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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 January 31, 2004
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 March 1, 2004
Common Stock, $0.001 par value 60,753,802
================================================================================
Table of Contents
Page No.
Item 1. Financial Statements (unaudited)............................................ 3
PART I. FINANCIAL INFORMATION ...................................................... 3
Condensed Consolidated Balance Sheets at January 31, 2004 and
July 31, 2003 ........................................................ 3
Condensed Consolidated Statements of Operations for the three
and six months ended January 31, 2004 and January 25, 2003 ........... 4
Condensed Consolidated Statements of Cash Flows for the six
months ended January 31, 2004 and January 25, 2003 ................... 5
Notes to Condensed Consolidated Financial Statements ................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations ...................................................... 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk ................. 36
Item 4. Controls and Procedures .................................................... 37
PART II. OTHER INFORMATION
Item 1. Legal Proceedings .......................................................... 37
Item 2. Changes in Securities and Use of Proceeds .................................. 38
Item 6. Exhibits and Reports on Form 8-K ........................................... 38
Signatures ............................................................................. 39
Certifications ......................................................................... 41
2
PART I
VA SOFTWARE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, unaudited)
January 31, July 31,
2004 2003
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents .................................................................... $ 11,475 $ 6,303
Short-term investments ....................................................................... 24,686 27,864
Restricted cash, current ..................................................................... 450 450
Accounts receivable, net ..................................................................... 2,932 1,928
Inventories .................................................................................. 677 388
Prepaid expenses and other assets ............................................................ 1,447 1,232
--------- ---------
Total current assets ................................................................. 41,667 38,165
Property and equipment, net .................................................................... 3,833 4,267
Long-term investments .......................................................................... 13,189 4,680
Restricted cash, non current ................................................................... 450 450
Other assets ................................................................................... 1,030 933
--------- ---------
Total assets ......................................................................... $ 60,169 $ 48,495
========= =========
LIABILITIES, COMMON STOCK SUBJECT TO REGISTRATION RIGHTS AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................................................................. $ 822 $ 863
Accrued restructuring liabilities, current portion ........................................... 3,383 4,117
Accrued compensation ......................................................................... 1,343 1,346
Deferred revenue ............................................................................. 1,622 751
Warrant liability ............................................................................ 1,665 --
Accrued liabilities and other ................................................................ 1,208 2,263
--------- ---------
Total current liabilities ............................................................ 10,043 9,340
Accrued restructuring liabilities, net of current portion ...................................... 9,472 10,772
Other long-term liabilities .................................................................... 1,212 1,181
--------- ---------
Total liabilities .................................................................... 20,727 21,293
Commitments and contingencies (Notes 7 and 9)
Common stock subject to registration rights .................................................... 12,185 --
Stockholders' equity:
Common stock ................................................................................. 57 56
Treasury stock ............................................................................... (4) (4)
Additional paid-in capital ................................................................... 769,548 766,765
Deferred stock compensation .................................................................. -- (20)
Accumulated other comprehensive gain ......................................................... 33 128
Accumulated deficit .......................................................................... (742,377) (739,723)
--------- ---------
Total stockholders' equity ............................................................ 27,257 27,202
--------- ---------
Total liabilities, common stock subject to registration rights and stockholders' equity $ 60,169 $ 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 Six Months Ended
------------------ ----------------
January 31, January 25, January 31, January 25,
2004 2003 2004 2003
-------- -------- -------- --------
Total revenues:
Software revenues ................................................ $ 1,183 $ 690 $ 1,998 $ 1,401
Online revenues .................................................. 7,658 5,656 12,609 9,811
Other revenues ................................................... 15 214 46 423
-------- -------- -------- --------
Total revenues ................................................ 8,856 6,560 14,653 11,635
Cost of revenues:
Software cost of revenues ........................................ 541 470 1,136 1,063
Online cost of revenues .......................................... 4,773 3,423 7,428 5,734
Other cost of revenues ........................................... -- (206) -- (363)
-------- -------- -------- --------
Cost of revenues .............................................. 5,314 3,687 8,564 6,434
-------- -------- -------- --------
Gross margin .................................................. 3,542 2,873 6,089 5,201
-------- -------- -------- --------
Operating expenses:
Sales and marketing .............................................. 2,592 2,325 4,984 4,646
Research and development ......................................... 1,716 1,956 3,543 4,000
General and administrative ....................................... 1,558 1,936 2,282 3,691
Restructuring costs and other special charges .................... (18) (120) (35) (135)
Amortization of deferred stock compensation ...................... -- 41 20 79
Amortization of intangible assets ................................ 3 644 6 1,288
-------- -------- -------- --------
Total operating expenses ................................. 5,851 6,782 10,800 13,569
-------- -------- -------- --------
Loss from operations ............................................... (2,309) (3,909) (4,711) (8,368)
Remeasurement of warrant liability ................................. 641 -- 641 --
Interest income, net ............................................... 237 274 485 628
Other income (expense), net ........................................ -- (37) 931 (65)
Net loss ........................................................... $ (1,431) $ (3,672) $ (2,654) $ (7,805)
======== ======== ======== ========
Other comprehensive gain (loss):
Unrealized gain (loss) on marketable securities and investments (26) 157 (106) 88
Foreign currency translation gain ............................. 8 9 11 7
-------- -------- -------- --------
Comprehensive loss ................................................. $ (1,449) $ (3,506) $ (2,749) $ (7,710)
======== ======== ======== ========
Net loss ........................................................... $ (1,431) $ (3,672) $ (2,654) $ (7,805)
======== ======== ======== ========
Basic and diluted net loss per share ............................... $ (0.02) $ (0.07) $ (0.05) $ (0.15)
======== ======== ======== ========
Shares used in computing basic and diluted net loss per share ...... 60,355 53,859 58,357 53,786
======== ======== ======== ========
The accompanying notes are an integral part of these financial statements.
4
VA SOFTWARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, unaudited)
Six Months Ended
----------------
January 31, January 25,
2004 2003
-------- --------
Cash flows from operating activities:
Net loss .................................................................. $ (2,654) $ (7,805)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization of intangibles ............................ 908 3,148
Remeasurement of warrant liability ...................................... (641) --
Provision for bad debts ................................................. (10) (98)
Provision for excess and obsolete inventory ............................. (1) 15
Loss on disposal of assets .............................................. -- 4
Amortization of deferred stock compensation ............................. 20 79
Non-cash restructuring expense .......................................... -- (170)
Changes in assets and liabilities:
Accounts receivable ................................................... (994) (363)
Inventories ........................................................... (288) (131)
Prepaid expenses and other assets ..................................... (318) (61)
Accounts payable ...................................................... (41) (699)
Accrued restructuring liabilities ..................................... (2,034) (1,653)
Deferred revenue ...................................................... 871 573
Accrued liabilities and other ......................................... (1,055) (1,179)
Other long-term liabilities ........................................... 32 90
-------- --------
Net cash used in operating activities .............................. (6,205) (8,250)
-------- --------
Cash flows from investing activities:
Purchase of property and equipment ........................................ (468) (83)
Purchase of marketable securities ......................................... (21,591) (23,695)
Sale of marketable securities ............................................. 16,260 8,162
Other, net ................................................................ (106) 88
-------- --------
Net cash used in investing activities .............................. (5,905) (15,528)
-------- --------
Cash flows from financing activities:
Payments on notes payable ................................................. -- (42)
Proceeds from issuance of common stock subject to registration rights, net 12,027 --
Proceeds from issuance of warrants net, ................................... 2,464 --
Proceeds from issuance of common stock, net ............................... 2,784 198
-------- --------
Net cash provided by financing activities .......................... 17,275 156
-------- --------
Effect of exchange rate changes on cash and cash equivalents ............... 7 7
-------- --------
Net increase (decrease) in cash and cash equivalents ....................... 5,172 (23,615)
-------- --------
Cash and cash equivalents, beginning of period ............................. 6,303 35,148
-------- --------
Cash and cash equivalents, end of period ................................... $ 11,475 $ 11,533
======== ========
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 Corporation ("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, consisting only of normal
recurring 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 and six months ended January 31,
2004 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 in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of such financial statements, as well as the reported
amounts of revenue and expenses during the periods indicated. Actual results
could differ from those estimates.
Principles of Consolidation
These consolidated financial statements include the accounts of VA and its
wholly-owned and majority-owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation. In September
2000, the Company acquired 68% of the outstanding shares of common stock of VA
Linux Systems Japan, K.K. ("VA Linux Japan") for a cash purchase price of
approximately $6.9 million. Effective January 11, 2002, VA sold 13,500 shares of
VA Linux Japan stock to a third party for approximately $5.1 million, 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 since 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 January 31, 2004, 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
6
establishes standards for related disclosures about products and services and
geographic areas. Operating segments are identified as components of an
enterprise about which separate discrete financial information is available for
evaluation by the chief operating decision-maker, or decision-making group, in
making decisions how to allocate resources and assess performance. The Company's
chief decision-making group, as defined under SFAS No. 131, is comprised of VA's
Chief Executive Officer and its 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 and six months ended January 31,
2004 and January 25, 2003 were primarily generated from sales to end users in
the United States.
