Components of the total accrued restructuring liability are as follows (in thousands):
The Company’s restructuring liability is comprised of non-cancelable operating lease payments of $1.8 million, $1.8 million and $1.5 million for the years ending July 31, 2008, July 31, 2009 and July 31, 2010, respectively.
The Company leases its facilities under operating leases that expire at various dates through fiscal year 2012. Future minimum lease payments under non-cancelable operating leases, net of sublease income, as of July 31, 2007 are as follows (in thousands):
Gross rent expense for the years ended July 31, 2007, July 31, 2006 and July 31, 2005 was approximately $2.5 million, $2.6 million and $2.8 million, respectively. This rent expense was offset by sublease income of $1.5 million, $1.6 million and $1.8 million for the years ended July 31, 2007, July 31, 2006 and July 31, 2005, respectively. No rent expense as a result of idle facilities charges was recorded for the years ended July 31, 2007, July 31, 2006 and July 31, 2005. The idle facilities charge for the year ended July 31, 2007 has been included in discontinued operations in the consolidated statements of operations.
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 issuer defendants and plaintiffs negotiated a stipulation of settlement for the claims against the issuer defendants, including the Company, that was submitted to the Court for approval in June 2004. In August 2005, the Court preliminarily approved the settlement. In December 2006, the appellate court overturned the certification of classes in the six test cases that were selected by the underwriter defendants and
plaintiffs in the coordinated proceedings. Because class certification was a condition of the settlement, it was unlikely that the settlement would receive final Court approval. On June 25, 2007, the Court entered an order terminating the proposed settlement based upon a stipulation among the parties to the settlement. Plaintiffs have filed an amended complaint and filed a motion for class certification based on their amended allegations. It is uncertain whether there will be any revised or future settlement. The Company believes that it has meritorious defenses to plaintiffs’ claims and intends to defend the action vigorously.
On Nov 9, 2001, a former employee of the Company, who had worked as a sales person in the Company’s former hardware business, filed a complaint captioned Okerman v. VA Linux Systems, Inc. & Larry Augustin, Civil No. 01-01825 (Norfolk Superior Court), in the Commonwealth of Massachusetts. As amended, the complaint alleges that changes made to certain commission and bonus plans during the plaintiff’s tenure at the Company entitled him to recover damages for Breach of Contract, Breach of the Implied Covenant of Good Faith and Fair Dealing, violation of the Massachusetts Wage Act Statute, Promissory Estoppel, and Quantum Meruit. On June 25, 2002, the Court dismissed the Massachusetts Wage Act claim brought against the Company’s former chief executive officer. On July 26, 2002, dismissal of the Wage Act claim in favor of the Company’s former chief executive officer was upheld on interlocutory appeal. On July 9, 2003, the Court granted summary judgment in the Company’s favor regarding claims for Breach of Contract, Promissory Estoppel, and Quantum Meruit, and granted judgment on the pleadings in favor of the Company regarding the Massachusetts Wage Act claim. On September 24, 2004, following a jury trial on the sole remaining claim for Breach of the Covenant of Good Faith and Fair Dealing, a jury awarded damages of $136,876 to the plaintiff, which have been included in accrued liabilities and other in the Company’s condensed consolidated balance sheets as of April 30, 2007. The plaintiff and the Company filed their appellate briefs and the Appeals Court for the Commonwealth of Massachusetts heard oral arguments on May 17, 2007.On August 20, 2007, the Appeals Court issued its decision, vacating the Superior Court’s dismissal of the Wage Act Claims and affirming all other counts. On September 17, 2007, Mr. Okerman and the Company filed petitions for rehearing and, on September 24, 2007, the Company filed an application for further appellate review with the Supreme Judicial Court regarding the Wage Act Claims. The Company believes that it has meritorious defenses to plaintiff’s claims and intends to defend the action 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.
As described in Note 12 – Subsequent Event, on September 26, 2007, Company received notification that it had been named as a defendant in a civil action filed in Paris, France.
6. Guarantees and Indemnifications
The following is a summary of our agreements that we have determined are within the scope of FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” some of which are specifically grandfathered because the guarantees were in effect prior to December 31, 2002. Accordingly, we have no liabilities recorded for these agreements as of July 31, 2007.
In conjunction with the sale of its Software business to CollabNet, the Company has agreed to indemnify CollabNet for damages arising from any misrepresentation of representations and warranties, the breach of a covenant or agreement or the failure by the Company to assume certain liabilities excluded from the sale of the business. Except in the case of fraud, the indemnification is limited to the 2,933,444 shares of CollabNet preferred stock held in escrow; however the maximum amount of the indemnification for breach of the non-competition covenant is equal to the 11,733,777 shares of CollabNet Series C-1 preferred stock, owned by the Company. CollabNet may not make an indemnification claim until their aggregate losses under the indemnification provisions exceed $0.1 million. The term of the indemnification is generally through April 24, 2008, except for certain claims for fraud or breaches of the non-competition covenant. The Company believes that it has complied with all of those items for which it has agreed to indemnify CollabNet, and the Company has not been subject to any claims or suffered any losses, and CollabNet has not made any claims pursuant to the Company’s indemnification obligations. Accordingly, the Company has no liabilities recorded for this indemnification as of July 31, 2007.
