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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 October 31, 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 December 1, 2003
Common Stock, $0.001 par value 60,516,449
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Table of Contents
PART I. FINANCIAL INFORMATION Page No.
Item 1. Financial Statements (unaudited)............................................................ 3
Condensed Consolidated Balance Sheets at October 31, 2003 and July 31, 2003............. 3
Condensed Consolidated Statements of Operations for the months three
ended October 31, 2003 and October 26, 2002............................................ 4
Condensed Consolidated Statements of Cash Flows for the three months ended
October 31, 2003 and 5 October 26, 2002.................................................
Notes to Condensed Consolidated Financial Statements.................................... 6
Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations....... 13
Item 3 Quantitative and Qualitative Disclosures About Market Risk.................................. 31
Item 4 Controls and Procedures..................................................................... 32
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................................................... 32
Item 5. Other Information........................................................................... 32
Item 6. Exhibits and Reports on Form 8-K............................................................ 33
Signatures................................................................................................ 33
Certifications............................................................................................ 35
2
PART I
VA SOFTWARE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, unaudited)
October 31, July 31,
2003 2003
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents ............................. $ 4,539 $ 6,303
Short-term investments ................................ 26,627 27,864
Restricted cash, current .............................. 450 450
Accounts receivable, net .............................. 2,539 1,928
Inventories ........................................... 568 388
Prepaid expenses and other assets ..................... 1,771 1,232
--------- ---------
Total current assets .......................... 36,494 38,165
Property and equipment, net ........................... 4,165 4,267
Goodwill and intangibles, net ......................... 18 21
Long-term investments ................................. 6,133 4,680
Restricted cash, non current .......................... 450 450
Other assets .......................................... 1,049 912
--------- ---------
Total assets .................................. $ 48,309 $ 48,495
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ...................................... $ 977 $ 863
Accrued restructuring liabilities, current portion .... 3,577 4,117
Accrued compensation .................................. 1,358 1,346
Deferred revenue ...................................... 1,400 751
Accrued liabilities and other ......................... 1,186 2,263
--------- ---------
Total current liabilities ..................... 8,498 9,340
Accrued restructuring liabilities, net of current portion 10,272 10,772
Other long-term liabilities ............................. 1,166 1,181
--------- ---------
Total liabilities ............................. 19,936 21,293
Commitments and contingencies (Notes 7 and 9)
Stockholders' equity:
Common stock .......................................... 57 56
Treasury stock ........................................ (4) (4)
Additional paid-in capital ............................ 769,215 766,765
Deferred stock compensation ........................... -- (20)
Accumulated other comprehensive gain .................. 51 128
Accumulated deficit ................................... (740,946) (739,723)
--------- ---------
Total stockholders' equity .................... 28,373 27,202
--------- ---------
Total liabilities and stockholders' equity .... $ 48,309 $ 48,495
========= =========
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
October 31, October 26,
2003 2002
-------- --------
Net revenues:
Software revenues ......................................... $ 815 $ 711
Online revenues ........................................... 4,951 4,155
Other revenues ............................................ 31 209
-------- --------
Net revenues ........................................... 5,797 5,075
Cost of revenues:
Software cost of revenues ................................. 595 593
Online cost of revenues ................................... 2,655 2,311
Other cost of revenues .................................... -- (157)
-------- --------
Cost of revenues ....................................... 3,250 2,747
-------- --------
Gross margin ........................................... 2,547 2,328
-------- --------
Operating expenses:
Sales and marketing ....................................... 2,392 2,321
Research and development .................................. 1,827 2,044
General and administrative ................................ 724 1,755
Restructuring costs and other special charges ............. (17) (15)
Amortization of deferred stock compensation ............... 20 38
Amortization of goodwill and intangible assets ............ 3 644
-------- --------
Total operating expenses .......................... 4,949 6,787
-------- --------
Loss from operations ........................................ (2,402) (4,459)
Interest income, net ........................................ 248 354
Other income (expense), net ................................. 931 (28)
-------- --------
Net loss .................................................... $ (1,223) $ (4,133)
======== ========
Basic and diluted net loss per share ........................ $ (0.02) $ (0.08)
======== ========
Shares used in computing basic and diluted net loss per share 56,255 53,717
======== ========
The accompanying notes are an integral part of these financial statements.
4
VA SOFTWARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, unaudited)
Three Months Ended
October 31, October 26,
2003 2002
-------- --------
Cash flows from operating activities:
Net loss .................................................................. $ (1,223) $ (4,133)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization of intangibles ............................ 489 1,618
Provision for bad debts ................................................. 8 (2)
Provision for excess and obsolete inventory ............................. (1) 6
Loss on disposal of assets .............................................. -- 1
Amortization of deferred stock compensation ............................. 20 38
Non-cash restructuring expense .......................................... -- (85)
Changes in assets and liabilities:
Accounts receivable ................................................... (619) (126)
Inventories ........................................................... (179) (42)
Prepaid expenses and other assets ..................................... (676) (166)
Accounts payable ...................................................... 114 (271)
Accrued restructuring liabilities ..................................... (1,040) (852)
Deferred revenue ...................................................... 649 (129)
Accrued liabilities and other ......................................... (1,065) (1,571)
Other long-term liabilities ........................................... (15) 36
-------- --------
Net cash used in operating activities .............................. (3,538) (5,678)
-------- --------
Cash flows from investing activities:
Purchase of property and equipment ........................................ (384) (33)
Purchase of marketable securities ......................................... (6,148) (17,671)
Sale of marketable securities ............................................. 5,932 3,501
Other, net ................................................................ (80) (69)
-------- --------
Net cash used in investing activities .............................. (680) (14,272)
-------- --------
Cash flows from financing activities:
Payments on notes payable ................................................. -- (42)
Proceeds from issuance of common stock, net ............................... 2,451 165
-------- --------
Net cash provided by financing activities .......................... 2,451 123
-------- --------
Effect of exchange rate changes on cash and cash equivalents ............... 3 (3)
-------- --------
Net decrease in cash and cash equivalents .................................. (1,764) (19,830)
-------- --------
Cash and cash equivalents, beginning of period ............................. 6,303 35,148
-------- --------
Cash and cash equivalents, end of period ................................... $ 4,539 $ 15,318
======== ========
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 31, 2003, filed with the SEC
on October 14, 2003. The condensed consolidated balance sheet as of July 31,
2003 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 months ended October 31, 2003 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, 2004.
2. Summary of Significant Accounting Policies
Use of Estimates in Preparation of Consolidated Financial Statements
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted by the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of such financial statements, as well as the reported
amounts of revenue and expenses during the periods indicated. Actual results
could differ from those estimates.
Principles of Consolidation
These consolidated financial statements include the accounts of VA and its
wholly-owned and majority-owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation. In September
2000, the Company acquired 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%. 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.
