. The Company anticipates continued
growth in its enterprises services business, including particularly its managed
services business.
The decrease in sales in fiscal 2002 was comprised of decreases in
enterprise and network systems sales of 19% and 44%, respectively, an 18%
decrease in network services sales and a 20% increase in enterprise services
sales. The decline in system sales reflects the sharp decline in the Company's
primary markets, particularly the decline in the market for telecommunications
equipment and services during the year. This decline was particularly pronounced
in the fourth quarter of 2002 when the Company's sales declined by 52% from the
23
third quarter of fiscal 2002. As in fiscal 2003, the network services decline
reflects a reduction in the division's managed services revenues, particularly
those attributable to its contract with O2 as further described below. The
increase in enterprise services was primarily attributable to growth in the sale
of service and support contracts. The impact of foreign currency changes during
the year on annual sales for fiscal 2002 was not material.
The Company has historically made significant sales of systems, customer
services and managed services to British Telecom and its affiliate BT Cellnet
(together "BT"). In November 2001, BT Cellnet was separated from the British
Telecom consolidated group and became O2. Sales to a combination of the BT and
O2 entities accounted for 11%, 15% and 19% of the Company's total revenues
during fiscal 2003, 2002 and 2001, respectively. Sales under a single managed
services contract with BT Cellnet and subsequently with O2 accounted for 8%, 12%
and 13% of the Company's total revenues for such years. Monthly minimum managed
service revenues under this managed services contract declined during fiscal
2002 from a fiscal 2002 high of approximately $2.6 million per month in March
2001 to a fixed fee of approximately $0.9 million per month as of January 2002
in accordance with the terms of the customer contract. Beginning in June 2003,
in conjunction with a contract amendment that extends the term of the managed
services agreement for two years to June 2005, the fixed fee will be further
reduced to approximately $0.7 million per month. The Company expects its cost of
providing services under this contract to rise slightly during the extension
period. No other customer accounted for 10% or more of the Company's sales
during fiscal 2003, 2002, or 2001.
The Company uses a system combining estimated sales from its service and
support contracts, "pipeline" of systems sales opportunities, and backlog of
committed systems orders to estimate sales and trends in its business. Sales in
fiscal 2003 from service and support contracts, including contracts for ASP
managed services, comprised approximately 46% of the Company's total sales, up
from 40% in fiscal 2002. On average, the backlog of systems sales and the
pipeline of opportunities for systems sales during the same period have
contributed approximately 29% and 25%, respectively. Each contributed
approximately 30% of sales during fiscal 2002.
The Company's service and support contracts range in duration from one
month to three years, with many longer duration contracts allowing customer
cancellation privileges. It is easier for the Company to estimate service and
support sales than to measure systems sales for the next quarter because service
and support contracts generally span multiple quarters, and revenues recognized
under each contract are generally similar from one quarter to the next.
The Company's backlog is made up of customer orders for systems for which
it has received complete purchase orders and which the Company expects to ship
within twelve months. At February 28, 2003, 2002 and 2001, the Company's backlog
of systems sales was approximately $37 million, $26 million, and $35 million,
respectively.
The Company's pipeline of opportunities for systems sales is the
aggregation of its sales opportunities, with each opportunity evaluated for the
date the potential customer will make a purchase decision, competitive risks,
and the potential amount of any resulting sale. No matter how promising a
pipeline opportunity may appear, there is no assurance it will ever result in a
sale. While this pipeline may provide the Company some sales guidelines in its
business planning and budgeting, pipeline estimates are necessarily speculative
and may not consistently correlate to revenues in a particular quarter or over a
longer period of time. While the Company knows the amount of systems backlog
available at the beginning of a quarter, it must speculate on its pipeline of
systems opportunities for the quarter. The Company's accuracy in estimating
total systems sales for future fiscal quarters is, therefore, highly dependent
upon its ability to successfully estimate which pipeline opportunities will
close during the quarter.
In fiscal 2003, management implemented an Oracle-based customer
relationship management (CRM) tool to provide the necessary data to allow the
Company to better, track, manage and forecast its active global sales backlog
and pipeline. In fiscal 2004, the Intervoice sales force is performing required
weekly forecasting with the CRM tool. The forecasts are expected to provide
management and the sales force with the information necessary to effectively
direct the Company's complex global sales organization and increase sales
productivity. Other projected benefits of the automated CRM process are enhanced
strategy formulation
24
through greater insight into market demand and trends and increased visibility
into the Company's sales pipeline and backlog.
The Company is prone to quarterly sales fluctuations. Some of the Company's
transactions are completed in the same fiscal quarter as ordered. The quantity
and size of large sales (sales valued at approximately $2.0 million or more)
during any quarter can cause wide variations in the Company's quarterly sales
and earnings, as such sales are unevenly distributed throughout the fiscal year.
To compete effectively in its target markets in fiscal 2004 and beyond, the
Company believes it must transition its products and services to an open,
standards-based business model. The Company has historically provided complete,
bundled hardware and software systems using internally developed components to
address its customers' total business needs. Increasingly, the markets for the
Company's products are requiring a shift to the development of products and
services based on an open, standards-based architecture such as the J2EE and
Microsoft's(R).NET environments utilizing VoiceXML and/or SALT standards. Such
an open, standards-based approach allows customers to independently purchase and
combine hardware components, standardized software modules, and customization,
installation and integration services from individual vendors deemed to offer
the best value in the particular class of product or service. In such an
environment, the Company believes it may sell less hardware and fewer bundled
systems and may become increasingly dependent on its development and sale of
software application packages, customized software and consulting and
integration services. This shift will place new challenges on the Company's
management to transition its products and to hire and retain the mix of
personnel necessary to respond to this business environment, to adapt to the
changing expense structure that the new environment may tend to foster, and to
increase sales of services, customized software and application packages to
offset reduced sales of hardware and bundled systems.
SPECIAL CHARGES
FISCAL 2003
During fiscal 2003, the Company continued to implement actions designed to
lower cost and improve operational efficiency in response to continued softness
in the primary markets for its products. It also reviewed its intangible assets
for evidence of impairment in light of changes in its business and continued
weakness in the world-wide telecommunications networks markets. (See
"Amortization and Impairment of Goodwill and Acquired Intangible Assets").
The following table summarizes the effect of the special charges on fiscal
2003 operations by financial statement category (in millions).
IMPAIRMENT
COST OF RESEARCH & OTHER OF
GOODS SOLD DEVELOPMENT SG&A EXPENSES INTANGIBLES TOTAL
---------- ----------- ---- -------- ----------- -----
Write down of intangible assets......... $ -- $ -- $-- $ -- $16.7 $16.7
Severance payments and related
benefits.............................. 2.3 0.8 3.1 -- -- 6.2
Facilities closures..................... 0.2 0.1 0.4 -- -- 0.7
Write down of excess inventories........ 4.1 -- -- -- -- 4.1
Costs associated with loss contracts.... 4.7 -- -- -- -- 4.7
Loss on early extinguishment of debt.... -- -- -- 1.9 -- 1.9
----- ---- ---- ---- ----- -----
Total................................. $11.3 $0.9 $3.5 $1.9 $16.7 $34.3
===== ==== ==== ==== ===== =====
The severance and related costs recognized during fiscal 2003 relate to
three separate workforce reductions that affected a total of 273 employees. One
of the reductions was associated with the Company's consolidation of its
separate Enterprise and Networks divisions into a single, integrated
organizational structure. The charge also includes costs associated with the
resignation of the Networks division president during the first quarter of
fiscal 2003. Costs related to facilities closures include $0.4 million for the
closure of the Company's leased facility in Chicago, Illinois and $0.3 million
associated with the closure of a portion of the Company's leased facilities in
Manchester, United Kingdom. The downsizing of the leased space in
25
Manchester followed from the Company's decision to consolidate virtually all of
its manufacturing operations into its Dallas, Texas facilities. The inventory
adjustments reflect the Company's continued assessment of its inventory levels
in light of sales projections, the decision to eliminate the U.K. manufacturing
operation and the consolidation of the business units. The charges for loss
contracts reflect the costs incurred on two contracts which are expected to
result in net losses to the Company upon completion. The loss on early
extinguishment of debt includes $1.4 million in non-cash charges to write-off
unamortized debt discount and unamortized debt issue costs and $0.5 million in
prepayment premiums. As of February 28, 2003, approximately $0.4 of severance
and related costs remain unpaid. Unpaid amounts are expected to be paid in full
during fiscal 2004.
FISCAL 2002
During the fourth quarter of fiscal 2002, the Company performed a
comprehensive review of the positioning of its product lines, including lines
brought forward from its merger with Brite, reevaluated its physical plant
needs, and reviewed its aggregate staffing levels. Based on these reviews, the
Company took a number of strategic actions designed to lower costs and
streamline product offerings. As a result of these actions, the Company incurred
special charges of approximately $33.4 million, including $16.4 million for the
write down of intangible assets and inventories associated with discontinued
product lines, $6.5 million for the write down of excess inventories, $5.2
million for severance payments and related benefits, $4.2 million for facilities
closures, and $1.1 million relating to the write down of non-productive fixed
assets.
The following table summarizes the effect of these special charges on
fiscal 2002 operations by financial statement category (in millions).
COST OF RESEARCH & IMPAIRMENT
GOODS SOLD DEVELOPMENT SG&A OF INTANGIBLES TOTAL
---------- ----------- ---- -------------- -----
Write down of intangible assets and
inventories associated with discontinued
product lines............................ $ 4.4 $ -- $0.3 $11.7 $16.4
Write down of excess inventories........... 6.5 -- -- -- 6.5
Severance payments and related benefits.... 2.2 0.8 2.2 -- 5.2
Facilities closures........................ -- -- 4.2 -- 4.2
Write down of non-productive fixed
assets................................... 0.3 0.7 0.1 -- 1.1
----- ---- ---- ----- -----
Total................................. $13.4 $1.5 $6.8 $11.7 $33.4
===== ==== ==== ===== =====
The $11.7 million write down of intangible assets reflects the impairment
of the Brite tradename, the impairment of certain IVR technology acquired as
part of the Brite acquisition and the impairment of related goodwill (See
"Amortization and Impairment of Goodwill and Acquired Intangible Assets"). The
$4.4 million write down of inventories and $0.3 million charge to selling,
general and administrative ("SG&A") expenses relate to the Company's decision to
discontinue sales of certain earlier versions of its payment and messaging
systems that run on a different hardware platform than that used by the current
versions of those systems. The additional writedown of inventories totaling
approximately $6.5 million relates to items which the Company will continue to
use in current sales situations but which, given the slowdown in market demand,
it held in excess quantities at year end.
As part of its fiscal 2002 initiatives, the Company announced plans to
forego expansion into existing leased space in Allen, Texas and to close its
Jacksonville, Florida and Wichita, Kansas locations. As a result of these
actions, the Company recorded charges of approximately $4.2 million, including
approximately $3.8 million accrued for future lease commitments and
approximately $0.4 million for accelerated depreciation expense arising from a
reassessment of the useful lives of certain related property and equipment. As
part of its overall facilities assessment, the Company also identified and wrote
off approximately $1.1 million of fixed assets no longer being used by the
Company. As of February 28, 2003, approximately $1.9 million of the accrued
lease costs remain unpaid. The Company completed the sale of its Wichita, Kansas
office building on May 31, 2002. The $2.0 million in gross proceeds was used to
pay down amounts outstanding under the Company's then outstanding revolving
credit facility.
26
The severance and related costs recognized in the fourth quarter of fiscal
2002 were associated with two workforce reductions that affected 198 employees.
As of February 28, 2003, approximately $0.1 million of the total severance and
related costs remained unpaid. Unpaid amounts are expected to be paid in full
during fiscal 2004.
FISCAL 2001
During the fourth quarter of fiscal 2001, the Company changed its
organizational structure and eliminated certain product offerings in order to
reduce costs and improve the Company's focus on its core competencies and
products. As a result of these actions, the Company incurred special charges of
approximately $8.2 million, including $3.6 million for severance and related
costs, $3.1 million for the write-off of assets associated with discontinued
product lines and $1.5 million for estimated customer accommodations related to
the discontinued product lines.
The following table summarizes the effect of these special charges on
fiscal 2001 operations by financial statement category (in millions).
COST OF RESEARCH AND
GOODS SOLD DEVELOPMENT SG&A TOTAL
---------- ------------ ---- -----
Severance payments and related benefits................ $1.3 $0.4 $1.9 $3.6
Write down of assets associated with discontinued
product lines........................................ 3.1 -- -- 3.1
Customer accommodations associated with discontinued
product lines........................................ -- 1.5 1.5
---- ---- ---- ----
Total.................................................. $4.4 $0.4 $3.4 $8.2
==== ==== ==== ====
The severance and related costs were associated with a workforce adjustment
that affected approximately 130 employees and included the resignation of the
Company's President and Chief Operating Officer. During the third quarter of
fiscal 2002, the Company determined that it had settled its severance related
obligations for less than originally anticipated, and, accordingly, the Company
reversed the remaining accrual of $0.4 million, reducing selling, general and
administrative expenses.
The $3.1 million charge to write off assets is primarily attributable to
the Company's decision to discontinue its AgentConnect product line and includes
a $2.9 million charge for the impairment of unamortized purchased software
(included in other intangible assets) associated with this product. The $1.5
million charge for estimated customer accommodations is comprised primarily of
bad debts and customer settlements associated with the Company's decision to
discontinue the AgentConnect product line. This charge is reflected in selling,
general and administrative expenses. During fiscal 2002, the Company reached
settlements with its affected customers for amounts that were less than
originally anticipated. As a result, it reversed $0.5 million of the accrual,
reducing selling, general and administrative expenses in the third fiscal
quarter.
During the fourth quarter of fiscal 2001, the Company realized a gain of
$21.4 million upon the sale of shares of stock of SpeechWorks International,
Inc. acquired through the exercise of a warrant received in connection with a
1996 supply agreement between the Company and SpeechWorks. This gain is
reflected as other income in the accompanying Consolidated Statements of
Operations. In prior periods, the warrant had been assigned no value in the
Company's balance sheets because the warrant and the underlying shares were
unregistered securities, and significant uncertainties existed regarding the
Company's ability to monetize the warrant and the timing of any such
monetization.
SUBSEQUENT EVENT
During April 2003, the Company reduced its workforce by 56 positions. The
Company estimates that it will incur charges of approximately $1.4 million
during the first quarter of fiscal 2004 in connection with this action, with
approximately $0.6 million, $0.2 million, and $0.6 million impacting cost of
goods sold, research and development, and SG&A expenses, respectively. The
majority of such charges are expected to be paid
27
during the first half of fiscal 2004. The Company anticipates that operating
expenses will be reduced approximately $0.9 million to $1.2 million per quarter
from fourth quarter fiscal 2003 levels once these restructuring activities are
completed.
COST OF GOODS SOLD
Cost of goods sold was $88.0 million (56.3% of sales), $125.6 million
(59.3% of sales) and $139.7 million (50.9% of sales) in fiscal 2003, 2002 and
2001, respectively. During fiscal 2003, 2002 and 2001, the Company incurred
special charges to cost of goods sold totaling $11.3 million (7.2% of sales),
$13.4 million (6.3% of sales) and $4.4 million (1.6% of sales), respectively, as
described in the preceding "Special Charges" section. A significant portion of
the Company's cost of goods sold is comprised of labor costs that are fixed over
the near term as opposed to direct material and license/royalty costs that vary
directly with sales volume. The decrease in the cost of goods sold percentage
relating to other than special charges for fiscal 2003 is attributable to
actions taken during fiscal 2003 and 2002 to reduce this fixed component of
cost. The Company reduced manufacturing headcount by 70 from ending fiscal 2002
levels, consolidated its manufacturing operations in a single location, and
consolidated certain customer service and managed service support centers. The
increase in the cost of goods sold percentage relating to other than special
charges during fiscal 2002 is primarily attributable to the softness in the
Company's fiscal 2002 sales, including, particularly, its fiscal fourth quarter
sales.
RESEARCH AND DEVELOPMENT
Research and development expenses during fiscal 2003, 2002 and 2001 were
approximately $22.6 million (14.5% of sales), $29.3 million (13.8% of sales),
and $34.6 million (12.6% of sales), respectively. The Company incurred special
charges of $0.9 million (0.6% of sales), $1.5 million (0.7% of sales) and $0.4
million (0.1% of sales) in fiscal 2003, 2002 and 2001, respectively, as
described in "Special Charges" above. Recurring research and development
expenses included the design of new products and the enhancement of existing
products.
The Company's research and development spending is focused in four key
areas. First, software tools are being developed to aid in the development,
deployment and management of customer applications incorporating speech
recognition and text to speech technologies. Next, hardware and software
platforms are being developed which interface with telephony networks and an
enterprise's internal data network. Such platforms are being developed to
operate in traditional enterprise networks as well as newer network environments
such as J2EE and Microsoft's.NET. Third, "voice browsers" based on open
standards such as SALT and VoiceXML are being developed. Voice browsers
incorporate speech recognition technologies and perform the task of formatting a
user's verbal query into an inquiry that can be acted upon and/or responded to
by an enterprise system. Finally, research and development activities are
focusing on modularization of key hardware and software elements. This is
increasingly important in a standards-based, open systems architecture as
modularization will allow for interchange of commodity elements to reduce
overall systems cost and for the Company's best of breed and core technology
strengths to be leveraged into new applications and vertical markets.
The Company expects to maintain a strong commitment to research and
development to remain at the forefront of technology development in its business
markets, which is essential to the continued improvement of the Company's
position in the industry.
SELLING, GENERAL AND ADMINISTRATIVE
SG&A expenses totaled $65.9 million (42.2% of sales), $83.3 million (39.4%
of sales), and $86.2 million (31.4% of sales), in fiscal 2003, 2002 and 2001,
respectively. Such amounts included special charges of $3.5 million (2.2% of
sales), $6.8 million (3.2% of sales) and $3.4 million (1.2% of sales),
respectively, as described in "Special Charges" above. SG&A expenses have
declined in absolute dollars as a result of cost control initiatives implemented
by the Company and as a result of lower commissions and incentive bonuses
28
being earned on lower sales volumes. SG&A expenses have increased as a percent
of the Company's total sales because of the decline in sales.
AMORTIZATION AND IMPAIRMENT OF GOODWILL AND ACQUIRED INTANGIBLE ASSETS
In connection with its purchase of Brite in fiscal 2000, the Company
recorded intangible assets and goodwill totaling $103.8 million. These assets
were assigned useful lives ranging from 5 to 10 years. For the fiscal years
ended February 28, 2003, 2002 and 2001, the Company recognized amortization and
impairment expense related to these assets as follows (in millions):
2003 2002 2001
----- ----- -----
Amortization of goodwill.................................... $ -- $ 2.6 $ 2.9
Amortization of other acquisition related intangible
assets.................................................... 7.1 12.8 10.9
----- ----- -----
Total amortization of goodwill and other acquisition
related intangible assets............................ 7.1 13.4 13.8
----- ----- -----
Impairment of other acquisition related intangible assets as
described below........................................... 16.7 8.0 --
Impairment of goodwill in connection with the impairment of
other acquisition related intangible assets as described
below..................................................... -- 3.7 --
----- ----- -----
Total impairment charged to operating income........... 16.7 11.7 --
----- ----- -----
Total amortization and impairment charged to operating
income.................................................... $23.8 $25.1 $13.8
===== ===== =====
Impairment of goodwill in connection with the adoption of
SFAS No. 142 as described below........................... $15.8 $ -- $ --
===== ===== =====
Effective March 1, 2002, the Company adopted Statements of Financial
Accounting Standards No. 141, Business Combinations, and No. 142, Goodwill and
Other Intangible Assets (the "Statements"). Statement No. 141 refines the
definition of what assets may be considered as separately identified intangible
assets apart from goodwill. Statement No. 142 provides that goodwill and
intangible assets deemed to have indefinite lives will no longer be amortized,
but will be subject to impairment tests on at least an annual basis.