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In conjunction with the sale of its Online Images business to Jupitermedia, the Company agreed to indemnify Jupitermedia for losses arising from any misrepresentation of representations and warranties, the breach of a covenant or agreement or the failure by the Company to assume certain liabilities excluded from the sale of the business. The maximum amount of the indemnification is $1.4 million and no claim for indemnification may be made until aggregate losses exceed $0.08 million. The term of the indemnification was generally through June 23, 2007; however, certain items have different indemnification periods. The Company believes that it has complied with all of those items for which it has agreed to indemnify Jupitermedia, and the Company has not been subject to any claims or suffered any losses, and Jupitermedia has not made any claims pursuant to the Company’s indemnification obligations. Accordingly, the Company has no liabilities recorded for this indemnification as of July 31, 2007.
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 obtained 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. Accordingly, the Company has no liabilities recorded for these agreements as of July 31, 2007.
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 patent, 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 July 31, 2007.
The Company’s former Software business warranted that its software products would 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 did not exceed 90 days. Additionally, the Company warranted that its maintenance services performed consistently with generally accepted industry standards through the completion of the agreed upon services. In conjunction with the Company’s sale of its Software business to CollabNet, certain of these warranties were assumed by CollabNet. 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 July 31, 2007.
7. Retirement Savings Plan
The Company maintains an employee savings and retirement plan which is qualified under Section 401(k) of the Internal Revenue Code and is available to substantially all full-time employees of the Company. The plan provides for tax deferred salary deductions and after-tax employee contributions. Contributions include employee salary deferral contributions and discretionary employer contributions. To date, there have been no employer discretionary contributions.
8. Common Stock
Warrants
On November 6, 2003, the Company issued two warrants to purchase up to 705,883 and 25,000 shares of common stock to The Riverview Group LLC and Wharton Capital Partners Ltd., respectively in connection with a private placement of the Company’s common stock. These warrants were exercisable at exercise prices of $6.00 and $6.14 per share and the warrants expired unexercised on November 6, 2006.
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Stock option plans
In fiscal year 1999, the Company adopted and the Board of Directors approved the 1998 Stock Option Plan (the “1998 Plan”). Since inception, a total of 37,824,386 shares of common stock have been reserved for issuance under the 1998 Plan, subject to an annual increase of the lesser of 4,000,000 shares or 4.9% of the then outstanding common stock or an amount to be determined by the Board of Directors. Through July 31, 2007, 50,087,162 options and stock purchase rights have been granted under the 1998 Plan. Under the 1998 Plan, the Board of Directors may grant to employees and consultants options and/or stock purchase rights to purchase the Company’s common stock at terms and prices determined by the Board of Directors. The 1998 Plan will terminate in 2008. Nonqualified options granted under the 1998 Plan must be issued at a price equal to at least 85% of the fair market value of the Company’s common stock at the date of grant. All options may be exercised at any time within 10 years of the date of grant or within one month of termination of employment, or such shorter time as may be provided in the stock option agreement, and vest over a vesting schedule determined by the Board of Directors. The Company’s policy is to issue new shares upon exercise of options under the 1998 Plan.
The Company’s 1999 Director’s Option Plan (the “Directors’ Plan”) was adopted by the Company’s Board of Directors in October 1999. Since inception, a total of 1,500,000 shares of common stock have been reserved for issuance under the Directors’ Plan, subject to an annual increase of the lesser of 250,000 shares, or 0.5% of the then outstanding common stock or an amount determined by the Board of Directors. Through July 31, 2007, 1,210,000 options have been granted under the Directors’ Plan. Under the Directors’ Plan, options are granted when a non-employee director joins the Board of Directors and at each annual meeting where the director continues to serve on the Board of Directors. The Directors’ Plan establishes an automatic grant of 80,000 shares of common stock to each non-employee director who is elected. The Directors’ Plan also provides that upon the date of each annual stockholders’ meeting, each non-employee director who has been a member of the Board of Directors for at least six months prior to the date of the stockholders’ meeting will receive automatic annual grants of options to acquire 20,000 shares of common stock. On September 5, 2007, the Compensation Committee of the Board of Directors amended the grants as further described in Note 12 - Subsequent Events. Each automatic grant has an exercise price per share equal to the fair market value of the common stock at the date of grant, vest 25% immediately upon the grant date, one thirty-sixth per month thereafter and become fully vested three years after the date of grant. Each automatic grant has a term of ten years. In the event of a merger with another corporation or the sale of substantially all of its assets, each non-employee director’s outstanding options will become fully vested and exercisable. Options granted under the Directors’ Plan must be exercised within 3 months of the end of the non-employee director’s tenure as a member of the Board of Directors, or within 12 months after a non-employee director’s termination by death or disability, provided that the option does not terminate earlier under its terms earlier. Unless terminated sooner, the Directors’ Plan terminates automatically in 2009. The Company’s policy is to issue new shares upon exercise of options under the Director’s Plan.
The Company has assumed certain option plans and the underlying options of companies which the Company has acquired (the “Assumed Plans”). Options under the Assumed Plans have been converted into the Company’s options and adjusted to effect the appropriate conversion ratio as specified by the applicable acquisition agreement, but are otherwise administered in accordance with the terms of the Assumed Plans. Options under the Assumed Plans generally vest over four years and expire ten years from the date of grant. No additional options will be granted under the Assumed Plans.