Foreign Currency Translation
The functional currency of all the Company's foreign subsidiaries is the
country's local currency. Balance sheet accounts are translated into U.S.
dollars at exchange rates prevailing at balance sheet dates. Revenue and
expenses are translated into U.S. dollars at average rates for the period. Gains
and losses resulting from translation are charged or credited in comprehensive
income as a component of stockholders' equity. As of October 31, 2003 the
Company did not hold any foreign currency derivative instruments.
Segment and Geographic Information
Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures
about Segments of an Enterprise and Related Information", establishes standards
for reporting information regarding operating segments in annual financial
statements and requires selected information for those segments to be presented
in interim financial reports issued to stockholders. SFAS No. 131 also
establishes standards for related disclosures about products and services and
geographic areas. Operating segments are identified as
6
components of an enterprise about which separate discrete financial information
is available for evaluation by the chief operating decision-maker, or
decision-making group, in making decisions how to allocate resources and assess
performance. The Company's chief decision-making group, as defined under SFAS
No. 131, is comprised of the Chief Executive Officer and the executive team. The
Company operates as two reportable business segments: software and online. Due
to the significant amount of shared operating resources that are utilized by
both of the business segments, the Company only reports segment information for
revenues and cost of sales.
The Company markets its products in the United States through its direct
sales force. Revenues for each of the three months ended October 31, 2003 and
October 26, 2002 were primarily generated from sales to end users in the United
States.
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 revenue represents $815,000 and
$711,000, or 14.1% and 14.0%, of total revenue for the three months ended
October 31, 2003 and October 26, 2002, respectively.
Revenues from software license agreements follows American Institute of
Certified Public Accountants ("AICPA") Statement of Position ("SOP") 97-2, are
recognized when objective, persuasive evidence of an agreement exists, delivery
of the product has occurred, provided the arrangement does not require
significant customization of the software, the fee is fixed or determinable and
collectibility is probable.
For perpetual licenses, the Company uses the residual method to recognize
revenues. Under the residual method, the fair value of the undelivered elements
is deferred and the remaining portion of the arrangement fee is recognized as
revenue. If evidence of the vendor specific fair value of one or more
undelivered elements does not exist, revenues are deferred and recognized when
delivery of those elements occurs or when fair value can be established. A
typical perpetual license agreement may include professional services,
maintenance and training. Revenue from non-essential professional services is
recognized as the work is performed based on fair value. When an agreement
includes professional services that are significant or essential to the
functionality of the software, the Company uses the percentage of completion
contract accounting method for the entire arrangement, including license fees.
Maintenance revenues are recognized ratably over the term of the maintenance
period (generally one year). Software maintenance agreements provide technical
support and the right to unspecified updates/upgrades on an
if-and-when-available basis. Fair value for the ongoing maintenance obligations
are based upon separate sales or maintenance sold to customers or upon renewal
rates quoted in the contract, when these exist. The unrecognized portion of
amounts paid in advance for licenses and services are recorded as deferred
revenue.
For term arrangements, which include licenses and bundled post-contract
support ("PCS"), the Company uses ratable revenue recognition. Under ratable
revenue recognition, the only undelivered element is PCS and objective evidence
of fair value of PCS does not exist. If the term license agreement includes
multiple elements (such as training and non-essential professional services),
then the Company defers revenue until all elements except PCS are delivered, at
which time revenue is recognized ratably over the remaining contract term.
If the fee due from the customer is not fixed or determinable, 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 120 days, the Company presumes the
fee not to be fixed or determinable.
Online Revenues
Online revenues include online advertising and e-commerce revenues. Total
online revenues of $5.0 million and $4.2 million represented 85.4% and 81.9% of
total revenues for the three months ended October 31, 2003 and October 26, 2002,
respectively. Online advertising revenues of $2.3 million and $2.3 million
represented 39.7% and 45.0% of total revenues for the three months ended October
31, 2003 and October 26, 2002, respectively. Online advertising revenues
included $0.5 million of barter revenue for each of the three months ended
October 31, 2003 and October 26, 2002. E-commerce revenues of $2.7 million and
$1.9 million represented 46.6% and 36.9% of total revenues for the three months
ended October 31, 2003, and October 26, 2002, respectively.
Advertising revenues are derived from the sale of advertising space on our
various Web sites. Advertising revenues are
7
recognized over the period in which the advertisements are displayed, provided
that no significant obligations remain and collection of the receivable is
reasonable assured. Our obligations typically include guarantees of a minimum
number of "impressions" (times that an advertisement is viewed by users of our
online services over a specified period of time). To the extent that minimum
guaranteed impressions are not met, the Company does not recognize the
corresponding revenues until the guaranteed impressions are achieved. Barter
revenue transactions are recorded at their estimated fair value based on the
Company's historical experience of selling similar advertising for cash in
accordance with Emerging Issues Task Force ("EITF") Issue 99-17, "Accounting for
Advertising Barter Transactions." The Company broadcasts banner advertising in
exchange for similar banner advertising on third party Web sites.
E-commerce revenues are derived from the online sale of consumer goods and
digital animations. E-commerce revenues from the sale of consumer goods are
recognized in accordance with SEC Staff Accounting Bulletin ("SAB") No. 101,
"Revenue Recognition in Financial Statements." Under SAB 101, product revenues
are recognized when persuasive evidence of an arrangement exists, delivery has
occurred, the sale price is fixed or 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. The majority of the revenues derived from
digital animation sales are related to membership arrangements. As a result, we
recognize the value ratably over the term of the contract, normally 3 or 12
months.
Other Revenues
Other revenues are derived from the Company's former hardware, customer
support, and hardware-related professional services businesses. Other revenues
represent $31,000 and $209,000 or 0.5% and 4.1% of total revenues, for the three
months ended October 31, 2003 and October 26, 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 can be reasonably
estimated. The Company records any payments received prior to revenue
recognition as deferred revenue. For the three months ended October 31, 2003,
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.
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
8
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 months ended October 31, 2003, and October 26, 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
October 31, October 26,
2003 2002
-------- --------
Net loss as reported .......................................................... $ (1,223) $ (4,133)
Add back employee stock-based compensation expense related to
stock options included in reported net loss ................................ 20 38
Less employee stock-based compensation expense determined under
fair value based method for all employee stock option awards, net of related
tax effects ................................................................. (1,402) (2,300)
-------- --------
Pro forma net ............................................................... $ (2,605) $ (6,395)
-------- --------
Shares used in computing basic and diluted net loss per share .................. 56,255 53,717
======== ========
Reported Basic and diluted net loss per ....................................... $ (0.02) $ (0.08)
-------- --------
Pro forma basic and diluted net loss per share ................................. $ (0.05) $ (0.12)
-------- --------
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:
Stock option Plans ESPP Plans
For The Three Months Ended For The Three Months Ended
---------------------------------- -------------------------------------
October 31, October 26, October 31, October 26,
2003 2002 2003 2002
---------------- ------------- ----------------- ---------------
Expected life (years).................. 5.09 4.74 0.49 0.50
Risk-free interest rate................ 3.3% 2.9% 1.1% 1.2%
Volatility............................. 1.1% 1.1% 1.0% 1.0%
Dividend yield......................... None None None None
Goodwill and Intangibles
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 months ended
October 31, 2003 that would indicate a possible impairment in the carrying value
of intangible assets at October 31, 2003.
