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(Exact
name of registrant as specified in its charter)
Delaware
54-1987541
(State
or other jurisdiction of
(I.R.S.
Employer
incorporation
or organization)
Identification
No.)
1921
Gallows Road, Suite 200, Vienna, Virginia
22182
(Address
of principal executive offices)
(Zip
Code)
Registrant's
telephone number, including area code: (703) 761 -
3700
Securities
registered pursuant to Section 12(b) of the Act:
None
Securities
registered pursuant to Section 12(g) of the Act: Common
Stock
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities
Act. Yes No ü
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the
Act. YesNo ü
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 the filing requirements for
the past 90 days. Yes ü
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
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. __
Indicate
by check mark whether the registrant is a large accelerated filer, accelerated
filer, or a non-accelerated filer. See definition of “accelerated filer and
large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large
Accelerated Filer Accelerated
Filer ü Non-Accelerated
Filer
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). YesNo ü
The
aggregate market value of the voting stock held by non-affiliates of the
registrant as of July 31, 2005 (based on the closing sales price as reported
on
the NASDAQ National Market System) was $201,536,203.
The
statements contained in this report that are not purely historical are
“forward-looking statements” within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including
without limitation statements about the expectations, beliefs, intentions or
strategies regarding the future of Convera Corporation (“Convera” or the
“Company.”) Words such as “expects,”“intends,”“plans,”“projects,”“believes,”“estimates,” and similar expressions are used to identify these forward-looking
statements. These include, among others, statements relating to the Company's
future expectations, performance, plans, and prospects, as well as assumptions
about future events. All forward-looking statements included in this report
are
based on information available to the Company on the date hereof, and the
Company assumes no obligation to update any such forward-looking statements.
The
forward-looking statements contained herein involve risks and uncertainties
discussed under the heading “Risk Factors” below. The Company’s actual results
could differ materially from those anticipated in these forward-looking
statements as a result of such factors, including those set forth in this
report.
Overview
Convera
designs, develops, markets, implements and supports search and categorization
software solutions that enable a broad range of mission critical applications
within government agencies and commercial enterprises. These applications
include knowledge management, enterprise portals, intelligence gathering and
analysis, safety and national security, law enforcement, research and discovery,
regulatory compliance and customer service. Convera believes its enterprise
solution, RetrievalWare, offer customers the ability to manage vast stores
of
unstructured information by providing highly scalable, fast, accurate and secure
search capabilities across more than 200 forms of text, video, image and audio
information, in more than 45 languages. Convera also offers professional
services for its software solutions to ensure Convera products integrate
seamlessly into customer environments. Training, consulting and maintenance
services are also provided to facilitate optimal use of its
technologies.
Convera
maintains a portfolio of patented and proprietary technologies. Its core
technologies include: advanced computational linguistics and semantic networking
that leverage lexical knowledge using built-in knowledge bases to search not
only for specific word meanings, but also for related terms and concepts;
Adaptive Pattern Recognition Processing (“APRP”) that identifies patterns in
digital data, providing the capability to build content-based analysis and
retrieval applications for any type of digital information; and intelligent
real-time video analysis that detects scene changes as they occur. The Company’s
most recent software release, RetrievalWare 8, includes technical advancements
such as categorization, dynamic classification, profiling and distributed
indexing capabilities. In addition, the Company has embarked on an advanced
Web
indexing development effort focused on applying portions of the Company’s
existing core technology to also locate contextually relevant information on
the
World Wide Web (the “Web”). This next-generation search technology, called
Excalibur, achieved its initial development milestone in October 2004 by
creating an “Alpha” stage, search platform for open-source Web content. On
November 1, 2005the Company announced that the Excalibur Web offering was
commercially available as the technology had advanced to then contain more
than
4 billion documents in the index and a redundant hosting environment was
established with AT&T.
As
of
January 31, 2006 and 2005, Allen Holding, Inc., together with Allen &
Company Incorporated, Herbert A. Allen and certain related parties (collectively
“Allen & Company”) beneficially owned approximately 47% and more than 50% of
the voting power of Convera, and would therefore in each instance be able to
effectively control the outcome of matters requiring a stockholder vote.
RetrievalWare and Screening Room are registered trademarks of Convera
Corporation or its subsidiaries in the United States and other
countries.
The
Company can be contacted via email at invest@convera.com
and
visited at its web site, www.convera.com.
On our
web site, we post the following filings as soon as reasonably practicable after
they are electronically filed with or furnished to the Securities and Exchange
Commission: our annual report on Form 10-K, our quarterly reports on Form 10-Q,
our current reports on Form 8-K, our proxy statement on Form 14A related to
our
annual stockholder’s meeting
and any amendments to those reports or statements filed or furnished pursuant
to
Section 13(a) of 15(d) of the Securities Exchange Act of 1934, as amended.
All
such filings on our web site are available free of charge. Information on the
Convera web site is not part of this Form 10-K.
The
Company licenses its software products directly to government agencies and
commercial enterprises throughout North America, Europe and other parts of
the
world. The Company also distributes its software products through license
agreements with systems integrators, Original Equipment Manufacturers (“OEMs”),
value-added resellers, and other strategic partners. The Company’s technology
may also be customized to meet the specific needs of its customers. Further,
the
Company continues to focus a substantial amount of resources on further
penetration of the national security, defense, law enforcement and intelligence
gathering community with the United States and its allies, while limiting its
selling and marketing efforts to commercial customers for the RetrievalWare
enterprise application. The Company has also increased its efforts with regard
to its Excalibur Web offering. Convera has begun focusing much of its selling
and marketing resources on establishing distribution channels for Excalibur.
The
Company is again targeting the government marketplace, as well as the media
and
publishing sectors for Excalibur at this time. This strategy is expected to
capitalize on customer requirements within these market segments seeking both
Intranet and Web-based search and categorization technologies to manage the
vast
amounts of content within their environments. The Company may elect to seek
additional and/or alternative market segments for the Excalibur offering over
the coming quarters.
Convera
continues to conduct international sales activities through Convera Technologies
International, Limited (“CTIL”), its wholly owned subsidiary in the United
Kingdom.
Convera
Products
Products
Convera
develops, markets, licenses, services and supports its enterprise software
product RetrievalWare, which offers customers mission-critical search and
categorization solutions powering a broad range of applications including
enterprise portals, knowledge management, intelligence gathering, profiling,
corporate policy compliance, regulatory compliance, and customer service. These
applications are utilized within corporate intranets, Internet e-commerce,
online publishing and OEM market segments.
Convera’s
products are designed to address the search and categorization needs of a
diverse customer base within government agencies and commercial enterprises
on a
global basis. From supporting the most demanding requirements of the
intelligence and law enforcement communities within government agencies, to
providing the enterprise search backbone of Fortune 500 companies, Convera
products are often a critical part of customers’ information management
infrastructure.
RetrievalWare
is a secure, highly scalable software platform for mission-critical, search
and
categorization applications. The RetrievalWare distributed architecture provides
a high performance, high scalability infrastructure for indexing, searching,
categorizing and linking information across a broad range of content sources.
Convera
products are best suited for organizations that face the following
challenges:
·
Searching
a large collection of unstructured information assets distributed
in
information silos across the
enterprise;
·
Dealing
with large volumes of incoming unstructured data on a daily
basis;
·
Searching
disparate collections of documents and records regardless of their
format,
including scanned paper, text, audio, video, images and relational
databases;
·
Tightly
integrating the search solution as part of the corporate security
infrastructure;
·
Providing
a robust, scalable and highly available information discovery platform;
and
·
Searching
information that exists in multiple
languages.
With
the
release of RetrievalWare 8, Convera enhanced its software product offering
with
new categorization and classification capabilities, as well as tools for
developing and deploying taxonomies, and architectural enhancements
that
allow RetrievalWare to easily fit within J2EE and Web Services environments.
Convera’s
Categorization and Dynamic Classification software introduced with RetrievalWare
8 allows enterprises and government agencies to more easily search and browse
unstructured information from diverse user perspectives and roles. It also
allows organization to more easily discover hidden information that is most
relevant to queries against large repositories of information.
Convera’s
Cartridge and Classification Workbench allows enterprises to develop, import,
change and integrate various taxonomies and semantic networks that may be used
for organizing and accessing an enterprise’s unstructured content. This new
suite of tools also helps enterprises measure the quality of the taxonomies
being used to organize their information assets. This provides predictive
insight into the user’s satisfaction that will result from the search and
categorization solution being deployed.
RetrievalWare
8 was built using the modern Application Server Architecture, effectively
supporting those customers who have chosen to adopt the Service Oriented
Application Architecture within their enterprises. The support of open
Application Programming Interfaces (“APIs”) like Java Services and Web Services
APIs allows RetrievalWare 8 to be integrated into a variety of enterprise
applications with relative ease.
The
RetrievalWare 8 product line includes:
RetrievalWare®
Search (Base Product)
Optional
Components:
RetrievalWare®
Categorization and Dynamic Classification;
RetrievalWare
provides a secure, scalable information retrieval and knowledge discovery
infrastructure utilizing advanced indexing, search and categorization
technology. The RetrievalWare distributed process architecture enables
government agencies and commercial enterprises to integrate information assets
into a single point of access, to navigate that information and to collaborate
on retrieved information to achieve mission-critical objectives. By utilizing
multi-mode searching built around Convera’s proprietary semantic network
technologies, pattern matching (APRP) and Boolean search, RetrievalWare empowers
users to securely access and retrieve mission critical information assets across
multiple data types.
With
Convera’s semantic networks and natural language processing, users can easily
find needed information without having to specify exact keywords. RetrievalWare
incorporates syntax, morphology and the actual meaning of words in its search
algorithms. The baseline semantic network in the English language version of
RetrievalWare gives users a built-in knowledge base of approximately 500,000
word meanings, 50,000 language idioms and 1.6 million word associations. Users
submit plain English queries that are automatically expanded to include related
terms and concepts, thereby increasing the likelihood that highly relevant
content will be retrieved. RetrievalWare also supports domain specific semantic
networks to further enhance search precision and recall in specific fields
of
interest,
including: Biology, Chemistry, Computers, Electronics, Finance, Food Science,
Geography, Geology, Health Sciences, Information Science, Law, Mathematics,
Medical, Military, Petroleum, Natural Gas & Petrochemicals, Pharmaceutical,
Pharmacology, Physics, Plastics, Rubber and Telecommunications. Other
disciplines can be supported through the use of Convera tools that enable the
development of enterprise-specific semantic networks.
APRP
identifies patterns in digital information. In text applications, it allows
users to retrieve relevant information regardless of spelling errors contained
in queries or the existence of inconsistencies in the searched data that may
be
caused by errors in optical character recognition processes. The software works
at high speed and supports the rapid development of multi-language
text-retrieval systems.
RetrievalWare
supports more than 200 document formats stored on file servers, in groupware
systems, relational databases, document management systems, intranets and the
Internet. RetrievalWare provides real time profiling which enables users to
automatically receive incoming documents of interest. The RetrievalWare
Profiling Server filters, stores and distributes incoming data from many sources
including real-time news feeds, relational databases, paper repositories and
the
RetrievalWare Internet Spider.
Convera
provides what it believes was the industry’s first enterprise search product to
offer multimedia and cross-lingual search as off-the-shelf product features.
By
providing users with a single product that simultaneously searches and organizes
all data types (such as text, video, image and audio files) in multiple
languages from a single user interface, customers do not have to buy and piece
together several disparate systems to manage multiple data types and languages.
RetrievalWare
provides access to both unstructured and structured information across
enterprise networks, workgroup LANs, and intranets. The software may be deployed
on a single server or across any number of distributed physical servers.
RetrievalWare server solutions can be run on multiple platforms including
leading UNIX, LINUX and Windows platforms.
The
RetrievalWare 8 product line includes the following optional
components:
Categorization
and Dynamic Classification
The
RetrievalWare Categorization and Dynamic Classification solution enables
enterprises to bring consistency and scalability to the organization and access
of information assets through the use of stable, industry standard taxonomies.
RetrievalWare uses one or more taxonomies to extract concepts and context from
information assets. These assets can then be organized into specific views
that
reflect the personalized knowledge requirements, roles and perspectives of
each
user. This approach to organizing information facilitates knowledge discovery
and collaboration among knowledge workers.
Profiling
RetrievalWare
Profiling automatically detects, routes and stores relevant documents in
user-defined profiles, thus accelerating the timely discovery of relevant
information as it enters the RetrievalWare environment.
Cartridge
& Classification Workbench
Convera’s
Cartridge & Classification Workbench enables the use of manual and automated
tools to streamline taxonomy classification development, benchmarking, and
deployment. These tools reduce taxonomy development and deployment times as
well
as maintenance costs.
Language,
Domain and Taxonomy Cartridges
RetrievalWare
provides highly accurate and relevant search and categorization results based
upon its linguistic processing capability. Through the use of robust semantic
networks and taxonomies that cover many languages and domain specific fields
of
interest, RetrievalWare recognizes and processes words, phrases and concepts
in
the context in which they exist. The result is a comprehensive search and
retrieval solution enabling basic keyword search, advanced natural language
and
conceptual search, as well as information categorization in many languages
and
fields of interest. Language, Domain and Taxonomy Cartridges are provided as
pre-packaged optional components to RetrievalWare. Convera also provides
development tools that allow customers, partners or integrators to develop,
edit
and customize cartridge content for specific business solutions.
RetrievalWare
Synchronizers provide document-level secure access for users to search multiple
native repositories from a single point of access. Supported repositories
include Lotus Notes, Microsoft Exchange, Documentum, FileNET Panagon, native
file systems and major relational database management systems including
Microsoft SQL Server, Oracle, DB2, Sybase, Informix, Teradata and any
ODBC-compliant database.
Internet
Spider
Internet
Spider is a multimedia, high-performance Web spider/crawler for augmenting
the
retrieval capabilities of RetrievalWare, for stand-alone use, or for integration
with other applications. In addition to HTML-based Web pages, Internet Spider
retrieves word processing, PDF and multimedia assets including audio, video
and
images. It is highly configurable and multi-threaded and can provide deep,
broad
and repetitive crawling. Users who want immediate notification when items of
interest arrive can post Agent Profiles to pull links to related documents
to
their desktops. Components
can be deployed on multiple machines for optimum performance and
bandwidth.
FileRoom
RetrievalWare
FileRoom is an optional component that allows loading, indexing, viewing and
managing scanned documents, images and text. Users access FileRoom through
a
hierarchy consisting of FileRoom documents, where each tier in the hierarchy
is
a container for storing documents. Users can directly view the scanned image
of
a retrieved document from FileRoom. Graphs, diagrams, handwritten notations
and
signatures in the retrieved document are immediately accessible. Document-level
security lets organizations control user access at the FileRoom (library),
cabinet, drawer, folder and document level.
Screening
Room®
Screening
Room is an optional product to RetrievalWare Search that enables a comprehensive
solution for video asset management. It provides scalable access, search and
retrieval of video assets, both analog and digital, from any desktop. Used
in
conjunction with RetrievalWare Search, it provides for real-time capturing,
encoding, analyzing, cataloging, browsing, searching and retrieving of video,
as
well as related captured text (closed captions or speech-to-text conversions)
and metadata, over corporate intranets/extranets. Designed to manage video
content in Internet portal and corporate intranet environments, Screening Room
also supports media, broadcast and entertainment video asset management
solutions.
It
enables users to easily capture analog or digital video, automatically create
an
intelligent video storyboard, and play it back in any of the industry’s standard
video file formats. Screening Room users then can automatically browse, search
and retrieve precisely what video clips they are looking for without having
to
play or watch the video in its entirety.
Screening
Room consists of four components: Screening Room Capture, Screening Room
Metadata Edit, Screening Room Explorer and Screening Room Video Asset Server.
Screening Room Capture ingests, analyzes and storyboards analog or digital
video
assets, including live feeds. It also extracts, indexes and searches associated
metadata such as captured text (both closed-caption text and spoken audio
content converted to text), keyframe images of significant scenes and
annotations. Screening Room Metadata Edit enables users to browse, search,
edit
and annotate storyboards. In addition, users can select and compile clips from
multiple video assets to create new derivative works, export files and metadata
in industry-standard XML format or output rough-cut edit segments to Edit
Decision Lists (“EDLs”) for import into high-end offline editing systems.
Screening Room Explorer allows user access to catalogs of video assets through
any standard Web browser. The Video Asset Server indexes
and stores
captured video assets for instantaneous browsing, or search and retrieval via
RetrievalWare.
Screening
Room Capture (Stand-alone)
Screening
Room Capture (Stand-alone) can be deployed as a stand-alone product. It provides
the ability to log, analyze and encode video, and save the data and video assets
in a non-proprietary (XML) format. Screening Room Capture
does not require purchase of the entire RetrievalWare or Screening Room system,
enabling loading of video assets and metadata into a third party database or
content management system, or otherwise re-purposing the asset. Screening Room
Capture is also a suitable component for sale to OEM customers.
The
RetrievalWare SDK (Software Developer’s Kit) is a comprehensive set of tools for
building advanced search-based solutions. At its core is highly scalable,
distributed client/server architecture. Independent server processes maximize
the efficiency and reliability of document loading, indexing and query handling,
and support security and encryption/decryption features. Dedicated server
processes enable integration of text search and relational database storage
capabilities through an open database management system (“DBMS”) gateway. The
client environment is optimized for the development of graphical interfaces
using industry standard tools such as Java and Visual Basic. RetrievalWare
delivers Visual Basic custom controls, remote procedure calls and open server
capabilities, as well as engine-level, high-level and client/server application
program interfaces (“APIs”). These features speed the development of systems
that can support thousands of users and contain custom
functionality.