In adopting the Statements, the Company first reclassified $2.7 million of
intangible assets associated with its assembled workforce (net of related
deferred taxes of $1.4 million) to goodwill because such assets did not meet the
new criteria for separate identification. The Company then allocated its
adjusted goodwill balance of $19.2 million to its then existing Enterprise and
Networks divisions and completed the transitional impairment tests required by
Statement No. 142. The fair values of the reporting units were estimated using a
combination of the expected present values of future cash flows and an
assessment of comparable market values. As a result of these tests, the Company
determined that the goodwill associated with its Networks division was fully
impaired, and, accordingly, it recognized a non-cash, goodwill impairment charge
of $15.8 million as the cumulative effect on prior years of this change in
accounting principle. This impairment resulted primarily from the significant
decline in Networks sales and profitability during the fourth quarter of fiscal
2002 and related reduced forecasts for the division's sales and profitability.
Effective August 1, 2002, the Company combined its divisions into a single
integrated organizational structure in order to address changing market demands
and global customer requirements. The Company conducted its required annual test
of goodwill impairment during the fourth quarter of fiscal 2003. No additional
impairment of goodwill was indicated. Accordingly, at February 28, 2003, the
Company's remaining acquired goodwill totaled $3.4 million
During fiscal 2003, the Company was adversely affected by continuing
softness in the general U.S. economy, by extreme softness in the worldwide
network/telecommunications market and by political tensions in parts of South
America and the Middle East. The Company experienced a second year of declining
network revenue and significantly reduced its estimates of near term growth in
revenue and net income for its networks based products. As a result, the Company
determined that a triggering event, as defined in SFAS No. 144, had occurred
during the fourth quarter of fiscal 2003 and, accordingly, the Company evaluated
its
29
intangible assets for evidence of impairment. Based on the results of its
review, the Company recognized impairment charges of $14.2 million and $2.5
million, respectively, to reduce the carrying value of its customer relations
and developed technology intangible assets to their respective fair values,
which were based on estimated discounted future cash flows.
During the fourth quarter of fiscal 2002, the Company performed a
comprehensive review of the positioning of all product lines, including lines
brought forward from its fiscal 2000 merger with Brite. As a result of decisions
made during that review, the Company performed impairment tests in accordance
with its stated policies on the Brite tradename and on certain of the developed
technology associated with the Brite acquisition. Based on these tests, the
Company recorded impairment charges of $4.8 million and $3.2 million,
respectively, to reduce the carrying value of these intangible assets and an
additional charge of $3.7 million to reduce the carrying value of goodwill
associated with the impaired assets.
At February 28, 2003, the Company had $9.3 million in net intangible assets
other than goodwill which will be subject to amortization in future periods. The
estimated amortization expense attributable to the Company's intangible assets
for each of the next five years and thereafter is as follows (in millions):
Fiscal 2004................................................. $3.0
Fiscal 2005................................................. $1.6
Fiscal 2006................................................. $1.2
Fiscal 2007................................................. $1.1
Fiscal 2008................................................. $1.1
Thereafter.................................................. $1.3
OTHER INCOME (EXPENSE)
Other income (expense) during fiscal 2003 and 2002 was primarily interest
income on cash and cash equivalents. During fiscal 2003, the Company also
incurred foreign currency transaction losses of approximately $0.9 million.
During the fourth quarter of fiscal 2001, the Company realized a gain of
$21.4 million from the sale of SpeechWorks International, Inc. common stock
acquired through the exercise of a warrant received in connection with a 1996
supply agreement between the Company and SpeechWorks. In prior periods, the
warrant had been assigned no value because the warrant and the shares underlying
the warrant were unregistered securities, and significant uncertainties existed
regarding the Company's ability to monetize the warrant and the timing of any
such monetization.
INTEREST EXPENSE
The Company incurred interest expense of approximately $4.7 million, $4.9
million and $8.2 million during fiscal 2003, 2002 and 2001, respectively.
Substantially all of this expense relates to the Company's long term borrowings
initially obtained in connection with the Brite merger and as subsequently
refinanced (See "Liquidity and Capital Resources" for a description of the
Company's long term borrowings). The reduction in interest expense from fiscal
2001 through fiscal 2003 is primarily attributable to the lower levels of debt
outstanding during 2002 and 2003, partially offset in fiscal 2003 by additional
costs associated with the amortization of debt issuance costs and debt discounts
associated with financings undertaken during the year. Borrowings under the
credit agreements totaled $19.1 million, $30.0 million and $49.6 million at
February 28, 2003, 2002 and 2001, respectively. Assuming principal payments in
accordance with the Company's existing financing agreements and interest rates
consistent with current market rates, the Company expects its fiscal 2004
interest expense to be approximately $2.5 million
From July 1999 through October 2001, the Company used interest rate swap
arrangements to hedge the variability of interest payments on its variable rate
credit facilities. While in effect, the swap arrangements essentially converted
the Company's outstanding floating rate debt to a fixed rate basis. Of the $4.9
million total interest expense in fiscal 2002, approximately $1.5 million was
attributable to net settlements under the
30
interest rate swap arrangements. The Company terminated its swap arrangements in
October 2001 in response to the continued downward movement in interest rates
during fiscal 2002 and had no derivative contracts in place as of February 28,
2003 and 2002.
INCOME TAXES
The Company's income tax benefit for fiscal 2003 and 2002 differs
significantly from the federal statutory rate of 35% primarily as a result of
benefits recognized in fiscal 2003 as a result of a change in U.S. tax law,
operating losses and credit carryforwards generated but not benefited,
non-deductible amortization of goodwill resulting from the merger with Brite,
and various U.S. tax credits.
On March 7, 2002, United States tax law was amended to allow companies
which incurred net operating losses in 2001 and 2002 to carry such losses back a
maximum of five years instead of the maximum of two years previously allowed. As
a result of this change, during the first quarter of fiscal 2003, the Company
used $21.5 million of its previously reported net operating loss carryforwards
and $0.4 million of its previously reported tax credit carryforwards and
recognized a one-time tax benefit of $7.9 million, of which $2.2 million was
recognized as additional capital associated with previous stock option
exercises.
The Company's federal income tax returns for fiscal years 2000 and 2001 are
currently being audited by the Internal Revenue Service. The Company has
tentatively agreed to proposed adjustments from the IRS challenging certain
positions taken by the Company on those returns. Although resolution of the
issues is still subject to final review by the Joint Committee on Taxation, it
is probable that as a result of these proposed adjustments, the Company will
lose the ability to carry back approximately $5.4 million in net operating
losses generated in fiscal 2001. If this occurs, the Company will be required to
repay up to $2.0 million of refunds previously received from the IRS plus
accrued interest. The Company has recorded a charge for these probable
adjustments as part of its net tax provision (benefit) for fiscal 2003. The
Company expects final resolution of the issue and cash settlement with the IRS
to occur during the first half of fiscal 2004. Any net operating losses which
ultimately cannot be carried back to prior years under the settlement with the
IRS may be carried forward to future years.
At February 28, 2003, the Company had U.S. net operating loss carryforwards
totaling $45.0 million, including $13.7 million which will expire in 2022 and
$31.3 million which will expire in 2023. The Company also had $4.3 million and
$1.3 million in research and development and foreign tax credit carryforwards,
respectively, at February 28, 2003. If unused, the R&D tax credit carryforwards
will begin to expire in 2019, and the foreign tax credit carryforwards will
begin to expire in 2005.
The Company has established a valuation allowance of $29.3 million against
its net deferred tax assets, including the carryforwards described above. The
Company believes the existence of losses in its U.S. operations and the
dependency of its international subsidiaries on continuing U.S. operations
prevent it from concluding that it is more likely than not that its deferred tax
assets will be realized. If some or all of such reserved deferred tax assets are
ultimately realized, approximately $1.8 million of the valuation allowance
reversal related to stock option deductions will not provide future benefit to
income but rather will be credited to additional capital.
In fiscal 2002, the Company did not provide a valuation allowance for
deferred assets associated with its foreign subsidiaries. In providing such a
reserve during fiscal 2003, the Company recognized tax expense totaling $0.8
million to increase the valuation allowance for net foreign deferred tax assets
that existed at February 28, 2002. During fiscal 2003, and as discussed in
"Amortization and Impairment of Goodwill and Acquired Intangible Assets", the
Company reduced its deferred tax liabilities by $1.4 million in connection with
the reclassification of its assembled workforce intangible asset to goodwill. As
a result of this transaction, the Company increased the valuation allowance
associated with its U.S. net deferred tax asset by $1.4 million.
INCOME (LOSS) FROM OPERATIONS AND NET INCOME (LOSS)
The Company generated a loss from operations of $(44.1) million, a loss
before the cumulative effect of a change in accounting principle of $(50.6)
million and a net loss of $(66.4) million during fiscal 2003. Its loss
31
from operations and net loss totaled $(51.6) million and $(44.7) million,
respectively, in fiscal 2002. In fiscal 2001, the Company generated operating
income of $0.4 million, income before the cumulative effect of a change in
accounting principle of $9.5 million and a net loss of $(2.3) million.
During each of fiscal 2003, 2002 and 2001, the Company incurred significant
special charges as previously described in this Item 7 totaling $34.3 million,
$33.4 million and $8.2 million, respectively. In fiscal 2003, the Company
benefited from a change in the U.S. federal tax law that allowed it to recognize
net tax benefits of approximately $3.0 million. In fiscal 2001, the Company also
recognized the previously described non-recurring gain of $21.4 million
associated with the Company's sale of SpeechWorks International, Inc. common
stock.
The Company's losses in fiscal 2003 and fiscal 2002 are primarily
attributable to the significant decline in the Company's sales volumes from 2001
levels and to the significant restructuring and other special charges incurred
by the Company in its efforts to adjust its operations to the rapidly changing
market for its products. While the Company benefited throughout fiscal 2003 and
2002 from the cumulative effect of these efforts, its aggregate costs were too
high to allow the Company to operate profitably in the face of the sharp
downturn in sales activity.
The cumulative effect of a change in accounting principle on prior years
associated with the Company's adoption of SFAS No. 142 in fiscal 2003 resulted
in a charge to income of $15.8 million. Assuming the accounting change had been
applied retroactively by the Company to prior periods, pro forma net loss for
fiscal 2002 and pro forma net income for 2001 would have been ($40.3) million
and $1.8 million, respectively. Net loss per common share would have been
($1.21) in 2002, and net income per diluted share would have been $0.05 in 2001.
Had the Company not adopted SFAS No. 142, the Company's net loss for the year
ended February 28, 2003 would have been $54.7 million or $1.61 per share.
LIQUIDITY AND CAPITAL RESOURCES
CASH AND CASH EQUIVALENTS
The Company had $26.2 million in cash and cash equivalents at February 28,
2003, an increase of $8.6 million over ending fiscal 2002 balances. Borrowings
under the Company's long-term credit facilities totaled $19.1 million at
February 28, 2003, a reduction of $10.9 million from fiscal 2002 ending
balances.
Although it incurred a net loss for fiscal 2003 of $66.4 million, over 80%
of this loss was attributable to non-cash charges for depreciation and
amortization ($16.1 million), the impairment of intangible assets ($32.5
million), and the reduction of certain inventory values ($5.7 million). In
addition, the Company aggressively managed its inventory holdings, its extension
of credit and its accounts receivable collection efforts during the year.
Inventory balances excluding the write-down in certain values described above
declined significantly during fiscal 2003, generating $12.4 million of operating
cash, and days sales outstanding (DSOs) of accounts receivable were 61 days at
February 28, 2003, down from 133 days at February 28, 2002. As a result, despite
the net loss, the Company generated $23.6 million in cash from operating
activities during fiscal 2003.
For sales of certain of its more complex, customized systems (generally
ones with a sales price of $500,000 or more), the Company recognizes revenue
based on a percentage of completion methodology. Unbilled receivables accrued
under this methodology totaled $4.9 million (19.0% of total net receivables) at
February 28, 2003. The Company expects to bill and collect unbilled receivables
as of February 28, 2003 within the next twelve months.
While the Company continues to focus on the level of its investment in
accounts receivable, it now generates a significant percentage of its sales,
particularly sales of enhanced telecommunications services systems, outside the
United States. Customers in certain countries are subject to significant
economic and political challenges that affect their cash flow, and many
customers outside the United States are generally accustomed to vendor financing
in the form of extended payment terms. To remain competitive in markets outside
the United States, the Company may offer selected customers such payment terms.
In all cases, however, the Company only recognizes revenue at such time as its
system or service fee is fixed or
32
determinable, collectibility is probable and all other criteria for revenue
recognition have been met. In some limited cases, this policy may result in the
Company recognizing revenue on a "cash basis", limiting revenue recognition on
certain sales of systems and/or services to the actual cash received to date
from the customer, provided that all other revenue recognition criteria have
been satisfied.
The Company's federal income tax returns for its fiscal years 2000 and 2001
are currently being audited by the Internal Revenue Service. The Company has
tentatively agreed to proposed adjustments from the IRS challenging certain
positions taken by the Company on those returns. Although resolution of the
issues is still subject to final review by the Joint Committee on Taxation, it
is probable that as a result of these proposed adjustments, the Company will
lose the ability to carry back approximately $5.4 million in net operating
losses generated in fiscal 2001. If this occurs, the Company will be required to
repay up to $2.0 million of refunds previously received from the IRS plus
accrued interest. The Company has recorded a charge for these probable
adjustments as part of its net tax provision (benefit) for fiscal 2003. The
Company expects final resolution of the issue and cash settlement with the IRS
to occur during the first half of fiscal 2004. Any net operating losses which
ultimately cannot be carried back to prior years under the settlement with the
IRS may be carried forward to future years.
The Company's wholly owned subsidiary, Brite Voice Systems, Inc. ("Brite")
has filed a petition in the United States Tax Court seeking a redetermination of
a Notice of Deficiency issued by the IRS to Brite. The amount of the proposed
deficiency is $2.4 million before interest or penalties and relates primarily to
a disputed item in Brite's August 1999 federal income tax return. The Company
and the IRS have reached a tentative agreement, subject to final review and
approval by the Joint Committee on Taxation, which eliminates the proposed
deficiency and, in fact, results in the Company receiving a small net refund.
The Company expects final resolution of this matter to occur during the first
half of fiscal 2004.
The Company used $2.6 million of cash in net investing activities and used
$13.7 million of cash in net financing activities, including the net repayment
of debt described above and the payment of $2.5 million in debt issuance costs
associated with various refinancing activities undertaken during the year as
further described below.
MORTGAGE LOAN
In May 2002, the Company entered into a $14.0 million mortgage loan secured
by a first lien on the Company's Dallas headquarters. The mortgage loan bears
interest, payable monthly, at the greater of 10.5% or the prime rate plus 2%.
The principal balance is due in May 2005. Proceeds from the loan were used to
partially repay amounts outstanding under the amortizing term loan that existed
at the time the Company entered into the mortgage. In October 2002 and February
2003, the Company amended the mortgage loan to modify a minimum net equity
covenant contained in the loan agreement. Under the amended loan, the Company
must have at least $5.0 million in net equity at the end of each of its fiscal
quarters beginning with the quarter ending August 31, 2004. In connection with
these amendments, the Company prepaid $3.5 million of the original principal
amount outstanding under the loan. The mortgage loan contains cross-default
provisions with respect to the Company's new term loan and revolving credit
agreement, such that a default under the credit facility which leads to the
acceleration of amounts due under the facility and the enforcement of liens
against the mortgaged property also creates a default under the mortgage loan.
NEW TERM LOAN AND REVOLVING CREDIT AGREEMENT
In August 2002, the Company entered into a new credit facility agreement
with a lender which provided for an amortizing term loan of $10.0 million and a
revolving credit commitment equal to the lesser of $25.0 million minus the
principal outstanding under the term loan and the balance of any letters of
credit ($16.4 million maximum at February 28, 2003) or a defined borrowing base
comprised primarily of eligible U.S. and U.K. accounts receivable ($0.3 million
maximum at February 28, 2003). The term loan bears interest, payable monthly, at
the prime rate plus 2.75% (7% at February 28, 2003). Principal is due in equal
monthly installments of approximately $0.3 million through July 2005 and final
payments of approximately $0.6 million in August 2005. Proceeds from the term
loan were used to retire $9.0 million of convertible notes
33
outstanding at the time the Company entered into the credit facility, to pay
$0.6 million in accrued interest and early termination premiums related to the
convertible notes and to provide additional working capital to the Company.
Any advances under the revolver loan will accrue interest at the prime rate
plus a margin of 0.5% to 1.5%, or at the London Inter-bank Offering Rate plus a
margin of 3% to 4%. The Company may request an advance under the revolver loan
at any time during the term of the revolver agreement so long as the requested
advance does not exceed the then available borrowing base. The Company has not
requested an advance under the revolver as of the date of this filing. The term
loan and the revolving credit agreement expire on August 29, 2005.
The new credit facility contains terms, conditions and representations that
are generally customary for asset-based credit facilities, including
requirements that the Company comply with certain significant financial and
operating covenants. In particular, the Company is initially required to have
EBITDA, as defined in the agreement, in minimum cumulative amounts on a monthly
basis through August 31, 2003. While lower amounts are allowed within each
fiscal quarter, the Company must generate cumulative EBITDA of $5.0 million and
$9.0 million, respectively, for the nine and twelve month periods ending May 31,
2003 and August 31, 2003. Thereafter, the Company is required to have minimum
cumulative EBITDA, as defined, of $15 million and $20 million for the 12-month
periods ending November 30, 2003 and February 29, 2004, respectively, and $25
million for the 12-month periods ending each fiscal quarter thereafter. In order
for the Company to comply with the escalating minimum EBITDA requirements in the
credit facility, the Company will have to continue to increase revenues and/or
lower expenses in future quarters. The Company is also required to maintain
defined levels of actual and projected service revenues and is prohibited from
incurring capital expenditures in excess of $4.0 million for any fiscal year
beginning on or after March 1, 2003 except in certain circumstances and with the
lender's prior approval.
Borrowings under the new credit facility are secured by first liens on
virtually all of the Company's personal property and by a subordinated lien on
the Company's Dallas headquarters. The new credit facility contains
cross-default provisions with respect to the Company's mortgage loan, such that
an event of default under the mortgage loan which allows the mortgage lender to
accelerate the mortgage loan or terminate the agreement creates a default under
the credit facility. As of February 28, 2003, the Company was in compliance with
all financial and operating covenants.
WARRANTS
In connection with a sale of convertible notes during fiscal 2003, which
notes were subsequently redeemed in full for cash prior to year end, the Company
issued warrants to the buyers. The warrants give the holders the right to
purchase from the Company, for a period of three years, an aggregate of 621,304
shares of the Company's common stock for $4.0238 per share as of the date of
issuance. Under certain circumstances, this "purchase" may be accomplished
through a cashless exercise. Both the number of warrants and the exercise price
of the warrants are subject to antidilution adjustments as set forth in the
warrants. If the Company is prohibited from issuing warrant shares under the
rules of the Nasdaq National Market, the Company must redeem for cash those
warrant shares which cannot be issued at a price per warrant share equal to the
difference between the weighted average market price of the Company's common
stock on the date of attempted exercise and the applicable exercise price. The
Company's obligations under the warrants remain in force and are unaffected by
the redemption of the convertible notes.
COSTS ASSOCIATED WITH THE REFINANCINGS
During fiscal 2003, the Company incurred approximately $1.5 million in debt
issuance costs, consisting primarily of investment banking and legal fees, to
establish the new term loan and revolving credit agreement and the mortgage
loan. Such costs were capitalized and are being charged to interest expense over
the life of the related debt obligations. In addition, in connection with the
restructuring of its fiscal 2002 debt, the Company incurred approximately $1.0
million in debt issuance costs associated with the convertible notes and
warrants. During the third quarter of fiscal 2003, the Company recognized a loss
of approximately $1.9 million
34
on the early extinguishment of the convertible notes. The loss included a $0.5
million early conversion/ retirement premium as well as the non-cash costs to
write off the unamortized debt issuance costs and unamortized discount
associated with the convertible notes.