Revenue Recognition
Software Revenues
Revenue consists principally of fees for licenses of the Company's software
products, maintenance, consulting and training. The Company recognizes revenue
using the residual method in accordance with Statement of Position ("SOP") 97-2,
"Software Revenue Recognition," as amended by SOP 98-9, "Modification of SOP
97-2, Software Revenue Recognition with Respect to Certain Transactions." 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. Company-specific
objective evidence of fair value of maintenance and other services is based on
the Company's customary pricing for such maintenance and/or services when sold
separately. At the outset of the arrangement with the customer, the Company
defers revenue for the fair value of its undelivered elements (e.g.,
maintenance, consulting and training) and recognizes revenue for the remainder
of the arrangement fee attributable to the elements initially delivered in the
arrangement (i.e., software product) when the basic criteria in SOP 97-2 have
been met. If such evidence of fair value for each undelivered element of the
arrangement does not exist, all revenue from the arrangement is deferred until
such time that evidence of fair value does exist or until all elements of the
arrangement are delivered.
Under SOP 97-2, revenue attributable to an element in a customer
arrangement is recognized when (i) persuasive evidence of an arrangement exists,
(ii) delivery has occurred, (iii) the fee is fixed or determinable, (iv)
collectibility is probable and (v) the arrangement does not require services
that are essential to the functionality of the software.
Persuasive evidence of an arrangement exists. The Company determines that
persuasive evidence of an arrangement exists with respect to a customer when it
has a written contract, which is signed by both the customer and the Company, or
a purchase order from the customer when the customer has previously executed a
standard license arrangement with the Company. The Company does not offer
product return rights to resellers or end users.
Delivery has occurred. The Company's software may be either physically or
electronically delivered to the customer. The Company determines that delivery
has occurred upon shipment of the software pursuant to the billing terms of the
agreement or when the software is made available to the customer through
electronic delivery.
The fee is fixed or determinable. If at the outset of the customer
arrangement, the Company determines that the arrangement fee is not fixed or
determinable, revenue is recognized when the arrangement fee becomes due and
payable. Fees due under an arrangement are generally deemed not to be fixed or
determinable if a significant portion of the fee is beyond the Company's normal
payment terms, which are generally no greater than 120 days from the date of
invoice.
Collectibility is probable. The Company determines whether collectibility
is probable on a case-by-case basis. When assessing probability of collection,
the Company considers the number of years in business, history of collection,
and product acceptance for each customer. The Company typically sells to
customers, for whom there is a history of successful collection. New customers
are subject to a credit review process, which evaluates the customer's financial
position and ultimately such customer's ability to pay. If the Company
determines from the outset of an arrangement that collectibility is not probable
based upon its review process, revenue is recognized as payments are received.
The Company allocates revenue on software arrangements involving multiple
elements to each element based on the relative fair value of each element. The
Company's determination of fair value of each element in multiple-element
arrangements is based on vendor-specific objective evidence ("VSOE"). The
Company limits its assessment of VSOE for each element to the price charged
7
when the same element is sold separately. The Company has analyzed all of the
elements included in its multiple-element arrangements and has determined that
it has sufficient VSOE to allocate revenue to the maintenance, support and
professional services components of its perpetual license arrangements. The
Company sells its professional services separately, and has established VSOE for
professional services on this basis. VSOE for maintenance and support is
determined based upon the customer's annual renewal rates for these elements.
Accordingly, assuming all other revenue recognition criteria are met, revenue
from perpetual licenses is recognized upon delivery using the residual method in
accordance with SOP 98-9, and revenue from maintenance and support services is
recognized ratably over their respective terms.
Services revenues consist of professional services and maintenance fees. In
general, the Company's professional services, which are comprised of software
installation and integration, business process consulting and training, are not
essential to the functionality of the software. The Company's software products
are fully functional upon delivery and implementation and do not require any
significant modification or alteration of products for customer use. Customers
purchase these professional services to facilitate the adoption of the Company's
technology and dedicate personnel to participate in the services being
performed, but they may also decide to use their own resources or appoint other
professional service organizations to provide these services. Software products
are billed separately from professional services, which are generally billed on
a time-and-materials basis. The Company recognizes revenue from professional
services as services are performed.
Maintenance agreements are typically priced based on a percentage of the
product license fee and have a one-year term, renewable annually. Services
provided to customers under maintenance agreements include technical product
support and unspecified product upgrades. Deferred revenues from advanced
payments for maintenance agreements are recognized ratably over the term of the
agreement, which is typically one year.
The Company expenses all manufacturing, packaging and distribution costs
associated with software license sales as cost of license revenues.
Online Revenues
Advertising revenues are derived from the sale of advertising space on our
various Web sites. Advertising revenues are recognized over the period in which
the advertisements are displayed, provided that no significant obligations
remain and collection of the receivable is reasonably assured. Our obligations
typically include guarantees of a minimum number of "impressions" (times that an
advertisement is viewed by users of our online services over a specified period
of time). To the extent that minimum guaranteed impressions are not met, the
Company does not recognize the corresponding revenues until the guaranteed
impressions are achieved. Barter revenue transactions are recorded at their
estimated fair value based on the Company's historical experience of selling
similar advertising for cash in accordance with Emerging Issues Task Force
("EITF") Issue 99-17, "Accounting for Advertising Barter Transactions." The
Company broadcasts banner advertising in exchange for similar banner advertising
on third party 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") 104,
"Revenue Recognition in Financial Statements." Under SAB 104, 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
The Company's revenue recognition policy related to its former hardware
systems business follows SAB 104. Under SAB 104, 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 associated
with VA's former hardware business, 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
8
recognition as deferred revenue. For the three months ended January 31, 2004,
revenues from customer support services and professional service contracts
associated with the Company's 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 Selling, Goods or
Services. Deferred stock-based compensation is included as a component of
stockholders' equity and is being amortized by charges to operations over the
vesting period of the options and restricted stock consistent with the method
described in FIN No. 28, Accounting for Stock Appreciation Rights and Other
Variable Stock Option or Award Plans.
Had compensation cost been recognized based on the fair value at the date
of grant for options granted and Employee Stock Purchase Plan issuances during
the three and six months ended January 31, 2004, and January 25, 2003 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 Six Months Ended
------------------ ----------------
January 31, January 25, January 31, January 25,
2004 2003 2004 2003
-------- -------- -------- --------
Net loss as reported ........................................... $ (1,431) $ (3,672) $ (2,654) $ (7,805)
Add back employee stock-based compensation expense related to
stock options included in reported net loss ................ -- 41 20 79
Less employee stock-based compensation expense determined under
fair value based method for all employee stock option awards,
net of related tax effects ............................... (1,606) (2,285) (3,008) (4,586)
-------- -------- -------- --------
Pro forma net loss .......................................... $ (3,037) $ (5,916) $ (5,642) $(12,312)
-------- -------- -------- --------
Shares used in computing basic and diluted net loss per share .. 60,355 53,859 58,357 53,786
-------- -------- -------- --------
Reported basic and diluted net loss per share .................. $ (0.02) $ (0.07) $ (0.05) $ (0.15)
======== ======== ======== ========
Pro forma basic and diluted net loss per share ................. $ (0.05) $ (0.11) $ (0.10) $ (0.23)
======== ======== ======== ========
9
The Company calculated the fair value of each option grant using the
Black-Scholes option-pricing model as prescribed by SFAS No. 123 using the
following assumptions:
Stock Option Plans Stock Option Plans
For The Three Months Ended For The Six Months Ended
-------------------------- --------------------------
January 31, January 25, January 31, January 25,
2004 2003 2004 2003
----------- ----------- ----------- -----------
Expected life (years) .. 5.01 4.74 5.03 4.74
Risk-free interest rate 3.4% 3.1% 3.3% 3.1%
Volatility ............. 110% 110% 110% 110%
Dividend yield ......... None None None None
ESPP Plans ESPP Plans
For The Three Months Ended For The Six Months Ended
-------------------------- --------------------------
January 31, January 25, January 31, January 25,
2004 2003 2004 2003
----------- ----------- ----------- -----------
Expected life (years) .. .48 .49 0.49 0.50
Risk-free interest rate 1.1% 0.9% 1.1% 1.2%
Volatility ............. 120% 100% 100% 100%
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
January 31, 2004 that would indicate a possible impairment in the carrying value
of intangible assets at January 31, 2004.
The changes in the carrying amount of the intangible assets are as follows
(in thousands):
As of January 31, 2004 As of July 31, 2003
------------------------ ------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Amount Amortization
-------- -------- -------- --------
Domain and trade names ........................ $ 5,922 $ (5,907) $ 5,922 $ (5,901)
Purchased technology .......................... 2,534 (2,534) 2,534 (2,534)
-------- -------- -------- --------
Total intangible assets ................. 8,456 (8,441) 8,456 (8,435)
Goodwill ...................................... 60,362 (60,362) 60,362 (60,362)
-------- -------- -------- --------
Total changes in goodwill and intangible assets $ 68,818 $(68,803) $ 68,818 $(68,797)
======== ======== ======== ========
The aggregate amortization expense of intangible assets, net of
restructuring charges were $3,000 and $644,000 for the three-months ending
January 31, 2004 and January 25, 2003, respectively and were $6,000 and
$1,288,000 for the six months ending January 31, 2004 and January 25, 2003,
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 receivables. The Company
provides credit, in the normal course of business, to a number of companies and
performs ongoing credit
10
evaluations of its customers. At January 31, 2004, one customer, Google Inc.
accounted for 24.3% of gross accounts receivable outstanding. The receivable is
current and the Company believes the receivable is fully collectable.
