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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2009
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File Number: 000-50640
SUMTOTAL SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware | 42-1607228 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
1808 North Shoreline Boulevard
Mountain View, California 94043
(Address of principal executive offices, including zip code)
(650) 934-9500
(Registrant’s telephone number, including area code)
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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
¨ Large accelerated filer | x Accelerated filer | ¨ Non-accelerated filer | ¨ Smaller reporting company |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes ¨ No x
The number of shares outstanding of the issuer’s Common Stock, par value $0.001, as of May 1, 2009 was 31,236,602 shares.
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SUMTOTAL SYSTEMS, INC.
FORM 10–Q
For the Quarter Ended March 31, 2009
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PART I – FINANCIAL INFORMATION
Item 1. | Consolidated Financial Statements |
SUMTOTAL SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited, in thousands)
March 31, 2009 | December 31, 2008 | |||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 34,838 | $ | 44,059 | ||||
Short-term investments | 9,990 | 3,790 | ||||||
Accounts receivable, net of allowance for sales returns and doubtful accounts of $678 and $879, respectively | 18,096 | 23,498 | ||||||
Prepaid expenses and other current assets | 4,733 | 4,953 | ||||||
Total current assets | 67,657 | 76,300 | ||||||
Property and equipment, net | 6,951 | 6,132 | ||||||
Intangible assets, net | 5,999 | 7,084 | ||||||
Other assets | 1,940 | 1,786 | ||||||
Total assets | $ | 82,547 | $ | 91,302 | ||||
Liabilities and Stockholders’ Equity | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 3,135 | $ | 1,693 | ||||
Accrued compensation and benefits | 5,228 | 7,117 | ||||||
Other accrued liabilities | 4,149 | 4,045 | ||||||
Restructuring accrual | 113 | — | ||||||
Deferred revenue | 33,128 | 32,416 | ||||||
Notes payable | — | 4,667 | ||||||
Total current liabilities | 45,753 | 49,938 | ||||||
Non-current liabilities: | ||||||||
Other accrued liabilities, non-current | 103 | 107 | ||||||
Restructuring accrual, non-current | 93 | — | ||||||
Deferred revenue, non-current | 2,448 | 2,111 | ||||||
Total liabilities | 48,397 | 52,156 | ||||||
Commitments and contingencies | ||||||||
Stockholders’ equity: | ||||||||
Preferred stock | — | — | ||||||
Common stock | 31 | 31 | ||||||
Additional paid-in capital | 401,888 | 400,932 | ||||||
Treasury stock | (8,274 | ) | (7,744 | ) | ||||
Accumulated other comprehensive loss | (1,090 | ) | (833 | ) | ||||
Accumulated deficit | (358,405 | ) | (353,240 | ) | ||||
Total stockholders’ equity | 34,150 | 39,146 | ||||||
Total liabilities and stockholders’ equity | $ | 82,547 | $ | 91,302 | ||||
Refer to the accompanying Notes to the Unaudited Condensed Consolidated Financial Statements.
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SUMTOTAL SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands, except per share data)
Three-Months Ended March 31, | ||||||||
2009 | 2008 | |||||||
Revenue: | ||||||||
Subscriptions and support | $ | 16,774 | $ | 17,627 | ||||
Service | 5,295 | 9,672 | ||||||
License | 1,631 | 8,693 | ||||||
Total revenue | 23,700 | 35,992 | ||||||
Cost of revenue: | ||||||||
Subscriptions and support | 5,581 | 5,961 | ||||||
Service | 4,391 | 6,891 | ||||||
License | 52 | 64 | ||||||
Amortization of intangible assets | 1,085 | 1,684 | ||||||
Total cost of revenue | 11,109 | 14,600 | ||||||
Gross margin | 12,591 | 21,392 | ||||||
Operating expenses: | ||||||||
Research and development | 5,003 | 5,830 | ||||||
Sales and marketing | 7,127 | 8,728 | ||||||
General and administrative | 4,167 | 5,176 | ||||||
Restructuring | 1,295 | 85 | ||||||
Total operating expenses | 17,592 | 19,819 | ||||||
Income (loss) from operations | (5,001 | ) | 1,573 | |||||
Interest expense | (139 | ) | (222 | ) | ||||
Interest income | 103 | 493 | ||||||
Other income (expense), net | (48 | ) | 21 | |||||
Income (loss) before provision for income taxes | (5,085 | ) | 1,865 | |||||
Provision for income taxes | 80 | 363 | ||||||
Net income (loss) | $ | (5,165 | ) | $ | 1,502 | |||
Net income (loss) per share, basic and diluted | $ | (0.17 | ) | $ | 0.05 | |||
Weighted average common shares outstanding: | ||||||||
Basic | 31,237 | 32,177 | ||||||
Diluted | 31,237 | 32,483 | ||||||
Three-Months Ended March 31, | ||||||||
2009 | 2008 | |||||||
Stock-based compensation expense: | ||||||||
Cost of revenue - subscriptions and support | $ | 60 | $ | 70 | ||||
Cost of revenue - service | 154 | 150 | ||||||
Research and development | 52 | 175 | ||||||
Sales and marketing | 139 | 355 | ||||||
General and administrative | 286 | 469 | ||||||
Restructuring | 115 | — | ||||||
Total stock-based compensation expense | $ | 806 | $ | 1,219 | ||||
Refer to the accompanying Notes to the Unaudited Condensed Consolidated Financial Statements.