Screening
Room and Screening Room Capture APIs
The
Screening Room and Screening Room Capture APIs enable developers to integrate
and control the Screening Room components from other programs and applications.
Visual
RetrievalWare
Leveraging
the APRP technology, Visual RetrievalWare is a visual retrieval engine and
a
comprehensive image-processing library that enables the development of
client/server systems for indexing and retrieving digital images. Users can
search for visual information directly from their intranet, a corporate
database, the Internet, or other sources using images or video clips as clues.
Visual data is reduced to a searchable index that is typically less than 10%
of
the size of the original image and is automatically recognized based on its
shape, color and texture. Users submit queries using examples of visual data
or
by authoring a visual clue with a graphical product. Based on the shape, color
and texture of the visual clue, a list of similar or exact matches is returned.
The product delivers its advanced retrieval capabilities in an open, scalable
and secure architecture designed for ease of implementation, integration or
extension.
Excalibur
Web Offering
During
fiscal year 2005, the Company initiated a research and development project
aimed
at applying portions of the Company’s existing technology to searching and
indexing contextually relevant information on the World Wide Web. This
next-generation search technology achieved its initial development milestone
in
October 2004 by creating an “Alpha” stage search platform for open-source or
Web-based content. As of February 1, 2005the Company’s efforts advanced to
“Beta” stage as the technology contained more than 1 billion documents in the
index. On November 1, 2005the Company announced that the Excalibur Web offering
was commercially available as the technology had advanced to then contain more
than 4 billion documents in the index and a redundant hosting environment was
established with AT&T.
The
Excalibur Web offering has been developed to add structure to the Web through
the use of proprietary taxonomies and ontologies, semantic analysis and deep
knowledge resources capable of providing end-users with more relevant search
results. The technology also supports complex queries, offers built in video
and
image search, and provides geo-locational data. Excalibur may be used in concert
with RetrievalWare, Convera’s enterprise search solution, or with an
organization’s existing internal applications to create an integrated portal
offering “blended” results from both Intranet and Web-based searches.
The
Excalibur Web offering utilizes advanced semantic analysis in combination with
broad and deep knowledge resources to better understand the meaning of Web
content as well as the user query. It has incorporated a large set of
commercially recognized taxonomies in addition to privately compiled taxonomies
and thesauri to create a large and very granular Web index. These two core
design features enable Excalibur to draw dynamic connections between topically
or contextually related content resulting in a better understanding of the
nature of the query along with the relevancy of the content.
The
Excalibur Web Search platform offers blended results - incorporating information
from the web at large, as well as from multiple proprietary sources - enabling
content providers and web portals to readily consolidate relevant content and
information. End users are presented with relevant search results in a
comprehensive, consolidated manner, regardless of the repository source. Search
results may be further personalized in the form of “profiles” in which users can
choose and save the particular elements they would like to use in a particular
search or situation. The profiles can be triggered to create an “event” or send
an “alert” when new or relevant information is received. All results can be
presented to the user through an integrated, intuitive and dynamic page layout
that is designed, controlled and branded by the website or portal owner.
Convera
owns and operates the Excalibur Web offering infrastructure as either a hosted
search service deployed at one or more Tier 1 co-location facilities, or under
a
software licensing model. The Excalibur Web search service is expected to be
delivered through partnerships with Web sites, Web portals and other customer
relationships in which high quality, advanced Web search is a priority.
Excalibur Web search is offered as an unbranded search capability offering
site
owners' greater control over viewers and Web “stickiness”, along with the
opportunity to develop, deliver and control their own content and advertising
channels.
Excalibur
is planned to provide a multi-lingual Web index of over 4 billion pages. Layered
on top of this index are additional knowledge resources, described below, which
enable Excalibur to dynamically identify connections between topically and
contextually related content. Excalibur delivers search results that are
vertical, personal and focused.
Knowledge
Resources
Taxonomies-
Excalibur uses a collective taxonomic resource of more than 5 million categories
(or taxonomic nodes) covering commercial, technical and social realms of both
vertical and general interest. This taxonomic knowledge base comprises much
publicly available as well as privately compiled taxonomy augmented by the
Company’s years of information retrieval and knowledge management expertise
involving thousands of large-scale search projects worldwide. All of these
taxonomic resources are used to index the Web providing data organization and
precision of response.
Entities
-
Excalibur identifies and extracts entities (people, places, things) using
large-scale, proprietary resources of known entities in addition to dynamic
entity detection rules that identify and extract likely entities. For example,
Excalibur recognizes that “George Bush” is the 43rd
President
of the United States and not just a proper noun, two adjacent terms, or a shrub
that might be named George. The Company believes that the breadth, depth and
sophistication of Excalibur’s entity recognition are some of the factors driving
improved accuracy and relevance of results.
Ontologies
-
An
ontology provides a powerful semantic model that logically groups and represents
related information. Excalibur employs ontologic representations to define
connections between topically related content and then to dynamically present
relevant content in the context most closely related to a user’s search. An
entertainment focused ontology would understand that celebrities have
biographical information, official web sites, discographies, gossip, awards,
events and so on. A sports oriented ontology would understand that a given
sport
has teams, rosters, game schedules, news, gossip, fantasy teams, scores and
results, and so. For each case, the ontology helps to define the various types
of information that would interest a user on a given subject.
Facets
-
Excalibur utilizes hundreds of pre-defined facets to identify relevant aspects
of different subject areas or ontological groupings that are likely to be of
interest to a broad cross section of users. For example, facets chosen to define
the context for a music celebrity might include: news, controversy (or scandal),
books, CDs, DVDs, biography, film clips and so on. Alternatively, facets
defining a context for a politician might include: news, poll results, blogs,
events and biographical information. Facets are linked through one or more
ontologies and are triggered when conceptually related results are found in
response to a Web search. Facets may be dynamically personalized to create
a
specific user profile or customized to search for a particularly focused and
comprehensive set of results.
Verticalization
-
Excalibur results are vertically oriented, allowing users to achieve a very
focused yet comprehensive search result. For example, a search for thyroid
disease should return results that include information about diagnosis,
research, experts, news and so on. Thyroid disease should also be understood
as
an “endocrine disease” with many related terms and concepts, both more general
and more specific. This breadth of information can only be represented through
the incorporation of large-scale vertically oriented taxonomies. By employing
deep taxonomic analysis, Excalibur understands scientific and technical subject
matter at a level of granularity and specificity that is unique when compared
to
existing Web-scale analysis.
Personalization
-
Excalibur strives to solve the enormous and complex task of consolidating
billions of pages of Web content and independent information sources to find
and
present the most relevant results in a compelling and personalized manner.
It
does this by understanding what is actually intended by the query and returning
not just the most relevant list of results, but also information originated
by
related facets. Presenting information in this way provides the user with a
broader, but better focused view of information that is more informative and
easier to digest. Because these facets can be individually selected, mixed
and
matched for a specific search, web masters or end users can create highly
personalized profiles and alert mechanisms at will. The profiles can be easily
defined through the Excalibur GUI (graphical user interface) or its web services
interface. In this way, users can define and update the profiles most useful
to
them. They can also define the timing and sequence of alerting mechanisms that
will keep them abreast of events and news most relevant to them. Excalibur’s
ontology and faceting mechanism can be exposed through personalization tools
that allow personalization and customization at various levels. For example,
if
a user wanted a specific profile to find information related to vacationing
and
dining in New York, they could select relevant facets for Reviews, Opinions,
Events, FAQ’s and associate these with a stored search for “restaurants” in “New
York, NY”. Running this profile or setting an alert would allow the user to
locate the latest information regarding dining out in New York, including
content from the Web as well as any number of related third party
content sources.
Authority
- One of
Excalibur’s features is its use of content analysis and authority determination
mechanisms. This analysis attempts to comprehend the editorial quality of
content and its embedded meaning in a manner that is more insightful and less
subject to manipulation that existing ranking methods. These ranking mechanisms
eliminate low-value or low-quality content and return content with the highest
possible quality regardless of its popularity or obscurity. Multiple elements
including source, author, genre, density and specificity are collectively
weighed to determine authority and value.
Blending
-
Excalibur’s blending mechanism is supported through direct and indirect access
to non-Web and proprietary content sources, including valued thirdparty
content channels, content partners and advertisers. This is useful to
organizations that wish to combine search results from the general Internet
along with information residing within specific controlled datasets or datasets
they license from content producers and aggregators. Leveraging these sources
in
a process that is transparent to the user, Excalibur can return “blended”
results, enabling content providers or users to comb for the best, most relevant
information using the terms and contexts most familiar to them. At the same
time, Excalibur safeguards “protected” data by building in a number of tunable
access restrictions, insuring that only designated users or websites can search
these data repositories and that the data will not be readily distributed across
the worldwide web.
Multi-Lingual
- The
same set of knowledge resources and language processing capabilities that power
Excalibur search over English language content, is planned to be extended and
optimized to other languages including Spanish, French, German, Dutch,
Portuguese, Chinese, Japanese, Korean and so on. This is facilitated through
a
large-scale translation operation that translates concepts and terminology
into
their cross-lingual equivalents. This means that the millions of categories
and
related semantic resources applied to understanding content in one language
are
reproduced and consistently applied to understanding the content of other
languages - uniformly and reliably delivering authoritative results across
multiple languages.
Localization
-
Excalibur Web search enables global localization services. It uses a large
set
of consolidated geographical and geospatial resources totaling more than five
million unique data points. These resources are used during indexing and results
generation to correlate content with locations worldwide. Geographic reference
data might include: country, city, population, place names, longitude, latitude,
ZIP codes (where applicable), and so on. Collectively, these resources allow
Excalibur to provide results localization with enhanced granularity.
Multimedia
Search
-
Excalibur incorporates multimedia search of images and video. Convera’s
“Screening Room” functionality facilitates this full-scale video indexing and
search capability. Screening Room ingests video to create a storyboard of key
frames and associated metadata including time/date/source along with cctext.
Screening Room also incorporates manually created metadata - such as clip notes
or frame notes. Excalibur’s multimedia image crawler also identifies images and
associated descriptive information (meta data) to enable highly relevant search
results across various media types available on the Web. This capability insures
that Excalibur can retrieve and display relevant information from news or video
archives, as well as other multimedia repositories.
Mining
On-Demand
-
Excalibur optionally provides a set of mining and analysis tools designed to
provide greater insight and perspective over the search processes. This set
of
tools enable users to dynamically classify content into various views according
to their own unique requirements. The tools provide timeline analysis,
storyboarding, clustering, and itinerary generation tools to connect
information, people and events across time and space.
Technical
Support, Professional Services and Education
Convera
provides technical support and maintenance to customers through its technical
support personnel located in the Company’s Columbia, Maryland; Carlsbad,
California; and through certain product distributors. Technical support consists
of bug fixes, telephone support and upgrades or enhancements of particular
software product releases when and if they become generally available. Technical
support typically is provided to customers under a renewable annual contract.
All Convera service plan customers have access to the Convera Online Technical
Support Web site that provides the latest product information, general service
updates and Web forums for technical discussions. The Web site also provides
electronic forms for opening technical support cases and suggesting product,
service and Company enhancements.
The
Company also provides on-site consulting services to its customers through
employees and independent consultants who have been trained and certified by
the
Company. Consulting services are offered as a package or on a time-and-materials
or fixed price basis. The Company conducts training seminars at its offices
in
Vienna, Virginia; Carlsbad, California; and Bracknell, United Kingdom, as well
as on-site training for its customers and distribution channel partners.
Training customers typically pay on a per-course basis for regularly scheduled
classes and on a per-day basis for on-site or dedicated courses.
Marketing
and Distribution
The
Company’s sales and marketing strategy focuses on the licensing of Convera
products to customers both through a direct sales force and through distribution
partners and OEMs. Members of the North American direct sales team are primarily
located throughout the United States, and the majority of the international
direct sales team is located in the United Kingdom. Distribution throughout
the
Europe, Middle East, Africa and Asia Pacific regions is also covered by a
network of reseller partners. The Company typically licenses its RetrievalWare
products to end-users as either an enterprise-wide or work-group level solution.
The Excalibur Web offering may be sold as a hosted service in addition to the
license model.
The
Company generally has three license types: OEM, reseller and end-user. Each
of
these license types generally includes the same standard terms regarding such
things as confidentiality, infringement, indemnification and limitations of
liability. OEM licenses generally stipulate royalties due to the Company based
on the sale of the OEM customer’s product incorporating the Company’s
technology. OEM contracts generally require the customer to pay some of the
royalties in advance of the sale of their integrated product. Reseller licenses
generally include a predetermined discount or margin that the reseller is
required to pay the Company based on their sales of the Company’s products to
their customers. Reseller agreements are occasionally structured to include
minimum amounts due from the resellers in advance of their sales to end user
customers. This is generally in consideration for some type of exclusivity
arrangement in a particular territory. Generally, arrangements with OEM
customers and resellers are structured as term licenses ranging from two to
five
years. This provides future revenue opportunities to the Company through term
renewals. End-user license agreements are generally structured as perpetual
software licenses for a specific number of users and/or for use on a specific
number of servers. Payment terms generally tend to be shorter on end user
perpetual licenses compared to those of OEM licenses. Hosted service
arrangements, specifically
for the Excalibur Web offering, will utilize similar standard terms as noted
above regarding such things as confidentiality, infringement, indemnification
and limitations of liability and theses contracts are also expected to be
primarily structured based on a combination of usage and/or documents
thresholds.
Convera
focuses its sales and marketing efforts on enterprises that have large, rapidly
changing content collections in diverse formats and have large numbers of
knowledge workers. In that regard, the Company concentrates a significant amount
of sales and marketing resources on vertical markets such as government agencies
and media & publishing concerns. In addition, the Company has begun to adopt
a direct selling model with respect to its Excalibur Web offering while also
exploring the prospect of strategic partners or resellers who may provide
increased distribution, access to incremental human resources and possible
hosting facility alternatives.
Marketing
efforts focus on building brand awareness and establishing demand for the
Company’s products and include public relations, trade show participation,
electronic marketing campaigns, and advertising and telemarketing/lead
management activities. The Company’s web site, www.convera.com,
is an
integral part of its marketing and sales efforts, but information on the
Company's Web site is not a part of this Form 10-K. Through the web site,
prospective customers can learn about Convera’s suite of products and services
and view online demonstrations. Existing customers can enroll in training
courses and access password-protected areas for technical and other customer
support.
Product
Development and Advanced Research
The
Company’s research and development program focuses on enhancing and expanding
the capabilities of its products and services to address emerging markets and
customer requirements. Over time and as the technology evolves, RetrievalWare
is
expected to remain the basic building block of a modular suite of products
as
previously described for enterprise customers over the near-term. In addition
to
providing seamless access to both structured and unstructured data in the
enterprise, this modular approach simplifies system administration for the
customer and makes it easier for Convera to update existing features and add
new
components such as support for new data types and taxonomies for specific
vertical markets. The Excalibur Web offering is an open-source search
technology, capable of searching and indexing Web-based content, however, it
may
also evolve to offer certain internal search and categorization features similar
to that of RetrievalWare.
Certain
elements of the Company’s software products are supplied to the Company by other
independent software vendors under license agreements with varying terms.
Pursuant to these agreements, the Company makes periodic royalty payments
generally based on either actual or anticipated revenues or units. The
technologies acquired by the Company in this manner include word processing
filters, optical character recognition engines, dictionaries, language
analyzers, spider and thesauri in electronic form, image and audio processing,
and face and speech recognition technologies.
Protection
of Proprietary Technology
The
Company regards its software as proprietary and relies primarily on a
combination of patents, copyright, trademark and trade secret laws of general
applicability, employee confidentiality and invention assignment agreements,
software distribution protection agreements and other intellectual property
protection methods to safeguard its technology and software products. The
Company holds one patent related to its current business strategy. This
patent, which concerns multimedia document retrieval, expires on August 24,2018. The Company owns several other patents and patent applications unrelated
to its current business strategy. The Company is actively engaged in
seeking additional patents specifically related to its Excalibur Web offering.
The Company has undertaken to protect all significant marks used to identify
the
Company's core software products and related services. The Company owns U.S.
trademark registrations or pending applications for its material trademarks,
including CONVERA, RETRIEVALWARE, SCREENING ROOM and
EXCALIBUR. Renewals are due at various
dates between July 2008 and August 2013. In addition, the Company
owns numerous foreign applications and registrations for its material
trademarks.
Competition
in the information technology industry in general and the software development
industry in particular, is intense. Convera competes primarily in the search
and
categorization software market which all Convera products and services address.
Within this market, there are current and potential competitors who are larger
and more established than Convera and have significantly greater financial,
technical, marketing and other resources.
Convera
considers its principal competitive advantages to be an environment that: (1)
is
scalable due to the distributed-processing architecture, (2) provides more
accurate results due to the semantic network and APRP technologies, (3) provides
more comprehensive results due to its ability to manage and retrieve information
in multiple languages and in rich media file formats and (4) offers the ability
to provide “blended” search results involving data derived from an
organization’s internal data repositories with open source or Web-based content
through the use of the Company’s Excalibur Web offering.
There
can
be no assurance that the Company will be able to compete successfully against
current or future competitors or that competition will not materially affect
the
Company’s operating results and financial condition in an adverse
manner.
Government
Regulation
The
Company’s activities currently are subject to no particular regulation by
governmental agencies other than those routinely imposed on corporate businesses
and no such regulation is now anticipated.
Segment
Information
At
the
conclusion of fiscal 2005, the Company determined that it had two reportable
segments. Management viewed the core software products business (e.g.,
RetrievalWare) separately from its Excalibur Web offering. Substantially all
of
the Company’s revenues for fiscal 2006 were derived from third party customers
from within the core software products business. For fiscal year 2006, revenues
earned from the Excalibur Web offering totaled approximately $20,000.
