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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended July 27, 2002
Or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the transition period from ______________ to ______________.
Commission File Number: 000-28369
VA Software Corporation
(Exact name of Registrant as specified in its charter)
Delaware 77-0399299
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
47071 Bayside Parkway, Fremont, California, 94538
(Address, including zip code, of principal executive offices)
(510) 687-7000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
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 10K or any
amendment to this Form 10-K. [ ]
As of September 30, 2002, there were 54,360,006 shares of the
Registrant's Common Stock outstanding. The aggregate market value of the Common
Stock held by non-affiliates of the Registrant as of September 30, 2002 (based
on the closing price for the Common Stock on the NASDAQ National Market for such
date) was approximately $36,963,792. Shares of common stock held by each of our
officers and directors and by each person or group who owns 5% or more of our
outstanding common stock have been excluded in that such persons or groups may
be deemed to be our affiliate. This determination of affiliate status is not
necessarily a conclusive determination for other purposes.
DOCUMENTS INCORPORATED BY REFERENCE
Specified portions of the Registrant's definitive Proxy Statement to be
issued in conjunction with Registrant's Annual Meeting of Stockholders are
incorporated by reference into Part III of this Form 10-K.
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Table of Contents
PART I
Item 1 Business ........................................................................................................... 3
Overview ...................................................................................................... 3
Company Background ............................................................................................ 3
The SourceForge "Development Intelligence" Solution .......................................................... 4
Sales, Marketing, and Customers ............................................................................... 5
Research and Development
Competition ................................................................................................... 5
Significant Customers ......................................................................................... 6
Seasonality ................................................................................................... 6
Backlog ....................................................................................................... 6
Intellectual Property Rights .................................................................................. 6
Employees ..................................................................................................... 6
Segments ...................................................................................................... 7
Item 2 Properties ......................................................................................................... 7
Item 3 Legal Proceedings .................................................................................................. 7
Item 4 Submission of Matters to a Vote of Security Holders ................................................................ 7
PART II
Item 5 Market for the Registrant's Common Stock and Related Stockholder Matters ........................................... 8
Item 6 Selected Financial Data ............................................................................................ 10
Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations .............................. 11
Item 7A Quantitative and Qualitative Disclosures About Market Risk ......................................................... 31
Item 8 Financial Statements and Supplementary Data ........................................................................ 32
Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ............................... 60
PART III
Item 10 Directors and Executive Officers of the Registrant ................................................................. 60
Item 11 Executive Compensation ............................................................................................. 60
Item 12 Security Ownership of Certain Beneficial Owners and Management ..................................................... 60
Item 13 Certain Relationships and Related Transactions ..................................................................... 60
PART IV
Item 14 Exhibits, Financial Statement Schedules, and Reports on Form 8-K ................................................... 60
Signatures .................................................................................................................. 61
2
PART I
Item 1. Business
Special Note Regarding Forward-Looking Statements
This Form 10-K contains forward-looking statements that involve risks
and uncertainties. Words such as "intend," "expect," "believe," "in our view,"
and variations of such words and similar expressions, are intended to identify
such forward-looking statements, which include, but are not limited to,
statements regarding our expectations and beliefs regarding future revenue
growth; gross margins; financial performance and results of operations;
technological trends in, and emergence of Development Intelligence software; the
future functionality, business potential, demand for, efficiencies created by
and adoption of SourceForge; management's strategy, plans and objectives for
future operations; the growth of license revenue; the impact of our
restructuring, reductions in force and new business model on our operating
expenses and the amount of cash utilized by operations; our intentions and
strategies regarding customers and customer relationships; our intent to
continue to invest significant resources in software development; competition,
competitors and our ability to compete; liquidity and capital resources; the
outcome of any litigation to which we are a party; our accounting policies;
sufficiency of our cash resources, cash generated from operations and
investments to meet our operating and working capital requirements; and our
ability to attract and retain highly qualified personnel. Actual results may
differ materially from those expressed or implied in such forward-looking
statements due to various factors, including those set forth in the Risk Factors
contained in the section of this Form 10-K entitled "Management's Discussion and
Analysis of Financial Condition and Results of Operations." We undertake no
obligation to update the forward-looking statements to reflect events or
circumstances occurring after the date of this Form 10-K.
Overview
We develop, market and support SourceForge Enterprise Edition
("SourceForge"), which is proprietary software designed for corporate and
public-sector information technology ("IT") and software engineering
organizations. SourceForge provides Development Intelligence (DI) to our
customers by combining software development tools with the ability to track,
measure and report on software project activity in real-time. Development
Intelligence allows organizations to access, analyze and share information on
software development activity as it takes place. By aligning software
development activity with business goals, Development Intelligence helps
organizations improve operational efficiency and build better quality software.
SourceForge is a relatively new product and additional development and
enhancements are expected in the future.
A component of our SourceForge sales strategy is the Open Source
Development Network, Inc. ("OSDN"). OSDN is our network of web sites that serve
the IT and software development communities. OSDN web sites include
SourceForge.net, which is the largest reference site for potential SourceForge
customers. As of September 30, 2002, SourceForge.net is the development home for
more than 48,000 software projects and more than 490,000 registered users. In
addition to the credibility SourceForge derives from the substantial and growing
usage of OSDN's SourceForge.net, we market SourceForge through product
advertising on and sales leads from all of the OSDN web sites.
Company Background
We incorporated in January 1995 in California as VA Research, Inc. In
June 1999, we changed our name to VA Linux Systems, Inc., and in December 1999
we reincorporated in Delaware. In December 1999, we sold 5,060,000 shares
(including 660,000 shares associated with the underwriters' exercise of their
option to cover the over-allotment of shares) of common stock to the public in
our initial public offering ("IPO"). In December 2001, we changed our name to VA
Software Corporation ("VA Software," "VA" or the "Company"). Our principal
executive offices are located at 47071 Bayside Parkway, Fremont, California,
94538, and our telephone number is (510) 687-7000. Our corporate web site is
located at www.vasoftware.com.
From incorporation until the end of fiscal 1998, we grew very modestly.
From July 31, 1998 though October 27, 2000 (the end of the first quarter of our
fiscal year 2001), we experienced significant growth as a leading provider of
Linux-based solutions, integrating systems, software and services. Commensurate
with strong growth, we invested in hiring personnel with Linux expertise,
growing our direct sales force, acquiring companies and expanding our facilities
and operations, customer support and administration infrastructure. We
outsourced our systems manufacturing but provided systems support through our
internal organization.
- --------------------------------------------------------------------------------
SOURCEFORGE, OSDN, VA SOFTWARE and the VA logo, SLASHDOT, THINKGEEK and
ANIMATION FACTORY are trademarks, trade names or service marks that we use.
Several of these marks are registered trademarks in the United States and in
other countries. This Form 10-K contains other trademarks and trade names of
other individuals and companies.
3
Increasing demand from customers in the Internet infrastructure and
"dot-com" markets fueled our growth through the first quarter of fiscal year
2001. Thereafter, the market for our systems products and professional services
declined significantly due in large part to the general economic downturn, which
resulted in reduced availability of capital for our Internet infrastructure and
"dot-com" customers. This decline had a significant, negative effect on our
sales and margins, which resulted in increased operating losses. We endeavored
to market our hardware products to larger "enterprise" customers, but were
unable to make sufficient progress to build a sustainable business in the midst
of a slowing economy and fierce competition from incumbent hardware vendors that
were moving into the Linux-based hardware market.
Rather than continue with a business model that was not going to enable
us to achieve profitability and would significantly decrease our cash levels, on
June 27, 2001 we announced our strategic decision to exit the systems business
and pursue our application software business. During the first quarter of fiscal
year 2002, we exited the professional services and Linux software engineering
services fields in order to focus on SourceForge. As a result of exiting these
businesses, we have experienced significant cost reductions and preserved our
cash. Software license revenue levels have been modest during our first year in
this new business but we expect our license revenues to grow as SourceForge
gains acceptance in the marketplace.
In the near term, we expect OSDN advertising, sponsorship and
e-commerce revenue to represent a substantial majority of our consolidated
revenue, however, we expect OSDN revenue to decline as a percentage of total
revenue over time as our revenue from SourceForge increases. We also expect that
our proprietary software business model will enable us to maintain the lower
level of operating expenses and cash usage that we have experienced since we
stopped selling hardware. We believe our decision to exit our hardware business
will allow us to build a successful software company around SourceForge using
existing resources.
The SourceForge "Development Intelligence" Solution
Software now plays a critical role in corporate and public-sector
organizations, including those operating in non-technology sectors. As a result,
such organizations often devote significant resources to software application
development. Software application development organizations are increasingly
under pressure to manage software development more efficiently and effectively
- -- controlling costs and risks while improving software quality and process.
We believe that our target market -- IT and software engineering
organizations in sectors such as financial services, defense and aerospace,
manufacturing and government -- is currently driving major changes to address
the challenges associated with the management of software development. These
changes include initiatives for software process improvement; quality standards
certification; and software development outsourcing. We believe SourceForge will
help our customers implement these changes faster, improve their ability to
manage software development, and increase their overall efficiency by providing
Development Intelligence.
SourceForge
SourceForge provides Development Intelligence to our customers by
combining software development tools with the ability to track, measure and
report on software development activity in real-time. By aligning software
development with business goals, SourceForge helps organizations improve
operational efficiency and build better quality software.
We believe SourceForge provides a comprehensive solution to many of the
software development challenges facing our targeted customers. SourceForge
supports software development process improvement initiatives by capturing and
archiving software development code, documentation and communication in a
central location. SourceForge helps companies build better quality software by
providing managers and developers with improved visibility into software
development activity, enabling better resource and requirements management, as
well as better defect tracking. SourceForge helps companies outsource software
development more effectively by providing a standard set of development tools
for in-house and third-party development teams, a central repository, and a
secure environment for managing and safeguarding intellectual property.
SourceForge is designed to integrate with, and enhance, best-of-breed
development tools from other vendors, and extend them with Development
Intelligence functionality.
Finally, SourceForge helps companies manage the costs and risks
associated with software development by enabling managers to gain insight into
project status and to resolve critical problems earlier in the development
cycle.
4
Sales, Marketing, and Customers
SourceForge
We primarily market and sell our products (software, professional
services, maintenance and support and training) directly to our end users
through our SourceForge field sales organization, on the Internet at
vasoftware.com and on our various OSDN web sites. Our direct sales organization
includes a telesales operation to augment our direct sales presence.
We maintain a complete customer service and support organization for
SourceForge, which provides support for installation, software usage, updates
and system administration. Customer service and support are typically provided
as part of the SourceForge maintenance contract to ensure end user productivity.
We also release periodic bug or security fix updates and version upgrades.
We believe that the success of SourceForge will depend partly on our
ability to enhance our product to meet the needs of a rapidly evolving
marketplace and increasingly sophisticated and demanding customers. We intend to
extend and strengthen our software by enhancing existing features, adding
additional features and offering higher levels of integration with popular
software development tools. Although we primarily develop SourceForge technology
internally, we may, based on timing and cost considerations, acquire
technologies or products from third parties.
OSDN
We own and manage a network of web sites, collectively known as OSDN,
which are widely used by the IT and software development communities. As of
September 30, 2002, OSDN received more than 134 million page views and more than
6.8 million unique visitors per month. SourceForge benefits from OSDN in a
variety of ways. First, because IT professionals, including senior management,
middle management and a variety of technical staff including developers and
systems and network administrators comprise the OSDN audience, SourceForge
advertising on OSDN is a targeted sales tool for SourceForge. Second, the OSDN
web site SourceForge.net is the largest reference web site for potential
SourceForge customers, providing further sales leads.
Our OSDN sites include:
o sourceforge.net, our flagship web site and software
development center. As of September 30, 2002, SourceForge was
the development home for more than 48,000 software development
projects and had more than 490,000 registered users.
o slashdot.org, our most frequently visited site. Slashdot is
dedicated to providing the IT and software development
communities with cutting-edge news and interactive commentary.
o freshmeat.net, one of the Internet's most comprehensive
indices of Linux, Unix and cross-platform software.
o thinkgeek.com, our e-commerce site, which provides online
sales of a variety of retail products of interest to the
software development and IT communities.
o linux.com, our comprehensive web site for Linux and open
source news and information. Linux.com caters to business and
IT managers looking for migration strategies on Linux.
o animationfactory.com, a source for three-dimensional art,
animations and presentations. Animation Factory offers a
dynamic collection of easy to use animations that work in
email, web pages and presentations.
Research and Development
We have devoted the majority of our research and development budget to
the goal of improving SourceForge to better serve our customers. In addition to
our internal software engineering efforts, we also utilize an independent
contractor, Cybernet Software Solutions, Inc. ("CSS"), for certain aspects of
our SourceForge product development process. CSS utilizes software-engineering
resources in India and the United States to perform software development
projects and consulting services for us on a contractual time and material
basis. We coordinate our internal software engineering with ongoing development
at CSS using SourceForge.
5
Competition
We believe SourceForge gives us an opportunity to operate in the
Development Intelligence market without an entrenched competitor. However, we
face competition from software development tools and processes developed
internally by customers, including ad hoc integrations of commercial software
development tools and applications. There are also many entrenched competitors
in closely related markets who compete for customer budget allocations. Such
competition could arise from, among others, Collab.Net, Inc., Rational Software
Corporation, IBM Corporation, Starbase Corporation, Merant plc, Microsoft
Corporation, Oracle Corporation, Borland Software Corporation, as well as
numerous other public and privately held software application development and
tools suppliers.
The market for Internet products and services provided by OSDN is
highly competitive. Advertisers have many alternatives available to reach their
target audience, including print (e.g., Ziff Davis Media's eWeek and
Computerworld, Inc.'s Computerworld), general portal sites (e.g., aol.com,
yahoo.com and msn.com) and other Web sites focused on vertical markets (e.g.,
CNet Networks, Inc.'s cnet.com and techrepublic.com). Many of these potential
competitors are likely to have substantial competitive advantages including:
o greater resources that can be devoted to the development,
promotion and sale of their products;
o more established sales forces and channels;
o greater software development experience; and
o greater name recognition.
To be competitive, we must respond promptly and effectively to the
challenges of technological change, evolving standards and our competitors'
innovations by continuing to enhance our products and grow our sales and
professional services organizations. Any pricing pressures or loss of potential
customers resulting from our failure to compete effectively would reduce our
revenues.
Significant Customers
For the fiscal year ended July 27, 2002, one customer, Intel
Corporation, accounted for approximately 20% of net revenues. For the fiscal
year ended July 28, 2001, one customer, Akamai Technologies, Inc., accounted for
approximately 25% of net revenues
Seasonality
During the past two years, our revenues have not been significantly
impacted by seasonality. It is not yet clear whether our new business model
focusing on SourceForge will be subject to seasonal fluctuations.
Backlog
We have operated historically with little or no backlog. As an
application software provider, however, we have backlog relating to deferred
revenue on SourceForge contracts.
Intellectual Property Rights
SourceForge is licensed to our end-user customers as proprietary
software code and documentation. We protect our property through a combination
of copyright, trademark, patent, trade-secret laws, employee and third-party
nondisclosure agreements, and other methods of protection.
We require our customers to enter into license agreements that impose
restrictions on their ability to reproduce, distribute and utilize our software.
In addition, we seek to avoid disclosure of our trade secrets through a number
of means, including restricting access to our source code and object code and
requiring those entities and persons with access to agree to confidentiality
terms which restrict their use and disclosure.
6
Employees
We believe our success will depend in part on our continued ability to
attract and retain highly qualified personnel in a competitive market for
experienced and talented software engineers and sales and marketing personnel.
Our employees are not represented by any collective bargaining organization, we
have never experienced a work stoppage, and we believe that our relations with
our employees are good. As of July 27, 2002, our employee base totaled 144,
including 44 in operations, 29 in sales and marketing, 44 in research and
development and 27 in finance and administration.
Segments
Information regarding our previous two operating segments over the last
three fiscal years is set forth in Note 12 of the Notes to the Consolidated
Financial Statements. Since the start of the 2002 fiscal year, which began on
July 29, 2001, we have operated as one business segment, providing application
software products and related OSDN products.
Item 2. Properties
In September 2000, we relocated our corporate headquarters to Fremont,
California from Sunnyvale, California. Our Fremont facility consists of
approximately 140,000 square feet, which is occupied pursuant to a lease that
expires in May 2010. We subleased approximately 52,000 square feet of our
Fremont facility pursuant to an agreement with an original expiration date in
2002. In December 2001, we terminated the sublease of this space by agreement.
We also maintain a lease related to the Sunnyvale building that expires
in 2005. We had previously subleased the entire Sunnyvale facility pursuant to
an agreement that would extend for the remainder of our lease term. In March
2002, we terminated the sublease of our Sunnyvale facility by agreement.
Item 3. Legal Proceedings
The Company, two of our former officers (the "Former Officers"), and
the lead underwriter in our IPO were named as defendants in a consolidated
shareholder lawsuit in the United States District Court for the Southern
District of New York, captioned In re VA Software Corp. Initial Public Offering
Securities Litigation, 01-CV-0242. This is one of a number of actions
coordinated for pretrial purposes as In re Initial Public Offering Securities
Litigation, 21 MC 92. Plaintiffs in the coordinated proceeding have brought
claims under the federal securities laws against numerous underwriters,
companies, and individuals, alleging generally that defendant underwriters
engaged in improper and undisclosed activities concerning the allocation of
shares in the initial public offerings of more than 300 companies during late
1998 through 2000. Among other things, plaintiffs allege that the underwriters'
customers had to pay excessive brokerage commissions and purchase additional
shares of stock in the aftermarket in order to receive favorable allocations of
shares in an initial public offering. The consolidated amended complaint in our
case seeks unspecified damages on behalf of a purported class of purchasers of
our common stock between December 9, 1999 and December 6, 2000. Defendants have
filed motions to dismiss.
In September 2002, plaintiffs agreed to voluntarily dismiss all claims
(the "Dismissed Claims") against our Former Officers. In the event, however,
that facts emerge prior to September 30, 2003, that support the Dismissed
Claims, the Court may permit plaintiffs to reassert some or all of the Dismissed
Claims.
We believe we have meritorious defenses to the claims against us and
will defend ourselves vigorously.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
7
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters
Our common stock is traded in the NASDAQ National Market System under
the symbol LNUX. As of October 7, 2002, there were 1,008 holders of record of
our common stock. We have not declared any cash dividends since our inception
and do not expect to pay any dividends in the foreseeable future. The high and
low closing sales prices, as reported by NASDAQ, of our common stock are as
follows:
High Low
---- ---
Fiscal Year Ended July 27, 2002:
Fourth Quarter....................................... $ 1.37 $ 0.61
Third Quarter........................................ 2.42 1.20
Second Quarter....................................... 3.23 1.22
First Quarter........................................ 2.26 0.78
Fiscal Year Ended July 28, 2001:
Fourth Quarter....................................... 5.48 1.80
Third Quarter........................................ 10.44 1.59
Second Quarter....................................... 31.75 7.00
First Quarter........................................ 61.25 26.88
The foregoing reflects interdealer prices without retail markup,
markdown, or commissions and may not necessarily reflect actual transactions.
During the fiscal year ended July 27, 2002, we issued 511,674 shares of
our common stock upon the exercise of stock grants under our 1998 Stock Plan.
The proceeds from the sale of these shares were used for working capital. We
issued the shares pursuant to an exemption either by reason of Section 4(2) or
Rule 701 under the Securities Act of 1933. We made these sales without general
solicitation or advertising. For purposes of qualifying for such exemptions,
each purchaser either was an accredited investor, a sophisticated investor
(either alone or through its representative) or a natural person satisfying the
requirements of Rule 701, with access to all relevant information necessary to
make an investment decision.
Equity Compensation Plans
The following table summarizes our equity compensation plans as of July
27, 2002, all of which have been approved by our stockholders:
A B C
Plan Category (1) Number of securities to Weighted average Number of securities remaining available for
be issued upon exercise exercise price of future issuance under equity compensation plan
of outstanding options outstanding options (excluding securities reflected in column (a))
Equity compensation plan
approved by stockholders 12,108,599 (2) $4.50 10,432,114 (3) - (6)
(1) The table does not include information for equity compensation plans
assumed by the Company in acquisitions. As of July 27, 2002, a total of
199,302 shares of the Company's common stock remain issuable and
outstanding upon exercise of options granted under plans assumed by the
Company in its acquisition of OSDN. The weighted average exercise price
of all outstanding options granted under these plans at July 27, 2002
is $31.46. The Company does not grant additional awards under these
assumed plans.
(2) Includes 11,728,599 options outstanding from the Company's 1998 Stock
Plan and 380,000 options outstanding from the Company's 1999 Director's
Plan.
(3) Includes 1,803,677 shares of common stock reserved for issuance under
the Company's 1999 Employee Stock Purchase Plan
8
(4) Subject to the terms of the 1998 Stock Plan, an annual increase is to
be added on the first day of the Company's fiscal year equal to the
lesser of:4,000,000 shares, or 4.9% of the outstanding shares on the
first day of the new fiscal year or a lesser amount determined by the
Board of Directors.
(5) Subject to the terms of the 1999 Directors Plan, an annual increase is
to be added on the first day of the Company's fiscal year equal to the
lesser of the:250,000 shares, 0.5% of the outstanding shares on the
first day of the new fiscal year or a lesser amount determined by the
Board of Directors.
(6) Subject to the terms of the 1999 Employee Stock Purchase Plan, an
annual increases is to be added on the first day of the Company's
fiscal year equal to the lesser of: 500,000 shares, 1% of the
outstanding shares on the first day of the new fiscal year or a lesser
amount determined by the Board of Directors.
9
Item 6. Selected Financial Data
You should read the selected consolidated financial data set forth
below in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and our financial statements and the
related notes included elsewhere in this Form 10-K. The statement of operations
data for the years ended July 27, 2002, July 28, 2001 and July 28, 2000 and the
balance sheet data as of July 27, 2002 and July 28, 2001 are derived from the
audited financial statements and related notes appearing elsewhere in this Form
10-K. The statement of operations data for the fiscal years ended July 31, 1999
and 1998 and the balance sheet data as of July 28, 2000, July 31, 1999 and July
31, 1998 are derived from audited financial statements not appearing in this
Form 10-K. Historical results are not necessarily indicative of results that may
be expected for any future period.
Summary Financial Information
(In thousands, except per share data)
For the years ended
-------------------------------------------------------------
July 27, July 28, July 28, July 31, July 31,
2002 2001 2000 1999 1998
--------- --------- --------- --------- ---------
Selected Consolidated Statements of Operations Data:
Net revenues .................................................... $ 20,385 $ 134,890 $ 120,296 $ 17,710 $ 5,556
Cost of revenues ................................................ 9,661 154,103 98,181 17,766 4,494
--------- --------- --------- --------- ---------
Gross margin .................................................... 10,724 (19,213) 22,115 (56) 1,062
Income (loss) from operations ................................... (93,248) (531,798) (95,387) (14,531) 73
Net income (loss) ............................................... (91,038) (525,268) (89,758) (14,512) 84
========= ========= ========= ========= =========
Dividend related to convertible preferred stock ................. -- -- (4,900) -- --
--------- --------- --------- --------- ---------
Net income (loss) attributable to common stockholders ........... $ (91,038) $(525,268) $ (94,658) $ (14,512) $ 84
========= ========= ========= ========= =========
Basic net income (loss) per share ............................... $ (1.72) $ (10.78) $ (3.52) $ (2.62) $ 0.02
========= ========= ========= ========= =========
Diluted net income (loss) per share ............................. $ (1.72) $ (10.78) $ (3.52) $ (2.62) $ 0.01
========= ========= ========= ========= =========
Shares used in computing basic net income (loss) per share ...... 53,064 48,741 26,863 5,530 5,100
========= ========= ========= ========= =========
Shares used in computing diluted net income (loss)
per share .................................................... 53,064 48,741 26,863 5,530 12,249
========= ========= ========= ========= =========
Selected Balance Sheet data at year-end:
Cash, cash equivalents and investments .......................... $ 53,046 $ 80,083 $ 174,032 $ 18,653 $ 62
Working capital ................................................. 30,992 62,444 169,930 16,230 (214)
Total assets .................................................... 66,968 173,033 585,099 27,595 1,195
Liabilities, net of current portion ............................. 15,575 13,178 1,656 424 275
Total stockholders' equity (deficit) ............................ 39,388 126,362 543,875 18,363 (420)
Quarterly Financial Data
Fiscal Year 2002
For the three months ended
-----------------------------------------------------
October 28 January 27 April 27 July 27
---------- ---------- -------- -------
Net revenues ........................................................... $ 5,578 $ 5,052 $ 5,140 $ 4,615
Loss from operations ................................................... (55,963) (10,701) (7,906) (18,678)
Net loss attributable to common stockholders ........................... $(54,881) $ (9,656) $ (7,729) $(18,772)
Per share amounts:
Basic and diluted net loss per share ................................. $ (1.04) $ (0.18) $ (0.15) $ (0.35)
Shares used in computing basic and diluted net loss per share ........ 52,678 53,005 53,210 53,487
10
Fiscal Year 2001
For the three months ended
-----------------------------------------------------
October 27 January 27 April 28 July 28
---------- ---------- -------- -------
Net revenues ........................................................... $ 56,062 $ 42,513 $ 20,334 $ 15,981
Loss from operations ................................................... (53,526) (75,662) (111,356) (291,254)
Net loss attributable to common stockholders ........................... $ (51,347) $ (74,148) $(109,655) $(290,118)
Per share amounts:
Basic and diluted net loss per share ................................. $ (1.12) $ (1.57) $ (2.21) $ (5.58)
Shares used in computing basic and diluted net loss per share ........ 45,978 47,362 49,629 52,006
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis should be read in conjunction
with "Selected Financial Data" and our financial statements and the related
notes included elsewhere in this Form 10-K. This discussion contains
forward-looking statements that involve risks and uncertainties. Our actual
results could differ materially from those anticipated in the forward-looking
statements as a result of certain factors including the risks discussed in "Risk
Factors" and elsewhere in this Form 10-K. See Part I -- Item 1 -- "Special Note
Regarding Forward Looking Statements."
