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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended April 26, 2003
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 whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Title Of Class Outstanding At May 31, 2003
Common Stock, $0.001 par value 54,676,144
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Table of Contents
PART I. FINANCIAL INFORMATION Page No.
Item 1. Financial Statements............................................................................................ 3
Condensed Consolidated Balance Sheets at April 26, 2003 and July 27, 2002................................... 3
Condensed Consolidated Statements of Operations for the three and nine months ended April 26, 2003
and April 27, 2002.......................................................................................... 4
Condensed Consolidated Statements of Cash Flows for the nine months ended April 26, 2003 and April
27, 2002.................................................................................................... 5
Notes to Condensed Consolidated Financial Statements........................................................ 6
Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations...........................15
Item 3 Quantitative and Qualitative Disclosures About Market Risk......................................................35
Item 4 Controls and Procedures.........................................................................................35
Page No.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings...............................................................................................36
Item 5. Other Information...............................................................................................36
Item 6. Exhibits and Reports on Form 8-K................................................................................36
Signatures....................................................................................................................37
Certifications................................................................................................................38
2
PART I
VA SOFTWARE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, unaudited)
April 26, July 27,
2003 2002
-------- --------
ASSETS
Current assets:
Cash and cash equivalents ..................................................... $ 7,919 $ 35,148
Short-term investments ........................................................ 4,270 5,458
Restricted cash, current ...................................................... 450 450
Accounts receivable, net ...................................................... 1,275 764
Inventories ................................................................... 358 300
Prepaid expenses and other assets ............................................. 1,221 877
--------- ---------
Total current assets .................................................. 15,493 42,997
Property and equipment, net ..................................................... 4,765 7,223
Goodwill and intangibles, net ................................................... 238 2,169
Long-term investments ........................................................... 29,284 12,440
Restricted cash, non current .................................................... 900 900
Other assets .................................................................... 1,156 1,239
--------- ---------
Total assets .......................................................... $ 51,836 $ 66,968
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of notes payable .............................................. $ -- $ 42
Accounts payable .............................................................. 1,308 2,075
Accrued restructuring liabilities, current portion ............................ 4,277 3,397
Accrued compensation .......................................................... 1,312 1,517
Deferred revenue .............................................................. 817 774
Accrued liabilities and other ................................................. 2,960 4,200
--------- ---------
Total current liabilities ............................................. 10,674 12,005
Accrued restructuring liabilities, net of current portion ....................... 11,567 14,597
Other long-term liabilities ..................................................... 1,154 978
--------- ---------
Total liabilities ..................................................... 23,395 27,580
Stockholders' equity:
Common stock .................................................................. 55 54
Additional paid-in capital .................................................... 765,598 765,418
Deferred stock compensation ................................................... (61) (245)
Accumulated other comprehensive income ........................................ 189 86
Accumulated deficit ........................................................... (737,340) (725,925)
--------- ---------
Total stockholders' equity ............................................ 28,441 39,388
--------- ---------
Total liabilities and stockholders' equity ............................ $ 51,836 $ 66,968
========= =========
The accompanying notes are an integral part of these financial statements.
3
VA SOFTWARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts, unaudited)
Three Months Ended Nine Months Ended
April 26, April 27, April 26, April 27,
2003 2002 2003 2002
-------- -------- -------- --------
Net revenues:
Software revenues ................................................ $ 671 $ 205 $ 2,072 $ 545
Online revenues .................................................. 5,185 4,236 14,996 12,148
Other revenues ................................................... 181 699 604 3,077
-------- -------- -------- --------
Net revenues .................................................. 6,037 5,140 17,672 15,770
Cost of revenues:
Software cost of revenues ........................................ 450 561 1,513 1,825
Online cost of revenues .......................................... 2,658 2,458 8,392 7,547
Other cost of revenues ........................................... (14) (240) (377) (340)
-------- -------- -------- --------
Cost of revenues .............................................. 3,094 2,779 9,528 9,032
-------- -------- -------- --------
Gross margin .................................................. 2,943 2,361 8,144 6,738
-------- -------- -------- --------
Operating expenses:
Sales and marketing .............................................. 2,614 2,961 7,260 10,453
Research and development ......................................... 1,987 1,349 5,987 6,192
General and administrative ....................................... 1,422 2,619 5,113 9,521
Restructuring costs and other special charges .................... 101 35 (34) 44,991
Amortization of deferred stock compensation ...................... 37 89 116 1,633
Amortization of intangible assets ................................ 644 3,214 1,932 8,518
-------- -------- -------- --------
Total operating expenses ................................. 6,805 10,267 20,374 81,308
-------- -------- -------- --------
Loss from operations ............................................... (3,862) (7,906) (12,230) (74,570)
Interest and other, net ............................................ 252 177 815 2,304
-------- -------- -------- --------
Net loss ........................................................... $ (3,610) $ (7,729) $(11,415) $(72,266)
======== ======== ======== ========
Other comprehensive gain:
Unrealized gain (loss) on marketable securities and investments 7 (7) 95 104
Foreign currency translation gain ............................. 1 4 8 1,349
-------- -------- -------- --------
Comprehensive loss ................................................. $ (3,602) $ (7,732) $(11,312) $(70,813)
======== ======== ======== ========
Net loss ........................................................... $ (3,610) $ (7,729) $(11,415) $(72,266)
======== ======== ======== ========
Basic and diluted net loss per share ............................... $ (0.07) $ (0.15) $ (0.21) $ (1.37)
======== ======== ======== ========
Shares used in computing basic and diluted net loss per share ...... 53,935 53,210 53,835 52,889
======== ======== ======== ========
The accompanying notes are an integral part of these financial statements.
4
VA SOFTWARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, unaudited)
Nine Months Ended
April 26, April 27,
2003 2002
------- -------
Cash flows from operating activities:
Net loss ..................................................................................... $(11,415) $(72,266)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization of intangibles ............................................... 4,511 11,914
Provision for bad debts .................................................................... (42) (1,016)
Provision for excess and obsolete inventory ................................................ (15) (2,003)
Loss on disposal of assets ................................................................. 4 1,220
Proportionate share of Japan losses in Japan investment .................................... -- 2,012
Minority interest of 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 ................................................ 116 1,633
Non-cash compensation expense .............................................................. -- 72
Non-cash restructuring expense ............................................................. (256) 36,230
Changes in assets and liabilities:
Accounts receivable ...................................................................... (502) 10,582
Inventories .............................................................................. (43) 2,107
Prepaid expenses and other assets ........................................................ (4) 2,733
Accounts payable ......................................................................... (767) (12,053)
Accrued restructuring liabilities ........................................................ (2,150) 7,480
Accrued liabilities and other ............................................................ (1,370) (5,506)
Other long-term liabilities .............................................................. 176 (409)
------- -------
Net cash used in operating activities ................................................. (11,757) (29,325)
------- -------
Cash flows from investing activities:
Change in restricted cash .................................................................... -- 609
Purchase of property and equipment ........................................................... (125) (205)
Purchase of marketable securities ............................................................ (30,828) (21,719)
Sale of marketable securities ................................................................ 15,171 28,338
Cash proceeds on sale of Japan investment .................................................... -- 5,059
Other, net ................................................................................... 95 103
------- -------
Net cash provided by (used in) investing activities ................................... (15,687) 12,185
------- -------
Cash flows from financing activities:
Payments on notes payable .................................................................... (42) (231)
Proceeds from issuance of common stock, net .................................................. 249 310
------- -------
Net cash provided by financing activities ............................................. 207 79
------- -------
Effect of exchange rate changes on cash and cash equivalents .................................. 8 1,349
------- -------
Net decrease in cash and cash equivalents ..................................................... (27,229) (15,712)
Cash and cash equivalents, beginning of period ................................................ 35,148 57,488
------- -------
Cash and cash equivalents, end of period ...................................................... $ 7,919 $ 41,776
======== ========
The accompanying notes are an integral part of these financial statements.
5
VA SOFTWARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The condensed consolidated financial statements included herein have been
prepared by VA Software Corp. ("VA," "VA Software" or the "Company"), without
audit, pursuant to the rules and regulations of the Securities and Exchange
Commission ("SEC"). Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. In the opinion of management, the unaudited interim financial
statements reflect all adjustments necessary for a fair presentation of the
financial position, results of operations and other comprehensive loss and cash
flows for the interim periods presented. The financial statements and the
accompanying notes, however, should be read in conjunction with VA's audited
consolidated financial statements and the notes thereto included in VA's Annual
Report on Form 10-K for the fiscal year ended July 27, 2002, filed with the SEC
on October 18, 2002. The condensed consolidated balance sheet as of July 27,
2002 has been derived from the audited financial statements as of that date, but
does not include all disclosures required by generally accepted accounting
principles for complete financial statements.
The results of operations for the three- and nine-month periods ended April
26, 2003 and April 27, 2002 are not necessarily indicative of the results that
may be expected for any other interim period or for the full fiscal year ending
July 31, 2003.
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 in 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 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
was recorded as other income in the Company's consolidated statements of
operations during the second quarter of fiscal 2002. 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 over it, VA Linux Japan has been accounted for
under the cost method of accounting as of January 11, 2002. The minority
interest included in the results of operations for VA Linux Japan has not been
significant for any period presented and has been recorded in other income in
the accompanying statements of operations. During the periods for which VA Linux
Japan is included in the consolidated financial statements, its operations
primarily related to the VA's former systems and services business.
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 $0.7 million, or
11.1%, and $2.1 million, or 11.7%, of total revenues for the three- and
nine-month periods ended April 26, 2003, respectively. Software revenues
represent $0.2 million, or 4.0%, and $0.5 million, or 3.5%, of total revenues
for the three- and nine-month periods ended April 27, 2002, respectively.
6
Revenues from software license agreements are accounted for in accordance
with American Institute of Certified Public Accountants ("AICPA") Statement of
Position ("SOP") 97-2 and 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 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 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 derived from published professional service rates.
When an agreement includes professional services that are significant or
essential to the functionality of the software, and the Company can reasonably
estimate the cost to complete the contract, 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 renewal rates, if stated, or separate sales of maintenance sold
to customers. The unrecognized portion of amounts paid in advance for licenses,
maintenance and professional services are recorded as deferred revenue.
For term arrangements, the Company does not use the residual method to
recognize revenues because we are currently unable to establish fair value for
the individual contract components such as software license, maintenance and
support. As a result, the Company currently recognizes the entire contract value
ratably over the term of the contract, normally 12 months. In the event that the
contract includes essential professional services, the Company defers revenue
until the professional services have been fully delivered. At that time, the
Company then recognizes the revenue ratably over the remaining contract term.
If the fee due from the customer is not fixed or determinable, the Company
recognizes 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. If
a significant portion of the fee is due after the shorter of our normal payment
terms or 120 days, the Company considers the fee not to be fixed or
determinable.
Online Revenues
Online revenues include online advertising as well as e-commerce revenues.
Online advertising revenues represent $2.7 million, or 44.7%, and $7.3 million,
or 41.1%, of total revenues for the three- and nine-month periods ended April
26, 2003, respectively. Online advertising revenues represent $2.5 million, or
49.1%, and $6.8 million, or 43.1%, of total revenues for the three- and
nine-month periods ended April 27, 2002, respectively. E-commerce revenues
represent $2.5 million, or 41.2%, and $7.7 million, or 43.8%, of total revenues
for the three- and nine-month periods ended April 26, 2003, respectively.