SUMMARY OF FUTURE OBLIGATIONS
The following table summarizes the Company's obligations and commitments as
of February 28, 2003, to be paid in fiscal 2004 through 2008 (in millions):
NATURE OF COMMITMENT 2004 2005 2006 2007 2008
-------------------- ---- ---- ----- ---- ----
Long-term debt, excluding related interest
amounts.......................................... $3.3 $3.3 $12.5 $ -- $ --
Operating lease payments........................... 3.2 2.8 2.4 1.3 0.8
---- ---- ----- ---- ----
Total obligations and commitments.................. $6.5 $6.1 $14.9 $1.3 $0.8
==== ==== ===== ==== ====
The Company believes its cash reserves and internally generated cash flow
along with any cash availability under its revolver loan will be sufficient to
meet its operating cash requirements for the next twelve months.
IMPACT OF INFLATION
The Company does not expect any significant short-term impact of inflation
on its financial condition. Technological advances should continue to reduce
costs in the computer and communications industries. Further, the Company
presently is not bound by long term fixed price sales contracts. The absence of
such contracts should reduce the Company's exposure to inflationary effects.
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
THREE MONTHS ENDED
--------------------------------------------------
MAY 31, AUGUST 31, NOVEMBER 30, FEBRUARY 28,
FISCAL 2003* 2002 2002 2002 2003
------------ ------- ---------- ------------ ------------
(IN MILLIONS, EXCEPT PER SHARE DATA)
Sales..................................... $ 38.4 $ 35.6 $ 44.0 $ 38.2
Gross profit (loss)....................... 15.6 10.9 21.7 20.0
Income (loss) from operations............. (9.8) (15.8) (0.9) (17.6)
Income (loss) before the cumulative effect
of a change in accounting principle..... (8.7) (16.3) (7.8) (17.8)
Net income (loss)......................... (24.5) (16.3) (7.8) (17.8)
Income (loss) before the cumulative effect
of a change in accounting principle per
diluted share........................... (0.26) (0.48) (0.23) (0.52)
Net income (loss) per diluted share....... (0.72) (0.48) (0.23) (0.52)
THREE MONTHS ENDED
--------------------------------------------------
MAY 31, AUGUST 31, NOVEMBER 30, FEBRUARY 28,
FISCAL 2002 2001 2001 2001 2002**
----------- ------- ---------- ------------ ------------
(IN MILLIONS, EXCEPT PER SHARE DATA)
Sales..................................... $ 61.5 $ 64.5 $ 58.1 $ 27.6
Gross profit (loss)....................... 33.7 33.1 30.5 (11.2)
Income (loss) from operations............. 3.2 3.6 1.3 (59.7)
Net income (loss)......................... 1.4 1.7 -- (47.8)
Net income (loss) per diluted share....... 0.04 0.05 0.00 (1.42)
---------------
* During fiscal 2003, the Company incurred special charges of $2.6 million,
$10.1 million, $4.9 million and $16.7 million, respectively, in its first,
second, third and fourth fiscal quarters. The special charges included
35
$6.2 million of severance and related benefit costs, $0.7 million related to
facilities closures, $4.1 million write down of excess inventories, $4.7
million of charges for contracts expected to result in losses to the Company,
$1.9 million loss on early extinguishment of debt, and $16.7 million related
to impairment of certain intangible assets. (See "Special Charges".) The
Company benefited from a change in the U.S. federal tax law that allowed it
to recognize net tax benefits of approximately $3.0 million.
** During the fourth quarter of fiscal 2002, the Company incurred special
charges of $33.4 million, including $16.4 million for the write down of
intangible assets and inventories associated with discontinued product lines,
$6.5 million for the write down of excess inventories, $5.2 million for
severance payments and related benefits, $4.2 million for facilities
closures, and $1.1 million relating to the write down of non-productive fixed
assets. (See "Special Charges".) Sales for the quarter were reduced as a
result of the Company's decisions to accept the return of two systems sales
in the aggregate amount of $7.7 million. Pretax income for the fourth quarter
was reduced by approximately $6.5 million as a result of these returns.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company invests cash balances in excess of operating requirements in
short-term securities that generally have maturities of 90 days or less. The
carrying value of these securities approximates market value, and there is no
long-term interest rate risk associated with this investment.
At February 28, 2003, the Company's outstanding long-term debt was
comprised of the following (in millions):
FEBRUARY 28, 2003
-----------------
Mortgage loan, bearing interest payable monthly at the
greater of 10.5% or the prime rate plus 2.0%; principal
due May 28, 2005.......................................... $10.5
Amortizing term loan, principal due in equal monthly
installments of approximately $0.3 million through July
2005 with final payments totaling approximately $0.6
million in August 2005; interest payable monthly, accruing
at a rate equal to the prime rate plus 2.75% (7.0% at
February 28, 2003)........................................ 8.6
-----
$19.1
=====
The following table provides information about the Company's credit
agreements that are sensitive to changes in interest rates. For the credit
agreements, the table presents cash flows for scheduled principal payments and
related weighted-average interest rates by expected maturity dates.
Weighted-average variable rates are based on rates in effect as of February 28,
2003.
FISCAL
----------------------
2004 2005 2006
----- ----- ------
(DOLLARS IN MILLIONS)
Long-term debt variable rate U.S.$.......................... $3.3 $3.3 $12.5
Projected weighted average interest rate.................... 9.1% 9.6% 10.0%
FOREIGN CURRENCY RISKS
The Company transacts business in certain foreign currencies including,
particularly, the British pound and the Euro. The Company's primary software
application development, research and development and other administrative
activities are conducted from offices in the United States and the United
Kingdom, and its primary manufacturing operations are conducted in the United
States. Virtually all sales arranged through the Company's U.S. offices are
denominated in U.S. dollars, which is the functional and reporting currency of
the U.S. entity. Sales arranged through the Company's U.K. subsidiary are
denominated in various currencies, including the British pound, the U.S. dollar
and the Euro; however, the U.K. subsidiary's functional currency is the British
pound. For the fiscal year ended February 28, 2003, sales originating from the
Company's U.K. subsidiary represented approximately 34% of consolidated sales.
As a result of its international operations, the Company is subject to exposure
from adverse movements in certain foreign currency exchange rates. The Company
has not historically used foreign currency options or forward contracts to hedge
its currency
36
exposures because of variability in the timing of cash flows associated with its
larger contracts where payments are tied to the achievement of project
milestones, and it did not have any such hedge instruments in place at February
28, 2003. Rather, the Company attempts to mitigate its foreign currency risk by
transacting business in the functional currency of each of its major
subsidiaries, thus creating natural hedges by paying expenses incurred in the
local currency in which revenues will be received.
At February 28, 2003, the Company had an intercompany balance payable to
its U.K. subsidiary totaling approximately $24.5 million. The Company considers
such intercompany balance to be a long-term investment, as defined under the
guidance of Statement of Financial Accounting Standards No. 52 -- Foreign
Currency Translation, and management has no plans within the foreseeable future
to pay amounts owed to its U.K. subsidiary. Accordingly, foreign exchange
fluctuations on the balance are recorded as a component of accumulated other
comprehensive loss in the statement of stockholders' equity.
As noted above, the Company's operating results are exposed to changes in
certain exchange rates including, particularly, those between the U.S. dollar,
the British pound and the Euro. When the U.S. dollar strengthens against the
other currencies, the Company's sales are negatively affected upon the
translation of U.K. operating results to the reporting currency. The effect of
these changes on the Company's operating profits varies depending on the level
of British pound denominated expenses and the U.K. subsidiary's overall
profitability. For the fiscal year ended February 28, 2003, the result of a
hypothetical, uniform 10% strengthening in the value of the U.S. dollar relative
to the British pound and the Euro would have been a decrease in sales of
approximately $3.4 million and a reduction in the net loss of approximately $1.3
million. In addition to the direct effects of changes in exchange rates, which
are a changed dollar value of the resulting sales and/or operating expenses,
changes in exchange rates also could affect the volume of sales or the foreign
currency sales price as competitors' products become more or less attractive.
The Company's sensitivity analysis of the effects of changes in foreign currency
exchange rates does not factor in a potential change in sales levels or local
currency prices.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Independent Auditor's Report of Ernst & Young LLP and the Consolidated
Financial Statements of the Company as of February 28, 2003 and 2002 and for
each of the three years in the period ended February 28, 2003 follow:
37
REPORT OF INDEPENDENT AUDITORS
Stockholders and Board of Directors
Intervoice, Inc.
We have audited the accompanying consolidated balance sheets of Intervoice,
Inc. and subsidiaries as of February 28, 2003 and 2002 and the related
consolidated statements of operations, changes in stockholders' equity and cash
flows for each of the three years in the period ended February 28, 2003. Our
audits also included the financial statement schedule listed in the index at
Item 16(a). These financial statements and schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Intervoice, Inc. and subsidiaries at February 28, 2003 and 2002, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended February 28, 2003, in conformity with accounting
principles generally accepted in the United States. Also, in our opinion, the
related financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.
As discussed in Notes C and D and to the consolidated financial statements,
respectively, effective March 1, 2002 the Company changed its method of
accounting for goodwill and other intangible assets and effective March 1, 2000
the Company changed its method of accounting for certain revenues.
ERNST & YOUNG LLP
Dallas, Texas
May 5, 2003
38
INTERVOICE, INC.
CONSOLIDATED BALANCE SHEETS
FEBRUARY 28, FEBRUARY 28,
2003 2002
------------ ------------
(IN THOUSANDS, EXCEPT SHARE
AND PER SHARE DATA)
ASSETS
Current Assets
Cash and cash equivalents................................. $ 26,211 $ 17,646
Trade accounts receivable, net of allowance for doubtful
accounts of $2,527 in 2003 and $3,492 in 2002.......... 25,853 40,783
Inventory................................................. 8,895 27,524
Prepaid expenses and other current assets................. 5,277 6,152
Deferred income taxes..................................... -- 819
-------- --------
66,236 92,924
Property and Equipment
Land and buildings........................................ 16,708 19,530
Computer equipment and software........................... 32,660 30,379
Furniture, fixtures and other............................. 2,667 2,328
Service equipment......................................... 8,744 7,902
-------- --------
60,779 60,139
Less allowance for depreciation........................... 40,406 33,787
-------- --------
20,373 26,352
Other Assets
Intangible assets, net of accumulated amortization of
$32,218 in 2003 and $29,992 in 2002.................... 9,326 37,439
Goodwill.................................................. 3,401 16,500
Other assets.............................................. 1,655 2,153
-------- --------
$100,991 $175,368
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable.......................................... $ 12,513 $ 22,661
Accrued expenses.......................................... 12,705 10,826
Customer deposits......................................... 9,061 5,963
Deferred income........................................... 25,478 24,426
Current portion of long term borrowings................... 3,333 6,000
Income taxes payable...................................... 6,240 4,162
-------- --------
69,330 74,038
Long Term Liabilities....................................... 856 1,916
Deferred Income Taxes....................................... 44 --
Long Term Borrowings........................................ 15,778 23,980
Stockholders' Equity
Preferred Stock, $100 par value -- 2,000,000 shares
authorized: none issued Common Stock, no par value, at
nominal assigned value -- 62,000,000 shares authorized:
34,111,101 issued and outstanding in 2003, 34,029,180
issued and outstanding in 2002......................... 17 17
Additional capital........................................ 65,144 61,725
Retained earnings (accumulated deficit)................... (46,768) 19,618
Accumulated other comprehensive loss...................... (3,410) (5,926)
-------- --------
14,983 75,434
-------- --------
$100,991 $175,368
======== ========
See notes to consolidated financial statements.
39
INTERVOICE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FISCAL YEAR ENDED
------------------------------------------
FEBRUARY 28, FEBRUARY 28, FEBRUARY 28,
2003 2002 2001
------------ ------------ ------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Sales
Systems................................................. $ 84,755 $126,379 $182,784
Services................................................ 71,457 85,257 91,963
-------- -------- --------
156,212 211,636 274,747
-------- -------- --------
Cost of goods sold
Systems................................................. 60,723 87,173 95,800
Services................................................ 27,292 38,389 43,924
-------- -------- --------
88,015 125,562 139,724
-------- -------- --------
Gross margin
Systems................................................. 24,032 39,206 86,984
Services................................................ 44,165 46,868 48,039
-------- -------- --------
68,197 86,074 135,023
-------- -------- --------
Research and development expenses......................... 22,592 29,308 34,594
Selling, general and administrative expenses.............. 65,941 83,316 86,193
Amortization of goodwill and acquisition related
intangible assets....................................... 7,101 13,378 13,844
Impairment of goodwill and acquisition related intangible
assets.................................................. 16,710 11,684 --
-------- -------- --------
Income (loss) from operations............................. (44,147) (51,612) 392
Other income (expense).................................... (658) 1,433 22,435
Loss on early extinguishment of debt...................... (1,868) -- --
Interest expense.......................................... (4,674) (4,939) (8,187)
-------- -------- --------
Income (loss) before income taxes and the cumulative
effect of a change in accounting principle.............. (51,347) (55,118) 14,640
Income tax (benefit)...................................... (752) (10,428) 5,124
-------- -------- --------
Income (loss) before the cumulative effect of a change in
accounting principle.................................... $(50,595) $(44,690) $ 9,516
Cumulative effect of change in accounting principle....... (15,791) -- (11,850)
-------- -------- --------
Net loss.................................................. $(66,386) $(44,690) $ (2,334)
======== ======== ========
Per Basic Share:
Income (loss) before the cumulative effect of a change in
accounting principle.................................... $ (1.49) $ (1.34) $ 0.29
Cumulative effect of change in accounting principle....... (0.46) -- (0.36)
-------- -------- --------
Net loss.................................................. $ (1.95) $ (1.34) $ (0.07)
======== ======== ========
Per Diluted Share:
Income (loss) before the cumulative effect of a change in
accounting principle.................................... $ (1.49) $ (1.34) $ 0.28
Cumulative effect of a change in accounting principle..... (0.46) -- $ (0.35)
-------- -------- --------
Net loss.................................................. $ (1.95) $ (1.34) $ (0.07)
======== ======== ========
See notes to consolidated financial statements.
40
INTERVOICE, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
ACCUMULATED
COMMON STOCK OTHER
------------------- ADDITIONAL UNEARNED RETAINED COMPREHENSIVE
SHARES AMOUNT CAPITAL COMPENSATION EARNINGS LOSS TOTAL
---------- ------ ---------- ------------ -------- ------------- --------
(IN THOUSANDS, EXCEPT SHARE DATA)
Balance at February 29,
2000.................... 32,587,524 $16 $49,984 $(3,701) $ 66,642 $ (910) $112,031
Net loss................ -- -- -- -- (2,334) -- (2,334)
Foreign currency
translation
adjustment............ -- -- -- -- -- (3,145) (3,145)
--------
Comprehensive loss...... (5,479)
--------
Exercise of stock
options............... 532,123 1 3,060 -- -- -- 3,061
Tax benefit from
exercise of stock
options............... -- -- 3,311 -- -- -- 3,311
Amortization of unearned
compensation, net of
forfeiture............ (20,000) -- (684) 2,390 -- -- 1,706
---------- --- ------- ------- -------- ------- --------
Balance at February 28,
2001.................... 33,099,647 17 55,671 (1,311) 64,308 (4,055) 114,630
Net loss................ -- -- -- -- (44,690) -- (44,690)
Foreign currency
translation
adjustment............ -- -- -- -- -- (1,679) (1,679)
Cumulative effect on
prior years Of
adopting Statement of
Financial Accounting
Standards No. 133, as
amended, net of tax
effect of $261........ -- -- -- -- -- (425) (425)
Valuation adjustment of
interest rate swap
hedge, net of tax
effect of ($143)...... -- -- -- -- -- 233 233
--------
Comprehensive loss...... (46,561)
--------
Exercise of stock
options............... 929,533 -- 6,054 -- -- -- 6,054
Amortization of unearned
compensation.......... -- -- -- 1,311 -- -- 1,311
---------- --- ------- ------- -------- ------- --------
Balance at February 28,
2002.................... 34,029,180 17 61,725 -- 19,618 (5,926) 75,434
Net loss................ -- -- -- -- (66,386) -- (66,386)
Foreign currency
translation
adjustment............ -- -- -- -- -- 2,324 2,324
Valuation adjustment of
interest rate swap
hedge, net of tax
effect of ($118)...... -- -- -- -- -- 192 192
--------
Comprehensive loss...... (63,870)
--------
Exercise of stock
options............... 81,921 -- 192 -- -- -- 192
Tax benefit from
exercise of stock
options............... -- -- 2,171 -- -- -- 2,171
Issuance of warrants.... -- -- 1,056 -- -- -- 1,056
---------- --- ------- ------- -------- ------- --------
Balance at February 28,
2003.................... 34,111,101 $17 $65,144 $ -- $(46,768) $(3,410) $ 14,983
========== === ======= ======= ======== ======= ========
See notes to consolidated financial statements.
41
INTERVOICE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FISCAL YEAR ENDED
------------------------------------------
FEBRUARY 28, FEBRUARY 28, FEBRUARY 28,
2003 2002 2001
------------ ------------ ------------
(IN THOUSANDS)
Operating activities
Net loss................................................ $(66,386) $(44,690) $(2,334)
Adjustments to reconcile net loss to net cash provided
by operating activities:
Depreciation and amortization........................ 16,065 26,518 32,367
Gain on sale of investment........................... -- -- (21,391)
Deferred income taxes (benefit)...................... 2,200 (16,860) (5,550)
Provision for doubtful accounts...................... (774) 408 2,935
Write down of inventories............................ 5,667 14,488 4,752
Disposal of equipment................................ 736 2,568 17
Write off of goodwill and intangible assets.......... 32,501 11,866 2,863
Loss on early extinguishment of debt acquisition
costs.............................................. 1,868 -- --
Changes in operating assets and liabilities:
Accounts receivable.................................. 17,788 31,835 18,074
Inventories.......................................... 12,353 (3,287) (20,156)
Prepaid expenses and other assets.................... 2,494 4,365 2,313
Accounts payable and accrued expenses................ (10,389) (6,314) (2,021)
Income taxes payable................................. 1,804 818 3,891
Customer deposits.................................... 2,943 (1,746) (280)
Deferred income...................................... 988 4,756 5,255
Other................................................ 3,761 (4,309) 1,903
-------- -------- -------
Net cash provided by operating activities................. 23,619 20,416 22,638
Investing activities
Purchase of property and equipment...................... (4,169) (4,869) (5,866)
Proceeds from sale of investment........................ -- -- 21,391
Proceeds from sale of fixed assets...................... 1,890 -- --
Purchased software...................................... (323) (184) (704)
Other................................................... -- -- 2,800
-------- -------- -------
Net cash provided by (used in) investing activities....... (2,602) (5,053) 17,621
-------- -------- -------
Financing activities
Paydown of debt......................................... (44,869) (19,657) (57,863)
Debt issuance costs..................................... (2,515) -- --
Premium on early extinguishment of debt................. (470) -- --
Exercise of stock options............................... 192 6,054 3,061
Borrowings.............................................. 34,000 -- 7,500
-------- -------- -------
Net cash used in financing activities..................... (13,662) (13,603) (47,302)
Effect of exchange rate on cash........................... 1,210 (15) (319)
-------- -------- -------
Increase (decrease) in cash and cash equivalents.......... 8,565 1,745 (7,362)
Cash and cash equivalents, beginning of period............ 17,646 15,901 23,263
-------- -------- -------
Cash and cash equivalents, end of period.................. $ 26,211 $ 17,646 $15,901
======== ======== =======
See notes to consolidated financial statements.
42
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A -- DESCRIPTION OF BUSINESS
Intervoice, Inc. (together with its subsidiaries, collectively referred to
as the "Company") is a leader in providing converged voice and data solutions
for the network and enterprise markets. Through its open, standards based
product suites, the Company offers speech-enabled IVR applications, multi-media
and network-grade portals, voicemail and prepaid calling solutions that allow
network carriers and service providers to increase revenue through value-added
services and/or reduce costs through automation and that allow enterprise
customers to reduce costs and improve customer service levels. In addition, the
Company provides a suite of professional services including maintenance,
implementation, and business and technical consulting services that supports its
installed systems. To further leverage the strong return on investment offered
by its systems offerings, the Company also offers enhanced communications
solutions to network and enterprise customers on an outsourced basis as an
Application Service Provider, or ASP. For the fiscal year ended February 28,
2003, the Company reported revenues of $156.2 million, with systems and services
sales representing approximately 54% and 46% of revenues, respectively.