Restricted Stock Awards
During the fiscal year ended July 31, 2007, the Board of Directors granted executive management as well as certain other employees, 1,507,500 restricted shares at $0.001 per share. Restricted stock award grants are generally measured at fair value on the date of grant based on the number of shares granted and the quoted price of the Company’s common stock. This fair value has been reduced for estimated forfeitures based on the awards ultimately expected to vest and is recognized as an expense over the corresponding service period. The restricted stock awards have both service and performance conditions attached to them. The weighted-average grant date fair value per share was $3.90.
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A total of 1,275,000 restricted shares were granted with service conditions. The service conditions have a three year vesting period. A total of 232,500 restricted shares were granted with performance conditions and vest based on the Company attaining certain performance conditions during its fiscal year ending July 31, 2007, of which 182,500 shares were outstanding at July 31, 2007. The Company did not attain these performance conditions and the shares were repurchased by the Company in August 2007.
As of July 31, 2007, the Company had reserved shares of its common stock for future issuance as follows:
| 1998 Stock Option Plan and Assumed Plans | 14,713,523 |
| 1999 Director Option Plan | 1,140,002 |
| | 15,853,525 |
The following table summarizes option and restricted stock activities from July 31, 2004 through July 31, 2007:
| | | | Stock Options Outstanding | | | | Stock Options | |
| | | | | | | | | | | | | | Weighted- | | | | |
| | | | | | | | | | | Weighted- | | Average | | Aggregate |
| | | | Restricted Stock | | | | | Average | | Remaining | | Intrinsic |
| | Available for | | Outstanding | | Number | | Exercise Price | | Contractual | | Value |
| | Grant | | (1) | | Outstanding | | per Share | | Term | | ($ 000’s) |
| Balance at July 31, 2004 | 10,908,627 | | | — | | | 12,131,872 | | | | $ | 3.58 | | | | | | | | | |
| Granted | (1,552,900 | ) | | — | | | 1,552,900 | | | | $ | 2.05 | | | | | | | | | |
| Exercised | — | | | — | | | (300,374 | ) | | | $ | 1.09 | | | | | | | | | |
| Cancelled | 2,152,685 | | | — | | | (2,158,352 | ) | | | $ | 5.27 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | |
| Balance at July 31, 2005 | 11,508,412 | | | — | | | 11,226,046 | | | | $ | 3.11 | | | | | | | | | |
| Granted | (1,902,000 | ) | | — | | | 1,902,000 | | | | $ | 3.68 | | | | | | | | | |
| Exercised | — | | | — | | | (2,847,520 | ) | | | $ | 2.00 | | | | | | | | | |
| Cancelled | 1,317,974 | | | — | | | (1,327,111 | ) | | | $ | 3.28 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | |
| Balance at July 31, 2006 | 10,924,386 | | | — | | | 8,953,415 | | | | $ | 3.56 | | | | | | | | | |
| Granted | (2,661,475 | ) | | 1,507,500 | | | 1,153,975 | | | | $ | 4.21 | | | | | | | | | |
| Exercised | — | | | | | | (2,820,406 | ) | | | $ | 1.50 | | | | | | | | | |
| Restricted stock released | — | | | (25,000 | ) | | — | | | | $ | — | | | | | | | | | |
| Restricted stock repurchased | 165,000 | | | (165,000 | ) | | — | | | | $ | — | | | | | | | | | |
| Cancelled | 703,989 | | | — | | | (716,738 | ) | | | $ | 6.26 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | |
| Balance at July 31, 2007 | 9,131,900 | | | 1,317,500 | | | 6,570,246 | | | | $ | 4.26 | | | | 6.07 | | | | $4,131 | |
| Exercisable at July 31, 2007 | | | | | | | 4,760,716 | | | | $ | 4.33 | | | | 4.93 | | | | $3,785 | |
____________________
| (1) | | Restricted stock outstanding is included in common stock outstanding. |
The total intrinsic value of options exercised was $8.6 million, $5.5 million and $0.3 million during the years ended July 31 2007, July 31, 2006 and July 31, 2005, respectively. The Company issues new shares upon the exercise of options. During the years ended July 31, 2007 and July 31, 2006, the Company realized tax benefits of $0.2 million and $0.1 million, respectively, from exercised options. For the year ended July 31, 2005 no tax benefit was realized from exercised options.