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SUMTOTAL SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
Three-Months Ended March 31, | ||||||||
2009 | 2008 | |||||||
Cash flows from operating activities: | ||||||||
Net income (loss) | $ | (5,165 | ) | $ | 1,502 | |||
Adjustments to reconcile net loss to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 1,038 | 1,171 | ||||||
Amortization of intangible assets | 1,085 | 1,683 | ||||||
Loss of disposals of property and equipment | 15 | — | ||||||
Provision for (recovery of) sales returns and doubtful accounts | 186 | (38 | ) | |||||
Accretion of interest on short-term investments | (13 | ) | (121 | ) | ||||
Amortization of discount on notes payable | — | 38 | ||||||
Stock-based compensation | 806 | 1,219 | ||||||
Changes in operating assets and liabilities: | ||||||||
Accounts receivable, net | 5,451 | 2,400 | ||||||
Prepaid expenses and other current assets | 247 | 645 | ||||||
Other assets | (116 | ) | (27 | ) | ||||
Accounts payable | 1,433 | 176 | ||||||
Accrued compensation and benefits | (1,931 | ) | (2,043 | ) | ||||
Other accrued liabilities | 60 | 703 | ||||||
Restructuring accrual | 206 | 35 | ||||||
Deferred revenue | 884 | (3,725 | ) | |||||
Net cash provided by operating activities | 4,186 | 3,618 | ||||||
Cash flows from investing activities: | ||||||||
Purchases of property and equipment | (1,918 | ) | (374 | ) | ||||
Purchases of short-term investments | (9,987 | ) | (5,052 | ) | ||||
Sales/maturities of short-term investments | 3,800 | 25,950 | ||||||
Net cash provided by (used in) investing activities | (8,105 | ) | 20,524 | |||||
Cash flows from financing activities: | ||||||||
Repayment of credit facility | (4,375 | ) | (1,094 | ) | ||||
Payment of notes payable | (292 | ) | (292 | ) | ||||
Purchase of treasury stock | (530 | ) | (646 | ) | ||||
Payment of taxes withheld in connection with restricted stock issuances | (112 | ) | ||||||
Net proceeds from the issuance of common stock and exercises of common stock options | 262 | 406 | ||||||
Net cash used in financing activities | (5,047 | ) | (1,626 | ) | ||||
Effect of foreign exchange rate changes on cash and cash equivalents | (255 | ) | 233 | |||||
Net increase (decrease) in cash and cash equivalents | (9,221 | ) | 22,749 | |||||
Cash and cash equivalents at beginning of period | 44,059 | 19,182 | ||||||
Cash and cash equivalents at end of period | $ | 34,838 | $ | 41,931 | ||||
Supplemental disclosure of cash flow information | ||||||||
Interest paid | $ | 82 | $ | 201 | ||||
Taxes paid | $ | 231 | $ | 57 |
Refer to the accompanying Notes to the Unaudited Condensed Consolidated Financial Statements.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1: DESCRIPTION OF BUSINESS
SumTotal Systems, Inc. and its subsidiaries (“SumTotal Systems”, “SumTotal”, and “the Company”) develop, market, distribute and support learning, performance and talent management software solutions and on-demand subscriptions. SumTotal Systems’ markets are worldwide and include a broad range of industries. SumTotal Systems was formed on March 18, 2004, as a result of the acquisition of Docent, Inc. by Click2learn, Inc.
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying financial data as of March 31, 2009, and for the three-months ended March 31, 2009 and 2008, respectively, has been prepared by SumTotal Systems, 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 accounting principles generally accepted in the United States (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. Certain insignificant prior period amounts have been reclassified to conform to the current period presentation. The December 31, 2008 condensed consolidated balance sheet was derived from audited consolidated financial statements, but does not include all disclosures required by GAAP.
In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (which include normal recurring adjustments, except as disclosed herein) necessary to present fairly SumTotal Systems’ financial position, results of operations and cash flows for the interim periods presented. SumTotal Systems’ accounting policies were outlined in its Annual Report on Form 10-K, which was filed with the SEC on March 11, 2009. There were no significant changes in the accounting policies that occurred during the three-month ended March 31, 2009 that has materially affected the Company’s financial reporting unless specifically outlined in these unaudited notes to the Condensed Consolidated Financial Statements. This Quarterly Report on Form 10-Q should be read in conjunction with SumTotal Systems’ audited consolidated financial statements contained in the Annual Report on Form 10-K.
Principles of Consolidation
All significant inter-company balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenue and expenses during the reporting period. Such estimates and assumptions are based on historical experience, where applicable and other assumptions. On an ongoing basis, SumTotal Systems evaluates estimates, including those related to revenue recognition, allowance for sales returns and doubtful accounts, goodwill impairment, intangible assets, restructuring reserves, stock-based compensation, valuation reserves for deferred tax assets and the income tax provision. Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents of $34.8 million and $44.1 million at March 31, 2009 and December 31, 2008, respectively, are comprised of highly liquid financial instruments consisting primarily of cash, investments in money market funds and commercial paper with insignificant interest rate risk and with original maturities of three months or less. Cash equivalents are stated at amounts that approximate fair value, based on quoted market prices.
Short-term Investments
Short-term investments of $10.0 million and $3.8 million at March 31, 2009 and December 31, 2008, respectively, are stated at fair value. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115,Accounting for Certain Investments in Debt and Equity Securities, management determines the appropriate classification of the debt securities at the time of purchase and re-evaluates the designation as of each balance sheet date. SumTotal Systems classified all of the debt securities as available-for-sale. Short-term investments consist principally of taxable, short-term marketable investment instruments; such as commercial paper, corporate bonds and treasury bills, with maturities or callable dates between three months and one year. SumTotal Systems states its investments at estimated fair value with unrealized gains and losses reported in accumulated other comprehensive loss. A decline in the market value of any available-for-sale or held-to-maturity security below cost that is deemed to be other-than-temporary results in an impairment to reduce the carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established. To determine whether an impairment is other-than-temporary, SumTotal Systems considers whether it has the ability and intent to hold the investment until a market price recovery and considers whether evidence indicating the costs of the investment
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is recoverable outweighs evidence to the contrary. Evidence considered in this assessment includes the reason for the impairment, the severity and duration of the impairment, changes in value subsequent to year-end, forecasted performance of the investee, and the general market condition in the geographic area or industry the investee operates in. The specific identification method is used to determine the costs of securities disposed of, with realized gains and losses reflected in other expense, net. Investments are anticipated to be used for current operations.
Fair Value of Financial Instruments
The carrying amounts of SumTotal Systems’ financial instruments including cash, cash equivalents and short-term investments approximate fair value due to their high liquidity in actively quoted trading markets and their short maturities. SumTotal Systems’ accounts receivable, accounts payable, accrued liabilities and deferred revenue approximate fair value due to their short maturities. The carrying amount of the credit facility approximates fair value as this facility bears interest at a variable rate tied to the current market, and has terms similar to other borrowing arrangements available to SumTotal Systems.
On January 1, 2008, SumTotal Systems adopted SFAS No. 157,Fair Value Measurements, and subsequently adopted certain related Financial Accounting Standards Board (“FASB”) staff positions. The adoption of SFAS No. 157 and related positions did not have a material impact on the Company’s consolidated financial statements. SFAS No. 157 defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required to be recorded at fair value, SumTotal Systems considers the principal or most advantageous market in which the Company would transact and consider assumptions that market participants would use when pricing the asset or liability, such as inherent risk, transfer restrictions, and risk of nonperformance.
SFAS No. 157 establishes a valuation hierarchy for disclosure of the inputs to valuation used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows:
• | Level 1: quoted prices (unadjusted) in active markets for identical assets or liabilities; |
• | Level 2: inputs other than quoted prices included within Level 1 that are either directly or indirectly observable; and |
• | Level 3: unobservable inputs in which little or no market activity exists, therefore requiring an entity to develop its own assumptions about the assumptions that market participants would use in pricing. |
A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement. The carrying amounts of SumTotal Systems’ financial instruments, including cash, cash equivalents and short-term investments, approximate fair value due to their high liquidity in actively quoted trading markets and their short maturities.