Overview
We were incorporated in California in January 1995 and reincorporated
in Delaware in December 1999. We develop, market and support SourceForge
Enterprise Edition ("SourceForge"), which is proprietary software designed for
corporate and public-sector information technology ("IT") and software
engineering organizations. SourceForge provides Development Intelligence (DI) to
our customers by combining software development tools with the ability to track,
measure and report on software project activity in real-time. Development
Intelligence allows organizations to access, analyze and share information on
software development activity as it takes place. By aligning software
development activity with business goals, Development Intelligence helps
organizations improve operational efficiency and build better quality software.
SourceForge is a relatively new product and additional development and
enhancements are expected in the future.
A component of our SourceForge sales strategy is the Open Source
Development Network, Inc. ("OSDN"). OSDN is our network of web sites that serve
the IT and software development communities. OSDN web sites include
SourceForge.net, which is the largest reference site for potential SourceForge
customers. As of September 30, 2002, SourceForge.net is the development home for
more than 48,000 software projects and more than 490,000 registered users. In
addition to the credibility SourceForge derives from the substantial and growing
usage of OSDN's SourceForge.net, we market SourceForge through product
advertising on and sales leads from all of the OSDN web sites.
Results of Operations
We believe that the application of accounting standards is central to a
company's reported financial position, results of operations and cash flows. We
believe that our accounting policies are prudent and provide a clear view of our
financial performance. We review our annual and quarterly results, along with
key accounting policies, with our audit committee prior to the release of
financial results. In addition, we have not entered into any significant
transactions with related parties. We do not use off-balance-sheet arrangements
with unconsolidated related parties, nor do we use other forms of
off-balance-sheet arrangements such as research and development arrangements.
The comparison of fiscal year 2002 current period operating results to
fiscal year 2001 prior period results principally reflects the significant
effects from the change of our business from hardware and services to
application software. Accordingly, there is little trend data to be taken from
the comparison. We have completed four quarters of operations as an applications
software company, and accordingly have a very short operating history in our
current business. While we believe that we are making good progress in our new
business, a substantial majority of our revenues continues to be derived from
OSDN and we face numerous risks and uncertainties that commonly confront new and
emerging businesses in emerging markets, which we have identified in the "Risk
Factors" section below.
11
The following table sets forth our operating results for the periods
indicated as a percentage of net revenues, represented by selected items from
the unaudited condensed consolidated statements of operations. This table should
be read in conjunction with the consolidated financial statements and the
accompanying notes thereto included in this Form 10-K.
For the years ended
----------------------------
July 27, July 28, July 28
2002 2001 2000
----- ----- -----
Consolidated Statements of Operations Data:
Software revenues ................................. 5.3% 0.0% 0.0%
Online revenues ................................... 78.4 10.9 1.7
Other revenues .................................... 16.3 89.1 98.3
----- ----- -----
Net revenues ................................... 100.0% 100.0% 100.0%
Software cost of revenues ......................... 11.7 0.0 0.0
Online cost of revenues ........................... 51.0 7.8 1.0
Other cost of revenues ............................ (15.3) 106.4 80.6
----- ----- -----
Cost of revenues ............................... 47.4 114.2 81.6
----- ----- -----
Gross margin ...................................... 52.6 (14.2) 18.4
----- ----- -----
Operating expenses:
Sales and marketing ............................ 61.4 29.6 24.5
Research and development ....................... 39.8 13.3 10.3
General and administrative ..................... 53.2 16.3 7.5
Restructuring costs and other special charges .. 230.2 84.1 0.0
Amortization of deferred stock compensation .... 8.2 45.4 32.8
Amortization of goodwill and intangible assets . 57.5 72.6 15.1
Impairment of long-lived assets ................ 59.6 118.6 0.0
Write-off of in-process research and development 0.0 0.0 7.5
----- ----- -----
Total operating expenses ..................... 509.9 379.9 97.7
----- ----- -----
Loss from operations .............................. (457.3) (394.1) (79.3)
Interest and other income, net .................... 10.8 4.8 4.7
----- ----- -----
Net loss .......................................... (446.5)% (389.3)% (74.6)%
===== ===== =====
Dividend related to convertible preferred stock ... 0.0 0.0 (4.1)
===== ===== =====
Net loss applicable to common stockholders ........ (446.5)% (389.3)% (78.7)%
===== ===== =====
Net Revenues
We had two reportable business segments for revenue during fiscal year
2001: systems and services and OSDN. We allocated our resources and evaluated
performance of our separate segments based on revenue. As a result of our
decision to exit the systems business in the fourth quarter of fiscal 2001,
effective as of July 29, 2001, we operate as one business segment.
Software Revenues
Software revenues are derived from our SourceForge application software
business and include software licenses, professional services, maintenance,
support and training. Software revenues represent $1.1 million, or 5.3%, of
total revenues for fiscal year 2002.
Revenues from software license agreements are recognized when
objective, persuasive evidence of an agreement exists, delivery of the product
has occurred, provided the arrangement does not require significant
customization of the software, the fee is fixed or determinable, and
collectibility is reasonably assured.
For perpetual licenses, we use the residual method to recognize
revenues. Under the residual method, the fair value of the undelivered elements
is deferred and the remaining portion of the arrangement fee is recognized as
revenue. If objective evidence of the fair value of one or more undelivered
elements does not exist, all revenues are deferred and recognized when delivery
of those elements occurs or when fair value can be established. A typical
perpetual license agreement may include professional services, maintenance and
training. Revenue from non-essential professional services is recognized as the
work is performed based on fair value, which is based on published professional
services rates. When an agreement includes professional services that are
significant or essential to the functionality of the software, we use the
percentage of completion contract accounting method for the entire
12
arrangement, including license fees. We recognize maintenance revenues ratably
over the term of the maintenance period (generally one year). Software
maintenance agreements provide technical support and the right to unspecified
updates/upgrades on an if-and-when-available basis. Fair value for the ongoing
maintenance obligations are based upon separate sales or maintenance sold to
customers or upon renewal rates quoted in the contract, when these exist. We
record the unrecognized portion of amounts paid in advance for licenses and
services as deferred revenue.
For term arrangements, which include licenses and bundled post-contract
support ("PCS"), we use ratable revenue recognition. Under ratable revenue
recognition, the only undelivered element is PCS and objective evidence of fair
value of PCS does not exist. If the term license agreement includes multiple
elements (such as training and non-essential professional services), then we
defer revenue until all elements except PCS are delivered, at which time we
recognize revenue ratably over the remaining contract term.
If the fee due from the customer is not fixed or determinable, we
recognize revenues at the earlier of the due date or when cash is received from
the customer, assuming all other revenue recognition criteria have been met. We
consider all arrangements with payment terms longer than normal not to be fixed
or determinable.
Online Revenues
Online revenues include advertising as well as e-commerce revenue.
Online advertising revenues represent $9.0, or 44.2%, of total revenues for
fiscal year 2002 and includes $2.0 million of barter revenue. E-commerce
revenues represent $7.0 million, or 34.3%, of total revenues for fiscal year
2002.
Advertising revenues are derived from the sale of advertising space on
our various websites. We recognize advertising revenues over the period in which
the advertisements are displayed, provided that no significant obligations
remain and collection of the receivable is probable. Our obligations typically
include guarantees of a minimum number of "impressions" (times that an
advertisement is viewed by users of our online services). To the extent that
minimum guaranteed impressions are not met in the specified time frame, we do
not recognize the corresponding revenues until the guaranteed impressions are
achieved. We record barter revenue transactions at their estimated fair value
based on our historical experience of selling similar advertising for cash in
accordance with Emerging Issues Task Force ("EITF") Issue 99-17, "Accounting for
Advertising Barter Transactions." We broadcast banner advertising in exchange
for similar banner advertising on third party websites. Online revenues for
fiscal year 2002 included approximately $2.0 million in barter revenue. Online
revenues for fiscal year 2001 included approximately $2.4 million of barter
revenue. There was no barter revenue for fiscal year 2000.
E-commerce revenues are derived from the online sale of consumer goods
and digital animations. We recognize e-commerce revenues in accordance with SEC
Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial
Statements." Under SAB 101, product revenues are recognized when persuasive
evidence of an arrangement exists, delivery has occurred, the sale price is
fixed and determinable, and collectibility is reasonably assured. In general, we
recognize e-commerce revenue upon the shipment of goods. We do grant customers a
right to return products and have recorded an allowance for such returns. This
allowance is a management estimate based on historical return rates.
Other Revenues
Other revenues are derived from our former hardware, customer support,
and professional services businesses. Other revenues represent $3.3 million, or
16.3%, of total revenues for the fiscal year 2002.
Our revenue recognition policy related to our former hardware systems
business follows SEC SAB No. 101, "Revenue Recognition in Financial Statements."
Under SAB No. 101, we recognized product revenues from the sale of Linux-based
servers, components, and desktop computers when persuasive evidence of an
arrangement existed, delivery occurred, the sales price was fixed and
determinable and collectibility was reasonably assured. In general, we
recognized product revenue upon shipment of the goods. We did not grant our
customers any rights to return products.
We recognized revenues from customer support services, including
on-site maintenance and technical support on a pro-rata basis over the term of
the related service agreement. We recognized revenues from professional service
contracts upon completion of the project, or using the percentage of completion
method of the project where project costs could be reasonably estimated. We
recorded any payments received prior to revenue recognition as deferred revenue.
13
Our net revenues decreased to $20.4 million in fiscal year 2002, from
$134.9 million in fiscal year 2001. The $114.5 million decrease in net revenues
was due primarily to the exiting of the systems and services business segment.
In fiscal year 2002, systems and services revenue decreased $116.9 million to
$3.3 million from $120.2 million in fiscal year 2001. In fiscal year 2002,
online revenue increased by $1.3 million to $16.0 million from $14.7 million in
fiscal year 2001. Online revenue for fiscal years 2002 and 2001 included
approximately $2.0 million and $2.4 million, respectively, of barter revenue
arising from web advertising. SourceForge revenues totaled $1.1 million for
fiscal year 2002.
Our overall net revenues increased to $134.9 million in fiscal year
2001 from $120.3 million in fiscal 2000. During fiscal year 2001, our systems
and services business segment accounted for $120.2 million or 89.1% of net
revenues and our OSDN business segment accounted for $14.7 million or 10.9% of
net revenues. Net revenues for the systems and services business segment
increased to $120.2 million in fiscal year 2001 from $118.2 million in fiscal
year 2000. This marginal increase in our systems and services business was
primarily due to a small increase in net revenues from services offset by a
decline in demand for our server products from the Internet infrastructure
market. Net revenues for our OSDN business segment increased to $14.7 million in
fiscal year 2001 from $2.1 million in fiscal year 2000. This increase in net
revenues for our OSDN business segment was primarily due to incurring a full
year's worth of net revenues for our OSDN business segment in fiscal year 2001
as compared to the period from June 7, 2000 (OSDN acquisition date) to July 28,
2000 in fiscal year 2000. The increase in our OSDN net revenues was also
partially offset by a decrease in demand in the second half of fiscal year 2001
for our web advertising offerings.
Sales for the fiscal years ended 2002, 2001, and 2000 were primarily to
customers located in the United States of America.
For the fiscal year ended July 27, 2002, one customer, Intel
Corporation, accounted for approximately 20% of net revenues. For the fiscal
year ended July 28, 2001, one customer, Akamai Technologies, Inc., accounted for
approximately 25% of net revenues.
Cost of Revenues
Cost of revenues decreased to $9.7 million in fiscal year 2002 from
$154.1 million in fiscal year 2001. Gross margin increased as a percentage of
revenue to 52.6% in fiscal year 2002 from a negative 14.2% in fiscal year 2001.
The increase in gross margin as a percentage of net revenue was due primarily to
the exiting of the systems business and an inventory provision allowance of
$28.0 million in fiscal year 2001 to establish a reserve for excess material.
Cost of revenues for fiscal year 2002 included restructuring charges of a net
credit of $5.8 million which included a $6.9 million credit adjustment to the
fiscal year 2001 fourth quarter systems restructuring composed of a $2.0 million
reversal of reserves for inventory (due to a better sell through of old and
excess material during fiscal year 2002 than anticipated at fiscal year-end
2001) and a $4.9 million reversal of an over estimate of warranty expense. We
recorded a $1.1 million restructuring charge for a workforce reduction, which
consisted mostly of severance and other related costs attributable to 50
employees. We expect cost of revenues to remain relatively constant or to
slightly increase in absolute dollars in the future.
Cost of revenues increased to $154.1 million in fiscal year 2001 from
$98.2 million in fiscal year 2000. Gross margin decreased as a percent of net
revenues to a negative 14.2% in fiscal year 2001 from 18.4% in fiscal 2000. The
decline in gross margin was mostly due to charges from the write-off of excess
inventory caused by lower demand for our server products and our decision to
exit the systems business, charges from lower of cost or market adjustments to
inventory, selling price reductions on our server products due to competitive
pricing pressure, lower sales volume in the second half of fiscal year 2001, and
increased investments in professional service, partially offset by an increase
in gross profit from the OSDN business segment.
Sales and Marketing Expenses
Sales and marketing expenses consist primarily of salaries, commissions
and related expenses for personnel engaged in sales, marketing and sales support
functions, as well as costs associated with trade shows, advertising and
promotional activities.
Sales and marketing expenses decreased to $12.5 million in fiscal year
2002 from $40.0 million in fiscal year 2001. The decrease in absolute dollars
was primarily due to the exiting of our systems and services business, which
accounted for a $30.6 million reduction and a decline in our sales and marketing
efforts related to our online business of $3.0 million, offset by a $6.3 million
increase in spending due to the shift in resources to our software business.
Headcount in sales and marketing decreased to 29 in fiscal year 2002 from 59 in
fiscal year 2001. Sales and marketing expenses as a percentage of net revenues
increased to 61.4% for fiscal year 2002 from 29.6% in fiscal year 2001. This
increase was primarily due to our significantly decreased revenues. We believe
our
14
sales and marketing expenses to support our SourceForge business will continue
to increase in absolute dollars as we intend to continue to grow our sales
force. However, in the future, we expect sales and marketing expenses to
decrease slightly as a percentage of revenue.
Sales and marketing expenses increased to $40.0 million in fiscal year
2001 from $29.5 million in fiscal year 2000. Sales and marketing expenses as a
percent of net revenues increased to 29.6% in fiscal year 2001 from 24.5% in
fiscal year 2000. The increase was primarily due to the expansion of our sales
and marketing organizations in Europe and Japan which accounted for a $5.7
million increase and incurring a full year's worth of expenses from our sales
and marketing organizations from our online business which accounted for a $4.0
million of the increase.
Research and Development Expenses
Research and development expenses consist primarily of salaries and
related expenses for software engineers. We expense all of our research and
development costs as they are incurred.
Research and development expenses decreased to $8.1 million in fiscal
year 2002 from $18.0 million in fiscal year 2001. The decrease in absolute
dollars was primarily due to the exiting of the systems business, which
accounted for a $15.0 million reduction offset by an increase in our research
and development efforts related to our online business of $0.8 million and a
$4.2 million increase in spending as a result of our decision to focus on our
software business. Headcount in research and development decreased to 44 in
fiscal year 2002 from 66 in fiscal year 2001. Research and development expenses
as a percentage of net revenues increased to 39.8% for fiscal year 2002 from
13.3% for fiscal year 2001. This increase was primarily due to our significantly
decreased revenues. We expect research and development expenses to increase
slightly in absolute dollars as we continue to staff the research and
development department for our application software business and to decrease as
a percentage of revenue.
Research and development expenses increased to $18.0 million in fiscal
year 2001 from $12.4 million in fiscal year 2000. Research and development as a
percent of net revenues increased to 13.3% in fiscal year 2001 from 10.3% in
fiscal year 2000. The increase was primarily due to incurring a full year's
worth of expenses from our research and development organization for our online
business which accounted for a $2.6 million increase and an increased investment
in cost relating to research and development personnel, partially offset by a
decrease in material spending for new product development.
In accordance with Statement of Financial Accounting Standards ("SFAS")
No. 86, "Accounting for the Cost of Computer Software to be Sold, Leased, or
Otherwise Marketed," development costs incurred in the research and development
of new software products are expensed as incurred until technological
feasibility in the form of a working model has been established at which time
such costs are capitalized, subject to a net realizable value evaluation.
Technological feasibility is established upon the completion of an integrated
working model. To date, our software development has been completed concurrent
with the establishment of technological feasibility and, accordingly, all
software development costs have been charged to research and development expense
in the accompanying statements of operations. Going forward, should
technological feasibility occur prior to the completion of our software
development, all costs incurred between technological feasibility and software
development completion will be capitalized.
General and Administrative Expenses
General and administrative expenses consist of salaries and related
expenses for finance and administrative personnel and professional fees for
accounting and legal services.
General and administrative expenses decreased to $10.9 million in
fiscal year 2002 from $22.0 million for fiscal year 2001. General and
administrative expenses for fiscal year 2002 included the reversal of excess bad
debt provisions of $1.0 million and included $0.9 million of accrued legal
expenses associated with the IPO Securities Litigation. See Part I - Item 3 -
Legal Proceedings. General and administrative expenses for fiscal year 2001
included a one-time provision for bad debts of $2.5 million related to the
reorganization of the business. Excluding these charges, the decrease in
absolute dollars resulted primarily from a decrease in administrative personnel
due to our exit from the systems and services businesses. Headcount in general
and administrative services decreased to 27 in fiscal year 2002 from 70 in
fiscal year 2001. General and administrative expenses as a percentage of net
revenues increased to 53.2% for fiscal year 2002 from 16.3% for fiscal year
2001. The increase as a percentage of net revenues was primarily due to our
significantly decreased revenue. We do not intend to increase our current level
of spending to support our infrastructure and, as a result, we expect general
and administrative expenses to decrease year over year in absolute dollars and
as a percentage of revenue, excluding one-time provisions.
15
General and administrative expenses increased to $22.0 million in
fiscal year 2001 from $9.0 million in fiscal year 2000. General and
administrative expenses as a percentage of net revenues increased to 16.3% for
fiscal year 2001 from 7.5% for fiscal year 2000. General and administrative
expenses for fiscal year 2001 included a one-time provision for bad debts of
$2.5 million related to restructuring charges. Excluding one-time charges, the
increase in absolute dollars was due to an increase in expenses for
administrative personnel and support costs relating to a full year of operations
from our OSDN business segment and increased international operations. Headcount
in general and administrative services increased to 70 in fiscal year 2001 from
59 in fiscal year 2000.
Restructuring Costs and Other Special Charges
During February 2001, in response to the general slowdown in the
economy, we adopted a formal plan to reduce operating costs. In connection with
these actions, we recorded a pre-tax restructuring charge of approximately $43.4
million. The principle actions of the plan to reduce costs involved the closure
of our San Diego facility and the exit from our managed services business. Of
the $43.4 million restructuring charge, $33.8 million related to the
acceleration of deferred stock compensation that was originally contingent on
future employment by three employees of TruSolutions, Inc. ("TruSolutions") and
one employee of Life BVBA ("Life") from companies we acquired in March 2000 and
September 2000, respectively. These employees' positions were terminated as part
of the restructuring and all stock held in escrow was released to them as part
of their severance agreements. In addition, as part of the plan to exit from our
managed services business, we accrued for the disposition of Brave New Worlds,
Inc. ("BNW"), a company we acquired in September 2000. Severance charges related
to six employees of BNW who were informed before April 28, 2001 of our formal
plan to divest BNW were included in the accrual. Further, we recorded $1.7
million for a workforce reduction, consisting of severance, acceleration of
stock options and other related costs attributable to 43 former employees,
primarily from our domestic systems business. Of the remaining $7.9 million,
$1.7 million was for excess facilities related primarily to non-cancelable
leases (with payments continuing until fiscal year 2010, unless we sublet
completely) the abandonment or disposal of property and equipment and other
costs and $6.2 million was for the impairment of goodwill and purchased
intangibles as there were no future cash flows expected from the managed
services business. The accrual for non-cancelable lease payments included
management's estimates of the time expected to sublet the facilities and
estimates of sublease income. These estimates are subject to change based on
actual events. We evaluate and update, if applicable, these estimates quarterly.
In addition to the above, the Company recorded $3.4 million in
connection with these restructuring charges, which are classified as cost of
revenues in the statement of operations. Of the $3.4 million, $0.2 million was
recorded for workforce reduction, consisting of severance and other related
costs attributable to 19 employees from our domestic systems business and nine
employees from the managed services business. Of the remaining $3.2 million,
$2.9 million related to a write down of inventory from the closing of the San
Diego facility, and $0.3 million related to other restructuring costs.
In June 2001, we adopted a plan to exit the systems business, which we
accounted for in the fourth quarter ended July 28, 2001. We decided to exit our
systems business and pursue our applications software business in order to
reduce operating losses and improve cash flow. We recorded a restructuring
charge of $70.1 million in the fourth quarter of fiscal year 2001 related to
exiting our systems business. Of the $70.1 million, $53.5 million related to the
impairment of goodwill and purchased intangibles resulting from our expectation
that we would receive no significant future cash flows from the systems
business. $6.6 million of the $70.1 million charge related to excess facilities
primarily from non-cancelable leases, net of $3.1 million in assumed sublease
income (with payments continuing until fiscal year 2010, unless sublet
completely), $3.2 million related to a workforce reduction consisting of
severance, acceleration of stock options, and other related costs attributable
to 84 employees primarily from our systems business, and $6.8 million related to
other restructuring charges related to the exit from the systems business. The
accrual for non-cancelable lease payments included management's estimates of the
time expected to sublet the facilities and estimates of sublease income. These
estimates are subject to change based on actual events. We evaluate and update,
if applicable, these estimates quarterly.
In addition to the above, the Company recorded $10.5 million of charges
in connection with the exit of the systems business, which was classified as
cost of revenues in the statements of operations. Of the $10.5 million, $7.6
million was related to excess inventory charges arising from the exit from the
systems business, $0.4 million was recorded for a workforce reduction consisting
of severance, and other related costs attributable to 64 former employees from
the Company's systems business, and the remaining $2.5 million related to other
restructuring costs.
In September 2001, we adopted a plan to exit the professional services
and Linux software engineering services businesses in order to focus on our
SourceForge application software business. We recorded a restructuring charge of
$45.0 million in the first quarter of fiscal 2002 related to this exit. Of the
$45.0 million, $30.6 million related to the impairment of goodwill and purchased
intangibles from our prior year acquisitions of NetAttach, Inc. ("NetAttach")
and Precision Insight, Inc. ("Precision Insight") resulting from our
16
expectation that we would receive no significant future cash flows from the
professional services and Linux software engineering services businesses. $12.9
million of the $45.0 million charge related to excess facilities primarily from
non-cancelable leases, net of $2.4 million in assumed sublease income (with
payments continuing until fiscal year 2010, unless sublet completely) or other
costs for the abandonment or disposal of property and equipment. Of the
remaining $1.5 million restructuring charge, $1.3 million was related to a
workforce reduction consisting of severance and other labor related costs
attributable to 50 former employees primarily from our Linux software
engineering service business and $0.2 million related to other restructuring
charges related to the exit of the services business. The accrual for
non-cancelable lease payments included management's estimates of the time
expected to sublet the facilities and estimates of sublease income. These
estimates are subject to change based on actual events. We evaluate and update,
if applicable, these estimates quarterly.
In addition to the above, we recorded a $3.1 million net credit
included in cost of revenues in the consolidated statement of operations for the
quarter ended October 27, 2001. The $3.1 million net credit included a $3.9
million credit adjustment relating to the fiscal 2001 fourth quarter systems
restructuring composed of a $2.0 million reversal of reserves for inventory (we
had a better than expected sell through of old and excess material in the three
months ended October 27, 2001 than was anticipated at July 28, 2001), $1.2
million adjustment for system shipments (we were able to sell product at a price
in excess of that originally estimated at July 28, 2001) and $0.7 million
reversal for an over estimate of warranty expense. A $0.8 million restructuring
charge was recorded for a workforce reduction which mostly consisted of
severance and other related costs attributable to 36 former employees primarily
associated with our professional services business.
During the third quarter of fiscal 2002, we recorded additional
restructuring charges associated with the termination of a sublease agreement of
$0.7 million offset by reversals of excess restructuring accruals related to
prior periods of $0.6 million.
In addition, we recorded a $0.3 million credit included in cost of
revenues in the consolidated statement of operations for the quarter ended April
27, 2002. This credit was due to the reversal of a prior period restructuring
accrual. The accrual was originally established as a result of a non-cancelable
contract for warranty services. The contract was renegotiated and settled during
the third quarter of fiscal 2002 and as a result the reserve was reversed.
In July 2002, we adopted a plan to reduce our general and
administrative overhead costs. As a result of this plan, we recorded a
restructuring charge of $1.9 million in the fourth quarter of fiscal 2002. Of
the $1.9 million, $1.2 million related to excess facilities from non-cancelable
leases (with payments continuing until fiscal year 2004, unless we sublet
completely) and the abandonment of property, and $0.7 million related to a
workforce reduction consisting of severance and other related costs attributable
to 35 employees. The accrual for non-cancelable lease payments included
management's estimates of the time expected to sublet the facilities and
estimates of sublease income. These estimates are subject to change based on
actual events. We evaluate and update, if applicable, these estimates quarterly.
In addition to the above, we recorded a $2.4 million net credit
included in cost of revenues in the consolidated statement of operations for the
quarter ended July 27, 2002. The $2.4 million net credit included a $2.7 million
credit adjustment relating to the overestimate of the fiscal 2001 fourth quarter
systems warranty restructuring accrual. A $0.3 million restructuring charge was
recorded for a workforce reduction, which mostly consisted of severance and
other related costs attributable to 14 former employees primarily in an effort
to align our infrastructure with our operations.