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The value of the option grants has been calculated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:
| | Year Ended July 31, |
| | 2007 | | 2006 |
| Expected life (years) | 6.13 | | | 6.5 | |
| Risk-free interest rate | 4.8 | % | | 4.9 | % |
| Volatility | 71 | % | | 83 | % |
| Dividend yield | None | | | None | |
| Weighted-average fair value at grant date | 2.84 | | | 2.74 | |
The options outstanding and currently exercisable by exercise price at July 31, 2007 were as follows (in thousands, except years and per-share amounts):
| | | | | | OPTIONS |
| | | | OPTIONS OUTSTANDING | | EXERCISABLE |
| | | | | | | Weighted | | | | | | |
| | | | | | | | Average | | Weighted | | | | Weighted |
| | | | | | | | Remaining | | Average | | | | Average |
| Range of Exercise | | Number | | Life (in | | Exercise | | | | Exercise |
| Prices | | Outstanding | | years) | | Price | | Shares | | Price |
| $ 0.23 - $1.85 | | | 668 | | | 6.60 | | $ | 1.44 | | | 508 | | $ | 1.36 | |
| $ 1.90 - $2.18 | | | 241 | | | 7.24 | | | 1.98 | | | 238 | | | 1.98 | |
| $ 2.45 - $2.45 | | | 889 | | | 5.50 | | | 2.45 | | | 889 | | | 2.45 | |
| $ 2.52 - $2.98 | | | 823 | | | 5.66 | | | 2.90 | | | 810 | | | 2.90 | |
| $ 3.00 - $3.70 | | | 649 | | | 4.19 | | | 3.08 | | | 617 | | | 3.05 | |
| $ 3.70 - $4.10 | | | 771 | | | 8.68 | | | 3.94 | | | 201 | | | 3.97 | |
| $ 4.10 - $4.33 | | | 621 | | | 8.52 | | | 4.15 | | | 183 | | | 4.15 | |
| $ 4.33 - $4.64 | | | 543 | | | 1.21 | | | 4.57 | | | 502 | | | 4.57 | |
| $ 4.64 - $5.50 | | | 759 | | | 8.94 | | | 4.83 | | | 207 | | | 4.79 | |
| $ 5.50 - $64.12 | | | 606 | | | 3.36 | | | 13.57 | | | 606 | | | 13.57 | |
| $ 0.23 $64.12 | | | 6,570 | | | 6.07 | | $ | 4.26 | | | 4,761 | | $ | 4.33 | |
The total intrinsic value of stock options outstanding and stock options exercisable as of July 31, 2007 was $4.1 million and $3.8 million, respectively. The intrinsic value is calculated as the difference between the market value as of July 31, 2007 and the exercise price of the shares. The market value as of July 31, 2007 was $3.71 as reported by the NASDAQ Global Market System. The weighted-average remaining contractual life of options exercisable as of July 31, 2007 was 4.93 years. The total number of in-the-money options exercisable as of July 31, 2007 was 3.1 million.
The total fair value of options vested during the years ended July 31, 2007, July 31, 2006 and July 31, 2005 were $0.3 million, $0.9 million, and $0.9 million, respectively. As of July 31, 2007, total compensation cost related to nonvested stock options not yet recognized was $4.5 million which is expected to be recognized over a weighted-average term of 3.0 years.
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Valuation and Expense Information under SFAS 123(R)
On August 1, 2005, the Company adopted SFAS 123(R), which requires the measurement and recognition of compensation expense for all share-based payment awards made to the Company’s employees and directors, including employee stock options based on estimated fair values. The following table summarizes stock-based compensation expense related to employee stock options under SFAS 123(R) which was allocated as follows (in thousands):
| | Year Ended July 31, |
| | 2007 | | 2006 |
| Online Media cost of revenue | $ | 76 | | $ | 16 |
| E-commerce cost of revenue | | 25 | | | 9 |
| Included in cost of revenue | | 101 | | | 25 |
| Sales and marketing | | 236 | | | 32 |
| Research and development | | 113 | | | 22 |
| General and administrative | | 993 | | | 356 |
| Included in operating expenses | | 1,342 | | | 410 |
| Discontinued operations | | 434 | | | 305 |
| Total share-based compensation expense | $ | 1,877 | | $ | 740 |
The table below reflects net loss and diluted net loss per share compared with the pro forma information for the year ended July 31, 2005 as follows (in thousands except per-share amounts):
| | Year Ended |
| | July 31, 2005 |
| Net loss — as reported | $ | (4,694 | ) |
| Add back employee stock-based compensation expense related | | | |
| to stock options included in reported net loss | $ | 68 | |
| Stock-based compensation expense related to employee stock options | | (13,335 | ) |
| Net loss, including the effect of stock-based compensation expense | $ | (17,961 | ) |
| Basic and diluted net loss per share — as reported | $ | (0.08 | ) |
| Basic and diluted net loss per share, including the effect of stock-based compensation expense | $ | (0.29 | ) |
The weighted-average estimated value of employee stock options granted during the year ended July 31, 2005 was $1.51 using the Black-Scholes model with the following weighted-average assumptions:
| | Year Ended |
| | July 31, 2005 |
| Expected life (years) | | 4.8 | | |
| Risk-free interest rate | | 3.6 | % | |
| Volatility | | 98 | % | |
| Dividend yield | | None | | |
Upon adoption of SFAS 123(R), the Company began estimating the value of employee stock options on the date of grant using the Black-Scholes model. The Company has used the simplified method for determining the expected term of options granted during the fiscal years ending July 31, 2007 and July 31, 2006. Prior to fiscal 2006, the value of each employee stock option was estimated on the date of grant using the Black-Scholes model for the purpose of pro forma financial information in accordance with SFAS 123.
As stock-based compensation expense recognized in the Consolidated Statement of Operations for the years ended July 31, 2007 and July 31, 2006 is based on awards ultimately expected to vest; it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based on historical experience. In the Company’s pro forma information required under SFAS 123 for the periods prior to August 1, 2005, the Company accounted for forfeitures as they occurred.
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Employee Stock Purchase Plan
In October 1999, the Company adopted an Employee Stock Purchase Plan (“ESPP”). Under the terms of the ESPP, as authorized by the Board of Directors in September 2003, the maximum aggregate number of shares of stock that were to issued under the ESPP was 3,000,000, cumulatively increased annually by an amount equal to the lesser of (a) 1% of the then issued and outstanding shares of common stock, (b) an amount determined by the Board of Directors, or (c) 500,000 shares of common stock. During each six-month offering period, employees could choose to have up to 10% of their annual base earnings withheld to purchase the Company’s common stock. The purchase price of the common stock was 85% of the lesser of the fair value as of the beginning or ending of the offering period. A total of 173,888 shares of common stock were issued under the ESPP through July 31, 2005. The Company cancelled its Employee Stock Purchase Plan on July 28, 2005.