E-commerce revenues represent $1.7 million, or 33.3%, and $5.3 million, or
33.9%, of total revenues for the three- and nine-month periods ended April 27,
2002, respectively.
Online advertising revenues are derived from the sale of advertising space
on our various websites. Online 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 reasonably 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 three and nine months
ended April 26, 2003 included approximately $0.5 million and $1.5 million of
barter revenue from banner advertising, respectively. Revenues for the three and
nine months ended April 27, 2002 included approximately $0.5 million and $1.5
million of barter revenue from banner advertising, respectively
E-commerce revenues are recognized in accordance with SEC Staff Accounting
Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements." Under
SAB No. 101, product revenues are recognized when persuasive objective 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. Such returns are recorded as
incurred and have been immaterial for the periods presented.
7
Other Revenues
Other revenues are derived from the Company's former hardware, customer
support, and hardware-related professional services businesses. Other revenues
represent $0.2 million, or 3.0%, and $0.6 million, or 3.4%, of total revenues
for the three and nine months ended April 26, 2003, respectively. Other revenues
represent $0.7 million, or 13.6%, and $3.1 million, or 19.5%, of total revenues
for the three and nine months ended April 27, 2002, respectively.
The Company's revenue recognition policy related to its former hardware
systems business follows SAB No. 101. Under SAB No. 101, the Company recognized
product revenues from the sale of Linux-based servers, components, and desktop
computers when persuasive objective evidence of an arrangement existed, delivery
occurred, the sales price was fixed or determinable and collectibility was
reasonably assured. In general, the Company recognized 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 contract accounting method where project costs could be reasonably
estimated. The Company records any payments received prior to revenue
recognition as deferred revenue. For the three and nine months ended April 26,
2003 and April 27, 2002, revenues from customer support services and
professional service contracts associated with our former hardware business were
not material.
Software Development Costs
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, 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.
Goodwill and Intangibles
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. Pursuant to SFAS No. 142, the Company periodically tests
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
No. 142. The Company has determined that it has only one Reporting Unit,
specifically the application of its software products and related online
products and services through its subsidiary, the Open Source Development
Network, Inc. ("OSDN"). There was no carrying value associated with goodwill at
April 26, 2003 and July 27, 2002 to be tested for impairment. As a result of the
restructuring plan adopted by the Company in September 2001, $26.7 million of
goodwill was written off related to the Company's previous acquisitions of
NetAttach, Inc. ("NetAttach"), and Precision Insight, Inc. ("Precision
Insight"). The charge is included in the caption "Restructuring costs and other
special charges" in the accompanying 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 events or circumstances 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. No events or circumstances occurred during the three and nine
months ended April 26, 2003 that would indicate a possible impairment in the
carrying value of intangible assets at April 26, 2003. As a result of the
restructuring plan adopted by the Company in September 2001, $3.9 million of
intangible assets were written off related to the Company's previous
acquisitions of NetAttach and Precision Insight. The charge is included in the
caption "Restructuring costs and other special charges" in the accompanying
statements of operations.
The changes in the carrying amount of the intangible assets are as follows
(in thousands):
8
As of April 26, 2003 As of July 27, 2002
---------------------------------------------- ----------------------------------------------
Gross Carrying Accumulated Net Carrying Gross Carrying Accumulated Net Carrying
Amount Amortization Amount Amount Amortization Amount
------- ------- ------- ------- ------- -------
Domain and trade names ...... $ 5,922 $(5,755) $ 167 $ 5,922 $(4,457) $ 1,465
Purchased technology ........ 2,534 (2,463) 71 2,534 (1,830) 704
------- ------- ------- ------- ------- -------
Total intangible assets 8,456 (8,218) 238 8,456 (6,287) 2,169
The aggregate amortization expense of intangible assets, net of
restructuring charges was $0.6 million and $3.2 million for the three-month
periods ending April 26, 2003 and April 27, 2002, respectively. The aggregate
amortization expense of intangible assets, net of restructuring charges was $1.9
million and $8.5 million for the nine-month periods ending April 26, 2003 and
April 27, 2002, respectively. The estimated total amortization expense of
acquired intangible assets is $2.1 million and $12,700 for the fiscal years
ending July 31, 2003 and July 31, 2004, respectively.
The changes in the carrying amount of goodwill are as follows (in
thousands):
As of As of
April 26, July 27,
2003 2002
-------- --------
Balance at beginning of period $ -- $ 3,582
Amortization in the period -- --
Goodwill additions -- --
Write-off of goodwill -- (3,582)
-------- --------
Balance at end of period $ -- $ --
======== ========
Inventories
Inventories consist of finished goods and are stated at the lower of cost
or market with cost being determined by the average cost method at April 26,
2003 and July 27, 2002. 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.
Accrued Liabilities and Other
Accrued liabilities and other mainly consists of accruals related to legal
reserves, deferred rent, and other unpaid expenses.
3. Restructuring Costs and Other Special Charges
In fiscal 2001 and 2002, the Company adopted plans to exit the systems and
hardware-related software engineering and professional services businesses, as
well as exit a sublease agreement and reduce its general and administrative
overhead costs. The Company exited these activities to pursue its SourceForge
application software and media and e-commerce businesses and reduce its
operating losses to improve cash flow. The Company recorded restructuring
charges of $180.2 million related to exiting these activities, $160.4 million of
which was included in restructuring charges and other special charges in
operating expenses and $19.8 million of which was included in cost of sales.
Included in the restructuring were charges related to excess facilities from
non-cancelable leases (with payments continuing until fiscal 2010, unless sublet
completely). The accrual from non-cancelable lease payments includes
management's estimates of sublease income. These estimates are subject to change
based on actual events. The Company evaluates and updates, if applicable, these
estimates quarterly. As of April 26, 2003, the Company had an accrual of
approximately $15.4 million outstanding related to these non-cancelable leases,
all of which was originally included in operating expenses.
The Company has recorded a net restructuring charge of $0.1 million for the
three months ended April 26, 2003. This was related to $0.4 million of
additional charges related to existing excess facilities as a result of the
termination of a subtenant lease, net of $0.3 million credit adjustments to
previously recorded restructuring reserves. As of April 26, 2003, the Company
had an accrual of $0.4 million related to these charges. The Company has
recorded a net restructuring credit of $34,000 for the nine months ended April
26, 2003 as a result of various insignificant adjustments to previously recorded
restructuring charges.
9
In addition to the above, the Company recorded a $14,000 and $0.4 million
net credit included in cost of revenues in the consolidated statement of
operations for the three and nine months ended April 26, 2003, respectively. The
$14,000 for the three months ended April 26, 2003 consisted of adjustments to
previously recorded restructuring reserves related to the systems warranty and
excess facility reserves originally established during fiscal 2001. The $0.4
million for the nine months ended April 26, 2003 consisted of $23,000 associated
with severance and other related costs attributable to the fiscal 2002 plan to
align the Company's infrastructure with its operations, net of adjustments to
previously recorded restructuring reserves of $0.4 million related to the
systems warranty reserve and excess facility reserves originally established
during fiscal 2001. As of April 26, 2003, no outstanding accruals remained
related to these restructuring charges.
Below is a summary of the restructuring charges in operating expenses (in
thousands):
Total
Total Charged Total Charged Total Charged Cash Restructuring
To Operations To Operations To Operations Receipts/ Liabilities at
Fiscal 2001 Fiscal 2002 Fiscal 2003 (Payments) April 26, 2003
----------- ----------- ----------- ---------- -------------
Cash Provisions:
Other special charges relating to
restructuring activities .................. $ 2,159 $ (888) $ 78 $ (1,349) $ --
Facilities charges .......................... 6,584 9,401 218 (359) 15,844
Employee severance and other related
charges ................................... 3,498 1,997 (74) (5,421) --
-------- -------- ------- -------- --------
Total cash provisions ................... 12,241 10,510 222 $ (7,129) $ 15,844
-------- -------- ------- ======== ========
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 (256)
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 (256)
-------- -------- -------
Total operating expense restructuring
provisions ............................ $113,478 $46,936 $ (34)
======== ======== =======
4. Computation of Per Share Amounts
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 all periods presented, the Company has
excluded all outstanding stock options from the calculation of diluted net loss
per common share because all such securities are anti-dilutive for those
periods.
The following table presents the calculation of basic and diluted net loss
per share (in thousands, except per share data):
Three Months Ended Nine Months Ended
---------------------------- --------------------------
April 26, April 27, April 26, April 27,
2003 2002 2003 2002
---- ---- ---- ----
Net loss ...................................................... $ (3,610) $ (7,729) $(11,415) $(72,266)
======== ======== ======== ========
Basic and diluted:
Weighted average shares of common stock outstanding ......... 53,935 53,288 53,843 53,209
Less: Weighted average shares subject to repurchase ......... -- (78) (8) (320)
-------- -------- ------- -------
Shares used in computing basic and diluted net loss per share 53,935 53,210 53,835 52,889
======== ======== ======= =======
Basic and diluted net loss per share ........................ $ (0.07) $ (0.15) $ (0.21) $ (1.37)
======== ======== ======= =======
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):
10
Three Months Ended Nine Months Ended
---------------------------- --------------------------
April 26, April 27, April 26, April 27,
2003 2002 2003 2002
---- ---- ---- ----
Anti-dilutive securities:
Options to purchase common stock.......................... 12,148 13,530 12,148 13,530
Common stock subject to repurchase........................ - 53 - 53
------- ------- ------- -------
12,148 13,583 12,148 13,583
======== ======== ======= =======
5. Stock-Based Compensation
The Company accounts for its employee stock-based compensation plans in
accordance with Accounting Principles Board ("APB") Opinion No. 25, Accounting
for Stock Issued to Employees, and Financial Accounting Standards Board ("FASB")
Interpretation ("FIN") No. 44, Accounting for Certain Transactions Involving
Stock Compensation--an Interpretation of APB Opinion No. 25, and complies with
the disclosure provisions of SFAS No. 123, Accounting for Stock-Based
Compensation. Accordingly, no compensation cost is recognized for any of the
Company's fixed stock options granted to employees when the exercise price of
the option equals or exceeds the fair value of the underlying common stock as of
the grant date for each stock option. The Company accounts for equity
instruments issued to non-employees in accordance with the provisions of 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. Deferred stock-based compensation is included as a component of
stockholders' equity and is being amortized by charges to operations over the
vesting period of the options and restricted stock consistent with the method
described in FIN No. 28, Accounting for Stock Appreciation Rights and Other
Variable Stock Option or Award Plans.