17
Below is a summary of the restructuring charges in operating expenses
(in thousands):
Total
Total Charged Total Charged Cash Restructuring
To Operations To Operations Receipts\ Liabilities at
Fiscal 2001 Fiscal 2002 (Payments) July 27, 2002
----------- ----------- ---------- -------------
Cash Provisions:
Other special charges relating to
restructuring activities ............................. $ 2,159 $ (888) $ (1,219) $ 52
Facilities charges ..................................... 6,584 9,401 1,545 17,530
Employee severance and other related
charges ............................................... 3,498 1,997 (5,083) 412
-------- -------- -------- --------
Total cash provisions .............................. 12,241 10,510 $ (4,757) $ 17,994
-------- -------- ======== ========
Non-cash:
Write-off of goodwill and intangibles .................. 59,723 30,632
Write-off of other special charges
relating to restructuring activities .................. 4,434 5,442
Write-off of accelerated options from
terminated employees ................................. 1,352 --
Acceleration of deferred stock
compensation .......................................... 35,728 352
-------- --------
Total non-cash provisions .......................... 101,237 36,426
-------- --------
Total provisions ................................... $113,478 $ 46,936
======== ========
Amortization of Deferred Stock Compensation
In connection with the grant of certain stock options to employees
during fiscal 2000 and 1999, we recorded deferred stock compensation within
stockholders' equity of approximately $37.8 million, representing the difference
between the estimated fair value of the common stock for accounting purposes and
the option exercise price of these options at the date of grant. We amortize the
deferred stock compensation expense on an accelerated basis over the vesting
period of the individual award which is generally equal to four years. This
method of deferred stock expense amortization is in accordance with Financial
Accounting Standards Board Interpretation No. 28. The amortization expense
relates to options awarded to employees in all operating expense categories. The
amortization of deferred stock compensation has not been separately allocated to
these categories. The amount of deferred stock compensation from year to year
has decreased as options for which accrued but unvested compensation has been
recorded have been forfeited. In connection with the acquisitions of
TruSolutions, Precision Insight and NetAttach, we recorded $113.1 million of
deferred stock compensation during fiscal 2000. In connection with the
acquisitions of BNW and Life, we recorded $6.8 million of deferred stock
compensation during fiscal 2001. We recorded amortization of deferred stock
compensation of $1.7 million, $61.3 million and $39.5 million for the fiscal
years ended July 27, 2002, July 28, 2001 and July 28, 2000, respectively. In
addition, in connection with the restructuring discussed above, we recorded an
expense of approximately $35.7 million related to the acceleration of deferred
stock compensation for the fiscal year ended July 28, 2001. Further, we made a
$0.3 million adjustment during fiscal year 2002 related to deferred stock
compensation for stock options of terminated employees. All adjustments have
been included in restructuring costs and other special charges in the statements
of operations. We expect amortization of deferred stock compensation, in
absolute dollars, to decrease through fiscal year 2004 as a result of the
accelerated basis of amortization.
Amortization of Goodwill and Intangibles
In connection with the acquisitions of BNW, Life and certain
intangibles of Alabanza Corporation ("Alabanza") and Lavaca Systems Inc.
("Lavaca"), we recorded $10.6 million of goodwill and intangibles during fiscal
2001. In connection with the acquisitions of TruSolutions, Precision Insight,
NetAttach, and OSDN (formerly known as "Andover.Net, Inc."), we recorded $381.3
million of goodwill and intangibles during fiscal 2000. We amortized $97.9
million and $18.2 million of goodwill and intangibles in fiscal 2001 and 2000,
respectively. In connection with our restructuring plans in fiscal 2001, we
wrote off goodwill and intangibles associated with BNW, Life, Alabanza and
TruSolutions in the amount of $59.7 million as we had exited from these lines of
business and expected no future cash flows from them. In connection with our
restructuring plans in fiscal 2002, we have written off goodwill and intangibles
associated with NetAttach and Precision Insight in the amount of $30.6 million
due to the exit of the professional services and Linux software engineering
businesses.
18
We periodically evaluate the carrying amount of our long-lived assets
and apply the provisions of SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of." SFAS No. 121
requires that long-lived assets and certain identifiable intangibles to be held
and used or disposed of by an entity be reviewed for impairment whenever events
or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable.
We performed an assessment of the carrying value of our long-lived
assets to be held and used including significant amounts of goodwill and other
intangible assets recorded in connection with our OSDN acquisition. We performed
the assessment pursuant to SFAS No. 121 due to the significant slowdown in the
economy affecting our current operations and our expected future sales as well
as the general decline of technology valuations. The conclusion of these
assessments was that the decline in market conditions within our industry was
significant and other than temporary. As a result, we recorded during the fourth
quarter of fiscal 2001 a charge of $160.0 million to reduce goodwill and other
intangible assets associated with the acquisition of OSDN, based on the amount
by which the carrying value of these assets exceeded their fair value. The
charge is included in the caption "Impairment of long-lived assets" in the
statements of operations. Fair value was determined based on discounted future
cash flows.
In July 2001, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 142, "Goodwill and Other Intangible Assets." Under SFAS No. 142,
goodwill and intangible assets with indefinite lives are not amortized but are
subject to at least an annual assessment for impairment applying a fair-value
based test. Upon adoption of SFAS No. 142 on July 29, 2001, we no longer
amortize goodwill. In connection with the acquisitions of NetAttach, Precision
Insight, and OSDN, we amortized $11.7 million of intangibles during fiscal 2002.
As noted above, in connection with the restructuring plan approved in September
2001, we wrote-off $30.6 million of goodwill and intangibles relating to our
NetAttach and Precision Insight acquisitions due to the exit of the professional
services and Linux software engineering businesses. In addition, an assessment
for impairment was performed during the quarter ended July 27, 2002. As a result
of that assessment, we determined that the carrying value of the remaining
goodwill and intangible assets associated with OSDN were impaired and an
impairment loss of $12.2 million was recorded and is included in the caption
"Impairment of long-lived assets" in the statements of operations.
Write-off of In-Process Research and Development
The value assigned to purchased in-process research and development in
fiscal 2000 related to the acquisitions of TruSolutions and OSDN and was based
on the income method prepared by an independent third party and was determined
by identifying research projects in areas for which technological feasibility
had not been established and no future alternative uses existed.
TruSolutions' in-process research projects included the research and
development associated with the 1/2U, 1U, 2U, and 4U server products. The value
of in-process research and development was determined by estimating the costs to
develop the purchased in-process technology into commercially viable products,
estimating the resulting net cash flows from such projects and discounting the
net cash flows back to their present value. The discount rate included a
risk-adjusted discount rate to take into account the uncertainty surrounding the
successful development of the purchased in-process technology. The risk-adjusted
discount rate applied to the projects' cash flows was 45% for the in-process
technology. We believed that the estimated in-process technology amounts
represented fair value and did not exceed the amount a third party would pay for
the projects. The valuation included cash inflows from in-process technology
through fiscal 2003 with revenues commencing in fiscal 2000 for the 1U, 2U and
4U servers, and in fiscal 2001 for the 1/2U server. Where appropriate, we
allocated anticipated cash flows from an in-process research and development
project to reflect contributions of the core technology.
OSDN's in-process research projects included next-generation web site
management tools, online web applications and other technologies that will
support our network of web sites. The value of in-process research and
development was determined by estimating the costs to develop the purchased
in-process technology into commercially viable products, estimating the
resulting net cash flows from such projects and discounting the net cash flows
back to their present value. The discount rate included a risk-adjusted discount
rate to take into account the uncertainty surrounding the successful development
of the purchased in-process technology. The risk-adjusted discount rate applied
to the projects' cash flows was 30% for the in-process technology. We believed
that the estimated in-process technology amounts represented fair value and did
not exceed the amount a third party would pay for the projects. The valuation
included cash inflows from in-process technology through fiscal 2005 with
revenues commencing in fiscal 2001. Where appropriate, we allocated anticipated
cash flows from an in-process research and development project to reflect
contributions of the core technology.
19
Interest and Other Income, Net
Interest and other income, net, includes income from our cash
investments, net of other expenses. Net interest and other income decreased to
$2.2 million for fiscal year 2002 from $6.5 million for fiscal year 2001. The
decrease was primarily due to a lower cash balance and decreased returns on our
cash as a result of declining interest rates from prior year. We expect interest
and other income, net to decline as our cash balance decreases to support our
operations.
Net interest and other income increased to $6.5 million for fiscal year
2001 from $5.6 million in fiscal year 2000. The increase was primarily due to
offsetting the appropriate amount of operating loss for our Japan joint venture
operations to the minority shareholders and the incremental increase in interest
income earned from our short-term investments, partially offset by the payment
of various state taxes.
Income Taxes
As of July 27, 2002, we had $226.2 million of federal and state net
operating loss carry-forwards for tax reporting purposes available to offset
future taxable income. A valuation allowance has been recorded for the total
deferred tax assets as a result of uncertainties regarding realization of the
assets based on the lack of profitability to date and the uncertainty of future
profitability. The federal and state net operating loss carry-forwards expire at
various dates through fiscal year 2021 and fiscal year 2012, respectively, to
the extent that they are not utilized. We have not recognized any benefit from
these net operating loss carry-forwards because of uncertainty surrounding their
realization. The amount of net operating losses that we can utilize is limited
under tax regulations because we have experienced a cumulative stock ownership
change of more than 50% over the last three years.
Preferred Stock Dividend
During fiscal 2000, we recorded a preferred stock dividend of $4.9
million representing the value of the beneficial conversion feature on the
issuance of convertible preferred stock in September 1999. The beneficial
conversion feature was calculated at the commitment date based on the difference
between the conversion price of $3.86 per share and the estimated fair value of
the common stock at that date. The amount of the beneficial conversion feature
was limited to the amount of the gross proceeds received from the issuance of
convertible preferred stock. No dividends were recorded in fiscal 2002 or 2001.
Liquidity and Capital Resources
As of July 27, 2002, our principal sources of liquidity included cash
and cash equivalents of $35.1 million, and marketable securities of $17.9
million. Cash and cash equivalents decreased to $35.1 million at July 27, 2002
from $57.5 million at July 28, 2001.
For fiscal year 2002, we used $35.1 million in cash for operating
activities, compared to $81.6 million for fiscal year 2001. Working capital
decreased to $31.0 million at July 27, 2002 from $62.4 million at July 28, 2001,
primarily due to using our cash and investments to support our operating
activities. The fiscal year 2002 decrease in cash used for operating activities
of $46.5 is primarily due to a decrease in our net loss to $91.0 million for
fiscal year 2002 compared to our net loss of $525.3 million for fiscal year
2001. This decrease in net loss was primarily due to our reduction in expenses
through our restructuring and exiting the systems and services business and
changing our focus to application software. Non-cash items consisting primarily
of depreciation and amortization of goodwill, non-cash restructuring, our
proportionate loss of our VA Linux Systems Japan, K.K. ("VA Linux Japan")
investment, gain on the sale of our Japan investment, impairment of long-lived
assets and amortization of deferred compensation were $52.4 million and $453.7
million for fiscal years 2002 and 2001, respectively. Other operating activities
during fiscal year 2002 consisted of decreases in accounts receivable, accounts
payable, inventories, prepaid expenses and other assets, accrued liabilities and
other long-term liabilities, and an increase in restructuring accruals. The
decrease in all accounts, with the exception of restructuring, reflects our
lower revenue and the exit from the systems business.
Cash and cash equivalents decreased to $57.5 million at July 28, 2001
from $121.6 million at July 28, 2000. For fiscal year 2001, we used $81.6
million in cash for operating activities, compared to $24.6 million for fiscal
year 2000. Working capital decreased to $62.4 million at July 28, 2001 from
$169.9 million at July 28, 2000, primarily due to using our cash and investments
to support our operating activities. The increase in net cash used in operating
activities was primarily due to the increase in operating losses to $525.3
million in fiscal year 2001, compared to our net loss of $89.8 million for
fiscal year 2000. Non-cash items consisting primarily of depreciation and
amortization of goodwill, bad debt and inventory provisions, loss on disposal of
assets, amortization of deferred compensation, non-cash restructuring and
impairment of long-lived assets were $453.7 million and $72.9 million for fiscal
years 2001 and 2000, respectively. Other operating activities during fiscal year
2001 consisted of an increase in inventories, prepaid expenses,
20
accrued restructuring liabilities, other accrued liabilities and other long-term
liabilities offset by decreases in accounts receivable and accounts payable.
For fiscal year 2002, we received $11.3 million in cash related to
investing activities primarily from the cash proceeds received on the partial
sale of our VA Linux Japan investment and the sale/purchase of marketable
securities. In fiscal year 2001, we received $17.9 million in cash for investing
activities primarily from the sales of marketable securities and partially
offset by the purchase of computer and facilities-related assets and other
long-lived assets and for acquisition-related activities. In fiscal year 2000,
we used $13.2 million in cash for investing activities due to purchases of
short-term investments of $52.4 million, capital equipment of $7.6 million,
offset by the net amount of cash acquired as a result of acquisitions of $46.9
million.
For fiscal years 2002, 2001 and 2000, we generated $0.1 million, $1.6
million and $143.0 million in cash from financing activities, respectively. In
fiscal years 2002 and 2001, cash provided by financing activities was due to
proceeds from the issuance of common stock to our employees, partially offset by
payments on notes payable. Fiscal year 2000 increase in cash from financing
activities reflects the proceeds from our initial public offering of $141.5
million.
For the fiscal year 2002, exchange rate changes had a positive effect
on cash and cash equivalents of $1.4 million. For the fiscal year 2001, exchange
rate changes had a negative effect on cash and cash equivalents of $1.5 million.
There was no effect on cash from exchange rate changes in fiscal year 2000.
As of July 27, 2002, we had outstanding letters of credit issued under
the Line of Credit of approximately $1.4 million, primarily related to the
corporate facility lease. The amount related to this letter of credit is
recorded in the "Restricted cash" section of the consolidated balance sheet.
Future payments due under debt and lease obligations as of July 27,
2002 are as follows (in thousands):
Obligations
Under
Obligations Non-cancelable
Under Capital Operating
Year Ending July 27, 2002 Leases Leases
------------------------- ------ ------
2003........................................... $ 42 $ 4,208
2004........................................... -- 4,428
2005........................................... -- 4,556
2006........................................... -- 3,632
2007........................................... -- 3,511
Thereafter..................................... -- 10,521
------- ---------
$ 42 $ 30,856
======= =========
Our liquidity and capital requirements depend on numerous factors,
including market acceptance of our application software products, the resources
we devote to developing, marketing, selling and supporting our application
software products, the timing and expense associated with expanding our
distribution channels, potential acquisitions and other factors. We expect to
devote capital resources to continue our research and development efforts, to
invest in our sales, support, marketing and product development organizations,
to enhance and introduce marketing programs, and for other general corporate
activities. We believe that our existing cash balances will be sufficient to
fund our operations through fiscal 2003 under our current business strategy.
21
Financial Risk Management
As a primarily US-centric company, we face limited exposure to adverse
movements in foreign currency exchange rates and we do not engage in hedging
activity. We do not anticipate significant currency gains or losses in the near
term. These exposures may change over time as business practices evolve and
could have a material adverse impact on our financial results.
We maintain investment portfolio holdings of various issuers, types and
maturities. These securities are classified as available-for-sale, and
consequently are recorded on the consolidated balance sheet at fair value with
unrealized gains and losses reported as a separate component of accumulated
other comprehensive income (loss). These securities are not leveraged and are
held for purposes other than trading.
Critical Accounting Policies
Accounting policies, methods and estimates are an integral part of the
consolidated financial statements prepared by management and are based upon
management's current judgments. Those judgments are normally based on knowledge
and experience with regard to past and current events and assumptions about
future events. Certain accounting policies, methods and estimates are
particularly sensitive because of their significance to the financial statements
and of the possibility that future events affecting them may differ markedly
from management's current judgments. While there are a number of accounting
policies, methods and estimates affecting our financial statements, areas that
are particularly significant include revenue recognition policies, the
assessment of recoverability of goodwill and other intangible assets,
restructuring reserves for excess facilities for non-cancelable leases, income
taxes, and contingencies and litigation.
Revenue Recognition
During the fourth quarter of fiscal 2001 and the first quarter of
fiscal 2002, we announced and executed our plan to exit from our systems, and
professional services and Linux software engineering services businesses and
pursue the application software business.
As discussed in Note 2 of the notes to the consolidated financial
statements, our revenue recognition policy related to the software business
follows American Institute of Certified Public Accountants ("AICPA") Statement
of Position ("SOP") 97-2, "Software Revenue Recognition," as amended, and was
implemented in the fourth quarter of fiscal 2001. Revenues from software license
agreements are recognized when objective, persuasive evidence of an agreement
exists, delivery of the product has occurred, provided the arrangement does not
require significant customization to the software, the fee is fixed or
determinable and collectibility is reasonably assured.
We use the residual method to recognize revenues from perpetual
licenses. Under the residual method, the fair value of the undelivered elements
is deferred and the remaining portion of the arrangement fee is recognized as
revenue. If objective evidence of the fair value of one or more undelivered
elements does not exist, revenues are deferred and recognized when delivery of
those elements occur or when fair value can be established. A typical perpetual
license agreement may include professional services, maintenance and training.
Revenue from non-essential professional services is recognized as the work is
performed based on fair value, based on published professional services rates.
When an agreement includes professional services that are significant or
essential to the functionality of the software, we use contract accounting
percentage completion for the entire arrangement, including license fees. We
recognize software maintenance revenues ratably over the term of the maintenance
period (generally one year). Software maintenance agreements provide technical
support and the right to unspecified updates/upgrades on an
if-and-when-available basis. Fair value for the ongoing maintenance obligations
are based upon separate sales or maintenance sold to customers or upon renewal
rates quoted in the contract, when these exist. We record the unrecognized
portion of amounts paid in advance for licenses and services as deferred
revenue.
For term arrangements, which include licenses and bundled PCS, we use
ratable revenue recognition. Under ratable revenue recognition, the only
undelivered element is PCS and objective evidence of fair value of PCS does not
exist. If the term license agreement includes multiple elements (such as
training and non-essential professional services), then we defer revenue until
all elements except PCS are delivered, at which time we recognize revenue
ratably over the remaining contract term.
If the fee due from the customer is not fixed or determinable, we
recognize revenues at the earlier of the due date or when cash is received from
the customer, assuming all other revenue recognition criteria have been met. We
consider all arrangements with payment terms longer than normal not to be fixed
or determinable.
22
Advertising revenues are derived from the sale of advertising space on
our various websites. We recognize advertising revenues over the period in which
the advertisements are displayed, provided that no significant obligations
remain and collection of the receivable is probable. Our obligations typically
include guarantees of a minimum number of "impressions" (times that an
advertisement is viewed by users of our online services over a specified period
of time). To the extent that minimum guaranteed impressions are not met, we do
not recognize the corresponding revenues until the guaranteed impressions are
achieved. We record barter revenue transactions at their estimated fair value
based on our historical experience of selling similar advertising for cash in
accordance with EITF Issue 99-17, "Accounting for Advertising Barter
Transactions." We broadcast banner advertising in exchange for similar banner
advertising on third party websites.
E-commerce revenues are derived from the online sale of consumer goods
and digital animations. We recognize E-commerce revenues in accordance with SEC
Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial
Statements." Under SAB 101, product revenues are recognized when persuasive
evidence of an arrangement exists, delivery has occurred, the sale price is
fixed and determinable, and collectibility is reasonably assured. In general, we
recognize e-commerce revenue upon the shipment of goods. We do grant customers a
right to return products and have recorded an allowance for such returns. This
allowance is a management estimate based on historical return rates.
From inception through June 27, 2001, we were a provider of Linux-based
computer systems and services, Internet infrastructure and Open Source software
services and OSDN.
Our revenue recognition policy related to our former hardware systems
business follows SEC SAB No. 101, "Revenue Recognition in Financial Statements."
Under SAB No. 101, we recognized product revenues from the sale of Linux-based
servers, components, and desktop computers when persuasive evidence of an
arrangement existed, delivery had occurred, the sales price was fixed and
determinable and collectibility was reasonably assured. In general, we
recognized product revenue upon shipment of the goods and did not grant our
customers any rights to return products. We recognized revenues from customer
support services, including on-site maintenance and technical support on a
pro-rata basis over the term of the related service agreement. We recognized
revenues from professional service contracts upon completion of the project, or
using the percentage of completion method of the project where project costs
could be reasonably estimated. We recorded any payments received prior to
revenue recognition as deferred revenue.
Amortization of Goodwill and Intangibles
As discussed in Note 2 of the notes to the condensed consolidated
financial statements, effective July 29, 2001, we adopted SFAS No. 142,
"Goodwill and Other Intangible assets." Upon adoption of SFAS No. 142, we no
longer amortize goodwill, and thereby eliminated goodwill amortization of
approximately $1.3 million based on anticipated goodwill amortization for fiscal
2002. Pursuant to SFAS No. 142, we test goodwill for impairment. SFAS No. 142
requires that goodwill be tested for impairment at the "reporting unit level"
("Reporting Unit") at least annually and more frequently upon the occurrence of
certain events, as defined by SFAS 142. We have determined that we have only one
Reporting Unit, specifically the license, implementation and support of our
software applications. We tested goodwill for impairment during the quarter
ended July 27, 2002. First, we tested to determine if the carrying value of our
net assets exceeded their "fair value", which would indicate that goodwill may
be impaired. Based on this test, we determined that goodwill could be impaired.
Therefore we compared the "implied fair value" of the goodwill, as defined by
SFAS 142, to our carrying amount to determine if there was an impairment loss.
As a result of the impairment test, we determined that the carrying value was
impaired and we recorded an impairment loss of $3.6 million.
Other intangible assets are amortized on a straight-line basis over
three to five years. We continually evaluate whether later events and
circumstances have occurred that indicate the remaining estimated useful life of
these intangible assets may not be recoverable. When factors indicate that the
intangible assets should be evaluated for possible impairment, we use an
estimate of the related business segment's undiscounted net income over the
remaining useful life of the intangible assets in measuring whether they are
recoverable. We performed an evaluation on the intangible assets during the
quarter ended July 27, 2002. As a result of this evaluation, we determined that
the carrying value was impaired and we recorded an impairment loss of $8.6
million. The write off of intangible assets will result in a savings in
amortization expense of $8.6 million in fiscal 2003.
Restructuring Costs and Other Special Charges
As discussed in Note 4 of notes to the consolidated financial
statements, we have recorded significant restructuring charges in connection
with exiting our managed services, systems, and professional services and Linux
software engineering services businesses
23
initiated in the third and fourth quarters of fiscal 2001 and the first quarter
of fiscal 2002, respectively. A significant portion of these charges related to
excess facilities primarily from non-cancelable leases (payments which, unless
we sublet completely, will continue until fiscal 2010) or other costs for the
abandonment or disposal of property and equipment. In addition, during the third
quarter of fiscal 2002, we recorded additional restructuring charges associated
with the exiting of a sublease agreement. Estimates related to sublease costs
and income are based on assumptions regarding the period required to locate and
contract with suitable sub-lessees and sublease rates which can be achieved
using market trend information analyses provided by a commercial real estate
brokerage firm retained by us. We review these estimates each reporting period
and to the extent that these assumptions change due to changes in the market,
the ultimate restructuring expenses for these excess facilities could vary by
material amounts. Savings related to fiscal year 2003 as a result of idle space
charges taken in fiscal year 2002 totaled $2.7 million. Should the Company be
unable to sublet the idle facilities under the current assumptions, additional
idle space charges may be recorded in future periods for a maximum of up to $6.5
million. Further, during the fourth quarter of fiscal 2002, we recorded
restructuring charges totaling a net credit amount of approximately $0.5 million
in connection with a plan to reduce our general and administrative overhead
costs.
Income Taxes
We are required to estimate our income taxes in each of the
jurisdictions in which we operate as part of the process in preparing our
consolidated financial statements. This process involves us estimating our
actual current tax exposure together with assessing temporary differences
resulting from differing treatment of items, such as deferred revenue, for tax
and accounting purposes. These differences result in deferred tax assets or
liabilities. We must then assess the likelihood that our net deferred tax assets
will be recovered from future taxable income and to the extent that we believe
recovery is not likely, we must establish a valuation allowance. While we have
considered future taxable income in assessing the need for the valuation
allowance, in the event that we were to determine that we would be able to
realize our deferred tax assets in the future in excess of its net recorded
amount, an adjustment to the deferred tax asset would be made, increasing income
in the period in which such determination was made.
Contingencies and Litigation
We are subject to proceedings, lawsuits and other claims. We assess the
likelihood of any adverse judgments or outcomes to these matters as well as
ranges of probable losses. A determination of the amount of loss contingency
required, if any, is assessed in accordance with SFAS No. 5 "Contingencies and
Commitments" and recorded if probable after careful analysis of each individual
matter. The required loss contingencies may change in the future as the facts
and circumstances of each matter change.
Recent Accounting Pronouncements
Effective July 29, 2001, the Company adopted SFAS No. 142, "Goodwill
and Other Intangible assets." Upon adoption of SFAS No. 142, the Company no
longer amortizes goodwill and thereby eliminated goodwill amortization of
approximately $1.3 million anticipated goodwill amortization for fiscal 2002. We
tested goodwill and intangible assets for impairment during the quarter ended
July 27, 2002. First, we determined if our carrying amount exceeded our "fair
value", which would indicate that goodwill may be impaired. We determined that
goodwill and intangible assets were impaired, therefore we compared the "implied
fair value" of the assets, as defined by SFAS 142, to our carrying amount to
determine if there was an impairment loss. As a result of the impairment test,
we determined that the carrying value was impaired and we recorded an impairment
loss of $12.2 million.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." SFAS No. 143 establishes accounting standards for
recognition and measurement of an asset retirement obligation and an associated
asset retirement cost and is effective for fiscal years beginning after June 15,
2002. The Company is currently evaluating the potential impact, if any, the
adoption of SFAS No. 143 will have on its future financial position and results
of operations.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
While SFAS No. 144 supersedes SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," it retains many
of the fundamental provisions of SFAS No. 121. SFAS No. 144 also supersedes the
accounting and reporting provisions of APB No. 30, "Reporting the Results of
Operations--Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for
the disposal of a segment of a business. However, it retains the requirement in
APB No. 30 to separately report discontinued operations and extends that
reporting to a component of an entity that either has been disposed of (by sale,
abandonment, or in a distribution to owners) or is classified as held for sale.
SFAS No. 144 is effective for fiscal years beginning after December 15, 2001 and
interim periods within those fiscal years. The adoption of SFAS No. 144 is not
expected to have a material effect on our consolidated financial statements.
24
In November 2001, the EITF reached a consensus on EITF Issue No. 01-09,
"Accounting for Consideration Given by a Vendor to a Customer or a Reseller of
the Vendor's Products," which is a codification of EITF Issue No. 00-14, 00-22
and 00-25. This issue presumes that consideration from a vendor to a customer or
reseller of the vendor's products to be a reduction of the selling prices of the
vendor's products and, therefore, should be characterized as a reduction of
revenues when recognized in the vendor's income statement and could lead to
negative revenues under certain circumstances. Revenue reduction is required
unless consideration relates to a separate identifiable benefit and the
benefit's fair value can be established. EITF No. 01-09 is effective for fiscal
years beginning after December 15, 2001 and interim periods within those fiscal
years. The adoption of EITF No. 01-9 is not expected to have a material effect
on our consolidated financial statements.