9. Income Taxes
The Company provides for income taxes using an asset and liability approach, under which deferred income taxes are provided based upon enacted tax laws and rates applicable to periods in which the taxes become payable.
Income (loss) from continuing operations before income taxes consists of the following components (in thousands):
| | Year Ended July 31, |
| | 2007 | | 2006 | | 2005 |
| ($ in thousands) | | | | | | | | | |
| United States | $ | 6,240 | | $ | 1,934 | | $ | (2,787 | ) |
| Foreign | | — | | | 2,081 | | | 2,530 | |
| | $ | 6,240 | | $ | 4,015 | | $ | (257 | ) |
The components of the provision for income taxes from continuing operations for the years ended July 31, 2007 and July 31, 2006 are as follows (in thousands):
| | Year Ended July 31, |
| | 2007 | | 2006 |
| ($ in thousands) | | | | | | |
| Current: | | | | | | |
| Federal | $ | 137 | | $ | 43 | |
| State | | 148 | | | 52 | |
| Foreign | | — | | | (3 | ) |
| | $ | 285 | | $ | 92 | |
| Deferred: | | | | | | |
| Federal | $ | — | | $ | — | |
| State | | — | | | — | |
| Foreign | | — | | | — | |
| | $ | — | | $ | — | |
| | $ | 285 | | $ | 92 | |
A summary of total tax expense, by classification, included in the accompanying consolidated statements of income is as follows (in thousands):
| | Year Ended July 31, |
| | 2007 | | 2006 |
| ($ in thousands) | | | | | |
| Continuing operations | $ | 285 | | $ | 92 |
| Discontinued operations | | 74 | | | 197 |
| | $ | 359 | | $ | 289 |
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Deferred tax assets (liabilities) consist of the following (in thousands):
| | Year Ended July 31, |
| | 2007 | | 2006 |
| ($ in thousands) | | | | | | | |
| Deferred tax assets: | | | | | | | |
| Accruals and reserves | $ | 5,768 | | | $ | 6,636 | |
| Net operating loss carryforwards | | 90,230 | | | | 93,796 | |
| Research and development credit carryforward | | 2,559 | | | | 2,819 | |
| Gross deferred tax asset | | 98,557 | | | | 103,251 | |
| Valuation allowance | | (98,557 | ) | | | (103,251 | ) |
| Net deferred tax asset | $ | — | | | $ | — | |
Reconciliation of the statutory federal income tax to the Company’s effective tax for the years ended July 31, 2007 and July 31, 2006 are as follows:
| | Year Ended July 31, |
| | 2007 | | 2006 |
| Tax at Federal statutory rate | 34.0% | | | 34.0% | |
| State, net of Federal benefit | 1.2% | | | 0.8% | |
| Meals and entertainment | 0.5% | | | 3.0% | |
| Stock compensation | 3.6% | | | 16.4% | |
| Fines and penalties | 0.0% | | | 0.1% | |
| Foreign income exclusion | 0.0% | | | (51.9% | ) |
| Research and development credit | (1.2% | ) | | (1.5% | ) |
| Change in valuation allowance | (35.0% | ) | | (0.9% | ) |
| Provision for taxes | 3.1% | | | 0.0% | |
A reconciliation for the fiscal year ended July 31, 2005 is not presented as the Company incurred losses during the period.
Included in the July 31, 2007 valuation allowance is approximately $31.0 million related to stock options, which will be credited to stockholder’s equity when realized for tax purposes.
At July 31, 2007, management believes that, based on a number of factors, the available objective evidence creates sufficient uncertainty regarding the realizability of the deferred tax assets such that a full valuation allowance was recorded.
As of July 31, 2007, the Company has approximately $252.4 million of federal net operating losses available to offset future federal taxable income, which expire at various dates through fiscal year 2026. This amount includes approximately $12.5 million of net operating loss carryforwards from the acquisition of Andover.net in fiscal 2000. The deferred tax assets related to this of approximately $5.6 million as of June 7, 2000, may be used to reduce the tax provision if and when realized. Approximately $23.2 million of federal net operating losses usage is limited pursuant to section 382 of the Internal Revenue Code due to certain changes in the Company’s ownership which occurred between 1996 and 1999, and a change in ownership resulting from the Company’s June 2000 acquisition of Andover.net. The Company also has California net operating loss carryforwards of approximately $75.5 million to offset future California taxable income, which expire at various dates through fiscal year 2016. The net operating loss carryforwards stated above are reflective of various federal and state tax limitations.
10. Segment and Geographic Information
The Company’s operating segments are significant strategic business units that offer different products and services. The Company has two operating segments: Online Media and E-commerce. In April 2007, the Company sold its Software business to CollabNet and in December 2005, the Company completed the sale of its Online Images business to Jupitermedia and no longer has operations in these segments.
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The Company’s Online Media segment consists of a network of Internet web sites serving the IT professional, software development and open source communities and the Company’s E-commerce segment provides online sales of a variety of retail products of interest to the software development and IT communities. The Company’s network of web sites that comprise the Online Media segment include: SourceForge.net, Slashdot, ThinkGeek, Linux.com, freshmeat.net, ITManagersJournal and NewsForge.com. Those corporate expenses that are not allocated to the individual operating segments and are not considered by the Company’s chief decision-making group in evaluating the performance of the operating segments are included in Other.