For the three and six months ending January 31, 2004, no single customer
accounted for more than 10% of VA's total revenues. For the three and six months
ending January 25, 2003 one customer, Intel Corporation, accounted for
approximately 15.2% and 17.2% of total revenues respectively.
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 January 31, 2004, the Company had
an accrual of approximately $12.9 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 an $18,000 and $35,000 net credit in restructuring
expenses in the consolidated statement of operations for the three and six
months ending January 31, 2004. The net credits were 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 To
Operations Restructuring
Total Total Total Six Months Total Liabilities
Charged To Charged To Charged To ended Cash at
Operations Operations Operations January 31, Receipts/ January 31,
Fiscal 2001 Fiscal 2002 Fiscal 2003 2004 Payments 2004
----------- ----------- ----------- ---------- -------- --------------
Cash Provisions:
Other special charges relating to
restructuring activities .................. $ 2,159 $ (888) $ 78 $ -- $ (1,349) $ --
Facilities charges ........................... 6,584 9,401 191 (35) (3,286) $ 12,855
Employee severance and other related charges . 3,498 1,997 37 -- (5,532) --
-------- -------- -------- -------- -------- --------
Total cash provisions .................... 12,241 10,510 306 (35) $(10,167) $ 12,855
-------- -------- -------- -------- -------- --------
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) $ (35)
======== ======== ======== ========
11
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 six months ended January 25, 2003 .................. $17,994 $ (135) $(1,518) $16,341
For the six months ended January 31, 2004 .................. $14,889 $ (35) $(1,999) $12,855
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 six months ended January 25, 2003 .................. $3,931 $12,410 $16,341
For the six months ended January 31, 2004 .................. $3,383 $ 9,472 $12,855
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 Six Months Ended
------------------ ----------------
January 31, January 25, January 31, January 25,
2004 2003 2004 2003
-------- -------- -------- --------
Net loss ...................................................... $ (1,431) $ (3,672) $ (2,654) $ (7,805)
-------- -------- -------- --------
Basic and diluted:
Weighted average shares of common stock outstanding ......... 60,355 53,861 58,357 53,797
Less: Weighted average shares subject to repurchase ......... -- (2) -- (11)
-------- -------- -------- --------
Shares used in computing basic and diluted net loss per share 60,355 53,859 58,357 53,786
======== ======== ======== ========
Basic and diluted net loss per share ........................ $ (0.02) $ (0.07) $ (0.05) $ (0.15)
======== ======== ======== ========
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 Six Months Ended
------------------ ----------------
January 31, January 25, January 31, January 25,
2004 2003 2004 2003
-------- -------- -------- --------
Anti-dilutive securities:
Options to purchase common stock 9,738 12,558 9,738 12,558
Warrants .................................................. 731 -- 731 --
------ ------ ------ ------
Total ................................................ 10,469 12,558 10,469 12,558
====== ====== ====== ======
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. Total comprehensive loss for the three and six months
ended January 31, 2004 was approximately $1.4 million and $2.7 million,
respectively. Total comprehensive loss for the three and six months ended
January 25, 2003 was approximately $3.5 million and $7.7 million, respectively.
12
6. Segment and Geographic Information
The accounting policies of the Company's segments are the same as those
described in the summary of significant accounting polices above. There are no
intersegment sales. The Company's 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 January 31, 2004
Revenue from external customers . $ 1,183 $ 7,658 $ 15 $ 8,856
Cost of revenues ................ $ 541 $ 4,773 $ -- $ 5,314
------- ------- ------- -------
Gross margin .................... $ 642 $ 2,885 $ 15 $ 3,542
Three Months Ended January 25, 2003
Revenue from external customers . $ 690 $ 5,656 $ 214 $ 6,560
Cost of revenues ................ $ 470 $ 3,423 $ (206) $ 3,687
------- ------- ------- -------
Gross margin .................... $ 220 $ 2,233 $ 420 $ 2,873
Six Months Ended January 31, 2004
Revenue from external customers . $ 1,998 $12,609 $ 46 $14,653
Cost of revenues ................ $ 1,136 $ 7,428 $ -- $ 8,564
------- ------- ------- -------
Gross margin .................... $ 862 $ 5,181 $ 46 $ 6,089
Six Months Ended January 25, 2003
Revenue from external customers . $ 1,401 $ 9,811 $ 423 $11,635
Cost of revenues ................ $ 1,063 $ 5,734 $ (363) $ 6,434
------- ------- ------- -------
Gross margin .................... $ 338 $ 4,077 $ 786 $ 5,201
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. Pursuant to a tolling agreement, the individual defendants
were dismissed without prejudice. On February 19, 2003, the court denied the
Company's motion to dismiss the claims against it. The litigation is now in
discovery. A proposal has been made for the settlement and release of claims
against the issuer defendants, including the Company. 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.
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.
13
In December 2003, the SEC issued SAB 104, Revenue Recognition, ("SAB 104")
which supercedes SAB 101, Revenue Recognition in Financial Statements. SAB 104's
primary purpose is to rescind accounting guidance contained in SAB 101 related
to multiple element revenue arrangements, which was superceded as a result of
the issuance of EITF 00-21, Accounting for Revenue Arrangements with Multiple
Deliverables. While the wording of SAB 104 has changed to reflect the issuance
of EITF 00-21, the revenue recognition principles of SAB 101 remain largely
unchanged by the issuance of SAB 104. The adoption of SAB 104 did not a material
impact on the 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 January 31, 2004.
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 January 31, 2004.
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
January 31, 2004.
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 January 31, 2004. Accordingly, the
Company has a liability of approximately $12,000 recorded for these agreements
as of January 31, 2004.
10. Common Stock Subject to Registration Rights
On November 6, 2003, the Company entered into a securities purchase
agreement (the "Securities Purchase Agreement") in which the Company completed a
private placement of 3,529,412 shares of VA Software common stock with The
Riverview Group LLC ("Riverview") at an issue price of $4.25 per share (the
"Riverview Shares") for aggregate proceeds of approximately $15 million (the
"Private Placement"). In connection with the Private Placement, the Company
retained Wharton Capital Partners Ltd. ("Wharton") to act as a financial
consultant and placement agent. Also in connection with the Private Placement,
Riverview and Wharton received three-year warrants to purchase a total of
705,883 (the "Riverview Warrants") and 25,000 (the "Wharton Warrants") shares of
VA Software common stock, respectively, at an exercise price of $6.00 and $6.14
per share, respectively (collectively, the Riverview Warrants and the Wharton
Warrants are referred to as the "Warrants"). The Company entered into a
registration rights agreement with Riverview on November 6, 2003 (the
"Registration Rights Agreement") in which the Company agreed to provide certain
registration rights under the Securities Act of 1933, as amended and the rules
and regulations, and applicable state securities laws with respect to the common
stock and the warrants issued to Riverview.
14
In accordance with the terms of the Registration Rights Agreement, the
Company has filed with the SEC a Form S-3, and two subsequent amendments (the
Registration Statement"), seeking to register the Riverview Shares and the
shares underlying the Warrants (the "Private Placement Shares"); however, the
SEC has not yet declared the Registration Statement to be effective. The terms
of the Registration Rights Agreement may subject the Company to certain
penalties in the event that the Registration Statement fails to be declared
effective by the SEC on or before May 4, 2004 ("Effectiveness Failure"). In the
event of Effectiveness Failure, the Company will pay Riverview $300,000 on the
earlier of each thirty day period following an Effectiveness Failure or the
third business day after the Effectiveness Failure is cured. In addition, in the
event that the Company fails to maintain the effectiveness of the Registration
Statement once it is declared effective by the SEC ("Maintenance Failure"), the
Company will pay Riverview $300,000 on the earlier of each thirty day period
following a Maintenance Failure or the third business day after such Maintenance
Failure is cured. A Maintenance Failure shall not be deemed to have occurred if
the Maintenance Failure is cured within three business days and there has been
no other Maintenance Failure at any time within the prior 120 days.
The Private Placement Shares do not currently have the same rights as the
other shares that are included in the Equity section of the Company's
consolidated balance sheet. Therefore, the Private Placement Shares are
classified as liabilities on the consolidated balance sheet. Because liabilities
must be reported at fair value as of the balance sheet date, the Company valued
the Warrants as of November 6, 2003 using the Black-Scholes valuation model and
then, on January 31, 2004, revalued them using the same Black-Scholes valuation
model. Based on the Company's remeasurement, its net warrant liability for the
Warrants decreased by $0.8 million to $1.7 million as of January 31, 2004, from
$2.5 million as of November 6, 2003. This $0.8 million decrease in warrant
liability was partially offset by a $0.2 million non-cash expense associated
with not having the Private Placement Shares registered as of January 31, 2004.