NOTE B -- SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: The consolidated financial statements include
the accounts of Intervoice, Inc. and its subsidiaries, all of which are directly
or indirectly 100% owned by Intervoice, Inc. All significant intercompany
transactions and accounts have been eliminated in consolidation. Certain prior
year balances have been reclassified to conform to the current year
presentation. Financial statements of the Company's foreign subsidiaries have
been translated into U.S. dollars at current and average exchange rates.
Resulting translation adjustments are recorded in stockholders' equity as a part
of accumulated other comprehensive loss. Any foreign currency transaction gains
or losses are included in the accompanying consolidated statements of
operations.
Use of Estimates: The preparation of financial statements in conformity
with accounting principles generally accepted in the United States requires
management to make certain estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results
could differ from those estimates.
Cash and Cash Equivalents: Cash equivalents include investments in highly
liquid securities with a maturity of three months or less at the time of
acquisition. The carrying amount of these securities approximates fair market
value. Interest income was $0.3 million, $1.1 million and $0.5 million in fiscal
2003, 2002 and 2001, respectively.
Inventories: Inventories are valued at the lower of cost or market.
Inventories are recorded at standard cost which approximate actual cost
determined on a first-in, first-out basis. The Company periodically reviews its
inventories for unsaleable or obsolete items and for items held in excess
quantities based on current and projected usage. Adjustments are made where
necessary to reduce the carrying value of individual items to reflect the lower
of cost or market, and any such adjustments create a new carrying value for the
affected items.
Property and Equipment: Property and equipment is stated at cost.
Depreciation is provided using the straight-line method over each asset's
estimated useful life. The range of useful lives by major category are:
buildings: 5 to 40 years; computer equipment and software: 3 to 5 years;
furniture, fixtures and other: 5 years; and service equipment: 3 years.
Depreciation expense totaled $8.7 million, $12.7 million and $14.0 million in
fiscal 2003, 2002 and 2001, respectively.
Intangible Assets and Impairment of Long-Lived Assets: Intangible assets
are comprised of separately identifiable intangible assets arising out of the
Company's fiscal 2000 acquisition of Brite Voice Systems, Inc., and certain
capitalized purchased software. Intangible assets are being amortized using the
straight-line method over each asset's estimated useful life. Such lives range
from five to twelve years. Amortization
43
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
expense for these items totaled $7.4 million, $11.3 million and $12.3 million in
fiscal 2003, 2002 and 2001, respectively. In accordance with the provisions of
Statement of Financial Accounting Standards No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets (SFAS No. 144), which the Company
adopted on March 1, 2002, and Statement of Financial Accounting Standards No.
121, which was effective for the Company's fiscal years 2002 and 2001, the
Company reviews its intangible and other long-lived assets for possible
impairment when events and circumstances indicate that the assets might be
impaired and the undiscounted projected cash flows associated with such assets
are less than the carrying amounts of the assets. In those situations, the
Company recognizes an impairment loss on the intangible asset equal to the
excess of the carrying amount of the asset over the asset's fair value,
generally determined based upon discounted estimates of future cash flows. The
Company recognized impairment losses related to intangible assets totaling $16.7
million in fiscal 2003 and $11.7 million in fiscal 2002. See "Note C -- Change
in Accounting Principle for Goodwill and Other Intangible Assets ".
The cost of internally developed software products and substantial
enhancements to existing software products for sale are expensed until
technological feasibility is established, at which time any additional costs
would be capitalized in accordance with Statement of Financial Accounting
Standards (SFAS) No. 86. Technological feasibility of a computer software
product is established when the Company has completed all planning designing,
coding, and testing activities that are necessary to establish that the product
can be produced to meet its design specifications including functions, features,
and technical performance requirements. No costs have been capitalized to date
for internally developed software products and enhancements as the Company's
current process for developing software is essentially completed concurrently
with the establishment of technological feasibility. The Company capitalizes
purchased software upon acquisition when such software is technologically
feasible or if it has an alternative future use, such as use of the software in
different products or resale of the purchased software.
Goodwill: The Company's goodwill also results from its fiscal 2000
purchase of Brite Voice Systems, Inc. Under the provisions of SFAS No. 141,
Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets,
which the Company adopted on March 1, 2002, goodwill is presumed to have an
indefinite life and is not subject to annual amortization. Goodwill is
subjected, however, to tests for impairment on at least an annual basis and more
frequently if triggering events are identified on an interim basis. The
impairment review follows the two-step approach defined in SFAS No. 142. The
first step compares the fair value of the Company, with its carrying amount,
including goodwill. If the fair value exceeds the carrying amount, goodwill is
considered not impaired. If the carrying amount exceeds fair value, the Company
must compare the implied fair value of goodwill with the carrying amount of that
goodwill. If the carrying amount of goodwill exceeds the implied fair value of
that goodwill, an impairment loss is recognized in an amount equal to the lesser
of that excess or the carrying amount of goodwill. See Note C for an expanded
discussion of the Company's fiscal 2003 adoption of SFAS No. 141 and SFAS No.
142 and for a summary of impairment charges recorded during the year.
Other Assets: Other Assets are comprised of refundable deposits, deferred
costs associated with one of the Company's managed services contracts, $0.6
million of restricted certificates of deposit and, in fiscal 2003, $0.7 million
of long term debt issuance costs. The CDs are pledged in support of certain
letters of credit issued on behalf of the Company to guarantee its performance
under a long-term, international managed service contract. The letters of credit
expire in December 2003. The deferred costs associated with a managed service
contract will be amortized to expense through July 2003. The debt issuance costs
will be amortized to expense during fiscal 2004, fiscal 2005 and fiscal 2006.
Derivatives: From July 1999 through October 2001, the Company used
interest rate swap arrangements to hedge the variability of interest payments on
its variable rate credit facilities. While in effect, the swap arrangements
essentially converted the Company's then outstanding floating rate debt to a
fixed rate basis. The Company terminated its swap arrangements in October 2001
in response to the continued downward
44
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
movement in interest rates during fiscal 2002 and had no derivative contracts in
place as of February 28, 2002, or 2003.
Prior to March 1, 2001, the Company did not assign a value to the interest
rate swaps, and gains and losses from the swaps were included on the accrual
basis in interest expense. Effective March 1, 2001, the Company adopted
Statement of Financial Accounting Standards No. 133 -- Accounting for Derivative
Instruments and Hedging Activities, as amended ("Statement No. 133"), which
required that the Company record an asset or liability for the fair value of its
derivatives and that it mark such asset or liability to market on an ongoing
basis. Because the Company's interest rate swaps were defined as cash flow
hedges, changes to the derivative's market value were initially reported at the
adoption of the Statement as a component of accumulated other comprehensive loss
to the extent that the hedge was determined to be effective. Such changes were
subsequently reclassified into earnings when the related transaction (the
quarterly payment of variable rate interest) affected earnings. Changes in
market value attributable to the ineffective portion of a hedge were reported in
earnings immediately as incurred.
The Company had no other derivative instruments during fiscal 2003, 2002
and 2001.
Product Warranties: The Company provides limited warranties on the sale of
certain of its systems in the U.S. Such warranties cover routine bug-fixes and
hardware problems and do not provide a right to system upgrades and
enhancements. The warranties are typically valid for one year. At February 28,
2003, the Company's accrued warranty costs totaled $0.8 million.
Revenue Recognition: The Company recognizes revenue from the sale of
hardware and software systems, from the delivery of maintenance and other
customer services associated with installed systems and from the provision of
its enhanced telecommunications services and IVR applications on an ASP (managed
service) basis. The Company's policies for revenue recognition follow the
guidance in Statement of Position No. 97-2 "Software Revenue Recognition," as
amended (SOP 97-2), and SEC Staff Accounting Bulletin No. 101 (SAB 101). The
Company adopted SAB 101 effective March 1, 2000. See Note D -- Change in
Accounting Principle for Revenue Recognition which describes the impact of that
change on the fiscal 2001 operating results. If contracts include multiple
elements, each element of the arrangement is separately identified and accounted
for based on the relative fair value of such element. Revenue is not recognized
on any element of the arrangement if undelivered elements are essential to the
functionality of the delivered elements.
Sale of Hardware and Software Systems: Many of the Company's sales are of
customized software or customized hardware/software systems. Such systems
incorporate newly designed software and/or standard building blocks of hardware
and software which have been significantly modified, configured and assembled to
match unique customer requirements defined at the beginning of each project.
Sales of these customized systems are accounted for using contract accounting
principles under either the percentage of completion (POC) or completed contract
methodology as further described below. In other instances, particularly in
situations where the Company sells to distributors or where the Company is
supplying only additional product capacity (i.e., similar hardware and software
systems to what is already in place) for an existing customer, the Company may
sell systems that do not require significant customization. In those situations,
revenue is recognized when there is persuasive evidence that an arrangement
exists, delivery has occurred, the fee is fixed or determinable, and
collectibility is probable. Typically, this is at shipment when there is no
installation obligation or at the completion of minor post-shipment installation
obligations.
Generally, the Company uses POC accounting for its more complex custom
systems. In determining whether a particular sale qualifies for POC treatment,
the Company considers multiple factors including the value of the contract, the
anticipated duration of the contract performance period, and the degree of
customization inherent in the project. Projects normally must have an aggregate
value of more than $500,000 to qualify for POC treatment. For a project
accounted for under the POC method, the Company recognizes revenue as work
progresses over the life of the project based on a comparison of actual labor
inputs (labor
45
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
hours worked) to current estimates of total labor inputs required to complete
the project. Project estimates are reviewed and updated on a quarterly basis.
Unbilled receivables accrued under this POC methodology totaled $4.9 million
(19.0% of total net receivables) and $17.8 million (43.6% of total net
receivables) at February 28, 2003 and 2002, respectively. The Company expects to
bill and collect unbilled receivables as of February 28, 2003 within the next
twelve months.
The terms of most POC projects require customers to make interim progress
payments during the course of the project based on the Company's completion of
contractually defined milestones. Such payments and a written customer
acknowledgement at the completion of the project, usually following a final
customer test phase, document the customer's acceptance of the project. In some
circumstances, the passage of a contractually defined time period or the
customer's use of the system in a live operating environment may also constitute
final acceptance of a project.
The Company uses completed contract accounting for smaller custom projects
not meeting the POC thresholds described above. The Company also uses completed
contract accounting in situations where the technical requirements of a project
are so complex or are so dependent on the development of new technologies or the
unique application of existing technologies that the Company's ability to make
reasonable estimates is in doubt or where a sale is subject to unusual "inherent
hazards" that make the Company's estimates doubtful. Such hazards are unrelated
to, or only incidentally related to, the Company's typical activities and
include situations where the enforceability of a contract is suspect, completion
of the contract is subject to pending litigation, or where the systems produced
are subject to condemnation or expropriation risks. These latter situations are
extremely rare. For all completed contract sales, the Company recognizes revenue
upon customer acceptance as evidenced by a written customer acknowledgement, the
passage of a contractually defined time period or the customer's use of the
system in a live operating environment.
The Company generates a significant percentage of its sales, particularly
sales of enhanced telecommunications services systems, outside the United
States. Customers in certain countries are subject to significant economic and
political challenges that affect their cash flow, and many customers outside the
United States are generally accustomed to vendor financing in the form of
extended payment terms. To remain competitive in markets outside the United
States, the Company may offer selected customers such payment terms. In all
cases, however, the Company only recognizes revenue at such time as its system
or service fee is fixed or determinable, collectibility is probable and all
other criteria for revenue recognition have been met. In some limited cases,
this policy may result in the Company recognizing revenue on a "cash basis",
limiting revenue recognition on certain sales of systems and/or services to the
actual cash received to date from the customer, provided that all other revenue
recognition criteria have been satisfied.
Sale of Maintenance and Other Customer Services: The Company recognizes
revenue from maintenance and other customer services when the services are
performed or ratably over the related contract period. All significant costs and
expenses associated with maintenance contracts are expensed as incurred. This
approximates a ratable recognition of expenses over the contract period.
Sale of Managed Services: The Company can provide enhanced communications
solutions to customers on an outsourced basis through its ASP (managed service)
business. While specific arrangements can vary, the Company generally builds a
customized computer system to address a specific customer's business need and
then owns, monitors, and maintains that system, ensuring that it processes the
customer's business transactions in accordance with defined specifications. For
its services, the Company generally receives a one-time setup fee paid at the
beginning of the contract and a service fee paid monthly over the life of the
contract. Most contracts range from 12 to 36 months in length.
The Company combines the setup fee and the total service fee to be received
from the customer and recognizes revenue ratably over the term of the ASP
contract. The Company capitalizes the cost of the computer system(s) used to
provide the service and depreciates such systems over the contract life (for
assets
46
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
unique to the individual contract) or the life of the equipment (for assets
common to the general managed service operations). All labor and other period
costs required to provide the service are expensed as incurred.
Loss Contracts: The Company updates its estimates of the costs necessary
to complete all customer contracts in process on a quarterly basis. Whenever
current estimates indicate that the Company will incur a loss on the completion
of a contract, the Company immediately records a provision for such loss as part
of the current period cost of goods sold.
Research and Development: Research and development costs are expensed as
incurred.
Advertising Costs: Advertising costs are expensed as incurred. Advertising
expense was $1.2 million in fiscal 2003, $1.4 million in fiscal 2002 and $1.5
million in fiscal 2001.
Income Taxes: Deferred income taxes are recognized using the liability
method and reflect the tax impact of temporary differences between the amounts
of assets and liabilities for financial reporting purposes and such amounts as
measured by tax laws and regulations. The Company provides a valuation allowance
for deferred tax assets in circumstances where it does not consider realization
of such assets to be more likely than not.
Stock Compensation: The Company accounts for its stock-based employee
compensation using the intrinsic value method as defined in Accounting
Principles Board Statement No. 25 (APB 25). Under this approach, the Company
recognizes expense at the grant date of an option only to the extent that the
exercise price of the option exceeds the fair value of the related common stock
at the grant date. In practice, the Company typically grants options at an
exercise price equal to the fair value of the stock on the grant date, and,
accordingly, the Company typically does not recognize any expense upon the
granting of an option. Because the Company has elected this treatment, Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation", ("SFAS No. 123") and Statement of Financial Accounting Standards
No. 148, "Accounting for Stock-Based Compensation -- Transition and Disclosure"
(SFAS No. 148) require disclosure of pro forma information which provides the
effects on net income (loss) and net income (loss) per share as if the Company
had accounted for its employee stock awards under the fair value method
prescribed by SFAS 123. Because options vest over several years and additional
option grants may occur in the future, however, the pro forma effects of
employee stock options accounted for under SFAS 123 are not likely to be
representative of the effects that may be derived from similar future
calculations.
The fair value of the Company's employee stock awards was estimated using a
Black-Scholes option pricing model with the following weighted-average
assumptions for fiscal 2003, 2002 and 2001, respectively: risk-free interest
rates of 2.95%, 3.71% and 6.37%; stock price volatility factors of 1.11, 0.96
and 1.06; and expected option lives of 2.73 years. The Company does not have a
history of paying dividends, and none have been assumed in estimating the fair
value of the options. The weighted-average fair value per share of options
granted in fiscal 2003, 2002 and 2001 was $1.95, $7.44 and $5.02, respectively.
A reconciliation of the Company's actual net loss and net loss per diluted
common share to its pro forma net loss and net loss per
47
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
diluted common share using the fair value method of accounting for stock options
for fiscal 2003, 2002 and 2001 is as follows (in millions, except per share
data):
2003 2002 2001
------ ------ ------
Net loss as reported........................................ $(66.4) $(44.7) $ (2.3)
Add: stock-based employee compensation expense included in
reported net income, net of related tax effect............ -- -- --
Deduct: total stock-based employee compensation expense
determined under fair value method, net of related tax
effect.................................................... (2.5) (5.9) (7.0)
------ ------ ------
Pro forma net loss.......................................... $(68.9) $(50.6) $ (9.3)
====== ====== ======
Loss per share:
Basic -- as reported...................................... $(1.95) $(1.34) $(0.07)
Basic -- pro forma........................................ $(2.02) $(1.51) $(0.27)
Diluted -- as reported.................................... $(1.95) $(1.34) $(0.07)
Diluted -- pro forma...................................... $(2.02) $(1.51) $(0.27)
NOTE C -- CHANGE IN ACCOUNTING PRINCIPLE FOR GOODWILL AND OTHER INTANGIBLE
ASSETS
Effective March 1, 2002, the Company adopted Statements of Financial
Accounting Standards No. 141, Business Combinations, and No. 142, Goodwill and
Other Intangible Assets (the "Statements"). Statement No. 141 refines the
definition of what assets may be considered as separately identified intangible
assets apart from goodwill. Statement No. 142 provides that goodwill and
intangible assets deemed to have indefinite lives will no longer be amortized,
but will be subject to impairment tests on at least an annual basis.
In adopting the Statements, the Company first reclassified $2.7 million of
intangible assets associated with its assembled workforce (net of related
deferred taxes of $1.4 million) to goodwill because such assets did not meet the
new criteria for separate identification. The Company then allocated its
adjusted goodwill balance of $19.2 million to its then existing Enterprise and
Networks divisions and completed the transitional impairment tests required by
Statement No. 142. The fair values of the reporting units were estimated using a
combination of the expected present values of future cash flows and an
assessment of comparable market values. As a result of these tests, the Company
determined that the goodwill associated with its Networks division was fully
impaired, and, accordingly, it recognized a non-cash, goodwill impairment charge
of $15.8 million as the cumulative effect on prior years of this change in
accounting principle. This impairment resulted primarily from the significant
decline in Networks sales and profitability during the fourth quarter of fiscal
2002 and related reduced forecasts for the division's sales and profitability.
Effective August 1, 2002, the Company combined its divisions into a single
integrated organizational structure in order to address changing market demands
and global customer requirements. The Company conducted its required annual test
of goodwill impairment during the fourth quarter of fiscal 2003. No additional
impairment of goodwill was indicated.
48
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The changes in the carrying amount of goodwill for the years ended February
28, 2003 and 2002 are as follows (in millions):
2003 2002
----- -----
Balance at beginning of year, net........................... $16.5 $22.8
Amortization................................................ -- (2.6)
Impairment charge........................................... -- (3.7)
Reclassification of assembled workforce, net of deferred
income taxes, upon adoption of SFAS No. 141............... 2.7 --
Transitional impairment loss upon adoption of SFAS No.
142....................................................... (15.8) --
----- -----
Balance at end of year...................................... $ 3.4 $16.5
===== =====
As required by SFAS No. 142, the following table of proforma net income (in
millions) and earnings per share presents summary results for fiscal 2003,
fiscal 2002 and fiscal 2001 adjusted to exclude amortization expense related to
goodwill and intangible assets that are no longer being amortized as a result of
the Company's adoption of SFAS No. 141 and 142.
FOR THE YEAR ENDED FEBRUARY 28
------------------------------
2003 2002 2001
-------- -------- --------
Reported net loss........................................... $(66.4) $(44.7) $ (2.3)
Add back goodwill amortization.............................. -- 2.6 2.9
Add back assembled workforce amortization................... -- 1.8 1.2
------ ------ ------
Adjusted net income (loss).................................. $(66.4) $(40.3) $ 1.8
====== ====== ======
Basic earnings per share:
Reported net loss........................................... $(1.95) $(1.34) $(0.07)
Add back goodwill amortization.............................. -- 0.08 0.09
Add back assembled workforce amortization................... -- 0.06 0.04
------ ------ ------
Adjusted net income (loss).................................. $(1.95) $(1.21) $ 0.05
====== ====== ======
Diluted earnings per share:
Reported net loss........................................... $(1.95) $(1.34) $(0.07)
Add back goodwill amortization.............................. -- 0.08 0.08
Add back assembled workforce amortization................... -- 0.06 0.03
------ ------ ------
Adjusted net income (loss).................................. $(1.95) $(1.21) $ 0.05
====== ====== ======
If the Company had not been required to adopt the Statements effective
March 1, 2002, the Company would not have recognized the cumulative effect on
prior years of a change in accounting principle of $15.8 million but would have
recognized approximately $4.1 million in additional amortization relating to
goodwill and other intangible assets. In such circumstances, the Company's net
loss for the year ended February 28, 2003 would have been approximately $54.7
million, or $1.61 per share.