The accounting policies of the segments are consistent with those described in the summary of significant accounting policies. All intersegment sales have been stated separately in the table below. The Company’s chief decision-making group, as defined under SFAS No. 131, consists of the Chief Executive Officer and the executive team. The Company’s chief decision-making group excludes all intersegment sales when evaluating the performance of the segments. The Company’s assets and liabilities are not discretely allocated or reviewed by operating segment. The depreciation of the Company’s property, equipment and leasehold improvements are allocated based on headcount, unless specifically identified by operating segment.
| | | Online | | | | | | | | | | | | | Total |
| (in thousands) | | Media | | E-commerce | | Other | | Eliminations | | Company |
| Year Ended July 31, 2007 | | | | | | | | | | | | | | | | | | | |
| Revenue from external customers | | $ | 17,496 | | | $ | 28,103 | | $ | — | | | $ | — | | | $ | 45,599 | |
| Revenue from intersegments | | $ | 211 | | | $ | — | | $ | — | | | $ | (211 | ) | | $ | — | |
| Cost of revenue | | $ | 4,733 | | | $ | 21,200 | | $ | — | | | $ | — | | | $ | 25,933 | |
| Gross margin | | $ | 12,974 | | | $ | 6,903 | | $ | — | | | $ | (211 | ) | | $ | 19,666 | |
| Operating income | | $ | 177 | | | $ | 3,336 | | $ | — | | | $ | (169 | ) | | $ | 3,344 | |
| Depreciation expense | | $ | 381 | | | $ | 18 | | $ | — | | | $ | — | | | $ | 399 | |
| Year Ended July 31, 2006 | | | | | | | | | | | | | | | | | | | |
| Revenue from external customers | | $ | 13,242 | | | $ | 20,416 | | $ | — | | | $ | — | | | $ | 33,658 | |
| Revenue from intersegments | | $ | 60 | | | $ | — | | $ | — | | | $ | (60 | ) | | $ | — | |
| Cost of revenue | | $ | 3,732 | | | $ | 15,605 | | $ | — | | | $ | — | | | $ | 19,337 | |
| Gross margin | | $ | 9,570 | | | $ | 4,811 | | $ | — | | | $ | (60 | ) | | $ | 14,321 | |
| Operating income | | $ | 360 | | | $ | 1,999 | | $ | 17 | | | $ | — | | | $ | 2,376 | |
| Depreciation expense | | $ | 218 | | | $ | 14 | | $ | — | | | $ | — | | | $ | 232 | |
| Year Ended July 31, 2005 | | | | | | | | | | | | | | | | | | | |
| Revenue from external customers | | $ | 8,130 | | | $ | 14,918 | | $ | — | | | $ | — | | | $ | 23,048 | |
| Revenue from intersegments | | $ | 279 | | | $ | — | | $ | — | | | $ | (279 | ) | | $ | — | |
| Cost of revenue | | $ | 3,320 | | | $ | 11,591 | | $ | — | | | $ | — | | | $ | 14,911 | |
| Gross margin | | $ | 5,089 | | | $ | 3,327 | | $ | — | | | $ | (279 | ) | | $ | 8,137 | |
| Operating income (loss) | | $ | (1,624 | ) | | $ | 673 | | $ | (264 | ) | | $ | — | | | $ | (1,215 | ) |
| Depreciation expense | | $ | 346 | | | $ | 29 | | $ | — | | | $ | — | | | $ | 375 | |
During the time period covered by the table above, the Company marketed its products in the United States through its direct sales force and its online web sites. Revenue for each of the fiscal years ended July 31, 2007, July 31, 2006 and July 31, 2005 were primarily generated from sales to end users in the United States of America.
11. Discontinued Operations
In February 2007, the Company announced that it had engaged a financial advisor to explore various alternatives for its Software business in order to allow management to focus on it core Online Media and E-commerce business. In April 2007, the Company sold substantially all of the assets and certain liabilities of its Software business to CollabNet, Inc. (“CollabNet”) in exchange for a minority equity interest in CollabNet, comprised of 11,733,777 shares of its Series C-1 Preferred Stock, valued at $6.6 million, which is included in “Other Assets” in the Consolidated Balance Sheets.
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In conjunction with the sale, the Company has agreed to indemnify CollabNet for damages arising from any misrepresentation of representations and warranties, the breach of a covenant or agreement or the failure by the Company to assume certain liabilities excluded from the sale of the business. The indemnification is generally limited to the 2,933,444 shares of CollabNet preferred stock which are held in escrow; however the maximum amount of the indemnification for breach of the non-competition covenant is equal to the 11,733,777 shares of CollabNet Series C-1 preferred stock, owned by the Company. CollabNet may not make an indemnification claim until their aggregate losses under the indemnification provisions exceed $0.1 million. The term of the indemnification is generally through April 24, 2008, except for certain claims for fraud or breaches of the non-competition covenant. The Company believes that it has complied with all of those items for which it has agreed to indemnify CollabNet, and the Company has not been subject to any claims or suffered any losses, and CollabNet has not made any claims pursuant to the Company’s indemnification obligations. Accordingly, the Company has no liabilities recorded for this indemnification as of July 31, 2007.