Due to the penalty clause in the Registration Rights Agreement, if the Company
is unable to effect registration of the Private Placement Shares, the Company
will be required to expense a total of $3.0 million over the next 56 months. The
Company presents the net $0.6 million on its income statement as remeasurement
of warrant liability income. Once the Private Placement Shares have been
registered, the Private Placement Shares will have the same rights as the
Company's other outstanding, registered common stock and the Company will no
longer be required to record income or expense associated with remeasurement of
the Warrants or for the potential penalty associated with not registering the
Private Placement Shares. After the Private Placement Shares have been
registered, they will be moved from the liability section of the Company's
consolidated balance sheet to the equity section of the Company's Consolidated
Balance sheet.
The Company will use the Private Placement proceeds for working capital.
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 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. From the date of our incorporation through October
2001, we sold Linux-based hardware systems and services under the name VA Linux
Systems, Inc. On June 27, 2001, we announced our decision to exit our
Linux-based hardware business. Today, we do business under the name VA Software
Corporation and 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.
15
SourceForge is a proprietary, Web-based software application
designed for corporate and public-sector information technology ("IT")
professionals and software engineering organizations. SourceForge combines
software development and collaboration tools with the ability to track, measure,
and report on software project activity in real-time. SourceForge improves the
software development process by capturing and archiving software development
code, documentation and communication in a central location. It enables managers
to gain insight and improved visibility into software development activity,
thereby providing better resource and requirements management, defect tracking
and the ability to resolve critical problems earlier in the development cycle.
Organizations with distributed, offshore and/or outsourced software development
teams can achieve improved productivity, communication, coordination,
collaboration, project clarity and insight through SourceForge's standard set of
development tools and secure, centralized code, documentation and communication
repository.
OSDN is a network of media and e-commerce Internet Web sites serving
the IT professionals and software development communities. As of January 31,
2004, OSDN reaches approximately 12 million unique visitors and serves more than
225 million page views per month. We believe that OSDN is the most dynamic
community-driven media network on the Web and a cornerstone of the open source
software development community. OSDN attracts IT decision-makers and buyers,
from chief technology officers to project managers. Technologists, developers
and system administrators turn to OSDN sites to create, debate and make IT news.
OSDN is supported by sponsors and advertisers who want to reach the unique
demographic of IT professionals and developers that visit our OSDN Web sites
monthly. In addition, OSDN runs e-commerce sites to allow its visitors to buy a
variety of retail goods of interest to the software development and IT
communities. Our OSDN Web sites include:
o SourceForge.net, our flagship Web site and software development center.
As of March 1, 2004, SourceForge.net was the development home for more
than 76,000 software development projects and had more than 801,000
registered users.
o Slashdot.org, our leading discussion site for technologically-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 AnimationFactory.com, a source for three-dimensional art, animations and
presentations. Animation Factory offers its subscribers a dynamic
collection of easy to use animations that work in email, Web pages and
presentations.
Critical Accounting Policies
Software Revenues
Software revenue consists principally of fees for licenses of our software
products, maintenance, consulting and training. We recognize revenue using the
residual method in accordance with Statement of Position ("SOP") 97-2, "Software
Revenue Recognition," as amended by SOP 98-9, "Modification of SOP 97-2,
Software Revenue Recognition with Respect to Certain Transactions." 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. Company-specific objective
evidence of fair value of maintenance and other services is based on our
customary pricing for such maintenance and/or services when sold separately. At
the outset of the arrangement with the customer, we defer revenue for the fair
value of its
16
undelivered elements (e.g., maintenance, consulting and training) and recognize
revenue for the remainder of the arrangement fee attributable to the elements
initially delivered in the arrangement (i.e., software product) when the basic
criteria in SOP 97-2 have been met. If such evidence of fair value for each
undelivered element of the arrangement does not exist, we defer all revenue from
the arrangement until such time that evidence of fair value does exist or until
all elements of the arrangement are delivered.
Under SOP 97-2, revenue attributable to an element in a customer
arrangement is recognized when (i) persuasive evidence of an arrangement exists,
(ii) delivery has occurred, (iii) the fee is fixed or determinable, (iv)
collectibility is probable and (v) the arrangement does not require services
that are essential to the functionality of the software.
Persuasive evidence of an arrangement exists. We determine that persuasive
evidence of an arrangement exists with respect to a customer when we have a
written contract, which is signed by both us and the customer, or a purchase
order from the customer when the customer has previously executed a standard
license arrangement with us. We do not offer product return rights.
Delivery has occurred. Our software may be either physically or
electronically delivered to the customer. We determine that delivery has
occurred upon shipment of the software pursuant to the billing terms of the
agreement or when the software is made available to the customer through
electronic delivery.
The fee is fixed or determinable. If at the outset of the customer
engagement we determine that the fee is not fixed or determinable, we recognize
revenue when the fee becomes due and payable. Fees due under a contract are
generally deemed not to be fixed or determinable if a significant portion of the
fee is beyond our normal payment terms, which are generally no greater than 120
days from the date of invoice.
Collectibility is probable. We determine whether collectibility is probable
on a case-by-case basis. When assessing probability of collection, we consider
the number of years in business, history of collection, and product acceptance
for each customer. We typically sell to customers, for whom there is a history
of successful collection. New customers are subject to a credit review process,
which evaluates the customer's financial position and ultimately such customer's
ability to pay. If we determine from the outset that collectibility is not
probable based upon our review process, revenue is recognized as payments are
received.
We allocate revenue on software arrangements involving multiple elements to
each element based on the relative fair value of each element. Our determination
of fair value of each element in multiple-element arrangements is based on
vendor-specific objective evidence ("VSOE"). We align our assessment of VSOE for
each element to the price charged when the same element is sold separately. We
have analyzed all of the elements included in our multiple-element arrangements
and determined that we have sufficient VSOE to allocate revenue to the
maintenance, support and professional services components of our perpetual
license arrangements. We sell our professional services separately, and have
established VSOE for professional services on that basis. VSOE for maintenance
and support is determined based upon the customer's annual renewal rates for
these elements. Accordingly, assuming all other revenue recognition criteria are
met, we recognize revenue from perpetual licenses upon delivery using the
residual method in accordance with SOP 98-9, and revenue from maintenance and
support services is recognized ratably over their respective terms.
Services revenues consist of professional services and maintenance fees. In
general, our professional services, which are comprised of software installation
and integration, business process consulting and training, are not essential to
the functionality of the software. Our software products are fully functional
upon delivery and implementation and do not require any significant modification
or alteration of products for customer use. Customers purchase these
professional services to facilitate the adoption of our technology and dedicate
personnel to participate in the services being performed, but they may also
decide to use their own resources or appoint other professional service
organizations to provide these services. Software products are billed separately
from professional services, which are generally billed on a time-and-materials
basis. We recognize revenue from professional services as services are
performed.
Maintenance agreements are typically priced based on a percentage of the
product license fee and have a one-year term, renewable annually. Services
provided to customers under maintenance agreements include technical product
support and unspecified product upgrades. Deferred revenues from advanced
payments for maintenance agreements are recognized ratably over the term of the
agreement, which is typically one year.
We expense all manufacturing, packaging and distribution costs associated
with software license sales as cost of license revenues.
17
Online Revenues
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. Our barter arrangements are documented with our standard customer
insertion order (and accompanying terms and conditions) or, in certain limited
instances, via an alternative written contract negotiated between the parties.
The standard terms and conditions include, but are not limited to, the Web sites
for each company that will display the impressions, the time frame that the
impressions will be displayed, the number, type and size of impressions to be
delivered.
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. 104, "Revenue
Recognition in Financial Statements." Under SAB 104, 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. We offer two Animation Factory membership
agreement options, Gold and Platinum. Both Gold and Platinum memberships are
available for either a three-month or one-year term. During a Gold or Platinum
membership term, a member has access to 150,000 animations, 50,000 Mediabuilder
Web Designs, 3D Clipart, tiled backgrounds and unlimited downloads. A Platinum
member also receives access to extra large animations, presentation elements and
PowerPoint presentations. As a result, we recognize the value ratably over the
term of the contract, normally 3 or 12 months.
Other Revenues
Our revenue recognition policy related to our former hardware systems
business follows SEC SAB 104, "Revenue Recognition in Financial Statements."
Under SAB 104, 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 these products.
We recognize revenues from customer support services, including on-site
maintenance and technical support on a pro-rata basis over the term of the
related service agreement. We 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.
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 ten quarters of operations focused on building our
application software business, and accordingly have a 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.