In November 2001, the FASB discussed Topic D-103, recharacterized as
EITF Issue No. 01-14, "Income Statement Characterization of Reimbursements
Received for "Out-of-Pocket" Expenses Incurred." This issue deals with
classification in the income statement of incidental expenses, which in practice
are commonly referred to as "out-of-pocket" expenses, incurred by entities that
provide services as part of their central ongoing operations. The Task Force
reached a consensus that reimbursements received for out-of-pocket expenses
incurred should be characterized as revenue in the income statement. This issue
is effective for fiscal years beginning after December 15, 2001. We have
recorded all "out-of-pocket" expenses for fiscal 2002 as revenue. Out-of-pocket
expenses for all periods presented were immaterial.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which addresses accounting for
restructuring and similar costs. SFAS No. 146 supercedes previous accounting
guidance, principally EITF issue No. 94-3. We are required to adopt SFAS No. 146
for restructuring activities initiated after December 31, 2002. SFAS No. 146
requires that the liability for costs associated with an exit or disposal
activity be recognized when the liability is incurred. Under EITF 94-3, a
liability for an exit cost was recognized at the date of the company's
commitment to an exit plan. SFAS No. 146 also established that the liability
should initially be measured and recorded at fair value. Accordingly, SFAS 146
may affect the timing of recognizing future restructuring plans. If we continue
to record significant restructuring charges in the future, the adoption of SFAS
No. 146 could have a significant impact on our results of operations.
Risk Factors
INVESTORS SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW BEFORE MAKING AN
INVESTMENT DECISION. IN ADDITION, THESE RISKS ARE NOT THE ONLY ONES FACING OUR
COMPANY. ADDITIONAL RISKS OF WHICH WE ARE NOT PRESENTLY AWARE OR THAT WE
CURRENTLY BELIEVE ARE IMMATERIAL MAY ALSO IMPAIR OUR BUSINESS OPERATIONS. OUR
BUSINESS COULD BE HARMED BY ANY OF THESE RISKS. THE TRADING PRICE OF OUR COMMON
STOCK COULD DECLINE DUE TO ANY OF THESE RISKS, AND INVESTORS MAY LOSE ALL OR
PART OF THEIR INVESTMENT.
Risks Related To Our Software Business
BECAUSE THE MARKET FOR DEVELOPMENT INTELLIGENCE (DI) APPLICATION SOFTWARE IS
NEW, WE DO NOT KNOW WHETHER EXISTING AND POTENTIAL CUSTOMERS WILL LICENSE
SOURCEFORGE IN SUFFICIENT QUANTITY FOR US TO ACHIEVE PROFITABILITY. The market
for Development Intelligence (DI) software is new and rapidly evolving. Our
future growth and financial performance will depend on broad market acceptance
of SourceForge, our Development Intelligence application. The number of
customers using SourceForge is still relatively small. We expect that we will
continue to need intensive marketing and sales efforts to educate prospective
clients about the uses and benefits of SourceForge. Various factors could
inhibit the growth of the market and market acceptance of SourceForge. In
particular, potential customers may be unwilling to make the significant capital
investment needed to license SourceForge and retrain their software developers
to develop software using our product. Many of our customers have licensed only
small quantities of SourceForge, and these or new customers may decide not to
broadly implement or license additional copies. We cannot be certain that a
viable market for SourceForge will emerge, or if it does emerge, that it will be
sustainable. If a sustainable viable market of SourceForge fails to emerge, this
would have a significant, adverse effect upon our business and operating
results.
WE ARE CONCENTRATING OUR SALES EFFORTS ON SOURCEFORGE, SO IF THIS SOFTWARE DOES
NOT ACHIEVE MARKET ACCEPTANCE WE ARE LIKELY TO EXPERIENCE LARGER OPERATING
LOSSES. We are directing the majority of our product research and development
efforts to SourceForge. The failure to achieve widespread market acceptance of
SourceForge would adversely affect our business and operating results. The
success of SourceForge is difficult to predict because SourceForge represents a
relatively new area of business for us. There can be no assurance that we will
be successful in marketing,
25
upgrading and supporting SourceForge. Our failure to do so could adversely
affect our business and operating results.
IF WE DO NOT DEVELOP AND ENHANCE SOURCEFORGE TO KEEP PACE WITH TECHNOLOGICAL,
MARKET, AND INDUSTRY CHANGES, OUR REVENUES MAY NOT GROW. Rapid technological
advances, changes in customer requirements, and frequent new product
introductions and enhancements characterize the software industry generally. We
must respond rapidly to developments related to hardware platforms, operating
systems, and software development tools. These developments will require us to
make substantial product-development investments. If we fail to anticipate or
respond adequately to technology developments, industry standards, or practices
and customer requirements, or if we experience any significant delays in product
development, introduction, or integration, SourceForge may become obsolete or
unmarketable, our ability to compete may be impaired, and our revenues may not
grow or may decline. We believe our continued success will become increasingly
dependent on our ability to:
o support multiple platforms, including Linux, commercial UNIX and
Microsoft Windows;
o use the latest technologies to continue to support Web-based
Development Intelligence; and
o continually support the rapidly changing standards, tools and
technologies used in software development.
IF WE FAIL TO ATTRACT AND RETAIN LARGER CORPORATE AND ENTERPRISE-LEVEL
CUSTOMERS, OUR REVENUES WILL DECLINE. We have focused our sales and marketing
efforts upon larger corporate and enterprise-level customers. This strategy may
fail to generate sufficient revenue to offset the substantial demands that this
strategy will place on our business, in particular the longer sales cycles,
higher levels of service and support and volume pricing and terms that larger
corporate and enterprise accounts often demand. In addition, these larger
customers generally have significant internal financial and personnel resources.
As a result, rather than license SourceForge, our target customers may develop
Development Intelligence applications internally, including ad hoc development
of Development Intelligence applications based on open source code. A failure to
successfully obtain revenues from larger corporate or enterprise-level customers
will materially and adversely affect our operations.
OUR PRODUCT HAS A LONG AND UNPREDICTABLE SALES CYCLE, WHICH MAKES IT DIFFICULT
TO FORECAST OUR FUTURE RESULTS AND MAY CAUSE OUR OPERATING RESULTS TO VARY
SIGNIFICANTLY. The period between initial contact with a prospective customer
and the licensing of our software varies and can range from three to more than
twelve months. Additionally, our sales cycle is long and complex as customers
consider a number of factors before committing to purchase SourceForge. Factors
considered by customers when evaluating SourceForge include product benefits,
cost and time of implementation, and the ability to operate with existing and
future computer systems. Customer evaluation, purchasing and budgeting processes
vary significantly from company to company. As a result, we spend significant
time and resources informing prospective customers about our software products,
which may not result in a completed transaction and may negatively impact our
operating margins. Even if SourceForge has been chosen by the customer,
completion of the transaction is subject to a number of contingencies, which
make our quarterly revenues difficult to forecast. These contingencies include
but are not limited to:
o Because the licensing of our software products is often an
enterprise-wide decision by our customers that involves many factors,
our ability to license our product may be impacted by changes in the
strategic importance of software projects to our customers, budgetary
constraints or changes in customer personnel.
o A customer's internal approval and expenditure authorization process
can be difficult and time consuming. Delays in approvals, even after
selection of a vendor, could impact the timing and amount of revenues
recognized in a quarterly period.
o Changes in our sales incentive plans may have an unpredictable impact
on our sales cycle and contracting activities.
o The number, timing and significance of enhancements to our software
products and the introduction of new software by our competitors and us
may affect customer-purchasing decisions.
CONTRACTUAL ISSUES MAY ARISE DURING THE NEGOTIATION PROCESS THAT MAY DELAY THE
ANTICIPATED CLOSURE OF THE TRANSACTION AND OUR ABILITY TO RECOGNIZE REVENUE AS
ANTICIPATED. Because we sell enterprise-wide solutions, the process of
contractual negotiation is becoming more protracted and critical. The additional
time needed to negotiate mutually acceptable terms that culminate in an
agreement to license our products could extend the sale cycle. Several factors
may also require us to defer recognition of license revenue for a significant
period of time after entering into a license agreement, including instances
where we are required to deliver either unspecified additional products or
specified upgrades for which we do not have vendor-specific objective evidence
of fair value. While we have a standard software license agreement that provides
for revenue recognition provided that delivery has taken place, collectibility
from the customer is reasonably assured and assuming no significant future
obligations or customer acceptance rights exist, customer negotiations and
revisions to these terms could impact our ability to recognize revenues at the
time of delivery.
26
In addition, slowdowns or variances from internal expectations in our quarterly
license contracting activities may impact our service offerings and may result
in lower revenues from our customer training, professional services and customer
support organizations. Our ability to maintain or increase service revenues is
highly dependent on our ability to increase the number of license agreements we
enter into with customers.
IF WE DO NOT CONTINUE TO RECEIVE REPEAT BUSINESS FROM EXISTING CUSTOMERS, OUR
REVENUE WILL SUFFER. We generate a significant amount of our software license
revenues from existing customers. Most of our current customers initially
purchase a limited number of licenses as they implement and adopt our
Development Intelligence application. Even if the customer successfully uses
SourceForge, customers may not purchase additional licenses to expand the use of
our product. Purchases of expanded licenses by these customers will depend on
their success in deploying SourceForge, their satisfaction with our product and
support services and their use of competitive alternatives. A customer's
decision to widely deploy SourceForge and purchase additional licenses may also
be affected by factors that are outside of our control or which are not related
to our product or services. In addition, as we deploy new versions of
SourceForge, or introduce new products, our current customers may not require
the functionality of our new versions or products and may decide not to license
these products.
IF WE FAIL TO MAINTAIN OUR STRATEGIC RELATIONSHIP WITH IBM, THE MARKET
ACCEPTANCE OF OUR PRODUCTS AND OUR FINANCIAL PERFORMANCE MAY SUFFER. To date,
the majority of our SourceForge revenue has come from our direct sales efforts.
To offer products and services to a larger customer base, our direct sales force
depends on strategic relationships and marketing alliances to obtain customer
leads, referrals and distribution. If we are unable to maintain our existing
strategic relationship with IBM, our ability to increase our sales will be
harmed. We would also lose anticipated customer introductions and co-marketing
benefits. In addition, IBM could terminate its relationship with us, pursue
other relationships, or attempt to develop or acquire products or services that
compete with our products and services. Even if we succeed in maintaining or
expanding our relationship with IBM, the relationship may not result in
additional customers or revenues.
IF WE ARE UNABLE TO PROVIDE HIGH-QUALITY CUSTOMER SUPPORT AND SERVICES, WE WILL
NOT MEET THE NEEDS OF OUR CUSTOMERS AND REVENUE MAY DECLINE. For our business to
succeed, we must effectively market and provide customer support for
SourceForge. If we do not develop our customer support organization to meet the
needs or expectations of customers, we face an increased risk that customers
will purchase software from other providers or forgo deployment of Development
Intelligence applications entirely, which would materially and adversely affect
our operations.
INCREASED UTILIZATION AND COSTS OF OUR TECHNICAL SUPPORT SERVICES MAY ADVERSELY
AFFECT OUR FINANCIAL RESULTS. Like many companies in the software industry,
technical support costs will likely comprise a significant portion of our
operating costs and expenses. Over the short term, we may be unable to respond
to fluctuations in customer demand for support services. We also may be unable
to modify the format of our support services to compete with changes in support
services provided by competitors. Further, customer demand for these services
could cause increases in the costs of providing such services and adversely
affect our operating results.
Risks Related To Competition
IF WE DO NOT EFFECTIVELY COMPETE WITH NEW AND EXISTING COMPETITORS, OUR REVENUES
AND OPERATING MARGINS WILL DECLINE. We believe that the newly emerging
Development Intelligence software market is fragmented, subject to rapid change
and highly sensitive to new product introductions and marketing efforts by
industry participants. Competition in related markets is intense. If our
products gain market acceptance, we expect the competition to rapidly intensify
as new competitors enter the Development Intelligence software marketplace. Our
potential competitors include entrenched companies in closely related markets
who may choose to enter and focus on the Development Intelligence software
marketplace. Although we do not believe that we presently have an entrenched
competitor, we expect competition to intensify in the future if the market for
Development Intelligence applications continues to expand. Many of these
potential competitors are much larger than we are and may have significantly
more resources and more experience. Our potential competitors include providers
of software and related services as well as providers of hosted application
services. Our potential competitors vary in size, scope of services offered and
platforms supported. Many of our competitors have longer operating histories and
greater financial, technical, sales and marketing resources than we do. We
cannot guarantee that we will be able to compete successfully against current
and future competitors or that competitive pressures will not result in price
reductions, reduced operating margins and loss of market share, any one of which
could seriously harm our business.
Because individual product sales often lead to a broader customer relationship,
our products must be able to successfully compete with and complement numerous
competitors' current and potential offerings. Moreover, we may be forced to
compete with our strategic
27
partners, and potential strategic partners, and this may adversely impact our
relationship with an individual partner or a number of partners.
ONLINE COMPETITION IS INTENSE. OUR FAILURE TO COMPETE SUCCESSFULLY COULD
ADVERSELY AFFECT OUR REVENUE AND FINANCIAL RESULTS. The market for Internet
content and services is intensely competitive and rapidly evolving. It is not
difficult to enter this market and current and new competitors can launch new
Internet sites at relatively low cost. We derive revenue from advertising, for
which we compete with various media including newspapers, radio, magazines and
various Internet sites. We cannot assure you that we will compete successfully
with current or future competitors. Moreover, increased competition could result
in price reductions, reduced margins or loss of market share, any of which could
have a material adverse effect on our future revenue and financial results.
If we do not compete successfully for new users and advertisers, our financial
results may be materially and adversely effected.
Risks Related To Our Financial Results
IT IS DIFFICULT TO EVALUATE OUR BUSINESS BECAUSE WE HAVE A LIMITED HISTORY
OPERATING AS A PROVIDER OF SOURCEFORGE. We have a brief operating history as a
provider of our SourceForge commercial Development Intelligence application. As
a result, our historical financial information is of limited value in projecting
future operating results. On June 27, 2001, we exited our hardware business. In
the first quarter of our fiscal year 2002, we made the strategic decision to
exit, and exited, the professional services and Linux software engineering
services fields to focus solely on SourceForge. These changes required us to
adjust our business processes and make a number of significant personnel
changes, including changes and additions to our engineering and management
teams. Therefore, in evaluating our business you must consider the risks and
difficulties frequently encountered by early stage companies in new and rapidly
evolving markets, including those discussed within these "Risk Factors" and in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
IF WE FAIL TO ADEQUATELY MONITOR AND MINIMIZE OUR USE OF EXISTING CASH, WE MAY
NEED ADDITIONAL CAPITAL TO FUND CONTINUED OPERATIONS BEYOND FISCAL YEAR 2003.
Since becoming a public company, we have experienced negative cash flow from
operations and expect to experience negative cash flow from operations for at
least the foreseeable future. Unless we monitor and minimize the level of use of
our existing cash, cash equivalents, marketable securities and credit
facilities, we may require additional capital to fund continued operations
beyond our fiscal year 2003. We may require additional funding within this time
frame, and this additional funding, if needed, may not be available on terms
acceptable to us, or at all. A continued slowdown in technology spending as
compared to the general economy, as well as other factors that may arise, could
affect our future capital requirements and the adequacy of our available funds.
As a result, we may be required to raise additional funds through private or
public financing facilities, strategic relationships or other arrangements. Any
additional equity financing would likely be dilutive to our stockholders. Debt
financing, if available, may involve restrictive covenants on our operations and
financial condition. Our inability to raise capital when needed could seriously
harm our business.
BECAUSE WE HAVE A LIMITED OPERATING HISTORY SELLING SOURCEFORGE, WE MAY NOT
ACCURATELY FORECAST OUR SALES AND REVENUES, WHICH WILL CAUSE QUARTERLY
FLUCTUATIONS IN OUR NET REVENUES AND RESULTS OF OPERATIONS. Our ability to
accurately forecast our quarterly sales and revenue is made difficult by our
limited operating history with our new business direction and the continued
slowdown in technology spending. In addition, most of our operating costs are
fixed and based on our revenue expectations. Therefore, if we have a shortfall
in revenues, we may be unable to reduce our expenses quickly enough to avoid
lower quarterly operating results.
DESPITE REDUCTIONS IN THE SIZE OF OUR WORKFORCE, OUR BUSINESS MAY FAIL TO GROW
RAPIDLY ENOUGH TO OFFSET OUR ONGOING OPERATING EXPENSES. In February, June and
August 2001, we substantially reduced our workforce such that as of July 28,
2001 we had 286 employees, down from 551 employees in January 2001. During
fiscal 2002, we further reduced our workforce such that as of July 27, 2002 we
had 144 employees. Nevertheless, despite these reductions in our workforce, our
business may fail to grow rapidly enough to offset our ongoing operating
expenses. As a result, our quarterly operating results could fluctuate, and such
fluctuation could adversely affect the market price of our common stock.
28
OUR QUARTERLY NET REVENUES AND RESULTS OF OPERATIONS MAY VARY SIGNIFICANTLY IN
THE FUTURE DUE TO A NUMBER OF ADDITIONAL FACTORS, MANY OF WHICH ARE OUTSIDE OF
OUR CONTROL. The primary factors that may cause our quarterly net revenues and
results of operations to fluctuate include the following:
o the acceptance of our products by the marketplace;
o the continued slowdown in technology spending and unfavorable
economic conditions in the technology industry;
o demand for and market acceptance of our software and services;
o reductions in the sales price of our software or software
offered by our competitors;
o our ability to develop, introduce and market new versions of
our software and product enhancements that meet customer
requirements in a timely manner.
o the discretionary nature of our customers' purchase and budget
cycles;
o difficulty predicting the size and timing of customer orders;
o long sales cycles;
o introduction or enhancement of our products or our
competitors' products;
o changes in our pricing policies or the pricing policies of our
competitors;
o an increase in our operating costs;
o whether we are able to expand our sales and marketing programs
for our software products;
o the level of sales incentives for our direct sales force;
o changes in accounting pronouncements applicable to us;
o the timing of announcements and releases of new or enhanced
versions of our products and product upgrades;
o the market's transition between new releases of third party
operating systems on which our software products run; and
o possibility that software development delays will result from
our outsourcing of certain SourceForge research and
development efforts to CSS, an independent contractor located
primarily in India, given that unstable relations currently
exist between India and Pakistan.
In addition to the foregoing factors, the risk of quarterly fluctuations is
increased by the fact that many enterprise customers negotiate site licenses
near the end of each quarter. In part, this is because enterprise customers are
able, or believe that they are able, to negotiate lower prices and more
favorable terms at that time. Our reliance on a large portion of revenue
occurring at the end of the quarter and the increase in the dollar value of
transactions that occur at the end of a quarter can result in increased
uncertainty relating to quarterly revenues. Due to end-of-period variances,
forecasts may not be achieved, either because expected sales do not occur or
because they occur at lower prices or on terms that are less favorable to us.
Factors that may decrease our online revenues include:
o decreased demand for advertising;
o the addition or loss of advertisers, and the size and timing
of the advertising purchases of individual advertisers;
o trends in Internet use and advertising;
o technical difficulties or system downtime; and
o economic conditions specific to advertising, the Internet and
Internet media.
Accordingly, you should not rely on the results of any past periods as an
indication of our future performance.
WE HAVE A HISTORY OF LOSSES AND EXPECT TO CONTINUE TO INCUR NET LOSSES FOR THE
FORESEEABLE FUTURE. We incurred a loss of $18.8 million for our fiscal fourth
quarter ended July 27, 2002, primarily due to the continued slowdown in
technology spending as compared to the general economy, restructuring charges,
long-lived asset impairments and our ramp up of our software business, and we
had an accumulated deficit of $725.9 million as of July 27, 2002. We expect to
continue to incur significant product development, sales and marketing and
administrative expenses. We expect to continue to incur net losses for at least
the foreseeable future. If we do achieve profitability, we may not be able to
sustain it. Failure to become and remain profitable may materially and adversely
affect the market price of our common stock and our ability to raise capital and
continue operations.
29
FUTURE GUIDELINES AND INTERPRETATIONS REGARDING SOFTWARE REVENUE RECOGNITION
COULD HAVE A MATERIAL IMPACT ON OUR BUSINESS. In October 1997, the AICPA issued
SOP No. 97-2, "Software Revenue Recognition" which superceded SOP No. 91-1. SOP
No. 97-2, as amended by SOP No. 98-4 and SOP No. 98-9, provides guidance on
applying generally accepted accounting principles for software revenue
recognition transactions. In December 1999, the SEC issued SAB No. 101, "Revenue
Recognition in Financial Statements," which provides further revenue recognition
guidance. We adopted SAB No. 101, as amended, and SOP No. 97-2, as amended by
SOP No. 98-4 and SOP No. 98-9 in the fourth quarter of fiscal 2001 as required.
The adoption of SAB No. 101 did not have a material effect on our consolidated
financial position, results of operations or cash flows. The accounting
profession continues to review certain provisions of SOP No. 97-2 and SAB No.
101 with the objective of providing additional guidance on implementing its
provisions. Depending upon the outcome of these reviews and the issuance of
implementation guidelines and interpretations, we may be required to change our
revenue recognition policies and business practices and such changes could have
a material adverse effect on our business, results of operations or financial
position.
ECONOMIC CONDITIONS HAVE AFFECTED AND COULD CONTINUE TO NEGATIVELY IMPACT OUR
REVENUES AND PROFITS. Our revenue growth depends on the overall demand for IT
software spending. The recession in the United States has and may continue to
result in cutbacks by our customers in the purchase of our software products and
services, postponed or canceled orders, longer sales cycles and lower average
selling prices. To the extent that the current downturn continues or increases
in severity, we believe demand for our products and services, and therefore
future revenues, could be further impacted.
Risks Related To Intellectual Property
WE ARE VULNERABLE TO CLAIMS THAT OUR PRODUCTS INFRINGE THIRD-PARTY INTELLECTUAL
PROPERTY RIGHTS. ANY RESULTING CLAIMS AGAINST US COULD BE COSTLY TO DEFEND OR
SUBJECT US TO SIGNIFICANT DAMAGES. We expect that our software products will
increasingly be subject to infringement claims as the number of products and
competitors in our industry segment grows and the functionality of products in
different industry segments overlaps. In addition, we may receive patent
infringement claims as companies increasingly seek to patent their software. Our
developers may fail to perform patent searches and may therefore unwittingly
infringe third-party patent rights. We cannot prevent current or future patent
holders or other owners of intellectual property from suing us and others
seeking monetary damages or an injunction against shipment of our software
offerings. A patent holder may deny us a license or force us to pay royalties.
In either event, our operating results could be seriously harmed. In addition,
employees hired from competitors might utilize proprietary and trade secret
information from their former employers without our knowledge, even though our
employment agreements and policies clearly prohibit such practices.
Any litigation regarding our intellectual property, with or without merit, could
be costly and time consuming to defend, divert the attention of our management
and key personnel from our business operations and cause product shipment
delays. Claims of intellectual property infringement may require us to enter
into royalty and licensing agreements that may not be available on terms
acceptable to us, or at all. In addition, parties making claims against us may
be able to obtain injunctive or other equitable relief that could effectively
block our ability to sell our products in the United States and abroad and could
result in an award of substantial damages against us. Defense of any lawsuit or
failure to obtain any required license could delay shipment of our products and
increase our costs. If a successful claim is made against us and we fail to
develop or license a substitute technology, our business, results of operations,
financial condition or cash flows could be immediately and materially adversely
affected.
IF WE FAIL TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, COMPETITORS
MAY USE OUR TECHNOLOGY AND TRADEMARKS, WHICH COULD WEAKEN OUR COMPETITIVE
POSITION, REDUCE OUR REVENUES, AND INCREASE OUR COSTS. We rely on a combination
of copyright, trademark, patent, and trade-secret laws, employee and third-party
nondisclosure agreements, and other arrangements to protect our proprietary
rights. Despite these precautions, it may be possible for unauthorized third
parties to copy our products or obtain and use information that we regard as
proprietary to create products that compete against ours. Some license
provisions protecting against unauthorized use, copying, transfer, and
disclosure of our licensed programs may be unenforceable under the laws of
certain jurisdictions and foreign countries.
In addition, the laws of some countries do not protect proprietary rights to the
same extent as do the laws of the United States. To the extent that we increase
our international activities, our exposure to unauthorized copying and use of
our products and proprietary information will increase.
Our collection of trademarks is important to our business. The protective steps
we take or have taken may be inadequate to deter misappropriation of our
trademark rights. We have filed applications for registration of some of our
trademarks in the United States
30
and internationally. Effective trademark protection may not be available in
every country in which we offer or intend to offer our products and services.
Failure to protect our trademark rights adequately could damage our brand
identity and impair our ability to compete effectively. Furthermore, defending
or enforcing our trademark rights could result in the expenditure of significant
financial and managerial resources.
The scope of United States patent protection in the software industry is not
well defined and will evolve as the United States Patent and Trademark Office
grants additional patents. Because patent applications in the United States are
not publicly disclosed until the patent is issued, applications may have been
filed that would relate to our products.
Our success depends significantly upon our proprietary technology. Despite our
efforts to protect our proprietary technology, it may be possible for
unauthorized third parties to copy certain portions of our products or to
reverse engineer or otherwise obtain and use our proprietary information. We do
not have any software patents, and existing copyright laws afford only limited
protection. In addition, we cannot be certain that others will not develop
substantially equivalent or superseding proprietary technology, or that
equivalent products will not be marketed in competition with our products,
thereby substantially reducing the value of our proprietary rights. We cannot
assure you that we will develop proprietary products or technologies that are
patentable, that any patent, if issued, would provide us with any competitive
advantages or would not be challenged by third parties, or that the patents of
others will not adversely affect our ability to do business. Litigation may be
necessary to protect our proprietary technology. This litigation may be
time-consuming and expensive.