The changes in the carrying amount of the intangible assets are as follows
(in thousands):
As of October 31, 2003 As of July 31, 2003
---------------------------- ----------------------------
Gross Carrying Accumulated Gross Carrying Accumulated
Amount Amortization Amount Amortization
-------- -------- -------- --------
Domain and trade .............................. $ 5,922 $ (5,904) $ 5,922 $ (5,901)
names
Purchased technology .......................... 2,534 (2,534) 2,534 (2,534)
-------- -------- -------- --------
Total intangible assets ................. 8,456 (8,438) 8,456 (8,435)
Goodwill ...................................... 60,362 (60,362) 60,362 (60,362)
-------- -------- -------- --------
Total changes in Goodwill and intangible assets $ 68,818 $(68,800) $ 68,818 $(68,797)
======== ======== ======== ========
9
The aggregate amortization expense of intangible assets, net of
restructuring charges was $3,000 and $644,000 for the three-month periods ending
October 31, 2003 and October 26, 2002, respectively. The estimated total
amortization expense of acquired intangible assets is $12,700 and $9,500 for the
fiscal years ending July 31, 2004 and July 31, 2005, respectively.
Inventories
Inventories related to our online operations consist of finished goods that
are valued using the average cost method. Provisions, when required, are made to
reduce excess and obsolete inventories to their estimated net realizable values.
Concentrations of Credit Risk and Significant Customers
The Company's investments are held with two reputable financial
institutions. Both institutions are headquartered in the United States.
Financial instruments that potentially subject the Company to concentrations of
credit risk consist primarily of cash and trade receivable. The Company provides
credit, in the normal course of business, to a number of companies and performs
ongoing credit evaluations of its customers. As of October 31, 2003, one
customer accounted for 11.2% of gross accounts receivables outstanding. The
receivable is less than 31 days old and the Company believes the receivable is
fully collectable.
For the three months ended October 31, 2003, no single customer accounted
for more than 10% of VA's net revenues. For the three months ended October 26,
2002 one customer, Intel Corporation, accounted for approximately 19.7% of net
revenues.
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 software and
online 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 October 31, 2003, the Company had
an accrual of approximately $13.8 million outstanding related to these
non-cancelable leases, all of which was originally included in operating
expenses. The non-cancelable leases will expire by the end of fiscal year 2010.
The Company recorded a $17,000 net credit in restructuring expenses in the
consolidated statement of operations for the three months ended October 31,
2003. The $17,000 net credit was a result of sublease income earned from a
non-related party.
Below is a summary of the restructuring charges in operating expenses (in
thousands):
Total Charged
Total Total To Operations Total
Total Charged Charged To Charged To Quarter ended Cash Restructuring
To Operations Operations Operations October 31, Receipts/ Liabilities at
Fiscal 2001 Fiscal 2002 Fiscal 2003 2003 (Payments) October 31, 2003
------------- ----------- ----------- ------------- ---------- ----------------
Cash Provisions:
Other special charges relating to
restructuring activities ........... $ 2,159 $ (888) $ 78 $ -- $ (1,349) $ --
Facilities charges ................... 6,584 9,401 191 (17) (2,310) $ 13,849
Employee severance and other related
charges ............................ 3,498 1,997 37 -- (5,532) --
-------- -------- -------- -------- ---------
Total cash provisions ............ 12,241 10,510 306 (17) $ (9,191) $ 13,849
-------- -------- -------- -------- ======== =========
Non-cash:
Write-off of goodwill and intangibles 59,723 30,632 -- --
Write-off of other special charges
relating to restructuring activities 4,434 5,442 (553) --
Write-off of accelerated options from
terminated employees ............... 1,352 -- -- --
Acceleration of deferred stock
compensation ....................... 35,728 352 (16) --
-------- -------- --------
Total non-cash provisions ........ 101,237 36,426 (569) --
-------- -------- --------
Total provisions ................. $113,478 $ 46,936 $ (263) $ (17)
======== ======== ======== ========
10
Below is a summary of the changes to the restructuring liability (in thousands):
Balance at Charged to Balance at
Beginning Costs and End
Changes in the total accrued restructuring liability of Period Expenses Deductions of Period
----------------------------------------------------- --------- ---------- ---------- ----------
For the year ended July 28, 2001.............................. $ -- $ 12,241 $ (2,728) $ 9,513
For the year ended July 27, 2002.............................. $ 9,513 $ 10,510 $ (2,029) $ 17,994
For the year ended July 31, 2003.............................. $ 17,994 $ 306 $ (3,411) $ 14,889
For the quarter ended October 26, 2002........................ $ 17,994 $ (15) $ (837) $ 17,142
For the quarter ended October 31, 2003........................ $ 14,889 $ (17) $ (1,023) $ 13,849
Short Long Total
Components of the total accrued restructuring liability Term Term Liability
------------------------------------------------------- ----------- ---------- -----------
For the year ended July 28, 2001.............................. $ 3,135 $ 6,378 $ 9,513
For the year ended July 27, 2002.............................. $ 3,397 $ 14,597 $ 17,994
For the year ended July 31, 2003.............................. $ 4,117 $ 10,772 $ 14,889
For the quarter ended October 26, 2002........................ $ 3,782 $ 13,360 $ 17,142
For the quarter ended October 31, 2003........................ $ 3,577 $ 10,272 $ 13,849
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
------------------------
October 31, October 26,
2003 2002
-------- --------
Net loss ...................................................... $ (1,223) $ (4,133)
======== ========
Basic and diluted:
Weighted average shares of common stock outstanding ......... 56,255 53,734
Less: Weighted average shares subject to repurchase ......... -- (17)
-------- --------
Shares used in computing basic and diluted net loss per share 56,255 53,717
======== ========
Basic and diluted net loss per share ........................ $ (0.02) $ (0.08)
======== ========
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):
Three Months Ended
------------------------
October 31, October 26,
2003 2002
------ ------
Anti-dilutive securities:
Options to purchase common stock ......................... 8,347 11,511
Common stock subject to repurchase ....................... -- 5
------ ------
Total 8,347 11,516
====== ======
11
5. 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 months ended October 31, 2003 and October
26, 2002, total comprehensive loss was approximately $1.3 million and $4.2
million, respectively.