18
The following table sets forth our operating results for the periods
indicated as a percentage of total 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.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended Six Month Ended
------------------ ---------------
January 31, January 25, January 31, January 25,
2004 2003 2004 2003
----- ----- ----- -----
Total revenues (unaudited) (unaudited)
Software revenues ............................. 13.4% 10.5% 13.6% 12.0%
Online revenues ............................... 86.5% 86.2% 86.1% 84.3%
Other revenues ................................ 0.2% 3.3% 0.3% 3.6%
----- ----- ----- -----
Total revenues .............................. 100.0% 100.0% 100.0% 100.0%
Cost of revenues
Software cost of revenues ..................... 6.1% 7.2% 7.8% 9.1%
Online cost of revenues ....................... 53.9% 52.2% 50.7% 49.3%
Other cost of revenues ........................ 0.0% -3.1% 0.0% -3.1%
Cost of revenues ............................. 60.0% 56.2% 58.4% 55.3%
----- ----- ----- -----
Gross margin ................................. 40.0% 43.8% 41.6% 44.7%
Operating expenses:
Sales and marketing .......................... 29.3% 35.4% 34.0% 39.9%
Research and development ..................... 19.4% 29.8% 24.2% 34.4%
General and administrative ................... 17.6% 29.5% 15.6% 31.7%
Restructuring costs and other special charges -0.2% -1.8% -0.2% -1.2%
Amortization of deferred stock compensation .. 0.0% 0.6% 0.1% 0.7%
Amortization of goodwill and intangible assets 0.0% 9.8% 0.0% 11.1%
----- ----- ----- -----
Total operating expenses ................. 66.1% 103.3% 73.7% 116.6%
----- ----- ----- -----
Loss from operations ........................... -26.1% -59.5% -32.1% -71.9%
Remeasurement of warrant liability ............. 7.2% 0.0% 4.4% 0.0%
Interest income, net ........................... 2.7% 4.2% 3.3% 4.8%
Other income (expense), net .................... 0.0% -0.6% 6.4% 0.0%
----- ----- ----- -----
Net loss ....................................... -16.2% -55.9% -18.0% -67.1%
===== ===== ===== =====
Total 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 total revenues increased to $8.9 million and $14.7 million for the
three months and six months ended January 31, 2004, respectively, from $6.6
million and $11.6 million for the three and six months ended January 25, 2003,
respectively. The $2.3 million and $3.1 million increase in total revenues for
the three and six months ended January 31, 2004 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 and six months ending January 31, 2004, no single customer
accounted for more than 10% of our total revenues. For the three and six months
ending January 25, 2003 one customer, Intel Corporation, accounted for
approximately 15.2% and 17.2% of our total revenues respectively.
Software Revenues
Software revenues are derived from our application software business and
include software licenses, professional services, maintenance, support and
training. Software revenues represent $1.2 million, or 13.4%, and $0.7 million,
or 10.5%, of total revenues for the three months ended January 31, 2004 and
January 25, 2003, respectively. The $0.5 million increase in software revenues
was
19
due to an increase in the licensing component of software revenue. During the
quarter ended January 31, 2004, we had one existing customer and one new
customer place license orders in excess of $0.2 million, compared to no license
orders in excess of $0.2 million for the quarter ended January 25, 2003.
Software revenues represent $2.0 million, or 13.6%, and $1.4 million, or
12.0%, of total revenues for the six months ended January 31, 2004 and January
25, 2003, respectively. The year-over-year $0.6 million increase in software
revenue was due to the increased number of new customers that were added during
the six months ended January 31, 2004 compared with the six months ended January
25, 2003, coupled with a larger installed base for maintenance revenue and
follow-on sales. We began fiscal year 2004 with an installed base of 55
customers and added 20 new customers during the six months ended January 31,
2004 compared to beginning fiscal year 2003 with an installed base of 24
customers and adding 7 new customers during the six months ended January 25,
2003.
Online Revenues
Online revenues include online advertising and e-commerce revenues. Total
online revenues of $7.7 million and $5.7 million represented 86.5% and 86.2% of
total revenues for the three months ended January 31, 2004 and January 25, 2003,
respectively. Total online revenues of $12.6 million and $9.8 million
represented 86.1% and 84.3% of total revenues for the six months ended January
31, 2004 and January 25, 2003, respectively.
Online advertising revenues of $2.2 million and $2.3 million represented
25.1% and 34.8% of total revenues for the three months ended January 31, 2004
and January 25, 2003, respectively. Online advertising revenues included $0.4
million and $0.5 million of barter revenue for the three months ended January
31, 2004 and January 25, 2003, respectively. Online advertising revenues of $4.5
million and $4.6 million represented 30.6% and 39.7% of total revenues for the
six months ended January 31, 2004 and January 25, 2003, respectively. Online
advertising revenues included $0.9 million and $1.0 million of barter revenue
for the six months ended January 31, 2004 and January 25, 2003, respectively.
The average CPM rate (i.e., the average rate at which we receive revenue per
1,000 banner advertisements we display to users of our online services) for the
three and six months ended January 31, 2004 decreased by 53.0% and 56.0%,
respectively, when compared to the three and six months ended January 25, 2003.
The CPM rate decrease was offset by a 456% and 560% increase in the number of
impressions delivered for the three and six months ended January 31, 2004,
respectively. The increase in the number of impressions was primarily due to
general improvement in demand for our online advertising coupled with sales
generated by an additional sales representative that we added in the second
quarter of fiscal year 2004. We expect the growth of our online advertising
revenue to outpace that of the general online advertising market. We believe
that our prominent position in serving the growing open source software and
Linux markets, along with our favorable online visitor demographics, makes us an
attractive advertising vehicle for advertising customers.
E-commerce revenues of $5.4 million and $3.4 million represented 60.7% and
51.5% of total revenues for the three months ended January 31, 2004 and January
25, 2003, respectively. E-commerce revenues of $8.1 million and $5.2 million
represented 55.1% and 44.8% of total revenues for the six months ended January
31, 2004 and January 25, 2003, respectively. The $2.0 million and $2.9 million
increases in e-commerce revenues for the three and six months ended January 31,
2004 were primarily due to increased consumer awareness of our site due to
expanded advertising, a broader product offering which attracted a larger
customer base, web site enhancements and affiliate programs that drove more
traffic to our site. As a result of our effort we had a 60.5% and 56.2%
year-over-year increase in the number of orders placed for the three and six
months ended January 31, 2004, respectively. We expect continued growth in our
e-commerce revenue, including the continued seasonal impact from online holiday
shoppers in our second fiscal quarter.
Other Revenues
Other revenues are derived from our former hardware, customer support, and
professional services businesses. Other revenues represent $15,000, or 0.2%, of
total revenues for the three months ended January 31, 2004 and $0.2 million, or
3.3%, for the three months ended January 25, 2003. Other revenues represent
$46,000 or 0.3%, of total revenues for the six months ended January 31, 2004 and
$0.4 million, or 3.6%, for the six months ended July 25, 2003.
20
Cost of Revenues
Cost of software revenues include direct material and production costs for
CDs and manuals, professional services cost and support department costs. Cost
of software revenues were $0.5 million for each of the three months ended
January 31, 2004 and January 25, 2003. Cost of software revenues were 6.1% and
7.2% of total revenues for the three months ended January 31, 2004 and January
25, 2003, respectively. Cost of software revenues were $1.1 million for each of
the six months ended January 31, 2004 and January 25, 2003. Cost of software
revenues were 7.8% and 9.1% of total revenues for the six months ended January
31, 2004 and January 25, 2003, respectively. The three and six month percentage
of total revenue decreases were completely related to the increase in total
revenue; the cost of software revenues did not increase in the three or six
months ended January 31, 2004 compared to the comparable periods ended January
25, 2003. We anticipate that cost of software revenues will remain relatively
constant through the end of our fiscal year 2005.
Software gross margin increased $0.4 million to $0.6 million for the three
months ended January 31, 2004 from $0.2 million for the three months ended
January 25, 2003. The software gross margin was 7.3% and 3.3% of total revenues
for the three months ended January 31, 2004 and January 25, 2003, respectively.
The $0.4 million increase in gross margin was due to a $0.5 million increase in
software revenue coupled with no significant year-over-year increase in the
services and support department cost structure. The software gross margin
increased $0.6 million to $0.9 million for the six months ended January 31, 2004
from $0.3 million for the six months ended January 25, 2003. The software gross
margin was 5.8% and 2.9% of total revenues for the six months ended January 31,
2004 and January 25, 2003, respectively. The $0.6 million increase in gross
margin was due to the $0.6 million increase in software revenue coupled with no
significant year-over-year increase in the services and support department cost
structure. We anticipate that software gross margins in absolute dollars will
increase in direct relationship to revenue increases.
Cost of online revenues includes cost of e-commerce materials, shipping and
fulfillment costs, and employee costs associated with the editorial, operations
and merchandising functions. Cost of online revenues increased $1.4 million to
$4.8 million for the three months ended January 31, 2004 from $3.4 million for
the three months ended January 25, 2003. Cost of online revenues were 53.9% and
52.2% of total revenues for the three months ended January 31, 2004 and January
25, 2003, respectively. The $1.4 million increase in online cost of revenues was
primarily due to a $1.1 million increase in e-commerce material costs and $0.6
million increase in shipping and fulfillment costs associated with e-commerce
partially offset by a $0.3 million reduction in our online advertising business
cost of revenues. Cost of online revenues increased $1.7 million to $7.4 million
for the six months ended January 31, 2004 from $5.7 million for the six months
ended January 25, 2003. Cost of online revenues were 50.7% and 49.3% of total
revenues for the six months ended January 31, 2004 and January 25, 2003
respectively. The $1.7 million increase in online cost of revenues was primary
due to the increase in material costs of $1.4 million and $0.8 million in
shipping and fulfillment costs associated with e-commerce partially offset by a
$0.5 million reduction in our online advertising cost of revenues. The increase
in e-commerce materials, shipping and fulfillment costs for both the three- and
six-month periods was directly related to increases in revenue.
Online gross margin increased $0.7 million to $2.9 million for the three
months ended January 31, 2004 from $2.2 million for the three months ended
January 25, 2003. Online gross margin was 32.6% and 34.0% of total revenues for
the three months ended January 31, 2004 and January 25, 2003, respectively.