Had compensation cost been recognized based on the fair value at the date
of grant for options granted and Employee Stock Purchase Plan issuances during
the three- and nine-month periods ended April 26, 2003 and April 27, 2002, the
Company's pro forma net loss and net loss per share would have been as follows
(in thousands, except per share amounts):
Three Months Ended Nine Months Ended
April 26, April 27, April 26, April 27,
2003 2002 2003 2002
---- ---- ---- ----
Reported net loss: .............................................. $ (3,610) $ (7,729) $(11,415) $(72,266)
======== ======== ======== ========
Add back employee stock-based compensation expense related to
stock options included in reported net loss ................ 37 89 116 1,633
Less employee stock-based compensation expense determined under
fair value based method for all employee stock option awards (2,320) (1,637) (6,907) (8,019)
-------- -------- -------- --------
Pro forma net loss .............................................. $ (5,893) $ (9,277) $(18,206) $(78,652)
======== ======== ======== ========
Three Months Ended Nine Months Ended
April 26, April 27, April 26, April 27,
2003 2002 2003 2002
---- ---- ---- ----
Reported basic and diluted net loss per share $ (0.07) $ (0.15) $ (0.21) $ (1.37)
======== ======== ======== ========
Pro forma basic and diluted net loss per share $ (0.11) $ (0.17) $ (0.34) $ (1.49)
======== ======== ======== ========
The Company calculated the fair value of each option grant on the date of
the grant and stock purchase right using the Black-Scholes option-pricing model
as prescribed by SFAS. No. 123 using the following assumptions:
Three Months Ended Nine Months Ended
April 26, April 27, April 26, April 27,
2003 2002 2003 2002
---- ---- ---- ----
Risk free interest rate - Options 3.0% 4.3% 3.1% 3.7%
Risk free interest rate - ESPP 1.0% 1.9% 1.1% 2.4%
Average expected life - Options 4.7 4.0 4.7 4.0
Average expected life - ESPP 0.5 0.5 0.5 0.5
Dividend yield 0.0% 0.0% 0.0% 0.0%
Expected volatility - Options 107.4% 100.0% 107.4% 100.0%
Expected volatility - ESPP 92.5% 100.0% 95.2% 100.0%
11
6. Comprehensive 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. The
Company follows SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130
requires unrealized gains or losses on the Company's available-for-sale
securities and foreign translation adjustments, which have been included in
stockholders' equity and excluded from net income, to be included in
comprehensive income. For the three- and nine-month periods ended April 26,
2003, total comprehensive loss was approximately $3.6 million and $11.3 million,
respectively, compared to comprehensive loss of approximately $7.7 million and
$70.8 million for the three- and nine-month periods ended April 27, 2002,
respectively.
7. Segment and Geographic Information
The Company operates as one business segment, providing application
software products and related online products and services through its
subsidiary, the Open Source Development Network, Inc. ("OSDN"). For the three-
and nine-month periods ended April 26, 2003, revenues from the Company's single
business segment and other revenues from the Company's former hardware business
were $6.0 million and $17.7 million, respectively. For the three- and nine-month
periods ended April 27, 2002, revenues from the Company's single business
segment and other revenues from the Company's former hardware business were $5.1
million and $15.8 million, respectively.
The Company sells its products in the United States through its direct
sales force and online e-commerce transactions. Revenues for the three- and
nine-month periods ended April 26, 2003 and April 27, 2002 were primarily
generated from sales to end users in the United States of America.
8. Customer Concentration
For the three-month periods ended April 26, 2003 and April 27, 2002, Intel,
which represented 16.6% and 19.7% of the Company's net revenues, respectively,
was the only customer that accounted for more than 10% of the Company's net
revenues. For the nine-month periods ended April 26, 2003 and April 27, 2002,
Intel, which represented 17.0% and 19.2% of the Company's net revenues,
respectively, was the only customer that accounted for more than 10% of the
Company's net revenues.
9. Litigation
The Company, two of its former officers (the "Former Officers"), and the
lead underwriter in its initial public offering ("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 with the first action filed on January 12, 2001.
Plaintiffs in the coordinated proceeding are bringing 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, the
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. In October 2002, the court, pursuant to a stipulation,
dismissed all claims against the Company's Former Officers without prejudice. On
February 19, 2003, the court denied in part and granted in part the motion to
dismiss filed on behalf of the defendants, including the Company. The court's
order did not dismiss any claims against the Company. As a result, discovery may
now proceed.
On February 28, 2003, a related case, captioned Liu v. Credit Suisse First
Boston, et al., Case No. 03-20459, was filed in the United States District Court
for the Southern District of Florida. The complaint names as defendants over
forty companies and their respective directors and officers, including VA
Software and the Former Officers. The Liu plaintiff is not alleged to have
bought or sold VA Software stock.
The Company is subject to various claims and legal actions arising in the
ordinary course of business. 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.
12
10. 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.
11. Recent Accounting Policies
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses significant
issues relating to the implementation of SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and
develops a single accounting method under which long-lived assets that are to be
disposed of by sale are measured at the lower of book value or fair value less
cost to sell. Additionally, SFAS No. 144 expands the scope of discontinued
operations to include all components of an entity with operations that (1) can
be distinguished from the rest of the entity and (2) will be eliminated from the
ongoing operations of the entity in a disposal transaction. SFAS No. 144 is
effective for financial statements issued for fiscal years beginning after
December 15, 2001 and its provisions are to be applied prospectively. The
adoption of SFAS No. 144 did not have a significant impact 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 Nos. 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 has not had a material effect on the
Company's 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 all periods presented 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. 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 No.
146 may affect the timing of recognizing future restructuring plans. If the
Company continues to record significant restructuring charges in the future, the
adoption of SFAS No. 146 could have a significant impact on its results of
operations. There were no significant restructuring charges recorded during the
three- and nine-month periods ended April 26, 2003.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure --an amendment of FASB Statement No.
123". This Statement amends FASB Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation", to provide alternative methods
of transition for an entity that voluntarily changes to the fair value based
method of accounting for stock-based employee compensation. SFAS No. 148 also
requires that disclosures of the pro forma effect of using the fair value method
of accounting for stock-based employee compensation be displayed more
prominently and in a tabular format. Additionally, SFAS No. 148 requires
disclosures of the pro forma effect in interim financial statements. The
transition and annual disclosure requirements of SFAS No. 148 are effective for
fiscal years ended after December 15, 2002. The interim disclosure requirements
are effective for interim periods beginning after December 15, 2002. The Company
has chosen to continue to account for stock-based compensation using the
intrinsic value method prescribed in APB Opinion No. 25 and related
interpretations. Accordingly, compensation expense for stock options is measured
as the excess, if any, of the estimate of the market value of the Company's
stock at the date of the grant over the amount an employee must pay to acquire
its stock. The Company adopted the interim disclosure provisions for its
financial reports during the quarter ended April 26, 2003. Refer to Note 5 of
Notes to Condensed Consolidated Financial Statements. The Company will adopt the
annual disclosure provisions of SFAS No. 148 in its
13
financial reports for the fiscal year ended July 31, 2003. As the adoption of
this standard involves disclosures only, it has not had a material impact on the
Company's consolidated financial statements.
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable
Interest Entities, an Interpretation of ARB No. 51." Generally, a variable
interest entity ("VIE") is a corporation, partnership, trust or any other legal
structure used for business purposes that either does not have equity investors
with substantive voting rights or has equity investors that do not provide
sufficient financial resources for the entity to support its activities. A VIE
often holds financial assets and may be passive or it may engage in such
activities as research and development or other activities on behalf of another
company. FIN No. 46 requires that a VIE be consolidated by a company if that
company is subject to a majority of the VIE's risk of loss or entitled to
receive a majority of the VIE's residual returns or both. A company that
consolidates a VIE is referred to as the primary beneficiary of that entity. The
consolidation requirements of FIN No. 46 apply immediately to VIEs created after
January 31, 2003. The consolidation requirements apply to entities existing
prior to January 31, 2003 in the first fiscal year or interim period beginning
after June 15, 2003. Certain of the disclosure requirements apply in all
financial statements issued after January 31, 2003 regardless of when the VIE
was established. The Company has adopted the disclosure provisions and will
adopt the consolidation requirements as of August 1, 2003. The Company does not
expect the adoption of the consolidation requirements of FIN No. 46 to have a
significant impact on its consolidated financial statements.
12. Guarantees and Indemnifications
As permitted under Delaware law, the Company has agreements whereby the
Company's officers and directors are indemnified for certain events or
occurrences while the officer or director is, or was serving, at the Company's
request in such capacity. The term of the indemnification period is for the
officer's or director's term in such capacity. The maximum potential amount of
future payments the Company could be required to make under these
indemnification agreements is unlimited; however, the Company has director and
officer liability insurance designed to limit the Company's exposure and to
enable the Company to recover a portion of any future amounts paid. As a result
of the Company's insurance policy coverage, the Company believes the estimated
fair value of these indemnification agreements is minimal. All of these
indemnification agreements were grandfathered under the provisions of FIN No. 45
as they were in effect prior to December 31, 2002. Accordingly, the Company has
no liabilities recorded for these agreements as of April 26, 2003.
The Company enters into standard indemnification agreements in the ordinary
course of business. Pursuant to these agreements, the Company indemnifies, holds
harmless, and agrees to reimburse the indemnified party for losses suffered or
incurred by the indemnified party, generally, the Company's business partners,
subsidiaries and/or customers, in connection with any U.S. patent or any
copyright or other intellectual property infringement claim by any third party
with respect to the Company's products. The term of these indemnification
agreements is generally perpetual any time after execution of the agreement. The
maximum potential amount of future payments the Company could be required to
make under these indemnification agreements is unlimited. The Company has not
incurred significant costs to defend lawsuits or settle claims related to these
indemnification agreements. As a result, the Company believes the estimated fair
value of these agreements is insignificant. Accordingly, the Company has no
liabilities recorded for these agreements as of April 26, 2003.
The Company warrants that its software products will perform in all
material respects in accordance with the Company's standard published
specifications in effect at the time of delivery of the licensed products to the
customer for a specified period, which generally does not exceed ninety days.
Additionally, the Company warrants that its maintenance services will be
performed consistent with generally accepted industry standards through the
completion of the agreed upon services. If necessary, the Company would provide
for the estimated cost of product and service warranties based on specific
warranty claims and claim history, however, the Company has not incurred
significant expense under its product or services warranties. As a result, the
Company believes the estimated fair value of these agreements is minimal.
Accordingly, the Company has no liabilities recorded for these agreements as of
April 26, 2003.
The Company warrants that its hardware products related to its previous
hardware business will perform in all material respects in accordance with the
Company's standard published specifications in effect at the time of delivery of
the products to the customer for the life of the product, typically 36 months.
The remaining estimated fair value of these agreements related to the Company's
previous hardware business is minimal at April 26, 2003. Accordingly, the
Company has a liability of approximately $18,000 recorded for these agreements
as of April 26, 2003.
14
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Special Note Regarding Forward-Looking Statements
This Form 10-Q 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 impact of our restructuring, reductions in force and new
business model on our operating expenses and the amount of cash utilized by
operations; 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; and sufficiency of our cash resources, cash generated from
operations and investments to meet our operating and working capital
requirements. 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-Q
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-Q.
Overview
We were incorporated in California in January 1995 and reincorporated in
Delaware in December 1999. We provide tools and intelligence to the information
technology ("IT") professionals and software development communities through the
sale of SourceForge Enterprise Edition ("SourceForge") and our network of media
sites, The Open Source Development Network, Inc., ("OSDN").