Revenues
derived from contracts and orders issued by agencies of the U.S. Government
were
approximately $11.3 million, $11.6 million and $15.2 million, respectively,
in
the fiscal years ended January 31, 2006, 2005 and 2004. These revenues,
expressed as a percentage of total revenues for the aforementioned fiscal years,
were approximately 54%, 45% and 52%, respectively.
Financial
information is located in the consolidated financial statements beginning on
page F-4. Additional information related to segment reporting can be found
in
Note 13 to the consolidated financial statements contained herein.
Employees
The
Company had 179 employees at January 31, 2006, of whom 89 were in research
and
development; 30 in sales and marketing; 27 in finance and administration, 18
in
technical support, professional services and training and 15 in web hosting
operations. The employees are not covered by collective bargaining agreements,
and the management of the Company considers relations with employees to be
good.
Competition for qualified personnel within the Company’s industry is intense.
There can be no assurance that the Company will be able to continue to attract,
hire or retain qualified personnel, and the inability to do so could have a
material adverse effect upon the Company’s operating results and financial
condition.
An
investment in our common stock involves substantial risks and uncertainties
and
our actual results and future trends may differ materially from our past
performance due to a variety of factors, including, without limitation, the
risk
factors identified below. The
risks
and uncertainties described below are not the only risks and uncertainties
we
face. Additional risks and uncertainties not presently known to us or that
we
currently deem immaterial also may impair our business operations. If any of
the
following risks actually occur, our business, results of operations and
financial condition would suffer. In that event, the trading price of our common
stock could decline, and our stockholders may lose part or all of their
investment in our common stock. The discussion below and elsewhere in this
report also includes forward-looking statements, and our actual results may
differ substantially from those discussed in these forward-looking statements
as
a result of the risks discussed below.
We
have had a history of operating losses and will likely incur future
losses;
if our losses continue and we are unable to achieve profitability, our stock
price will likely suffer.
We
have
operated at a loss for each of the past three fiscal years. For the fiscal
years
ended January 31, 2006, 2005, and 2004, our net losses were approximately $14.3
million, $19.8 million, and $18.1 million, respectively. These losses include
expenditures associated with selling software products, further developing
software products during these years and developing our Excalibur Web offering.
We expect that our losses will continue for the foreseeable future as we
continue to invest in Excalibur and these other programs and, accordingly,
we
cannot assure you that we will be able to achieve or maintain profitability
in
the future. Our failure to achieve and sustain our profitability will negatively
impact the market price of our common stock.
Our
ability to achieve profitability is highly dependent on our Excalibur Web
offering and if Excalibur fails to achieve market acceptance we will be unable
to grow our business and achieve profitability.
We
have
expended significant financial resources, as well as management attention,
on
Excalibur and expect that our expenditures on Excalibur will continue to be
significant. We
believe
that our future profitability will depend on our ability to successfully market,
and achieve market acceptance for, Excalibur, our Web offering. The
degree of market acceptance of Excalibur will depend upon a number of factors,
including:
·
the
advantages of Excalibur over competing
products;
·
our
ability to innovate and develop new features for
Excalibur;
·
customer
needs for search products;
·
the
price and cost-effectiveness of Excalibur;
and
·
the
strength of sales, marketing and distribution
support.
We
are
aware of a significant number of competing well-established search products
offered by companies with significantly greater financial and marketing
resources than us. Even if Excalibur achieves market acceptance, we may not
be
able to maintain that market acceptance over time if competing products are
introduced that are viewed as more effective or are more favorably received
than
Excalibur. If Excalibur does not achieve and maintain market acceptance, we
will
not be able to generate sufficient revenue to attain profitability.
While
we believe we will have sufficient funds for our operations for at least the
next twelve months, it is possible that we will
need additional capital during
or after that time.We
may need additional capital in the future, and it may not be available on
acceptable terms, or at all, and if we do not receive any necessary additional
capital, it could harm our financial condition and future
prospects.
As
of
March 15, 2006, our balances of cash, cash equivalents and short-term
investments were approximately $65.4 million. We believe
our
current balance
of cash,
cash
equivalents
and
short-term investments, combined with any funds generated from our
operations
will be
sufficient to meet our working capital and capital expenditure requirements
for
at least the next
twelve
months
based
upon our estimates of funds required to operate our business during such
period.
However, during
or
after
that time, we may need to raise additional funds for the following
purposes:
to
fund our operations, including sales, marketing and research and
development programs including the Excalibur Web
offering;
·
to
fund any growth we may experience;
·
to
enhance and/or expand the range of products and services we
offer;
·
to
increase our promotional and marketing activities;
or
·
to
respond to competitive pressures and/or perceived opportunities,
such as
investment, acquisition and international expansion
activities.
We
cannot
reassure our investors that if we need additional capital that it will be
available, and if so, on terms beneficial to us. Historically, we have obtained
external financing primarily from sales of our common stock. To the extent
we
raise additional capital by issuing equity securities, our shareholders may
experience substantial dilution. If we are unable to obtain additional capital,
we may then attempt to preserve our available resources by various methods
including deferring the creation or satisfaction of commitments, reducing
expenditures on our research and development programs or otherwise scaling
back
our operations. If we were unable to raise such additional capital or defer
certain costs as described above, that inability would have an adverse effect
on
our financial position, results of operations and prospects.
We
experience quarterly fluctuations in our operating results, which may adversely
affect our stock price.
Our
quarterly operating results have varied substantially in the past. For
example, our total revenues for the four quarters of fiscal year 2006 were
$5.1
million, $7.8 million, $4.5 million and $3.6 million respectively, and the
price
per share of our common stock during those quarters ranged from $3.92 to
$20.20.
Our
quarterly operating results are likely to continue to vary substantially
from
quarter to quarter in the future, due to a variety of factors including the
following:
·
the
ability of Excalibur, our new Web offering to achieve market
acceptance;
·
the
downturn in capital spending by customers as a result of general
economic
conditions;
·
the
level of customer demand for our products and services, including
Excalibur;
·
the
delay or deferral of customer
implementations;
·
the
budget cycles of our customers;
·
seasonality
of individual customer buying
patterns;
·
an
increase in competition in the software and search
industries;
·
the
size and timing of individual
transactions;
·
the
timing of new software introductions and software enhancements
by us and
our competitors;
·
changes
in operating expenses and
personnel;
·
changes
in accounting principles, such as a requirement that stock options
be
included in compensation, which would increase our expense and
have a
negative effect on earnings;
·
the
overall trend towards industry consolidation;
and
·
changes
in general economic and geo-political conditions and specific economic
conditions in the computer and software
industries.
In
particular, our period-to-period operating results have historically been
dependent upon the timing of the closing of significant license agreements.
Since purchasing our software products often requires significant capital
investment, our customers may defer or decide not to make their purchases.
This
means sales can involve sales cycles of six months or more. We derive a
significant portion of our revenues from sales to agencies of the U.S.
Government, and, therefore, the budget cycle of the U.S. Government impacts
our
total revenues. In certain financial quarters, we may derive a significant
portion of our revenues from a single customer. For example, revenues derived
from one customer accounted for approximately 14% of our total revenues in
fiscal year 2006. We have historically recorded a significant portion of our
total quarterly license revenues in the third month of a quarter, with a
concentration of these revenues occurring in the last half of that third month.
We expect these revenue patterns to continue. Despite these uncertainties in
our
revenue patterns, we base our operating expenses upon anticipated revenue
levels, and we incur these expenses on an approximately ratable basis throughout
a quarter. As a result, if expected revenues are deferred or otherwise not
realized in a quarter for any reason, our business, operating results and
financial condition would be materially adversely affected.
In
addition, steps which we have taken or may take in the future to control
operating expenses may hamper our development, sales and marketing efforts
and,
ultimately, our operating results. For instance, we aligned our resources
through a number of reorganizations during fiscal years 2002 through 2005 to
attempt to focus on markets that have been consistently successful for us.
These
reorganizations were intended to streamline our professional services, customer
support and sales organizations by reducing the number of our employees, improve
the productivity of each of those organizations and reduce management personnel
and other overhead costs in our marketing, development and administrative
organizations. However, the loss of key personnel in such restructurings and
any
severance and other costs incurred in such restructurings could negatively
affect our quarterly operating results and adversely affect our stock
price.
We
are in an extremely competitive market, and if we fail to compete effectively
or
respond to rapid technological change, our revenues and market share will be
adversely affected
Our
business environment and the search and software industries in general are
characterized by intense competition, rapid technological changes, changes
in
customer requirements and emerging new market segments. Our competitors include
many companies that are larger and more established and have substantially
more
resources than us. Current and potential competitors have established or may
establish cooperative relationships among themselves or with third parties
to
increase the ability of their products to address the needs of the markets
which
we serve. Accordingly, it is possible that new competitors or alliances among
competitors may emerge and rapidly acquire significant market share. Increased
competition may result in price reductions, reduced gross margins and loss
of
market share, any of which could have a material adverse effect on our business,
financial condition or results of operations.
In
order
for our strategy to succeed and to remain competitive, we must leverage our
core
technology to develop new product offerings, update existing features and add
new components to our current products such as support for new datatypes and
taxonomies for specific vertical markets. These development efforts are
expensive, and we plan to fund these developments with our existing capital
resources, and other sources, such as equity issuances and borrowings, which
may
be available to us. If these developments do not generate substantial revenues,
our business and results of operations will be adversely affected. We cannot
assure you that we will successfully develop any new products, complete them
on
a timely basis or at all, achieve market acceptance or generate significant
revenues with them.
We
design our products to work with certain systems and changes to these systems
may render our products incompatible with these systems, and we may be unable
to
sell our products
Our
ability to sell our products depends on the compatibility of our products with
other software and hardware products. These products may change or new products
may appear that are incompatible with our products. If we fail to adapt our
products to remain compatible with other vendors' software and hardware products
or fail to adapt our products as quickly as our competitors, we may be unable
to
sell our products.
Our
software products are complex and may contain errors that could damage our
reputation and decrease sales
Our
complex software products may contain errors that people may detect at any
point
in the products’ life cycles. We cannot assure you that, despite our testing and
quality assurance efforts and similar efforts by current and potential
customers, errors will not be found. The discovery of an error may result in
loss of or delay in market acceptance and sales.
We
derive a significant portion of our revenues from sales to U.S. Government
agencies, which are subject to budget cuts and, consequently, a change in the
size and timing of our U.S. Government contracts may materially affect our
operating results
For
the
year ended January 31, 2006, total revenues derived from sales to agencies
of
the U.S. Government were approximately $11.3 million, representing 54% of total
revenues. For the year ended January 31, 2005, revenues derived from sales
to
agencies of the U.S. Government were approximately $11.6 million, or 45% of
total revenues. While the U.S. Government has recently increased spending on
defense, information systems and homeland security initiatives, some government
agencies have realized budget reductions which may adversely impact their
purchasing decisions
and timing. We are actively pursuing several opportunities for business with
certain U.S. Government agencies. While the nature and timing of these
opportunities, as well as the ability to complete business transactions related
to these opportunities, is subject to certain risks and uncertainties,
successful completion of any of these transactions could have a material impact
on our future operating results and financial position. There can be no
assurance that we will complete any of these potential
transactions.
As
a U.S. Government contractor, we are subject to a number of procurement rules
and regulations.
We
must
comply with and are affected by laws and regulations relating to the award,
administration and performance of U.S. Government contracts. Government contract
laws and regulations affect how we do business with our customers and, in some
instances, impose added costs on our business. In some instances, these laws
and
regulations impose terms or rights that are more favorable to the government
than those typically available to commercial parties in negotiated transactions.
A violation of specific laws and regulations could result in the imposition
of
fines and penalties or the termination of our contracts or debarment from
bidding on contracts.
We
depend on international sales, particularly in the United Kingdom,
andany
economic downturn, changes in laws, changes in currency exchange rates or
political unrest in the United Kingdom or in other countries could have a
material adverse effect on our business
For
the
year ended January 31, 2006, total revenues derived from international sales
were approximately $5.2 million, representing approximately 25% of total
revenues. For the year ended January 31, 2005, revenues derived from
international sales were approximately $7.5 million, representing approximately
29% of total revenues. Most of our international sales are in the United
Kingdom. Our
international operations have historically exposed us to longer accounts
receivable and payment cycles and fluctuations in currency exchange rates.
International sales are made mostly from our U.K. subsidiary and are denominated
in British pounds or Euros. As of January 31, 2006, approximately 6% and 11%
of
our total consolidated accounts receivable were denominated in British pounds
and Euros, respectively. Additionally, our exposure to foreign exchange rate
fluctuations arises in part from intercompany accounts in which royalties on
our
foreign subsidiary’s sales are charged to our foreign subsidiary and recorded as
intercompany receivables on our books. We are also exposed to foreign exchange
rate fluctuations as the financial results of our foreign subsidiary are
translated into U.S. dollars in consolidation. Since exchange rates vary, those
results when translated may vary from expectations and adversely impact overall
expected profitability.
Our
international operations expose us to a variety of other risks that could
seriously impede our financial condition and growth. These risks include the
following:
·
potentially
adverse tax consequences;
·
difficulties
in complying with regulatory requirements and
standards;
·
trade
restrictions and changes in
tariffs;
·
import
and export license requirements and restrictions;
and
·
uncertainty
of the effective protection of our intellectual property rights in
certain
foreign countries.
If
any of
these risks described above materialize, our international sales could decrease
and our foreign operations could suffer.
Our
Excalibur Web offering relies on a third party hosting facility, and any failure
or interruption in the services provided by this third party could harm our
ability to operate our business and damage our reputation.
We
rely
on AT&T for both our primary and back-up hosting facilities to support our
Excalibur Web offering. We do not control the operation of these AT&T
facilities and each may be subject to damage or interruption from earthquakes,
floods, fires, power loss, telecommunications failures or similar events. These
facilities may also be subject to break-ins, sabotage, intentional acts of
vandalism or similar misconduct. Despite precautions taken at these facilities,
the occurrence of a natural disaster, cessation of operations by our third-party
web hosting provider or its decision to close a facility without adequate notice
or other unanticipated problems at either facility could result in lengthy
interruptions in our service. In addition, the failure by these facilities
to
provide our required data communications
capacity could result in interruptions in our service. Interruptions in our
service may cause us to lose revenue, cause us to issue credits or refunds
and
cause customers to terminate their contracts with us. Our business and
reputation will be adversely affected if our customers and potential customers
believe our Excalibur service is unreliable.
We
depend on proprietary technology licensed from third parties; if we lose these
licenses, it could delay shipments of products incorporating this technology
and
could be costly
Our
products use certain technology that we license from third parties, generally
on
a nonexclusive basis. We believe that there are alternative sources for each
of
the material components of technology we license from third parties. However,
the termination of any of these licenses, or the failure of the third-party
licensors to adequately maintain or update their products, could delay our
ability to ship these products while we seek to implement technology offered
by
alternative sources. Any required replacement licenses could prove costly.
Also,
any delay, to the extent it becomes extended or occurs at or near the end of
a
fiscal quarter, could harm our quarterly results of operations. While it may
be
necessary or desirable in the future to obtain other licenses relating to one
or
more of our products or relating to current or future technologies, we cannot
assure that we will be able to do so on commercially reasonable terms or at
all.
Because
of the technical nature of our business, our intellectual property is extremely
important to our business, and adverse changes to our intellectual property
could harm our competitive position
We
believe that our success depends, in part, on our ability to protect our
proprietary rights and technology. Historically, we have relied on a combination
of copyright, patents, trademark and trade secret laws, employee confidentiality
and invention assignment agreements, distribution and OEM software protection
agreements and other methods to safeguard our technology and software products.
Risks associated with our intellectual property, include the
following:
·
pending
patent applications may not be
issued;
·
intellectual
property laws may not protect our intellectual property
rights;
·
third
parties may challenge, invalidate, or circumvent any patent issued
to
us;
·
rights
granted under patents issued to us may not provide competitive advantages
to us;
·
unauthorized
parties may attempt to obtain and use information that we regard
as
proprietary despite our efforts to protect our proprietary
rights;
·
others
may independently develop similar technology or design around any
patents
issued to us; and
·
effective
protection of intellectual property rights may be limited or unavailable
in some foreign countries in which we
operate.
We
may in the future be subject to intellectual property rights claims, which
are
costly to defend, could require us to pay damages and could limit our ability
to
use certain technologies in the future.
Companies
in the software and technology industries own large numbers of patents,
copyrights, trademarks and trade secrets and frequently enter into litigation
based on allegations of infringement or other violations of intellectual
property rights. We face the possibility of intellectual property rights claims
against us. Our technologies may not be able to withstand any third-party claims
or rights against their use. Any intellectual property claims, with or without
merit, could be time-consuming, expensive to litigate or settle and could divert
management resources and attention.
With
respect to any intellectual property rights claim, we may have to pay damages
or
stop using technology if it is ultimately found by a court to be in violation
of
a third party’s rights. We may have to seek a license for the technology, which
may not be available on reasonable terms and may significantly increase our
operating expenses. The technology also may not be available for license to
us
at all. As a result, we may also be required to develop alternative
non-infringing technology, which could require significant effort and expense.
If we cannot license or develop technology for the infringing aspects of our
business, we may be forced to limit our product and service offerings and may
be
unable to compete effectively. Any of these results could harm our operating
results.
We
depend on our key personnel, the loss of whom would adversely affect our
business, and we may have difficulty attracting and retaining skilled
employees
Our
success depends to a significant degree upon the continued contributions of
our
key management, marketing, technical and operational personnel. We generally
do
not utilize employment agreements for our key employees. The loss of the
services of one or more key employees could have a material adverse effect
on
our operating results. We also believe that our future success will depend
in
large part upon our ability to attract and retain additional highly skilled
management, technical, marketing, product development, operational personnel
and
consultants. Competition for such personnel, particularly software developers,
professional service consultants and other technical personnel, is intense,
and
pay scales in the software industry have significantly increased. There can
be
no assurance that we will be successful in attracting and retaining such
personnel.