Online gross margin increased $1.1 million to $5.2 million for the six months
ended January 31, 2004 from $4.1 million for the six months ended January 25,
2003. Online gross margin was 35.4% and 35.0% of total revenues for the six
months ended January 31, 2004 and January 25, 2003, respectively. The three- and
six-month increases in online gross margin are related to increases in total
online revenue partially offset by an increase in cost of online revenues. We
expect to see continued quarterly variations in online gross margins as a
percent of online revenues due to the mix of our higher margin advertising
revenue with lower margin, seasonal e-commerce revenue.
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 increased $0.3 million to $2.6 million for the
three months ended January 31, 2004 from $2.3 million for the three months
January 25, 2003. The $0.3 million increase in expense was due to a $0.1 million
increase in commission expense associated with the increased revenue, a $0.1
million increase in outside contractor expense and a $0.1 million increase in
other miscellaneous expense categories. Sales and marketing expenses increased
$0.4 million to $5.0 million for the six months ended January 31, 2004 from $4.6
million for the six months ended January 25, 2003. The $0.4 million increase was
due to the $0.3 million expense increase explanation above coupled with a $0.1
million increase in marketing activities associated with our online business.
21
Sales and marketing expenses were 29.3% and 35.4% of total revenues for the
three months ended January 31, 2004 and January 25, 2003, respectively. Sales
and marketing expenses were 34.0% and 39.9% of total revenues for the six months
ended January 31, 2004 and January 25, 2003, respectively. These decreases as a
percentage of total revenues were 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 total revenues through our fiscal year
2005.
Research and Development Expenses
Research and development expenses consist primarily of salaries and related
expenses for software engineers. Total research and development expenses related
to our software business were $1.2 million and $1.5 million for the three months
ended January 31, 2004 and January 25, 2003, respectively. Total research and
development expenses related to our software business were $2.5 million and $3.2
million for the six month ended January 31, 2004 and January 25, 2003,
respectively. Software research and development expenses are primarily related
to the development of new products and enhancements to our current products.
Total research and development expenses for our online business were $0.5
million and $0.4 million for the three months ended January 31, 2004 and January
25, 2003, respectively. Total online research and development expenses were $1.0
million and $0.8 million for the six months ended January 31, 2004 and January
25, 2003, respectively. Online research and development is directed toward the
improvement of existing products and services.
Research and development expenses decreased by $0.2 million to $1.7 million
for the three months ended January 31, 2004 from $1.9 million for the three
months ended January 25, 2003. 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. Research and development expenses decreased by $0.5 million
to $3.5 million for the six months ended January 31, 2004 from $4.0 million for
the six months ended January 25, 2003. The $0.5 million decrease was due to a
$0.3 million decrease in employee labor expenses, a $0.1 million decrease in
outside contractor expense and a $0.1 million decrease in allocated overhead
expenses such as rent and utilities. Average headcount decreased by 6 to 38
during the three and six months ended January 31, 2004 from an average headcount
of 44 during the three and six months ended January 25, 2003.
Research and development expenses were 19.4% and 29.8% of total revenues
for the three months ended January 31, 2004 and January 25, 2003, respectively.
Research and development expenses were 24.2% and 34.4% of total revenues for the
six months ended January 31, 2004 and January 25, 2003, respectively. These
decreases as a percentage of total revenues were primarily related to our
increase in revenue and the year-over-year reduction in headcount. Going forward
we expect research and development expenses to remain stable in absolute dollars
and decrease as a percentage of total revenues through our fiscal year 2005.
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 $0.3 million to $1.6 million
for the three months ended January 31, 2004 from $1.9 million for the three
months ended January 25, 2003. The $0.3 million dollar decrease was due to a
$0.2 million decrease resulting from a change in the structure of our bonus plan
and $0.1 million in lower labor costs resulting from a decrease in headcount
from 21 to 18. General and administrative expenses decreased $1.4 million to
$2.3 million for the six months ended January 31, 2004 from $3.7 million for the
six months ended January 25, 2003. The $1.4 million dollar decrease was due to
lower labor and bonus costs as noted above; the remaining $1.1 million dollar
decrease was due to a $0.9 million reversal of accrued legal expenses reserved
for securities litigation expenses that were ultimately paid by one of our
insurers, and a $0.3 million reversal of legal expenses related to a lawsuit
that was favorably resolved during our first fiscal quarter, partially offset by
a $0.1 million increase in recruiting fees.
General and administrative expenses were 17.6% and 29.5% of total revenues
for the three months ended January 31, 2004 and January 25, 2003, respectively.
General and administrative expenses were 15.6% and 31.7% of total revenues for
the six months ended January 31, 2004 and January 25, 2003, respectively. These
decreases as a percentage of total revenues were primarily related to our
increase in revenue and due to the expense reduction reasons noted above. Going
forward we expect general and administrative expenses to increase slightly in
absolute dollars but decrease as a percentage of total revenues through our
fiscal year 2005.
22
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 January 31, 2004, we had an accrual of approximately $12.9
million outstanding related to these non-cancelable leases, all of which was
originally included in operating expenses
We recorded an $18,000 and $35,000 net credit in restructuring expenses in
the consolidated statement of operations for the three months and six months
ended January 31, 2004. The net credits were a result of sublease income earned
from a non-related party.
In February 2004, we adopted a plan to relocate our Fremont, California
headquarters to a smaller building in the same complex. As a result, we expect
to expense the remaining lease obligation, net of assumed sublease income of our
currently occupied space, and to write off the leasehold improvements and
furniture and fixtures in the current space. We had previously expensed the
remaining lease obligation, net of assumed sublease income of the space that we
are planning to move into; with the move, we will adjust the restructuring
reserve for the new smaller building. We expect to complete our relocation
during the quarter ended April 30, 2004, and anticipate that the move, coupled
with recent changes to our assumptions relating to expected future sublease
income from our restructured idle office space will result in our booking a net
restructuring expense of between $4.5 million and $5.0 million during the
quarter ended April 30, 2004.
Below is a summary of the restructuring charges in operating expenses (in
thousands):
Total
Charged To
Operations Restructuring
Total Total Total Six Months Total Liabilities
Charged To Charged To Charged To ended Cash at
Operations Operations Operations January 31, Receipts/ January 31,
Fiscal 2001 Fiscal 2002 Fiscal 2003 2004 Payments 2004
----------- ----------- ----------- ---------- -------- --------------
Cash Provisions:
Other special charges relating to
restructuring activities .................... $ 2,159 $ (888) $ 78 $ -- $ (1,349) $ --
Facilities charges ............................ 6,584 9,401 191 (35) (3,286) $ 12,855
Employee severance and other related charges .. 3,498 1,997 37 -- (5,532) --
-------- -------- -------- -------- -------- --------
Total cash provisions ..................... 12,241 10,510 306 (35) $(10,167) $ 12,855
-------- -------- -------- -------- ======== ========
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) $ (35)
======== ======== ======== ========
23
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 six months ended January 25, 2003 $17,994 $ (135) $(1,518) $16,341
For the six months ended January 31, 2004 $14,889 $ (35) $(1,999) $12,855
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 six months ended January 25, 2003 $3,931 $12,410 $16,341
For the six months ended January 31, 2004 $3,383 $ 9,472 $12,855
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 $0 and $20,000 during the three and six months
ended January 31, 2004, respectively, compared to $41,000 and $79,000 during the
three and six months ended January 25, 2003, respectively. We do not expect any
further expenses associated with deferred stock compensation 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 January 31, 2004 and January 25, 2003, respectively. We
amortized $6,000 and $1.3 million of intangibles for the six months ended
January 31, 2004 and January 25, 2003, 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 January 31, 2004 that would indicate a possible
impairment in the carrying value of intangible assets at January 31, 2004.
Remeasurement of Warrant Liability, Interest and Other Income, Net
On November 6, 2003, we entered into a securities purchase agreement in
which we completed a private placement of 3,529,412 shares of our common stock
with The Riverview Group LLC ("Riverview") at an issue price of $4.25 per share
for aggregate proceeds of approximately $15 million (the "Private Placement").
In connection with the Private Placement, the Company retained Wharton Capital
Partners Ltd. ("Wharton") to act as a financial consultant and placement agent.
Also in connection with the Private Placement, Riverview and Wharton received
three-year warrants to purchase a total of 705,883 and 25,000 shares of our
common stock, respectively, at an exercise price of $6.00 and $6.14 per share,
respectively (collectively, the "Warrants"). We entered into a registration
rights agreement with Riverview on November 6, 2003 (the "Registration Rights
Agreement") in which we agreed to provide certain registration rights under the
Securities Act of 1933, as amended and the rules and regulations promulgated
thereunder, and applicable state securities laws with respect to the common
stock and the warrants issued to Riverview.
The shares of our common stock sold in the Private Placement and the shares
of our common stock underlying the Warrants do not have the same rights as the
other shares which are included in the Equity section of the Consolidated
Balance sheet. Therefore, the shares of our common stock sold in the Private
Placement and the shares of our common stock underlying the Warrants are
classified as liabilities on the Consolidated Balance sheet. Liabilities must be
reported at fair value as of the balance sheet date. We valued the Warrants as
of November 6, 2003 using the Black-Scholes valuation model and then, on January
31, 2004, revalued them using the same Black-Scholes valuation model. Based on
our remeasurement, our net warrant liability for the Warrants decreased by $0.8
million to $1.7 million as of January 31, 2004, from $2.5 million as of November
6, 2003. This $0.8 million decrease in warrant liability was partially offset by
a $0.2 million non-cash expense associated with not having the shares of common
stock associated with the Private Placement registered as of January 31, 2004.