WE MAY BE SUBJECT TO CLAIMS AS A RESULT OF INFORMATION PUBLISHED ON, POSTED ON
OR ACCESSIBLE FROM OUR INTERNET SITES. We may be subject to claims of
defamation, negligence, copyright or trademark infringement (including
contributory infringement) or other claims relating to the information contained
on our Internet sites, whether written by third parties or us. These types of
claims have been brought against online services in the past and can be costly
to defend regardless of the merit of the lawsuit. Although recent federal
legislation protects online services from some claims when third parties write
the material, this protection is limited. Furthermore, the law in this area
remains in flux and varies from state to state. We receive notification from
time to time of potential claims, but have not been named as a party to
litigation involving such claims. While no formal complaints have been filed
against us to date, our business could be seriously harmed if one were asserted.
Other Risks Related To Our Business
IF WE ARE UNABLE TO IMPLEMENT APPROPRIATE SYSTEMS, PROCEDURES AND CONTROLS, WE
MAY NOT BE ABLE TO SUCCESSFULLY OFFER OUR SERVICES AND GROW OUR SOFTWARE
BUSINESS. Our ability to successfully offer our services and grow our software
business requires an effective planning and management process. Over the past
two and a half years, we have implemented or updated our operations and
financial systems, procedures and controls, including the implementation of an
enterprise resource planning system. Our systems will continue to require
additional modifications and improvements to respond to current and future
changes in our business. Our key personnel have limited experience managing this
type of fluctuation in operations. If we cannot grow our software business, and
manage that growth effectively, or if we fail to timely implement appropriate
internal systems, procedures, controls and necessary modifications and
improvements to these systems, our business will suffer.
PROMOTIONAL PRODUCT VERSIONS MAY ADVERSELY IMPACT OUR ACTUAL PRODUCT SALES. Our
marketing strategy relies in part on making elements of our technology available
for no charge or at a very low price. This strategy is designed to expose our
products to a broader customer base than to our historical customer base and to
encourage potential customers to purchase an upgrade or other full priced
products from us.
We may not be able to introduce enhancements to our full-price products or
versions of our products with intermediate functionality at a rate necessary to
adequately differentiate them from the promotional versions, which could reduce
sales of our products.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The primary objective of our investment activities is to preserve principal
while at the same time maximizing the income we receive from our investments
without significantly increasing risk. Some of the securities that we have
invested in may be subject to market risk. This means that a change in
prevailing interest rates may cause the principal amount of the investment to
fluctuate. For example, if we hold a security that was issued with a fixed
interest rate at the then-prevailing rate and the prevailing interest rate later
rises, the principal amount of our investment will probably decline. To minimize
this risk, we maintain a portfolio of cash equivalents
31
and short-term investments in a variety of securities, including commercial
paper, money market funds and government and non-government debt securities. In
general, money market funds are not subject to market risk because the interest
paid on such funds fluctuates with the prevailing interest rate.
The following table presents the amounts of our cash equivalents and
short-term investments (in thousands) that are subject to market risk and
weighted-average interest rates, categorized by expected maturity dates, as of
July 27, 2002. This table does not include money market funds because those
funds are not subject to market risk.
Maturing Maturing within three Maturing
(in thousands) within three months months to one year Greater than one year
------------------- -------------------- ---------------------
As of July 27, 2002
Cash equivalents $11,450
Weighted-average interest rate 1.95%
Short-term investments $5,458
Weighted-average interest rate 2.25%
Long-term investments $12,440
Weighted-average interest rate 3.11%
We have operated primarily in the United States, and virtually all
sales have been made in U.S. dollars. Accordingly, we have not had any material
exposure to foreign currency rate fluctuations.
The estimated fair value of our cash, cash equivalents and investments
approximate carrying value. We do not currently hold any derivative instruments
and do not engage in hedging activities.
32
Item 8. Financial Statements and Supplementary Data
TABLE OF CONTENTS
Page
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Reports of Independent Public Accountants.................................... 33
Consolidated Balance Sheets.................................................. 34
Consolidated Statements of Operations and Other Comprehensive Income/(Loss).. 35
Consolidated Statements of Stockholders' Equity.............................. 36
Consolidated Statements of Cash Flows........................................ 37
Notes to Consolidated Financial Statements................................... 39
All other schedules are omitted because they are not applicable, not
required, or because the required information is included in the consolidated
financial statements or notes thereto.
33
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
VA Software Corporation:
In our opinion, the accompanying consolidated financial statements
listed in the index appearing under Item 14(a)(1) on page 60 present fairly, in
all material respects, the financial position of VA Software Corporation and its
subsidiaries at July 27, 2002, and the results of their operations and their
cash flows for the year ended July 27, 2002 in conformity with accounting
principles generally accepted in the United States of America. In addition, in
our opinion, the financial statement schedule listed in the index appearing
under Item 14(a)(2) on page 60 presents fairly, in all material respects, the
information set forth therein when read in conjunction with the related
consolidated financial statements. These financial statements and financial
statement schedule are the responsibility of the Company's Management; our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audit. We conducted our audit of these
statements in accordance with auditing standards generally accepted in the
United States of America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
The financial statements of VA Software Corporation as of July 28,
2001, and for each of the two years in the period ended July 28, 2001, were
audited by other independent accountants who have ceased operations. These
independent accountants expressed an unqualified opinion on those financial
statements in their report dated August 22, 2001.
PricewaterhouseCoopers LLP
San Jose, California
August 22, 2002
34
This is a copy of the audit report previously issued by Arthur Andersen LLP in
connection with VA Software Corporation's (Formerly VA Linux Systems, Inc.)
filing on Form 10-K for the year ended July 28, 2001. This audit report has not
been reissued by Arthur Andersen LLP in connection with this filing on Form
10-K. See Exhibit 23.2 for further discussion. The consolidated balance sheet as
of July 28, 2000, the consolidated statements of operations, stockholders'
equity and cash flows for the years ended July 31, 1999 and the information in
the schedule for 1999 referred to in this report have not been included in the
accompanying financial statements or schedule.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To The Board of Directors and Stockholders of
VA Linux Systems, Inc.:
We have audited the accompanying consolidated balance sheets of VA
Software Corporation, formerly known as VA Linux Systems, Inc. (a Delaware
corporation) as of July 28, 2001 and 2000, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended July 28, 2001. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of VA Software Corp. as
of July 28, 2001 and 2000, and the results of its operations and its cash flows
for each of the three years in the period ended July 28, 2001, in conformity
with accounting principles generally accepted in the United States.
Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in Item 14(a)2 is
presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. This
schedule has been subjected to the auditing procedures applied in the audit of
the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
San Jose, California
August 22, 2001
35
VA SOFTWARE CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share information)
July 27, July 28,
2002 2001
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents ................................................................ $ 35,148 $ 57,488
Short-term investments ................................................................... 5,458 22,595
Restricted cash, current ................................................................. 450 1,509
Accounts receivable, net of allowances of $1,166 and $4,247, respectively ................ 764 10,107
Inventories .............................................................................. 300 343
Prepaid expenses and other assets ........................................................ 877 3,895
--------- ---------
Total current assets ............................................................. 42,997 95,937
Property and equipment, net ................................................................ 7,223 17,703
Goodwill and intangibles, net .............................................................. 2,169 56,730
Long-term investments ...................................................................... 12,440 --
Restricted cash, non current ............................................................... 900 1,350
Other assets ............................................................................... 1,239 1,313
--------- ---------
Total assets ..................................................................... $ 66,968 $ 173,033
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of notes payable ......................................................... $ 42 $ 756
Accounts payable ......................................................................... 2,075 14,319
Accrued restructuring liabilities, current portion ....................................... 3,397 3,135
Accrued compensation ..................................................................... 1,517 3,906
Deferred revenue ......................................................................... 774 2,120
Accrued liabilities and other ............................................................ 4,200 9,257
--------- ---------
Total current liabilities ........................................................ 12,005 33,493
Notes payable, net of current portion ...................................................... -- 42
Accrued restructuring liabilities, net of current portion .................................. 14,597 6,378
Other long-term liabilities ................................................................ 978 1,366
--------- ---------
Total liabilities ................................................................ 27,580 41,279
Commitments and contingencies (Note 7) Minority interest ................................... -- 5,392
Stockholders' equity:
Common stock, $0.001 par value; Authorized -- 250,000,000; Issued and
outstanding -- 54,165,411 shares in 2002 and 54,118,703 shares in 2001 ................ 54 54
Treasury stock ........................................................................... (4) (4)
Additional paid-in capital ............................................................... 765,422 768,797
Deferred stock compensation .............................................................. (245) (6,108)
Accumulated other comprehensive gain (loss) .............................................. 86 (1,490)
Accumulated deficit ...................................................................... (725,925) (634,887)
--------- ---------
Total stockholders' equity ....................................................... 39,388 126,362
--------- ---------
Total liabilities and stockholders' equity ....................................... $ 66,968 $ 173,033
========= =========
The accompanying notes are an integral part of these financial statements.
36
VA SOFTWARE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS AND OTHER COMPREHENSIVE INCOME/(LOSS)
(In thousands, except per share amounts)
Year Ended
July 27, July 28, July 28,
Net revenues: 2002 2001 2000
--------- --------- ---------
Software revenues ................................................................ $ 1,086 $ -- $ --
Online revenues .................................................................. 15,967 14,678 2,081
Other revenues ................................................................... 3,332 120,212 118,215
--------- --------- ---------
Net revenues .................................................................. 20,385 134,890 120,296
Cost of revenues:
Software cost of revenues ........................................................ 2,387 -- --
Online cost of revenues .......................................................... 10,393 10,497 1,147
Other cost of revenues ........................................................... (3,119) 143,606 97,034
--------- --------- ---------
Cost of revenues .............................................................. 9,661 154,103 98,181
--------- --------- ---------
Gross margin .................................................................. 10,724 (19,213) 22,115
--------- --------- ---------
Operating expenses:
Sales and marketing .............................................................. 12,513 39,981 29,479
Research and development ......................................................... 8,122 17,959 12,363
General and administrative ....................................................... 10,850 22,012 8,985
Restructuring costs and other special charges .................................... 46,936 113,478 --
Amortization of deferred stock compensation ...................................... 1,671 61,268 39,500
Amortization of goodwill and intangible assets ................................... 11,730 97,887 18,175
Impairment of goodwill, intangible assets and other long-lived assets ............ 12,150 160,000 --
Write-off of in-process research and development ................................. -- -- 9,000
--------- --------- ---------
Total operating expenses ............................................. 103,972 512,585 117,502
--------- --------- ---------
Loss from operations ........................................................... (93,248) (531,798) (95,387)
Interest income ................................................................ 1,714 6,803 5,805
Interest expense ............................................................... (32) (165) (142)
Other income (expense), net .................................................... 528 (108) (34)
--------- --------- ---------
Net loss ....................................................................... $ (91,038) $(525,268) $ (89,758)
Other comprehensive loss:
Unrealized gain (loss) on marketable securities and investments .......... 209 13 (47)
Foreign currency translation gain (loss) ........................ 1,367 (1,456) --
--------- --------- ---------
Comprehensive loss ............................................................. $ (89,462) $(526,711) $ (89,805)
========= ========= =========
Dividend related to convertible preferred stock ................................ -- -- (4,900)
--------- --------- ---------
Net loss attributable to common stockholders ................................... $ (91,038) $(525,268) $ (94,658)
========= ========= =========
Basic and diluted net loss per share ........................................... $ (1.72) $ (10.78) $ (3.52)
========= ========= =========
Shares used in computing basic and diluted net loss per share .................. 53,064 48,741 26,863
========= ========= =========
The accompanying notes are an integral part of these financial statements.
37
VA SOFTWARE CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands)
Convertible
Preferred Stock Common Stock Additional
---------------------- ---------------------- Treasury Paid-in
Shares Amount Shares Amount Stock Capital
--------- --------- --------- --------- --------- ---------
BALANCE AT JULY 31, 1999 ............................. 18,652 $ 19 15,445 $ 15 $ -- $ 45,461
Issuance of Series B convertible preferred
stock for assets acquired ......................... 13 -- -- -- -- 50
Issuance of Series B convertible preferred
stock for cash, net ............................... 1,256 1 -- -- -- 4,833
Exercise of stock options and stock
purchase rights for cash and services
rendered .......................................... -- -- 2,140 2 -- 3,333
Dividend related to convertible preferred
stock ............................................. -- -- -- -- -- 4,900
Issuance of common stock for cash and
services rendered ................................. -- -- 203 -- -- 530
Issuance of common stock from initial
public offering, net .............................. -- -- 5,060 5 -- 138,771
Repurchase of common stock for cash
related to options ................................ -- -- (593) -- -- (55)
Proceeds received from stockholders .................. -- -- -- -- -- --
Conversion of preferred stock to common
stock ............................................. (19,921) (20) 19,921 20 -- --
Issuance of common stock to acquire
businesses ........................................ -- -- 9,728 10 -- 541,983
Deferred stock compensation .......................... -- -- -- -- -- 23,369
Amortization of deferred stock
compensation ...................................... -- -- -- -- -- --
Unrealized gain or loss on marketable
securities ........................................ -- -- -- -- -- --
Net loss ............................................. -- -- -- -- -- --
--------- --------- --------- --------- --------- ---------
BALANCE AT JULY 28, 2000 ............................. -- -- 51,904 52 -- 763,175
Issuance of common stock for cash
related to options ................................ -- -- 2,522 3 -- 4,437
Repurchase of common stock for cash
related to options ................................ -- -- (1,028) (1) (4) (268)
Issuance of common stock to acquire
businesses or assets .............................. -- -- 721 -- -- 14,397
Amortization of deferred stock
compensation ...................................... -- -- -- -- -- --
Acceleration and forfeiture of deferred
stock compensation related to
terminations ...................................... -- -- -- -- -- (12,944)
Foreign currency translation adjustment
and unrealized gain or loss on
marketable securities ............................. -- -- -- -- -- --
Net loss ............................................. -- -- -- -- -- --
--------- --------- --------- --------- --------- ---------
BALANCE AT JULY 28, 2001 ............................. -- -- 54,119 54 (4) 768,797
Issuance of common stock for cash related
to options ........................................ -- -- 581 1 -- 402
Repurchase of common stock for cash
related to options ................................ -- -- (535) (1) -- (16)
Issuance of common stock to acquire
businesses or assets .............................. -- -- -- -- -- 1,313
Acceleration of stock options ........................ -- -- -- -- -- 74
Amortization of deferred stock
compensation ...................................... -- -- -- -- -- (1,926)
Acceleration and forfeiture of stock
options and deferred stock
compensation related to terminations,
restructuring ..................................... -- -- -- -- -- (3,222)
Foreign currency translation adjustment
and unrealized gain or loss on
marketable securities ............................. -- -- -- -- -- --
Net loss ............................................. -- -- -- -- -- --
--------- --------- --------- --------- --------- ---------
BALANCE AT JULY 27, 2002 ............................. -- $ -- 54,165 $ 54 $ (4) $ 765,422
========= ========= ========= ========= ========= =========
Accumulated
Stockholder Deferred Other Total
Note Stock Comprehensive Accumulated Stockholders'
Receivable Compensation Loss Deficit Equity
--------- --------- --------- --------- ---------
BALANCE AT JULY 31, 1999 ........................... $ (50) $ (12,121) $ -- $ (14,961) $ 18,363
Issuance of Series B convertible preferred
stock for assets acquired ....................... -- -- -- -- 50
Issuance of Series B convertible preferred
stock for cash, net ............................. -- -- -- -- 4,834
Exercise of stock options and stock
purchase rights for cash and services
rendered ........................................ -- -- -- -- 3,335
Dividend related to convertible preferred
stock ........................................... -- -- -- (4,900) --
Issuance of common stock for cash and
services rendered ............................... -- -- -- -- 530
Issuance of common stock from initial
public offering, net ............................ -- -- -- -- 138,776
Repurchase of common stock for cash
related to options .............................. -- -- -- -- (55)
Proceeds received from stockholders ................ 50 -- -- -- 50
Conversion of preferred stock to common
stock ........................................... -- -- -- -- --
Issuance of common stock to acquire
businesses ...................................... -- (113,106) -- -- 428,887
Deferred stock compensation ........................ -- (23,369) -- -- --
Amortization of deferred stock
compensation .................................... -- 38,910 -- -- 38,910
Unrealized gain or loss on marketable
securities ...................................... -- -- (47) -- (47)
Net loss ........................................... -- -- -- (89,758) (89,758)
--------- --------- --------- --------- ---------
BALANCE AT JULY 28, 2000 ........................... -- (109,686) (47) (109,619) 543,875
Issuance of common stock for cash
related to options .............................. -- -- -- -- 4,440
Repurchase of common stock for cash
related to options .............................. -- -- -- -- (273)
Issuance of common stock to acquire
businesses or assets ............................ -- (6,757) -- -- 7,640
Amortization of deferred stock
compensation .................................... -- 61,268 -- -- 61,268
Acceleration and forfeiture of deferred
stock compensation related to
terminations .................................... -- 49,067 -- -- 36,123
Foreign currency translation adjustment
and unrealized gain or loss on
marketable securities ........................... -- -- (1,443) -- (1,443)
Net loss ........................................... -- -- -- (525,268) (525,268)
--------- --------- --------- --------- ---------
BALANCE AT JULY 28, 2001 ........................... -- (6,108) (1,490) (634,887) 126,362
Issuance of common stock for cash related
to options ...................................... -- -- -- -- 403
Repurchase of common stock for cash
related to options .............................. -- -- -- -- (17)
Issuance of common stock to acquire
businesses or assets ............................ -- (1,308) -- -- 5
Acceleration of stock options -- -- -- -- 74
Amortization of deferred stock
compensation .................................... -- 3,597 -- -- 1,671
Acceleration and forfeiture of stock
options and deferred stock
compensation related to terminations,
restructuring ................................... -- 3,574 -- -- 352
Foreign currency translation adjustment
and unrealized gain or loss on
marketable securities ........................... -- -- 1,576 -- 1,576
Net loss ........................................... -- -- -- (91,038) (91,038)
--------- --------- --------- --------- ---------
BALANCE AT JULY 27, 2002 ........................... $ -- $ (245) $ 86 $(725,925) $ 39,388
========= ========= ========= ========= =========
The accompanying notes are an integral part of these financial statements.
38
VA SOFTWARE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year Ended
July 27, July 28, July 28,
2002 2001 2000
--------- --------- ---------
Cash flows from operating activities:
Net loss ......................................................................... $ (91,038) $(525,268) $ (89,758)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization .................................................. 16,153 102,786 19,588
Provision for bad debts ........................................................ (1,096) 3,968 1,328
Provision for excess and obsolete inventory .................................... (4,378) 24,441 1,878
Loss on disposal of assets ..................................................... 1,422 9 177
Proportionate share of net losses in Japan investment .......................... 2,012 -- --
Minority interest in Japan loss ................................................ (496) -- --
Gain on sale of Japan investment ............................................... (12,872) -- --
Release of contingent shares in relation to OSDN acquisition ................... 1,313 -- --
Amortization of deferred stock compensation .................................... 1,671 61,268 39,500
Non-cash compensation expense .................................................. 75 -- 1,429
Non-cash restructuring expense ................................................. 36,426 101,237 --
Impairment of long-lived assets ................................................ 12,150 160,000 --
Write-off of in-process research and development ............................... -- -- 9,000
Changes in assets and liabilities:
Accounts receivable .......................................................... 10,439 17,635 (23,468)
Inventories .................................................................. 2,046 (23,783) 1,191
Prepaid expenses and other assets ............................................ 3,391 (3,195) (2,098)
Accounts payable ............................................................. (12,244) (12,446) 11,902
Accrued restructuring liabilities ............................................ 8,481 9,513 --
Accrued liabilities and other ................................................ (8,159) 1,388 3,723
Other long-term liabilities .................................................. (388) 814 1,045
--------- --------- ---------
Net cash used in operating activities ..................................... (35,092) (81,633) (24,563)
--------- --------- ---------
Cash flows from investing activities:
Change in restricted cash ........................................................ 1,509 (609) (2,250)
Purchase of property and equipment ............................................... (417) (14,750) (7,601)
Purchase of marketable securities ................................................ (32,917) (80,329) (52,433)
Sale of marketable securities .................................................... 37,829 110,167 --
Businesses acquired, net of cash acquired ........................................ -- 4,627 46,870
Cash proceeds on sale of Japan investment ........................................ 5,059 -- --
Purchase of other long-lived assets .............................................. -- (1,929) --
Other, net ....................................................................... 209 161 (47)
--------- --------- ---------
Net cash provided (used) in investing activities .......................... 11,272 17,338 (15,461)
--------- --------- ---------
Cash flows from financing activities:
Payments on notes payable ........................................................ (273) (2,527) (3,363)
Proceeds from stockholder note receivable ........................................ -- -- 50
Proceeds from issuance of convertible preferred stock, net ....................... -- -- 4,834
Proceeds from issuance of common stock ........................................... 403 4,440 141,504
Repurchase of common stock ....................................................... (17) (273) (55)
--------- --------- ---------
Net cash provided by financing activities ................................. 113 1,640 142,970
--------- --------- ---------
Effect of exchange rate changes on cash and cash equivalents ...................... 1,367 (1,456) --
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents .............................. (22,340) (64,111) 102,946
--------- --------- ---------
Cash and cash equivalents, beginning of year ...................................... 57,488 121,599 18,653
--------- --------- ---------
Cash and cash equivalents, end of year ............................................ $ 35,148 $ 57,488 $ 121,599
========= ========= =========
Supplemental cash flow information:
Cash paid for state taxes .......................................................... $ 18 $ 335 $ 35
Cash paid for interest ............................................................. $ 32 $ 165 $ 142
Issuance of convertible preferred stock for assets ................................. $ -- $ -- $ 50
Dividends on convertible preferred stock ........................................... $ -- $ -- $ 4,900
Conversion of preferred stock to common stock at par ............................... $ -- $ -- $ 20
Issuance of common stock to acquire businesses ..................................... $ -- $ 14,397 $ 541,993
The accompanying notes are an integral part of these financial statements.
39
VA SOFTWARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Operations of the Company:
VA Software Corporation was incorporated in January 1995 in California
as VA Research, Inc. In June 1999, the Company changed its name to VA Linux
Systems, Inc., and in December 1999 the Company reincorporated in Delaware. In
December 1999, the Company sold 5,060,000 shares (including 660,000 shares
associated with the underwriter's exercise of their option to cover the
over-allotment of shares) of common stock to the public in our initial public
offering ("IPO"). In December 2001, the Company changed its name to VA Software
Corporation ("VA Software," "VA" or the "Company").
Through June 27, 2001, the Company was a provider of Linux-based
computer systems and services, Internet infrastructure and Open Source software
services and the Open Source Development Network ("OSDN"). From incorporation
until the end of fiscal 1998, the Company grew very modestly. From July 31, 1998
though October 27, 2000 (the end of the first quarter of our fiscal year 2001),
the Company experienced significant growth as a leading provider of Linux-based
solutions, integrating systems, software and services. Commensurate with strong
growth, the Company invested in hiring personnel with Linux expertise, growing
its direct sales force, acquiring companies and expanding its operations,
customer support and administration infrastructure. The Company outsourced its
systems manufacturing but provided systems support through its internal
organization.
Increasing demand from customers in the Internet infrastructure and
"dot-com" markets fueled the Company's growth through the first quarter of
fiscal year 2001. Thereafter, the market for the Company's systems products and
professional services declined significantly due in large part to the general
economic downturn, which resulted in reduced availability of capital for
Internet infrastructure and "dot-com" customers. This decline had a significant,
negative effect on the Company's sales and margins, which resulted in increased
operating losses. The Company endeavored to market its hardware products to
larger "enterprise" customers, but were unable to make sufficient progress to
build a sustainable business in the midst of a slowing economy and fierce
competition from incumbent hardware vendors that were moving into the
Linux-based hardware market.
Rather than continue with a business model that was not going to enable
the Company to achieve profitability and would significantly decrease its cash
levels, on June 27, 2001 the Company announced its strategic decision to exit
the systems business and pursue an application software business. During fiscal
year 2002, the Company decided to exit the professional services and Linux
software engineering services fields in order to focus solely on its SourceForge
Enterprise Edition ("SourceForge") application software product.
The Company operates on a 52-53 week year ending the Saturday before
July 31. Prior to the quarter ended January 27, 2001, the last day of each
fiscal quarter and year end was Friday. This change did not have a material
impact on the results of operations for the year ended July 28, 2001 or on prior
periods.
The Company is subject to certain risks, including without limitation,
risks relating to fluctuating operating results, customer and market acceptance
of new products, dependence on new products, rapid technological change,
litigation, dependence on growth in the software market, product concentration,
changing product mix, competition, dependence on proprietary technology,
intellectual property rights, dependence on key personnel and volatility of
stock price.
2. Summary of Significant Accounting Policies:
Use of Estimates in Preparation of Consolidated Financial Statements
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted by the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of such financial statements, as well as the reported
amounts of revenue and expenses during the periods indicated. Actual results
could differ from those estimates.
Principles of Consolidation
These consolidated financial statements include the accounts of VA and
its wholly-owned and majority-owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation. In September
2000, the Company acquired
40
68% of the outstanding shares of common stock of VA Linux Systems Japan, K.K.
("VA Linux Japan") for a cash purchase price of approximately $6.9 million.
Effective January 11, 2002, VA sold 13,500 shares of VA Linux Japan stock to a
third party for approximately $5.1 million, the effect of which decreased the
Company's investment in VA Linux Japan to approximately 11%. As a result of this
sale, the Company recorded a $0.4 million gain, which is included in other
income in the Company's consolidated statements of operations. On March 29,
2002, VA Linux Japan repurchased 10,000 shares of its outstanding stock from a
third party other than the Company, thereby decreasing the number of shares
outstanding and increasing the Company's investment to approximately 19%. As the
Company holds less than 20% of the voting stock of VA Linux Japan and does not
otherwise exercise significant influence, VA Linux Japan has been accounted for
under the cost method as of January 11, 2002. The minority interest included in
the results of operations for VA Linux Japan has not been material for any
period presented and has been recorded in other income in the accompanying
statements of operations. The minority interest in VA Linux Japan is reflected
separately in the balance sheet outside of stockholders' equity for the period
ended July 28, 2001. The operations of VA Linux Japan primarily related to our
former systems and services business.
Foreign Currency Translation
The functional currency of a foreign operation is the country's local
currency. Consequently, balance sheet accounts are translated into U.S. dollars
at exchange rates prevailing at balance sheet dates. Revenue and expenses are
translated into U.S. dollars at average rates for the period. Gains and losses
resulting from translation are charged or credited in comprehensive income as a
component of stockholders' equity. As of July 27, 2002 the Company did not hold
any foreign currency derivative instruments.