The following table provides the assets and liabilities carried at fair value measured on a recurring basis as of March 31, 2009 (in thousands):
Fair Value Measurements at March 31, 2009 Using: | ||||||||||||
Total Carrying Value | Quoted Prices in Active Markets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||
Cash | $ | 4,243 | $ | 4,243 | $ | — | $ | — | ||||
Certificates of deposit | 1,980 | 1,980 | — | — | ||||||||
Treasury bills | 9,990 | 9,990 | — | — | ||||||||
Money-market funds | 28,615 | 28,615 | — | — | ||||||||
Total cash, cash equivalents and short-term investments | $ | 44,828 | $ | 44,828 | $ | — | $ | — | ||||
Concentration of Credit Risk
Financial instruments that potentially subject SumTotal Systems to concentration of credit risk consist principally of cash, cash equivalents, short-term investments and accounts receivable. SumTotal Systems’ cash, cash equivalents and short-term investments are deposited with several financial institutions, which, at times, may exceed federally insured limits. Cash, cash equivalents and short-term investments are invested in short-term highly liquid investment-grade obligations of commercial issuers.
Accounts receivable include amounts due from customers in a wide variety of industries, throughout North and Latin America, Europe, Middle East and Africa and the Asia/Pacific region. Accounts receivable are recorded at the invoiced amount and do not bear interest. SumTotal Systems performs ongoing credit evaluations of its customers, does not require collateral and maintains allowances for potential credit losses based on the expected collectability of its accounts receivable. To date, such losses have been within management’s expectations. At March 31, 2009 and December 31, 2008, respectively, SumTotal Systems had no customers that accounted for greater than 10% of accounts receivable, net of allowance for sales returns and doubtful accounts. No customers accounted for greater than 10% of total revenue in the three-months ended March 31, 2009. One customer accounted for 15% of total revenue in the three-months ended March 31, 2008.
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Revenue Recognition
SumTotal Systems recognizes revenue from three sources: (1) maintenance and support services and subscription fees from clients accessing its on-demand software and hosting arrangements, all of which SumTotal Systems refers to as subscriptions and support sales, (2) services performed in connection with consulting arrangements, and (3) sales of software licenses and related products. Revenue derived from software licenses and related products is subject to the guidance and requirements of American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) No. 97-2,Software Revenue Recognition, as amended by SOP No. 98-9,Software Revenue Recognition with Respect to Certain Arrangements. Revenue from on-demand subscriptions is recognized in accordance with SEC Staff Accounting Bulletin (“SAB”) No. 104,Revenue Recognition. In the event of a multiple element arrangement, SumTotal Systems evaluates the transaction to determine if each element represents a separate unit of accounting taking into account all factors following the guidelines set forth in SOP No. 97-2 and Emerging Issues Task Force (“EITF”) No. 00-21,Accounting for Revenue Arrangements with Multiple Deliverables. In accordance with these standards, SumTotal Systems recognizes revenue when all of the following four conditions are met:
1. | Persuasive evidence of an arrangement exists.For the vast majority of transactions, SumTotal Systems considers a non-cancelable agreement signed by a customer and SumTotal Systems to be persuasive evidence of an arrangement. For maintenance renewals, an arrangement is evidenced by cash collection or a customer purchase order; |
2. | Delivery has occurred. In perpetual licensing arrangements, SumTotal Systems considers delivery to have occurred when the software has been delivered to the customer in the manner prescribed in the contractual arrangement and there are no further performance obligations. Services (including professional services, maintenance, and hosting) are typically considered to be delivered as performed and on-demand subscriptions are typically considered delivered once the customer has access to the software; |
3. | Fee is fixed or determinable. SumTotal Systems considers the fee to be fixed or determinable unless the fee is subject to refund or adjustment or is not payable within SumTotal Systems’ standard payment terms. SumTotal Systems considers payment terms greater than one fiscal quarter to be beyond SumTotal Systems’ customary payment terms. In these cases, or if the arrangement price is subject to refund, concession or other adjustment, then SumTotal Systems considers the fee to not be fixed or determinable. In these cases, revenue is deferred and recognized when payments become due and payable, or the right to refund or adjustment lapses; and |
4. | Collection is reasonably assured. SumTotal Systems conducts a credit review for all significant transactions at the time of the arrangement to determine the creditworthiness of the customer. Collection is deemed probable if SumTotal Systems expects that the customer will be able to pay amounts under the arrangement as payments become due. If SumTotal Systems determines that collection is not probable, SumTotal Systems defers the recognition of revenue until cash collection. |
SumTotal Systems sells both perpetual and term-based software licenses. SumTotal Systems’ customers may or may not purchase with licenses the following: (i) support services that provide for technical support and product updates, generally over renewable annual periods, (ii) professional services including consulting and training, and (iii) hosting. Depending upon the elements and the terms of the arrangement, SumTotal Systems recognizes license revenues under the residual method or using contract accounting.
Residual Method.License fees are recognized upon delivery whether sold separately or together with other services, described above, provided that: (i) the revenue recognition above have been met, (ii) payment of the license fees is not dependent on any implementation or performance criteria, (iii) the related services do not contain any acceptance provisions, and (iv) services are not essential to the functionality of the software. In these cases, SumTotal Systems recognizes license revenue utilizing the residual method. Under the residual method, revenue is recognized when vendor specific objective evidence (“VSOE”) of fair value exists for all of the undelivered elements in the arrangement (i.e.: maintenance, professional services and hosting), but does not exist for one or more of the delivered elements in the arrangement (i.e.: software license). Under the residual method, SumTotal Systems defers the fair value of undelivered elements and the remainder of the arrangement fee is then allocated to the delivered elements and is recognized as revenue assuming the other revenue recognition criteria are met. Each license arrangement requires careful analysis to ensure that all of the individual elements in the license transaction have been identified, along with the fair value of each undelivered element.
SumTotal Systems allocates revenue to each undelivered element based on its fair value, with the fair value determined by the price charged when that element is sold separately. If evidence of fair value cannot be established for the undelivered elements of a license agreement, the entire amount of revenue from the arrangement is deferred until evidence of fair value can be established, or until the items for which evidence of fair value cannot be established are delivered. If evidence of fair value has not been established and the only undelivered element is maintenance or hosting, then the entire amount of revenue is recognized ratably over the service period.
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VSOE is established for service, support and maintenance, and hosting based upon the amounts SumTotal Systems charges when service, maintenance and hosting are sold separately. The bell-shaped curve approach is used when doing VSOE analysis. VSOE of fair value is determined by a range of prices which approaches 80% of the total testing population falling within 15% above or below the median price of the range. VSOE of fair value for maintenance in deals over $1 million is determined based upon the stated renewal rate quoted in the arrangement, provided that the renewal rate is considered substantive.