We develop, market and support SourceForge, which is proprietary software
designed for corporate and public-sector IT and software engineering
organizations. SourceForge provides Development Intelligence 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.
OSDN is our network of media and e-commerce Internet sites that serve the
IT professionals and software development communities. As of May 30, 2003, OSDN
reaches 10 million unique visitors and serves more than 180 million page views
per month. OSDN web sites include SourceForge.net, the largest repository of
open source code and applications available on the Internet and an excellent
reference for potential SourceForge customers. As of May 30, 2003,
SourceForge.net is the development home for more than 62,000 software projects
and more than 630,000 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 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.
We have completed seven quarters of operations focused on building our
application software business, and accordingly have a very short operating
history in this business. While we believe that we are making good progress in
our application software 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, some of
which we have identified in the "Risk Factors" section below.
15
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 condensed consolidated financial statements and
the accompanying notes thereto included in this quarterly report on Form 10-Q.
Three Months Ended Nine Months Ended
April 26, April 27, April 26, April 27,
2003 2002 2003 2002
---- ---- ---- ----
Consolidated Statements of Operations Data:
Software revenues............................................ 11.1% 4.0% 11.7% 3.5%
Online revenues.............................................. 85.9 82.4 84.9 77.0
Other revenues............................................... 3.0 13.6 3.4 19.5
----- ----- ----- -----
Net revenues.............................................. 100.0% 100.0% 100.0% 100.0%
Software cost of revenues.................................... 7.5 10.9 8.5 11.6
Online cost of revenues...................................... 44.0 47.8 47.5 47.9
Other cost of revenues....................................... (0.2) (4.6) (2.1) (2.2)
----- ----- ----- -----
Cost of revenues.......................................... 51.3 54.1 53.9 57.3
----- ----- ----- -----
Gross margin................................................. 48.7 45.9 46.1 42.7
----- ----- ----- -----
Operating expenses:
Sales and marketing....................................... 43.3 57.6 41.1 66.3
Research and development.................................. 32.9 26.2 33.9 39.3
General and administrative................................ 23.6 51.0 28.9 60.4
Restructuring costs and other special charges............. 1.7 0.7 (0.2) 285.3
Amortization of deferred stock compensation............... 0.6 1.7 0.7 10.4
Amortization of goodwill and intangible assets............ 10.7 62.5 10.9 54.0
----- ----- ----- -----
Total operating expenses................................ 112.8 199.7 115.3 515.7
----- ----- ----- -----
Loss from operations......................................... (64.1) (153.8) (69.2) (473.0)
Interest and other income, net............................... 4.2 3.4 4.6 14.6
----- ----- ----- -----
Net loss..................................................... (59.9)% (150.4)% (64.6)% (458.4)%
===== ===== ===== =====
Net Revenues
Our net revenues increased to $6.0 million in the three-month period ended
April 26, 2003, from $5.1 million for the three-month period ended April 27,
2002. The $0.9 million net increase in revenues was due primarily to increases
in our software, online advertising, and e-commerce businesses, offset by a
decrease in other revenues. Software revenues increased $0.5 million to $0.7
million in the three-month period ended April 26, 2003 from $0.2 million in the
three-month period ended April 27, 2002. This increase was primarily due to an
increase in our installed customer base, which grew from 31 to 41 during the
three-month period ended April 26, 2003, compared to the installed customer
base, which grew from 12 to 19 during the three-month period ended April 27,
2002. Online advertising revenues increased $0.2 million to $2.7 million in the
three-month period ended April 26, 2003 from $2.5 million in the three-month
period ended April 27, 2002, which included approximately $0.5 million of barter
revenue arising from web advertising for both periods presented. This increase
was primarily due to increased demand for online advertising during the
three-month period ended April 26, 2003, compared to the three-month period
ended April 27, 2002. E-commerce revenues increased $0.8 million to $2.5 million
in the three-month period ended April 26, 2003 from $1.7 million in the
three-month period ended April 27, 2002. The increase was primarily the result
of increased traffic on the OSDN web sites resulting in an increase in our
e-commerce customer base and revenues. Other revenues decreased $0.5 million to
$0.2 million in the three-month period ended April 26, 2003 from $0.7 million in
the three-month period ended April 27, 2002.
Our net revenues increased to $17.7 million in the nine-month period ended
April 26, 2003, from $15.8 million for the nine-month period ended April 27,
2002. The $1.9 million net increase in revenues was due primarily to an increase
in our software, online advertising, and e-commerce revenues, offset by a
decrease in other revenues. Software revenues increased $1.6 million to $2.1
million in the nine-month period ended April 26, 2003 from $0.5 million in the
nine-month period ended April 27, 2002. This increase was primarily due to an
increase in our installed customer base, which grew from 24 to 41 during the
nine-month period ended April 26, 2003, compared to the installed customer base,
which grew from 2 to 19 during the nine-month period ended April 27, 2002.
Online advertising revenues increased $0.5 million to $7.3 million in the
nine-month period ended April 26, 2003 from $6.8 million in the nine-month
period ended April 27, 2002, which included approximately $1.5 million of barter
revenue arising from web advertising for both periods presented. This increase
was primarily due to increased demand for online advertising during the
nine-month period ended April 26, 2003, compared to the nine-month period ended
April 27, 2002. E-commerce revenues increased $2.4
16
million to $7.7 million in the nine-month period ended April 26, 2003 from $5.3
million in the nine-month period ended April 27, 2002. The increase was
primarily the result of increased traffic on the OSDN web sites resulting in an
increase in our e-commerce customer base and revenues. Other revenues decreased
$2.5 million to $0.6 million in the nine-month period ended April 26, 2003 from
$3.1 million in the nine-month period ended April 27, 2002.
Revenues for the three- and nine-month periods ended April 26, 2003 and
April 27, 2002 were generated primarily by sales to customers located in the
United States.
For the three-month periods ended April 26, 2003 and April 27, 2002, Intel,
which represented 16.6% and 19.7% of our net revenues, respectively, was the
only customer that accounted for more than 10% of VA's net revenues.
For the nine-month periods ended April 26, 2003 and April 27, 2002, Intel,
which represented 17.0% and 19.2% of our net revenues, respectively, was the
only customer that accounted for more than 10% of VA's net revenues.
We expect that software revenues as a percentage of total revenues will
continue to increase in the future. We expect that online revenues as a
percentage of total revenues will continue to be a significant part of our
revenues in the future. We expect that other revenues as a percentage of total
revenues will continue to decline in the future.
Software Revenues
Revenues from software license agreements are accounted for in accordance
with American Institute of Certified Public Accountants ("AICPA") Statement of
Position ("SOP") 97-2 and 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, 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, 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 a fair value determination using published professional
service rates. When an agreement includes professional services that are
significant or essential to the functionality of the software and we can
reasonably estimate the cost to complete the contract, we use 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 renewal rates, if stated, or separate sales of maintenance sold
to customers. The unrecognized portion of amounts paid in advance for licenses,
maintenance and professional services are recorded as deferred revenue.
For term arrangements, we do not use the residual method to recognize
revenues because we are currently unable to establish the fair value for the
individual contract components such as software license, maintenance and
support. As a result, we currently recognize the entire contract value ratably
over the term of the contract, normally 12 months. In the event that the
contract includes essential professional services, we defer revenue until the
professional services have been fully delivered. At that time, we then recognize
the 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. If a
significant portion of the fee is due after the shorter of our normal payment
terms or 120 days, we consider the fee not to be fixed or determinable.
Online Revenues
Online Advertising revenues are derived from the sale of advertising space
on our various websites. We recognize online 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
17
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.
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 No. 101, product revenues are recognized when persuasive
objective evidence of an arrangement exists, delivery has occurred, the sale
price is fixed or 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 e-commerce products. Such returns are recorded as
incurred and have been immaterial for the periods presented.
Other Revenues
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 objective 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 recognize 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 recognize revenues from professional service
contracts upon completion of the project, or use the percentage of completion
contract accounting method where project costs can be reasonably estimated. We
record any payments received prior to revenue recognition as deferred revenue.
Cost of Revenues
Cost of revenues increased to $3.1 million in the three-month period ended
April 26, 2003 from $2.8 million for the three-month period ended April 27,
2002. Gross margin increased as a percentage of revenue to 48.7% in the
three-month period ended April 26, 2003 from 45.9% in the three-month period
ended April 27, 2002. The increase in cost of revenues was primarily the net
result of increased e-commerce cost of revenues of $0.6 million due to higher
revenue levels during the three-month period ended April 26, 2003, partially
offset by a reduction in cost of sales in the software and online advertising
businesses of $0.1 million and $0.4 million, respectively. In addition, there
was a small increase in other cost of revenues of $0.2 million due to
adjustments to prior period reserves. Headcount related to cost of revenues was
36 at April 26, 2003, compared to 37 at April 27, 2002. Gross margin, excluding
the reversal of prior period inventory reserves, increased as a percentage of
revenues to 48.5% in the three-month period ended April 26, 2003 from 41.3% in
the three-month period ended April 27, 2002. The increase in gross margins
excluding the reversal of prior period inventory reserves related to our prior
hardware business was the result of improvements in the online advertising and
software businesses, offset by a small decline in the e-commerce business as
follows: Online advertising gross margins increased to 67.6% for the three-month
period ended April 26, 2003, compared to 49.8% for the three-month period ended
April 27, 2002; software gross margins increased to 32.9% for the three-month
period ended April 26, 2003, compared to a negative 173.3% for the three-month
period ended April 27, 2002; e-commerce gross margins decreased to 28.2% for the
three-month period ended April 26, 2003, compared to 30.4% for the three-month
period ended April 27, 2002. The increase in online advertising gross margins
was primarily driven by the increase in revenues while reducing the costs
associated with editorial content and online delivery. The increase in our
software gross margins was primarily due to an increase in revenues as well as
an effort to align our software cost of revenues infrastructure to support our
current revenue levels.
Cost of revenues increased to $9.5 million in the nine-month period ended
April 26, 2003 from $9.0 million for the nine-month period ended April 27, 2002.
Gross margin increased as a percentage of revenue to 46.1% in the nine-month
period ended April 26, 2003 from 42.7% in the nine-month period ended April 27,
2002. The increase in cost of revenues was due to a net credit of $3.4 million
primarily related to the reversal of inventory reserves included in the
nine-month period ended April 27, 2002. This credit was primarily the result of
a better than expected sell through of old and excess material as well as the
ability to sell product at a price in excess of that originally estimated in the
three-month period ended July 28, 2001. Cost of revenues for the nine-month
period ended April 26, 2003 included a credit of $0.4 million as a result of
adjustments to previous restructuring accruals. Net of these restructuring
credits, cost of revenues decreased to $9.9 million in the nine-month period
ended April 26, 2003 from $12.4 million in the nine-month period ended April 27,
2002. This decrease was primarily the result of exiting the systems business
which accounted for $3.1 million of the decrease, a reduction in cost of sales
in the SourceForge and online advertising businesses which accounted for a
decrease of $1.1 million, offset by an increase in e-commerce cost of revenues
of $1.7 million as a result of higher revenue levels. Headcount related to cost
of revenues was 36 at April 26, 2003, compared to 37 at April 27, 2002. Gross
margin, excluding the
18
reversal of prior period inventory and restructuring reserves, increased as a
percentage of revenues to 43.7% in the nine-month period ended April 26, 2003
from 21.3% in the nine-month period ended April 27, 2002. The increase in gross
margins excluding the reversal of prior period inventory and restructuring
reserves was the result of improvements in the online advertising and software
businesses as follows: Online advertising gross margins increased to 60.4 % for
the nine-month period ended April 26, 2003, compared to 46.4% for the nine-month
period ended April 27, 2002; software gross margins increased to 27.0% for the
nine-month period ended April 26, 2003, compared to a negative 234.9% for the
nine-month period ended April 27, 2002. E-commerce gross margins remained
consistent at approximately 28.0% for the nine-months periods ended April 26,
2003 and April 27, 2002. The increase in online advertising gross margins was
primarily driven by the increase in revenues while reducing the costs associated
with editorial content and online delivery. The increase in our software gross
margins was primarily due to an increase in revenues as well as an effort to
align our software cost of revenues infrastructure to support our current
revenue levels. We expect cost of revenues to continue to increase as revenues
increase, however, we expect overall gross margins to improve as a result of
leveraging the fixed cost portion of the cost of revenues.