Segment and Geographic Information
Statement of Financial Accounting Standards ("SFAS") No. 131,
"Disclosures about Segments of an Enterprise and Related Information",
establishes standards for reporting information regarding operating segments in
annual financial statements and requires selected information for those segments
to be presented in interim financial reports issued to stockholders. SFAS No.
131 also establishes standards for related disclosures about products and
services and geographic areas. Operating segments are identified as components
of an enterprise about which separate discrete financial information is
available for evaluation by the chief operating decision-maker, or
decision-making group, in making decisions how to allocate resources and assess
performance. The Company's chief decision-making group, as defined under SFAS
No. 131, are the Chief Executive Officer and the executive team. For the period
up to the acquisition of OSDN on June 7, 2000, the Company operated as one
operating segment, the provision of Linux-based systems and services referred to
as systems and services. From June 7, 2000 through June 27, 2001, the Company
viewed the operations of OSDN, as a second segment. On June 27, 2001, the
Company announced its decision to exit the hardware systems business. Subsequent
to the Company's fiscal year end of July 28, 2001, a decision was made to exit
the professional services and Linux software engineering services businesses,
which had been part of the Company's systems and services business segment, in
order to solely focus on SourceForge. Significant cost reduction actions
accompanied the exiting of these businesses which will help to preserve the
Company's cash (see Note 4). Consequently, for the fiscal year beginning July
29, 2001, the Company has operated as one business segment, providing
application software products and related OSDN services.
Cash, Cash Equivalents, Short-Term Investments and Long-Term Investments
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents. Cash and cash
equivalents consist principally of cash deposited in money market and checking
accounts.
The Company accounts for its investments under the provisions of SFAS
No. 115, "Accounting for Certain Investments in Debt and Equity Securities."
Investments in highly liquid financial instruments with original maturities
greater than three months and remaining maturities of less than one year are
classified as short-term investments. All short-term investments are classified
as available-for-sale and are reported at fair value with net unrealized gains
(losses) reported, net of tax, using the specific identification method as other
comprehensive gain/(loss) in stockholders' equity. The fair value of the
Company's available-for-sale securities are based on quoted market prices at the
balance sheet dates.
Cash equivalents and short-term investments are all due within one year
and consist of the following (in thousands) at market value:
41
July 27, July 28,
2002 2001
------- -------
Government obligations ............................. $22,319 $25,956
Corporate obligations .............................. 7,029 18,005
------- -------
Total .................................... $29,348 $43,961
======= =======
Included in cash and cash equivalents .............. $11,450 $21,366
Included in short-term investments ................. 5,458 22,595
Included in long-term investments .................. 12,440 --
------- -------
Total .................................... $29,348 $43,961
======= =======
Restricted Cash
During fiscal year 2000, the Company established letters of credit of
approximately $2.3 million that are used to collateralize payments related to
the Fremont building lease. As of July 27, 2002 and July 28, 2001, the Company
had approximately $1.4 million and $2.3 million, respectively, of restricted
cash related to this building lease.
During fiscal year 2001, the Company established letters of credit of
approximately $4.0 million that were used to collateralize the delivery of
customer parts from a single supplier. As of July 28, 2001, the Company had
approximately $0.6 million of restricted cash outstanding on the letters of
credit. As of July 27, 2002, there was no outstanding balance on this letter of
credit.
Inventories
Inventories consist of finished goods are stated at the lower of cost
or market with cost being determined by the first-in, first-out method at July
27, 2002 and July 28, 2001. Provisions, when required, are made to reduce excess
and obsolete inventories to their estimated net realizable values. Due to
competitive pressures, it is possible that estimates of net realizable value
could change.
Property and Equipment
Property and equipment are stated at cost and are depreciated using the
straight-line method over the estimated useful lives of the assets. Leasehold
improvements are amortized over the lesser of the estimated useful lives or the
corresponding lease term. Property and equipment consist of the following (in
thousands):
July 27, July 28,
2002 2001
-------- --------
Computer and office equipment (useful lives of 2 to 3 years) ......... $ 6,295 $ 8,983
Furniture and fixtures (useful lives of 2 to 4 years) ................ 2,464 4,093
Leasehold improvements (useful lives of lesser of estimated
life or lease term) ................................................ 3,748 7,186
Software (useful lives of 2 to 5 years) ............................. 2,016 2,856
-------- --------
Total property and equipment ............................... 14,523 23,118
Less: Accumulated depreciation and amortization ...................... (7,300) (5,415)
-------- --------
Property and equipment, net ................................ $ 7,223 $ 17,703
======== ========
Depreciation expense for the years ended July 27, 2002, July 28, 2001,
and July 28, 2000 was $4.4 million, $4.9 million, and $1.4 million,
respectively.
Goodwill and Intangibles and Impairment of Long-Lived Assets
In connection with the acquisitions of TruSolutions, Inc.
("TruSolutions"), Precision Insight, Inc. ("Precision Insight"), NetAttach, Inc.
("NetAttach"), and OSDN (formerly known as "Andover.Net, Inc."), the Company
recorded $381.3 million of goodwill and intangibles during fiscal 2000. The
Company amortized $97.9 million and $18.2 million of goodwill and intangibles in
fiscal 2001 and 2000, respectively. In connection with the restructuring plans
in fiscal year 2001, the Company wrote off goodwill and intangibles associated
with BNW, Life, Alabanza and TruSolutions in the amount of $59.7 million as the
Company had exited these lines of business and expected no future cash flows. In
connection with the Company's restructuring plans in fiscal year 2002, the
Company wrote off goodwill and intangibles associated with NetAttach, and
Precision Insight in the amount of $30.6 million due to the exit of the
professional services and Linux software engineering businesses.
The Company continually evaluates whether events and circumstances have
occurred that indicate the remaining estimated useful life of long-lived assets
may warrant revision or that the remaining balance of long-lived assets may not
be recoverable in accordance
42
with SFAS No. 121, "Accounting for Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of." When factors indicate that long-lived
assets should be evaluated for possible impairment, the Company uses an estimate
of the related undiscounted future cash flows over the remaining life of the
long-lived assets in measuring whether they are recoverable. If the estimated
undiscounted future cash flows exceed the carrying value of the asset, a loss is
recorded as the excess of the assets carrying value over fair value. Long-lived
assets and certain identifiable intangible assets to be disposed of are reported
at the lower of carrying amount or fair value less costs to sell. See Note 4 for
details on impairment charges recognized during fiscal years 2002 and 2001.
The Company performed an assessment of the carrying value of its
long-lived assets to be held and used including significant amounts of goodwill
and other intangible assets recorded in connection with the Company's OSDN
acquisition. The Company performed the assessment pursuant to SFAS No. 121 due
to the significant slowdown in the economy affecting current operations and
expected future sales, as well as the general decline of technology valuations.
The conclusion of that assessment was that the decline in market conditions
within the industry was significant and other than temporary. As a result, the
Company recorded during the fourth quarter of fiscal year 2001 a charge of
$160.0 million to reduce goodwill and other intangible assets associated with
the acquisition of OSDN, based on the amount by which the carrying value of
these assets exceeded their fair value. The charge is included in the caption
"Impairment of long-lived assets" in the consolidated statements of operations.
Fair value was determined based on discounted future cash flows.
Effective July 29, 2001, the Company adopted SFAS No. 142, "Goodwill
and Other Intangible assets." Upon adoption of SFAS No. 142, the Company no
longer amortized goodwill, and thereby eliminated goodwill amortization of
approximately $1.3 million anticipated goodwill amortization for fiscal year
2002. Pursuant to SFAS No. 142, the Company tests goodwill for impairment. SFAS
142 requires that goodwill be tested for impairment at the "reporting unit
level" ("Reporting Unit") at least annually and more frequently upon the
occurrence of certain events, as defined by SFAS No. 142. The Company has
determined that it has only one Reporting Unit, specifically the licensing,
implementation and support of its software applications. Goodwill was tested for
impairment during the quarter ended July 27, 2002. First, the Company determined
whether its carrying amount exceeded its "fair value", which would indicate that
goodwill may be impaired. Based on this test, the Company determined that
goodwill could be impaired. Therefore, the Company compared the "implied fair
value" of goodwill, as defined by SFAS No. 142, to its carrying amount to
determine whether there was an impairment loss. As a result of the impairment
test, the Company determined that the carrying value was impaired and it
recorded an impairment loss of $3.6 million. The charge is included in the
caption "Impairment of long-lived assets" in the statements of operations.
Intangible assets are amortized on a straight-line basis over three to
five years. The Company continually evaluates whether events or circumstances
have occurred that indicate the remaining estimated useful lives of these
intangible assets may not be recoverable. When factors indicate that the
intangible assets should be evaluated for possible impairment, the Company uses
an estimate of the related business segment's undiscounted net income over the
remaining useful life of the intangible assets in measuring whether they are
recoverable. An evaluation was performed on the intangible assets during the
quarter ended July 27, 2002. As a result of this evaluation, the Company
determined that the carrying value was impaired and an impairment loss was
recorded for $8.6 million. The charge is included in the caption "Impairment of
long-lived assets" in the statements of operations.
The changes in the carrying amount of the goodwill and intangible
assets are as follows (in thousands):
As of July 27, 2002 As of July 28, 2001
------------------------------ ------------------------------
Gross Carrying Accumulated Gross Carrying Accumulated
Amount Amortization Amount Amortization
------ ------------ ------ ------------
Domain and trade names $ 5,922 $ (4,457) $ 6,610 $ (2,395)
Purchased technology 2,534 (1,830) 18,400 (14,999)
--------- --------- --------- ---------
Total intangible assets 8,456 (6,287) 25,010 (17,394)
Goodwill 60,362 (60,362) 127,049 (77,935)
--------- --------- --------- ---------
$ 68,818 $ (66,649) $ 152,059 $ (95,329)
========= ========= ========= =========
The aggregate amortization expense of intangible assets, net of
restructuring charges was $11.7 million and $15.6 million for the fiscal years
ending July 27, 2002 and July 28, 2001, respectively. The estimated total
amortization expense of acquired intangible assets is $2.2 million and $12,700
for the fiscal years ending 2003 and 2004, respectively.
The changes in the carrying amount of goodwill for the years ended July
27, 2002, and July 28, 2001 are as follows (in thousands):
43
July 27, July 28,
2002 2001
--------- ---------
Balance as of July $ 49,114 $ 313,640
Amortization in the period -- (82,249)
Goodwill additions 45 6,253
Write-off of goodwill (49,159) (188,530)
--------- ---------
Balance as of July $ -- $ 49,114
========= =========
The following table presents the effects on net loss and basic and
diluted net loss per share if the Company had followed the amortization
provisions of SFAS No. 142 for all periods presented (in thousands, except per
share data):
Twelve Months Ended
----------------------
July 27, July 28,
2002 2001
--------- ---------
Net loss (as reported) $ (91,038) $(525,268)
========= =========
Add: goodwill amortization -- 82,249
--------- ---------
Adjusted net loss $ (91,038) $(443,019)
========= =========
Basic and diluted net loss per share $ (1.72) $ (9.09)
========= =========
Weighted-average shares of common stock outstanding 53,290 51,410
Less: Weighted-average shares subject to repurchase (226) (2,669)
--------- ---------
Shares used in computing basic and diluted net loss
per share 53,064 48,741
========= =========
Revenue Recognition
Software Revenues
Software revenues are derived from the Company's SourceForge
application software business and include software licenses, professional
services, maintenance, support and training. Software revenues represent $1.1
million, or 5.3%, of total revenues for the fiscal year 2002.
Revenues from software license agreements follows American Institute of
Certified Public Accountants ("AICPA") Statement of Position ("SOP") 97-2, are
recognized when objective, persuasive evidence of an agreement exists, delivery
of the product has occurred, provided the arrangement does not require
significant customization of the software, the fee is fixed or determinable and
collectibility is probable.
For perpetual licenses, the Company uses the residual method to
recognize revenues. Under the residual method, the fair value of the undelivered
elements is deferred and the remaining portion of the arrangement fee is
recognized as revenue. If evidence of the fair value of one or more undelivered
elements does not exist, revenues are deferred and recognized when delivery of
those elements occurs or when fair value can be established. A typical perpetual
license agreement may include professional services, maintenance and training.
Revenue from non-essential professional services is recognized as the work is
performed based on fair value. When an agreement includes professional services
that are significant or essential to the functionality of the software, the
Company uses the percentage of completion contract accounting method for the
entire arrangement, including license fees. Maintenance revenues are recognized
ratably over the term of the maintenance period (generally one year). Software
maintenance agreements provide technical support and the right to unspecified
updates/upgrades on an if-and-when-available basis. Fair value for the ongoing
maintenance obligations are based upon separate sales or maintenance sold to
customers or upon renewal rates quoted in the contract, when these exist. The
unrecognized portion of amounts paid in advance for licenses and services are
recorded as deferred revenue.
For term arrangements, which include licenses and bundled post-contract
support ("PCS"), the Company uses ratable revenue recognition. Under ratable
revenue recognition, the only undelivered element is PCS and objective evidence
of fair value of PCS does not exist. If the term license agreement includes
multiple elements (such as training and non-essential professional services),
then the Company defers revenue until all elements except PCS are delivered, at
which time revenue is recognized ratably over the remaining contract term.
If the fee due from the customer is not fixed or determinable, revenues
are recognized as cash is received from the customer,
44
assuming all other revenue recognition criteria have been met. The Company
considers all arrangements with payment terms longer than normal not to be fixed
or determinable.
Online Revenues
Online revenues include advertising as well as e-commerce revenue.
Online advertising revenues represent $9.0 million, or 44.2%, of total revenues
for the fiscal year 2002, and includes $2.0 million of barter revenue.
E-commerce revenues represent $7.0 million, or 34.3%, of total revenues for the
fiscal year ending July 27, 2002.
Advertising revenues are derived from the sale of advertising space on
our various websites. Advertising revenues are recognized over the period in
which the advertisements are displayed, provided that no significant obligations
remain and collection of the receivable is reasonable assured. Our obligations
typically include guarantees of a minimum number of "impressions" (times that an
advertisement is viewed by users of our online services over a specified period
of time). To the extent that minimum guaranteed impressions are not met, the
Company does not recognize the corresponding revenues until the guaranteed
impressions are achieved. Barter revenue transactions are recorded at their
estimated fair value based on the Company's historical experience of selling
similar advertising for cash in accordance with Emerging Issues Task Force
("EITF") Issue 99-17, "Accounting for Advertising Barter Transactions." The
Company broadcasts banner advertising in exchange for similar banner advertising
on third party websites. Revenues for the year ended July 27, 2002, included
approximately $2.0 million of barter revenue. Revenues for the year ended July
28, 2001, included approximately $2.4 million of barter revenue. There was no
barter revenue for the fiscal year ended July 28, 2000.
E-commerce revenues are derived from the online sale of consumer goods
and digital animations. E-commerce revenues are recognized in accordance with
SEC Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial
Statements." Under SAB 101, product revenues are recognized when persuasive
evidence of an arrangement exists, delivery has occurred, the sale price is
fixed and determinable and collectibility is reasonably assured. In general, the
Company recognizes e-commerce revenue upon the shipment of goods. The Company
does grant customers a right to return e-commerce products and has recorded an
allowance for such returns. This allowance is a management estimate based on
historical return rates.
Other Revenues
Other revenues are derived from the Company's old hardware, customer
support, and professional services businesses. Other revenues represent $3.3
million, or 16.3%, of total revenues for the fiscal year ending July 27, 2002.
The Company's revenue recognition policy related to its former hardware
systems business follows SEC SAB No. 101, "Revenue Recognition in Financial
Statements." Under SAB No. 101, the Company recognized product revenues from the
sale of Linux-based servers, components, and desktop computers when persuasive
evidence of an arrangement existed, delivery occurred, the sales price is fixed
and determinable and collectibility is reasonably assured. In general, the
Company recognizes product revenue upon shipment of the goods. The Company does
not grant customers any rights to return these products.
The Company recognizes revenues from customer support services,
including on-site maintenance and technical support on a pro-rata basis over the
term of the related service agreement. The Company recognizes revenues from
professional service contracts upon completion of the project, or using the
percentage of completion method of the project where project costs could be
reasonably estimated. The Company records any payments received prior to revenue
recognition as deferred revenue.
Advertising Expenses
The Company expenses advertising costs as incurred. Total advertising
expenses were $2.7 million, $8.3 million and $5.7 million for fiscal years
ending July 27, 2002, July 28, 2001 and July 28, 2000, respectively.
Stock-Based Compensation
SFAS No. 123, "Accounting for Stock-Based Compensation" permits the use
of either a fair value based method or the intrinsic value method defined in
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees" to account for stock-based compensation arrangements. Companies
that elect to employ the valuation method provided in APB No. 25 are required to
disclose the pro forma net income (loss) that would have resulted from the use
of the fair value based method. The Company has elected to continue to determine
the value of stock-based compensation arrangements under the provisions of APB
No. 25 and the related Interpretations from Financial Accounting Standards Board
Interpretation No. 44 ("FIN 44") "Accounting for
45
Certain Transactions Involving Stock Compensation - an interpretation of APB No.
25" and, accordingly, it has included the pro forma disclosures required under
SFAS No. 123 in the notes to the financial statements (see Note 10).
The value of options, stock purchase rights and stock exchanged for
services rendered or assets acquired are accounted for in accordance with SFAS
No. 123 and EITF No. 96-18 "Accounting for Equity Instruments That Are Issued To
Other Than Employees for Acquiring or in Conjunction With Selling Goods or
Services", which require that such equity instruments are recorded at their fair
value on the measurement date which is typically the grant date. Such
instruments are valued using the Black-Scholes option pricing model.
Software Development Costs
In accordance with SFAS No. 86, "Accounting for the Cost of Computer
Software to be Sold, Leased, or Otherwise Marketed," development costs incurred
in the research and development of new software products are expensed as
incurred until technological feasibility in the form of a working model has been
established at which time such costs are capitalized, subject to a net
realizable value evaluation. Technological feasibility is established upon the
completion of an integrated working model. To date, the Company's software
development has been completed concurrent with the establishment of
technological feasibility and, accordingly, all software development costs have
been charged to research and development expense in the accompanying statements
of operations.
Computation of Per Share Amounts
In accordance with SFAS No. 128, basic net loss per common share has
been calculated using the weighted-average number of shares of common stock
outstanding during the period, less shares subject to repurchase. For the years
ended July 27, 2002, July 28, 2001 and July 28, 2000, the Company has excluded
all convertible preferred stock and outstanding stock options from the
calculation of diluted net loss per common share because all such securities are
antidilutive for those periods.
The following table presents the calculation of basic and diluted net
loss per share (in thousands, except per share data):
Year Ended
-----------------------------------
July 27, July 28, July 28,
2002 2001 2000
--------- --------- ---------
Net loss (as reported) ........................................ $ (91,038) $(525,268) $ (89,758)
Dividends related to convertible preferred stock ............ -- -- (4,900)
--------- --------- ---------
Net loss attributable to common stockholders .................. $ (91,038) $(525,268) $ (94,658)
========= ========= =========
Basic and diluted:
Weighted average shares of common stock outstanding ......... 53,290 51,410 33,398
Less: Weighted average shares subject to repurchase ......... (226) (2,669) (6,535)
--------- --------- ---------
Shares used in computing basic and diluted net loss per share 53,064 48,741 26,863
========= ========= =========
Basic and diluted net loss per share ........................ $ (1.72) $ (10.78) $ (3.52)
========= ========= =========
The following potential common shares have been excluded from the
calculation of diluted net loss per share for all periods presented because they
are anti-dilutive (in thousands):
Year Ended
----------------------------
July 27, July 28, July 28,
2002 2001 2000
------ ------ ------
Anti-dilutive securities:
Options to purchase common stock ........ 12,308 10,834 9,534
Common stock subject to repurchase ....... 226 2,669 6,535
------ ------ ------
12,534 13,503 16,069
====== ====== ======
Comprehensive Income (Loss)
Comprehensive loss is comprised of net loss and other non-owner changes
in stockholders' equity, including foreign currency translation gains or loss
and unrealized gains or losses on available-for sale marketable securities.
46
Income Taxes
The Company accounts for income taxes using the liability method in
accordance with SFAS No. 109, "Accounting for Income Taxes". Due to the
Company's loss position in fiscal years 2002, 2001 and 2000, there was no
provision for income taxes for the years ended July 27, 2002, July 28, 2001 and
July 28, 2000. Deferred tax assets are recognized for anticipated future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and their respective tax bases. A valuation
allowance has been recorded for the total deferred tax assets as a result of
uncertainties regarding realization of the assets based on the lack of
profitability to date and the uncertainty of future profitability.
Recent Accounting Pronouncements
Effective July 29, 2001, the Company adopted SFAS No. 142, "Goodwill
and Other Intangible assets." Upon adoption of SFAS No. 142, the Company no
longer amortizes goodwill, and thereby eliminated goodwill amortization of
approximately $1.3 million per year based on anticipated goodwill amortization
for fiscal 2002. Goodwill and intangible assets were tested for impairment
during the quarter ended July 27, 2002. First, the Company determined whether
the carrying amount of its goodwill and its intangible assets exceeded its "fair
value", which would indicate that goodwill may be impaired. The Company
determined that goodwill and intangible assets were impaired, therefore the
Company compared the "implied fair value" of the assets, as defined by SFAS 142,
to its carrying amount to determine whether there was an impairment loss. As a
result of the impairment test, the Company determined that the carrying value
was impaired and it recorded an impairment loss of $12.2 million.
In August 2001, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143
establishes accounting standards for recognition and measurement of an asset
retirement obligation and an associated asset retirement cost and is effective
for fiscal years beginning after June 15, 2002. The Company is currently
evaluating the potential impact, if any, the adoption of SFAS No. 143 will have
on its future financial position and results of operations.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", which addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
While SFAS No. 144 supersedes SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" it retains many
of the fundamental provisions of SFAS No. 121. SFAS No. 144 also supersedes the
accounting and reporting provisions of APB No. 30, "Reporting the Results of
Operations--Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions", for
the disposal of a segment of a business. However, it retains the requirement in
APB No. 30 to report separately discontinued operations and extends that
reporting to a component of an entity that either has been disposed of (by sale,
abandonment, or in a distribution to owners) or is classified as held for sale.
SFAS No. 144 is effective for fiscal years beginning after December 15, 2001 and
interim periods within those fiscal years. The adoption of SFAS No. 144 is not
expected to have a material effect on the Company's consolidated financial
statements.
In November 2001, the EITF reached a consensus on EITF Issue No. 01-09,
"Accounting for Consideration Given by a Vendor to a Customer or a Reseller of
the Vendor's Products," which is a codification of EITF Issue No. 00-14, 00-22
and 00-25. This issue presumes that consideration from a vendor to a customer or
reseller of the vendor's products to be a reduction of the selling prices of the
vendor's products and, therefore, should be characterized as a reduction of
revenues when recognized in the vendor's income statement and could lead to
negative revenues under certain circumstances. Revenue reduction is required
unless consideration relates to a separate identifiable benefit and the
benefit's fair value can be established. EITF No. 01-09 is effective for fiscal
years beginning after December 15, 2001 and interim periods within those fiscal
years. The adoption of EITF No. 01-9 is not expected to have a material effect
on our consolidated financial statements.
In November 2001, the FASB discussed Topic D-103, recharacterized as
EITF Issue No. 01-14, "Income Statement Characterization of Reimbursements
Received for "Out-of-Pocket" Expenses Incurred." This issue deals with
classification in the income statement of incidental expenses, which in practice
are commonly referred to as "out-of-pocket" expenses, incurred by entities that
provide services as part of their central ongoing operations. The Task Force
reached a consensus that reimbursements received for out-of-pocket expenses
incurred should be characterized as revenue in the income statement. This issue
is effective for fiscal years beginning after December 15, 2001. The Company has
recorded all "out-of-pocket" expenses for fiscal 2002 as revenue. Out-of-pocket
expenses for all periods presented were immaterial.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities", which addresses accounting for
restructuring and similar costs. SFAS No. 146 supercedes previous accounting
guidance, principally EITF
47
issue No. 94-3. The Company is required to adopt SFAS No. 146 for restructuring
activities initiated after December 31, 2002. SFAS No. 146 requires that the
liability for costs associated with an exit or disposal activity be recognized
when the liability is incurred. Under EITF 94-3, a liability for an exit cost
was recognized at the date of the company's commitment to an exit plan. SFAS No.
146 also established that the liability should initially be measured and
recorded at fair value. Accordingly, SFAS 146 may affect the timing of
recognizing future restructuring plans. If the Company continues to record
significant restructuring charges, the adoption of SFAS No. 146 could have a
significant impact on the Company's results of operations.
Supplier Concentration
Prior to exiting the hardware systems business in fiscal year 2001, the
Company was dependent on a single contract manufacturer for substantially all of
its manufacturing and supply chain management, including component procurement
and inventory management for its systems and services segment. Beginning July
29, 2001, under the software application business, no supplier concentration
exists.
Concentrations of Credit Risk and Significant Customers
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of cash trade receivables. The
Company provides credit, in the normal course of business, to a number of
companies and performs ongoing credit evaluations of its customers. As of July
27, 2002, approximately 40% of gross accounts receivables were concentrated with
one customer, Lavaca Systems, Inc. A reserve representing 100% of the gross
accounts receivable related to this customer has been established. As of July
28, 2001, approximately 24% of gross accounts receivables were concentrated with
one customer, AT&T.
For the fiscal year ended July 27, 2002, one customer, Intel
Corporation, accounted for approximately 20% of net revenues. For the fiscal
year ended July 28, 2001, one customer, Akamai Technologies, Inc., accounted for
approximately 25% of net revenues. For the fiscal year ended July 28, 2000, one
customer, Akamai Technologies, Inc. accounted for approximately 18% of net
revenues.
Reclassifications
Certain reclassifications have been made to the prior year's financial
statements to conform to the current year's presentation. These classifications
had no effect on the prior year's stockholders' equity or results of operations.
3. Acquisitions and Divestitures
There were no acquisitions or divestitures during the fiscal year ended
2002. During the fiscal years ended July 28, 2001 and 2000, the Company
completed a number of acquisitions accounted for using the purchase method and
as such, the purchase price was allocated to the assets acquired and the
liabilities assumed based on estimated fair values on the date of acquisition.