Our
stock price may fluctuate which may make it difficult to resell shares of our
stock
The
market price of our common stock has been highly volatile. For example, in
the
fourth quarter of fiscal year 2006, the market price per share of our common
stock ranged from $7.85 to $20.20. This volatility may adversely affect the
price of our common stock, and our stockholders may not be able to resell their
shares of common stock following periods of volatility because of the market's
adverse reaction to this volatility. We anticipate that this volatility, which
frequently affects the stock of software companies, will continue. Factors
that
could cause such volatility include:
·
future
announcements concerning us or our
competitors;
·
quarterly
variations in our operating
results;
·
actual
or anticipated announcements of technical innovations or new product
developments by us or our
competitors;
·
general
conditions in our industry;
·
developments
concerning litigation; and
·
worldwide
economic and financial conditions.
On
occasion, the equity markets, and in particular the markets for software
companies have experienced significant price and volume fluctuations. These
fluctuations have affected the market price for many companies' securities
and
may be unrelated to the companies' operating performance.
We
may not be able to use net operating loss carryforwards
As
of
January 31, 2006, we had net operating loss carryforwards of approximately
$185
million. The deferred tax assets representing the benefits of these
carryforwards have been offset completely by a valuation allowance due to our
lack of an earnings history. The realization of the benefits of these
carryforwards depends on sufficient taxable income in future years. Lack of
future earnings could adversely affect our ability to utilize these
carryforwards. Additionally, past or future changes in our ownership and control
could limit the ability to utilize these carryforwards. Despite the
carryforwards, we may have income tax liability in future years due to the
application of the alternative minimum tax rules of the United States Internal
Revenue Code.
Our
amended and restated certificate of incorporation, bylaws, ownership and
Delaware law contain provisions that could discourage a third party from
acquiring us and consequently decrease the market value of an investment in
our
stock
Some
provisions of our amended and restated certificate of incorporation and bylaws
and of Delaware law could delay or prevent a change of control or changes in
our
management that a stockholder might consider favorable. Any delay or prevention
of a change of control or change in management could cause the market price
of
our common stock to decline.
Allen
Holding Inc. and related parties exercise voting control over a significant
percentage of our outstanding shares, and our other shareholders may not have
an
effective say in any matters upon which our shareholders
vote
As
of
March 1, 2006, Allen Holding Inc., together with Allen & Company
Incorporated, Herbert A. Allen and certain related parties (collectively “Allen
& Company”) beneficially owned approximately 43% of our voting power, and
would therefore be able to effectively control the outcome of matters requiring
a stockholder vote. These matters could include offers to acquire us and
elections of directors. Allen & Company may have interests which are
different than the interests of our other stockholders.
The
Company’s corporate headquarters facility is occupied under a lease agreement
that expires in December 2007 for a total of approximately 13,200 square feet
of
space in an office building located at 1921 Gallows Road, Vienna, Virginia22182.
The
Company’s principal development and customer support centers are located in
Carlsbad, California and Columbia, Maryland. The Company leases additional
space
in Montreal, Canada, and Bracknell, United Kingdom. During fiscal 2006 the
Company closed its office in Frankfurt, Germany.
The
Company believes that its facilities are maintained in good operating condition
and are adequate for its operations.
On
November 1, 2001, DSMC, Incorporated ("DSMCi") filed a complaint against the
Company in the U.S. District Court for the District of Columbia in which it
alleged that the Company misappropriated DSMCi's trade secrets, and engaged
in
civil conspiracy with the NGT Library, Inc. ("NGTL"), an affiliate of the
National Geographic Society, to obtain access to DSMCi's trade secrets, and
was
unjustly enriched by the Company's alleged access to and use of such trade
secrets. In its complaint, DSMCi seeks $5 million in actual damages and $10
million in punitive damages from the Company. DSMCi subsequently amended its
complaint to add copyright infringement-related claims. NGTL intervened in
the
litigation as a co-defendant with Convera, and filed counterclaims against
DSMCi. Convera moved to compel arbitration of DSMCi's claims; the District
Court
denied the motion, and Convera filed an interlocutory appeal. The D.C. Circuit,
in November 2003, ruled that it did not have jurisdiction to consider the
appeal. During December 2005 DSMCi and NGTL entered into a Settlement Agreement
and Release. The U.S. District Court dismissed claims against NGTL on
December 23, 2005. The litigation between the Company and DSMCi is currently
in
the summary judgment phase in the District Court. The
Company has investigated the claims and continues to believe that the claims
are
without merit.
In
connection with this litigation, the Company brought an arbitration claim
against NGTL on September 13, 2005, seeking indemnification for its defense
costs and potential liability pursuant to an indemnity provision in a service
agreement between NGTL and the Company. In response, NGTL brought a cross claim
against the Company under the same contract provision for indemnification of
NGTL’s respective costs and liability. This arbitration is in its early stage.
In
addition, from time to time, the Company is a party to various legal
proceedings, claims, disputes and litigation arising in the ordinary course
of
business, including that noted above. The Company believes that the ultimate
outcome of these matters, individually and in the aggregate, will not have
a
material adverse affect on its financial position, operations or cash flow.
However, because of the nature and inherent uncertainties of litigation, should
the outcome of these actions or future actions be unfavorable, Convera’s
financial position, operations and cash flows could be materially adversely
affected.
Item
4.Submission
of Matters to a Vote of Security Holders
Item
5.Market
for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities
The
Company's Class A common stock is traded in the over--the-counter market and
is
listed on the National Market System of the NASDAQ Stock Market under the symbol
“CNVR.”
The
following table sets forth the high and low sale prices for Convera common
stock
for the period from February 1, 2004 through January 31, 2006, as reported
by
the National Market System of NASDAQ. The number of shareholders of record
as of
January 31, 2006 was 928. The Company has never declared or paid dividends
on
its common stock and anticipates that, for the foreseeable future, it will
not
pay dividends on its common stock.
The
selected financial data presented below have been derived from the Company’s
consolidated financial statements. The balance sheet data as of January 31,2006
and 2005, and the statement of operations data for the fiscal years ended
January 31, 2006, 2005 and 2004 should be read in conjunction with the
consolidated financial statements and notes thereto included elsewhere in this
Annual Report on Form 10-K.
Item
7.Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
Overview
The
Company principally earns revenues from the licensing of its software products
and the provision of services in deployment of the Company’s technology to
government agencies and commercial businesses throughout North America, Europe
and other parts of the world. The Company licenses its software to end users
directly and also distributes its software products through license agreements
with value-added resellers, system integrators, original equipment manufacturers
and other strategic partners. Revenues are generated from software licenses
with
customers and from the related sale of product maintenance, training and
professional services. Additions to the number of authorized users, licenses
issued for additional products and the renewal of product maintenance
arrangements by customers pursuant to existing licenses also provide revenues
to
the Company. Under software maintenance contracts, customers are typically
entitled to receive telephone support, software bug fixes and upgrades or
enhancements of particular software products when and if they are released.
With
respect to the Company’s Excalibur Web offering, revenues may be derived from
either a license model as described, or from a hosted service
offering.
The
Company believes its RetrievalWare product has unique capabilities supporting
the needs of customers within government agencies that will enable it to
capitalize on current market opportunities and achieve its operational goals.
Going forward, the Company expects to focus a substantial amount of resources
on
further penetration of the national security, defense, law enforcement and
intelligence gathering community with the United States and its allies. An
important objective in this market is to upgrade existing installations of
older
versions of RetrievalWare to the RetrievalWare 8 platform that includes
technical advancements such as categorization, dynamic classification, profiling
and distributed indexing software capabilities.
Further,
the Company expects to increase its development, selling & marketing efforts
with regard to its Excalibur Web offering. Excalibur is an advanced effort
aimed
at applying portions of the Company’s existing technology to searching and
indexing contextually relevant information on the Web. The Company launched
the
Excalibur platform on November 1, 2005 and has begun to focus on creating
distribution channels for this new technology. In concert with the Excalibur
Web
offering, Convera has entered into a hosting facility agreement with AT&T
and as of January 31, 2006, has established two hosting centers (San Diego,
CA
and Dallas, TX). The Company will look to focus a majority of its selling and
marketing efforts on the government and intelligence gathering community as
well
as the media and publishing sector for the Excalibur Web offering. This selling
and marketing strategy is designed to capitalize on the alignment between
customer requirements seeking both Intranet and Web-based search and
categorization technologies. Operating costs for this advanced development
effort totaled approximately $8.1 million for fiscal 2006, while capital
expenditures totaled approximately $6.6 million for the year ended January31,2006. Going-forward, cash outlays will be limited to equipment, personnel and
general operating costs, including marketing activities. The Company expects
to
continue to increase its investment in Excalibur and may also elect to seek
additional funding sources for this effort. The Company may also elect to seek
additional and/or alternative market segments for the Excalibur offering over
the coming quarters.
Management’s
primary objective is to achieve profitability and positive cash flow from
operations without hampering development, sales and marketing efforts. The
Company is committed to investing in the enhancement of its products to meet
the
needs of its customers and prospects. To achieve its main objective, the Company
continually evaluates revenue opportunities to determine the market sectors
in
which the Company should concentrate its sales and marketing efforts. The
Company’s business environment and the search software industry in general are
characterized by intense competition, rapid technological changes, changes
in
customer requirements and emerging new market segments. The Company competes
within the commercial sector where its market position has not been as strong
as
it has been within the government sector. As such, the Company has elected
to
focus the majority of its efforts within the commercial setting on the media
and
publishing sectors. The Company believes this segment may afford greater
opportunities when compared to addressing a wide array of commercial market
segments. The Company’s competitors include many companies that are larger and
more established and have substantially more resources. Accordingly, it is
possible that new competitors or alliances among competitors may emerge and
rapidly acquire significant market share. Increased competition may result
in
price reductions, reduced gross margins and loss of market share, any of which
could have a material adverse effect on the Company’s business, financial
condition or results of operations. To address the competition, the Company
will
continue to invest in research and development to advance its leadership
position in linguistic analysis, scalability, performance,
and taxonomy development and deployment. The Company may also make additional
investments in specific product features to better serve the needs of customers
looking for online customer service and support solutions and with regard to
the
Excalibur Web offering, may elect to create a public search portal.
In
2002
and 2003, the Company’s results of operations were impacted by the general
downturn in the economy, which resulted in a lengthier sales cycle, particularly
in the commercial marketplace. Further, reduced information technology budgets
and customer cash constraints caused by the difficult business environment
negatively impacted our business. Through a number of reorganizations during
fiscal years 2002 through 2005, the Company aligned its resources in an effort
to ensure it continued to capitalize on markets that have been consistently
successful, including the federal government, and to focus its resources on
those areas of the commercial sector that present vertical market opportunities.
The reorganizations, which are described in this section and elsewhere in this
Form 10-K, were intended to streamline the professional services, customer
support and sales organizations by reducing the number of employees, improve
the
productivity of each of those organizations and reduce management personnel
and
other overhead costs in the marketing, development and administrative
organizations within the Company.
On
August18, 2004, the Company announced that it further streamlined its expense
structure. As
part
of the restructuring, the Company reduced its personnel related costs,
eliminated certain marketing programs, renegotiated real estate obligations
and
decreased other general operating expenses.
The
Company recorded a restructuring charge of $518,000 during the third quarter
of
fiscal 2005 related to this effort. Further, on
December 10, 2004the Company announced an additional re-alignment of its
operational infrastructure. This
action included a general workforce reduction (including the transfer of certain
resources to the Company’s Excalibur Web offering), facility consolidations,
reduced marketing related expenses and decreased other general operating costs.
As part of this restructuring, the Company also announced that it would increase
its focus on accelerating its Excalibur development activities and would seek
to
advance the Company’s existing presence in the high-end search market,
specifically within the government and intelligence gathering community as
well
as the media and publishing sectors. The Company recorded a net restructuring
charge of $426,000 during the fourth quarter of fiscal 2005 related to this
effort. The Company will continue to invest in its Excalibur Web offering,
such
that on a consolidated basis, the Company is expected to remain in a net loss
position until such time as Excalibur is accepted into the commercial
marketplace and certain levels of revenue are attained. A detailed review of
the
numerous risks and challenges facing the Company is contained in the Risk
Factors section beginning on page 12.
Critical
Accounting Policies
Convera’s
consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States. For a
comprehensive discussion of the Company’s accounting policies, see Note 2 in the
accompanying consolidated financial statements included in this Form 10-K.
Convera does not have any material ownership interest in any entities that
are
not wholly owned and consolidated subsidiaries of the Company. The preparation
of these financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Management bases those estimates, including those related
to
bad debts, goodwill and other intangible assets, restructuring costs, income
taxes and litigation, on historical experience and other factors that are
believed to be reasonable under the circumstances, the results of which form
the
basis for making judgments about the carrying value of assets, liabilities
and
equity that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions.
Convera
believes the following accounting policies affect the more significant judgments
and estimates used in the preparation of the Company’s financial condition and
results of operations.
Revenue
Recognition
Convera’s
recognition of revenues requires judgment, particularly in the areas of
collectibility and whether the fee is fixed and determinable at the time the
sales are made. The Company bases its judgment on a variety of factors,
including the payment and other terms of the individual customer contracts,
credit history of the customer, prior dealings with specific customers, and
certain other factors. If the Company determines that the price under the
contract
is fixed and determinable, and that collectibility is reasonably assured, then
the Company recognizes revenue related to the software license at the time
of
sale. To the extent the Company determines that the price of a sales agreement
is not fixed, the Company delays revenue recognition until payments under the
contract become due. Alternatively, to the extent the Company determines that
the collection of payments under the contract is not reasonably assured, the
Company delays revenue recognition until the payments under the contract are
received. Thus, the assessment as to whether the fee is fixed and determinable
at the time of sale and that the fees are collectible is critical in determining
the extent of the revenue recognized in a given period.
The
revenue associated with other elements of the contract, such as maintenance,
training and professional services, are deferred and recognized as those
elements are delivered. Generally, the Company receives payments for maintenance
fees in advance and they are non-refundable. Maintenance revenues are recognized
ratably over the term of the applicable maintenance agreement, which is
typically twelve months.
Customization
work is sometimes required to ensure that the Company’s software functionality
meets the requirements of its customers. In those instances where the Company’s
revenues are generated from fixed price contracts related to this customization
work, then revenue is generally recognized using the percentage of completion
method based on the relationship of actual costs incurred to total costs
estimated over the duration of the contract. These cost estimates underlie
the
Company’s determinations as to overall contract profitability and the timing of
revenue recognition. Further, the Company believes that this method of
recognition is closely aligned with the evolution of the work product as
defined. If the Company does not accurately estimate the resources required
or
the scope of the work to be performed, or does not manage its projects properly
within the planned periods of time or satisfy its obligations under the
contracts, then actual results may differ from projected results and losses
on
contracts may need to be recognized.
Hosted
service revenues associated with the Excalibur Web offering are recognized
straight-line over the term of the applicable service agreement.
Provision
for Doubtful Accounts
Convera
maintains an allowance for doubtful accounts for estimated losses resulting
from
the inability of its customers to make required payments. A considerable amount
of judgment is required in assessing the ultimate realization of individual
accounts receivable balances. The allowance for doubtful accounts is determined
based on an analysis of the Company’s historical collection experience and the
Company’s portfolio of customers taking into consideration the general economic
environment as well as the industry in which the Company operates. To the extent
Convera does not recognize deterioration in its customers’ financial condition
in the period it occurs, or to the extent Convera does not accurately estimate
its customers’ ability to pay, the amount of bad debt expense recognized in a
given reporting period will be impacted.
Goodwill
and Other Intangible Assets
Convera’s
prior acquisitions of other companies resulted in the acquisition of certain
intangible assets and goodwill. Goodwill resulting from these acquisitions
is
associated with the Company’s core software products reporting segment. In
accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142,
“Goodwill and Other Intangible Assets”, the impairment of goodwill is assessed
on an annual basis or whenever changes in circumstances indicate that the fair
value of the Company is less than the carrying value. This assessment is
performed by comparing the market value of the Company’s outstanding common
stock with the carrying amount of the Company’s net assets. If the market value
exceeds the carrying amount of the Company’s net assets, impairment of goodwill
does not exist. If the market value is less than the carrying amount of the
Company’s net assets, the Company will perform further analysis and may be
required to record an impairment.
The
Company evaluates all of its long-lived assets, including intangible assets
other than goodwill, for impairment in accordance with the provisions of SFAS
No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS
No. 144 requires that long-lived assets and intangible assets other than
goodwill be evaluated for impairment whenever events or changes in circumstances
indicate that the carrying value of an asset may not be recoverable based on
expected undiscounted cash flows attributable to that asset. Should events
indicate that any of the Company’s assets are impaired; the amount of such
impairment will be measured as the difference between the carrying
value and the fair value of the impaired asset and recorded in earnings during
the period of such impairment.
Convera
records a valuation allowance to reduce its deferred tax assets to the amount
that is more likely than not to be realized. Realization of the deferred tax
assets is principally dependent upon the achievement of projected future taxable
income. If the estimates and related assumptions change in the future, the
Company may be required to adjust its valuation allowance against its deferred
tax assets, resulting in a benefit or a charge to income in the period such
determination is made. As of January 31, 2006, the Company has recorded a full
valuation allowance against the net deferred tax asset.
Stock-Based
Compensation
SFAS
No.