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 $2.6 million in the three-month
period ended April 26, 2003 from $3.0 million in the three-month period ended
April 27, 2002. The decrease was related to the decrease in overall sales and
marketing related spending, including significant headcount reductions.
Headcount in sales and marketing decreased to 29 at April 26, 2003 from 44 at
April 27, 2002. Sales and marketing expenses as a percentage of net revenues
decreased to 43.3% for the three-month period ended April 26, 2003 from 57.6% in
the three-month period ended April 27, 2002. This decrease was primarily due to
decreased spending levels as described above as well as increased revenue levels
for the three-month period ended April 26, 2003 compared to the three-month
period ended April 27, 2002.
Sales and marketing expenses decreased to $7.3 million in the nine-month
period ended April 26, 2003 from $10.5 million in the nine-month period ended
April 27, 2002. The decrease was related to various factors, primarily the
decrease in overall sales and marketing related spending, including significant
headcount reductions which accounted for $2.4 million of the decrease, the
reduction in our investment in VA Linux Japan which represented $0.7 million of
the decrease and the exiting of our Linux software engineering and professional
services businesses which represented $0.1 million of the decrease. Headcount in
sales and marketing decreased to 29 at April 26, 2003 from 44 at April 27, 2002.
Sales and marketing expenses as a percentage of net revenues decreased to 41.1%
for the nine-month period ended April 26, 2003 from 66.3% in the nine-month
period ended April 27, 2002. This decrease was primarily due to decreased
spending levels as described above as well as increased revenue levels for the
nine-month period ended April 26, 2003 compared to the nine-month period ended
April 27, 2002. We believe our sales and marketing expenses will remain
relatively consistent in the future. However, in the future, we expect sales and
marketing expenses to decrease slightly as a percentage of revenue.
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 in accordance with the requirements of Statement of
Financial Accounting Standards ("SFAS") No. 86, "Accounting for the Cost of
Computer Software to be Sold, Leased, or Otherwise Marketed."
Research and development expenses increased to $2.0 million in the
three-month period ended April 26, 2003 from $1.3 million in the three-month
period ended April 27, 2002. The increase in absolute dollars was due to an
increase in the use of outside contractors related to increased research and
development efforts related to our current business. Headcount in research and
development decreased to 43 at April 26, 2003 from 59 at April 27, 2002.
Research and development expenses as a percentage of net revenues increased to
32.9% for the three-month period ended April 26, 2003 from 26.2% for the
three-month period ended April 27, 2002. This increase was primarily due to
increased upfront SourceForge research and development efforts related to as of
yet unreleased products for the three-month period ended April 26, 2003.
Research and development expenses decreased to $6.0 million in the
nine-month period ended April 26, 2003 from $6.2 million in the nine-month
period ended April 27, 2002. The decrease in absolute dollars was primarily due
to the exiting of our Linux software engineering and professional services
businesses, which accounted for a $1.3 million reduction, the reduction in our
investment in VA Linux Japan, which accounted for a $0.5 million reduction,
offset by an increase in the use of outside contractors related to increased
19
research and development efforts related to our current business of $1.6
million. Headcount in research and development decreased to 43 at April 26, 2003
from 59 at April 27, 2002. Research and development expenses as a percentage of
net revenues decreased to 33.9% for the nine-month period ended April 26, 2003
from 39.3% for the nine-month period ended April 27, 2002. The decrease as a
percentage of net revenues was primarily due to our slight decreased spending
levels as described above as well as increased revenues during the nine-month
period ended April 26, 2003 compared to the nine-month period ended April 27,
2002. We expect research and development expenses to remain relatively
consistent in absolute dollars and decrease as a percentage of revenue in the
future.
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 $1.4 million in the
three-month period ended April 26, 2003 from $2.6 million for the three-month
period ended April 27, 2002. The decrease in absolute dollars was due to our
decision in the fourth quarter of fiscal 2002 to reduce our administrative and
overhead costs to align with our ongoing business model. Headcount in general
and administrative services decreased to 20 at April 26, 2003 from 37 at April
27, 2002. General and administrative expenses as a percentage of net revenues
decreased to 23.6% for the three-month period ended April 26, 2003 from 51.0%
for the three-month period ended April 27, 2002. The decrease as a percentage of
net revenues was primarily due to our decreased spending levels as described
above as well as increased revenues during the three-month period ended April
26, 2003 compared to the three-month period ended April 27, 2002.
General and administrative expenses decreased to $5.1 million in the
nine-month period ended April 26, 2003 from $9.5 million for the nine-month
period ended April 27, 2002. General and administrative expenses for the
nine-month period ended April 27, 2002 included the reversal of $0.9 million for
the over-estimate for bad debt provisions booked during the reorganization of
the business. Excluding these charges, the decrease in absolute dollars resulted
primarily from a decrease in administrative personnel. Our decision in the
fourth quarter of fiscal 2002 to reduce our administrative and overhead costs to
align with our business model represented $4.8 million of the decrease and the
reduction in our investment in VA Linux Japan represented $0.4 million of the
decrease. Headcount in general and administrative services decreased to 20 at
April 26, 2003 from 37 at April 27, 2002. General and administrative expenses as
a percentage of net revenues decreased to 28.9% for the nine-month period ended
April 26, 2003 from 60.4% for the nine-month period ended April 27, 2002. The
decrease as a percentage of net revenues was primarily due to our decreased
spending levels as described above as well as increased revenue levels for the
nine-month period ended April 26, 2003 compared to the nine-month period ended
April 27, 2002. We expect general and administrative expenses to remain
relatively consistent in absolute dollars and decrease as a percentage of
revenue in the future.
Restructuring Costs and Other Special Charges
In fiscal 2001 and 2002, we adopted plans to exit the systems and
hardware-related software engineering and professional services businesses, as
well as exit a sublease agreement and reduce our general and administrative
overhead costs. We exited these activities to pursue our SourceForge application
software and media and e-commerce businesses and reduce our operating losses to
improve cash flow. We recorded restructuring charges of $180.2 million related
to exiting these activities, $160.4 million of which was included in
restructuring charges and other special charges in operating expenses and $19.8
million of which was included in cost of sales. Included in the restructuring
were charges related to excess facilities from non-cancelable leases (with
payments continuing until fiscal 2010, unless sublet completely). The accrual
from non-cancelable lease payments includes management's estimates of sublease
income. These estimates are subject to change based on actual events. We
evaluate and update, if applicable, these estimates quarterly. As of April 26,
2003, we had an accrual of approximately $15.4 million outstanding related to
these non-cancelable leases, all of which was originally included in operating
expenses.
We have recorded a net restructuring charge of $0.1 million for the three
months ended April 26, 2003. This was related to $0.4 million of additional
charges related to existing excess facilities as a result of the termination of
a subtenant lease, net of $0.3 million credit adjustments to previously recorded
restructuring reserves. As of April 26, 2003, we had an accrual of $0.4 million
related to these charges. We have recorded a net restructuring credit of $34,000
for the nine months ended April 26, 2003 as a result of various insignificant
adjustments to previously recorded restructuring charges.
In addition to the above, we recorded a $14,000 and $0.4 million net credit
included in cost of revenues in the consolidated statement of operations for the
three and nine months ended April 26, 2003. The $14,000 for the three months
ended April 26, 2003 consisted of adjustments to previously recorded
restructuring reserves related to the systems warranty and excess facility
reserves
20
originally established during fiscal 2001. The $0.4 million for the nine months
ended April 26, 2003 consisted of $23,000 associated with severance and other
related costs attributable to the fiscal 2002 plan to align our infrastructure
with our operations, net of adjustments to previously recorded restructuring
reserves of $0.4 million related to the systems warranty reserve and excess
facility reserves originally established during fiscal 2001. As of April 26,
2003, no outstanding accruals remained related to these restructuring charges.
Below is a summary of the restructuring charges in operating expenses (in
thousands):
Total
Total Charged Total Charged Total Charged Cash Restructuring
To Operations To Operations To Operations Receipts/ Liabilities at
Fiscal 2001 Fiscal 2002 Fiscal 2003 (Payments) April 26, 2003
----------- ----------- ----------- ---------- --------------
Cash Provisions:
Other special charges relating to
restructuring activities .................. $ 2,159 $ (888) $ 78 $ (1,349) $ --
Facilities charges .......................... 6,584 9,401 218 (359) 15,844
Employee severance and other related
charges .................................... 3,498 1,997 (74) (5,421) --
------ ------ ------- ------- -------
Total cash provisions ................... 12,241 10,510 222 $ (7,129) $ 15,844
------ ------ ------- ======= =======
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 (256)
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 (256)
------- ------ -------
Total operating expense restructuring
provisions ............................ $113,478 $ 46,936 $ (34)
======= ====== =======
Amortization of Deferred Stock Compensation
In connection with the grant of stock options to employees during fiscal
1999 and prior to our initial public offering in fiscal 2000, we expensed
deferred stock compensation of $37,000 during the three-month period ended April
26, 2003, compared to $0.1 million during the three-month period ended April 27,
2002. No compensation expense was recorded during the three-month periods ended
April 26, 2003 and April 27, 2002 in connection with our prior fiscal year
acquisitions.
In connection with the grant of stock options to employees during fiscal
1999 and prior to our initial public offering in fiscal 2000, we expensed
deferred stock compensation of $0.1 million during the nine months ended April
26, 2003, compared to $1.6 million during the nine months ended April 27, 2002.
Included in the $1.6 million was $2.2 million of deferred compensation expense
offset by a $1.1 million adjustment during the three months ended January 26,
2002 related to deferred compensation that will never vest for stock options of
terminated employees. Also included in the $1.6 million was $0.5 million of
compensation expense associated with our prior fiscal year acquisitions. In
addition, in connection with restructuring, we recorded $2.7 million of
compensation expense related to NetAttach and Precision Insight in the
nine-month period ended April 27, 2002, which has been included in restructuring
costs and other special charges in the statements of operations. No compensation
expense was recorded during the nine-month period ended April 26, 2003 in
connection with our prior fiscal year acquisitions.