Partner Arrangements.Distributors, resellers and systems integrators purchase solutions for specific projects of the end-user and do not hold inventory. They perform functions that include importation, delivery to the end-customer, installation or integration and post-sales service and support. The agreements with these partners have terms which are generally consistent with the standard terms and conditions for the sale of SumTotal Systems’ software to end-users and do not provide for product rotation or pricing allowances, as are typically found in agreements with stocking distributors. Revenue on shipments to SumTotal Systems’ partners is generally recognized on sell-through after the end user has been identified and the product has been delivered.
Term Licenses.Time-based license sales which always include post-contract support (“PCS”) may or may not include installation services that do not involve significant production, modification, or customization of software and may or may not include hosting services. These time-based license sales are recognized in accordance with paragraph 12 of SOP No. 97-2 because company-specific objective evidence of fair value does not exist for the related post contract support and in cases where SumTotal Systems provides hosting for the customer, for the hosting element. As these arrangements are in essence subscriptions, SumTotal Systems recognizes revenue for the entire arrangement fee ratably over the longest performance period of these elements beginning at the time the customer has been provided access to the time-based license and can utilize the software, and after all other criteria for revenue recognition have been met.
Contract Accounting.When professional services are deemed essential to the functionality of the software element of the arrangement and separate accounting for the services is not permitted, contract accounting is applied to both the software and service elements. For these projects, revenue is recognized in accordance with SOP No. 81-1,Accounting for Performance of Construction Type and Certain Production Type Contracts.
Typically, a percentage-of-completion basis is evidenced by labor costs incurred compared to estimated total labor costs to complete the project. SumTotal Systems utilizes the cost basis alternative to allocate revenue under SOP No. 81-1. For percentage-of-completion basis contracts which SumTotal Systems has the ability to produce reasonably dependable estimates of contract billings and contract costs, SumTotal Systems recognizes revenue at the lesser of the percentage-of-completion basis or the contractual ability to invoice.
If SumTotal Systems is only able to estimate total contract revenue and total contract cost within a range and some level of profit is assured, SumTotal Systems recognizes revenue at the lowest probable level of profit within the range until the results can be estimated more precisely. If, based on the pertinent information used in estimating the range, SumTotal Systems can determine the amounts in the ranges that are most likely to occur, those amounts will be used in accounting for the contract under the percentage-of-completion method. If the most likely amounts cannot be determined, the lowest probable level of profit within the range will be used in accounting for the contract until the results can be estimated more precisely.
SumTotal Systems uses the zero margin estimate of profit method when it is impractical to estimate the final costs of the project, yet SumTotal Systems is certain that no loss will be incurred. Under these circumstances, SumTotal Systems recognizes equal amounts of revenue and cost until results can be estimated more precisely.
SumTotal Systems uses the completed-contract method for a single contract or a group of contracts when reasonably dependable estimates cannot be made or when inherent hazards make cost estimates and profit estimates doubtful. Under these circumstances, all costs and revenue are deferred until the project is completed.
Estimated losses on uncompleted contracts are recorded in the period in which it is first determined that a loss is apparent. Amounts billed in excess of revenue recognized are recorded as deferred revenue in the accompanying consolidated balance sheets, net of any direct incremental costs which have been determined to be recoverable. Revenue recognized in accordance with SOP No. 81-1 is allocated for classification purposes in the statement of operations between license and service revenues based on an estimate of the fair value of the service portion of the arrangement as indicated by rates that SumTotal Systems separately sells similar services and use of the residual method for the license component.
Professional services from time and materials contracts which have stand-alone value and are not essential to the functionality of the software and training services, along with the related costs, are recognized as these services are performed.
On-Demand Subscriptions
In hosted On-Demand subscription arrangements where SumTotal Systems provides its software applications as a service, SumTotal Systems considered EITF No. 00-03,Application of AICPA Statement of Position 97-2 to Arrangements That Include the Right to Use Software Stored on Another Entity’s Hardware, and concluded that generally these transactions are considered service arrangements and fall outside of the scope of SOP No. 97-2. Accordingly, SumTotal Systems follows the provisions of SAB No. 101,Revenue Recognition in Financial Statements, SAB No. 104 and EITF No. 00-21. Customers typically prepay for these services,
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amounts which SumTotal Systems defers and recognizes ratably over the non-cancelable term of the customer contract. In addition to the hosted On-Demand subscription solution, these arrangements may also include set-up fees which are sold at a fixed fee and/or customizations which are billed on a time-and-materials basis. SumTotal Systems recognizes the revenue from any set-up fees and/or customization services ratably over the term of the expected customer relationship once the customer has access to the software. SumTotal Systems recognizes the revenue from professional services, which have stand-alone value and are not essential to the functionality of the solution, ratably over the remaining term of the initial contract once the customer has access to the software since the Company is unable to establish an estimate of fair value for the subscription service in accordance with EITF 00-21. In addition, SumTotal Systems defers the direct and incremental costs of the implementation and configuration services and amortizes those costs over the same time period as the related revenue is recognized. For arrangements that include significant customization or modification of the software, or where software services are otherwise considered essential to the On-Demand subscriptions, SumTotal Systems recognizes no revenue until the services are completed. After the completion of the significant customization or modification of the software and the service start date, the entire arrangement fee is recognized ratably over the expected customer relationship. If the direct costs incurred for a contract exceed the non-cancelable contract value, then SumTotal Systems recognizes a loss for direct costs incurred in excess of the contract value as a period expense.
Hosting Revenue
SumTotal Systems provides hosting services to certain customers that own perpetual licenses. Based on the criteria outlined in EITF No. 00-03, SumTotal Systems has determined that the majority of SumTotal Systems’ hosting arrangements, other than On-Demand subscription contracts, are within the scope of SOP No. 97-2. The applicability of EITF No. 00-03 requires SumTotal Systems to recognize the portion of the fee attributable to the license on delivery, while the portion of the fee related to the hosting element is recognized ratably as the service is provided, assuming all other revenue recognition criteria of SOP No. 97-2 have been met. In cases where the arrangements fall outside of the scope of SOP No. 97-2, SumTotal Systems recognizes revenue from monthly subscription fees ratably over the term of the contract and any upfront fees over the term of the expected customer relationship under the provisions of SAB No. 104.
Maintenance Revenue
Revenue related to maintenance contracts is recognized ratably over the support term.
Royalty Revenue
SumTotal Systems recognizes royalty revenues from committed minimum royalty arrangements ratably over the contractual term. For royalty arrangements which do not have minimum royalty criteria, revenue is recognized upon the receipt of usage reports provided by SumTotal Systems’ customers.