123, “Accounting for Stock-Based Compensation” (“SFAS 123”), allows companies to
account for stock-based compensation either under the provisions of SFAS No.
123
or under the provisions of Accounting Principles Board Opinion No. 25,
“Accounting for Stock Issued to Employees” (“APB 25”), as amended by FASB
Interpretation No. 44, “Accounting for Certain Transactions Involving Stock
Compensation (an interpretation of APB Opinion No. 25).”The Company has elected
to account for its stock-based compensation in accordance with the provisions
of
APB 25. Stock options originally granted under the Company’s stock option plans
have an exercise price equal to the market value of the underlying common stock
on the date of grant, and accordingly no employee compensation cost related
to
the initial grant of options is included in expenses. Stock option modifications
associated with a change in employee status to a nonemployee have been accounted
for as a new award and measured using the intrinsic value method under APB
25,
resulting in the inclusion of compensation expense in the January 31, 2004
consolidated statement of operations. Nonvested shares of stock (referred to
as
deferred stock) granted under the Company’s stock option plan are measured at
fair value on the date of grant based on the number of shares granted and the
quoted price of the Company’s common stock. Such value is recognized as
compensation expense over the corresponding service period. If an employee
leaves the Company prior to the vesting of the deferred stock, the estimate
of
compensation expense recorded in previous periods is adjusted by decreasing
compensation expense in the period of forfeiture.
Results
of Operations
For
the
fiscal year ended January 31, 2006, total revenues were $21.0 million, a
decrease of 18% compared to revenues of $25.7 million in fiscal year 2005.
The
net loss for fiscal year 2006 was $14.3 million, or $0.33 per common share,
compared to $19.8 million, or $0.56 per common share, in the prior year. For
the
fiscal year ended January 31, 2005, total revenues decreased 12% from total
revenues of $29.3 million in fiscal year 2004. The net loss for fiscal year
2004
was $18.1 million, or $0.57 per common share.
The
following charts summarize the components of revenues and the categories of
expenses, including the amounts expressed as a percentage of total revenues,
for
each of the three fiscal years in the period ended January 31, 2006 (dollars
in
thousands):
License
revenues for the year ended January 31, 2006 decreased 26% to $10.6 million
from
$14.4 million in fiscal year 2005 and decreased 22% in fiscal year 2005 from
$18.3 million in fiscal year 2004. The average deal size for fiscal year 2006
was approximately $164,000 representing a 26% increase when compared to the
prior fiscal year. Approximately 63 license transactions were realized during
fiscal year 2006, a 42% decrease compared to approximately 109 for fiscal year
2005. The average deal size in fiscal year 2004 was approximately $110,000
and
was comprised of approximately 165 total deals closed. The decrease in total
license revenues in fiscal year 2006 compared to fiscal year 2005 is primarily
attributed to three factors: 1) A shift in marketing and selling efforts towards
the recently released Excalibur Web offering, 2) A decrease in international
transactions due primarily to a large compliance related transaction recognized
during the first quarter of fiscal 2005 and the absence of a like-sized
transaction in fiscal 2006, and 3) A decrease in the commercial RetrievalWare
business segment due to management’s prior decision to temper its selling and
marketing activities within this market segment. Federal license revenues
increased slightly compared to the prior fiscal year. The decrease in total
license revenues for fiscal year 2005 compared to fiscal year 2004 is primarily
attributable to a $3.4 million federal enterprise transaction recognized during
the third quarter of fiscal 2004 and the absence of a like-sized transaction
in
fiscal 2005 coupled with lengthier sales cycles.
Services
revenues, which include professional services, training, and hosted Web services
were $2.4 million for the year ended January 31, 2006, a 36% decrease when
compared to services revenues of $3.7 million for fiscal year 2005. Services
revenues for fiscal 2005 decreased 14% versus services revenues of $4.3 million
for fiscal year 2004. The decline in fiscal year 2006 services revenues versus
fiscal year 2005 was due primarily to a decline in professional services
revenues in our federal and commercial business segments resulting from the
conclusion of two major engagements. Those declines were offset by improvements
in professional services revenues in our international operations. The decline
in fiscal year 2005 professional services revenues versus fiscal year 2004
was
primarily due to the completion of two major contracts from within the Company’s
international operation, which was partially offset by one U.S. commercial
engagement. Federal professional services revenues for fiscal year 2005 mirrored
fiscal year 2004.
Maintenance
revenues were $8.0 million for the year ended January 31, 2006, compared to
$7.6
million and $6.6 million for fiscal years 2005 and 2004. The increase in
maintenance revenues during the prior two fiscal years can be attributed
to the
fiscal year 2005 implementation of new maintenance renewal processes and a
continued emphasis on identifying lapsed renewals from within the existing
customer base.
Revenues
from international operations are generated from software licenses with various
European commercial and government customers and a well-established European
reseller network. The Company's international sales operation, Convera
Technologies International, Ltd. (“CTIL”), is headquartered in the United
Kingdom. CTIL satellite offices in Paris, France and Munich, Germany were closed
during fiscal year 2005. International revenues from CTIL decreased 30% to
$5.2
million in fiscal year 2006 from $7.5 million in fiscal year 2005 due to a
decrease in license revenues as a result of the aforementioned large compliance
related transaction recognized during the first quarter of fiscal 2005 and
the
absence of a like-sized transaction in fiscal 2006. In fiscal year 2005,
international revenues increased 4% from $7.2 million in fiscal year 2004 due
to
increases in license and maintenance revenue offset by a decline in services
revenue.
Revenues
derived
from contracts and orders issued by agencies of the U.S. Government were
approximately 54%, 45%, and 52%, of total revenues for fiscal years 2006, 2005,
and 2004, respectively. In fiscal year 2006 one customer accounted for
approximately 14% of revenues. One reseller customer accounted for approximately
17% of revenues in fiscal year 2005.
Operating
Expenses
Cost
of Revenues
Cost
of
license revenues decreased 17% to $1.4 million for the year ended January 31,2006, and decreased 9% to $1.7 million in fiscal year 2005. As a percentage
of
license revenues, cost of license revenues was 13% for fiscal year 2006, 12%
for
fiscal year 2005, and 10% for fiscal year 2004. The decrease in cost of license
revenues over the last three fiscal years can be primarily attributed to a
decrease in third party royalty obligations.
Cost
of
services revenues increased 47% to $4.9 million for the year ended January31,2006 from $3.3 million in fiscal year 2005. Cost of services revenues decreased
29% in fiscal year 2005 from $4.7 million in fiscal year 2004. The increase
in
cost of services revenues during fiscal 2006 as compared to fiscal 2005 is
attributed to costs associated with the management of two AT&T hosting
facilities from the period of November 1, 2005 (attainment of commercial
availability) through January 31, 2006 for the Excalibur Web offering. Cost
of
professional services revenues for fiscal year 2006 was consistent with the
prior year. The decrease in cost of services revenues in fiscal year 2005 versus
2004 is attributable to a reduction in the overall number of employees
responsible for the management and delivery of professional services.
Cost
of
maintenance revenues for the year ended January 31, 2006 decreased 43% to $1.0
million from fiscal 2005 and decreased 15% to $1.7 million in fiscal year 2005
when compared to fiscal year 2004. As a percentage of maintenance revenues,
cost
of maintenance revenues was 12%, 23%, and 31% in fiscal years 2006, 2005, and
2004 respectively. The decrease in cost of maintenance revenues in fiscal years
2006 and 2005 is attributed to lower personnel-related costs resulting from
the
restructuring actions undertaken in fiscal year 2005.
Sales
& Marketing
Sales
and
marketing expenses decreased 43% to $8.2 million for the year ended January31,2006 from $14.5 million in fiscal year 2005. In fiscal year 2005, sales and
marketing expenses decreased 20% to $14.5 million from $18.1 million in fiscal
year 2004. As a percentage of total revenues, sales and marketing expenses
were
39%, 56%, and 62% in fiscal years 2006, 2005, and 2004 respectively. The
decrease in sales and marketing expenses for fiscal year 2006 is attributed
to
lower personnel-related costs stemming from the fiscal 2005 restructurings
that
resulted in a 47% year-over-year decrease in average monthly headcount, and
lower marketing programs costs. The decrease in sales and marketing expenses
for
fiscal year 2005 is attributed to lower personnel costs stemming from the
aforementioned restructurings, a decreased emphasis on the commercial enterprise
sector for the RetrievalWare product line, reduced marketing program costs
(e.g., trade shows, advertising, etc.) and a decrease in bad debt
expense.
Research
and Development
Reported
research and product development costs decreased 40% to $8.3 million for the
year ended January 31, 2006 from $13.8 million in fiscal year 2005, representing
40% and 54% of total revenues respectively. As previously disclosed, the Company
adopted FAS 86 during the first quarter of fiscal 2006, resulting in the
capitalization of approximately $8.1 million of research and development costs
for the first three quarters of fiscal year 2006. Absent the adoption of FAS
86,
gross research and development costs grew 19% in fiscal year 2006 when compared
to $13.8 million for fiscal year 2005. This increase is attributed to costs
associated with the establishment and management of two AT&T hosting
facilities and certain consulting fees for the period of February 1, 2005
(attainment of technological feasibility) through October 31, 2005 for the
Excalibur Web offering. For fiscal year 2005, research and product development
costs increased 15% from $12.0 million as reported in fiscal year 2004. The
increase in fiscal year 2005 research and development expenses was due to
increased personnel-related costs associated with Excalibur Web activities,
which accounted for approximately $4.2 million of fiscal year 2005
costs.
General
and Administrative
General
and administrative expenses grew by 14% to $11.1 million for the year ended
January 31, 2006 from $9.8 million in fiscal year 2005, representing 53% and
38%
of total revenues, respectively. In fiscal year 2005, general and administrative
expenses decreased 8% from $10.6 million in fiscal year 2004. The increase
in
fiscal year 2006 general and administrative costs is due to higher accountancy
fees associated with the Company’s required Section 404 compliance efforts under
the Sarbanes-Oxley Act. The decrease in fiscal year 2005 general and
administrative costs is due to reduced employee-related costs resulting from
the
restructurings as implemented across the year and reduced other general
operating costs.
Amortization
of capitalized research & product development costs
For
the
year ending January 31, 2006, the Company amortized approximately $1.0 million
of previously capitalized research and product development costs in accordance
with FAS 86 associated with the Excalibur Web offering. With commercial
availability of the Excalibur Web offering being achieved on November 1, 2005,
amortization of the
previously capitalized research & product development costs totaling
approximately $8.1 million commenced. This amortization is expected to continue
over a 24-month period, and as such, each of the next seven quarters is expected
to incur a similar $1 million amortization charge.
During
fiscal year 2006 the Company recorded a $57,000 restructuring credit to account
for the reversal of previously accrued utilities expense for the Hillsboro,
Oregon facility. The early termination of that lease caused this
reversal.
During
fiscal year 2005 the Company effected a re-alignment of its operational
infrastructure to align its expense structure with expected future revenue
streams. Restructurings in both the third and fourth quarters of fiscal 2005
totaling $0.9 million were implemented to reduce operating expenses through
general workforce reductions, facility consolidations, reduced marketing related
expenses and decreased other general operating costs. In connection with these
restructurings, the Company reduced its workforce by 77 employees worldwide,
including 23 employees from within the engineering group, 30 from the sales
and
marketing group, 19 from the professional services group, and five from the
general and administrative group.
The
Company paid approximately $0.8 million, $1.6 million, and $1.9 million against
the restructuring reserve in the fiscal years ended January 31, 2006, 2005
and
2004, respectively. As of January 31, 2006, there are no outstanding severance
obligations. As of January 31, 2005 unpaid amounts of $0.1 million representing
employee severance benefits and $0.7 million representing facility-related
charges, had been classified as a current restructuring reserve in the
accompanying consolidated balance sheet.
Other
income
Other
income increased to $0.6 million in fiscal year 2006 from $0.2 million in fiscal
year 2005 due to a higher average quarterly cash balance and higher interest
yields. Other income decreased to $0.2 million in fiscal year 2005 from $2.6
million in fiscal year 2004.
The
Company has obligations under certain contractual arrangements to make future
payments for goods and services. These contractual obligations secure the future
rights to various assets and services to be used in the normal course of
operations. For example, the Company is contractually committed to make certain
minimum lease payments for the use of property under operating lease agreements.
In accordance with applicable accounting rules, the future rights and
obligations pertaining to firm commitments such as operating lease obligations
and certain purchase obligations under contracts are not reflected as assets
or
liabilities on the accompanying consolidated balance sheet.
As
of
January 31, 2006, the Company had the following contractual obligations
associated with its lease commitments, debt facility and other contractual
obligations for the periods indicated below:
Contractual
Obligations
Payments
Due By Fiscal Period (in thousands)
Total
2007
2008-2009
2010-2011
2012
and thereafter
Operating
leases
$
2,417
$
1,570
$
847
$
-
$
-
Debt
facility
5,750
1,604
3,712
434
-
Other
contractual obligations
808
638
170
-
-
Total
$
8,975
$
3,812
$
4,729
$
434
$
-
·
Operating
lease obligations — represents the minimum lease rental payments
under non-cancelable leases, primarily for the Company’s office space and
operating equipment in various locations around the
world.
·
Debt
facility - represents the required amounts of principal and interest
payments due.
·
Other
contractual obligations — represents the principal amounts due on
outstanding contractual obligations relating to hosting agreements
between
the Company and AT&T related to the Excalibur Web
offering
Liquidity
and Capital Resources
The
Company’s combined balance of cash, cash equivalents and short-term investments
at January 31, 2006 as compared to January 31, 2005 is summarized below (in
thousands).
As
of
January 31, 2006, the Company’s balances of cash, cash equivalents and
short-term investments were $37.8 million.
The
Company believes that its current balance of cash, cash equivalents,
investments, funds generated from operations, if any, and the proceeds from
its
February 2006 private placement (see note 17 to the financial statements,
Subsequent Events) will be sufficient to fund the Company's current projected
cash needs for at least the next twelve months. Historically the Company has
primarily been financed by sales of its common stock. If the actions taken
by
management are not effective in achieving profitable operating results, the
Company may be required to pursue additional expense reductions and/or external
sources of financing in the future to support its operations and capital
requirements. There can be no assurances that external sources of financing
will
be available if required, or that such financing will be available on terms
acceptable to the Company.
On
March23, 2005the Company secured a $5 million term loan from Silicon Valley Bank,
the primary subsidiary of Silicon Valley Bancshares (NASDAQ: SIVB). The
four-year, term facility provided financing for capital purchases including
those for its Excalibur Web offering. The loan was retired on February 28,2006,
concurrent with the private placement completed on February 28, 2006 (see note
17 to the financial statements, Subsequent Events).
In
fiscal
year 2006, the Company’s operating activities utilized $8.4 million of net cash
and cash equivalents, compared to $19.9 million in fiscal year 2005. Net cash
used in operating activities was $15.5 million in fiscal year 2004. The fiscal
year 2006 net loss of $14.3 million was offset by non-cash charges totaling
approximately $5.7 million, consisting primarily of depreciation of $2.9
million, equity compensation expense of $1.6 million and amortization of $1.3
million. A reduction to accounts receivable provided $2.0 million. Cash was
also
provided from a reduction in prepaid expenses and other of $0.7 million and
an
increase to deferred revenues of $0.1 million. Decreases to accounts payable,
accrued expenses, accrued bonuses used cash of $2.0 million while paydown of
the
restructuring reserve used net cash of $0.8 million. The fiscal year 2005 net
loss of $19.8 million was offset by non-cash charges totaling $2.8 million,
consisting primarily of depreciation of $1.6 million, equity compensation
expense of $1.4 million and amortization of developed technologies of $0.3
million. A reversal to the provision for doubtful accounts and a non-cash
restructuring credit reduced the non-cash charges by $0.4 million and $0.1
million, respectively. Cash was provided from a reduction in prepaid expenses
and other of $0.9 million and an increase to deferred revenues of $0.5 million.
An increase to accounts receivable used cash of $0.6 million. Decreases to
accounts payable, accrued expenses, accrued bonuses and the restructuring
reserve used net cash of $2.1 million. A decrease to other long-term liabilities
used $1.6 million. The fiscal year 2004 net loss of $18.1 million was offset
by
non-cash charges totaling $2.8 million, consisting primarily of depreciation
of
$1.7 million, equity compensation expense of $0.8 million and amortization
of
developed technologies of $0.3 million. Cash was provided from a reduction
in
accounts receivable of $1.5 million and a decrease in prepaid expense and other
of $1.0 million. A decrease in accounts payable, accrued expense and accrued
bonuses and an increase in other long-term liabilities used net cash of $2.3
million. A decrease in the restructuring reserve used $1.3 million, while an
increase in deferred revenues contributed $0.9 million of net cash.
Cash
Flows Used in Investing Activities
In
fiscal
year 2006 cash flows from investing activities used $15.0 million, consisting
of
$6.9 million for purchases of equipment and leasehold improvements and $8.1
million for capitalized software development costs required under FAS 86. Of
the
$6.9 million used for purchases of equipment and leasehold improvements,
approximately $6.6 million was related to the Excalibur Web offering. In fiscal
year 2005 cash flows from investing activities used $5.0 million for purchases
of equipment and leasehold improvements. Of this, $4.1 million was related
to
the Excalibur Web offering. Cash flows from investing activities provided the
Company $19.5 million of cash in fiscal year 2004. Net cash provided from the
maturity of U.S. Treasury bills provided cash of $20.0 million, while purchases
of equipment and leasehold improvements used cash of $0.5 million
Cash
Flows Provided by Financing Activities
Financing
activities provided cash of $43.4 million during the fiscal year ended January31, 2006. Approximately $28.8 million of net proceeds were received through
a
July
2005 private placement of 6,555,556 newly-issued shares of common stock to
two
investors. The Company sold 5,555,556 shares directly to the Legg Mason
Opportunity Trust, a series of Legg Mason Investment Trust, Inc., a registered
investment company, at $4.50 per share. The other 1 million shares were
purchased by an affiliate of Herbert A. Allen, a significant stockholder and
director of the Company, at $4.84 per share, the market price at the time of
the
sale.