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. We do not expect any further compensation expense in connection
with our prior acquisitions.
Amortization of Intangible Assets
In July 2001, the 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
acquisition of OSDN, we amortized $0.6 million and $1.9 million of intangibles
during the three- and nine-month periods ended April
21
26, 2003, respectively. In connection with the acquisition of OSDN, we amortized
$3.2 million of intangibles during the three-month period ended April 27, 2002.
In connection with the acquisitions of NetAttach, OSDN, and Precision Insight,
we amortized $8.5 million of intangibles for the nine-month periods ended April
27, 2002. In addition, in connection with the restructuring plan approved in
September 2001, during the nine-month period ended April 27, 2002, we wrote-off
an additional $30.6 million of goodwill and intangibles related to our NetAttach
and Precision Insight acquisitions due to the exit of the hardware-related
professional services and Linux software engineering businesses.
We periodically evaluate the carrying amount of our long-lived assets and
apply the provisions of SFAS No. 144, "Accounting for the Impairment or Disposal
of Long-Lived Assets." SFAS No. 144 requires that long-lived assets and 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. No factors occurred
during the three- and nine-month periods ended April 26, 2003 that would
indicate a possible impairment in the carrying value of intangible assets at
April 26, 2003.
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 increased to $0.3 million
for the three-month period ended April 26, 2003 from $0.2 million for the
three-month period ended April 27, 2002. The increase in income was due to a
loss on the disposal of assets during the three-month period ended April 27,
2002 which represented $0.2 million of the increase, offset by a decrease due to
a lower cash balance and decreased returns on our cash as a result of declining
interest rates from prior year, which accounted for a decrease of $0.1 million.
Net interest and other income decreased to $0.8 million for the nine-month
period ended April 26, 2003 from $2.3 million for the nine-month period ended
April 27, 2002. The decrease was primarily due to our decreased investment in VA
Linux Japan, which accounted for $0.9 million of the decrease and a lower cash
balance and decreased returns on our cash as a result of declining interest
rates from prior year, which accounted for $0.5 million of the decrease. We
expect interest and other income, net to decline as our cash balance decreases
to support our operations.
Income Taxes
As of April 26, 2003, we had 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 consistent 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.
Liquidity and Capital Resources
As of April 26, 2003, our available capital resources totaled $41.5
million, comprised of marketable securities of $33.6 million and cash and cash
equivalents of $7.9 million. As of July 27, 2002, our available capital
resources totaled $53.0 million, comprised of $17.9 million in marketable
securities and $35.1 million in cash and cash equivalents. During the nine-month
period ended April 26, 2003, in an effort to maximize our rate of return, we
invested a greater portion of our capital resources in short- and long-term
marketable securities. The resulting $15.7 million increase in our marketable
securities investments over the nine-month period ended April 26, 2003, accounts
for 57.7% of the $27.2 million decline in our cash and cash equivalents to $7.9
million at April 26, 2003 from $35.1 million at July 27, 2002. The remaining
decline of approximately $11.6 million was due to cash utilized in our
operations of $11.8 million, offset by cash generated by our financing
activities of $0.2 million.
For the nine-month period ended April 26, 2003, we used $11.8 million in
cash for operating activities, compared to $29.3 million for the nine-month
period ended April 27, 2002. This represents a decrease of 59.9% and is
primarily due to our reduction in expenses as a result of exiting the systems
and services businesses and changing our focus to application software.
For the nine-month period ended April 26, 2003, our operating loss of $7.1
million, net of non-cash charges, accounted for 60.2% of our operating cash
utilization. Non-cash charges include depreciation and amortization of $4.5
million, provision for bad debts and provision for excess and obsolete inventory
of a negative $0.1 million, loss on disposal of assets, amortization of deferred
stock compensation of $0.1 million and non-cash restructuring charges of a
negative $0.2 million. In total, these net non-cash items reduced
22
the net loss of $11.4 million by $4.3 million. Other significant operating
activities resulting in the utilization of cash were accounts receivable,
accounts payable, accrued restructuring liabilities, and accrued liabilities and
other. The growth in accounts receivable utilized $0.5 million in cash. Accounts
receivable grew consistently with the $0.5 million growth in software and online
advertising revenues during the three-month period ended April 26, 2003 compared
to the three-month period ended July 27, 2002. The decline in accounts payable
utilized $0.8 million in cash. The decrease in accounts payable was due to a
decrease in expenses as well as more rapid payment under terms. Finally, $3.5
million was utilized in accrued liabilities primarily as a result of payments
made on excess facilities of $1.8 million, $0.8 million in payments made to
former employees related to severance agreements and $0.9 million in payments
made for other accrued liabilities during the normal course of business. We
expect that the above cash utilization trends will continue as we grow our
business and pay off our remaining lease obligations related to excess
facilities.
For the nine-month period ended April 27, 2002 the utilization of cash was
due to our operating loss of $34.3 million, net of non-cash charges, offset by
cash generated from other operating activities of $5.0 million. Non-cash charges
include depreciation and amortization of $11.9 million, provision for bad debts
of a negative $1.0 million, provision for excess and obsolete inventory of a
negative $2.0 million, loss on disposal of assets of $1.2 million, proportionate
share of Japan losses in VA Linux Japan investment of $2.0 million, minority
interest of VA Linux Japan loss of a negative $0.5 million, gain on sale of VA
Linux Japan investment of a negative $12.8 million, release of contingent shares
in relation to OSDN acquisition of $1.3 million, amortization of deferred stock
compensation of $1.6 million, non cash compensation expense of $0.1 million and
non-cash restructuring charges of $36.2 million. In total, these net non-cash
items reduced the net loss of $72.3 million by $38.0 million. Other significant
operating activities resulting in the utilization of cash were accounts payable,
accrued liabilities and other long-term liabilities. The decline in accounts
payable utilized $12.1 million in cash. The decrease in accounts payable was due
to a decrease in expenses as a result of exiting the hardware business. The
decline in accrued liabilities and other long-term liabilities utilized $5.9
million in cash primarily as a net result of payments made associated with
accrued compensation of $1.9 million, payments made associated with accrued
restructuring of $3.3 million and $1.9 million in payments made for other
accrued liabilities during the normal course of business, offset by cash
generated from deferred rent associated with a sublease termination of $1.2
million. Other significant operating activities resulting in the generation of
cash were accounts receivable, inventories, prepaid expenses and other assets
and accrued restructuring liabilities. The decrease in accounts receivable
generated $10.6 million in cash, and reflects a lower level of revenues as the
hardware business declined and we exited certain portions of that business. The
decrease in inventory generated $2.1 million and was due to exiting the hardware
business and selling inventory that was originally reserved for in
restructuring. The decline in prepaid expenses and other assets generated $2.7
million of cash and was the result of selling a portion of our VA Linux Japan
investment which represented $0.8 million of the decline. The remaining decline
of $1.9 million was the result of cash received from various miscellaneous
receivables during the nine-month period ended April 27, 2002. Finally, an
increase in accrued restructuring liabilities generated $7.5 million in cash as
a result of additional restructuring reserves established for $10.5 million,
offset by payments made on previously established accruals of $3.0 million.
For the nine-month period ended April 26, 2003, we used $15.7 million in
cash for investing activities, compared to generating $12.2 million for the
nine-month period ended April 27, 2002. This change is primarily due to our
strategic decision to increase our short- and long-term investments and decrease
our cash equivalent investments in an effort to maximize our rate of return.
During the nine-month period ended April 26, 2003, we utilized $15.6 million of
cash and cash equivalents to purchase short- and long-term investments, compared
to an increase of $6.6 million in cash and cash equivalents during the
nine-month period ended April 27, 2002, which resulted from our liquidation of
certain investments. In addition, during the nine-month period ended April 27,
2002 we sold a portion of our VA Linux Japan investment that generated $5.1
million. Further, we generated $0.6 million as a result of the release of
restricted cash during the nine-month period ended April 27, 2002. We expect
that cash utilization for investing activities will decline as we sell longer
term investments to fund our operations and our restricted cash is released
under terms of our corporate lease agreement.
For the nine-month period ended April 26, 2003, we generated $0.2 million
in cash from financing activities, compared to $0.1 million for the nine-month
period ended April 27, 2002. This represents an increase in cash generation of
162.0% primarily as a result of decreasing payments on notes payable, offset by
a slight decrease in cash generated from the issuance of common stock to our
employees. During the nine-month period ended April 26, 2003, $42,000 in cash
was utilized to make payments on our notes payable, compared to payments of $0.2
million during the nine-month period ended April 27, 2002. During the nine-month
period ended April 26, 2003, $0.2 million in cash was generated from the
issuance of common stock to our employees, compared to $0.3 million during the
nine-month period ended April 27, 2002. We are uncertain of the level of cash
that will be generated in the future from the issuance of common stock to our
employees as the exercising of options is dependant upon several factors such as
the price of our common stock and the number of employees participating in our
stock option plans.
For the nine-month period ended April 26, 2003, exchange rate changes had
an immaterial effect on cash and cash equivalents.
23
For the nine-month period ended April 27, 2002, exchange rate changes had a
positive effect on cash and cash equivalents of $1.3 million. We expect that
exchange rate changes will have an immaterial effect on cash and cash
equivalents in the near future due to our focus on US-based business.
As of April 26, 2003 and July 27, 2002, we had outstanding letters of
credit issued under a line of credit of approximately $1.4 million related to
the corporate facility lease. The amount related to this letter of credit is
recorded in the "Restricted cash" section of the condensed consolidated balance
sheet. We anticipate that this balance will decline by $0.5 million in the
fourth quarter of each fiscal year through 2005 under our existing lease
agreement.
Future payments due under lease obligations as of April 26, 2003 are as
follows:
Obligations
Under
Non-cancelable
Operating Leases
----------------
2003................................ $ 1,121
2004................................ 4,672
2005................................ 4,556
2006................................ 3,632
2007................................ 3,511
Thereafter.......................... 10,521
------
$ 28,013
========
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 2004 under our current business strategy,
however, 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
2004. We expect to continue 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 and marketable securities, we may require
additional capital to fund continued operations beyond our fiscal year 2004. See
"Risks Related to our Financial Results" in the Risk Factors section of this
Form 10-Q.
Financial Risk Management
As a primarily US-based 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 condensed 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
There have been no material changes to our critical accounting policies and
estimates from those disclosed in our report on Form 10-K for our fiscal year
ended July 27, 2002.
24
Recent Accounting Pronouncements
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses significant
issues relating to the implementation of SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and
develops a single accounting method under which long-lived assets that are to be
disposed of by sale are measured at the lower of book value or fair value less
cost to sell. Additionally, SFAS No. 144 expands the scope of discontinued
operations to include all components of an entity with operations that (1) can
be distinguished from the rest of the entity and (2) will be eliminated from the
ongoing operations of the entity in a disposal transaction. SFAS No. 144 is
effective for financial statements issued for fiscal years beginning after
December 15, 2001 and its provisions are to be applied prospectively. The
adoption of SFAS No. 144 did not have a significant impact on our 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 Nos. 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 has not had 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 all periods presented 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 No.
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.