Allowance for Sales Returns and Doubtful Accounts
SumTotal Systems assesses the credit worthiness of its customers based on multiple sources of information and analyzes such factors as its historical bad debt experiences, industry and geographic concentrations of credit risk, economic trends and changes in customer payment terms. This assessment requires significant judgment. Because of this assessment, which covers the sales of all SumTotal Systems’ solutions and services, SumTotal Systems maintains an allowance for doubtful accounts for potential future estimated losses resulting from the inability of certain customers to make all of their required payments. In making this estimate, SumTotal Systems analyzes historical payment performance, current economic trends, changes in customer demand of its solutions when evaluating the adequacy of the allowance for sales returns and doubtful accounts. A reserve for future sales returns is also established based on historical trends in product return rates and is recorded as a reduction to SumTotal Systems’ revenue and accounts receivable. Accounts receivable are written-off as a decrease to revenue or to the allowance for doubtful accounts when all collection efforts have been exhausted and it is deemed uncollectible.
Commissions
Commissions are generally expensed as they are earned per the terms of the sales compensation plans. SumTotal Systems’ commissions on non-cancelable subscriptions are deferred and amortized to sales expense over the non-cancelable term of the related customer contracts, which are typically 12 to 36 months.
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization are calculated using the straight-line method over the estimated useful lives of the related assets. Computer equipment and software have estimated useful lives typically ranging from between three to five years. Furniture and fixtures have useful lives typically of five years. Leasehold improvements and assets acquired under capital leases are amortized on a straight-line basis over the term of the lease, or the estimated useful life of the assets, whichever is shorter. Maintenance and repairs are charged to expense as incurred and improvements and betterments are capitalized. When assets are retired or otherwise disposed of, the cost and accumulated depreciation and amortization are removed from the accounts and any resulting gain or loss is reflected in the statement of operations for the period realized.
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Impairment of Long-Lived Assets
Long-lived assets, such as property, plant and equipment and purchased intangible assets subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable in accordance with SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset group to the estimated undiscounted future cash flows expected to be generated by the asset group. If the carrying amount of an asset group exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset group exceeds the fair value of the asset group. In the fourth quarter of fiscal 2008, SumTotal Systems recorded a non-cash, after-tax charge of $68.5 million for impairment of goodwill primarily triggered by the effects of adverse market conditions that caused a decrease in the Company’s stock price at December 31, 2008. This impairment charge represented the entire balance of SumTotal Systems’ goodwill. As a part of its annual goodwill impairment testing in accordance with the provisions of SFAS No. 142,Goodwill and Other Intangible Assets,SumTotal Systems also evaluated possible impairment of its other intangible assets in accordance with the provisions of SFAS No. 144,based on the future undiscounted cash flows projections of each intangible asset. SumTotal Systems had no impairment of the other intangible assets on the balance sheet at March 31, 2009 and December 31, 2008, respectively.
Business Combinations
In accordance with SFAS No. 141 (revised),Business Combinations,any future acquisition completed by SumTotal Systems will be accounted for under the acquisition method (previously referred to as the purchase method). Under this method the Company is required to identify the acquirer, determine the acquisition date and purchase price, and recognize at the acquisition-date the fair values of the identifiable assets acquired, liabilities assumed, and any noncontrolling interests in the acquiree. In the case of a bargain purchase, the acquirer is required to reevaluate the measurements of the recognized assets and liabilities at the acquisition date and recognize a gain on that date if an excess remains.
Goodwill and Intangible Assets
Goodwill represents the excess of costs over the fair value of net identifiable assets acquired in a business combination. Goodwill is not amortized, but is instead tested for impairment at least annually in accordance with the provisions of SFAS No. 142.
The goodwill impairment test is a two-step test. Under the first step, the fair value of the reporting unit is compared with its carrying value (including goodwill). If the fair value of the reporting unit is less than its carrying value, an indication of goodwill impairment exists for the reporting unit and the enterprise must perform step two of the impairment test (measurement). Under step two, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation, in accordance with SFAS No. 141. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill. Fair value for the reporting unit is determined using a discounted cash flow analysis. If the fair value of the reporting unit exceeds its carrying value, step two does not need to be performed. SumTotal Systems considers itself to be one reporting unit as its chief operating decision maker does not currently use product line or geographical financial performance as a basis for business operating decisions.
SFAS No. 142 dictates that if certain circumstances occur, such as a significant adverse change in legal factors, a change in the business climate or other significant changes were to occur at any time during the year outside of the annual impairment testing date, SumTotal Systems is required to evaluate whether a triggering event would indicate that its goodwill had been impaired. Due to market conditions at December 31, 2008, and as a part of its annual impairment testing in the fourth quarter of 2008, the Company conducted its first step test by computing its fair value based on the number of shares outstanding multiplied by their value, which is based on a 30-day closing average at December 31, 2008. This calculated fair value was compared to the carrying value of the Company. Since the carrying value exceeded the fair value as calculated in the first step, SumTotal Systems determined that a triggering event had occurred that caused it to evaluate whether its goodwill had been impaired. SumTotal Systems proceeded to the second test, which included estimation of the fair value of the reporting unit’s assets and liabilities, including previously unrecognized intangible assets. The discounted cash flow approach was utilized to value the identified intangible assets of the Company, which included customer relationships, developed technology and trade names. As a result of the step two test, the carrying value of SumTotal Systems’ goodwill was deemed to exceed the allocated fair value and the Company recorded a non-cash, after-tax charge of $68.5 million for impairment of goodwill, primarily triggered by the effects of adverse market conditions that caused a decrease in its stock price and market capitalization, which approximates the fair value of the Company at December 31, 2008. This charge represented the entire balance of SumTotal Systems’ goodwill.
Purchased intangible assets subject to amortization are reviewed for impairment in accordance with SFAS No. 144, whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset group to the estimated undiscounted future cash flows expected to be generated by the asset group. If the carrying amount of an asset group exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset group exceeds the fair value of the asset group. As a part of its annual goodwill impairment testing in accordance with the provisions of SFAS No. 142, SumTotal Systems also evaluated possible impairment of its other intangible assets in accordance with the provisions of SFAS No. 144,based on the future
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undiscounted cash flows projections of each intangible asset. There was no impairment of the Company’s other intangible assets on the balance sheet at March 31, 2009 and December 31, 2008, respectively. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values using straight-line and accelerated methods designed to match the amortization to the benefits received where applicable.
Restructuring Costs and Accruals for Excess Facilities
Restructuring costs and accruals for excess facilities are accounted for in accordance with SFAS No. 146, Accounting for Exit or Disposal Activities,as a liability for costs associated with an exit or disposal activity and is recognized and measured initially at fair value only when the liability is incurred. Refer to Note 5,Restructuring, in the Notes to the Condensed Consolidated Financial Statements.