An
additional $5.0 million was secured from a March 2005, four-year, term loan
financing from Silicon Valley Bank. The exercise of employee stock options
provided approximately $9.7 million while approximately $215,000 was provided
by
the issuance of stock under the employee stock purchase plan offset by the
repurchase of shares totaling $225,000. Financing activities provided cash
of
$12.2 million in fiscal year 2005. A private
placement of 3,433,333 newly-issued shares of common stock to several investors,
including affiliates of Allen & Company Incorporated, a significant
stockholder of the company, and certain directors resulted in net proceeds
of
$10.3 million. The shares were priced on September 7, 2004 at $3.00 per share,
representing a premium to the $2.80 closing market price on such date.
Additionally, cash of approximately
$0.2 million was provided by the issuance of stock under the employee stock
purchase plan offset by the repurchase of shares totaling $121,000. Cash of
$1.8
million was provided from the exercise of employee stock options. Financing
activities provided approximately $16.8 million of cash in fiscal year 2004,
including net proceeds of $16.0 million from a private placement and proceeds
of
$0.8 million from the issuance of stock under the employee stock purchase plan,
the issuance of warrants and the exercise of stock options
The
Company believes that inflation has not had a material effect on the results
of
its operations to date.
Recent
Pronouncements
On
December 16, 2004, the Financial Accounting Standards Board ("FASB") issued
SFAS
No. 123 (revised 2004), Share-Based Payment ("SFAS No. 123(R)"), which is a
revision of SFAS No. 123. SFAS No. 123(R) Supersedes APB No. 25, and amends
SFAS
No. 95, Statement of Cash Flows. Generally, the approach in SFAS No. 123(R)
is
similar to the approach described in SFAS No. 123; however, SFAS No. 123(R)
requires all share-based payments to employees, including grants of employee
stock options, to be recognized in the statements of operations based on their
fair values. Pro forma disclosure is no longer an alternative upon adopting
SFAS
No. 123(R). The Company will adopt SFAS No. 123(R) on February 1, 2006. SFAS
No.
123(R) permits public companies to adopt its requirements using one of two
methods: i. A "modified prospective" method in which compensation cost is
recognized beginning with the effective date (a) based on the requirements
of
SFAS No. 123(R) for all share-based payments granted after the effective date
and (b) based on the requirements of SFAS No. 123(R) for all awards granted
to
employees prior to the effective date of SFAS 123(R) that remain unvested on
the
effective date. ii. A "modified retrospective" method which includes the
requirements of the modified prospective method described above, but also
permits entities to restate based on the amounts previously recognized under
SFAS No. 123 for purposes of pro forma disclosures for either (a) all prior
periods presented or (b) prior interim periods of the year of adoption. The
Company will implement SFAS No. 123(R) in the first quarter or fiscal year
2007
and intends to use the modified prospective method.
Item
7A. Quantitative
and Qualitative Disclosures about Market Risk
The
Company's market risk is principally confined to changes in foreign currency
exchange rates and potentially adverse effects of differing tax structures.
International revenues from CTIL, the Company's foreign sales subsidiary located
in the United Kingdom were approximately 25% of total revenues in fiscal year
2006. International sales are made predominantly from the Company's foreign
subsidiary and are typically denominated in British pounds, EUROs or U.S.
Dollars. As of January 31, 2006, approximately 6% and 11% of total consolidated
accounts receivable were denominated in British pounds and EUROs, respectively.
The majority of these receivables are due within 90 days of the end of fiscal
year 2006, and all receivables are due within one year. Additionally, the
Company is exposed to potential foreign currency gains or losses resulting
from
intercompany accounts that are not of a long-term nature. The Company is also
exposed to foreign exchange rate fluctuations as the financial results of CTIL
are translated into U.S. dollars in consolidation. As exchange rates vary,
those
results when translated may vary from expectations and adversely impact overall
expected profitability.
As
of
January 31, 2006, less than one percent of the Company’s cash and cash
equivalents were denominated in British pounds and EUROs, respectively. Cash
equivalents consist of funds deposited in money market accounts with original
maturities of three months or less. Short-term investments consist primarily
of
U.S. Government treasury bills and are carried at amortized cost. The Company
also has a certificate of deposit for $71,000, which is pledged to collateralize
a letter of credit required for a leased facility. Given the relatively short
maturity periods of cash equivalents and short-term investments, the cost of
these investments approximates their fair values and the Company’s exposure to
fluctuations in interest rates is limited.
As
of the
end of the period covered by this Annual Report on Form 10-K, the Company,
under
the supervision and with the participation of its management, including the
Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness
of the design and operation of the Company’s “disclosure controls and
procedures” (as defined in Rule 13a-15(e) under the Securities Exchange Act
of 1934 (the “Exchange Act”)). Based on that evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that the Company’s disclosure
controls and procedures were effective to provide reasonable assurance that
information required to be disclosed in the Company's Exchange Act reports
is
recorded, processed, summarized and reported within the time periods specified
by the Securities and Exchange Commission, and that material information
relating to the Company and its consolidated subsidiaries is accumulated and
communicated to management, including the Chief Executive Officer and Chief
Financial Officer, as appropriate to allow timely decisions regarding required
disclosure.
(b)
Management’s
Report on Internal Control over Financial
Reporting
Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rules
13a-15(f). Our management conducted an evaluation of the effectiveness of our
internal control over financial reporting based on the framework in Internal
Control—Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission. Based on this evaluation under the framework in
Internal Control—Integrated Framework, our management concluded that our
internal control over financial reporting was effective as of January 31,2006.
Our
management’s assessment of the effectiveness of our internal control over
financial reporting as of January 31, 2006, has been audited by Ernst &
Young LLP, an independent registered public accounting firm, as stated in their
report which is included herein.
(c)
Changes
in Internal Controls
There
were no changes in the Company’s internal control over financial reporting that
occurred during the fourth quarter of fiscal 2006 that have materially affected,
or are reasonably likely to materially affect, the Company’s internal control
over financial reporting.
Item
10.Directors
and Executive Officers of the Registrant
Information
regarding directors and executive officers of the Company will be included
in
the Company's definitive Proxy Statement for the 2006 Annual Meeting of
Shareholders and is incorporated in this report by reference.
The
Company has adopted a written code of conduct and ethics (the "Code") which
is
applicable to all of the Company's officers, directors and employees, including
the Company's Chief Executive Officer and Chief Financial Officer (collectively,
the "Senior Officers"). In accordance with the rules and regulations of the
Securities and Exchange Commission and the rules of the NASDAQ Stock Market,
a
copy of the Code has been posted on the Company's website at www.convera.com.
The
Company intends to disclose any changes in or waivers from the Code applicable
to any Senior Officers on its website or by filing a Form 8-K.
Information
regarding executive compensation will be included in the Company’s definitive
Proxy Statement for the 2006 Annual Meeting of Shareholders and is incorporated
in this report by reference.
Item
12.Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
Information
regarding security ownership of certain beneficial owners and management and
related stockholder matters will be included in the Company’s definitive Proxy
Statement for the 2006 Annual Meeting of Shareholders and is incorporated in
this report by reference.
Item
13.Certain
Relationships and Related Transactions
Information
concerning certain relationships and related transactions, if any, will be
included in the Company’s definitive Proxy Statement for the 2006 Annual Meeting
of Shareholders and is incorporated in this report by reference.
Information
regarding principal accounting fees and services will be included in the
Company’s definitive Proxy Statement for the 2006 Annual Meeting of Shareholders
and is incorporated in this report by reference.
Item
15.Exhibits
and Financial Statement Schedules
(a)Documents
filed as part of Form 10-K
1.Financial
Statements:
The
following financial statements of the Company are submitted in a
separate
section pursuant to the requirements of Form 10-K, Part I, Item 8
and Part
IV, Items 14(a) and 14(d):
Index
to
Consolidated Financial Statements
Report
of
Independent Registered Public Accounting Firm
Consolidated
Balance Sheets
Consolidated
Statements of Operations and Comprehensive Loss
Consolidated
Statements of Shareholders' Equity
Consolidated
Statements of Cash Flows
Notes
to
Consolidated Financial Statements
2.Schedules
Supporting Financial Statements:
All
schedules are omitted because they are not required, are inapplicable, or the
information is otherwise shown in the consolidated financial statements or
notes
to the consolidated financial statements.
Pu
Persuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Pu
Persuant 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.
The
management of Convera Corporation (the “Company”) is responsible for
establishing and maintaining adequate internal control over financial reporting
and for the assessment of the effectiveness of internal control over financial
reporting. As defined by the SEC, internal control over financial reporting
is a
process designed under the supervision of the Company’s principal executive,
principal financial and principal accounting officers, and effected by the
Company’s board of directors, management and other personnel, to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements in accordance with generally accepted
accounting principles.
The
Company’s internal control over financial reporting is supported by written
policies and procedures, that (1) pertain to the maintenance of records that,
in
reasonable detail, accurately and fairly reflect the transactions and
dispositions of the Company’s assets; (2) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and
that
receipts and expenditures of the Company are being made only in accordance
with
authorizations of the Company’s management and directors; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use or disposition of the Company’s assets that could have a
material effect on the financial statements.
Because
of its inherent limitations, internal control over financial reporting may
not
prevent or detect misstatements. Projections of any evaluation of effectiveness
to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
Management
of the Company conducted an assessment of the effectiveness of the Company’s
internal control over financial reporting as of January 31, 2006 based on
criteria established in Internal Control—Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (“the COSO
Framework”). Based on this assessment, management has concluded that the
Company’s internal control over financial reporting was effective as of January31, 2006.
Management’s
assessment of the effectiveness of the Company’s internal control over financial
reporting as of January 31, 2006, has been audited by Ernst & Young LLP, the
registered public accounting firm that audited the Company’s consolidated
financial statements, as stated in their report, a copy of which is included
in
this Annual Report on Form 10-K.
We
have
audited the accompanying consolidated balance sheets of Convera Corporation
as
of January 31, 2006 and 2005, and the related consolidated statements of
operations, shareholders’ equity, and cash flows for each of the three years in
the period ended January 31, 2006. These consolidated financial statements
are
the responsibility of the Company’s management. Our responsibility is to express
an opinion on these consolidated financial statements based on our
audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (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 financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Convera Corporation
at
January 31, 2006 and 2005, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended January 31,2006,
in conformity with U.S. generally accepted accounting principles.
We
also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of Convera Corporation’s
internal control over financial reporting as of January 31, 2006, based on
criteria established in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report
dated March 21, 2006 expressed an unqualified opinion thereon.
REPORT
OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board
of
Directors and Shareholders
Convera
Corporation
We
have
audited management’s assessment, included in the accompanying Management’s
Annual Report on Internal Control Over Financial Reporting, that Convera
Corporation maintained effective internal control over financial reporting
as of
January 31, 2006, based on criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (the COSO criteria). Convera Corporation’s management is responsible
for maintaining effective internal control over financial reporting and for
its
assessment of the effectiveness of internal control over financial reporting.
Our responsibility is to express an opinion on management’s assessment and an
opinion on the effectiveness of the company’s internal control over financial
reporting based on our audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control
over
financial reporting, evaluating management’s assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing
such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain
to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors
of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.
Because
of its inherent limitations, internal control over financial reporting may
not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In
our
opinion, management’s assessment that Convera Corporation maintained effective
internal control over financial reporting as of January 31, 2006, is fairly
stated, in all material respects, based on the COSO criteria. Also, in our
opinion, Convera Corporation maintained, in all material respects, effective
internal control over financial reporting as of January 31, 2006, based
onthe
COSO
criteria.
We
also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of Convera
Corporation as of January 31, 2006 and 2005, and the related consolidated
statements of operations, shareholders’ equity, and cash flows for each of the
three years in the period ended January 31, 2006 of Convera Corporation and
our
report dated March 21, 2006 expressed an unqualified opinion
thereon.
Accounts
receivable, net of allowance for doubtful accounts of $218 and
$537,
respectively
4,364
6,530
Prepaid
expenses and other
2,396
2,390
Total
current assets
44,572
26,757
Equipment
and leasehold improvements, net of accumulated depreciation of
$15,683 and
$13,940, respectively
9,152
5,145
Other
assets
819
1,551
Capitalized
research and development costs
7,102
-
Goodwill
2,275
2,275
Other
intangible assets, net of accumulated amortization of $1,049 and
$780,
respectively
297
566
Total
assets
$
64,217
$
36,294
LIABILITIES
AND SHAREHOLDERS’ EQUITY
Current
Liabilities:
Accounts
payable
1,367
1,967
Accrued
expenses
2,680
4,055
Restructuring
reserve
-
835
Deferred
revenues
3,931
4,279
Current
maturities of long-term debt
1,283
-
Total
current liabilities
9,261
11,136
Deferred
revenues - long-term
398
9
Long-term
debt, net of current portion
3,717
-
Total
liabilities
13,376
11,145
Commitments
and Contingencies
Shareholders'
Equity:
Common
stock Class A, $0.01 par value, 100,000,000 shares authorized;
47,803,186
and 38,740,215 shares issued, respectively;
47,128,833 and 38,013,807 shares outstanding, respectively
477
387
Treasury
stock at cost, 674,353 and 726,408 shares, respectively
(dollars
in thousands, except share and per share data)
(1)THE
COMPANY
Operations
and Organization
Convera
Corporation (“Convera” or the “Company”) was established through the combination
on December 21, 2000 of the former Excalibur Technologies Corporation
(“Excalibur”) and Intel Corporation’s (“Intel”) Interactive Media Services
(“IMS”) division (the “Combination”).
As
of
January 31, 2006 Allen Holding, Inc., together with Allen & Company
Incorporated, Herbert A. Allen and certain related parties (collectively “Allen
& Company”) beneficially owned approximately 47% of the voting power of
Convera. As of January 31, 2005 and 2004, Allen & Company beneficially owned
more than 50% of the voting power of Convera.
Convera
principally earns revenues from the licensing of its software products and
the
provision of services in deployment of the Company’s technology to government
agencies and commercial businesses throughout North America, Europe and other
parts of the world. The Company licenses its software to end users directly
and
also distributes its software products through license agreements with system
integrators, original equipment manufacturers, resellers and other strategic
partners. Revenues are generated from software licenses with customers and
from
the related sale of product maintenance, training and professional services.
Further, during fiscal year 2005, the Company embarked on an advanced Web
indexing development effort focused on applying portions of the Company’s
existing technology to also locate contextually relevant information on the
World Wide Web (the “Web”). On November 1, 2005the Company announced that the
Excalibur Web offering was commercially available as the technology had advanced
to then contain more than 4 billion documents in the index and a redundant
hosting environment was established with AT&T. The Company began focusing
much of its selling and marketing resources on establishing distribution
channels for this technology. The Company is targeting both the commercial
and
the government sectors for the Excalibur Web offering at this time. Excalibur
revenues may be derived from either a license model as described, or from a
hosted service offering.
The
Company’s operations are subject to certain risks and uncertainties including,
but not limited to, the effect of general business and economic trends; the
ability to continue funding operating losses and achieve profitability; the
ability of Excalibur to gain market acceptance; the availability of additional
capital financing on terms acceptable to the Company, if at all; fluctuations
in
operating results including impacts from reduced corporate IT spending and
lengthier sales cycles; reduced customer demand for the Company’s products and
services; continued success in technological advances and development including
the Excalibur Web offering; the delay or deferral of customer software
implementations; the potential for U.S. Government agencies from which the
Company has historically derived a significant portion of its revenues to be
subject to budget cuts; a dependence on international sales; actual and
potential competition by entities with greater financial resources, experience
and market presence than the Company; reliance on third party hosting facilities
for our Excalibur Web offering; changes in software and hardware products that
may render the Company’s products incompatible with these systems; the potential
for errors in its software products that may result in loss of or delay in
market acceptance and sales; the dependence on proprietary technology licensed
from third parties; possible adverse changes to the Company’s intellectual
property which could harm its competitive position; the need to retain key
personnel; the ability of the Company to use net operating loss carryforwards;
and the present ownership structure of the Company which includes Allen Holdings
Inc. and related parties who exercise voting control of the Company such that
other shareholders will not have an effective say in any matters upon which
its
shareholders vote. Although
management believes that its current cash position is sufficient to sustain
operations through January 31, 2007, should cash needs dictate, additional
cost
saving measures could be enacted to conserve cash.
The
consolidated financial statements include the accounts of Convera Corporation
and its wholly owned subsidiaries. All significant intercompany transactions
and
accounts have been eliminated.
Use
of Estimates
The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Revenue
Recognition
The
Company recognizes revenue in accordance with American Institute of Certified
Public Accountants’
Statement of Position 97-2, Software Revenue Recognition, as amended by
Statement of Position 98-9, Software Revenue Recognition, with respect to
certain transactions.
Revenue
from the sale of software licenses is recognized upon shipment of product,
provided that the fee is fixed and determinable, persuasive evidence of an
arrangement exists and collection of the resulting receivable is considered
probable. Historically, the Company has not experienced significant returns
or
exchanges of its products.
Revenue
from training and professional services is recognized when the services are
performed. Such services are sold as part of a bundled software license
agreement as well as separately to customers who have previously purchased
software licenses. When training or professional services that are not essential
to the functionality of the software are sold as part of a bundled license
agreement, the fair value of these services, based on the price charged for
the
services when sold separately, is deferred and recognized when the services
are
performed.