There were no significant restructuring charges recorded during the three- and
nine-month periods ended April 26, 2003.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." FIN No. 45 requires that a liability be
recorded in the guarantor's balance sheet upon issuance of a guarantee or
indemnification. In addition, FIN No. 45 requires disclosures about the
guarantees that an entity has issued, including a reconciliation of changes in
the entity's product warranty liabilities. The initial recognition and initial
measurement provisions of FIN No. 45 are applicable on a prospective basis to
guarantees issued or modified after December 31, 2002, irrespective of the
guarantor's fiscal year-end. The disclosure requirements of FIN No. 45 are
effective for financial statements of interim or annual periods ending after
December 15, 2002. The adoption of FIN No. 45 has not had a material effect on
these quarterly consolidated financial statements, however, management is
continuing to evaluate the impact on future financial statements.
As permitted under Delaware law, we have agreements whereby our officers
and directors are indemnified for certain events or occurrences while the
officer or director is, or was serving, at our request in such capacity. The
term of the indemnification period is for the officer's or director's term in
such capacity. The maximum potential amount of future payments we could be
required to make under these indemnification agreements is unlimited; however,
we have director and officer liability insurance designed to limit our exposure
and to enable us to recover a portion of any future amounts paid. As a result of
our insurance policy coverage, we believe the estimated fair value of these
indemnification agreements is minimal. All of these indemnification agreements
were grandfathered under the provisions of FIN No. 45 as they were in effect
prior to December 31, 2002. Accordingly, we have no liabilities recorded for
these agreements as of April 26, 2003.
25
We enter into standard indemnification agreements in the ordinary course of
business. Pursuant to these agreements, we indemnify, hold harmless, and agree
to reimburse the indemnified party for losses suffered or incurred by the
indemnified party, generally, our business partners, subsidiaries and/or
customers, in connection with any U.S. patent or any copyright or other
intellectual property infringement claim by any third party with respect to our
products. The term of these indemnification agreements is generally perpetual
any time after execution of the agreement. The maximum potential amount of
future payments we could be required to make under these indemnification
agreements is unlimited. We have not incurred significant costs to defend
lawsuits or settle claims related to these indemnification agreements. As a
result, we believe the estimated fair value of these agreements is
insignificant. Accordingly, we have no liabilities recorded for these agreements
as of April 26, 2003.
We warrant that our software products will perform in all material respects
in accordance with our standard published specifications in effect at the time
of delivery of the licensed products to the customer for a specified period,
which generally does not exceed ninety days. Additionally, we warrant that our
maintenance services will be performed consistent with generally accepted
industry standards through completion of the agreed upon services. If necessary,
we would provide for the estimated cost of product and service warranties based
on specific warranty claims and claim history, however, we have not incurred
significant expense under its product or services warranties. As a result, we
believe the estimated fair value of these agreements is minimal. Accordingly, we
have no liabilities recorded for these agreements as of April 26, 2003.
We warrant that our hardware products related to our previous hardware
business will perform in all material respects in accordance with the our
standard published specifications in effect at the time of delivery of the
products to the customer for the life of the product, typically 36 months. The
remaining estimated fair value of these agreements related to our previous
hardware business is minimal at April 26, 2003. Accordingly, we have a liability
of approximately $18,000 recorded for these agreements as of April 26, 2003.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure -- an amendment of FASB Statement No.
123." This Statement amends FASB SFAS No. 123, "Accounting for Stock-Based
Compensation,", to provide alternative methods of transition for an entity that
voluntarily changes to the fair value based method of accounting for stock-based
employee compensation. SFAS No. 148 also requires that disclosures of the pro
forma effect of using the fair value method of accounting for stock-based
employee compensation be displayed more prominently and in a tabular format.
Additionally, SFAS No. 148 requires disclosures of the pro forma effect in
interim financial statements. The transition and annual disclosure requirements
of SFAS No. 148 are effective for fiscal years ended after December 15, 2002.
The interim disclosure requirements are effective for interim periods beginning
after December 15, 2002. We have chosen to continue to account for stock-based
compensation using the intrinsic value method prescribed in APB Opinion No. 25
and related interpretations. Accordingly, compensation expense for stock options
is measured as the excess, if any, of the estimate of the market value of our
stock at the date of the grant over the amount an employee must pay to acquire
its stock. We adopted the interim disclosure provisions for our financial
reports during the quarter ended April 26, 2003. Refer to Note 5 of Notes to
Condensed Consolidated Financial Statements. We will adopt the annual disclosure
provisions of SFAS No. 148 in our financial reports for the fiscal year ended
July 31, 2003. As the adoption of this standard involves disclosures only, it
has not had a material impact on our consolidated financial statements.
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable
Interest Entities, an Interpretation of ARB No. 51." Generally, a variable
interest entity ("VIE") is a corporation, partnership, trust or any other legal
structure used for business purposes that either does not have equity investors
with substantive voting rights or has equity investors that do not provide
sufficient financial resources for the entity to support its activities. A VIE
often holds financial assets and may be passive or it may engage in such
activities as research and development or other activities on behalf of another
company. FIN No. 46 requires that a VIE be consolidated by a company if that
company is subject to a majority of the VIE's risk of loss or entitled to
receive a majority of the VIE's residual returns or both. A company that
consolidates a VIE is referred to as the primary beneficiary of that entity. The
consolidation requirements of FIN No. 46 apply immediately to VIEs created after
January 31, 2003. The consolidation requirements apply to entities existing
prior to January 31, 2003 in the first fiscal year or interim period beginning
after June 15, 2003. Certain of the disclosure requirements apply in all
financial statements issued after January 31, 2003 regardless of when the VIE
was established. We have adopted the disclosure provisions and will adopt the
consolidation requirements as of August 1, 2003. We do not expect the adoption
of the consolidation requirements of FIN No. 46 to have a significant impact on
its consolidated financial statements.
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
26
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 Business
BECAUSE THE MARKET FOR DEVELOPMENT INTELLIGENCE APPLICATION SOFTWARE IS NEW AND
RAPIDLY EVOLVING, WE DO NOT KNOW WHETHER EXISTING AND POTENTIAL CUSTOMERS WILL
LICENSE SOURCEFORGE IN SUFFICIENT QUANTITIES FOR US TO ACHIEVE PROFITABILITY.
Our future growth and financial performance will depend on market acceptance of
SourceForge. 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. Many
of our customers have licensed only limited quantities of SourceForge, and these
or new customers may decide not to broadly implement our software by licensing
additional copies from us. 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 for 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 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, 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 WILL NOT GROW AND MAY DECLINE. 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 NOT GROW AND MAY 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 operating
results.
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 complex because customers
consider a number of factors before committing to license SourceForge. Factors
that may be 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 and applications. 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
27
impact our operating margins. Even if SourceForge has been chosen by a 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 the following:
o our ability to license our product may be impacted by changes in the
strategic importance of software projects due 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; and
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 A TRANSACTION AND OUR ABILITY TO RECOGNIZE REVENUE AS
ANTICIPATED. Because we focus on selling enterprise solutions, the process of
contractual negotiation is critical and may be lengthy. Additionally, several
factors may 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.
In addition, slowdowns 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 NOT GROW AND MAY DECLINE. We generate a significant amount of our
software license revenues from existing customers. Most of our current customers
initially purchased a limited number of licenses as they implemented and adopted
our Development Intelligence application. Even if customers successfully use
SourceForge, such customers may not purchase additional licenses to expand the
use of our product. Purchases of additional 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, we entered into a
commercial relationship with IBM. If we are unable to maintain our existing
strategic relationship with IBM, our ability to increase our sales may 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. We have begun exploring other possible
relationships and marketing alliances to obtain customer leads, referrals and
distribution opportunities. Even if we succeed in securing such additional
strategic relationships, the relationships may not result in additional
customers or revenues.
OUR RESEARCH AND DEVELOPMENT EFFORTS MAY BE COSTLY AND MAY NOT PRODUCE
SUCCESSFUL NEW PRODUCTS AND PRODUCT UPGRADES. Our future success will depend
upon our ability to enhance our current products and develop and introduce new
products on a timely basis, particularly if new technology or new industry
standards render any existing products obsolete. We believe that we will need to
incur significant research and development expenditures to remain competitive,
particularly because many of our competitors have substantially greater
resources. The products that we are currently developing or may develop in the
future may not be technologically successful or may not be accepted in our
market. In addition, the length of our product development cycle may be greater
than we expect. If the resulting products are not introduced in a timely manner,
or do not compete effectively with products of our competitors, our business
will be harmed.
28
DELAYS IN INTRODUCING UPGRADES TO OUR PRODUCTS MAY CAUSE US TO LOSE CUSTOMERS TO
OUR COMPETITORS OR HARM OUR REPUTATION. We attempt to maintain a consistent
release schedule for upgrades of existing products. Due to uncertainties
inherent in software development, it is likely that delays will materialize from
time to time in the future. We could lose customers as a result of substantial
delays in the shipment of product upgrades.
IF WE ARE UNABLE TO PROVIDE HIGH-QUALITY CUSTOMER SUPPORT AND SERVICES, WE WILL
NOT MEET THE NEEDS OF OUR CUSTOMERS AND REVENUE WILL NOT GROW AND 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 operating results.
INCREASED UTILIZATION AND COSTS OF OUR TECHNICAL SUPPORT SERVICES MAY ADVERSELY
AFFECT OUR FINANCIAL RESULTS. 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.
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.
OUR ONLINE CONTENT AND SERVICES MAY NOT ACHIEVE CONTINUED ACCEPTANCE, WHICH
COULD ADVERSELY AFFECT OUR FINANCIAL RESULTS. Our future success depends upon
our ability to deliver original and compelling content and services that attract
and retain users. The successful development and production of content and
services is subject to numerous uncertainties, including the ability to:
o anticipate and successfully respond to rapidly changing consumer
tastes and preferences;
o fund new program development; and
o attract and retain qualified editors, writers and technical personnel.
We cannot assure you that our online content and services will be attractive to
a sufficient number of users to generate revenues consistent with our estimates
or sufficient to sustain operations. In addition, we cannot assure you that any
new content or services will be developed in a timely or cost-effective manner.
If we are unable to develop content and services that allow us to attract,
retain and expand a loyal user base that is attractive to advertisers and
sellers of technology products, we will be unable to generate sufficient revenue
to grow our online business.
Risks Related To Our Financial Results
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 2004.
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 and marketable securities, we may require
additional capital to fund continued operations beyond our fiscal year 2004. 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.
29
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 announced our plan to exit our
hardware business. In the first quarter of our fiscal year 2002, we made the
strategic decision to exit, and exited, the hardware-related software
engineering and professional services fields to focus 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.
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.