6. Segment and Geographic Information
The accounting policies of the segments are the same as those described in
the summary of significant accounting polices. There are no intersegment sales.
Our chief operating decision maker evaluates performance based on each segment's
revenue and gross margin rather than profit or similar measure. The Company's
assets and liabilities are not discretely allocated or reviewed by segment.
Total
(in thousands) Software Online Other Company
--------- ---------- ----------- ----------
Three Months Ended October 31, 2003
Revenue from external customers................. $ 815 $ 4,951 $ 31 $ 5,797
Cost of revenues................................ $ 595 $ 2,655 $ -- $ 3,250
--------- ---------- ----------- ----------
Gross margin.................................... $ 220 $ 2,296 $ 31 $ 2,547
Three Months Ended October 26, 2002
Revenue from external customers................. $ 711 $ 4,155 $ 209 $ 5,075
Cost of revenues................................ $ 593 $ 2,311 $ (157) $ 2,747
--------- ----------- ----------- ----------
Gross margin.................................... $ 118 $ 1,844 $ 366 $ 2,328
7. 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. A proposal has been made for the settlement and release of claims
against the issuer defendants, including VA Software. The settlement is subject
to a number of conditions, including approval of the proposed settling parties
and the court. If the settlement does not occur, and litigation against the
Company continues, the Company believes it has meritorious defenses and intends
to defend the case vigorously.
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
8. Recent Accounting Policies
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." SFAS
No. 150 addresses certain financial instruments that, under previous guidance,
could be accounted for as equity, but now must be classified as liabilities in
statements of financial position. These financial instruments include: 1)
mandatory redeemable financial instruments, 2) obligations to repurchase the
issuer's equity shares by transferring assets, and 3) obligations to issue a
variable number of shares. SFAS No. 150 is effective for all financial
instruments entered into or modified after May 31, 2003, and otherwise effective
at the beginning of the first interim period beginning after June 15, 2003. The
implementation of SFAS No. 150 is not expected to have a material effect on the
Company's consolidated financial statements.
9. 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 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 October 31, 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 October 31, 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
October 31, 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 October 31, 2003. Accordingly, the
Company has a liability of approximately $12,000 recorded for these agreements
as of October 31, 2003.
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 the market for collaborative software development
applications; the future functionality, business potential, demand for,
efficiencies created by and adoption of SourceForge; demand for online
advertising; management's strategy, plans and objectives for future operations;
the
13
impact of our restructuring and the amount of cash utilized by operations; our
intent to continue to invest significant resources in 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 develop market and support a software application
known as SourceForge Enterprise Edition ("SourceForge") and also own and operate
the Open Source Development Network, Inc. ("OSDN"), a network of Internet Web
sites.
SourceForge is a Web-based, proprietary software application designed for
corporate and public-sector information technology ("IT") professionals and
software engineering organizations. SourceForge enables IT and software
engineering organizations to manage application development more effectively.
SourceForge combines software development and collaboration tools with the
ability to track, measure, and report on software project activity in real-time.
With SourceForge, developers and project managers gain access to the information
they need to reduce risk and become more productive. SourceForge is a relatively
new product and additional development and enhancements are expected in the
future.
OSDN is a network of media and e-commerce Internet sites serving the IT
professional and the software development communities. As of December 1, 2003,
OSDN reaches 12 million unique visitors and serves more than 225 million page
views per month. Our OSDN Web sites include:
o SourceForge.net, our flagship Web site and software development center.
As of December 1, 2003, SourceForge.net was the development home for
more than 72,000 software development projects and had more than 740,000
registered users.
o Slashdot.org, our leading discussion site for technically-inclined
individuals. Slashdot is dedicated to providing the IT and software
development communities with cutting-edge technology, science and
culture news and interactive commentary.
o ThinkGeek.com, our e-commerce site, which provides online sales of a
variety of retail products of interest to the software development and
IT communities.
o Linux.com, our comprehensive Web site for Linux and open source news and
information. Linux.com caters to business and IT managers looking for
migration strategies to Linux.
o freshmeat.net, one of the Internet's most comprehensive indices of
downloadable Linux, Unix and cross-platform software.
o NewsForge.com, the online newspaper of record for Linux and open source
software.
o ITManagersJournal.com, a Web site delivering strategic and technical
information to help top-level IT professionals implement
enterprise-level Open Source and proprietary architecture, applications,
and infrastructure solutions.
o Animation Factory.com, a source for three-dimensional art, animations
and presentations. Animation Factory offers a dynamic collection of easy
to use animations that work can be added to email, Web pages and
presentations.
Results of Operations
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 nine quarters of operations focused on building our
application software business, and accordingly have a
14
limited 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 our online business 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.
The following table sets forth our operating results for the periods
indicated as a percentage of net revenues, represented by selected items from
the unaudited condensed consolidated statements of operations. This table should
be read in conjunction with the consolidated financial statements and the
accompanying notes included in this Form 10-Q.
Three Months Ended
October 31, October 26,
2003 2002
----- -----
Consolidated Statements of Operations Data:
Software revenues ............................... 14.1% 14.0%
Online revenues ................................. 85.4 81.9
Other revenues .................................. 0.5 4.1
----- -----
Net revenues ................................. 100.0% 100.0%
Software cost of revenues ....................... 10.3 11.7
Online cost of revenues ......................... 45.8 45.5
Other cost of revenues .......................... -- (3.1)
----- -----
Cost of revenues ............................. 56.1 54.1
----- -----
Gross margin .................................... 43.9 45.9
----- -----
Operating expenses:
Sales and marketing .......................... 41.3 45.7
Research and development ..................... 31.5 40.3
General and administrative ................... 12.5 34.6
Restructuring costs and other special charges (0.3) (0.3)
Amortization of deferred stock compensation .. 0.3 0.7
Amortization of goodwill and intangible assets 0.1 12.7
----- -----
Total operating expenses ................... 85.4 133.7
----- -----
Loss from operations ............................ (41.5) (87.8)
Interest Income, net ............................ 4.3 7.0
Interest and other income, net .................. 16.0 (0.6)
----- -----
Net loss ........................................ (21.2)% (81.4)%
===== =====
Net Revenues
During the fourth quarter of fiscal 2003, two separate businesses emerged
and as of July 31, 2003, we operate as two reportable business segments:
software and online.
Our net revenues increased to $5.8 million for the three months ended
October 31, 2003, from $5.1 million for the three months ended October 26, 2002.
The $0.7 million increase in net revenues was due primarily to an increase in
our online and software businesses, offset by a decrease in other revenue
derived from our exited hardware business.