To
the
extent that a discount exists in a multiple element or “bundled” arrangement
that includes a software license, the Company attributes that discount entirely
to the delivered elements utilizing the residual method as described in
paragraph 12 of SOP 97-2 as amended by SOP 98-9. The Company generally utilizes
the residual methodology for recognizing revenue related to multi-element
software agreements. Under the residual methodology, the Company recognizes
the
arrangement fee as follows: (a) the total fair value of the undelivered
elements, as indicated by vendor-specific objective evidence, is deferred and
(b) the difference between the total arrangement fee and the amount deferred
for
the undelivered elements is recognized as revenue related to the delivered
elements. This assumes that (a) all other applicable revenue recognition
criteria in SOP 97-2 are met and (b) the fair value of all of the undelivered
elements is less than the arrangement fee.
Certain
of the Company’s customers are Original Equipment Manufacturers (OEMs) and
resellers. OEM contracts generally stipulate prepaid royalties due at varying
dates as well as royalties due to the Company on the sale of the customer's
integrated product over a specified contract term, generally ranging from two
to
five years. With prepaid royalties, the Company recognizes revenue upon
shipment of the software and/or software developer's kit, as appropriate,
provided the payment terms are considered normal and customary for these types
of arrangements, the fee is considered fixed and determinable, and all other
criteria within SOP 97-2 have been met. To the extent the
OEM product sales exceed the level provided for by the guaranteed
prepaid royalty and additional royalties are due, the Company generally
recognizes the additional royalties as the sales occur and are reported to
the Company. Reseller contracts generally stipulate royalties due to the Company
on the resale of the Company's products and call for a guaranteed minimum
royalty payment in exchange for the right to sell the Company's products within
a specified territory over a specified period of time. The Company
recognizes the prepaid royalties as revenue upon delivery of the initial copy
of
the software, provided the payment terms are considered normal and customary
for
these types of arrangements, the fee is considered fixed and determinable,
and
all other criteria within SOP 97-2 have been met. To the extent the reseller's
product sales exceed the level provided for by the guaranteed minimum royalty
and additional royalties
are due, the Company generally recognizes the additional royalties as the
reseller sales occur and are reported to the Company.
Customization
work is sometimes required to ensure that the Company’s software functionality
meets the requirements of its customers. Under these circumstances, the
Company’s revenues are derived from fixed price contracts and revenue is
recognized using the percentage of completion method based on the relationship
of actual costs incurred to total costs estimated over the duration of the
contract. Further, the Company believes that this method of recognition is
closely aligned with the evolution of the work product as defined. Estimated
losses on such contracts are charged against earnings in the period such losses
are identified.
Maintenance
revenue related to customer support agreements is deferred and recognized
ratably over the term of the respective agreements. Customer support agreements
generally include bug fixes, telephone support and product release upgrades
on a
when and if available basis. When the Company provides a software license and
the related customer support arrangement for one bundled price, the fair value
of the customer support, based on the price charged for that element when sold
separately, is deferred and recognized ratably over the term of the respective
agreement.
Deferred
revenue consists of deferred training and professional services revenues,
deferred maintenance revenues and deferred license revenues.
Hosted
service revenues associated with the Excalibur Web offering are recognized
straight-line over the term of the applicable service agreement.
The
Company incurs shipping and handling costs which are recorded in cost of license
revenues.
Research
and Development Costs
Software
development costs are included in research and development and are expensed
as
incurred. Statement of Financial Accounting Standards (“SFAS”) No. 86,
“Accounting for the Cost of Computer Software to be Sold, Leased or Otherwise
Marketed” requires the capitalization of certain software development costs once
technological feasibility is established, which for the Company generally occurs
upon completion of a working model. Capitalization ceases when the products
are
available for general release to customers, at which time amortization of the
capitalized costs begins on a straight-line basis over the estimated product
life, or on the ratio of current revenues to total projected product revenues,
whichever is greater. Historically, the period between achieving technological
feasibility and the general availability of the Company’s core software products
has been short, and software development costs qualifying for capitalization
have been insignificant. Accordingly, the Company has not capitalized any
software development costs related to its core software products, that being
the
RetrievalWare product suite. The Company’s new Excalibur Web offering
encountered a longer period between technological feasibility and the attainment
of commercial availability. The Excalibur Web offering was determined to have
reached technological feasibility as of January 31, 2005. As a result, the
Company began capitalizing software development costs related to the Excalibur
Web offering during the first quarter of fiscal year 2006 and continued to
do so
until such time as “commercial availability” was determined. Effective November1, 2005, based on commercial availability, capitalization of software
development costs associated with the Excalibur Web offering ceased and
amortization of previously capitalized software development costs for this
offering commenced. This amortization is expected to continue over a twenty-four
month period, the estimated useful life of the existing product.
Advertising
Advertising
costs are expensed as incurred and included with sales and marketing in the
consolidated statements of operations and comprehensive loss. The Company
incurred approximately $55, $197 and $449 in advertising costs for the years
ended January 31, 2006, 2005 and 2004, respectively.
Stock-based
Compensation
SFAS
No.
123, “Accounting for Stock-Based Compensation” (“SFAS 123”), allows companies to
account for stock-based compensation either under the provisions of SFAS No.
123
or under the provisions of Accounting Principles Board Opinion No. 25,
“Accounting for Stock Issued to Employees” (“APB 25”), as amended by FASB
Interpretation No. 44, “Accounting for Certain Transactions Involving Stock
Compensation (an interpretation of APB Opinion No. 25).”
The
Company has elected to account for its stock-based compensation in accordance
with the provisions of APB 25. Stock options originally granted under the
Company’s stock option plans have an exercise price equal to the market value of
the underlying common stock on the date of grant, and accordingly no employee
compensation cost related to the initial grant of options is included in
expenses. Stock option modifications associated with a change in employee status
to a nonemployee have been accounted for as a new award and measured using
the
intrinsic value method under APB 25, resulting in the inclusion of compensation
expense in the January 31, 2004 consolidated statement of operations. Nonvested
shares of stock (referred to as deferred stock) granted under the Company’s
stock option plan are measured at fair value on the date of grant based on
the
number of shares granted and the quoted price of the Company’s common stock.
Such value is recognized as compensation expense over the corresponding service
period. If an employee leaves the Company prior to the vesting of the deferred
stock, the estimate of compensation expense recorded in previous periods is
adjusted by decreasing compensation expense in the period of forfeiture.
Had
compensation cost for the Company’s stock-based compensation plans been
determined based on the fair value at the grant dates for awards made under
the
respective plans in fiscal years 2006, 2005 and 2004 consistent with the method
of SFAS No. 123, the Company’s net loss and basic and diluted net loss per
common share would have been increased to the pro forma amounts indicated
below.
2006
2005
2004
Net
loss, as reported
$
(14,261
)
$
(19,820
)
$
(18,059
)
Stock-based
compensation, as reported
1,419
1,416
788
Total
stock-based compensation determined under fair value based method
for all
awards
(5,539
)
(6,274
)
(6,773
)
Pro
forma net loss
$
(18,381
)
$
(24,678
)
$
(24,044
)
Basic
and diluted net loss per common share, as
reported
($0.33
)
($0.56
)
($0.57
)
Basic
and diluted net loss per common share, pro
forma
($0.43
)
($0.70
)
($0.76
)
The
pro
forma net loss after applying the provisions of SFAS No. 123 is not necessarily
representative of the effects on reported net loss for future years due to,
among other things, vesting period of the stock options and the fair value
of
additional options in future years.
The
fair
value of each option was estimated on the date of grant using the Black-Scholes
option-pricing model. The following table shows the assumptions used for the
grants that occurred in each fiscal year.
2006
2005
2004
Expected
volatility
80%
90%
96%
Risk
free interest rates
3.9%
to 4.4%
3.1%
to 3.8%
2.5%
to 3.3%
Dividend
yield
None
None
None
Expected
lives
5
years
5
years
5
years
The
weighted average fair value per share for stock option grants that were awarded
in fiscal years 2006, 2005 and 2004 was $4.40, $3.20 and $3.01, respectively.
See Note 11 for additional information related to the Company’s stock
compensation plans.
During
fiscal year 2004, pursuant to the Company’s 2000 Stock Option Plan, several
senior officers of the Company were awarded an aggregate of 1,800,000 shares
of
deferred stock with a five-year cliff vesting provision. Pursuant to a May
2003
deferred stock agreement as amended in May 2004, Mr. Condo was awarded 600,000
deferred shares of the Company's common stock. Under the amended agreement,
150,000 shares of common stock vest on each consecutive one-year anniversary
of
the date of grant as long as Mr. Condo remains continuously employed with the
Company through such vesting date. Notwithstanding such vesting schedule, all
of
the deferred shares will vest on the earlier occurrence of Mr. Condo's
termination of employment without cause, death or disability or a change of
control of the Company. On May 20, 2004, and 2005, in accordance with the terms
of the amended deferred stock agreement, tranches totaling 150,000 shares each
vested. On both of these vest dates the Company withheld 48,675 of the shares
at
a cost of approximately $121,000 and $225,000, respectively, to fulfill Mr.
Condo’s tax obligation with respect to the
award. The deferred stock covering the remaining 700,000 shares, which is held
by several senior officers, has a five-year cliff vesting provision, or vests
immediately upon a change in control. The weighted-average fair value of the
awards granted in fiscal year 2004 was $4.84 per share, based on the market
price of the Company’s stock on the date of award. Compensation cost for Mr.
Condo’s stock award is expensed on a straight-line basis over the four-year
vesting period. Compensation cost for the remaining 700,000 shares is expensed
on a straight-line basis over the five-year vesting period. In October 2005
an
additional 200,000 shares of deferred stock were awarded to a new senior
officer. This grant also carries a five-year cliff vesting provision, or vest
immediately upon a change in control followed (a) by the officer’s continuous
employment for a period of 12 months or (b) within 12 months by a termination
of
employment without cause, or a substantial diminution of the officer's duties
and responsibilities compared to that immediately prior to the change of
control. The fair value of the awards granted in October 2005 was $12.76 per
share, based on the market price of the Company’s stock on the date of the
award. Compensation expense, net of reversals for terminated employees, recorded
by the Company in fiscal year 2006 was $1.4 million. Compensation expense of
$979 and $440 is included in general and administrative costs and research
and
development costs, respectively, in the accompanying consolidated statements
of
operations and comprehensive loss. As of January 31, 2006, an aggregate of
1,200,000 shares of deferred stock were outstanding.
The
Company follows SFAS No. 128, “Earnings Per Share,” for computing and presenting
net loss per share information. Basic loss per common share is computed by
dividing net loss available to common stockholders by the weighted average
number of common shares outstanding for the period. Diluted loss per common
share excludes common stock equivalent shares and unexercised stock options
as
the computation would be anti-dilutive. A reconciliation of the net loss
available to common stockholders and the number of shares used in computing
basic and diluted net loss per share is in Note 10.
Translation
of Foreign Financial Statements
The
functional currency of the Company’s foreign subsidiaries is their local
currency. Accordingly, assets and liabilities of the Company’s foreign
subsidiary are translated into U.S. dollars at exchange rates in effect at
the
balance sheet date. Income and expense items are translated at average rates
for
the period. Foreign currency translation adjustments are accumulated in a
separate component of shareholders’ equity. Foreign currency transaction
(losses) gains recorded in operating expenses were ($56), $81 and $741 for
the
years ended January 31, 2006, 2005 and 2004, respectively.
Financial
Instruments
The
carrying value of the Company’s financial instruments, including cash and cash
equivalents, short-term investments, accounts receivable, accounts payable
and
accrued expenses, approximates their fair value.
Concentrations
of Credit Risk
Financial
instruments that potentially subject the Company to concentrations of credit
risk consist primarily of cash equivalents, short-term investments and accounts
receivable. Management believes that the Company’s investment policy limits the
Company’s exposure to concentrations of credit risk. The Company sells its
products primarily to government agencies and to major corporations, including
distributors that serve a wide variety of U.S. and foreign markets. The Company
extends credit to its corporate customers based on an evaluation of the
customer’s financial condition, generally without requiring a deposit or
collateral. Exposure to losses on receivables is principally dependent on each
customer’s financial condition. The Company monitors its exposure for credit
losses and maintains an allowance for anticipated losses. The allowance for
doubtful accounts is determined based on an analysis of the Company’s historical
collection experience and the Company’s portfolio of customers taking into
consideration the general economic environment as well as the industry in which
the Company operates.
The
Company considers all highly liquid investments purchased with an original
maturity of three months or less to be cash equivalents. Cash equivalents
consist of funds deposited in money market accounts. Consequently, the carrying
amount of cash and cash equivalents approximates this fair value. Substantially
all cash and cash equivalents are on deposit with two major financial
institutions.
Short
Term Investments
Highly
liquid investments with maturities of one year or less at the time of purchase
are classified as short-term investments. Short-term investments as of January31, 2006 and January 31, 2005 consist of a certificate of deposit for $71,
which
is pledged to collateralize a letter of credit required for a leased
facility
Income
Taxes
Deferred
taxes are provided utilizing the liability method, whereby deferred tax assets
are recognized for deductible temporary differences and operating loss and
tax
credit carryforwards and deferred tax liabilities are recognized for taxable
temporary differences. Temporary differences are the differences between the
reported amounts of assets and liabilities for financial reporting purposes
and
the amounts for income tax purposes at the tax rates expected to be in effect
when the differences reverse. Deferred tax assets and liabilities are adjusted
for the effects of changes in tax laws and rates on the date of enactment.
Deferred tax assets are reduced by a valuation allowance when, in the opinion
of
management, it is more likely than not that some portion or all of the deferred
tax assets will not be realized. The Company provided a full valuation allowance
against its net deferred tax assets as of January 31, 2006.
Equipment
and Leasehold Improvements
Office
furniture and computer equipment are recorded at cost. Depreciation of office
furniture and equipment is provided on a straight-line basis over the estimated
useful lives of the assets, generally three to five years. Amortization of
leasehold improvements and leased assets are provided on a straight-line basis
over the shorter of the term of the applicable lease or the useful life of
the
asset.
Expenditures
for normal repairs and maintenance are charged to operations as incurred. The
cost of property and equipment retired or otherwise disposed of and the related
accumulated depreciation or amortization are removed from the accounts and
any
resulting gain or loss is reflected in current operations.
Convera’s
prior acquisitions of other companies resulted in the acquisition of certain
intangible assets and goodwill. Goodwill resulting from such acquisitions is
associated with the Company’s core software products segment. In accordance with
Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and
Other Intangible Assets”, the impairment of goodwill is assessed on an annual
basis or whenever changes in circumstances indicate that the fair value of
the
Company is less than the carrying value.. This assessment is performed by
comparing the market value of the Company’s outstanding common stock with the
carrying amount of the Company’s net assets, including goodwill. If the market
value exceeds the carrying amount of the Company’s net assets, impairment of
goodwill does not exist. If the market value is less than the carrying amount
of
the Company’s net assets, the Company will perform further analysis and may be
required to record an impairment. The Company continues to amortize intangible
assets that are deemed to have a finite useful life, and amortization is being
charged to income on a straight-line basis over the periods estimated to
benefit. Acquired developed technology is being amortized on a straight-line
basis over five years.
Impairment
of Long-Lived Assets
The
Company evaluates all of its long-lived assets, including intangible assets
other than goodwill, for impairment in accordance with the provisions of SFAS
No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS
No. 144 requires that long-lived assets and intangible assets other than
goodwill be evaluated for impairment whenever events or changes in circumstances
indicate that the carrying value of an asset may not be recoverable based on
expected undiscounted cash flows attributable to that asset. Should events
indicate that any of the Company’s assets are impaired, the amount of such
impairment will be measured as the difference between the carrying value and
the
fair value of the impaired asset and the impairment will be recorded in earnings
during the period of such impairment.
Reclassifications
Certain
amounts presented in the prior year’s financial statements have been
reclassified to conform to the fiscal year 2006 presentation.
Other
Income
For
the
year ended January 31, 2006 other income consisted of $908 of net interest
income offset by interest expense of $306. In fiscal year 2005 other income
consisted entirely of net interest income of $175. For the year ended January31, 2004 other income consisted of $204 in interest income offset by interest
expense of $17, plus a reversal of $2,363 of accrued expenses resulting from
a
settlement agreement reached between the Company and another party in fiscal
year 2004. As a result of the settlement, the Company’s liability was reduced
from $5.6 million to $3.2 million, and the previously recorded accruals were
reversed into other income.
Recent
Pronouncements
On
December 16, 2004, the Financial Accounting Standards Board ("FASB") issued
SFAS
No. 123 (revised 2004), Share-Based Payment ("SFAS No. 123(R)"), which is a
revision of SFAS No. 123. SFAS No. 123(R) Supersedes APB No. 25, and amends
SFAS
No. 95, Statement of Cash Flows. Generally, the approach in SFAS No. 123(R)
is
similar to the approach described in SFAS No. 123; however, SFAS No. 123(R)
requires all share-based payments to employees, including grants of employee
stock options, to be recognized in the statements of operations based on their
fair values. Pro forma disclosure is no longer an alternative upon adopting
SFAS
No. 123(R). The Company will adopt SFAS No. 123(R) on February 1, 2006. SFAS
No.
123(R) permits public companies to adopt its requirements using one of two
methods: i. A "modified prospective" method in which compensation cost is
recognized beginning with the effective date (a) based on the requirements
of
SFAS No. 123(R) for all share-based payments granted after the effective date
and (b) based on the requirements of SFAS No. 123(R) for all awards granted
to
employees prior to the effective date of SFAS 123(R) that remain unvested on
the
effective date. ii. A "modified retrospective" method which includes the
requirements of the modified prospective method described above, but also
permits entities to restate based on the amounts previously recognized under
SFAS No. 123 for purposes of pro forma disclosures for either (a) all prior
periods presented or (b) prior interim periods of the year of adoption. The
Company will implement SFAS No. 123(R) in the first quarter of fiscal year
2007
and intends to use the modified prospective method.