Capitalized Software
For other development costs related to software to be used solely for internal use, such as for the on-demand subscription offering, SumTotal Systems follows the guidance of EITF No. 00-2,Accounting for Web Site Development Costs, EITF No. 00-3,Application of AICPA Statement of Position 97-2 to Arrangements That Include the Right to Use Software Stored on Another Entity’s Hardware,and SOP No. 98-1,Accounting for the Cost of Computer Software Developed or Obtained for Internal Use. EITF No. 00-2 sets forth the accounting for website development costs. EITF No. 00-3 sets forth the accounting for software in a hosted arrangement. SOP No. 98-1 sets forth the guidance for costs incurred for computer software developed or obtained for internal use and requires companies to capitalize qualifying computer software costs, which are incurred during the application development stage. These capitalized costs are to be amortized on a straight-line basis over the expected useful life of the software. Costs related to preliminary project activities and post-implementation activities are expensed as incurred. SumTotal Systems has not capitalized any software development costs for external or internal use for the three-months ended March 31, 2009 and 2008, respectively.
Advertising
Costs related to advertising and promotion of products is charged to sales and marketing expense as incurred.
Income Taxes
Income taxes are accounted for under the asset and liability method in accordance with SFAS No. 109,Accounting for Income Taxes, and in accordance with FASB Interpretation (“FIN”) No. 48,Accounting for Uncertainty in Income Taxes- an interpretation of FASB Statement No. 109.
Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets to amounts expected to be realized.
In June 2006, the FASB issued FIN No. 48, which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109. This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 also provides guidance on de-recognition of tax benefits, classification on the balance sheet, interest and penalties, accounting in interim periods, disclosure, and transition. SumTotal Systems adopted FIN No. 48 effective January 1, 2007.
Net Income (Loss) Per Share
Basic net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of shares of common stock outstanding during the period, less outstanding unvested shares. The calculation of diluted net income per share includes potential dilutive common shares. Potential dilutive common shares are comprised of common stock subject to repurchase rights and incremental shares of common stock issuable upon the exercise of stock options or warrants.
The following table sets forth the computation of basic and diluted net income (loss) per share for the three-months ended March 31, 2009 and 2008 (in thousands, except per share amounts):
Three-Months Ended March 31, | ||||||||
2009 | 2008 | |||||||
Net income (loss) | $ | (5,165 | ) | $ | 1,502 | |||
Weighted average common shares outstanding: | ||||||||
Basic | 31,237 | 32,177 | ||||||
Assumed conversion of dilutive securities: | ||||||||
Common stock equivalents | — | 932 | ||||||
Treasury stock repurchased | — | (626 | ) | |||||
Potentially dilutive common shares | — | 306 | ||||||
Diluted | 31,237 | 32,483 | ||||||
Net income (loss) per share: | ||||||||
Basic | $ | (0.17 | ) | $ | 0.05 | |||
Diluted | $ | (0.17 | ) | $ | 0.05 | |||
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The following table sets forth the equity awards; including common stock options, restricted stock awards and restricted stock units, and warrants that were excluded from the computation of diluted loss per share because their effects would have been anti-dilutive due to SumTotal Systems’ net loss position for the three-months ended March 31, 2009, and due to exercise prices being in excess of market price for the three-months ended March 31, 2008 (in thousands, except per option and warrant amounts):
Three-Months Ended March 31, | ||||||
2009 | 2008 | |||||
Equity awards to acquire shares of common stock | 7,263 | 5,497 | ||||
Weighted average option price | $ | 5.31 | $ | 7.30 | ||
Warrants to acquire shares of common stock | — | 1,424 | ||||
Weighted average warrant price | $ | — | $ | 7.54 |
Comprehensive Income (Loss) and Accumulated Other Comprehensive Income (Loss)
The following table sets forth the components of comprehensive loss for the three-months ended March 31, 2009 and 2008 presented below (in thousands):
Three-Months Ended March 31, | ||||||||
2009 | 2008 | |||||||
Net income (loss) | $ | (5,165 | ) | $ | 1,502 | |||
Foreign currency translation adjustment | (254 | ) | 59 | |||||
Unrealized gain (loss) on investments | (3 | ) | (7 | ) | ||||
Comprehensive income (loss) | $ | (5,422 | ) | $ | 1,554 | |||
SumTotal Systems’ total comprehensive income (loss) for the three-months ended March 31, 2009 and 2008 consisted of net income (loss), the change in foreign currency translation adjustments and unrealized gain/loss on investments. The tax effects on the foreign currency translation adjustments have not been significant. Accumulated other comprehensive loss at March 31, 2009, consists of foreign currency translation loss adjustments of $1,091,000 and unrealized gain on investments of $1,000.
Stock-Based Compensation
SFAS No. 123R,Share-Based Payment, requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in SumTotal Systems’ consolidated statement of operations. SFAS No. 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The estimated forfeiture rates for the three-months ended March 31, 2009 and 2008 were 14.73% and 10.54%, respectively, and were based on historical compound annual forfeiture experience.
The fair value of stock options-based awards to employees is calculated using the Black-Scholes option pricing model, even though this model was developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which differ significantly from SumTotal Systems’ stock options. The Black-Scholes model also requires subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The expected term of options granted prior to June 30, 2008 was derived from the use of the simplified method under SAB No. 107 and the expected term of options granted subsequent to July 1, 2008 was derived based on historical experience. The risk-free rate is based on the U.S. Treasury rates in effect which most closely corresponds to a period of grant. The expected volatility is based on the historical volatility of the stock price over a period at least as long as the expected term of the options. These factors could change in the future, which would affect the stock-based compensation expense in future periods.
For restricted stock and restricted stock unit awards, stock compensation is calculated based on the quoted fair market value of the common stock on the actual grant date.
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Adoption of Accounting Standards
In December 2007, the FASB issued SFAS No. 141 (revised),Business Combinations. SFAS No. 141R changes the accounting for business combinations including the measurement of acquirer shares issued in consideration for a business combination, the recognition of contingent consideration, the accounting for preacquisition gain and loss contingencies, the recognition of capitalized in-process research and development, the accounting for acquisition-related restructuring cost accruals, the treatment of acquisition related transaction costs and the recognition of changes in the acquirer’s income tax valuation allowance. On January 1, 2009, SumTotal Systems adopted SFAS No. 141R, which did not have a material impact on SumTotal Systems’ financial position and results of operations in the current reporting period, but will affect how future acquisitions are treated.