For the three months ended October 31, 2003, no single customer accounted
for more than 10% of VA's net revenues. For the three months ended October 26,
2002 one customer, Intel Corporation, accounted for approximately 19.7% of net
revenues. Going forward, we do not anticipate that any one customer will
represent more than 10% of net revenues.
Software Revenues
Software revenues are derived from our application software business and
include software licenses, professional services, maintenance, support and
training. Software revenues represent $0.8 million, or 14.1%, and $0.7 million,
or 14.0%, of total revenues for the three months ended October 31, 2003 and
October 26, 2002, respectively. The increase in software revenues is primarily
due to the year over year increase in our installed customer base. [Consider
discussing whether these increases were the result of additional new customers
or greater orders from existing customers.]
Revenues from software license agreements are accounted for in accordance
with American Institute of Certified Public
15
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 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 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 where we are unable to establish fair value for the
individual contract components such as software license, maintenance and
support, we recognize the entire contract value ratably over the term of the
contract. 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 presume the fee not to be fixed or determinable.
Online Revenues
Online revenues include online advertising and e-commerce revenues. Total
online revenues of $5.0 million and $4.2 million represented 85.4% and 81.9% of
total revenues for the three months ended October 31, 2003 and October 26, 2002,
respectively. Online advertising revenues of $2.3 million and $2.3 million
represented 39.7% and 45.0% of total revenues for the three months ended October
31, 2003 and October 26, 2002, respectively. Online advertising revenues
included $0.5 million of barter revenue for each of the three months ended
October 31, 2003 and October 26, 2002. E-commerce revenues of $2.7 million and
$1.9 million represented 46.6% and 36.9% of total revenues for the three months
ended October 31, 2003 and October 26, 2002, respectively. The increase in
e-commerce revenues was primarily due to an increase in our online community,
web site enhancements and an increase in the number of product offerings sold on
our sites.
Advertising revenues are derived from the sale of advertising space on our
various Web sites. We recognize advertising revenues over the period in which
the advertisements are displayed, provided that persuasive evidence of an
arrangement exists, no significant obligations remain, the fee is fixed or
determinable, 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). To the
extent that minimum guaranteed impressions are not met in the specified time
frame, we do not recognize the corresponding revenues until the guaranteed
impressions are achieved. We record barter revenue transactions at their
estimated fair value based on our historical experience of selling similar
advertising for cash in accordance with Emerging Issues Task Force ("EITF")
Issue 99-17, "Accounting for Advertising Barter Transactions." We broadcast
banner advertising in exchange for similar banner advertising on third party Web
sites.
E-commerce revenues are derived from the online sale of consumer goods and
digital animations. We recognize e-commerce revenues from the sale of consumer
goods in accordance with SEC Staff Accounting Bulletin ("SAB") No. 101, "Revenue
Recognition in Financial Statements." Under SAB 101, product revenues are
recognized when persuasive evidence of an arrangement exists, delivery has
occurred, the sale price is fixed 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. The majority of the revenues derived from digital animation sales are
related to membership arrangements. As a result, we recognize the value ratably
over the term of the contract, normally 3 or 12 months.
16
Other Revenues
Other revenues are derived from our former hardware, customer support, and
professional services businesses. Other revenues represent $31,000 or 0.5%, of
total revenues for the three months ended October 31, 2003 and $0.2 million or
4.1% for the three months ended October 26, 2002.
Our revenue recognition policy related to our former hardware systems
business follows SEC SAB No. 101, "Revenue Recognition in Financial Statements."
Under SAB No. 101, we recognized product revenues from the sale of Linux-based
servers, components, and desktop computers when persuasive evidence of an
arrangement existed, delivery occurred, the sales price was fixed or
determinable and collectibility was reasonably assured. In general, we
recognized product revenue upon shipment of the goods. We did not grant our
customers any rights to return products.
We recognized revenues from customer support services, including on-site
maintenance and technical support on a pro-rata basis over the term of the
related service agreement. We recognized revenues from professional service
contracts upon completion of the project, or using the percentage of completion
method of the project where project costs could be reasonably estimated. We
recorded any payments received prior to revenue recognition as deferred revenue.
Cost of Revenues
Cost of software revenues were $0.6 million for each of the three months
ended October 31, 2003 and October 26, 2002. Cost of software revenues were
10.3% and 11.7% of total revenues for the three months ended October 31, 2003
and October 26, 2002, respectively. This percentage decrease was primary related
to an increase in total revenue. Software margin increased to $0.2 million for
the three months ended October 31, 2003, from $0.1 million for the three months
ended October 26, 2002. Software gross margin was 3.8% and 2.3% of total
revenues for the three months ended October 31, 2003 and October 26, 2002,
respectively. This percentage increase was primary related to an increase in
total revenue
Cost of online revenues increased to $2.7 million for the three months
ended October 31, 2003, from $2.3 million for the three months ended October 26,
2002. Cost of online revenues was 45.8% and 45.5% of total revenues for the
three months ended October 31, 2003 and October 26, 2002 respectively. The
increase in cost of online revenues was primary due to the increase in
e-commerce revenue which carries a higher variable cost of revenues than our
other businesses. Online gross margin increased to $2.3 million for the three
months ended October 31, 2003, from $1.8 million for the three months ended
October 26, 2002. Online gross margin was 39.6% and 36.3% of total revenues for
the three months ended October 31, 2003 and October 26, 2002, respectively. The
increase in online gross margin was related to an increase in total revenue
partially offset by an increase in cost of online 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 were $2.4 million for the three months ended
October 31, 2003 and $2.3 million for the three months ended October 26, 2002.
The 4% increase was primarily related to increased marketing activities related
to our online business. Sales and marketing expenses were 41.3% and 45.7% of
total revenues for the three months ended October 31, 2003 and October 26, 2002,
respectively. This decrease as a percentage of net revenues was primarily
related to our increase in revenue. Going forward we expect sales and marketing
expenses to increase in absolute dollars but decrease as a percentage of net
revenues.
Research and Development Expenses
Research and development expenses consist primarily of salaries and related
expenses for software engineers.
Research and development expenses decreased by 10% to $1.8 million for the
three months ended October 31, 2003 from $2.0 million for the three months ended
October 26, 2002. The $0.2 million decrease was primarily due to a $0.1 million
decrease in salary expense and a $0.1 million decrease in outside contractor
expense. Average headcount decreased to 39 during the three months ended October
31, 2003 from an average headcount of 44 during the three months ended October
26, 2002. Research and development expenses as a percentage of net revenues
decreased to 31.5% for the three months ended October 31, 2003 from 40.3% for
the three months ended October 26, 2002. This decrease as a percentage of net
revenues was the result of both lower expenses and increased
17
revenues. Going forward we expect research and development expenses to nominally
increase in absolute dollars but to decrease as a percentage of net revenues.