In
fiscal
years 2004 and 2005 the Company effected a re-alignment
of its operational infrastructure
by
adopting a restructuring plan to reduce operating costs and increase
efficiencies. These restructuring programs were composed entirely of workforce
reductions. As a result of these restructuring programs, in conformity with
SEC
Staff Accounting Bulletin (SAB) No. 100, Restructuring
and Impairment Charges,
and
EITF No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit
an
Activity Including Certain Costs incurred in a Restructuring,
the
Company recorded restructuring charges during the years ended January 31, 2005
and 2004. In the years ended January 31, 2006 and 2005the Company recorded
restructuring adjustments related to restructurings that originated in fiscal
years 2002 through 2005.
Workforce
Reductions
In
connection with the restructuring programs in fiscal years 2005 and 2004 the
Company reduced its workforce by 105 employees worldwide, including 20
individuals from the professional services group, 33 from engineering, 27 from
sales, 14 from marketing and 11 from the general and administrative group.
During the fiscal years ended January 31, 2005 and 2004the Company recorded
restructuring charges related to terminated employee severance costs of $1,081
and $621, respectively.
Changes
in Estimates and Adjustments
During
the years ended January 31, 2006 and 2005the company recorded adjustments
to
previous restructuring programs of ($57) and ($137), respectively. The fiscal
year 2005 adjustment reflects the reversal of fiscal year 2002 restructuring
charge related to a facility closing. The adjustment in fiscal year 2006
consisted of a reversal of $51 related to the aforementioned facility closing
in
fiscal year 2002 and a $6 reversal of employee termination benefits related
to
the restructuring in fiscal year 2005.
Restructuring
costs and adjustments recorded are summarized as follows (in
thousands):
The
Company paid an aggregate of approximately $776, $1,616 and $1,934 against
the
restructuring reserve in the fiscal years ended January 31, 2006, 2005, and
2004, respectively. As of January 31, 2006 all restructuring obligations have
been fully settled.
(4)ACCOUNTS
RECEIVABLE
Accounts
receivable, net of allowances, consist of the following as of January 31, (in
thousands):
2006
2005
Billed
$
4,215
$
6,455
Unbilled
367
612
4,582
7,067
Less:
allowance for doubtful accounts
(218
)
(537
)
$
4,364
$
6,530
The
unbilled total represents the recognized sales value of performance and such
amounts that had not been billed and were not billable to customers as of the
balance sheet date. The billing is customarily determined by the delivery of
milestones as set forth in the contract.
Equipment
and leasehold improvements at January 31, 2006 and 2005 consisted of the
following:
2006
2005
Computer
equipment
$
21,407
$
15,426
Office
furniture
2,831
2,918
Leasehold
improvements
597
741
24,835
19,085
Less
accumulated depreciation
(15,683
)
(13,940
)
$
9,152
$
5,145
Equipment
and leasehold improvements are recorded at cost. Depreciation is calculated
on
the straight-line method over three years for computer equipment, five years
for
office furniture and over the shorter of the depreciable life or the life of
the
related lease for leasehold improvements. Depreciation expense for fiscal years
2006, 2005 and 2004 was $2,903, $1,584 and $1,660, respectively.
(6)GOODWILL
AND OTHER INTANGIBLE ASSETS
Goodwill
and other acquisition-related intangibles at fiscal year ends were as
follows:
2006
2005
Goodwill
$
2,275
$
2,275
Developed
technologies
$
1,346
$
1,346
Less
accumulated amortization
(1,049
)
(780
)
$
297
$
566
Amortization
expense for fiscal years 2006, 2005 and 2004 was $269, $269 and $269,
respectively. Based on the current amount of intangible assets subject to
amortization, the estimated amortization expense for each of the succeeding
5
years is as follows: 2007 - $269; 2008 - $28; --none thereafter.
Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amount of assets and liabilities for financial reporting purposes
and
the amounts used for income tax purposes.
The
Company’s net deferred tax assets at January 31, 2006 and 2005 were as
follows:
2006
2005
Deferred
tax assets:
Net
operating loss carryforwards,not
yet utilized
$
70,720
$
61,627
Capitalized
research & development costs
14,576
14,862
Restructuring
reserve
-
325
Other
2,289
2,119
Total
deferred tax assets
87,585
78,933
Valuation
allowance
(87,585
)
(78,933
)
Net
deferred tax assets
$
-
$
-
At
January 31, 2006the Company had net operating loss carryforwards (“NOLs”) of
approximately $185 million that expire at various dates through fiscal year
2025. The use of these NOLS may be limited by Section 382 of the Internal
Revenue Code as a result of the Combination or other equity transactions.
Approximately $26,880 of the NOLs relate to stock option exercises, and $17,425
and $1,470 relate to UK and Canada operations, respectively. The tax benefit
associated with the stock option exercises will be credited to equity when
and
if realized.
As
of
January 31, 2006, the Company’s deferred tax assets exceeded the deferred tax
liabilities. As the Company has not generated earnings and no assurance can
be
made of future earnings needed to utilize these assets, a valuation allowance
in
the amount of the net deferred tax assets has been recorded.
The
authorized capital stock of Convera consists of 100 million shares of Class
A
voting common stock, par value $0.01 per share, 40 million shares of Class
B
non-voting common stock, par value $0.01 per share, and five million shares
of
cumulative convertible preferred stock, par value $0.01 per share.
In
the
second quarter of fiscal year 2006, the Company completed a private placement
of
6,555,556 newly issued shares of its Class A common stock to two investors.
The
Company sold 5,555,556 shares directly to the Legg Mason Opportunity Trust
at a
purchase price of $4.50 per share. The remaining 1 million shares were purchased
by an affiliate of Herbert A. Allen, a significant stockholder and director
of
the Company, at a purchase price of $4.84 per share. Net proceeds to the Company
of approximately $28.8 million were and will continue to be used for the
continued funding of activities related to the Excalibur Web offering and for
general corporate purposes. Allen & Company LLC, a company affiliated with
the majority shareholder, acted as placement agent for the private placement
and
was paid a commission of 4% on the shares purchased directly by the Legg Mason
Opportunity Trust.
In
the
third quarter of fiscal year 2005, the Company completed a private
placement of 3,433,333 newly-issued shares of Class A common stock to several
investors, including affiliates of Allen & Company Incorporated, a
significant stockholder of the Company, and certain directors. The shares were
priced on September 7, 2004 at $3.00 per share, representing a premium to the
$2.80 closing market price on such date. Net proceeds to the Company of
approximately $10.3 million were
used to
finance ongoing operations and for general corporate purposes, including
potential acquisitions.
In
the
second quarter of fiscal year 2004, the Company completed a private placement
of
4,714,111 shares of its Class A common stock to a group of unaffiliated
institutional investors. The Company sold the shares at a purchase price of
$3.60 per share, resulting in net proceeds to the Company of approximately
$16.0
million. In connection with this private placement, the Company has incurred
expenses of approximately $946, which have been recorded in equity as an offset
against the proceeds. The Company used the net proceeds to finance ongoing
operations and for general corporate purposes, including potential acquisitions.
Allen & Company LLC, a company affiliated with the majority shareholder,
acted as placement agent for the private placement and was paid a commission
of
5%, which is included in the offering expenses above.
Weighted
average number of common shares outstanding - basic and
diluted
43,088,677
35,432,754
31,486,032
Basic
and diluted net loss per common share
$
(0.33
)
$
(0.56
)
$
(0.57
)
Using
the
treasury stock method the following equity instruments were not included in
the
computation of diluted net loss per common share because their effect would
be
anti-dilutive:
The
Convera 2000 Stock Option Plan authorizes the granting of stock options and
other forms of incentive compensation to purchase up to 11.25 million shares
of
the Company’s Class A common stock in order to attract, retain and reward key
employees. In addition, at the closing of the Combination, Convera assumed
Excalibur’s existing stock option plans. The various plans are administered by a
Committee appointed by the Board of Directors, which has the authority to
determine which officers, directors and key employees are awarded options and
other stock based compensation pursuant to the plans and the terms and option
exercise prices of the stock options. Of the total number of shares authorized
for stock based compensation, options or warrants to purchase 8,495,022 shares
and 1,200,000 deferred shares were outstanding as of January 31, 2006. The
Company had a total of 334,348 shares of Class A common stock reserved for
the
issuance of warrants, deferred shares and options under the plans as of January31, 2006.
Each
qualified incentive stock option granted pursuant to the plans has an exercise
price as determined by the Committee but not less than 100% of the fair market
value of the underlying common stock at the date of grant, a ten-year term
and
typically a four-year vesting period.
A
non-qualified option granted pursuant to the plans may contain an exercise
price
that is below the fair market value of the common stock at the date of grant
and/or may be immediately exercisable. The term of non-qualified options is
usually five or ten years.
The
following table summarizes the Company's activity for all of its stock option
awards:
Options
to purchase 3,971,846, 5,324,042 and 4,830,097 shares of the Company’s common
stock were vested and exercisable at January 31, 2006, 2005 and 2004,
respectively, at weighted-average exercise prices of $5.16, $5.44 and $5.64
per
share, respectively.
The
following table summarizes additional information about stock options
outstanding at January 31, 2006:
Options
Outstanding
Options
Exercisable
Range
of Exercise Prices
Number
of
Options
Weighted-Average
Remaining Contractual
Life
Weighted-Average
Exercise
Price
Number
Exercisable
Weighted-Average
Exercise
Price
$1.70
to $ 4.07
1,701,255
8.13
years
$
2.68
406,285
$
3.13
$4.14
to $ 5.09
5,650,527
7.13
4.54
3,168,699
4.43
$5.31
to $8.13
203,628
3.35
7.03
173,250
7.19
$8.19
to $16.09
819,562
8.89
12.33
103,562
10.42
$20.52
to $46.06
120,050
3.01
23.77
120,050
23.77
8,495,022
7.35
years
$
5.25
3,971,846
$
5.16
Employee
Stock Purchase Plan
The
Company’s employee stock purchase plan (“ESPP”) is available for all active
employees and provides that participating employees may purchase common stock
each plan quarter at a purchase price equal to the lesser of 85% of the closing
price on the date of purchase or 85% of the closing price on the date of grant.
Payment for the shares is made through authorized payroll deductions of up
to
10% of eligible annual compensation.
Of
the
250,000 shares of Class A common stock that were reserved for issuance, 73
and
152,778 shares were purchased by employees in fiscal years 2003 and 2002,
respectively.
During
the fourth quarter of the fiscal year ended January 31, 2002, the Convera
shareholders approved an amendment to the ESPP authorizing an additional
1,000,000 shares to be reserved for issuance under the plan. These shares were
included as treasury stock as of January 31, 2002 and are released from the
treasury as employees purchase the shares through the ESPP. During the fiscal
years 2006, 2005, 2004 and 2003, 52,055, 86,849, 63,898 and 122,845 shares
were
purchased by the employees, respectively, leaving 674,353 shares in treasury
as
of January 31, 2006.
Employee
Savings Plan
The
Company has an employee savings plan that qualifies under Section 401(k) of
the
Internal Revenue Code. Under the plan, participating eligible employees in
the
United States may defer up to 100 percent of their pre-tax salary, but not
more
than statutory limits. The plan was amended in the fiscal year ended January31,2001 to allow the Company to match $0.50 on every dollar up to the maximum
of 8%
of the employee’s contribution on total compensation.
For
the
fiscal years ended January 31, 2006, 2005 and 2004, the Company contributed
approximately $424, $483 and $477, respectively, to the employee savings plan.
The
Company conducts its operations using leased facilities. The leases terminate
at
various dates through fiscal year 2009 with options to renew. Certain leases
provide for scheduled rent increases and obligate the Company to pay shared
portions of the operating expenses such as taxes, maintenance and repair costs.
The Company also has operating leases for equipment and its foreign subsidiary
has operating leases for automobiles that are included in the figures below.
Future minimum rental payments under non-cancelable operating leases as of
January 31, 2006 are as follows:
Total
rental expense under operating leases was approximately $1,805, $2,743 and
$2,982 for fiscal years 2006, 2005 and 2004, respectively.
Contingencies
On
November 1, 2001, DSMC, Incorporated ("DSMCi") filed a complaint against the
Company in the U.S. District Court for the District of Columbia in which it
alleged that the Company misappropriated DSMCi's trade secrets, and engaged
in
civil conspiracy with the NGT Library, Inc. ("NGTL"), an affiliate of the
National Geographic Society, to obtain access to DSMCi's trade secrets, and
was
unjustly enriched by the Company's alleged access to and use of such trade
secrets. In its complaint, DSMCi seeks $5 million in actual damages and $10
million in punitive damages from the Company. DSMCi subsequently amended its
complaint to add copyright infringement-related claims. NGTL intervened in
the
litigation as a co-defendant with Convera, and filed counterclaims against
DSMCi. Convera moved to compel arbitration of DSMCi's claims; the District
Court
denied the motion, and Convera filed an interlocutory appeal. The D.C. Circuit,
in November 2003, ruled that it did not have jurisdiction to consider the
appeal. During December 2005 DSMCi and NGTL entered into a Settlement Agreement
and Release. The U.S. District Court dismissed claims against NGTL on
December 23, 2005. The litigation between the Company and DSMCi is currently
in
the summary judgment phase in the District Court. The
Company has investigated the claims and continues to believe that the claims
are
without merit.
In
connection with this litigation, the Company brought an arbitration claim
against NGTL on September 13, 2005, seeking indemnification for its defense
costs and potential liability pursuant to an indemnity provision in a service
agreement between NGTL and the Company. In response, NGTL brought a cross claim
against the Company under the same contract provision for indemnification of
NGTL’s respective costs and liability. This arbitration is in its early stage.
In
addition, from time to time, the Company is a party to various legal
proceedings, claims, disputes and litigation arising in the ordinary course
of
business, including that noted above. The Company believes that the ultimate
outcome of these matters, individually and in the aggregate, will not have
a
material adverse affect on its financial position, operations or cash flow.
However, because of the nature and inherent uncertainties of litigation, should
the outcome of these actions or future actions be unfavorable, Convera’s
financial position, operations and cash flows could be materially and adversely
affected.
The
Company is engaged in the design, development, marketing and support of search,
retrieval and categorization solutions. All of the Company’s revenues result
from the sale of the Company’s software products and related services for all
fiscal year’s presented. During fiscal year 2005, the Company embarked on an
advanced development effort focused on applying portions of its existing core
technology to also locate contextually relevant information on the World Wide
Web. This development effort has resulted in the Excalibur Web offering.
Accordingly, as of January 31, 2006the Company considers itself to have two
reportable segments, specifically the license, implementation and support of
its
core software products business as well as the Web indexing segment. The
Company’s chief operating decision-making group reviews financial information
presented on a consolidated basis, accompanied by disaggregated information
about revenues, expenses and relevant balance sheet items for both product
segments and by geographic region for purposes of making operating decisions
and
assessing financial performance.
The
following table reconciles the Company’s segment activity to its consolidated
results of operations for the years ended January 31, 2006, 2005 and
2004.
Revenues
derived from contracts and orders issued by agencies of the U.S. Government
were
approximately $11,310 $11,600 and $15,200, respectively, in the fiscal years
ended January 31, 2006, 2005 and 2004. These revenues, expressed as a percentage
of total revenues for each such fiscal year, were approximately 54%, 45% and
52%, respectively. For the fiscal year ended January 31, 2006 one customer
accounted for approximately 14% of the Company’s total revenues. One reseller
customer accounted for approximately 17% of the Company’s total revenues for the
fiscal year ended January 31, 2005 and one customer accounted for 12% of the
Company’s total revenues for the fiscal year ended January 31, 2004.
(14)SUPPLEMENTAL
DISCLOSURE OF CASH FLOW INFORMATION
On
March23, 2005the Company secured a $5 million term loan from Silicon Valley Bank
(“SVB”), the primary subsidiary of Silicon Valley Bancshares (NASDAQ: SIVB). The
four-year, term facility was secured to provide financing for capital purchases
including those for the Excalibur Web offering. The loan bears interest at
7%
per annum and is secured by a first lien on all corporate assets, excluding
intellectual property. Scheduled monthly payments of interest only are due
through March 2006. The balance is scheduled to be paid in 36 monthly
installments of approximately $155 including principal and interest.
Additionally, a balloon interest payment of $125 is due in March 2009. The
note
includes certain financial covenants including cash to debt ratios. The
agreement also requires the Company to maintain a cash balance with SVB equal
to
twice the amount of the loan outstanding. During the fiscal year ended January31, 2006the Company recorded interest expense of $306. As of January 31, 2006,
the Company was in compliance will all required covenants. The Company retired
this facility on February 28, 2006.
(17)SUBSEQUENT
EVENTS
On
February 28, 2006the Company completed a private placement of 5,103,333
newly-issued shares of common stock to a group of institutional investors
resulting in net proceeds of approximately $36.7 million. The shares were sold
at a price of $7.50 per share, which represented a 6.58% discount to the
Company’s trailing 10-day average closing price preceding the date of Board
approval. Allen
& Company LLC, a company affiliated with the majority shareholder, acted as
placement agent for the private placement and was paid a commission of
4%.
Concurrent
with this private placement, the Company retired the Silicon Valley Bank term
loan facility. The remaining balance of the private placement proceeds, which
totaled approximately $31.6 million are to be used for general corporate
purposes, including the Excalibur Web offering.