In December 2007, the FASB issued SFAS No. 160,Noncontrolling Interests in Consolidated Financial Statements, an amendment of Accounting Research Bulletin (“ARB”) No. 51,Consolidated Financial Statements. SFAS No. 160 changes the accounting for noncontrolling (minority) interests in consolidated financial statements including the requirements to classify noncontrolling interests as a component of consolidated stockholders’ equity, and to eliminate “minority interest” accounting in results of operations with earnings attributable to noncontrolling interests reported as part of consolidated earnings. Additionally, SFAS No. 160 revises the accounting for both increases and decreases in a parent’s controlling ownership interest. On January 1, 2009, SumTotal Systems adopted SFAS No. 160, which did not have a material impact on its financial position, results of operations and cash flows.
In March 2008, the FASB issued SFAS No. 161,Disclosure about Derivative Instruments and Hedging Activities. SFAS No. 161 amends and expands the disclosure requirements of SFAS No. 133. SFAS No. 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments. SFAS No. 161 applies to all entities that prepare consolidated financial statements and to all derivative instruments, including bifurcated derivative instruments (and nonderivative instruments that are designated and qualify as hedging instruments as defined in SFAS No. 133) and related hedged items accounted for under SFAS No. 133 and its related interpretations. On January 1, 2009, SumTotal Systems adopted SFAS No. 161, which did not have a material impact on its financial disclosures.
In April 2008, the FASB issued FASB Staff Position (“FSP”) SFAS No. 142-3,Determination of the Useful Life of Intangible Assets. This guidance is intended to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142, and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141R when the underlying arrangement includes renewal or extension of terms that would require substantial costs or result in a material modification to the asset upon renewal or extension. On January 1, 2009, SumTotal Systems adopted FSP SFAS No. 142-3, which did not have a material impact on its financial position, results of operations and cash flows.
In November 2008, the FASB ratified EITF Issue No. 08-6,Equity Method Investment Accounting Considerations, which clarifies the accounting for certain transactions and impairment considerations involving equity method investments. SumTotal Systems did not have any investments that are accounted for under the equity method as of March 31, 2009. Therefore, the adoption of EITF No. 08-6 on January 1, 2009 did not have any financial impact on its financial position, results of operations and cash flows.
In November 2008, the FASB ratified EITF No. 08-7,Accounting for Defensive Intangible Assets, which clarifies the accounting for certain separately identifiable intangible assets which an acquirer does not intend to actively use but intends to hold to prevent its competitors from obtaining access to them. EITF No. 08-7 requires an acquirer in a business combination to account for a defensive intangible asset as a separate unit of accounting which should be amortized to expense over the period the asset diminishes in value. SumTotal Systems did not have any defensible intangible assets as of March 31, 2009. Therefore, the adoption of EITF No. 08-7 on January 1, 2009 did not have any financial impact on its financial position, results of operations and cash flows.
In May 2008, the FASB issued SFAS No. 162, TheHierarchy of Generally Accepted Accounting Principles. SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with GAAP in the U.S. The current GAAP hierarchy is set forth in the AICPA Statement of Auditing Standards (“SAS”) No. 69,The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles. The FASB believes that GAAP hierarchy should be directed to entities because it is the entity (not its auditor) that is responsible for selecting accounting principles for financial statements that are presented in conformity with GAAP. Accordingly, the FASB concluded that the GAAP hierarchy should reside in the accounting literature established by the FASB and has issued SFAS No. 162 to achieve that result. SFAS No. 162 became effective on November 15, 2008, and did not have any impact on SumTotal Systems’ financial position, results of operations and cash flows upon adoption.
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NOTE 3: INTANGIBLE ASSETS
Intangible assets at March 31, 2009 and December 31, 2008 are as follows (in thousands):
March 31, 2009 | ||||||||||
Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | ||||||||
Intangible assets: | ||||||||||
Acquired technology | $ | 13,312 | $ | (12,738 | ) | $ | 574 | |||
Customer installed-base relationships | 17,094 | (11,974 | ) | 5,120 | ||||||
Customer hosted relationships | 1,014 | (1,014 | ) | — | ||||||
Customer contract relationships | 8,525 | (8,220 | ) | 305 | ||||||
Total intangible assets | $ | 39,945 | $ | (33,946 | ) | $ | 5,999 | |||
December 31, 2008 | ||||||||||
Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | ||||||||
Intangible assets: | ||||||||||
Acquired technology | $ | 13,312 | $ | (12,495 | ) | $ | 817 | |||
Customer installed-base relationships | 17,094 | (11,249 | ) | 5,845 | ||||||
Customer hosted relationships | 1,014 | (971 | ) | 43 | ||||||
Customer contract relationships | 8,525 | (8,146 | ) | 379 | ||||||
Total intangible assets | $ | 39,945 | $ | (32,861 | ) | $ | 7,084 | |||
There was no impairment of intangible assets for the three-months ended March 31, 2009 and 2008, respectively.
The following represents the expected future amortization of intangible assets as of March 31, 2009 (in thousands):
Remainder of 2009 | $ | 2,953 | |
2010 | 1,841 | ||
2011 | 1,080 | ||
2012 | 125 | ||
Total expected future amortization of intangible assets | $ | 5,999 | |
Amortization expense related to intangible assets was approximately $1,085,000 and $1,684,000 in the three-months ended March 31, 2009 and 2008, respectively.
NOTE 4: BORROWINGS
The current portion of notes payable consists of the following (in thousands):
March 31, 2009 | December 31, 2008 | |||||
Credit facility | $ | — | $ | 4,375 | ||
Litigation settlement | — | 292 | ||||
Total current portion of notes payable | $ | — | $ | 4,667 | ||
Credit Facility
Concurrent with the closing of the acquisition of Pathlore on October 4, 2005, SumTotal Systems entered into a credit facility with Wells Fargo Foothill, principally to fund a portion of the acquisition price and to provide for its ongoing working capital requirements. Under the terms of the facility, Wells Fargo Foothill loaned SumTotal Systems $17.5 million to complete the acquisition of Pathlore and provided a revolving credit facility to a maximum of $5.0 million (the “Revolver”), as adjusted, to meet the working capital requirements of the business.
The credit facility, as amended at various times, included interest on a scalable schedule of the base rate, with a 6% minimum, based on earnings before interest, taxes, depreciation and amortization (“EBITDA”), as defined in the agreement. On August 26, 2008, SumTotal Systems entered into an amendment of its credit facility to remove the contractual 6% minimum rate. SumTotal Systems agreed to perform an initial transfer of $25.0 million to a Wells Fargo investment account, and maintain at least 50% of its total aggregate amount of invested cash and cash equivalents at all times thereafter until the loan is fully repaid. The Term Loan is due in principal installments of $1,093,750 quarterly and is secured by all of SumTotal Systems’ assets. The Term Loan and any remaining balance on the Revolver are due and payable on October 5, 2009. Any interest due on the Revolver must be paid at least every three months.