Due to a penalty clause in the Registration Rights Agreement, if we are unable
to effect registration of the shares of our common stock sold in the Private
Placement and the shares of our common stock
24
underlying the Warrants, we will be required to expense a total of $3.0 million
over the next 56 months. We present the net $0.6 million on our income statement
as remeasurement of warrant liability income (for additional information please
see footnote number 10 in the notes to the consolidated financial statements).
Once the shares of our common stock sold in the Private Placement and the shares
underlying the Warrants have been registered, they will have the same rights as
our other outstanding, registered common stock and we will no longer be required
to record income or expense associated with remeasurement of the Warrants or for
the potential penalty associated with not registering the shares of our common
stock sold in the Private Placement and the shares underlying the Warrants.
After the shares of our common stock sold in the Private Placement and the
shares underlying the Warrants have been registered, they will then be moved
from the liability section of our consolidated balance sheet to the equity
section of our consolidated balance sheet.
Interest income, net, includes income from our cash investments net of
interest expense. Net interest income decreased $0.1 million to $0.2 million for
the three months ended January 31, 2004 from $0.3 million for the three months
ended January 25, 2003. Net interest income decreased $0.1 million to $0.5
million for the six months ended January 31, 2004 from $0.6 million for the six
months ended January 25, 2003. These decreases were primarily related to the
year-over-year interest rate decline.
Interest income, net, was 2.7% and 4.2% of total revenues for the three
months ended January 31, 2004 and January 25, 2003, respectively. Interest
income, net, was 3.3% and 5.4% of total revenues for the six months ended
January 31, 2004 and January 25, 2003, respectively. These decreases as a
percentage of total revenues were primarily related to our increase in revenue
and due to lower interest rates. Going forward we expect interest income to
decrease as a percentage of total revenues.
Other income, net, includes items such as legal settlement proceeds net of
other expenses. Other income net, was $0 for the three months ended January 31,
2004 and a $37,000 expense for the three months ended January 25, 2003. Other
income net, increased $1.0 million to $0.9 million for the six months ended
January 31, 2004 from a $65,000 expense for the six months ended January 25,
2003. The $1.0 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.
Income Taxes
As of January 31, 2004, 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 January 31, 2004, our available capital resources totaled $49.4
million, comprised of marketable securities of $37.9 million and cash and cash
equivalents of $11.5 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. Our average net
monthly cash flow shortfall during the three months ended January 31, 2004 was
approximately $0.8 million. The cash flow shortfall is primarily due to
operating lease commitments that were entered into while we were operating our
hardware business and employee costs associated with our software business. We
believe that at our current cash flow shortfall rates, we have enough cash to
operate through fiscal year 2005. We will continue to invest significant
resources in an effort to grow our software business.
Net cash used in operating activities was $6.2 million in the six months
ended January 31, 2004 and $8.3 million in the six months ended January 25,
2003. Net cash used in operating activities during the six months ended January
31, 2004 primarily reflected a net loss of $2.7 million, a decrease in accrued
liabilities of $3.1 million, including a $2.0 million reduction in accrued
restructuring accruals as we make lease payments on restructured space and a
$0.9 million reduction in legal expenses due to the agreement by our insurers to
pay the legal expenses associated with the initial public offering securities
litigation; an increase in accounts receivable of $1.0 million, related to the
higher level of sales in the three months ending January 31, 2004 compared to
the three months ending July 31, 2003; net remeasurement of warrant liability of
$0.6 million, associated with the private placement; and an increase in prepaid
assets and inventories of $0.6 million, due to the payment of insurance premiums
and seasonal inventory needs
25
for our e-commerce business, respectively; partially offset by depreciation
expense $0.9 million and an increase in deferred revenue of $0.9 million. Net
cash used in operating activities during the six months ended January 25, 2003
of $8.3 million primarily reflected a net loss of $7.8 million, a decrease in
accrued liabilities of $2.8 million, a decrease in accounts payable of $0.7
million, an increase in accounts receivable of $0.4 million, a restructuring
expense of $0.2 million and an increase in prepaid assets and inventories of
$0.2 million partially offset by depreciation and amortization of intangible
asset expense $3.1 million, an increase in deferred revenue of $0.6 million and
an increase in other long-term liabilities of $0.1 million.
A significant portion of our cash inflows have historically been generated
by our sales. These inflows may fluctuate significantly from period to period. A
decrease in customer demand or decrease in the market acceptance of our products
would jeopardize our future ability to generate positive cash flows from
operations.
For the six months ended January 31, 2004, we used $5.9 million in cash for
investing activities, compared to the use of $15.5 million for the six months
ended January 25, 2003. During the six months ended January 31, 2004 we
purchased $0.5 million in fixed assets and $10.1 million in marketable
securities and sold $4.8 million in marketable securities. Cash used for
investing activities was significantly higher for the six months ended January
25, 2003 when we purchased $23.7 million in marketable securities and sold $8.1
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 six months ended January 31, 2004, we generated $17.3 million in
cash from financing activities, compared to $0.2 million for the six months
ended January 25, 2003. Net proceeds from the private placement generated $14.5
million during the six months ended January 31, 2004 and cash generated from the
issuance of common stock to our employees increased to $2.8 million during the
six months ended January 31, 2004 compared to the $0.2 million for the six
months ended January 25, 2003. We do not anticipate entering into additional
private placement transactions in the foreseeable future and the level of cash,
if any, that will be generated in the future from the issuance of common stock
to our employees from the exercising of options is dependant upon several
factors, including the market price of our common stock and the number of
employees participating in our stock option plans.
For the six months ended January 31, 2004 and January 25, 2003, 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 January 31, 2004 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.
Future payments due under debt and lease obligations as of January 31, 2004
are as follows (in thousands):
Gross Net
Operating Sublease Operating
Leases Income Leases
------- ------ -------
2004 .................................. $ 2,647 $ 341 $ 2,306
2005 .................................. 5,002 663 4,339
2006 .................................. 3,741 151 3,590
2007 .................................. 3,511 -- 3,511
2008 .................................. 3,616 -- 3,616
Thereafter ............................ 6,905 -- 6,905
------- ------ -------
Total minimum lease payments $25,422 $1,155 $24,267
======= ====== =======
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
26
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.
In December 2003, the SEC issued SAB 104, Revenue Recognition, ("SAB 104")
which supercedes SAB 101, Revenue Recognition in Financial Statements. SAB 104's
primary purpose is to rescind accounting guidance contained in SAB 101 related
to multiple element revenue arrangements, which was superceded as a result of
the issuance of EITF 00-21, Accounting for Revenue Arrangements with Multiple
Deliverables. While the wording of SAB 104 has changed to reflect the issuance
of EITF 00-21, the revenue recognition principles of SAB 101 remain largely
unchanged by the issuance of SAB 104. We do not believe the adoption of SAB 104
will have a material impact on the financial statements.
Risk Factors
INVESTORS SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW BEFORE MAKING AN
INVESTMENT DECISION. IN ADDITION, THESE RISKS ARE NOT THE ONLY ONES FACING OUR
COMPANY. ADDITIONAL RISKS OF WHICH WE ARE NOT PRESENTLY AWARE OR THAT WE
CURRENTLY BELIEVE ARE IMMATERIAL MAY ALSO IMPAIR OUR BUSINESS OPERATIONS. OUR
BUSINESS COULD BE HARMED BY ANY OF THESE RISKS. THE 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.
27
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 devoting the majority of our research and development spending on our
SourceForge application, so if this software does not achieve market acceptance
we are likely to experience continued operating losses.
Although in the second quarter of our fiscal year 2004, which ended on January
31, 2004, approximately 13% of our revenue was derived from our software
business, we devoted 70.6%, or $1.2 million, of our research and development
spending to research and development associated with our SourceForge software
application. Given that SourceForge remains a relatively new enterprise software
application, we expect to continue to allocate the majority of our research and
development resources to SourceForge for the foreseeable future. There can be no
assurance, however, that we will be sufficiently successful in marketing,
licensing, upgrading and supporting SourceForge to offset our substantial
software research and development expenditures. A failure to grow SourceForge
revenue sufficiently to offset SourceForge's significant research and
development costs will materially and 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 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.
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. We believe
the success of our software business will become increasingly dependent on our
ability to:
o support multiple platforms, including Linux, commercial UNIX and
Microsoft Windows;
o use the latest technologies to continue to support Web-based
collaborative software development; and
o continually support the rapidly changing standards, tools and
technologies used in software development.
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 has often exceeded three and occasionally exceeded
twelve months. Additionally, our sales cycle is complex because customers
consider a number of factors before committing to license SourceForge. Factors
that our customers and potential customers have informed us that they considered
when evaluating SourceForge included product benefits, cost and time of
implementation, and the ability to operate with existing and future computer
systems and applications. We have found that customer evaluation, purchasing and
budgeting processes vary
28
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 completed transactions and associated revenue. 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.
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 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.
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.