49
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Intangible assets other than goodwill at February 28, 2003 and 2002 are
comprised of the following (in millions):
FEBRUARY 28, 2003
-------------------------------------
GROSS
AMORTIZATION CARRYING ACCUMULATED UNAMORTIZED
AMORTIZED INTANGIBLE ASSETS PERIOD AMOUNT AMORTIZATION BALANCE
--------------------------- ------------ -------- ------------ -----------
Customer relations.............................. 10 years $18.6 $12.3 $6.3
Developed technology............................ 5 years 20.2 17.9 2.3
Other intangibles............................... 5-12 years 2.7 2.0 0.7
----- ----- ----
Total......................................... $41.5 $32.2 $9.3
===== ===== ====
FEBRUARY 28, 2002
-------------------------------------
GROSS
AMORTIZATION CARRYING ACCUMULATED UNAMORTIZED
AMORTIZED INTANGIBLE ASSETS PERIOD AMOUNT AMORTIZATION BALANCE
--------------------------- ------------ -------- ------------ -----------
Customer relations.............................. 10 years $32.8 $ 9.0 $23.8
Developed technology............................ 5 years 22.7 14.1 8.6
Assembled workforce............................. 5 years 9.2 5.1 4.1
Other intangibles............................... 5-12 years 2.7 1.8 0.9
----- ----- -----
Total......................................... $67.4 $30.0 $37.4
===== ===== =====
The estimated amortization expense attributable to these intangible assets
for each of the next five years and thereafter is as follows (in millions):
Fiscal 2004................................................. $3.0
Fiscal 2005................................................. $1.6
Fiscal 2006................................................. $1.2
Fiscal 2007................................................. $1.1
Fiscal 2008................................................. $1.1
Thereafter.................................................. $1.3
During fiscal 2003, the Company was adversely affected by continuing
softness in the general US economy, by extreme softness in the worldwide
network/telecommunications market and by political tensions in parts of South
America and the Middle East. The Company experienced a second year of declining
network revenue and significantly reduced its estimates of near term growth in
revenue and net income for its networks based products. As a result, the Company
determined that a triggering event, as defined in SFAS No. 144, had occurred
during the fourth quarter of fiscal 2003 and, accordingly, the Company evaluated
its intangible assets for evidence of impairment. Based on the results of its
review, the Company recognized impairment charges of $14.2 million and $2.5
million, respectively, to reduce the carrying value of its customer relations
and developed technology intangible assets to their respective fair values,
which were based on estimated discounted future cash flows.
During the fourth quarter of fiscal 2002, the Company performed a
comprehensive review of the positioning of all product lines, including lines
brought forward from its fiscal 2000 merger with Brite. As a result of decisions
made during that review, the Company performed impairment tests in accordance
with its stated policies on the Brite tradename and on certain of the developed
technology associated with the Brite acquisition. Based on these tests, the
Company recorded impairment charges of $4.8 million and $3.2 million,
50
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
respectively, to reduce the carrying value of these intangible assets and an
additional charge of $3.7 million to reduce the carrying value of goodwill
associated with the impaired assets.
On September 15, 1998, the Company purchased a computer telephony software
suite from Dronen Consulting, Incorporated for $3.5 million in cash and 75,000
shares of the Company's stock valued at $1.5 million. The transaction was
accounted for as an asset purchase. The full purchase price of $5.0 million was
being amortized over the software suite's estimated useful life of five years.
In fiscal 2001, the remaining book value of approximately $2.9 million was
written off to cost of goods sold as a result of the Company's decision to
discontinue its AgentConnect product.
NOTE D -- CHANGE IN ACCOUNTING PRINCIPLE FOR REVENUE RECOGNITION
Effective March 1, 2000, the Company changed its method of accounting for
revenue recognition in accordance with Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements." For systems that do not require
customization to be performed by the Company, revenue is now recognized when
there is persuasive evidence that an arrangement exists, when the related
hardware and software are delivered and any installation or other post-delivery
obligation has been fulfilled, when the fee is fixed or determinable and when
collection is probable. Prior to the adoption of SAB 101, although the Company's
contracts often included installation and customer acceptance provisions,
revenue generally was recognized at the time of shipment based on the Company's
belief that no significant uncertainties about customer acceptance existed.
For systems that require significant customization and where the completed
contract method of accounting is applicable, the Company now recognizes revenue
upon customer acceptance. Prior to the implementation of SAB 101, the Company
recognized revenue on these systems upon completion of installation and testing
but prior to customer acceptance. The Company's accounting for its complex,
customized systems sales using the percentage of completion methodology and for
its revenues from services was not affected by its adoption of SAB 101.
The cumulative effect of the change on prior years (which principally
relates to changes relating to customer acceptance provisions) resulted in a
charge to operations of $11.9 million (after reduction for income taxes of $6.4
million) which is included in results of operations for fiscal 2001. During
fiscal 2001, the Company recognized $22.4 million in revenue whose contribution
to income is included in the cumulative effect adjustment as of March 1, 2000.
NOTE E -- INVENTORY
Inventory at February 28 consists of the following (in millions):
2003 2002
---- -----
Purchased parts............................................. $5.0 $19.2
Work in progress............................................ 3.9 8.3
---- -----
$8.9 $27.5
==== =====
The Company recorded approximately $4.1 million and $10.9 million in
special charges during fiscal 2003 and fiscal 2002, respectively, to reduce the
carrying value of inventories. See Note K.
51
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE F -- ACCRUED EXPENSES
Accrued expenses consisted of the following at February 28 (in millions):
2003 2002
----- -----
Accrued compensation........................................ $ 1.8 $ 4.6
Other....................................................... 10.9 6.2
----- -----
$12.7 $10.8
===== =====
NOTE G -- LONG-TERM BORROWINGS
At February 28, 2003 and 2002, the Company's long-term debt was comprised
of the following (in millions)
FEBRUARY 28,
-------------
2003 2002
----- -----
Mortgage loan, bearing interest payable monthly at the
greater of 10.5% or the prime rate plus 2.0%; principal
due May 28, 2005.......................................... $10.5 $ --
Amortizing term loan, principal due in equal monthly
installments of approximately $0.3 million through July
2005 with final payments totaling approximately $0.6
million in August 2005; interest payable monthly, accruing
at a rate equal to the prime rate plus 2.75% (7.0% at
February 28, 2003)........................................ 8.6 --
Amortizing term loan, refinanced in full during fiscal
2003...................................................... -- 22.5
Revolving credit; repaid in full during the second quarter
of fiscal 2003; terminated by Company in August 2002 in
anticipation of subsequent refinancing.................... -- 7.5
----- -----
Total debt outstanding...................................... 19.1 30.0
Less: current portion....................................... (3.3) (6.0)
----- -----
Long-term debt, net of current portion...................... $15.8 $24.0
===== =====
RESTRUCTURING OF FISCAL 2002 DEBT
During fiscal 2003, the Company restructured its long-term debt that was
outstanding as of February 28, 2002. In connection with this restructuring, the
Company entered into the $14.0 million mortgage loan described below, issued $10
million in convertible notes (subsequently repaid in full) and related warrants
as further described below and, using proceeds from these new notes and
available cash, repaid in full all amounts then outstanding under the prior debt
agreements. Subsequently during fiscal 2003, the Company entered into a new term
loan and revolving credit agreement, described below, using the proceeds from
the new term loan to repay the convertible notes and related accrued interest
and early termination premiums.
MORTGAGE LOAN
In May 2002, the Company entered into a $14.0 million mortgage loan secured
by a first lien on the Company's Dallas headquarters. Proceeds from the loan
were used to partially repay amounts outstanding under the amortizing term loan
that existed at the time. In October 2002 and February 2003, the Company amended
the mortgage loan to modify a minimum net equity covenant contained in the loan
agreement. Under the amended loan, the Company must have at least $5.0 million
in net equity at the end of each of its fiscal quarters beginning with the
quarter ending August 31, 2004. In connection with these amendments, the Company
prepaid $3.5 million of the original principal amount outstanding under the
loan. The mortgage loan contains cross-default provisions with respect to the
Company's new term loan and revolving credit agreement,
52
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
such that a default under the credit facility which leads to the acceleration of
amounts due under the facility and the enforcement of liens against the
mortgaged property also creates a default under the mortgage loan.
NEW TERM LOAN AND REVOLVING CREDIT AGREEMENT
In August 2002, the Company entered into a new credit facility agreement
with a lender which provided for an amortizing term loan of $10.0 million and a
revolving credit commitment equal to the lesser of $25.0 million minus the
principal outstanding under the term loan and the balance of any letters of
credit ($16.4 million maximum at February 28, 2003) or a defined borrowing base
comprised primarily of eligible U.S. and U.K. accounts receivable ($0.3 million
maximum at February 28, 2003). As noted above, proceeds from the term loan were
used to retire the convertible notes outstanding at the time the Company entered
into the credit facility and to provide additional working capital to the
Company.
Any advances under the revolver loan will accrue interest at the prime rate
plus a margin of 0.5% to 1.5%, or at the London Inter-bank Offering Rate plus a
margin of 3% to 4%. The Company may request an advance under the revolver loan
at any time during the term of the revolver agreement so long as the requested
advance does not exceed the then available borrowing base. The Company has not
requested an advance under the revolver as of the date of this filing. The term
loan and the revolving credit agreement expire on August 29, 2005.
The new credit facility contains terms, conditions and representations that
are generally customary for asset-based credit facilities, including
requirements that the Company comply with certain significant financial and
operating covenants. In particular, the Company is initially required to have
EBITDA in minimum cumulative amounts on a monthly basis through August 31, 2003.
While lower amounts are allowed within each fiscal quarter, the Company must
generate cumulative EBITDA of $5.0 million and $9.0 million, respectively, for
the nine and twelve month periods ending May 31, 2003 and August 31, 2003.
Thereafter, the Company is required to have minimum cumulative EBITDA of $15
million and $20 million for the 12-month periods ending November 30, 2003 and
February 29, 2004, respectively, and $25 million for the 12-month periods ending
each fiscal quarter thereafter. The Company is also required to maintain defined
levels of actual and projected service revenues and is prohibited from incurring
capital expenditures in excess of $4.0 million for any fiscal year beginning on
or after March 1, 2003 except in certain circumstances and with the lender's
prior approval.
Borrowings under the new credit facility are secured by first liens on
virtually all of the Company's personal property and by a subordinated lien on
the Company's Dallas headquarters. The new credit facility contains
cross-default provisions with respect to the Company's mortgage loan, such that
an event of default under the mortgage loan which allows the mortgage lender to
accelerate the mortgage loan or terminate the agreement creates a default under
the credit facility. As of February 28, 2003, the Company was in compliance with
all financial and operating covenants.
CONVERTIBLE NOTES, WARRANTS AND REGISTRATION REQUIREMENTS
On May 29, 2002, the Company entered into a securities purchase agreement,
by and among the Company and the buyers named therein, pursuant to which the
buyers agreed to purchase convertible notes in an aggregate principal amount of
$10.0 million, convertible into shares of the Company's common stock, and
warrants initially exercisable for an aggregate of 621,304 shares of the
Company's common stock at an exercise price of $4.0238 per share. The fair value
($1.1 million) of the warrants issued by the Company was recorded as a discount
on the convertible notes.
The securities purchase agreement obligated the Company to seek shareholder
approval of the potential issuance of common stock upon the conversion and
exercise, respectively, of the convertible notes and
53
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
warrants to the extent such issuance equals or exceeds 20% of the Company's
outstanding shares. The Company obtained such approval at its annual meeting in
August 2002.
AMORTIZATION AND REPAYMENT OF CONVERTIBLE NOTES
The convertible notes were scheduled to be repaid in monthly installments
of principal in the amount of $1.0 million, plus accrued interest on the
applicable installments at 6% per annum, commencing September 1, 2002. The terms
of the convertible notes allowed the Company, at its option, to make payment in
cash or, through a partial conversion of the convertible notes, through the
Company's issuance of common stock. The convertible notes also allowed the
Company, subject to certain conditions, to redeem some or all of the principal
amount of the convertible notes in excess of current monthly installments for a
cash amount equal to the sum of 105% of the principal amount being redeemed plus
accrued interest at 6% per annum with respect to the principal amount. In
September 2002, the Company made its first scheduled principal payment of $1.0
million under the convertible notes and then subsequently repaid the remaining
$9.0 million principal balance outstanding under the convertible notes along
with accrued interest and a repayment premium of approximately $0.5 million
using the proceeds of the new $10.0 million term loan discussed above.
WARRANTS
In connection with the sale of the convertible notes, the Company issued
warrants to the buyers. The warrants give the holders the right to purchase from
the Company, for a period of three years, an aggregate of 621,304 shares of the
Company's common stock for $4.0238 per share as of the date of issuance. Under
certain circumstances, this "purchase" may be accomplished through a cashless
exercise. Both the number of warrants and the exercise price of the warrants are
subject to antidilution adjustments as set forth in the warrants. If the Company
is prohibited from issuing warrant shares under the rules of the Nasdaq National
Market, the Company must redeem for cash those warrant shares which cannot be
issued at a price per warrant share equal to the difference between the weighted
average market price of the Company's common stock on the date of attempted
exercise and the applicable exercise price. The Company's obligations under the
warrants remain in force and are unaffected by the redemption in September 2002
of the convertible notes.
REGISTRATION REQUIREMENTS
The Company and the buyers also entered into a registration rights
agreement, dated as of May 29, 2002, pursuant to which the Company has filed a
registration statement on Form S-3 covering the resale of the warrant shares.
The registration statement became effective on June 27, 2002.
COSTS ASSOCIATED WITH THE REFINANCINGS
During fiscal 2003, the Company incurred a total of approximately $1.5
million in new debt issuance costs, consisting primarily of investment banking
and legal fees, to establish the new term loan and revolving credit agreement
and the mortgage loan. Such costs were capitalized and are being charged to
interest expense over the life of the related debt obligations. In connection
with the restructuring of its fiscal 2002 debt, the Company wrote off to
interest expense $0.4 million in unamortized debt issuance costs related to the
retired term loan and incurred approximately $1.2 million in new debt issuance
costs associated with the convertible notes and warrants. During the third
quarter of fiscal 2003, the Company recognized a loss of approximately $1.9
million on the early extinguishment of the convertible notes. The loss includes
the cost of the early conversion premium discussed above as well as the non-cash
costs to write off the unamortized debt issuance costs and unamortized discount
associated with the convertible notes. In accordance with the early adoption
provisions of recently issued Statement of Financial Accounting Standards No.
145 ("SFAS 145") governing the classification of gains and losses on the early
extinguishment of debt, the Company has presented the loss on the early
extinguishment of its convertible notes as an element of other operating
expenses in its
54
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
consolidated statement of operations. Prior to the enactment of SFAS 145, this
loss would have been reflected, net of tax, as an extraordinary item.
USE OF INTEREST RATE SWAP ARRANGEMENTS
From July 1999 through October 2001, the Company used interest rate swap
arrangements to hedge the variability of interest payments on its variable rate
credit facilities. While in effect, the swap arrangements essentially converted
the Company's then outstanding floating rate debt to a fixed rate basis. The
Company terminated its swap arrangements in October 2001 in response to the
continued downward movement in interest rates during fiscal 2002 and had no
derivative contracts in place as of February 28, 2003 and 2002.
NOTE H -- INCOME TAXES
Income (loss) before income taxes and the cumulative effect of a change in
accounting principle attributable to domestic and foreign operations was
approximately $(51.7) million and $0.4 million, respectively, in fiscal 2003,
$(56.9) million and $1.8 million, respectively, in fiscal 2002, and
approximately $(12.7) million and $27.3 million, respectively, in fiscal 2001.
Details of the income tax provision (benefit) attributable to income (loss)
before income taxes and the cumulative effect of a change in accounting
principle are as follows (in millions):
2003 2002 2001
----- ------ -----
INCOME TAX PROVISION (BENEFIT):
Current:
Federal................................................ $(2.3) $ 4.4 $(5.0)
State.................................................. -- 0.3 0.6
Foreign................................................ (0.7) 1.8 8.6
----- ------ -----
Total current........................................ (3.0) 6.5 4.2
----- ------ -----
Deferred:
Federal................................................ 1.4 (12.8) 0.9
State.................................................. -- (3.4) --
Foreign................................................ 0.8 (0.7) --
----- ------ -----
Total deferred....................................... 2.2 (16.9) 0.9
----- ------ -----
$(0.8) $(10.4) $ 5.1
===== ====== =====
55
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A reconciliation of the Company's income taxes (benefit) with the United
States federal statutory rate is as follows (in millions):
2003 2002 2001
------ ------ ----
Federal income taxes (benefit) at statutory rates........... $(18.0) $(19.3) $5.1
Operating losses and credit carryforwards not benefited..... 18.1 7.7 --
Change in US federal tax law, net of related IRS audit
issues.................................................... (3.0) -- --
Change in valuation allowance............................... 2.2 -- --
Goodwill amortization and impairment........................ -- 2.2 1.0
Effect of non-US rates...................................... -- 0.5 (1.0)
Research and development tax credit......................... -- -- (1.0)
State taxes, net of federal effect.......................... -- -- 0.7
Other....................................................... (0.1) (1.5) 0.3
------ ------ ----
$ (0.8) $(10.4) $5.1
====== ====== ====
Income taxes (refunds), net, of $(7.9) million, $4.1 million and $(6.9)
million were paid (received) in fiscal 2003, 2002 and 2001, respectively.
On March 7, 2002, United States tax law was amended to allow companies
which incurred net operating losses in 2001 and 2002 to carry such losses back a
maximum of five years instead of the maximum of two years previously allowed. As
a result of this change, during the first quarter of fiscal 2003, the Company
used $21.5 million of its previously reported net operating loss carryforwards
and $0.4 million of its previously reported tax credit carryforwards and
recognized a one-time tax benefit of $7.9 million, of which $2.2 million was
recognized as additional capital associated with previous stock option
exercises.
The Company's federal income tax returns for its fiscal years 2000 and 2001
are currently being audited by the Internal Revenue Service. The Company has
tentatively agreed to proposed adjustments from the IRS challenging certain
positions taken by the Company on those returns. Although resolution of the
issues is still subject to final review by the Joint Committee on Taxation, it
is probable that as a result of these proposed adjustments, the Company will
lose the ability to carry back approximately $5.4 million in net operating
losses generated in fiscal 2001. If this occurs, the Company will be required to
repay up to $2.0 million of refunds previously received from the IRS plus
accrued interest. The Company has recorded a charge for these probable
adjustments as part of its net tax provision (benefit) for fiscal 2003. The
Company expects final resolution of the issue and cash settlement with the IRS
to occur during the first half of fiscal 2004. Any net operating losses which
ultimately cannot be carried back to prior years under the settlement with the
IRS may be carried forward to future years.
56
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Deferred taxes result from the effect of transactions which are recognized
in different periods for financial and tax reporting purposes. Significant
components of the Company's deferred tax assets and liabilities are as follows
at February 28 (in millions):
2003 2002
----- ------
DEFERRED TAX ASSETS:
Net operating loss carryforwards.......................... $15.8 $ 9.7
Tax credit carryforwards.................................. 5.6 5.0
Inventory................................................. 2.4 4.5
Accrued expenses.......................................... 2.8 4.3
Deferred revenue.......................................... 1.0 --
Allowance for doubtful accounts........................... 0.7 1.0
Depreciation and amortization............................. 2.3 1.0
Other items............................................... 2.3 2.6
----- ------
Total deferred tax assets.............................. 32.9 28.1
Valuation allowance....................................... (29.3) (14.3)
----- ------
Net deferred tax assets................................ 3.6 13.8
----- ------
DEFERRED TAX LIABILITIES:
Acquisition-related identified intangibles................ (3.0) (12.8)
Other items............................................... (0.6) (0.2)
----- ------
Total deferred tax liabilities......................... (3.6) (13.0)
----- ------
Net deferred tax assets................................ $ -- $ 0.8
===== ======
At February 28, 2003, the Company had U.S. net operating loss carryforwards
totaling $45.0 million, including $13.7 million which will expire in 2022 and
$31.3 million which will expire in 2023. The Company also had $4.3 million and
$1.3 million in research and development and foreign tax credit carryforwards,
respectively, at February 28, 2003. If unused, the R&D tax credit carryforwards
will begin to expire in 2019, and the foreign tax credit carryforwards will
begin to expire in 2005.