The consolidated financial statements include the operating results of each
business from the date of acquisition. The value assigned to purchased
in-process research and development, based on the income method prepared by an
independent third party, was determined by identifying research projects in
areas for which technological feasibility had not been established and no future
alternative uses existed. Amounts allocated to goodwill and purchased intangible
assets have been amortized on a straight-line basis over three to five years
through July 28, 2001. As of July 29, 2001, in accordance with SFAS No. 142,
"Goodwill and Other Intangible assets," the Company no longer amortizes
goodwill. Other intangible assets continue to be amortized on a straight-line
basis over three to five years.
Acquisitions and Divestitures - Fiscal Year 2000
TruSolutions, Inc.
On March 28, 2000, in an acquisition accounted for under the purchase
method of accounting, the Company acquired all of the outstanding shares of
TruSolutions for approximately $72.9 million (including acquisition costs of
approximately $400,000). The consideration included 767,000 shares of the
Company's common stock with a fair market value of $56.7 million based on the
average closing price for ten days prior to the acquisition closing date, cash
of approximately $10 million and the assumption of outstanding options to
purchase TruSolutions common stock valued at $5.8 million based on the
Black-Scholes model using the following assumptions: risk free rate of 6.34%;
average expected life of 4 years; dividend yield of 0.0%; volatility of common
stock of 60.0%. The purchase agreement contained additional payments to be made
in common stock that were solely contingent upon the continued
48
employment of certain key employees for a period of three years. Maximum future
payments, contingent on employment of the key employees, was $96.3 million
payable in stock (approximately 1,303,000 shares) and was originally payable
after 12 months, 24 months and 36 months (approximately 501,000 shares, 501,000
shares and 301,000 shares, respectively). The contingent payments were to be
accounted for as compensation expense over the term of the employment condition
and not as part of the purchase price. The purchase price of $72.9 million was
allocated as follows: $62.2 million to goodwill, $7.7 million to other
intangible assets, $4.0 million to in-process research and development and the
remainder of $1.0 million to other assets and liabilities.
TruSolutions' in-process research projects included the research and
development associated with the 1/2U, 1U, 2U, and 4U server products. The value
of in-process research and development was determined by estimating the costs to
develop the purchased in-process technology into commercially viable products,
estimating the resulting net cash flows from such projects and discounting the
net cash flows back to their present value. The discount rate included a
risk-adjusted discount rate to take into account the uncertainty surrounding the
successful development of the purchased in-process technology. The risk-adjusted
discount rate applied to the projects' cash flows was 45% for the in-process
technology. The Company believes that the estimated in-process technology
amounts represent fair value and do not exceed the amount a third party would
pay for the projects. The valuation included cash inflows from in-process
technology through fiscal year 2003 with revenues commencing in fiscal year 2000
for the 1U, 2U and 4U servers, and in fiscal year 2001 for the 1/2U server.
Where appropriate, the Company allocated anticipated cash flows from an
in-process research and development project to reflect contributions of the core
technology.
In February 2001, in response to the general slowdown in the economy,
the Company adopted a plan to reduce operating costs. The plan included charges
related to the closure of TruSolution's sole facility located in San Diego. In
addition, compensation expense of $33.3 million was recorded for the
acceleration of the contingent consideration related to severance arrangements
with terminated TruSolutions' employees. These charges were recorded as
restructuring costs and other special charges in the statements of operations
(see Note 4). In June 2001, the Company adopted a plan to exit the systems
business. As a result, the net book value of goodwill and intangible assets of
$50.6 million related to the TruSolutions acquisition was written down to zero
as there were no future cash flows expected from this business pursuant to the
completion of the restructuring plan (see Note 4).
NetAttach, Inc.
On April 5, 2000, in an acquisition accounted for under the purchase
method of accounting, the Company acquired all of the outstanding shares of
NetAttach for approximately $37.4 million (including acquisition costs of
approximately $300,000). The purchase price included 396,000 shares of the
Company's common stock with a fair market value of $24.6 million based on the
average closing price for five days prior to the acquisition closing date, cash
of $10.0 million and the assumption of outstanding options valued at $2.5
million based on the Black-Scholes model using the following assumptions: risk
free rate of 6.34%; average expected life of 4 years; dividend yield of 0.0%;
volatility of common stock of 60.0%. The purchase agreement also contained
additional payments to be made in common stock. These payments were solely
contingent upon the continued employment of certain key employees for a period
of two years. Maximum future payments, contingent on employment of the key
employees, were $5.4 million payable in stock (approximately 86,000 shares of
the Company's common stock) and were payable on the two-year anniversary date of
the merger. The contingent payments were accounted for as compensation expense
over the term of the employment condition and not as part of the purchase price.
The total purchase price of $37.4 million was allocated as follows: $33.1
million to goodwill, $4.8 million to other intangible assets and the remainder
of $0.5 million to other assets and liabilities. As part of the NetAttach
acquisition, the Company assumed certain warrant agreements in association with
the purchase. The fair market value of the warrants was not material. All
warrants have been converted into common stock.
In September 2001, the Company adopted a plan to exit the professional
services and Linux software engineering services businesses in order to focus
solely on the Company's SourceForge software application business. The Company
recorded a restructuring charge of $45.0 million in the first quarter of fiscal
2002 related to exiting these fields. Of the $45.0 million, $27.6 million
related to the impairment of goodwill and purchased intangibles from the
Company's prior year acquisition of NetAttach, resulting from the expectation
that the Company would receive no significant future cash flows from the Linux
software engineering services businesses as a result of the exit decision made
in September 2001.
Precision Insight, Inc.
On April 14, 2000, in an acquisition accounted for under the purchase
method of accounting, the Company acquired all of the outstanding shares of
Precision Insight for approximately $4.1 million. The consideration included
approximately 32,000 shares of the Company's common stock with a fair market
value of $2.3 million based on the average closing price for five days prior to
the acquisition closing date and cash of approximately $1.8 million. The
purchase agreement contained additional payments to be made
49
in common stock that were solely contingent upon the continued employment of
certain key employees for a period of four years. Maximum future payments,
contingent on employment of the key employees, was $11.5 million in stock
(approximately 157,000 shares of the Company's common stock) and were originally
payable after 24 months, 36 months and 48 months (approximately 52,300 shares
each year). The contingent payments were to be accounted for as compensation
expense over the term of the employment condition and not as a part of the
purchase price. The disclosures of the allocation of purchase price and pro
forma data have not been disclosed as the amounts are not material.
In September 2001, the Company adopted a plan to exit the professional
services and Linux software engineering services businesses in order to focus
solely on the Company's SourceForge software application business. The Company
recorded a restructuring charge of $45.0 million in the first quarter of fiscal
2002 related to exiting these fields. Of the $45.0 million, $3.0 million related
to the impairment of goodwill and purchased intangibles from the Company's prior
year acquisition of Precision Insight, resulting from the expectation that the
Company would receive no significant future cash flows from the professional
services business as a result of the exit decision made in September 2001.
OSDN
On June 7, 2000, in an acquisition accounted for under the purchase
method of accounting, the Company acquired all of the outstanding shares of OSDN
for approximately $342.0 million (including acquisition costs of approximately
$5.0 million). The purchase price included 6,986,000 shares of the Company's
common stock with a fair market value of $315.0 million based on the average
closing price for five days prior to the acquisition closing date and the
assumption of outstanding options to purchase the Company's common stock valued
at approximately $22.0 million based on the Black-Scholes model using the
following assumptions: risk free rate of 6.64%; average expected life of 7
years; dividend yield of 0.0%; volatility of common stock of 70.0%. The purchase
price was allocated as follows: $229.7 million to goodwill, $38.4 million to
other intangible assets, $5.0 million to in-process research and development and
the remainder to other assets and liabilities.
OSDN's in-process research projects included next-generation web site
management tools, online web applications, and other technologies that support
the Company's network of web sites. The value of in-process research and
development was determined by estimating the costs to develop the purchased
in-process technology into commercially viable products, estimating the
resulting net cash flows from such projects and discounting the net cash flows
back to their present value. The discount rate included a risk-adjusted discount
rate to take into account the uncertainty surrounding the successful development
of the purchased in-process technology. The risk-adjusted discount rate applied
to the projects' cash flows was 30% for the in-process technology. The Company
believed that the estimated in-process technology amounts represented fair value
and did not exceed the amount a third party would pay for the projects.
The valuation included cash inflows from in-process technology through
fiscal year 2005 with revenues commencing in fiscal year 2001. Where
appropriate, the Company allocated anticipated cash flows from an in-process
research and development project to reflect contributions of the core
technology. At the time of the merger, OSDN's remaining tasks that were
substantially incomplete included certain planning, designing, coding,
prototyping, and testing activities that were necessary to establish that the
developmental technologies could be produced to meet their design specifications
including functional, technical, and economic performance requirements. The
Company estimated that it would cost approximately $1,000,000 to complete the
projects with significant remaining development efforts. The Company did not
incur any additional charges related to these projects in fiscal year 2002 and
does not expect to incur additional charges going forward.
In the fourth quarter of fiscal 2001, the Company performed an
assessment of the carrying value of the Company's long-lived assets to be held
and used including significant amounts of goodwill and other intangible assets
recorded in connection with its acquisition of OSDN. The assessment was
performed pursuant to SFAS No. 121 due to the significant slowdown in the
economy affecting both the Company's current operations and expected future
sales, as well as the general decline of technology valuations. The conclusion
of that assessment was that the decline in market conditions within the
Company's industry was significant and other than temporary. As a result, the
Company recorded during the fourth quarter of fiscal 2001, a charge of $160.0
million to reduce goodwill associated with the acquisition of OSDN, based on the
amount by which the carrying value of these assets exceeded their fair value.
The charge is included in the caption "Impairment of long-lived assets" in the
statements of operations. Fair value was determined based on discounted future
cash flows.
Effective July 29, 2001, the Company adopted SFAS No. 142, "Goodwill
and Other Intangible assets." SFAS 142 requires that goodwill be tested for
impairment at the "reporting unit level" at least annually and more frequently
upon the occurrence of certain events, as defined by SFAS 142. In accordance
with SFAS No. 142, the Company tested the remaining OSDN goodwill and
50
intangibles for impairment during the quarter ended July 27, 2002. First, the
Company determined if its carrying amount exceeded its "fair value" which would
indicate that goodwill may be impaired. The Company determined that goodwill and
intangible assets were impaired. Therefore, the Company compared the "implied
fair value" of the assets, as defined by SFAS 142, to its carrying amount to
determine if there was an impairment loss. As a result of the impairment test,
the Company determined that the carrying value was impaired and recorded an
impairment loss of $12.2 million.
Acquisitions and Divestitures - Fiscal Year 2001
Brave New Worlds, Inc.
On September 26, 2000, in an acquisition accounted for under the
purchase method of accounting, the Company acquired all of the outstanding
shares of Brave New Worlds, Inc. ("BNW") for approximately $2.5 million. The
consideration included approximately 35,000 shares of the Company's common stock
with a fair market value of $1.7 million based on the average closing price for
three days prior to the acquisition closing date and cash of approximately
$750,000. The purchase agreement contained additional payments to be made in
common stock that were solely contingent upon the continued employment of
certain key employees for a period of four years. Maximum future payments
contingent on employment of the key employees was to be $4.8 million in stock
(approximately 97,000 shares) and was payable after 12 months, 24 months, 36
months and 48 months. The contingent payments were accounted for as compensation
expense on a pro rata basis over the term of the employment condition and not as
purchase price. Upon consummation of the acquisition, the Company established an
escrow for these contingent payments. The disclosures of the allocation of
purchase price and pro forma data have been omitted as the amounts are not
material. In February 2001, in response to the general slowdown in the economy,
the Company adopted a plan to reduce operating costs. The plan involved the
divestiture of the managed services business, including the recently acquired
BNW. Charges were recorded to write down the net book value of the BNW net
assets acquired to the Company's estimate of proceeds to be received on the sale
of the business, which was estimated to be nominal. In addition, compensation
expense of $1.4 million was recorded for the acceleration of a portion of the
contingent consideration related to severance arrangements made with terminated
BNW employees. The sale of BNW was completed on June 10, 2001 for minimal
proceeds. The charges associated with this divestiture have been recorded as
restructuring costs and other special charges in the statement of operations
(see Note 4).
Life BVBA
On September 29, 2000, in an acquisition accounted for under the purchase method
of accounting, the Company acquired all of the outstanding shares of Life BVBA
("Life") for approximately $860,000. The consideration included approximately
14,000 shares of the Company's common stock with a fair market value of $660,000
based on the average closing price for three days prior to the acquisition
closing date and cash of approximately $200,000. The purchase agreement
contained additional payments to be made in common stock that were solely
contingent upon the continued employment of certain key employees for a period
of four years. Maximum future payments contingent on employment of the key
employees were capped at $2.0 million in stock (approximately 43,000 shares) and
was originally payable after 12 months, 24 months, 36 months and 48 months. Upon
consummation of the acquisition, the Company established an escrow for these
contingent payments. The disclosures of the allocation of purchase price and pro
forma data have been omitted as the amounts are not material. In February 2001,
in response to the general slowdown in the economy, the Company adopted a plan
to reduce operating costs. The plan involved the divestiture of the managed
services business, including the recently acquired Life. The sale of Life was
completed on April 25, 2001 for minimal proceeds. In addition, compensation
expense of $1.3 million was recorded for the acceleration of the contingent
consideration related to severance arrangements made with terminated Life
employees. The charges associated with this divestiture have been recorded as
restructuring costs and other special charges in the statement of operations
(see Note 4).
Help Desk Facility
On November 27, 2000, the Company acquired certain assets of Alabanza
Corporation ("Alabanza") for approximately $3.6 million. The consideration
included 224,090 shares of the Company's common stock valued at $2.6 million and
cash of approximately $950,000. The agreement contained no additional contingent
payments, options or commitments. In February 2001, in response to the general
slowdown in the economy, the Company adopted a plan to reduce operating costs.
In connection with these actions, the plan involved the divestiture of its
managed services business, including the help desk facility recently acquired
from Alabanza. Charges were recorded to write down the net book value of
intangible assets to the Company's estimate of proceeds to be received on the
sale of the assets, which was estimated to be nominal. The divestiture of
Alabanza was completed on July 10, 2001 for approximately $0.5 million, which
has been fully reserved for during restructuring. The charges associated with
this divestiture were recorded as restructuring costs and other special charges
in the statements of operations (see Note 4).
51
Software Technology
On December 7, 2000, the Company acquired certain assets of Lavaca
Systems, Inc. ("Lavaca") for approximately $3.6 million. The consideration
included 306,122 shares of the Company's common stock valued at $2.6 million and
cash of approximately $1.0 million. The agreement contained no additional
contingent payments, options or commitments. Purchased intangible assets
included intellectual property and technology related to specific software
applications of approximately $3.6 million. During the fourth quarter of fiscal
2001, charges were recorded to write down the net book value of intangible
assets to the Company's estimate of proceeds to be received on the sale of the
assets. The divestiture of Lavaca was completed in the first quarter of fiscal
2002 for minimal proceeds. The charges associated with this write-down have been
recorded as restructuring costs and other special charges in the statements of
operations (see Note 4).
4. Restructuring Costs and Other Special Charges
During February 2001, in response to the general slowdown in the
economy, the Company adopted a formal plan to reduce operating costs. In
connection with these actions, a pre-tax restructuring charge of approximately
$43.4 million was recorded in the third quarter of fiscal 2001. The principle
actions of the plan involved the closure of the Company's San Diego facility and
the exit from its managed services business. Of the $43.4 million, $33.8 million
related to the acceleration of deferred stock compensation that was originally
contingent on future employment by three employees of TruSolutions and one
employee of Life, companies VA acquired in March 2000 and September 2000,
respectively. These employees' positions were terminated as part of the
restructuring and all stock held in escrow was released to them as part of their
severance agreements. In addition, as part of the plan to exit from the
Company's managed services business, VA accrued for the disposition of BNW, a
company VA acquired in September 2000. Included in the accrual were severance
charges related to six employees of BNW who were informed before April 28, 2001
of the formal plan of the Company to divest of BNW. Further, $1.7 million was
recorded for workforce reduction, consisting of severance, acceleration of stock
options, and other related costs attributable to 43 former employees, primarily
from the Company's domestic systems business. Of the remaining $7.9 million,
$1.7 million was for excess facilities related primarily to non-cancelable
leases (payments which will continue until fiscal year 2010 unless VA sublets
completely) or other costs and the abandonment or disposal of property and
equipment, and $6.2 million was for the impairment of goodwill and purchased
intangibles as there were no future cash flows expected from the managed
services business that was exited pursuant to the restructuring plan. The
accrual for non-cancelable lease payments includes management's estimates of the
time expected to sublet the facilities and estimates of sublease income. These
estimates are subject to change based on actual events. VA evaluates and
updates, if applicable, these estimates quarterly.
In addition to the above, the Company recorded $3.4 million in
connection with these restructuring charges, which was classified as cost of
revenues in the statement of operations. Of the $3.4 million, $0.2 million was
recorded for workforce reduction, consisting of severance and other related
costs attributable to 19 employees from the domestic systems business and nine
employees from the managed services business. Of the remaining $3.2 million,
$2.9 million related to a write down of inventory from the closing of the San
Diego facility, and $0.3 million related to other restructuring costs.
In June 2001, the Company adopted a plan to exit the systems business
which was accounted for in the fourth quarter ended July 28, 2001. The Company
decided to exit its systems business in reaction to the negative impact of the
slowdown in the economy on VA's customer base and VA's inability to effectively
penetrate the larger enterprise market. VA exited the systems business to pursue
its SourceForge application software business in order to reduce operating
losses and improve cash flow. The Company recorded a restructuring charge of
$70.1 million in the fourth quarter of fiscal 2001 related to exiting its
systems business. Of the $70.1 million, $53.5 million related to the impairment
of goodwill and purchased intangibles, resulting from its expectation that VA
would receive no significant future cash flows from the systems business. $6.6
million of the $70.1 million charge related to excess facilities primarily from
non-cancelable leases (payments which, unless VA sublets completely, will
continue until fiscal year 2010), $3.2 million related to a workforce reduction
consisting of severance, acceleration of stock options, and other related costs
attributable to 84 employees primarily from the Company's systems business, and
$6.8 million related to other restructuring charges related to the exit from the
systems business. The accrual for non-cancelable lease payments includes
management's estimates of the time expected to sublet the facilities and
estimates of sublease income. These estimates are subject to change based on
actual events. VA evaluates and updates, if applicable, these estimates
quarterly.
52
In addition to the above, the Company recorded $10.5 million of charges
in connection with the exit of the systems business, which were classified as
cost of revenues in the statements of operations. Of the $10.5 million, $7.6
million was related to excess inventory charges arising from the exit of the
systems business, $0.4 million was recorded for a workforce reduction consisting
of severance, and other related costs attributable to 64 former employees from
the Company's systems business, and the remaining $2.5 million related to other
restructuring costs.
In September 2001, the Company adopted a plan to exit the professional
services and Linux software engineering services businesses in order to focus
solely on its SourceForge software application business. The Company recorded a
restructuring charge of $45.0 million in the first quarter of fiscal year 2002
related to this exit. Of the $45.0 million, $30.6 million related to the
impairment of goodwill and purchased intangibles from its prior year
acquisitions of NetAttach and Precision Insight resulting from its expectation
that the Company would receive no significant future cash flows from the
professional services and Linux software engineering services businesses. $12.9
million of the $45.0 million charge related to excess facilities primarily from
non-cancelable leases (payments which will continue until fiscal year 2010
unless VA sublets completely) and other costs for the abandonment or disposal of
property and equipment. Of the remaining $1.5 million restructuring charge, $1.3
million was related to a workforce reduction consisting of severance and other
labor related costs attributable to 50 former employees primarily from its Linux
software engineering service business, and $0.2 million related to other
restructuring charges related to the exit of the services business. The accrual
for non-cancelable lease payments includes management's estimates of the time
expected to sublet the facilities and estimates of sublease income. These
estimates are subject to change based on actual events. VA evaluates and
updates, if applicable, these estimates quarterly.
In addition to the above, the Company recorded a $3.1 million net
credit included in cost of revenues in the consolidated statement of operations
for the quarter ended October 27, 2001. The $3.1 million net credit included a
$3.9 million credit adjustment relating to the fiscal 2001 fourth quarter
systems restructuring composed of a $2.0 million reversal of reserves for
inventory (the Company had a better than expected sell through of old and excess
material in the three months ended October 27, 2001 than was anticipated in July
2001), $1.2 million adjustment for system shipments (the Company was able to
sell product at a price in excess of that originally estimated at July 28, 2001)
and $0.7 million reversal for an over estimate of warranty expense. A $0.8
million restructuring charge was recorded for a workforce reduction which mostly
consisted of severance and other related costs attributable to 36 former
employees primarily from exiting the professional services business.
During the third quarter of fiscal 2002, the Company recorded
additional restructuring charges associated with the exiting of a sublease
agreement of $0.7 million, offset by reversals of excess restructuring accruals
related to prior periods of $0.6 million.
In addition, the Company recorded a $0.3 million credit included in
cost of revenues in the consolidated statement of operations for the quarter
ended April 27, 2002. This credit was due to the reversal of a prior period
restructuring accrual. The accrual was originally established as a result of a
non-cancelable contract for warranty services. The contract was renegotiated and
settled during the third quarter of fiscal 2002 and as a result the reserve was
reversed.
In July 2002, the Company adopted a plan to reduce its general and
administrative overhead costs. As a result of this plan, a $1.9 million
restructuring charge was recorded in the fourth quarter of fiscal year 2002. Of
the $1.9 million, $1.2 million related to excess facilities from non-cancelable
leases (payments which will continue until fiscal year 2004, unless VA sublets
completely) and the abandonment of property, and $0.7 million related to a
workforce reduction consisting of severance and other related costs attributable
to 35 employees.
In addition to the above, the Company recorded a $2.4 million net
credit included in cost of revenues in the consolidated statement of operations
for the quarter ended July 27, 2002. The $2.4 million net credit included a $2.7
million credit adjustment relating to the overestimate of the fiscal 2001 fourth
quarter systems warranty restructuring accrual. A $0.3 million restructuring
charge was recorded for a workforce reduction, which mostly consisted of
severance and other related costs attributable to 14 former employees primarily
in an effort to align the Company's infrastructure with its operations.
53
Below is a summary of the restructuring charges in operating expenses
(in thousands):
Total Total
Total Charged Charged To Cash Restructuring
To Operations Operations Receipts/ Liabilities at
Fiscal 2001 Fiscal 2002 (Payments) July 27, 2002
----------- ----------- ---------- -------------
Cash Provisions:
Other special charges relating to
restructuring activities ................................. $ 2,159 $ (888) $ (1,219) $ 52
Facilities charges ......................................... 6,584 9,401 1,545 17,530
Employee severance and other related
charges ................................................. 3,498 1,997 (5,083) 412
-------- -------- -------- --------
Total cash provisions .................................. 12,241 10,510 $ (4,757) $ 17,994
-------- -------- ======== ========
Non-cash Provisions:
Write-off of goodwill and intangibles ...................... 59,723 30,632
Write-off of other special charges relating
to restructuring activities ............................... 4,434 5,442
Write-off of accelerated options from
terminated employees ..................................... 1,352 --
Acceleration of deferred stock
compensation .............................................. 35,728 352
-------- --------
Total non-cash provisions .............................. 101,237 36,426
-------- --------
Total operating expense restructuring
provisions ........................................... $113,478 $ 46,936
======== ========
5. Other Obligations
OSDN Notes Payable
As part of the OSDN acquisition, the Company assumed three note payable
agreements (the "Notes") with an employee of OSDN. The Notes bore interest rates
of 9.0% to 9.75% totaling $2,043,000 and were to mature through fiscal year
2003. As of July 28, 2001, the remaining principal maturities under the note
payables of $922,000 were currently due and were recorded as accrued
compensation in the accompanying balance sheet. During fiscal year 2002, the
Company settled the remaining loan balance as part of the employee's separation
agreement for face value. As of July 27, 2002, there were no remaining balances
under the Notes.
6. Line of Credit and Equipment Loan
In September 2001, the Company amended its loan and security agreement
with a bank. In accordance with the amended agreement, the committed revolving
line of credit was reduced from $10,000,000 to $7,500,000. The amount available
for borrowing was not to exceed the committed revolving line, less any
outstanding letters of credit issued under the line of credit, which was not to
exceed $3,000,000. If the sum of outstanding advances plus the face amount of
all outstanding letters of credit exceeded $4,000,000, then advances were not to
exceed the lesser of (i) the committed revolving line or (ii) 70% of eligible
accounts receivables minus, in each case, the face amount of all outstanding
letters of credit.
In May 2002, the Company further amended its loan and security
agreement. In accordance with the amended agreement, the committed revolving
line of credit was reduced from $7,500,000 to $5,000,000. The amount available
for borrowing was not to exceed the committed revolving line, less any
outstanding letters of credit issued under the line of credit, which was not to
exceed $3,000,000. If the sum of outstanding advances plus the face amount of
all outstanding letters of credit exceeded $4,000,000, then advances were not to
exceed the lesser of (i) the committed revolving line or (ii) 70% of eligible
accounts receivables minus, in each case, the face amount of all outstanding
letters of credit. Borrowings under the amended agreement matured on June 30,
2002. The loan and security agreement were not renewed or amended on its
maturity date of June 30, 2002.
54
7. Commitments and Contingencies
The Company leases its facilities under operating leases that expire at
various dates through fiscal year 2010. Future minimum lease payments under
non-cancelable operating leases, net of sublease income, as of July 27, 2002 are
as follows (in thousands):
Operating
Leases
-------
2003 ......................................................... $ 4,208
2004 ......................................................... 4,428
2006 ......................................................... 4,556
2006 ......................................................... 3,632
2007 ......................................................... 3,511
Thereafter ................................................... 10,521
-------
Total minimum lease payments ....................... $30,856
=======
Effective June 1, 2000, the Company entered into a ten-year lease
agreement for a new corporate facility.
Gross rent expense for the years ended July 27, 2002, July 28, 2001 and
July 28, 2000 was approximately $18,866,000, $13,601,000 and $2,163,000,
respectively. $11,029,000 and $8,300,000 of the rent expense for the years ended
July 27, 2002 and July 28, 2001, respectively, were attributable to an estimate
of the loss related to idle facilities, which has been recorded as restructuring
costs and other special charges in the statements of operations.