As specified in the agreement, the assets sold to CollabNet consisted primarily of intellectual property and property and equipment. In conjunction with the sale, the Company terminated those employees of our Software business who were not offered employment by CollabNet and also recorded a restructuring reserve for the excess facility space formerly used by its Software business. The Company’s gain on the sale of this business is as follows (in thousands):
| Proceeds from sale: | | | |
| CollabNet, Inc. Series C-1 Preferred Stock | $ | 6,564 | |
| Cash | | 19 | |
| Total proceeds | | 6,583 | |
| Costs and expenses | | (676 | ) |
| Net proceeds | | 5,907 | |
| Net book value of assets and liabilities sold | | 1,533 | |
| Severance and benefits of terminated employees | | (1,080 | ) |
| Idle space restructuring charge | | (581 | ) |
| Other | | (57 | ) |
| Gain on sale, before income taxes | | 5,722 | |
| Provision for income taxes | | 148 | |
| Gain on sale, net of income taxes | $ | 5,574 | |
In December 2005, the Company sold the assets, net of deferred revenue, of its Online Images business to Jupitermedia Corporation (“Jupitermedia”) for $9.4 million. The Company received $8.4 million in cash, and $0.9 million in an escrow account, which was fully paid as of July 31, 2007. As specified in the agreement, the assets sold to Jupitermedia consisted primarily of intellectual property, inventories and property and equipment.
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Income from discontinued operations consists of direct revenue and direct expenses of the Software and Online Images businesses, including cost of revenue, as well as other fixed and allocated costs. A summary of the operating results of the discontinued operations in the accompanying condensed consolidated statements of income is as follows:
| | Year Ended July 31, |
| | 2007 | | 2006 | | 2005 |
| ($ in thousands) | | | | | | | | | | | |
| Revenue: | | | | | | | | | | | |
| Software | $ | 5,236 | | | $ | 9,974 | | | $ | 7,555 | |
| Online Images | | — | | | | 914 | | | | 2,284 | |
| Revenue | $ | 5,236 | | | $ | 10,888 | | | $ | 9,839 | |
| | |
| Loss from operations: | | | | | | | | | | | |
| Software | $ | (2,875 | ) | | $ | (2,699 | ) | | $ | (5,392 | ) |
| Online Images | | — | | | | 340 | | | | 955 | |
| Loss from operations before income taxes | | (2,875 | ) | | | (2,359 | ) | | | (4,437 | ) |
| Income taxes | | (74 | ) | | | (81 | ) | | | — | |
| Loss from operations, net of income taxes | $ | (2,801 | ) | | $ | (2,278 | ) | | $ | (4,437 | ) |
| | |
| Gain from sale of assets: | | | | | | | | | | | |
| Software | | 5,722 | | | $ | — | | | $ | — | |
| Online Images | | — | | | | 9,595 | | | | — | |
| Gain from sale of assets before income taxes | | 5,722 | | | | 9,595 | | | | — | |
| Income taxes | | 148 | | | | 278 | | | | — | |
| Gain from sale, net of income taxes | $ | 5,574 | | | $ | 9,317 | | | $ | — | |
12. Subsequent Events
On September 5, 2007, the Compensation Committee of the Board of Directors approved an amendment to the Directors’ Plan which reduced the automatic grant of options from 80,000 shares to 70,000 shares for each newly-elected non-employee director. In addition, the annual automatic grant of options for 20,000 shares to each non-employee director who has been a member of the Board of Directors for at least six months prior to the annual stockholders’ meeting was replaced by a restricted stock award of 10,000 shares at $0.001 per share at each annual stockholders’ meeting.
On September 26, 2007, Company received notification that it had been named as a defendant in a civil action filed by the Societe des Producteurs de Phonogrammes Francais (“SPPF”) in Paris, France. The action asserted statutory claims under the French Intellectual Property Code. The Company believes that it has meritorious defenses to the action and intends to defend itself vigorously.
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| Quarterly Financial Data |
| | | For the three months ended |
| (in thousands) | | October 31 | | January 31 | | April 30 | | July 31 |
| Fiscal Year 2007 | | | | | | | | | | | | | |
| Net revenue | | $ | 8,164 | | | $ | 17,104 | | $ | 10,252 | | $ | 10,079 |
| Gross margin | | | 3,517 | | | | 6,310 | | | 4,887 | | | 4,952 |
| Operating income (loss) | | | (11 | ) | | | 2,253 | | | 1,096 | | | 6 |
| Income from continuing operations | | | 669 | | | | 2,817 | | | 1,761 | | | 708 |
| Net income (loss): | | $ | (140 | ) | | $ | 1,776 | | $ | 6,491 | | $ | 601 |
| Income per share from continuing operations: | | | | | | | | | | | | | |
| Basic | | $ | 0.01 | | | $ | 0.04 | | $ | 0.03 | | $ | 0.01 |
| Diluted | | $ | 0.01 | | | $ | 0.04 | | $ | 0.03 | | $ | 0.01 |
| Net income per share: | | | | | | | | | | | | | |
| Basic | | $ | — | | | $ | 0.03 | | $ | 0.10 | | $ | 0.01 |
| Diluted | | $ | — | | | $ | 0.03 | | $ | 0.09 | | $ | 0.01 |
| |
| Fiscal Year 2006 | | | | | | | | | | | | | |
| Net revenue | | $ | 6,167 | | | $ | 11,756 | | $ | 7,901 | | $ | 7,834 |