The Company has established a valuation allowance of $29.3 million against
its net deferred tax assets, including the carryforwards described above. The
Company believes the existence of losses in its U.S. operations and the
dependency of its international subsidiaries on continuing U.S. operations
prevent it from concluding that it is more likely than not that its deferred tax
assets will be realized. If some or all of such reserved deferred tax assets are
ultimately realized, approximately $1.8 million of the valuation allowance
reversal related to stock option deductions will not provide future benefit to
income but rather will be credited to additional capital.
In fiscal 2002, the Company did not provide a valuation allowance for
deferred assets associated with its foreign subsidiaries. In providing such a
reserve during fiscal 2003, the Company recognized tax expense totaling $0.8
million to increase the valuation allowance for net foreign deferred tax assets
that existed at February 28, 2002. During fiscal 2003, and as further discussed
in Note C, the Company reduced its deferred tax liabilities by $1.4 million in
connection with the reclassification of its assembled workforce intangible asset
to goodwill. As a result of this transaction, the Company increased the
valuation allowance associated with its U.S. net deferred tax asset by $1.4
million.
57
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE I -- STOCKHOLDERS' EQUITY
The Company has five plans under which options may be issued to employees
and/or non-employee members of the Company's Board of Directors. As of February
28, 2003, 6,631,881 shares of common stock were reserved for future issuance
under all option plans as follows:
SHARES AVAILABLE FOR
-----------------------------
OUTSTANDING FUTURE STOCK
PLAN NAME STOCK OPTIONS OPTION GRANTS
--------- ------------- -------------
1990 Employee Stock Option Plan............................ 1,613,960 --
1990 Non-Employee Option Plan.............................. 76,000 --
1998 Employee Non-Qualified Plan........................... 407,500 85,919
1999 Non-Qualified Plan.................................... 3,413,546 408,231
Employee Stock Purchase Plan............................... 498,369 128,356
--------- -------
Total.................................................... 6,009,375 622,506
========= =======
Options outstanding at February 28, 2003 are summarized as follows:
WEIGHTED AVERAGE
REMAINING
WEIGHTED AVERAGE CONTRACTUAL LIFE
EXERCISE PRICES SHARES EXERCISE PRICE IN YEARS
--------------- --------- ---------------- ----------------
$1.02 -- $4.88 1,948,479 $ 2.65 5.74
$5.00 -- $6.97 1,748,060 $ 5.84 6.50
$7.52 -- $34.41 2,312,836 $12.12 6.13
---------
6,009,375
=========
Options exercisable at February 28, 2003 are summarized as follows:
WEIGHTED AVERAGE
REMAINING
WEIGHTED AVERAGE CONTRACTUAL LIFE
EXERCISE PRICES SHARES EXERCISE PRICE IN YEARS
--------------- --------- ---------------- ----------------
$4.50 -- $5.15 1,149,435 $ 4.92 4.67
$6.06 -- $9.73 1,265,845 $ 7.20 7.20
$10.38 -- $34.41 1,514,208 $13.18 5.42
---------
3,929,488
=========
58
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1990 EMPLOYEE STOCK OPTION PLAN
A stock option plan is in effect under which shares of common stock were
authorized for issuance by the Compensation Committee of the Board of Directors
as stock options to key employees. Option prices per share are the fair market
value per share of stock, based on the closing per share price on the date of
grant. The Company has granted options at various dates with terms under which
the options generally become exercisable at the rate of 20%, 25% or 33% per
year. Options becoming exercisable at 33% per year expire six or ten years after
the date of grant. Options becoming exercisable at 20% or 25% per year expire
ten years after the date of grant.
WEIGHTED AVERAGE
EXERCISE PRICE
SHARES PER SHARE
--------- ----------------
Balance at February 29, 2000.............................. 2,207,765 $6.31
Granted................................................. 253,000 7.41
Exercised............................................... (391,492) 4.97
Forfeited............................................... (145,971) 5.17
--------- -----
Balance at February 28, 2001.............................. 1,923,302 $6.82
Granted................................................. -- --
Exercised............................................... (229,184) 5.05
Forfeited............................................... (22,234) 6.65
--------- -----
Balance at February 28, 2002.............................. 1,671,884 $7.06
Granted................................................. -- --
Exercised............................................... (14,286) 4.92
Forfeited............................................... (43,638) 4.92
--------- -----
Balance at February 28, 2003.............................. 1,613,960 $7.14
========= =====
Options for a total of 1,613,960 shares were exercisable at an average
price of $7.14 at February 28, 2003.
1990 NON-EMPLOYEE OPTION PLAN
Under the 1990 non-employee stock option plan, nonqualified stock options
were issued to non-employee members of the Company's Board of Directors in
accordance with a formula prescribed by the plan. Option prices per share are
the fair market value per share based on the closing per share price on the date
of grant. Each option became exercisable within the period specified in the
optionee's agreement and is exercisable for 10 years from the date of grant.
WEIGHTED AVERAGE
EXERCISE PRICE
SHARES PER SHARE
------ ----------------
Balance at February 29, 2000................................ 92,000 $7.08
Exercised................................................. (8,000) 4.25
------ -----
Balance at February 28, 2001................................ 84,000 $7.35
Granted................................................... -- --
Exercised................................................. (8,000) 6.97
------ -----
Balance at February 28, 2002................................ 76,000 $7.39
Granted................................................... -- --
Exercised................................................. -- --
------ -----
Balance at February 28, 2003................................ 76,000 $7.39
====== =====
Options for a total of 76,000 shares were exercisable at an average price
of $7.39 at February 28, 2003.
59
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1998 EMPLOYEE NON-QUALIFIED PLAN
During fiscal 1999, the Company adopted a stock option plan under which
shares of common stock may be authorized for issuance by the Compensation
Committee of the Board of Directors as non-qualified stock options to key
employees. Option prices per share are the fair market value per share of stock
based on the average of the high and low price per share on the date of grant.
The Company has granted options at various dates with terms under which the
options become exercisable at a rate of 25% or 33% per year and are exercisable
for a period of ten years after the date of grant.
WEIGHTED
AVERAGE EXERCISE
SHARES PRICE PER SHARE
-------- ----------------
Balance at February 29, 2000............................... 844,924 $6.24
Granted.................................................. -- --
Exercised................................................ (60,418) 4.98
Forfeited................................................ (67,501) 6.53
-------- -----
Balance at February 28, 2001............................... 717,005 $6.47
Granted.................................................. -- --
Exercised................................................ (328,671) 7.03
Forfeited................................................ (12,916) 9.27
-------- -----
Balance at February 28, 2002............................... 375,418 $5.83
Granted.................................................. 87,000 2.43
Exercised................................................ (3,750) 4.88
Forfeited................................................ (51,168) 8.87
-------- -----
Balance at February 28, 2003............................... 407,500 $4.73
======== =====
Options for a total of 319,250 shares were exercisable at an average price
of $5.31 at February 28, 2003.
1999 NON-QUALIFIED PLAN
During fiscal 2000, the Company adopted a stock option plan under which
shares of common stock may be authorized for issuance by the Compensation
Committee of the Board of Directors as non-qualified stock options to key
employees and non-employee members of the Company's Board of Directors. Option
prices per share are the fair market value per share of stock based on the
average of the high and low price per share on the date of grant. The Company
has granted options to employees at various dates with terms under which the
options become exercisable at a rate of 25% or 33% per year and are exercisable
for a period of ten years after the date of grant. In addition, the Company has
granted options to non-employee directors at various dates with terms under
which the options become exercisable within the period specified in the
optionee's agreement and are exercisable for a period of ten years from the date
of grant.
WEIGHTED AVERAGE
EXERCISE PRICE
SHARES PER SHARE
--------- ----------------
Balance at February 29, 2000.............................. 1,503,000 $14.88
Granted................................................. 2,458,000 7.92
Exercised............................................... (10,000) 6.88
Forfeited............................................... (541,063) 10.99
--------- ------
60
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
WEIGHTED AVERAGE
EXERCISE PRICE
SHARES PER SHARE
--------- ----------------
Balance at February 28, 2001.............................. 3,409,937 $10.50
Granted................................................. 259,000 11.47
Exercised............................................... (168,223) 8.27
Forfeited............................................... (317,398) 11.37
--------- ------
Balance at February 28, 2002.............................. 3,183,316 $10.62
Granted................................................. 907,750 1.86
Exercised............................................... -- --
Forfeited............................................... (677,520) 10.33
--------- ------
Balance at February 28, 2003.............................. 3,413,546 $ 8.35
========= ======
Options held by employees and non-employees for 1,860,278 and 60,000
shares, respectively, were exercisable at an average price of $10.90 at February
28, 2003.
EMPLOYEE STOCK PURCHASE PLAN
The Company has adopted an Employee Stock Purchase Plan under which an
aggregate of 1,500,000 shares of common stock may be issued. Options are granted
to eligible employees in accordance with a formula prescribed by the plan and
are exercised automatically at the end of a one-year payroll deduction period.
The payroll deduction periods begin either January 1 or July 1 and end on the
following December 31 and June 30, respectively. No grants were made for the
period beginning July 1, 2002 pending shareholder approval of an increase in
aggregate shares available for issuance under the plan. Such approval was given
at the annual meeting held August 28, 2002. Option prices are 85% of the lower
of the closing price per share of the Company's common stock on the option grant
date or the option exercise date.
WEIGHTED AVERAGE
EXERCISE PRICE
SHARES PER SHARE
-------- ----------------
Balance at February 29, 2000............................... 90,244 $15.50
Granted.................................................. 236,505 5.80
Exercised................................................ (62,213) 7.93
Forfeited................................................ (28,031) 7.12
-------- ------
Balance at February 28, 2001............................... 236,505 $ 5.80
Granted.................................................. 130,518 10.29
Exercised................................................ (194,455) 5.84
Forfeited................................................ (42,050) 5.62
-------- ------
Balance at February 28, 2002............................... 130,518 $10.29
Granted.................................................. 498,369 1.84
Exercised................................................ (63,885) 1.62
Forfeited................................................ (66,633) 1.69
-------- ------
Balance at February 28, 2003............................... 498,369 $ 1.84
======== ======
As of February 28, 2003, no options were exercisable under this plan.
61
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
RESTRICTED STOCK PLAN
During fiscal 1996, the Company adopted a Restricted Stock Plan under which
an aggregate of 1,000,000 shares may be issued. Shares issued to senior
executives are earned based on the achievement of certain targeted share prices
and the continued service of each executive for a two-year period after each
target is met. Shares are available for annual grants to other key executives as
a component of their annual bonuses on the achievement of targeted annual
earnings per share objectives and the completion of an additional two years of
service after the grant.
Activity related to restricted stock is as follows:
SENIOR
EXECUTIVE
PLAN
---------
Balance at February 29, 2000................................ 154,078
Forfeited................................................. (20,000)
Vested.................................................... (46,914)
-------
Balance at February 28, 2001................................ 87,164
Vested.................................................... (87,164)
-------
Balance at February 28, 2002................................ --
=======
Shares forfeited in fiscal 2001 had been granted at a weighted average
share price of $34.22. There was no activity during fiscal 2003 in the
Restricted Stock Plan. At February 28, 2003, 770,570 shares were reserved for
future restricted stock grants.
PREFERRED SHARE PURCHASE RIGHTS
One Preferred Share Purchase Right is attached to each outstanding share of
the Company's common stock. The rights will become exercisable upon the earlier
to occur of ten days after the first public announcement that a person or group
has acquired beneficial ownership of 20 percent or more, or ten days after a
person or group announces a tender offer that would result in beneficial
ownership of 20 percent or more, of the Company's outstanding common stock. At
such time as the rights become exercisable, each right will entitle its holder
to purchase one eight-hundredth of a share of Series A Preferred Stock for
$37.50, subject to adjustment. If the Company is acquired in a business
combination transaction while the rights are outstanding, each right will
entitle its holder to purchase for $37.50 common shares of the acquiring company
having a market value of $75. In addition, if a person or group acquires
beneficial ownership of 20 percent or more of the Company's outstanding common
stock, each right will entitle its holder (other than such person or members of
such group) to purchase, for $37.50, a number of shares of the Company's common
stock having a market value of $75. Furthermore, at any time after a person or
group acquires beneficial ownership of 20 percent or more (but less than 50
percent) of the Company's outstanding common stock, the Board of Directors may,
at its option, exchange part or all of the rights (other than rights held by the
acquiring person or group) for shares of the Company's common stock on a
one-for-one basis. At any time prior to the acquisition of such a 20 percent
position, the Company can redeem each right for $0.00125. The Board of Directors
is also authorized to reduce the 20 percent thresholds referred to above to not
less than 10 percent if, in its judgement, it is to the Company's benefit to do
so. The rights expire in May 2011.
SUBSEQUENT EVENT
Effective April 22, 2003, the Company granted options to employees to
purchase approximately 538,000 shares of common stock under its 1998 and 1999
Non-Qualified Plans at an option price of $1.88 per
62
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
share. The options become exercisable at a rate of 33% per year and are
exercisable for a period of ten years after the date of grant.
ACCUMULATED COMPREHENSIVE LOSS
Changes in accumulated comprehensive loss are as follows (in millions):
FOREIGN FAS 133
CURRENCY DERIVATIVE
TRANSLATION LIABILITY
ADJUSTMENTS ADJUSTMENTS TOTAL
----------- ----------- -----
Balance at February 29, 2000........................... $(0.9) $ -- $(0.9)
Foreign Currency Translation Adjustments............. (3.1) -- (3.1)
----- ----- -----
Balance at February 28, 2001........................... (4.0) -- (4.0)
Foreign Currency Translation Adjustments............. (1.7) -- (1.7)
Cumulative Effect of Adopting FAS 133, net of tax
effect of $0.3.................................... -- (0.4) (0.4)
Reclassification of derivative losses into earnings,
net of tax effect of $(0.1)....................... -- 0.2 0.2
----- ----- -----
Balance at February 28, 2002........................... $(5.7) $(0.2) $(5.9)
Foreign Currency Translation Adjustments............. 2.3 -- 2.3
Reclassification of derivative losses into earnings,
net of tax effect of $(0.1)....................... -- 0.2 0.2
----- ----- -----
Balance at February 28, 2003........................... $(3.4) $ -- $(3.4)
===== ===== =====
NOTE J -- LEASES
Rental expense, before the effect of special charges discussed in Note K,
was $2.5 million, $3.9 million and $3.6 million in fiscal 2003, 2002 and 2001,
respectively. Rental costs in all years generally related to office and
manufacturing facility leases. The lease agreements include purchase and renewal
provisions and require the company to pay taxes, insurance and maintenance
costs. At February 28, 2003, the Company's commitments for minimum rentals under
noncancelable operating leases were as follows (in millions):
FISCAL YEAR AMOUNT
----------- ------
2004........................................................ $3.2
2005........................................................ $2.8
2006........................................................ $2.4
2007........................................................ $1.3
2008........................................................ $0.8
Thereafter.................................................. $0.4
Of the total commitments under noncancelable operating leases, $1.9 million
has already been charged to expense as of February 28, 2003 in connection with
the fiscal 2003 and 2002 special charges described in Note K.
63
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE K -- SPECIAL CHARGES AND NON-RECURRING GAIN
FISCAL 2003
During fiscal 2003, the Company continued to implement actions designed to
lower cost and improve operational efficiency. It also reviewed its intangible
assets for evidence of impairment in light of changes in its business and
continued softness in the world-wide telecommunications networks markets. (See
Note C).
The following table summarizes the effect of the special charges on fiscal
2003 operations by financial statement category (in millions).
IMPAIRMENT
COST OF RESEARCH & OTHER OF
GOODS SOLD DEVELOPMENT SG&A EXPENSES INTANGIBLES TOTAL
---------- ----------- ---- -------- ----------- -----
Write down of intangible assets.... $ -- $ -- $-- $ -- $16.7 $16.7
Severance payments and related
benefits......................... 2.3 0.8 3.1 -- -- 6.2
Facilities closures................ 0.2 0.1 0.4 -- -- 0.7
Write down of excess inventories... 4.1 -- -- -- -- 4.1
Costs associated with loss
contracts........................ 4.7 -- -- -- -- 4.7
Loss on early extinguishment of
debt............................. -- -- -- 1.9 -- 1.9
----- ---- ---- ---- ----- -----
Total............................ $11.3 $0.9 $3.5 $1.9 $16.7 $34.3
===== ==== ==== ==== ===== =====
The severance and related costs recognized during fiscal 2003 relate to
three separate workforce reductions that affected a total of 273 employees. One
of the reductions was associated with the Company's consolidation of its
separate Enterprise and Networks divisions into a single, integrated
organizational structure. The charge also includes costs associated with the
resignation of the Networks division president during the first quarter of
fiscal 2003. Costs related to facilities closures include $0.4 million for the
closure of the Company's leased facility in Chicago, Illinois and $0.3 million
associated with the closure of a portion of the Company's leased facilities in
Manchester, United Kingdom. The downsizing of the leased space in Manchester
followed from the Company's decision to consolidate virtually all of its
manufacturing operations into its Dallas, Texas facilities. The inventory
adjustments reflect the Company's continued assessment of its inventory levels
in light of sales projections, the decision to eliminate the U.K. manufacturing
operation and the consolidation of the business units. The charges for loss
contracts reflect the costs incurred on two contracts which are expected to
result in net losses to the Company upon completion. The loss on early
extinguishment of debt includes $1.4 million in non-cash charges to write-off
unamortized debt discount and unamortized debt issue costs and $0.5 million in
prepayment premiums. As of February 28, 2003, approximately $0.4 of severance
and related costs remain unpaid. Unpaid amounts are expected to be paid in full
during fiscal 2004.
FISCAL 2002
During the fourth quarter of fiscal 2002, the Company performed a
comprehensive review of the positioning of its product lines, including lines
brought forward from its merger with Brite, reevaluated its physical plant
needs, and reviewed its aggregate staffing levels. Based on these reviews, the
Company took a number of strategic actions designed to lower costs and
streamline product offerings. As a result of these actions, the Company incurred
special charges of approximately $33.4 million, including $16.4 million for the
write down of intangible assets and inventories associated with discontinued
product lines, $6.5 million for the write down of excess inventories, $5.2
million for severance payments and related benefits, $4.2 million for facilities
closures, and $1.1 million relating to the write down of non-productive fixed
assets.
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INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes the effect of these special charges on
fiscal 2002 operations by financial statement category (in millions).
COST OF RESEARCH & IMPAIRMENT
GOODS SOLD DEVELOPMENT SG&A OF INTANGIBLES TOTAL
---------- ----------- ---- -------------- -----
Write down of intangible assets and
inventories associated with discontinued
product lines............................ $ 4.4 $ -- $0.3 $11.7 $16.4
Write down of excess inventories........... 6.5 -- -- -- 6.5
Severance payments and related benefits.... 2.2 0.8 2.2 -- 5.2
Facilities closures........................ -- -- 4.2 -- 4.2
Write down of non-productive fixed
assets................................... 0.3 0.7 0.1 -- 1.1
----- ---- ---- ----- -----
Total................................. $13.4 $1.5 $6.8 $11.7 $33.4
===== ==== ==== ===== =====
The $11.7 million write down of intangible assets reflects the impairment
of the Brite tradename, the impairment of certain IVR technology acquired as
part of the Brite acquisition and the impairment of related goodwill (See Note
C). The $4.4 million write down of inventories and $0.3 million charge to SG&A
relate to the Company's decision to discontinue sales of certain earlier
versions of its payment and messaging systems that run on a different hardware
platform than that used by the current versions of those systems. The additional
writedown of inventories totaling approximately $6.5 million relates to items
which the Company will continue to use in current sales situations but which,
given the slowdown in market demand, it held in excess quantities at year end.