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. The occurrence of such issues might cause our software revenue and
operating results to fall below our publicly-stated expectations, the
expectations of securities analysts or the expectations of investors. Failure to
meet public expectations is likely to materially and adversely affect the
trading price of our common stock.
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.
29
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.
Risks Related To Our Online Business
If our online business fails to continue to deliver original and compelling
content and services, we will be unable to attract and retain users, which will
adversely affect our financial results.
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, 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, which would adversely
affect our financial results.
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 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. If we fail to accurately assess and predict our
e-commerce customers' preferences, it will adversely impact our financial
results.
Our e-commerce offerings on our ThinkGeek.com Web site are designed to appeal to
IT professionals, software developers and others in technical fields. Misjudging
either the market for our products or our customers' purchasing habits will
cause our sales to decline, our inventories to increase and/or require us to
sell our products at lower prices, all of which 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.
Failure to properly assess our inventory needs will adversely affect our
financial results.
In order to be successful, we must accurately predict our consumer tastes 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.
30
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 financial results will be
adversely affected.
Our ThinkGeek e-commerce Web site is dependent upon a single third party
fulfillment and warehouse provider. The satisfaction of our e-commerce customers
is highly dependent upon fulfillment of orders in a professional and timely
manner, so any decrease in the quality of service offered by our fulfillment and
warehouse provider will adversely affect our reputation and the growth of our
e-commerce business.
Our ThinkGeek e-commerce Web site's ability to receive inbound inventory and
ship completed orders efficiently to our customers is substantially dependent on
efillit Inc., a third-party contract fulfillment and warehouse provider located
in Baltimore, Maryland. efillit has generally kept pace with ThinkGeek's growth
to date, however, we cannot be certain that efillit will be able to
satisfactorily accommodate ThinkGeek's future growth. If efillit fails to meet
our future distribution and fulfillment needs, our relationship with and
reputation among our e-commerce customers will suffer and this will adversely
effect our e-commerce growth. Additionally, if efillit cannot meet our
distribution and fulfillment needs, or our contract with efillit terminates, we
may fail to secure a suitable replacement or second-source distribution and
fulfillment provider on comparable terms, which would adversely affect our
e-commerce financial results.
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 2005.
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. Our average net monthly cash flow shortfall during the quarter
ended January 31, 2004 was approximately $0.8 million. Although this average net
monthly cash flow shortfall approximation should not be relied upon as an
indicator of our average net monthly cash flow shortfall in the future, it
further illustrates that 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.
While we believe we will not require additional capital to fund continued
operations through fiscal year 2005, 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. Debt financing, if available, may
involve restrictive covenants on our operations and financial condition. Our
inability to raise capital when needed could seriously harm our business.
Because we have a limited operating history selling SourceForge, we may not
accurately forecast our sales and revenues, which will cause quarterly
fluctuations in our total revenues and financial results.
We have a limited 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. 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. 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.
Certain factors specific to our businesses over which we have limited or no
control may nonetheless adversely impact our quarterly total revenues and
financial results.
31
The primary factors over which we have limited or no control that may adversely
impact our quarterly total revenues and financial results include the following:
o specific economic conditions relating to IT spending;
o the discretionary nature of our software customers' purchase and budget
cycles;
o the size and timing of software customer orders;
o long software sales cycles;
o our ability to retain skilled software engineers and sales personnel;
o the timing of announcements and releases of new or enhanced versions of
our products and product upgrades;
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 economic conditions relating to online advertising and sponsorship, and
e-commerce;
o our ability to demonstrate and maintain attractive online user
demographics;
o our ability to retain a skilled online advertising and sponsorship
sales force;
o the addition or loss of specific online advertisers or sponsors, and
the size and timing of advertising or sponsorship purchases by
individual customers; and
o our ability to keep our Web sites operational at a reasonable cost.
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 will 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 cause delays in our ability to recognize revenue, which will adversely
impact our quarterly financial results.
From time to time, the American Institute of Certified Public Accountants
(AICPA), the Public Company Accounting Oversight Board (PCAOB) and the SEC will
issue guidelines and interpretations regarding the recognition of revenue from
software and other activities. These new guidelines and interpretations could
result in a delay in the company's ability to recognize revenue. If the company
has to delay the recognition of a significant amount of revenue in the future,
this will have a material impact on the company's reported financial results.
We have a history of losses and expect to continue to incur net losses for the
foreseeable future. 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.
We incurred a loss of $1.4 million for our fiscal second quarter ended January
31, 2004, and we had an accumulated deficit of $742.4 million as of January 31,
2004. 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 beyond our fiscal year 2005.
Despite reductions in the size of our workforce, our business may fail to grow
rapidly enough to offset our ongoing operating expenses.
32
During fiscal years 2001, 2002 and 2003, we substantially reduced the size of
our workforce. As of January 31, 2004, we had 121 employees. Despite these
reductions in our workforce, our business may fail to grow rapidly enough to
offset our ongoing operating expenses. As a result, our quarterly operating
results could fluctuate, and such fluctuation could adversely affect the market
price of our common stock.
The lack of inclusion of a consent of Arthur Andersen LLP to this Registration
Statement limits your ability to assert a claim against Arthur Andersen LLP.
Our financial statements for the fiscal year ended July 28, 2001 are included in
our Annual Report on Form 10-K. On April 17, 2002, we dismissed Arthur Andersen
LLP ("Arthur Andersen") as our independent auditor. Given the changes at Arthur
Andersen, we are unable to obtain Arthur Andersen's written consent to the
incorporation of its audit report into the Registration Statement with respect
to our financial statements as of July 28, 2001.
As a result, Arthur Andersen will not have any liability under Section 11(a) of
the Securities Act for any untrue statements of a material fact contained in the
financial statements audited by Arthur Andersen or any omissions of a material
fact required to be stated therein. Accordingly, investors would be unable to
assert a claim against Arthur Andersen under Section 11(a) of the Securities Act
for any purchases of securities under Registration Statements made on or after
the date of this Form S-3.
Risks Related To Competition
If we do not effectively compete with new and existing competitors, our revenues
will not grow and may decline, which will adversely impact our financial
results.
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 companies entrenched 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.
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.
33
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.
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, which could be costly to defend and
subject us to significant damage claims.
34
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, which could be costly to
defend and subject us to significant damage claims.
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. We updated our operations
and financial systems, procedures and controls following our strategic decision
to focus 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 second quarter of fiscal year 2004, the closing
sale prices of our common stock on the Nasdaq ranged from $2.98 to $5.26 per
share and the closing sale price on January 30, 2004 was $3.99 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.
35
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.
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.
Risks Related to the sale of shares of our common stock in the Private Placement
The common stock sold in the Private Placement will increase the supply of our
common stock on the public market, which may cause our stock price to decline.
The sale into the public market of the common stock to be sold in the Private
Placement could adversely affect the market price of our common stock. Most of
our shares of common stock outstanding are eligible for immediate and
unrestricted sale in the public market at any time. Once the registration
statement in connection with the Private Placement is declared effective, the
5,107,354 shares of common stock covered by that prospectus will be eligible for
immediate and unrestricted resale into the public market. The presence of these
additional shares of common stock in the public market may depress our stock
price.
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.
36
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
January 31, 2004. 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 months three months to one year Greater than one year
------------------- ------------------------ ---------------------
As of January 31, 2004
Cash equivalents $8,000
Weighted-average interest rate 1.10%
Short-term investments $24,686
Weighted-average interest rate 2.23%
Long-term investments $13,189
Weighted-average interest rate 2.05%
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.
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. Pursuant to a tolling agreement, the individual defendants
were dismissed without prejudice. On February 19, 2003, the court denied the
Company's motion to dismiss the claims against it. The litigation is now in
discovery. A proposal has been made for the settlement and release of claims
against the issuer defendants, including the Company. 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,
37
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 2. Changes in Securities and Use of Proceeds
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 (the "Riverview Warrants") to The Riverview Group LLC for
aggregate consideration of $15 million. These securities were sold pursuant to
an exemption from registration under Section 4(2) of the Securities Act of 1933
(the "Offering").
The Company retained Wharton Capital Partners Ltd. ("Wharton") to act as a
financial consultant and placement agent in the Offering. The Company entered
into an agreement with Wharton on October 29, 2003 (the "Wharton Agreement"),
pursuant to which Wharton agreed to act as the Company's non-exclusive financial
consultant and/or placement agent from the date of the agreement through
November 28, 2003. Pursuant to the terms of the Wharton Agreement, the Company
issued Wharton warrants to purchase a total of 25,000 shares of VA Software
common stock at an exercise price of $6.14 per share (the "Wharton Warrants") as
compensation for its services in connection with the Offering. These securities
were sold pursuant to an exemption from registration under Section 4(2) of the
Securities Act of 1933.
Both the Riverview Warrants and the Wharton Warrants include a cashless
exercise provision pursuant to which Riverview and Wharton may exercise the
warrants in whole or in part and receive fewer shares upon such exercise in lieu
of making the cash payment otherwise required upon such exercise.
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 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.
38
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.
On February 24, 2004, the Company furnished a Current Report on Form 8-K
under Item 12 (Results of Operations and Financial Condition) disclosing the
issuance of a February 24, 2004 press release announcing its financial results
for the quarter ended January 31, 2004.
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: March 16, 2004
39
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
40