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 by 61% to $0.7 million for the
three months ended October 31, 2003 from $1.8 million for the three months ended
October 26, 2002. The $1.1 million dollar decrease was primarily due to a $0.9
million reversal of accrued legal expenses reserved for securities litigation
expenses that were ultimately paid by a Company insurer, and a $0.3 million
reversal of legal expenses related to a lawsuit that was favorably resolved
during the quarter, partially offset by a $0.1 million increase in direct labor
costs. General and administrative expenses as a percentage of net revenues
decreased to 12.5% for the three months ended October 31, 2003 from 34.6% for
the three months ended October 26, 2002. This decrease as a percentage of net
revenues was primarily the result of lower expenses. As a result of the one-time
expense reductions noted above, going forward, we expect G&A expenses to
increase substantially both in absolute dollars and as a percentage of net
revenues.
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 software and online
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 October 31, 2003, we had an accrual of approximately $13.8
million outstanding related to these non-cancelable leases, all of which was
originally included in operating expenses.
We recorded a $17,000 net credit in restructuring expenses in the
consolidated statement of operations for the three ended months October 31,
2003. The $17,000 net credit was related to sublease income received from a
non-related party.
Below is a summary of the restructuring charges in operating expenses (in
thousands):
Total Charged
Total Total To Operations Total Restructuring
Total Charged Charged To Charged To Quarter ended Cash Liabilities at
To Operations Operations Operations October 31, Receipts/ October 31,
Fiscal 2001 Fiscal 2002 Fiscal 2003 2003 (Payments) 2003
------- -------- -------- -------- -------- --------
Cash Provisions:
Other special charges relating to
restructuring activities ........... $ 2,159 $ (888) $ 78 $ -- $ (1,349) $--
Facilities charges ................... 6,584 9,401 191 (17) (2,310) $ 13,849
Employee severance and other related
charges ............................ 3,498 1,997 37 -- (5,532) --
------- -------- -------- -------- --------
Total cash provisions ........... 12,241 10,510 306 (17) $ (9,191) $ 13,849
------- -------- -------- -------- -------- --------
Non-cash:
Write-off of goodwill and intangibles 59,723 30,632 -- --
Write-off of other special charges
relating to restructuring activities 4,434 5,442 (553) --
Write-off of accelerated options from
terminated employees ............... 1,352 -- -- --
Acceleration of deferred stock
compensation ....................... 35,728 352 (16) --
-------- -------- --------
Total non-cash provisions ....... 101,237 36,426 (569) --
-------- -------- --------
Total provisions ................ $113,478 $ 46,936 $ (263) $ (17)
======== ======== ======== ========
18
Below is a summary of the changes to the restructuring liability (in thousands):
Balance at Charged to Balance at
Beginning Costs and End
Changes in the total accrued restructuring liability of Period Expenses Deductions of Period
----------------------------------------------------- ---------- ---------- ---------- ----------
For the year ended July 28, 2001............................... $ -- $ 12,241 $ (2,728) $ 9,513
For the year ended July 27, 2002............................... $ 9,513 $ 10,510 $ (2,029) $ 17,994
For the year ended July 31, 2003............................... $ 17,994 $ 306 $ (3,411) $ 14,889
For the quarter ended October 26, 2002......................... $ 17,994 $ (15) $ (837) $ 17,142
For the quarter ended October 31, 2003......................... $ 14,889 $ (17) $ (1,023) $ 13,849
Short Long Total
Components of the total accrued restructuring liability Term Term Liability
------------------------------------------------------- ---------- ---------- ----------
For the year ended July 28, 2001............................... $ 3,135 $ 6,378 $ 9,513
For the year ended July 27, 2002............................... $ 3,397 $ 14,597 $ 17,994
For the year ended July 31, 2003............................... $ 4,117 $ 10,772 $ 14,889
For the quarter ended October 26, 2002......................... $ 3,782 $ 13,360 $ 17,142
For the quarter ended October 31, 2003......................... $ 3,577 $ 10,272 $ 13,849
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 $20,000 during the three months ended October 31,
2003, compared to $38,000 during the three months ended October 26, 2002. We
expect amortization of deferred stock compensation, in absolute dollars, to
decrease through fiscal year 2004.
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 $3,000 and $0.6 million of intangibles for the
three months ended October 31, 2003 and October 26, 2002, respectively. The
estimated total amortization expense of acquired intangible assets is $12,700
and $9,500 for the fiscal years ending July 31, 2004 and July 31, 2005,
respectively.
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 changes occurred
during the three months ended October 31, 2003 that would indicate a possible
impairment in the carrying value of intangible assets at October 31, 2003.
Interest and Other Income, Net
Interest income, net, includes income from our cash investments net of
interest expense. Net interest income decreased to $0.2 million for the three
months ended October 31, 2003 from $0.4 million for the three months ended
October 26, 2002. This decrease was primarily related to our lower average cash
balance coupled with the year over year interest rate decline.
Other income, net, includes items such as legal settlement proceeds net of
other expenses. Other income, net increased to $0.9 million for the three months
ended October 31, 2003 from a $28,000 expense for the three months ended October
26, 2002. The $0.9 million increase in interest and other income was due to a
$1.0 million legal settlement and a $0.3 million business recovery payment
related to the World Trade Center disaster, partially offset by a decrease $0.3
million of other expenses related to our exited hardware business.
19
Income Taxes
As of October 31, 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 October 31, 2003, our available capital resources totaled $37.3
million, comprised of marketable securities of $32.8 million and cash and cash
equivalents of $4.5 million. As of July 31, 2003, our available capital
resources totaled $38.8 million, comprised of $32.5 million in marketable
securities and $6.3 million in cash and cash equivalents
For the three months ended October 31, 2003, we used $3.5 million in cash
for operating activities, compared to $5.7 million for the three months ended
October 26, 2002. This represents a decrease of 38.6% and is primarily due to
the reduction in our net loss. Net loss for the three months ended October 31,
2003 was $1.2 million compared to a net loss of $4.1 million for the three
months ended October 26, 2002. The decrease in net loss was primarily due to
reversal of a $0.9 million reserve for securities litigation expenses that were
ultimately paid by a Company insurer, $1.3 million from the settlement of
contract litigation, $0.6 million decrease in amortization of intangible assets
expense and $0.2 million increase in gross margin. Non-cash items consisting
primarily of depreciation and amortization of fixed assets and intangibles,
provision for bad debts and obsolete inventory, loss on disposal of assets,
non-cash restructuring and compensation expense were $0.5 million and $1.6
million for the three months ended October 31, 2003 and October 26, 2002,
respectively. The $1.1 million decrease was primarily related to a decrease in
depreciation and amortization expense. Other significant operating activities
during the three months ended were increases in accounts receivable, inventory,
prepaid assets and other assets and decreases in accounts payable, accrued
restructuring liabilities, and accrued liabilities and other.