As part of its fiscal 2002 initiatives, the Company announced plans to
forego expansion into existing leased space in Allen, Texas and to close its
Jacksonville, Florida and Wichita, Kansas locations. As a result of these
actions, the Company recorded charges of approximately $4.2 million, including
approximately $3.8 million accrued for future lease commitments and
approximately $0.4 million for accelerated depreciation expense arising from a
reassessment of the useful lives of certain related property and equipment. As
part of its overall facilities assessment, the Company also identified and wrote
off approximately $1.1 million of fixed assets no longer being used by the
Company. As of February 28, 2003, approximately $1.9 million of the accrued
lease costs remain unpaid. The Company completed the sale of its Wichita, Kansas
office building on May 31, 2002. The $2.0 million in gross proceeds was used to
pay down amounts outstanding under the Company's then outstanding revolving
credit facility.
The severance and related costs recognized in the fourth quarter of fiscal
2002 were associated with two workforce reductions that affected 198 employees.
As of February 28, 2003, approximately $0.1 million of the total severance and
related costs remained unpaid. Unpaid amounts are expected to be paid in full
during fiscal 2004.
FISCAL 2001
During the fourth quarter of fiscal 2001, the Company changed its
organizational structure and eliminated certain product offerings in order to
reduce costs and improve the Company's focus on its core competencies and
products. As a result of these actions, the Company incurred special charges of
approximately $8.2 million, including $3.6 million for severance and related
costs, $3.1 million for the write-off of assets associated with discontinued
product lines and $1.5 million for estimated customer accommodations related to
the discontinued product lines.
65
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes the effect of these special charges on
fiscal 2001 operations by financial statement category (in millions).
COST OF RESEARCH AND
GOODS SOLD DEVELOPMENT SG&A TOTAL
---------- ------------ ---- -----
Severance payments and related benefits................ $1.3 $0.4 $1.9 $3.6
Write down of assets associated with discontinued
product lines........................................ 3.1 -- -- 3.1
Customer accommodations associated with discontinued
product lines........................................ -- 1.5 1.5
---- ---- ---- ----
Total.................................................. $4.4 $0.4 $3.4 $8.2
==== ==== ==== ====
The severance and related costs were associated with a workforce adjustment
that affected approximately 130 employees and included the resignation of the
Company's President and Chief Operating Officer. During the third quarter of
fiscal 2002, the Company determined that it had settled its severance related
obligations for less than originally anticipated, and, accordingly, the Company
reversed the remaining accrual of $0.4 million, reducing selling, general and
administrative expenses.
The $3.1 million charge to write off assets is primarily attributable to
the Company's decision to discontinue its AgentConnect product line and includes
a $2.9 million charge for the impairment of unamortized purchased software
(included in other intangible assets) associated with this product. The $1.5
million charge for estimated customer accommodations is comprised primarily of
bad debts and customer settlements associated with the Company's decision to
discontinue the AgentConnect product line. This charge is reflected in selling,
general and administrative expenses. During fiscal 2002, the Company reached
settlements with its affected customers for amounts that were less than
originally anticipated. As a result, it reversed $0.5 million of the accrual,
reducing selling, general and administrative expenses in the third fiscal
quarter.
During the fourth quarter of fiscal 2001, the Company realized a gain of
$21.4 million upon the sale of shares of stock of SpeechWorks International,
Inc. acquired through the exercise of a warrant received in connection with a
1996 supply agreement between the Company and SpeechWorks. This gain is
reflected as other income in the accompanying Consolidated Statements of
Operations. In prior periods, the warrant had been assigned no value in the
Company's balance sheets because the warrant and the underlying shares were
unregistered securities, and significant uncertainties existed regarding the
Company's ability to monetize the warrant and the timing of any such
monetization.
SUBSEQUENT EVENT
During April 2003, the Company reduced its workforce by 56 positions. The
Company estimates that it will incur charges of approximately $1.4 million
during the first quarter of fiscal 2004 in connection with this action, with
approximately $0.6 million, $0.2 million, and $0.6 million impacting cost of
goods sold, research and development, and selling, general and administrative
expenses, respectively. The majority of such charges are expected to be paid
during the first half of fiscal 2004.
66
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE L -- EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share:
YEAR ENDED FEBRUARY 28
------------------------
2003 2002 2001
------ ------ ------
(IN MILLIONS, EXCEPT
PER SHARE DATA)
NUMERATOR:
Income (loss) before the cumulative effect of a change in
accounting principle...................................... $(50.6) $(44.7) $ 9.6
Cumulative effect on prior years of a change in accounting
principle................................................. (15.8) -- (11.9)
------ ------ ------
Net Loss.................................................... $(66.4) $(44.7) $ (2.3)
------ ------ ------
DENOMINATOR:
Denominator for basic earnings per share.................... 34.0 33.4 32.7
Effect of dilutive securities-employee stock options........ -- -- 1.6
------ ------ ------
Denominator for diluted earnings per share.................. 34.0 33.4 34.3
------ ------ ------
BASIC:
Income (loss) before the cumulative effect of a change in
accounting principle...................................... $(1.49) $(1.34) $ 0.29
Cumulative effect on prior years of a change in accounting
principle................................................. (0.46) -- (0.36)
------ ------ ------
Net Loss.................................................... $(1.95) $(1.34) $(0.07)
====== ====== ======
DILUTED:
Income (loss) before the cumulative effect of a change in
accounting principle...................................... $(1.49) $(1.34) $ 0.28
Cumulative effect on prior years of a change in accounting
principle................................................. (0.46) -- (0.35)
------ ------ ------
Net Loss.................................................... $(1.95) $(1.34) $(0.07)
====== ====== ======
Options to purchase 6,009,375, 5,437,136 and 6,370,749 shares of common
stock at average exercise prices of $7.23, $9.14 and $8.72, respectively, were
outstanding at February 28, 2003, February 28, 2002 and February 28, 2001,
respectively, but were not included in the computations of diluted earnings
(loss) per share because the effect would have been anti-dilutive to the
calculations. For fiscal 2003 and 2002, the anti-dilution is due to the loss for
the year. For fiscal 2001, the anti-dilution is due to options' exercise prices
which were greater than the average market prices of the common shares.
NOTE M -- OPERATING SEGMENT INFORMATION AND MAJOR CUSTOMERS
During fiscal 2003, the Company reorganized into a single, integrated
business unit. This action was taken as part of the Company's efforts to reduce
its operating costs and to focus its activities and resources on a streamlined
product line. The Company's Chief Operating Decision Maker assesses performance
and allocates resources on an enterprise wide basis. Therefore, no separately
reportable operating segments exist as of February 28, 2003.
67
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company sells systems and related services into the Enterprise and
Network markets. The Company's net sales by market for fiscal 2003, 2002 and
2001 were as follows (in millions):
2003 2002 2001
------ ------ ------
Enterprise Systems Sales................................... $ 52.4 $ 77.6 $ 95.8
Enterprise Services Sales.................................. 35.9 30.8 25.6
------ ------ ------
Enterprise Total Sales..................................... 88.3 108.4 121.4
------ ------ ------
Network Systems Sales...................................... 32.3 48.8 86.9
Network Services Sales..................................... 35.6 54.4 66.4
------ ------ ------
Network Total Sales........................................ 67.9 103.2 153.3
------ ------ ------
Total Company Systems Sales................................ 84.7 126.4 182.7
Total Company Services Sales............................... 71.5 85.2 92.0
------ ------ ------
Total Company Sales........................................ $156.2 $211.6 $274.7
====== ====== ======
GEOGRAPHIC OPERATIONS
Revenues are attributed to geographic locations based on locations of
customers. The Company's net sales by geographic area for fiscal years 2003,
2002 and 2001 were as follows (in millions):
REVENUES: 2003 2002 2001
--------- ------ ------ ------
(IN MILLIONS)
North America.............................................. $ 91.5 $118.8 $141.6
Central and South America.................................. 6.1 7.4 14.9
Pacific Rim................................................ 2.9 5.5 11.6
Europe, Middle East and Africa............................. 55.7 79.9 106.6
------ ------ ------
Total.................................................... $156.2 $211.6 $274.7
====== ====== ======
The Company's fixed assets by geographic location are as follows:
PROPERTY AND EQUIPMENT: 2003 2002
----------------------- ----- -----
(IN MILLIONS)
United States............................................... $17.8 $21.9
United Kingdom.............................................. 2.6 4.5
----- -----
$20.4 $26.4
===== =====
CONCENTRATION OF REVENUE
One customer, O2, formerly BT Cellnet, has purchased both systems and ASP
managed services from the Company. Such combined purchases accounted for 11%,
15% and 19% of the Company's total sales during fiscal 2003, 2002 and 2001,
respectively. Under the terms of its managed services contract with BT Cellnet
and at current exchange rates the Company will recognize revenues of $0.9
million per month through July 2003 and $0.7 million per month from August 2003
through July 2005. The amount received under the agreement may vary based on
future changes in the exchange rate between the dollar and the British pound.
There were no other customers accounting for 10% or more of the Company's sales
during the three years ended February 28, 2003.
68
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE N -- CONCENTRATIONS OF CREDIT RISK
The Company sells systems directly to end-users and distributors primarily
in the banking and financial, telecommunications, human resource, and healthcare
markets. Customers are dispersed across different geographic areas, primarily
North America and Europe. Credit is extended based on an evaluation of a
customer's financial condition, and a deposit is generally required. The Company
has made a provision for credit losses in these financial statements.
NOTE O -- EMPLOYEE BENEFIT PLAN
The Company sponsors an employee savings plan in the United States which
qualifies under section 401(k) of the Internal Revenue Code. All full time
employees who have completed three months of service are eligible to participate
in the plan. The Company matches 50% of employee contributions up to 6% of the
employee's eligible compensation. Company contributions totaled $1.1 million,
$1.3 million and $1.4 million in fiscal 2003, 2002 and 2001, respectively.
NOTE P -- CONTINGENCIES
INTELLECTUAL PROPERTY MATTERS
The Company provides its customers a qualified indemnity against the
infringement of third party intellectual property rights. From time to time
various owners of patents and copyrighted works send the Company or its
customers letters alleging that the Company's products do or might infringe upon
the owners' intellectual property rights, and/or suggesting that the Company or
its customers should negotiate a license or cross-license agreement with the
owner. The Company's policy is to never knowingly infringe upon any third
party's intellectual property rights. Accordingly, the Company forwards any such
allegation or licensing request to its outside legal counsel for their review
and opinion. The Company generally attempts to resolve any such matter by
informing the owner of its position concerning non-infringement or invalidity,
and/or, if appropriate, negotiating a license or cross-license agreement. Even
though the Company attempts to resolve these matters without litigation, it is
always possible that the owner of the patent or copyrighted works will institute
litigation. Owners of patent(s) and/or copyrighted work(s) have previously
instituted litigation against the Company alleging infringement of their
intellectual property rights, although no such litigation is currently pending
against the Company. The Company currently has a portfolio of 62 patents, and it
has applied for and will continue to apply for and receive a number of
additional patents to reflect its technological innovations. The Company
believes that its patent portfolio could allow it to assert counterclaims for
infringement against certain owners of intellectual property rights if those
owners were to sue the Company for infringement.
From time to time Ronald A. Katz Technology Licensing L.P. ("RAKTL") has
sent letters to certain customers of the Company suggesting that the customer
should negotiate a license agreement to cover the practice of certain patents
owned by RAKTL. In the letters, RAKTL has alleged that certain of its patents
pertain to certain enhanced services offered by network providers, including
prepaid card and wireless services and postpaid card services. RAKTL has further
alleged that certain of its patents pertain to certain call processing
applications, including applications for call centers that route calls using a
called party's DNIS identification number. As a result of the correspondence, an
increasing number of the Company's customers have had discussions, or are in
discussions, with RAKTL. Certain products offered by the Company can be
programmed and configured to provide enhanced services to network providers and
call processing applications for call centers. The Company's contracts with
customers usually include a qualified obligation to indemnify and defend
customers against claims that products as delivered by the Company infringe a
third party's patent.
None of the Company's customers have notified the Company that RAKTL has
claimed that any product provided by the Company infringes any claims of any
RAKTL patent. Accordingly, the Company has
69
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
not been required to defend any customers against a claim of infringement under
a RAKTL patent. The Company has, however, received letters from customers
notifying the Company of the efforts by RAKTL to license its patent portfolio
and reminding the Company of its potential obligations under the indemnification
provisions of the applicable agreements in the event that a claim is asserted.
In response to correspondence from RAKTL, a few customers have attempted to
tender to the Company the defense of its products under contractual indemnity
provisions. The Company has informed these customers that while it fully intends
to honor any contractual indemnity provisions, it does not believe it currently
has any obligation to provide such a defense because RAKTL does not appear to
have made a claim that a Company product infringes a patent. Some of these
customers have disagreed with the Company and believe that the correspondence
from RAKTL can be construed as claim(s) against the Company's products. An
affiliate of Verizon Communications, Inc., Cellco Partnership d/b/a Verizon
Wireless, recently settled all claims of patent infringement asserted against it
in the matter of RAKTL v. Verizon Communications, Inc. et al, No. 01-CV-5627, in
U.S. District Court, Eastern District of Pennsylvania. Verizon Wireless had
previously notified the Company of the lawsuit and referenced provisions in a
contract for prepaid services which required a wholly owned subsidiary of the
Company, Brite Voice Systems Inc., to indemnify Verizon Wireless against claims
that its services infringe patents. The clams in the lawsuit made general
reference to prepaid services and a variety of other services offered by Verizon
Wireless and its affiliates but did not refer to Brite's products or services.
The Company had informed Verizon Wireless that it could find no basis for an
indemnity obligation under the expired contract and, accordingly, the Company
did not participate in the defense or settlement of the matter.
Even though RAKTL has not alleged that a product provided by the Company
infringes a RAKTL patent, it is always possible that RAKTL may do so. In the
event that a Company product becomes the subject of litigation, a customer could
attempt to invoke the Company's indemnity obligations under the applicable
agreement. As with most sales contracts with suppliers of computerized
equipment, the Company's contractual indemnity obligations are generally limited
to the products and services provided by the Company, and generally require the
customer to allow the Company to have control over any litigation and settlement
negotiations with the patent holder. The customers who have received letters
from RAKTL generally have multiple suppliers of the types of products that might
potentially be subject to claims by RAKTL.
Even though no claims have been made that a specific product offered by the
Company infringes any claim under the RAKTL patent portfolio, the Company has
received opinions from its outside patent counsel that certain products and
applications offered by the Company do not infringe certain claims of the RAKTL
patents. The Company has also received opinions from its outside counsel that
certain claims under the RAKTL patent portfolio are invalid or unenforceable.
Furthermore, based on the reviews by outside counsel, the Company is not aware
of any valid and enforceable claims under the RAKTL portfolio that are infringed
by the Company's products. If the Company does become involved in litigation in
connection with the RAKTL patent portfolio, under a contractual indemnity or any
other legal theory, the Company intends to vigorously contest the claims and to
assert appropriate defenses. An increasing number of companies, including some
large, well known companies and some customers of the Company, have already
licensed certain rights under the RAKTL patent portfolio. RAKTL has previously
announced license agreements with, among others, AT&T Corp., Microsoft
Corporation and International Business Machines Corporation.
In the matter of Aerotel, Ltd. et al, v. Sprint Corporation, et al, Cause
No. 99-CIV-11091 (SAS), pending in the United States District Court, Southern
District of New York, Aerotel, Ltd., has sued Sprint Corporation alleging that
certain prepaid services offered by Sprint are infringing Aerotel's U.S. Patent
No. 4,706,275 ("275 patent"). According to Sprint, the suit originally focused
on land-line prepaid services not provided by the Company. As part of an
unsuccessful mediation effort, Aerotel also sought compensation for certain
prepaid wireless services provided to Sprint PCS by the Company. As a result of
the mediation effort, Sprint has requested that the Company provide a defense
and indemnification to Aerotel's infringement claims, to the extent that they
pertain to any wireless prepaid services offered by the Company. In response to
this request, the Company offered to assist (and has in fact been assisting)
Sprint's counsel in defending
70
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
against such claims, to the extent they deal with issues unique to the system
and services provided by the Company. Sprint has asserted, among other things,
that Intervoice should reimburse Sprint for legal expenses Sprint incurs in
connection with defending the wireless services. The trial court, which had
temporarily stayed proceedings, recently recommenced proceedings following
certain rulings from the United States Patent and Trademark Office. The Company
has received opinions from its outside patent counsel that the wireless prepaid
services offered by the Company do not infringe the "275 patent". Aerotel has
filed expert reports that assert that wireless services provided by the Company
are covered under Claim 23 of the "275 patent". Sprint has filed its own expert
report rebutting Aerotel's expert.
PENDING LITIGATION
David Barrie, et al., on Behalf of Themselves and All Others Similarly
Situated v. InterVoice-Brite, Inc., et al.; No. 3-01CV1071-D, pending in the
United States District Court, Northern District of Texas, Dallas Division:
Several related class action lawsuits were filed in the United States
District Court for the Northern District of Texas on behalf of purchasers of
common stock of the Company during the period from October 12, 1999 through June
6, 2000 the ("Class Period"). Plaintiffs have filed claims which, were
consolidated into one proceeding, under sec.sec. 10(b) and 20(a) of the
Securities Exchange Act of 1934 and the Securities and Exchange Commission Rule
10b-5 against the Company as well as certain named current and former officers
and directors of the Company on behalf of the alleged class members. In the
complaint, Plaintiffs claim that the Company and the named current and former
officers and directors issued false and misleading statements during the Class
Period concerning the financial condition of the Company, the results of the
Company's merger with Brite and the alleged future business projections of the
Company. Plaintiffs have asserted that these alleged statements resulted in
artificially inflated stock prices.
The Company believes that it and its officers complied with their
obligations under the securities laws, and intends to defend the lawsuit
vigorously. The Company responded to this complaint by filing a motion to
dismiss the complaint in the consolidated proceeding. The Company asserted that
the complaint lacked the degree of specificity and factual support to meet the
pleading standards applicable to federal securities litigation. On this basis,
the Company requested that the United States District Court for the Northern
District of Texas dismiss the complaint in its entirety. Plaintiffs responded to
the Company's request for dismissal. On August 8, 2002, the Court entered an
order granting the Company's motion to dismiss the class action lawsuit. In the
order dismissing the lawsuit, the Court granted plaintiffs an opportunity to
reinstate the lawsuit by filing an amended complaint. Plaintiffs filed an
amended complaint on September 23, 2002. The Company has filed a motion to
dismiss the amended complaint, and plaintiffs have filed a response in
opposition to the Company's motion to dismiss. The court has ordered the parties
to attend a mediation with a neutral third-party mediator during June 2003. All
discovery and other proceedings not related to the dismissal have been stayed
pending resolution of the Company's request to dismiss the amended complaint.
TELEMAC ARBITRATION
On March 28, 2003 the Company announced a settlement of an arbitration
proceeding in the Los Angeles, California, office of JAMS initiated by Telemac
Corporation ("Telemac") against the Company, InterVoice Brite Ltd. and Brite
Voice Systems, Inc., JAMS Case No. 1220026278. Telemac's allegations arose out
of the negotiation of an Amended and Restated Prepaid Phone Processing Agreement
between Telemac and Brite Voice Systems Group, Ltd., and certain amendments
thereto, under which Telemac licensed prepaid wireless software for use in the
United Kingdom under agreement with 02, formerly BT Cellnet, a provider of
wireless telephony in the United Kingdom. The terms of the settlement included a
cash payment to Telemac, which was not significant to the Company's consolidated
financial condition.
71
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OTHER MATTERS
The Company is a defendant from time to time in lawsuits incidental to its
business. Based on currently available information, the Company believes that
resolution of all known lawsuits, including the matter described above, is
uncertain, and there can be no assurance that future costs related to such
matters would not be material to the Company's financial position or results of
operations.