8. Litigation
The Company, two of its former officers (the "Former Officers"), and
the lead underwriter in its IPO were named as defendants in a consolidated
shareholder lawsuit in the United States District Court for the Southern
District of New York, captioned In re VA Software Corp. Initial Public Offering
Securities Litigation, 01-CV-0242. This is one of a number of actions
coordinated for pretrial purposes as In re Initial Public Offering Securities
Litigation, 21 MC 92. Plaintiffs in the coordinated proceeding bring claims
under the federal securities laws against numerous underwriters, companies, and
individuals, alleging generally that defendant underwriters engaged in improper
and undisclosed activities concerning the allocation of shares in the IPOs of
more than 300 companies during late 1998 through 2000. Among other things,
plaintiffs allege that the underwriters' customers had to pay excessive
brokerage commissions and purchase additional shares of stock in the aftermarket
in order to receive favorable allocations of shares in an IPO. The consolidated
amended complaint in the Company's case seeks unspecified damages on behalf of a
purported class of purchasers of its common stock between December 9, 1999 and
December 6, 2000. Defendants have filed motions to dismiss.
In September 2002, plaintiffs agreed to voluntarily dismiss all claims
(the "Dismissed Claims") against the Company's Former Officers. In the event,
however, that facts emerge prior to September 30, 2003, which support the
Dismissed Claims, the Court may permit plaintiffs to reassert some or all of the
Dismissed Claims.
The Company believes it has meritorious defenses to all of the claims
against the Company and will defend them vigorously.
The Company is subject to various claims and legal actions arising in
the ordinary course of business. In the opinion of management, after
consultation with legal counsel, the ultimate disposition of these matters is
not expected to have a material effect on the Company's business, financial
condition or results of operations. The Company has accrued for estimated losses
in the accompanying consolidated financial statements for those matters where it
believes that the likelihood that a loss will occur is probable and the amount
of loss is reasonably estimable. Although management currently believes that the
outcome of other outstanding legal proceedings, claims and litigation involving
the Company will not have a material adverse effect on its business, results of
operations or financial condition, litigation is inherently uncertain, and there
can be no assurance that existing or future litigation will not have a material
adverse effect on the Company's business, results of operations or financial
condition.
9. Retirement Savings Plan
The Company maintains an employee savings and retirement plan which is
intended to be qualified under Section 401(k) of the Internal Revenue Code and
is available to substantially all full-time employees of the Company. The plan
provides for tax deferred salary deductions and after-tax employee
contributions. Contributions include employee salary deferral contributions and
discretionary employer contributions. To date, there have been no employer
discretionary contributions.
55
10. Common Stock
In October 1999, the Company's board of directors approved the
reincorporation into Delaware by way of a merger with a newly-formed Delaware
subsidiary in connection with the Company's IPO. In conjunction with the IPO,
the Company issued 4,400,000 shares of common stock with an initial public
offering price of $30.00 per share. Upon closing of the initial public offering,
all of the outstanding shares of convertible preferred stock were automatically
converted into 19,921,322 shares of common stock. In addition, the underwriters
exercised their option to purchase 660,000 additional shares to cover the
over-allotments of shares at the $30.00 per share offering price. The IPO raised
approximately $141,000,000 after underwriting fees and $139,000,000 after all
other direct costs. In fiscal year 2002, the Company cancelled 10,934 shares of
its common stock, which has been recorded as treasury stock in the balance sheet
and statement of stockholders' equity. In fiscal year 2001, the Company
repurchased 41,114 shares of common stock for approximately $4,000 and cancelled
63,386 shares of its common stock, which has been recorded as treasury stock in
the balance sheet and statement of stockholders' equity.
As of July 27, 2002 there were 54,165,411 shares of common stock issued
and outstanding. VA Software is authorized to issue 250,000,000 shares of common
stock, $0.001 par value. Each share of common stock has the right to one vote.
The holders of common stock are also entitled to receive dividends whenever
funds are available and when declared by the Board of Directors. No cash
dividends have been declared or paid through July 27, 2002.
As of July 27, 2002, the Company had reserved shares of its common
stock for future issuance as follows:
1998 Stock Option Plan and Assumed Plans .................... 19,936,338
1999 Director Option Plan ................................... 1,000,000
1999 Employee Stock Purchase Plan ........................... 1,803,677
----------
22,740,015
==========
Stock Repurchase Agreements
In connection with the exercise of options pursuant to the Company's
Stock Option Plan, employees entered into restricted stock purchase agreements
with the Company. Under the terms of these agreements, the Company has a right
to repurchase any unvested shares at the original exercise price of the shares
upon termination of the employee. The repurchase right lapses ratably over the
vesting term of the original option grant. As of July 27, 2002, 29,106 shares of
the Company's common stock were subject to repurchase by the Company.
Stock Option Plan
In fiscal year 1997, the Company adopted and the board of directors
approved the 1996 Stock Option Plan ("1996 Plan"), under which a total of
4,650,000 shares of the Company's common stock were reserved for issuance. The
1996 Plan permitted options to be granted to employees, consultants and
directors to purchase shares of the Company's common stock at a price determined
by the board of directors. The Company granted 4,650,000 options under the 1996
Plan during fiscal 1997 and 1998. In fiscal 1998, the Company granted options to
purchase 4,026,000 shares of common stock outside of the 1996 Plan at an
exercise price of $0.02 per share. In October 1998, the Company cancelled all
stock options outstanding under the 1996 Plan and the 4,026,000 options that had
been issued in fiscal year 1998 outside of the 1996 Plan. The cancelled options
were replaced with options under the 1998 Stock Plan ("1998 Plan") that had
vesting and exercise prices consistent with the terms of the cancelled options.
The 1996 Plan was terminated in October 1998.
In fiscal year 1999, the Company adopted and the board of directors
approved the 1998 Plan. A total of 32,452,248 shares of common stock have been
reserved for issuance under the 1998 Plan, subject to an annual increase of the
lesser of 4,000,000 shares or 4.9% of the then outstanding common stock or an
amount to be determined by the Board of Directors. Through July, 27, 2002,
36,939,966 options have been granted under the 1998 Plan. Under the 1998 Plan,
the board of directors may grant to employees and consultants options and/or
stock purchase rights to purchase the Company's common stock at terms and prices
determined by the board of directors. The Plan will terminate in 2008.
Nonqualified options granted under the 1998 Plan must be issued at a price equal
to at least 85% of the fair market value of the Company's common stock at the
date of grant. All options may be exercised at any time within 10 years of the
date of grant or within three months of termination of employment, or such
shorter time as may be provided in the stock option agreement, and vest over a
vesting schedule determined by the board of directors.
56
The Company's 1999 Directors Option Plan (the "Directors' Plan") was
adopted by the Company's board of directors in October 1999. A total of
1,000,000 shares of common stock have been reserved for issuance under the
Directors' Plan, subject to an annual increase of the lesser of 250,000 shares,
0.5% of the then outstanding common stock or an amount determined by the board
of directors. Through July 27, 2002, 430,000 options have been granted under the
Directors' Plan. Under the Directors' Plan, options are granted when a
non-employee director joins the board of directors following the IPO and at each
annual meeting where the director continues to serve on the board of directors.
The Directors' Plan establishes an automatic grant of 80,000 shares of common
stock to each non-employee director who is elected after the completion of the
IPO. The Directors' Plan also provides that upon the date of each annual
stockholders' meeting, each non-employee director who has been a member of the
board of directors for at least six months prior to the date of the
stockholders' meeting will receive automatic annual grants of options to acquire
20,000 shares of common stock. Each automatic grant will have an exercise price
per share equal to the fair market value of the common stock at the date of
grant, will vest 25% immediately upon the grant date and monthly thereafter and
become fully vested three years after the date of grant. Each automatic grant
will have a term of ten years. In the event of a merger with another corporation
or the sale of substantially all of its assets, each non-employee director's
outstanding option will become fully vested and exercisable. Options granted
under the Directors' Plan must be exercised within 3 months of the end of the
non-employee director's tenure as a member of the board of directors, or within
12 months after a non-employee director's termination by death or disability,
provided that the option does not terminate by its terms earlier. Unless
terminated sooner, the Directors' Plan terminates automatically in 2009.
The Company has assumed certain option plans and the underlying options
of companies which the Company has acquired (the "Assumed Plans"). Options under
the Assumed Plans have been converted into the Company's options and adjusted to
effect the appropriate conversion ratio as specified by the applicable
acquisition agreement, but are otherwise administered in accordance with the
terms of the Assumed Plans. Options under the Assumed Plans generally vest over
four years and expire ten years from the date of grant. No additional options
will be granted under the Assumed Plans.
The following is a summary of the option activity under all of the
stock option plans for the three years ended July 27, 2002 follows:
Options Outstanding
-------------------------
Options Weighted
Available Number of Average
for Grant Shares Exercise Price
--------- ------ --------------
Balance at July 31, 1999......................................... 6,552,640 6,482,976 $ 0.46
Authorized..................................................... 4,000,000 -- --
Granted........................................................ (3,911,088) 5,465,563 20.89
Exercised...................................................... -- (2,139,936) 1.12
Cancelled...................................................... 275,085 (275,085) 9.26
Repurchases.................................................... 593,048 -- --
------------- -------------
Balance at July 28, 2000......................................... 7,509,685 9,533,518 11.77
Authorized..................................................... 3,293,288 -- --
Granted........................................................ (8,683,574) 8,683,574 9.10
Exercised...................................................... -- (2,395,276) 1.25
Cancelled...................................................... 4,272,107 (4,987,636) 16.62
Repurchases.................................................... 923,844 -- --
------------- -------------
Balance at July 28, 2001......................................... 7,315,350 10,834,180 9.72
============= =============
Authorized..................................................... 2,901,816 -- --
Granted........................................................ (8,082,800) 8,082,800 1.15
Exercised...................................................... -- (511,674) 0.63
Cancelled...................................................... 5,970,320 (6,097,405) 8.79
Repurchases.................................................... 523,751 -- --
------------- -------------
Balance at July 27, 2002......................................... 8,628,437 12,307,901 4.94
============= =============
57
Outstanding Options Options Exercisable
---------------------------------------------------------------------------------------- -------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Number Life (in Exercise Exercise
Exercise Prices Outstanding years) Price Shares Price
--------------- ----------- ------ ----- ------ -----
$ 0.02 - $ 0.85 1,313,342 7.45 $ 0.38 858,622 $ 0.15
$ 0.92 - $ 0.99 4,619,693 9.22 $ 0.99 936,760 $ 0.99
$ 1.00 - $ 3.00 2,896,271 9.10 $ 2.39 673,050 $ 2.73
$ 3.22 - $ 8.75 2,523,486 8.43 $ 7.52 1,085,934 $ 7.44
$ 9.63 - $112.06 955,109 7.87 $ 31.23 562,532 $ 30.93
------------ -----------
$ 0.02 - $112.06 12,307,901 8.74 $ 4.94 4,116,898 $ 6.89
============ ===========
During fiscal 2000, 185,000 options and stock purchase rights, with a
weighted average exercise price of $0.09 were exercised. During fiscal years
2002 and 2001, there were no options or stock purchase rights granted outside of
the 1998 Plan outstanding. The compensation expense recorded in connection with
these fiscal year 2000 grants was not material. Total options exercisable at
July 27, 2002 and July 28, 2001 were 4,116,898 and 2,804,395, respectively.
Employee Stock Purchase Plan
In October 1999, the Company adopted an Employee Stock Purchase Plan
("ESPP"). Under the terms of the ESPP, the maximum aggregate number of shares of
stock that may be issued under the ESPP is 2,000,000, cumulatively increased
annually by an amount equal to the lesser of (a) one percent (1%) of the then
issued and outstanding shares of common stock, (b) an amount determined by the
Board of Directors, or (c) 500,000 shares of common stock. During each six-month
offering period, employees can choose to have up to 10% of their annual base
earnings withheld to purchase the Company's common stock. The purchase price of
the common stock is 85% of the lesser of the fair value as of the beginning or
ending of the offering period. A total of 196,323 shares of common stock were
issued under the ESPP through July 27, 2002. At July 27, 2002, 1,803,677 shares
were available for issuance.
Employee Stock Option and Stock Purchase Plan
The Company accounts for stock options issued to employees under APB
Opinion No. 25 whereby the difference between the exercise price and the fair
value at the date of grant is recognized as compensation expense. Had
compensation expense been determined consistent with SFAS No. 123, net loss
would have increased to the following pro forma amounts (in thousands, except
per share data):
Year Ended
----------------------------------------
July 28,
2001 2001 2000
----------- ----------- ----------
Net loss as reported ......................... $ (91,038) $ (525,268) $ (94,658)
Pro forma net loss ........................... $ (101,628) $ (545,600) $ (98,971)
Basic and diluted net loss per share ......... $ (1.72) $ (10.78) $ (3.52)
Pro forma basic and diluted net loss per share $ (1.92) $ (11.20) $ (3.68)
The weighted average fair value of options granted during fiscal years
2002, 2001 and 2000 was $0.81, $6.52 and $10.28, respectively. Pursuant to the
provisions of SFAS No. 123, the compensation cost associated with options
granted in fiscal years 2002, 2001 and 2000 were estimated on the grant date
using the Black-Scholes model and the following assumptions:
Options
Year Ended
--------------------------------- ESPP
Year Ended
----------------------------------------------
July 27, July 28, July 28, July 27,
2002 2001 2000 2002
------- ------- --------- ---------
Risk free interest rate.............................. 3.7% 5.1% 6.9% 2.4%
Average expected life of option...................... 4 years 4 years 5.3 years 0.5 years
Dividend yield....................................... 0% 0% 0% 0%
Volatility of common stock........................... 100% 100% 60% 100%
58
Deferred Stock Compensation
In connection with the grant of certain stock options to employees
during fiscal years 2000 and 1999, the Company recorded deferred stock
compensation within stockholders' equity of approximately $37,800,000,
representing the difference between the estimated fair value of the common stock
for accounting purposes and the option exercise price of these options at the
date of grant. The deferred stock compensation expense is being amortized on an
accelerated basis over the vesting period of the individual award, generally
four years. The method is in accordance with FASB Interpretation No. 28. The
amortization expense relates to options awarded to employees in all operating
expense categories. The amortization of deferred compensation has not been
separately allocated to these categories. The amount of deferred compensation
expense to be recorded in future periods could decrease if options for which
accrued but unvested compensation has been recorded are forfeited. In connection
with the acquisitions of TruSolutions, Precision Insight and NetAttach, the
Company recorded $113.1 million of deferred stock compensation during fiscal
year 2000. In connection with the acquisitions of BNW, Inc. and Life, the
Company recorded $6.8 million of deferred stock compensation during fiscal year
2001. The Company recorded amortization of deferred stock compensation of $1.7
million, $61.3 million and $39.5 million for the years ended July 27, 2002, July
28, 2001 and 2000, respectively. In addition, in connection with the
restructuring discussed in Note 4, expense of approximately $0.3 million and
$35.7 million related to the acceleration of deferred stock compensation has
been recorded for the fiscal years ended July 27, 2002 and July 28, 2001,
respectively, and has been included in restructuring costs and other special
charges in the statements of operations.
11. Income Taxes
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes". Due to the Company's loss position in fiscal
years 2002, 2001 and 2000, there was no provision for income taxes for the years
ended July 27, 2002, July 28, 2001 and July 28, 2000. A valuation allowance has
been recorded for the total deferred tax assets as a result of uncertainties
regarding realization of the assets based on the lack of consistent
profitability to date and the uncertainty of future profitability.
The components of the net deferred tax assets are as follows (in
thousands):
July 27, July 28, July 28,
2002 2001 2000
-------- -------- --------
Net operating loss carryforwards ..... $ 80,446 $ 68,965 $ 34,578
Other reserves and accruals .......... 11,494 19,726 2,901
-------- -------- --------
91,940 88,691 37,479
Valuation allowance .................. (91,940) (88,691) (37,479)
-------- -------- --------
Net deferred income tax asset ........ $ -- $ -- $ --
======== ======== ========
As of July 27, 2002, the Company has net operating loss carryforwards of
approximately $226.2 million to offset future federal taxable income, which
expires at various dates through fiscal year 2021. This amount includes
approximately $12.5 million of net operating loss carryforwards from the
acquisition of OSDN. The deferred tax assets related to the acquisition of OSDN,
approximately $5.6 million as of June 7, 2000, and if and when realized, will be
used to reduce the remaining intangibles recorded at the date of acquisition to
zero first and then to reduce the tax provision. The Company also has California
net operating loss carryforwards of approximately $61.0 million to offset future
California taxable income, which expire at various dates through fiscal year
2012. The net operating loss carryforwards also include approximately $21.3
million resulting from employee exercises of non-qualified stock options or
disqualifying dispositions, the tax benefits of which, when realized, will be
recorded as an addition to additional paid-in capital rather than a reduction of
the provision for income taxes. The operating loss carryforwards to be used in
future years is limited in accordance with the provisions of the Tax Reform Act
of 1986 as the Company has experienced a cumulative stock ownership change of
more than 50% over the last three years. The net operating loss carryforwards
stated above are reflective of various federal and state tax limitations.
12. Segment and Geographic Information
Through June 27, 2001, the Company had two reportable business
segments: Systems and Services and OSDN, which was formerly known as
Andover.Net, Inc. ("Andover.Net"). The Systems and Services segment consisted of
a broad line of Linux systems and Open Source services, including system
architecture design and integration, development of Open Source software and
managed services. The OSDN segment helps customers develop, distribute and
discuss open source software. The Company allocated resources to and evaluated
the performance of its segments based on each segment's revenue. As a result of
the Company's decision to exit the systems business in the fourth quarter of
fiscal 2001, effective July 29, 2001, the Company operates as one business
segment,
59
providing application software products and related OSDN products and services.
For fiscal year 2002, revenue from the Company's single business segment was
$20.4 million. For fiscal year 2001, revenue from OSDN was $14.7 million, and
revenue from the Systems and Services segment was $120.2 million.
The Company marketed its products in the United States through its
direct sales force. Revenues for each of the fiscal years ended July 27, 2002,
July 28, 2001 and 2000 were primarily generated from sales to end users in the
United States of America.
13. Subsequent Events (Unaudited)
On August 13, 2002, the Company entered into a significant commercial
agreement with IBM focused on the joint marketing and sales of the next
generation of SourceForge, which will offer full support for IBM's DB2 database.
As part of the agreement, IBM's direct and indirect sales channels will engage
with VA Software in joint sales activities. The terms of the agreement include
VA Software's and IBM's ongoing integration of SourceForge with a suite of IBM
infrastructure, application development and system management tools, including
DB2 database software; WebSphere Application Server; WebSphere Studio
Application Developer; and Tivoli management software. In addition, SourceForge
will also be optimized to run on IBM eServer xSeries Linux servers.
60
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
On April 18, 2002, the Company filed a current report on Form 8-K to
report a change in independent public accountants, effective as of April 17,
2002.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information called for by this item is incorporated by reference to
the sections entitled "Certain Beneficial Owners" and "Security Ownership of
Directors and Executive Officers" in the Proxy Statement for the annual
stockholders' meeting to be held on December 4, 2002.
Item 11. Executive Compensation
The information called for by this item is incorporated by reference to
the section entitled "Compensation of Directors and Executive Officers" in the
Proxy Statement for the annual stockholders' meeting to be held on December 4,
2002.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information called for by this item is incorporated by reference to
the sections entitled "Certain Beneficial Owners" and "Security Ownership of
Directors and Executive Officers" in the Proxy Statement for the annual
stockholders' meeting to be held on December 4, 2002.
Item 13. Certain Relationships and Related Transactions
The information called for by this item is incorporated by reference to
the sections entitled "Certain Relationships and Related Transactions" in the
Proxy Statement for the annual stockholders' meeting to be held on December 4,
2002.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) The following documents are filed as part of this report:
1. All Financial Statements:
See the Consolidated Financial Statements and notes thereto in Item 8 above.
2. Schedule II-- Valuation and Qualifying Accounts are filed as part of
this Form 10-K.
3. Exhibits:
See the Exhibit Index.
(b) Reports on Form 8-K.
None.
61
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
VA SOFTWARE CORPORATION
By: /s/ ALI JENAB
---------------------------------
Ali Jenab
Chief Executive Officer, President
and Member of Board of Directors
Date: October 18, 2002
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below hereby constitutes and appoints Ali Jenab and Kathleen R. McElwee,
and each of them, his true and lawful attorneys-in-fact, each with full power of
substitution, for him and all capacities, to sign any amendments to this report
on Form 10-K and to file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission and does
hereby ratify and confirm all that each of said attorneys-in-fact or their
substitute or substitutes may do or cause to be done by virtue hereof.
Pursuant to the requirement of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ ALI JENAB Chief Executive Officer, President October 18, 2002
- ----------------------------------------------------- (principle executive officer) and Director
Ali Jenab
/s/ KATHLEEN R. MCELWEE Chief Financial Officer October 18, 2002
- ----------------------------------------------------- (principle accounting officer)
Kathleen R. McElwee
/s/ LARRY M. AUGUSTIN Chairman of the Board of Directors October 18, 2002
- -----------------------------------------------------
Larry M. Augustin
/S/ ANDRE M. BOISVERT Director October 18, 2002
- -----------------------------------------------------
Andre M. Boisvert
/s/ RAM GUPTA Director October 18, 2002
- -----------------------------------------------------
Ram Gupta
/s/ DOUGLAS LEONE Director October 18, 2002
- -----------------------------------------------------
Douglas Leone
/s/ ROBERT M. NEUMEISTER, JR. Director October 18, 2002
- -----------------------------------------------------
Robert M. Neumeister, Jr.
/s/ CARL REDFIELD Director October 18, 2002
- -----------------------------------------------------
Carl Redfield
/s/ DAVID B. WRIGHT Director October 18, 2002
- -----------------------------------------------------
David B. Wright
62
CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO
SECTION 302(a) OF THE SARBANES-OXLEY ACT OF 2002
I, Ali Jenab, certify that:
1. I have reviewed this annual report on Form 10-K of VA Software
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
Date: October 18, 2002 /s/ ALI JENAB
-----------------------------------
Ali Jenab
Chief Executive Officer
CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO
SECTION 302(a) OF THE SARBANES-OXLEY ACT OF 2002
I, Kathleen R. McElwee, certify that:
1. I have reviewed this annual report on Form 10-K of VA Software
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
Date: October 18, 2002 /s/ KATHLEEN R. MCELWEE
-----------------------------------
Kathleen R. McElwee
Chief Financial Officer
63
VA SOFTWARE CORPORATION
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
Balance at Charged to Additions Balance at
Beginning Costs and due to End
Description of Period Expenses Acquisitions Deductions of Period
----------- --------- -------- ------------ ---------- ---------
Year Ended July 28, 2000
Allowance for doubtful accounts ...................... $ 207 $ 1,328 $ 150 $ 210 $ 1,475
Allowance for excess and obsolete inventory .......... $ 833 $ 1,878 $ -- $ 1,540 $ 1,171
Year Ended July 28, 2001
Allowance for doubtful accounts ...................... $ 1,475 $ 3,968 $ -- $ 1,196 $ 4,247
Allowance for excess and obsolete inventory .......... $ 1,171 $ 24,441 $ -- $ 7,265 $ 18,347
Accrued restructuring liabilities .................... $ -- $ 12,241 $ -- $ 2,728 $ 9,513
Year Ended July 27, 2002
Allowance for doubtful accounts ...................... $ 4,247 $ (1,096) $ -- $ 1,985 $ 1,166
Allowance for excess and obsolete inventory .......... $ 18,347 $ (4,378) $ -- $ 13,939 $ 30
Accrued restructuring liabilities .................... $ 9,513 $ 10,510 $ -- $ 2,029 $ 17,994
64
EXHIBIT INDEX
Exhibit
Number
------
2.1* -- Amended and Restated Agreement and Plan of Reorganization between the Registrant, Atlanta Acquisition
Corp. and Andover.Net, Inc.
3.1** -- Amended and Restated Certificate of Incorporation of the Registrant
3.2** -- Bylaws of the Registrant
4.1** -- Specimen Common Stock Certificate
10.1** -- Form of Indemnification Agreement between the Registrant and each of its directors and officers
10.2** -- 1998 Stock Plan and forms of agreement thereunder
10.3** -- 1999 Employee Stock Purchase Plan
10.4** -- 1999 Director Option Plan
10.5# -- First Amended and Restated Registration Rights Agreement between Registrant and certain holders of
preferred stock
10.6## -- Loan and Security Agreement between Registrant and Comerica Bank-- California
10.7+*** -- Master Lease Agreement between Boca Global, Inc. and Bordeaux Partners LLC
10.8+### -- Master Lease Agreement between Registrant and Renco Investment Company
10.9**** -- Consent of Linus Torvalds
23.1 -- Consent of PricewaterhouseCoopers LLP, Independent Public Accountants (see page 66)
23.2 -- Notice regarding Consent of Arthur Andersen LLP (see page 67)
24.1** -- Power of Attorney (see signature page)
99.1 -- Certification Of Chief Executive Officer Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To
Section 906 Of The Sarbanes-Oxley Act Of 2002
99.2 -- Certification Of Chief Financial Officer Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To
Section 906 Of The Sarbanes-Oxley Act Of 2002
- ------------
+ Confidential treatment has been requested by the Registrant as to
certain portions of this exhibit. The omitted portions have been
separately filed with the Commission.
* Incorporated by reference to the corresponding exhibit of Registrant's
form S-4 and the amendment thereto (Commission registration no.
333-35704).
** Incorporated by reference to the corresponding exhibit of Registrant's
form S-1 and the amendment thereto (Commission registration no.
333-88687).
*** Incorporated by reference from Exhibit 10.16 of Registrant's form S-1
and the amendments thereto (Commission registration no. 333-88687).
65
**** Incorporated by reference from Exhibit 10.18 of Registrant's Quarterly
Report on Form 10-Q for the period ended January 28, 2000 filed on
March 13, 2000 (Commission file number 000-28369).
# Incorporated by reference from Exhibit 10.6 of Registrant's form S-1
and the amendments thereto (Commission registration no. 333-88687).
## Incorporated by reference from Exhibit 10.9 of Registrant's form S-1
and the amendments thereto (Commission registration no. 333-88687).
### Incorporated by reference from Exhibit 10.14 of Registrant's Annual
Report on Form 10-K for the period ended June 28, 2000 filed on October
26, 2000 (Commission file number 000-28369).
66