For the three months ended October 31, 2003, we used $0.7 million in cash
for investing activities, compared to the use of $14.3 million for the three
months ended October 26, 2002. During the three months ended October 31, 2003 we
purchased $0.4 million in fixed assets and $6.1 million in marketable securities
and sold $5.9 million in marketable securities. Cash used for investing
activities was significantly higher for the three months ended October 26, 2002
when we purchased $17.7 million in marketable securities and sold $3.5 million
in marketable securities, due to implementing 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.
For the three months ended October 31, 2003, we generated $2.5 million in
cash from financing activities, compared to $0.1 million for the three months
ended October 26, 2002. The increase was related to cash generated from the
issuance of common stock to our employees. 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 three months ended October 31, 2003 and October 26, 2002, exchange
rate changes had an immaterial effect on cash and cash equivalents. 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 October 31, 2003 and July 31, 2003, we had outstanding letters of
credit issued under a line of credit of approximately $0.9 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.
20
Future payments due under debt and lease obligations as of October 31, 2003
are as follows (in thousands):
Gross Net
Operating Sublease Operating
Leases Income Leases
------- ------- -------
2004 .......................... $ 4,837 $ 512 $ 4,325
2005 .......................... 5,002 662 4,340
2006 .......................... 3,733 151 3,582
2007 .......................... 3,511 -- 3,511
2008 .......................... 3,616 -- 3,616
Thereafter .................... 6,905 -- 6,905
------- ------- -------
Total minimum lease payments $27,604 $ 1,325 $26,279
======= ======= =======
Our liquidity and capital requirements depend on numerous factors, including
market acceptance of our products, the resources we devote to developing,
marketing, selling and supporting our 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 2005 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 2005. 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 2005. 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 31, 2003.
Recent Accounting Pronouncements
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." SFAS
No. 150 addresses certain financial instruments that, under previous guidance,
could be accounted for as equity, but now must be classified as liabilities in
statements of financial position. These financial instruments include: 1)
mandatory redeemable financial instruments, 2) obligations to repurchase the
issuer's equity shares by transferring assets, and 3) obligations to issue a
variable number of shares. SFAS No. 150 is effective for all financial
instruments entered into or modified after May 31, 2003, and otherwise effective
at the beginning of the first interim period beginning after June 15, 2003. The
implementation of SFAS No. 150 is not expected to have a material effect on our
consolidated financial statements.
21
Risk Factors
INVESTORS SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW BEFORE MAKING
AN INVESTMENT DECISION. IN ADDITION, THESE RISKS ARE NOT THE ONLY ONES FACING
OUR COMPANY. ADDITIONAL RISKS OF WHICH WE ARE NOT PRESENTLY AWARE OR THAT WE
CURRENTLY BELIEVE ARE IMMATERIAL MAY ALSO IMPAIR OUR BUSINESS OPERATIONS. OUR
BUSINESS COULD BE HARMED BY ANY OF THESE RISKS. THE TRADING PRICE OF OUR COMMON
STOCK COULD DECLINE DUE TO ANY OF THESE RISKS, AND INVESTORS MAY LOSE ALL OR
PART OF THEIR INVESTMENT.
Risks Related To Our Software Business
Because the market for our SourceForge 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 and our ability to license our software in sufficient quantities
and under acceptable terms. 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 for 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 software 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 continued 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. There can be no
assurance that we will be successful in marketing, licensing, upgrading and
supporting SourceForge. Our failure to do so could adversely affect our business
and operating results.
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 financial and personnel resources. As a result, rather than license
SourceForge, our target customers may develop collaborative software development
applications internally, including ad hoc development of 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.
If we do not develop and enhance SourceForge to keep pace with technological,
market, and industry changes, our software revenue 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 software revenues may not grow or may decline. We believe the
success of our software business will become increasingly dependent on our
ability to:
o support multiple platforms, including Linux, commercial UNIX, Microsoft
Windows and Apple Mac OS X;
o use the latest technologies to continue to support Web-based
collaborative software development; and
o continually support the rapidly changing standards, tools and
technologies used in software development.
In addition, our software products are complex and may contain undetected
defects or errors when first introduced or as new versions are released.
Although we have not experienced adverse effects resulting from any software
errors, we cannot be sure that,
22
despite testing by us and our clients, defects or errors will not be found in
new products after commencement of commercial shipments, resulting in loss of or
delay in market acceptance, which could seriously harm our business.
Our application software 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 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 sell SourceForge licenses 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 we are
selected as 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 future introductions 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.
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 software 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.
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 SourceForge. 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
23
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.
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
collaborative software development 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 may also 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.
24
Risks Related To Our Online Business
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 our 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.
Decreases or delays in advertising spending due to general economic conditions
could harm our ability to generate advertising revenue.
Expenditures by advertisers tend to be cyclical, reflecting overall economic
conditions as well as budgeting and buying patterns. The overall market for
advertising, including Internet advertising, has been generally characterized in
recent quarters by softness of demand and minimal growth of marketing and
advertising budgets and delays in spending of budgeted resources. Because we
derive a large part of our revenues from advertising fees, the decrease in or
delay of advertising spending could reduce our revenues or negatively impact our
ability to grow our revenues. Even if economic conditions continue to improve,
marketing budgets and advertising spending may not increase from current levels.
We cannot predict our e-commerce customers' preferences with certainty and such
preferences may change rapidly.
Our e-commerce offerings on our ThinkGeek.com Web site are designed to
appeal to IT professionals, software developers and others in technical fields.
If we misjudge either the market for our products or our customers' purchasing
habits, our sales may decline, our inventories may increase or we may be
required to sell our products at lower prices. This would have a negative effect
on our business.
We are exposed to significant inventory risks as a result of seasonality, new
product launches, rapid changes in product cycles and changes in consumer tastes
with respect to our products offered at our ThinkGeek e-commerce web site.
In order to be successful, we must accurately predict these trends and avoid
overstocking or under-stocking products. Demand for products can change
significantly between the time inventory is ordered and the date of sale. In
addition, when we begin selling a new product, it is particularly difficult to
forecast product demand accurately. The acquisition of certain types of
inventory, or inventory from certain sources, may require significant lead-time
and prepayment, and such inventory may not be returnable. We carry a broad
selection and significant inventory levels of certain products and we may be
unable to sell products in sufficient quantities or during the relevant selling
seasons. Our ability to receive inbound inventory efficiently or ship completed
orders to customers may be negatively affected by a number of factors, including
our dependence on a single third party contract fulfillment and warehouse
facility in Baltimore, Maryland to handle the majority of our ThinkGeek
e-commerce distribution and fulfillment operations and reliance upon third party
carriers for all of our product shipments.