OUR QUARTERLY NET REVENUES AND RESULTS OF OPERATIONS MAY VARY SIGNIFICANTLY IN
THE FUTURE DUE TO A NUMBER OF 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 macroeconomic factors such as the general condition of the U.S.
economy;
o specific economic conditions relating to IT spending;
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 our ability to develop and retain a skilled software sales force;
o introduction or enhancement of our products or our competitors'
products;
o an increase in our operating costs;
o whether we are able to expand our sales and marketing programs for our
software products;
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;
o the possibility that software development delays will result from our
outsourcing of certain SourceForge research and development efforts to
Cybernet Software Systems, Inc., an independent contractor located
primarily in India;
o specific economic conditions relating to online advertising and
sponsorship, and e-commerce;
o the pricing of advertising on our network of Internet sites and our
competitors' Internet sites;
30
o the amount of traffic on our network of Internet sites;
o our ability to achieve, demonstrate and maintain attractive online
user demographics;
o our ability to develop and retain a skilled advertising and
sponsorship sales force;
o the demand for advertising or sponsorships;
o the addition or loss of specific advertisers or sponsors, and the size
and timing of advertising or sponsorship purchases by individual
customers;
o our ability to manage effectively our development of new business
opportunities and markets;
o our ability to upgrade and develop our systems and infrastructure;
o our ability to keep our websites operational at a reasonable cost;
o technical difficulties, system downtime, Internet brownouts or denial
of service or other similar attacks;
o consumer confidence in the safety and security of transactions on our
e-commerce websites; and
o disruption to our operations, employees, affiliates, customers and
facilities caused by international or domestic terrorist attacks or
armed conflict.
In addition to the foregoing factors, the risk of quarterly fluctuations is
increased by the fact that many enterprise customers negotiate software 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.
Due to all of the foregoing factors, any significant shortfall in revenues in
relation to planned expenditures could materially and adversely affect our
operating results and financial condition. If our revenues and operating results
fall below our expectations, the expectations of securities analysts or the
expectations of investors, the trading price of our common stock would likely be
materially and adversely affected. You should not rely on the results of our
business in any past periods as an indication of our future financial
performance.
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.
WE HAVE A HISTORY OF LOSSES AND EXPECT TO CONTINUE TO INCUR NET LOSSES FOR THE
FORESEEABLE FUTURE. We incurred a loss of $3.6 million for our fiscal third
quarter ended April 26, 2003, and we had an accumulated deficit of $737.3
million as of April 26, 2003. 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.
31
DESPITE REDUCTIONS IN THE SIZE OF OUR WORKFORCE, OUR BUSINESS MAY FAIL TO GROW
RAPIDLY ENOUGH TO OFFSET OUR ONGOING OPERATING EXPENSES. During fiscal year
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 years
2002 and 2003, we further reduced our workforce such that as of April 26, 2003
we had 128 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.
Risks Related To Competition
IF WE DO NOT EFFECTIVELY COMPETE WITH NEW AND EXISTING COMPETITORS, OUR REVENUES
AND OPERATING MARGINS WILL NOT GROW AND MAY 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.
Our potential competitors include providers of software and related services as
well as providers of hosted application services.
Many of our potential competitors have significantly more resources, more
experience, 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
pressure 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 partners, and potential strategic partners, and this
may adversely impact our relationship with an individual partner or a number of
partners.
Consolidation is underway among companies in the software industry as firms seek
to offer more extensive suites of software products and broader arrays of
software solutions. Changes resulting from this consolidation may negatively
impact our competitive position and operating results.
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 online advertising
and sponsorships, for which we compete with various media including newspapers,
radio, magazines and various Internet sites. We also derive revenue from
e-commerce, for which we compete with other e-commerce companies as well as
traditional, "brick and mortar" retailers. We may fail to 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 affected.
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 on 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.
32
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 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.
Other Risks Related To Our Business
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 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.
WE MAY BE SUBJECT TO PRODUCT LIABILITY CLAIMS IF PEOPLE OR PROPERTY ARE HARMED
BY THE PRODUCTS WE SELL ON OUR E-COMMERCE WEBSITES. Some of the products we
offer for sale on our e-commerce websites, such as consumer electronics, toys,
computers and peripherals, toiletries, beverages and clothing, may expose us to
product
33
liability claims relating to personal injury, death or property damage caused by
such products, and may require us to take actions such as product recalls.
Although we maintain liability insurance, we cannot be certain that our coverage
will be adequate for liabilities actually incurred or that insurance will
continue to be available to us on economically reasonable terms, or at all. In
addition, some of our vendor agreements with our suppliers do not indemnify us
from product liability.
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
year, we have implemented or updated our operations and financial systems,
procedures and controls as we focused on our application software business. Our
systems will continue to require additional modifications and improvements to
respond to current and future changes in our business. 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.
SALES OF OUR COMMON STOCK BY SIGNIFICANT STOCKHOLDERS MAY CAUSE THE PRICE OF OUR
COMMON STOCK TO DECREASE. Several of our stockholders own significant portions
of our common stock. If these stockholders were to sell significant amounts of
their holdings of our common stock, then the market price of our common stock
could be negatively impacted. The effect of such sales, or of significant
portions of our stock being offered or made available for sale, could result in
strong downward pressure on our stock. Investors should be aware that they could
experience significant short-term volatility in our stock if such stockholders
decide to sell a substantial amount of their holdings of our common stock at
once or within a short period of time.
OUR NETWORKS MAY BE VULNERABLE TO UNAUTHORIZED PERSONS ACCESSING OUR SYSTEMS,
WHICH COULD DISRUPT OUR OPERATIONS AND RESULT IN THE THEFT OF OUR PROPRIETARY
INFORMATION. A party who is able to circumvent our security measures could
misappropriate proprietary information or cause interruptions or malfunctions in
our Internet operations. We may be required to expend significant capital and
resources to protect against the threat of security breaches or to alleviate
problems caused by breaches in security.
INCREASING REGULATION OF THE INTERNET OR IMPOSITION OF SALES AND OTHER TAXES ON
PRODUCTS SOLD OR DISTRIBUTED OVER THE INTERNET COULD HARM OUR BUSINESS. The
electronic commerce market on the Internet is relatively new and rapidly
evolving. While this is an evolving area of the law in the United States and
overseas, currently there are relatively few laws or regulations that directly
apply to commerce on the Internet. Changes in laws or regulations governing the
Internet and electronic commerce, including, without limitation, those governing
an individual's privacy rights, pricing, content, encryption, security,
acceptable payment methods and quality of products or services could have a
material adverse effect on our business, operating results and financial
condition. Taxation of Internet commerce, or other charges imposed by government
agencies or by private organizations, may also be imposed. Any of these
regulations could have an adverse effect on our future sales and revenue growth.
BUSINESS DISRUPTIONS COULD AFFECT OUR FUTURE OPERATING RESULTS. Our operating
results and financial condition could be materially and adversely affected in
the event of a major earthquake, fire or other catastrophic event, such as the
recent terrorist attacks upon the United States. Our corporate headquarters, the
majority of our research and development activities and certain other critical
business operations are located in California, near major earthquake faults. A
catastrophic event that results in the destruction of any of our critical
business or information technology systems could severely affect our ability to
conduct normal business operations and as a result our future operating results
could be adversely affected.
SYSTEM DISRUPTIONS COULD ADVERSELY AFFECT OUR FUTURE OPERATING RESULTS. Our
ability to attract and maintain relationships with users, advertisers, merchants
and strategic partners will depend on the satisfactory performance, reliability
and availability of our Internet channels and network infrastructure. Our
Internet advertising revenues relate directly to the number of advertisements
delivered to our users. System interruptions or delays that result in the
unavailability of Internet channels or slower response times for users would
reduce the number of advertisements and sales leads delivered to such users and
reduce the attractiveness of our Internet channels to users, strategic partners
and advertisers or reduce the number of impressions delivered and thereby reduce
revenue. In the past twelve months, some of our sites have experienced a small
number of brief service interruptions. We will continue to suffer future
interruptions from time to time whether due to natural disasters,
telecommunications failures, other system failures, rolling blackouts, viruses,
hacking or other events. System interruptions or slower response times could
have a material adverse effect on our revenues and financial condition.
34
Item 3. 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 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
April 26, 2003. 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 April 26, 2003
Cash equivalents $4,388
Weighted-average interest rate 1.23%
Short-term investments $4,270
Weighted-average interest rate 1.45%
Long-term investments $29,284
Weighted-average interest rate 2.66%
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.
Item 4. Controls and Procedures
Evaluation of disclosure controls and procedures
Based on an evaluation with the participation of management of our
disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c)
under the Securities Exchange Act of 1934) as of a date within 90 days of the
filing date of this Quarterly Report on Form 10-Q, our principal executive
officer and principal financial officer have concluded that our disclosure
controls and procedures are effective to ensure that information that we are
required to disclose in the reports that we file or submit under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the
time periods specified in the rules and forms of the Securities and Exchange
Commission. However, the design of any system of controls is based in part upon
certain assumptions about the likelihood of future events and our controls and
procedures can only provide reasonable, not absolute, assurance that their
designed objectives are met. In addition, like many companies, we have resource
constraints and the benefits of controls must be considered relative to their
costs. Because of these and other inherent limitations, there is no certainty
that our controls and procedures will be able to satisfy all potential future
considerations, regardless of how remote.
Changes in internal controls
There were no significant changes in our internal controls or in other
factors that could significantly affect these controls subsequent to the date of
the evaluation by our principal executive officer and principal financial
officer, including any corrective actions with regard to significant
deficiencies and material weaknesses.
35
PART II
Item 1. Legal Proceedings
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 with the first action filed on January 12, 2001. Plaintiffs
in the coordinated proceeding are bringing 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. In
October 2002, the court, pursuant to a stipulation, dismissed all claims against
the Company's Former Officers without prejudice. On February 19, 2003, the court
denied in part and granted in part the motion to dismiss filed on behalf of
defendants, including the Company. The court's order did not dismiss any claims
against the Company. As a result, discovery may now proceed.
On February 28, 2003, a related case, captioned Liu v. Credit Suisse First
Boston, et al., Case No. 03-20459, was filed in the United States District Court
for the Southern District of Florida. The complaint names as defendants over
forty companies and their respective directors and officers, including VA
Software and the Former Officers. The Liu plaintiff is not alleged to have
bought or sold VA Software stock. The Company anticipates that this new case
will be transferred to the United States District Court for the Southern
District of New York and coordinated with the existing IPO-related litigation,
discussed above.
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.
Item 5. Other Information
Section 10A(i)(2) of the Securities Exchange Act of 1934, as added in
Section 202 of the Sarbanes-Oxley Act of 2002, requires us to disclose the
approval by our Audit Committee of any non-audit services to be performed by our
auditor. Non-audit services are defined as services other than those performed
in connection with an audit or a review of our financial statements. The Audit
Committee of our Board of Directors has previously approved the performance of
certain tax-related services by our auditor, PricewaterhouseCoopers LLP.
Item 6. Exhibits and Reports On Form 8-K
(a) Exhibits
Exhibit No. Description
- ----------- -----------
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.
(b) Reports on Form 8-K
None.
36
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
President and Chief Executive Officer
By: /s/ KATHLEEN R. MCELWEE
-----------------------------------------------
Kathleen R. McElwee
Vice President and Chief Financial Officer
Date: June 6, 2003
37
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 quarterly report on Form 10-Q of VA Software
Corporation;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: June 6, 2003 /s/ ALI JENAB
-----------------------
Ali Jenab
Chief Executive Officer
38
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 quarterly report on Form 10-Q of VA Software
Corporation;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: June 6, 2003 /s/ KATHLEEN R. MCELWEE
------------------------
Kathleen R. McElwee
Chief Financial Officer
39
EXHIBIT INDEX
Exhibit
Number
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
40