The Company is a party to many routine contracts in which it provides
general indemnities and warranties in the normal course of business to third
parties for various risks. These indemnities and warranties are discussed in the
following paragraphs. Except in specific circumstances where the Company has
determined that the likelihood of loss is probable and the amount of the loss
quantifiable, the Company has not recorded a liability for any of these
indemnities. In general, the Company is not able to estimate the potential
amount of any liability relating to these indemnities and warranties.
Many of the Company's contracts, particularly for managed services, foreign
contracts and contracts with telecommunication companies, include provisions for
the assessment of liquidated damages for delayed project completion and/or for
the Company's failure to achieve certain minimum service levels. The Company has
had to pay liquidated damages in the past and may have to pay additional
liquidated damages in the future. Any such future liquidated damages could be
significant.
The Company's contracts with its customers generally contain qualified
indemnifications against third party claims relating to the infringement of
intellectual property as described in "Intellectual Property Matters" above.
The Company's contracts with its customers also generally contain
warranties and, in some cases, general indemnifications against other
unspecified third party and general liability claims. The Company has liability
insurance protecting it against certain obligations, primarily certain claims
related to property damage, that result from these indemnities.
The Company's revolving credit agreement allows for certain amounts that
may be advanced under the agreement to accrue interest at LIBOR plus a margin.
The agreement states that the LIBOR rate may be adjusted by the lender on a
prospective basis to take into account any additional or increased costs to the
lender of maintaining or obtaining any eurodollar deposits or increased costs
due to changes in applicable law occurring subsequent to the start of the then
applicable interest period. The agreement also requires the Company to indemnify
the lender against any loss incurred by the lender as a result of actions taken
by the Company to settle the LIBOR based loans and related interest obligations
on other than the predetermined settlement date. The provisions described above
continue for the entire term of the credit agreement, and there is no limitation
on the maximum additional amounts the Company could be obligated to pay under
such provisions. Any failure to pay amounts due under such provisions generally
would trigger an event of default and would entitle the lender to foreclose upon
the collateral to realize the amounts due. The Company had no amounts
outstanding under the revolving credit agreement at February 28, 2003.
The Company has employment agreements with three executive officers. Each
agreement requires the Company to make termination payments to the officer of
from one to two times the officer's annual base compensation in the event the
officer's services are terminated without cause or payments of up to 2.99 times
the officer's annual compensation including bonuses in connection with a
termination of the officer's services following a change in ownership of the
Company, as defined in the agreement, prior to the expiration of the agreement.
If all three officers were terminated without cause as described above during
fiscal 2004, the cost to the Company would range from $0.8 million to $2.5
million.
The Company, under the terms of its Articles of Incorporation and Bylaws,
indemnifies its directors, officers, employees or agents or any other person
serving at the Company's request as a director, officer, employee or agent of
another corporation in connection with a derivative suit if (1) he or she is
successful on
72
INTERVOICE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the merits or otherwise or (2) acted in good faith, and in a manner he or she
reasonably believed to be in or not opposed to the best interests of the
corporation, but the Company will not provide indemnification for any claim as
to which the person was adjudged liable for negligence or misconduct unless the
court determines that under the circumstances the person is fairly and
reasonably entitled to indemnification. The Company provides the same category
of persons with indemnification in a non-derivative suit only if such person (1)
is successful on the merits or otherwise or (2) acted in good faith, and in a
manner he or she reasonably believed to be in or not opposed to the best
interests of the corporation, and with respect to any criminal action or
proceeding, had no reason to believe his or her conduct was unlawful.
In connection with certain lawsuits filed against the Company and certain
of its present and former officers and directors (see "Pending Litigation"
above, the Company has agreed to pay in advance any expenses, including
attorneys' fees, incurred by such present and former officers and directors in
defending such litigation, in accordance with Article 2.02-1 of the Texas
Business Corporation Act and the Company's Articles of Incorporation and Bylaws.
Each of these parties has provided the Company with a written undertaking to
repay the Company the expenses advanced if the person is ultimately not entitled
to indemnification.
The merger agreement between Intervoice, Inc. and Brite Voice Systems, Inc.
provides that until the fifth anniversary of the merger in 2004, the Company
shall, as the surviving corporation, indemnify, defend and hold harmless, to the
fullest extent permitted under Kansas law or the terms of Brite's Articles of
Incorporation or Bylaws as in effect at the effective time of the merger, the
present and former officers and directors of Brite and its subsidiaries against
all losses, claims, damages, liabilities, costs, fees and expenses, including
reasonable attorneys' fees and judgments, fines, losses, claims, liabilities and
amounts paid in settlement, arising out of actions or omissions occurring at or
prior to the effective time of the merger. The merger agreement also provides
that the Company will maintain Brite's existing directors' and officers'
liability insurance or a substantially equivalent policy, for at least five
years after the effective time of the merger. The Company is not, however,
required to pay total premiums for insurance in excess of $250,000. If the
Company is unable to obtain substantially equivalent coverage for an aggregate
premium not to exceed $250,000, then it will obtain as much insurance as can be
obtained for $250,000.
Texas corporations are authorized to obtain insurance to protect officers
and directors from certain liabilities, including liabilities against which the
corporation cannot indemnify its officers and directors. The Company has
obtained liability insurance for its officers and directors as permitted by
Article 2.02-1 of the Texas Business Corporation Act.
73
INTERVOICE, INC.
SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
-------- ---------- ---------- ---------- ----------
ADDITIONS
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COST AND END OF
DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS PERIOD
----------- ---------- ---------- ---------- ----------
(IN MILLIONS)
Year Ended February 28, 2003:
Allowance for doubtful accounts.................. $3.5 $ (0.7)(B) $ (0.3)(A) $2.5
Year Ended February 28, 2002:
Allowance for doubtful accounts.................. $3.6 $ 0.4 $ (0.5)(A) $3.5
Year Ended February 28, 2001:
Allowance for doubtful accounts.................. $4.2 $ 2.9 $ (3.5)(A) $3.6
---------------
(A) Accounts written off.
(B) Recovery of accounts written off in a preceding year, net of current period
account charges.
74
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item will be contained in the sections
entitled "Election of Directors" and "Executive Officers" in the Company's
Definitive Proxy Statement, involving the election of directors, to be filed
pursuant to Regulation 14A with the Securities and Exchange Commission not later
than 120 days after the end of the fiscal year covered by this Form 10-K (the
"Definitive Proxy Statement") and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item will be contained in the section
entitled "Executive Compensation" in the Definitive Proxy Statement. Such
information is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item will be contained in the section
entitled "Election of Directors" in the Definitive Proxy Statement. Such
information is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item will be contained in the section
entitled "Certain Transactions" in the Definitive Proxy Statement. Such
information is incorporated herein by reference.
ITEM 14. CONTROLS AND PROCEDURES
The Company's chief executive officer and chief financial officer have
reviewed and evaluated the effectiveness of the Company's disclosure controls
and procedures (as defined in Rules 240.13a-14(c) and 15d-14(c) promulgated
under the Securities Exchange Act of 1934) as of a date within ninety days
before the filing date of this annual report. Based on that review and
evaluation, which included inquiries made to certain other employees of the
Company, the chief executive officer and chief financial officer have concluded
that the Company's current disclosure controls and procedures, as designed and
implemented, are reasonably adequate to ensure that they are provided with
material information relating to the Company required to be disclosed in the
reports the Company files or submits under the Securities Exchange Act of 1934.
There have not been any significant changes in the Company's internal controls
or in other factors that could significantly affect these controls subsequent to
the date of their evaluation. There were no significant deficiencies or material
weaknesses, and therefore no corrective actions were taken.
ITEM 15. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Not applicable.
PART IV
ITEM 16. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following consolidated financial statements and financial statement
schedule of Intervoice, Inc. and subsidiaries are included in Items 8 and 16(a),
respectively.
75
PAGE
----
(1) Financial Statements
Report of Independent Auditors.............................. 38
Consolidated Balance Sheets at February 28, 2003 and 2002... 39
Consolidated Statements of Operations for each of the three
years in the period ended February 28, 2003................. 40
Consolidated Statements of Changes in Stockholders' Equity
for each of the three years in the period ended February 28,
2003........................................................ 41
Consolidated Statements of Cash Flows for each of the three
years in the period ended February 28, 2003................. 42
Notes to Consolidated Financial Statements.................. 43
(2) Financial Statement Schedule II Valuation and Qualifying 74
Accounts....................................................
All other schedules are omitted because they are not applicable or the
required information is shown in the financial statements or notes thereto.
(3) Exhibits:
The exhibits required to be filed by this Item 16 are set forth in the
Index to Exhibits accompanying this report.
(b) Reports on Form 8-K
1. A report on Form 8-K filed on December 20, 2002 to announce the
Company's third quarter earnings release.
76
SIGNATURES
Pursuant to the requirements of Sections 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
INTERVOICE, INC.
By: /s/ DAVID W. BRANDENBURG
------------------------------------
David W. Brandenburg
Chairman of the Board of Director
and Chief Executive Officer
Dated: May 29, 2003
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.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ DAVID W. BRANDENBURG Chairman of the Board of Directors May 29, 2003
------------------------------------------------ and Chief Executive Officer
David W. Brandenburg
/s/ ROB-ROY J. GRAHAM Chief Financial Officer and May 29, 2003
------------------------------------------------ Controller
Rob-Roy J. Graham
/s/ MARK C. FALKENBERG Chief Accounting Officer May 29, 2003
------------------------------------------------
Mark C. Falkenberg
/s/ JOSEPH J. PIETROPAOLO Director May 29, 2003
------------------------------------------------
Joseph J. Pietropaolo
/s/ GEORGE C. PLATT Director May 29, 2003
------------------------------------------------
George C. Platt
Director
------------------------------------------------
Grant A. Dove
/s/ JACK P. REILY Director May 29, 2003
------------------------------------------------
Jack P. Reily
/s/ GERALD F. MONTRY Director May 29, 2003
------------------------------------------------
Gerald F. Montry
77
CERTIFICATIONS
I, David W. Brandenburg, certify that:
1. I have reviewed this annual report on Form 10-K of Intervoice, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrants' disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
/s/ DAVID W. BRANDENBURG
--------------------------------------
David W. Brandenburg
Chief Executive Officer and Chairman
Date: May 29, 2003
78
CERTIFICATIONS
I, Rob-Roy J. Graham, certify that:
1. I have reviewed this annual report on Form 10-K of Intervoice, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrants' disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
/s/ ROB-ROY J. GRAHAM
--------------------------------------
Rob-Roy J. Graham
Executive Vice President and Chief
Financial Officer
Date: May 29, 2003
79
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------- -----------
3.1 Articles of Incorporation, as amended, of Registrant.(2)
3.2 Amendment to Articles of Incorporation of Registrant.(9)
3.3 Amendment to Articles of Incorporation of Registrant.(19)
3.4 Second Restated Bylaws of Registrant, as amended.(1)
4.1 Third Amended and Restated Rights Agreement dated as of May
1, 2001 between the Registrant and Computershare Investor
Services, LLC, as Rights Agent.(4)
4.2 Securities Purchase Agreement, dated as of May 29, 2002,
between the Registrant and the Buyers named therein (the
"Securities Purchase Agreement").(17)
4.3 Form of Convertible Note, dated as of May 29, 2002, between
the Registrant and each of the Buyers under the Securities
Purchase Agreement.(17)
4.4 Form of Warrant, dated as of May 29, 2002, between the
Registrant and each of the Buyers under the Securities
Purchase Agreement.(17)
4.5 Registration Rights Agreement, dated as of May 29, 2002,
between the Registrant and each of the Buyers under the
Securities Purchase Agreement.(17)
4.6 First Amendment to Third Amended and Restated Rights
Agreement dated as of May 29, 2002, between the Registrant
and Computershare Investor Services, LLC.(17)
10.1 The InterVoice, Inc. 1990 Incentive Stock Option Plan, as
amended(8)
10.2 The InterVoice, Inc. 1990 Nonqualified Stock Option Plan for
Non-Employees, as amended(3)
10.3 The InterVoice, Inc. Employee Stock Purchase Plan(6)
10.4 InterVoice, Inc. Employee Savings Plan(5)
10.5 InterVoice, Inc. Restricted Stock Plan(7)
10.6 Employment Agreement dated as of September 16, 1998 between
the Company and Rob-Roy J. Graham(8)
10.7 InterVoice, Inc. 1998 Stock Option Plan(8)
10.8 Acquisition Agreement and Plan of Merger dated as of April
27, 1999, by and among the Company, InterVoice Acquisition
Subsidiary III, Inc. ("Acquisition Subsidiary") and Brite
Voice Systems, Inc.(11)
10.9 Patent License Agreement between Lucent Technologies GRL
Corp. and InterVoice Limited Partnership, effective as of
October 1, 1999. Portions of this exhibit have been excluded
pursuant to a request for confidential treatment.(9)
10.10 Intervoice, Inc. 1999 Stock Option Plan.(12)
10.11 Credit Agreement dated June 1, 1999 among InterVoice, Inc.,
InterVoice Acquisition Subsidiary III, Inc. and Bank of
America National Trust and Savings Association, as "Agent",
Banc of America Securities LLC and certain other financial
Institutions indicated as being parties to the Credit
Agreement (collectively, "Lenders") incorporated by
reference to Exhibit 99.(b)(1) of the Schedule 14-D1
(Amendment No. 4) filed by InterVoice, Inc. and InterVoice
Acquisition Subsidiary III, Inc. on June 14, 1999.(11)
10.12 Forebearance Agreement dated as of March 7, 2002, by and
among the Company, Brite Voice Systems, Inc., Bank of
America, National Association, as agent, and the Lenders
party thereto.(15)
10.13 Consent and Amendment to Forebearance Agreement, dated as of
March 31, 2002, by and among the Company, Brite Voice
Systems, Inc., Bank of America, National Association, as
agent, and the Lenders party thereto.(16)
10.14 Form of Commitment Letter dated May 29, 2002.(17)
10.15 Consent, Waiver and Third Amendment to Credit Agreement,
effective as of May 29, 2002 among the Registrant, Brite
Voice Systems, Inc. (successor by merger to InterVoice
Acquisition Subsidiary III, Inc.), Bank of America, National
Association (successor by merger to Bank of America National
Trust and Savings Association), as Agent, and the other
Lenders named therein.(17)
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.16 Subordination and Intercreditor Agreement effective as of
May 29, 2002 by and among the Registrant, the Buyers under
the Securities Purchase Agreement, and Bank of America,
National Association, as Agent for the Senior Creditors
(defined therein).(17)
10.17 Promissory Note, dated May 29, 2002, executed by the
Registrant in favor of Beal Bank, S.S.B.(17)
10.18 Deed of Trust, Security Agreement, and Assignment of Leases
and Rents dated May 29, 2002, executed by the Registrant for
its benefit of Beal Bank, S.S.B.(17)
10.19 First Amendment to Employment Agreement effective as of July
1, 2000, between the Company and Rob-Roy J. Graham.(10)
10.20 First Amendment to Credit Agreement effective as of January
15, 2001, between the Company, Agent and the Lenders.(13)
10.21 Consent and Second Amendment to Credit Agreement effective
as of February 28, 2001, between the Company, Agent and the
Lenders.(13)
10.22 Second Amendment to Employment Agreement dated as of October
31, 2001, between the Company and Rob-Roy J. Graham.(14)
10.23 Second Amended Employment Agreement dated as of February 18,
2002, between the Company and David W. Brandenburg.(18)
10.24 Loan and Security Agreement dated as of August 29, 2002
between the Company and Foothill Capital Corporation.(20)
10.25 Modification Agreement dated as of September 30, 2002, by
and between the Company and Beal Bank S.S.B., modifying a
deed of trust.(19)
10.26 Second Modification Agreement dated as of February 27, 2003
by and between the Company and Beal Bank S.S.B., modifying a
deed of trust.(21)
10.27 Employment Agreement dated as of October 23, 2002, between
the Company and Robert E. Ritchey.(21)
21 Subsidiaries(21)
23 Consent of Independent Auditors(21)
99.1 Certification Pursuant to 18 U.S.C. Section 1350, signed by
David W. Brandenburg(21)
99.2 Certification Pursuant to 18 U.S.C. Section 1350, signed by
Rob-Roy J. Graham(21)
99.3 Pages 12, 13, 18, 38-40, 43 and 45 of the Registration
Statement on Form S-4, as amended (incorporated by reference
to page 12, 13, 18, 38-40, 43 and 45 of the Registration
Statement on Form S-4/A (Amendment No. One) filed by the
Company on July 13, 1999)(9)
99.4 Letter Agreement dated April 2, 2002 between the Company and
a prospective purchaser of the Company's facilities in
Wichita, Kansas. Portions of this exhibit have been excluded
pursuant to a request for confidentiality treatment.(16)
---------------
(1) Incorporated by reference to exhibits to the Company's 1991 Annual Report
on Form 10-K for the fiscal year ended February 28, 1991, filed with the
Securities and Exchange Commission (SEC) on May 29, 1991, as amended by
Amendment No. 1 on Form 8 to Annual Report on Form 10-K, filed with the SEC
on August 1, 1991.
(2) Incorporated by reference to exhibits to the Company's 1995 Annual Report
on Form 10-K for the fiscal year ended February 28, 1995, filed with the
SEC on May 30, 1995.
(3) Incorporated by reference to exhibits to the Company's Registration
Statement on Form S-8 filed with the SEC on April 6, 1994, with respect to
the Company's 1990 Nonqualified Stock Option Plan for Non-Employees,
Registration Number 33-77590.
(4) Incorporated by reference to exhibits to Form 8-A/A (Amendment 3) filed
with the SEC on May 9, 2001.
(5) Incorporated by reference to exhibits to the Company's 1994 Annual Report
on Form 10-K for the fiscal year ended February 28, 1994, filed with the
SEC on May 31, 1994.
(6) Incorporated by reference to exhibits to Registration Statement on Form S-8
filed with the SEC on November 20, 2002, Registration Number 333-1013280.
(7) Incorporated by reference to exhibits to the Company's 1996 Annual Report
on Form 10-K for the fiscal year ended February 29, 1996, filed with the
SEC on May 29, 1996.
(8) Incorporated by reference to exhibits to the Company's Quarterly Report on
Form 10-Q for the quarter ended August 31, 1998, filed with the SEC on
October 14, 1998.
(9) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the fiscal quarter ended August 31, 1999, filed with the SEC on October
14, 1999.
(10) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the fiscal quarter ended August 31, 2000, filed with the SEC on October
14, 2000.
(11) Incorporated by reference to Registration Statement on Form S-4 filed with
the SEC on July 13, 1999, Registration Number 333-79839.
(12) Incorporated by reference to Registration Statement on Form S-8 filed with
the SEC on October 15, 1999, Registration Number 333-89127.
(13) Incorporated by reference to exhibits to the Company's 2001 Annual Report
on form 10-K for the fiscal year ended February 28, 2001, filed with the
SEC on May 18, 2001.
(14) Incorporated by reference to exhibits to the Company's Quarterly Report on
Form 10-Q for the quarter ended November 30, 2001, filed with the SEC on
January 11, 2002.
(15) Incorporated by reference to exhibits to the Company's Current Report on
Form 8-K, filed with the SEC on March 13, 2002.
(16) Incorporated by reference to exhibits to the Company's Current Report on
Form 8-K, filed with the SEC on April 18, 2002.
(17) Incorporated by reference to exhibits to the Company's Current Report on
Form 8-K, filed with the SEC on May 30, 2002.
(18) Incorporated by reference to exhibits to the Company's 2002 Annual Report
on Form 10-K for the fiscal year ended February 28, 2002, filed with the
SEC on May 30, 2002.
(19) Incorporated by reference to exhibits to the Company's Quarterly Report on
Form 10-Q for the quarter ended August 31, 2002, filed with the SEC on
October 15, 2002.
(20) Incorporated by reference to exhibits to the Company's Current Report on
Form 8-K, filed with the SEC on August 29, 2002.
(21) Filed herewith.