If we do not maintain sufficient e-commerce inventory levels, or if we are
unable to deliver our e-commerce products to our customers in sufficient
quantities, our online business operating results will be adversely affected.
We must be able to deliver our merchandise in sufficient quantities to meet
the demands of our customers and deliver this merchandise to customers in a
timely manner. We must be able to maintain sufficient inventory levels,
particularly during the peak holiday selling seasons. If we fail to achieve
these goals, we may be unable to meet customer demand, and our future results
will be adversely affected.
25
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
fiscal year 2004. 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.
While we believe we will not require additional capital to fund continued
operations during 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 or
advertising 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. For example, in November 2003 we issued
shares of our common stock and warrants to purchase shares of our common stock
in a private placement and on November 26, 2003 we filed a registration
statement on Form S-3 with the SEC covering 5,104,354 shares of our common stock
in connection with the private placement. The presence of these additional
shares of our common stock in the public market may depress our stock price.
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.
It is difficult to evaluate our business because we have a limited history
operating as a provider of application software.
We have a brief operating history as a provider of SourceForge, our
proprietary software 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 and OSDN. 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 software 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;
26
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 weak 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;
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 Web sites 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 Web sites; and
o disruption to our operations, employees, affiliates, customers and
facilities caused by international or domestic terrorist attacks or armed
conflict.
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
27
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 or of future 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 $1.2 million for our first quarter ended October 31,
2003, and we had an accumulated deficit of $740.9 million as of October 31,
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.
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, 2002 and 2003 we substantially reduced the size of
our workforce. As of October 31, 2003, we had 122 employees. Despite, the
substantial reductions in the size of our workforce, our business my never the
less 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 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 collaborative software development 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 marketplace.
Our potential competitors include entrenched companies in closely related
markets who may choose to enter and focus on collaborative software development.
Although we do not believe that we presently have an entrenched competitor, we
expect competition to intensify in the future if the market for collaborative
software development 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.
28
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.
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 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 software business 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.
29
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 web sites.
Some of the products we offer for sale on our e-commerce Web sites, such as
consumer electronics, toys, computers and peripherals, toiletries, beverages and
clothing, may expose us to product 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 and online
businesses. 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 and online businesses, 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 businesses will suffer.
Our stock price has been volatile historically and may continue to be volatile.
The trading price of our common stock has been and may continue to be
subject to wide fluctuations. During the first quarter of fiscal year 2004, the
closing sale prices of our common stock on the Nasdaq ranged from $1.92 to $5.84
per share and the closing sale price on October 31, 2003 was $5.10 per share.
Our stock price may fluctuate in response to a number of events and factors,
such as quarterly variations in operating results, announcements of
technological innovations or new products and media properties by us or our
competitors, changes in financial estimates and recommendations by securities
analysts, the operating and stock price performance of other companies that
investors may deem comparable to us, and news reports relating to trends in our
markets or general economic conditions.
In addition, the stock market in general, and the market prices for
Internet-related companies in particular, have experienced volatility that often
has been unrelated to the operating performance of such companies. These broad
market and industry fluctuations may adversely affect the price of our stock,
regardless of our operating performance. Additionally, volatility or a lack of
positive performance in our stock price may adversely affect our ability to
retain key employees, all of whom have been granted stock options.
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.
30
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.
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
October 31, 2003. This table does not include money market funds because those
funds are not subject to market risk.
Maturing Maturing within Maturing
(in thousands) within three three months to Greater than
months one year one year
-------------- -------------------- --------------
As of October 31, 2003
Cash equivalents $2,090
Weighted-average interest rate 1.08%
Short-term investments $26,627
Weighted-average interest rate 2.35%
Long-term investments $6,133
Weighted-average interest rate 2.00%
31
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
a) Evaluation of disclosure controls and procedures. Our management
evaluated, with the participation of our Chief Executive Officer and
our Chief Financial Officer, the effectiveness of our disclosure
controls and procedures as of the end of the period covered by this
Quarterly Report on Form 10-Q. Based on this evaluation, our Chief
Executive Officer and our Chief Financial Officer have concluded that
our disclosure controls and procedures are effective to ensure that
information we are required to disclose in 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
Securities and Exchange Commission rules and forms.
b) Changes in internal controls over financial reporting. There was no
change in our internal control over financial reporting (as defined in
Rule 13a-15(f) of the Securities Exchange Act of 1934) that occurred
during the period covered by this Quarterly Report on Form 10-Q that
has materially affected, or is reasonably likely to materially affect,
our internal control over financial reporting.
32
PART II
Item 1. Legal Proceedings
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. A proposal has been made for the settlement and release of claims
against the issuer defendants, including VA Software. The settlement is subject
to a number of conditions, including approval of the proposed settling parties
and the court. If the settlement does not occur, and litigation against the
Company continues, the Company believes it has meritorious defenses and intends
to defend the case vigorously.
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.
Item 5. Other Information
On November 6, 2003 we sold 3,529,412 shares of our common stock and
warrants to purchase 705,883 shares of our common stock at an exercise price of
$6.00 per share to The Riverview Group LLC for aggregate consideration of $15
million. These securities were sold pursuant to Section 4(2) of the Securities
Act of 1933, as emended.
Item 6. Exhibits and Reports On Form 8-K
(a) Exhibits
----------------- ---------------------------------------------------------
Exhibit No. Description
----------------- ---------------------------------------------------------
31.1 Rule 13a-14(a) Certification of Chief Executive Officer.
----------------- ---------------------------------------------------------
31.2 Rule 13a-14(a) Certification of Chief Financial Officer.
----------------- ---------------------------------------------------------
32.1 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.
----------------- ---------------------------------------------------------
32.2 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
On August 27, 2003, the Company furnished a Current Report on Form 8-K
under Item 12 (Results of Operations and Financial Condition) disclosing the
issuance of an August 27, 2003 press release announcing its financial results
for the quarter and fiscal year ended July 31, 2003.
On November 7, 2003, the Company filed a Current Report on Form 8-K under
Item 5 (Other Events and Regulation FD Disclosure) disclosing the issuance of a
November 6, 2003 press release announcing that VA Software Corporation had
completed a private placement of its common stock and warrants to purchase
shares of its common stock.
On November 19, 2003, the Company furnished a Current Report on Form 8-K
under Item 12 (Results of Operations and Financial Condition) disclosing the
issuance of a November 19, 2003 press release announcing its financial results
for the Company's first quarter ended October 31, 2003.
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: December 11, 2003
33
EXHIBIT INDEX
Exhibit
Number
31.1 -- Rule 13a-14(a) Certification of Chief Executive Officer.
31.2 -- Rule 13a-14(a) Certification of Chief Financial Officer.
32.1 -- 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
32.2 -- 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
34