| Gross margin | | | 2,462 | | | | 4,290 | | | 3,797 | | | 3,772 |
| Operating income (loss) | | | (127 | ) | | | 1,202 | | | 778 | | | 521 |
| Income from continuing operations | | | 142 | | | | 1,436 | | | 1,172 | | | 1,173 |
| Net income (loss): | | $ | (1,234 | ) | | $ | 10,502 | | $ | 997 | | $ | 697 |
| Income per share from continuing operations: | | | | | | | | | | | | | |
| Basic | | $ | — | | | $ | 0.02 | | $ | 0.02 | | $ | 0.02 |
| Diluted | | $ | — | | | $ | 0.02 | | $ | 0.02 | | $ | 0.02 |
| Net income (loss) per share: | | | | | | | | | | | | | |
| Basic | | $ | (0.02 | ) | | $ | 0.17 | | $ | 0.02 | | $ | 0.01 |
| Diluted | | $ | (0.02 | ) | | $ | 0.17 | | $ | 0.02 | | $ | 0.01 |
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PART IV
Item 15, “Exhibits and Financial Statement Schedules,” is hereby amended to add to the content thereof the following exhibits:
23.3 — Consent of Stonefield Josephson, Inc., Independent Registered Public Accounting Firm
23.4 — Consent of BDO Seidman, LLP, Independent Registered Public Accounting Firm
24.2 — Power of Attorney (see signature page)
31.3 — Certification of Chief Executive Officer Pursuant to Section 302 of The Sarbanes-Oxley Act Of 2002
31.4 — Certification of Chief Financial Officer Pursuant to Section 302 of The Sarbanes-Oxley Act Of 2002
32.3 — Certification of Chief Executive Officer Pursuant to Section 906 of The Sarbanes-Oxley Act Of 2002
32.4 — Certification of Chief Financial Officer Pursuant to Section 906 of The Sarbanes-Oxley Act Of 2002
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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.
| | SOURCEFORGE, INC. |
| |
| | By: | /s/ ALI JENAB |
| | | Ali Jenab |
| | | Chief Executive Officer and President |
| Date: December 7, 2007 | | |
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POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below hereby constitutes and appoints Ali Jenab and Patricia S. Morris, and each of them, his true and lawful attorneys-in-fact, each with full power of substitution, for him and all capacities, to sign any amendments to this report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission and does hereby ratify and confirm all that each of said attorneys-in-fact or their substitute or substitutes may do or cause to be done by virtue hereof.
Pursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
| Signature | | Title | | Date |
| |
| /s/ ALIJENAB | | Chief Executive Officer, President | | December 7, 2007 |
| Ali Jenab | | (principle executive officer) and Director | |
| |
| /s/ PATRICIAS. MORRIS | | Senior Vice President and Chief Financial Officer | | December 7, 2007 |
| Patricia S. Morris | | (principle accounting officer) | |
| |
| * | | Director | | December 7, 2007 |
| Andrew Anker | | |
| |
| * | | Chairman of the Board of Directors | | December 7, 2007 |
| Ram Gupta | | |
| |
| * | | Director
| | December 7, 2007 |
| Scott E. Howe | | |
| |
| * | | Director | | December 7, 2007 |
| Robert M. Neumeister, Jr. | | |
| |
| * | | Director | | December 7, 2007 |
| Carl Redfield | | |
| |
| * | | Director | | December 7, 2007 |
| David B. Wright | | |
| |
| * | /s/ ALIJENAB | | | Attorney-in-fact | | |
| Ali Jenab | | | |
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SOURCEFORGE, INC.
SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
| | Balance | | Charged to | | | | | |
| | Beginning of | | Costs and | | | | Balance End |
| Description | | Period | | Expenses | | Deductions | | of Period |
| Year Ended July 31, 2005 | | | | | | | | | | | |
| Allowance for doubtful accounts | | $ | 71 | | 36 | | | 7 | | $ | 100 |
| Allowance for excess and obsolete inventory | | $ | 33 | | 57 | | | 31 | | $ | 59 |
| Year Ended July 31, 2006 | | | | | | | | | | | |
| Allowance for doubtful accounts | | $ | 100 | | 84 | | | 62 | | $ | 122 |
| Allowance for excess and obsolete inventory | | $ | 59 | | 40 | | | 3 | | $ | 96 |
| Year Ended July 31, 2007 | | | | | | | | | | | |
| Allowance for doubtful accounts | | $ | 122 | | 7 | | | 53 | | $ | 76 |
| Allowance for excess and obsolete inventory | | $ | 96 | | (38 | ) | | 1 | | $ | 57 |
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EXHIBIT INDEX
| Exhibit | | |
| Number | | |
| 23.3 | — | Consent of Stonefield Josephson, Inc., Independent Registered Public Accounting Firm |
| 23.4 | — | Consent of BDO Seidman, LLP, Independent Registered Public Accounting Firm |
| 24.1 | — | Power of Attorney (see signature page) |
| 31.3 | — | Certification of Chief Executive Officer Pursuant to Section 302 of The Sarbanes-Oxley Act Of 2002 |
| 31.4 | — | Certification of Chief Financial Officer Pursuant to Section 302 of The Sarbanes-Oxley Act Of 2002 |
| 32.3 | — | Certification of Chief Executive Officer Pursuant to Section 906 of The Sarbanes-Oxley Act Of 2002 |
| 32.4 | — | Certification of Chief Financial Officer Pursuant to Section 906 of The Sarbanes-Oxley Act Of 2002 |
____________________
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