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The Term Loan is subject to certain restrictive covenants which include, but are not limited to, maintaining certain levels of EBITDA, leverage ratios, as well as restrictions on capital expenditures, indebtedness, distributions, investments and on change of control. There is only monitoring and no enforcement of the financial covenants if SumTotal Systems maintains a minimum balance of at least $15.0 million between qualified cash accounts (accounts pledged to the lender) and excess availability under the Revolver. As of March 31, 2009, SumTotal Systems had $44.6 million, comprised of $39.8 million in qualified cash accounts and $4.8 million in excess availability under the Revolver and therefore no test of the covenants was required. SumTotal Systems was in compliance with all terms of its credit facility as of March 31, 2009. In the event that SumTotal Systems’ qualified cash balance falls below the $15.0 million threshold and it cannot achieve the financial results necessary to maintain compliance with these covenants, SumTotal Systems could be declared in default and be required to sell or liquidate its assets to repay the outstanding credit facility, if utilized.
In January 2009, SumTotal Systems made total payments of $4.5 million to Wells Fargo Foothill to fully pay off its outstanding Term Loan, of which $4.4 million and $0.1 million were principal and interest, respectively. Included in the $4.4 million principal payments were a $1.1 million quarterly installment and a $3.3 million prepayment of the remaining principal. As a result of the loan payoff, SumTotal Systems did not have any outstanding principal or interest payments at March 31, 2009.
SumTotal Systems has an agreement with Wells Fargo Foothill in which SumTotal Systems will enter into forward foreign exchange contracts to mitigate certain foreign exchange exposures related to foreign trade receivables. As part of this agreement, the credit facility provides for a 5% reserve against the Revolver. As a result of the 5% reserve requirement, the Company has $250,000 less in funds available for use from the Revolver including debt covenant compliance and, accordingly, only $4,750,000 of the Revolver was available for borrowings at March 31, 2009. Prospectively, at this time, SumTotal Systems anticipates it will only enter into forward foreign exchange hedging contracts to mitigate foreign currency exposures and will not enter into forward foreign exchange contracts for trading or speculative purposes. SumTotal Systems had no forward contracts at March 31, 2009.
The effect of foreign exchange rate fluctuations accounted for in accumulated other comprehensive loss for the three-months ended March 31, 2009 was a foreign translation loss of $254,000, as compared to a gain of $59,000 in the comparable period in 2008. Due to the substantial volatility of currency exchange rates, among other factors, SumTotal Systems cannot predict the effect of exchange rate fluctuations on its future operating results.
Litigation Settlement
On March 14, 2006, SumTotal Systems entered into an agreement to settle all patent infringement claims with IpLearn that included, among other terms, a binding mutual release of all claims the parties may have had against each other, certain licenses and covenants not to sue, a payment from SumTotal Systems to IpLearn of $3.5 million, payable over three years and the issuance of 50,000 shares of SumTotal Systems’ common stock to IpLearn valued at $181,000. The settlement was reached with no admission of liability or wrongdoing by any party. The aggregate amount of the settlement was accrued as of December 31, 2005. The liability was fully settled in January 2009.
NOTE 5: RESTRUCTURING
The following table depicts restructuring activity for the three-months ended March 31, 2009 (in thousands):
Balance at December 31, 2008 | Additions | Reductions/ Cash Expenditures | Balance at March 31, 2009 | ||||||||||
Vacated facilities | $ | — | $ | 193 | $ | (31 | ) | $ | 162 | ||||
Stock-based compensation | — | 115 | (115 | ) | — | ||||||||
Employee severance and other related costs | — | 987 | (943 | ) | 44 | ||||||||
$ | — | $ | 1,295 | $ | (1,089 | ) | $ | 206 | |||||
Obligations for restructured facility leases are accrued on the consolidated balance sheet at their net present values including estimated future sublease rentals based on current market expectations. Employee severance and other related costs consist of severance and other benefits resulting from the Company’s reduction in force to reduce its cost structure. During the first quarter of 2009, SumTotal Systems committed to a cost reduction plan to reduce 8% of its headcount across all functions in all regions and restructured a portion of its facilities in Bellevue, Washington and Mountain View, California Locations, and recorded a restructuring charge of $1.3 million. Included in this charge are vacated facilities of $193,000, stock-based compensation related to workforce reduction of $115,000, and employee severance and other benefits of $987,000. SumTotal Systems estimates it will incur additional employee related restructuring charges of approximately $10,000 in the second quarter of 2009.
NOTE 6: TREASURY SHARE PURCHASES
On August 20, 2007, SumTotal Systems’ Board of Directors authorized the repurchase of up to $15.0 million of SumTotal Systems’ outstanding shares of common stock. Stock repurchases will be made in the open market, in block purchase transactions, or in structured Rule 10b5-1 share repurchase plans, and may be made from time to time or in one or more larger repurchases. SumTotal Systems intends to conduct the repurchase in compliance with Rule 10b-18 of the Securities Exchange Act of 1934. The program does not obligate SumTotal Systems to acquire any particular amount of common stock and the program may be modified, suspended or
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terminated at any time at SumTotal Systems’ discretion. As of March 31, 2009, SumTotal Systems has purchased 2,016,690 shares of common stock for an aggregate cost of $8.3 million as follows:
Period | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Average Price Paid Per Share | Total Value of Shares Purchased as Part of Publicly Announced Plans or Programs | Approximate Dollar Value of Shares that May Yet be Purchased Under the Programs | |||||||
Through December 31, 2008 | 1,670,272 | $ | 4.64 | $ | 7,743,716 | $ | 7,256,284 | ||||
January 1-31, 2009 | — | — | — | 7,256,284 | |||||||
February 1-28, 2009 | 17,686 | 1.78 | 31,507 | 7,224,777 | |||||||
March 1-31, 2009 | 328,732 | 1.52 | 498,307 | 6,726,470 | |||||||
Total | 2,016,690 | $ | 4.10 | $ | 8,273,530 | $ | 6,726,470 | ||||
NOTE 7: COMMITMENTS AND CONTINGENCIES
Commitments
SumTotal Systems leases office space in Mountain View, California; Bellevue, Washington; Gainesville, Florida; Columbus, Ohio; Rochester, New York; Tokyo, Japan; Paris, France; Datchet, United Kingdom; Frankfurt, Germany; Hyderabad, India; and Beijing, People’s Republic of China; and certain equipment under non-cancelable operating leases expiring in years through 2014. Rent expense under operating leases was approximately $708,000 and $704,000 during the three-months ended March 31, 2009 and 2008, respectively.
Future payments under operating lease obligations at March 31, 2009 are presented in the table below (in thousands):
Payments Due by Period | |||||||||||||||||||||
Total | Remainder of 2009 | 2010 | 2011 | 2012 | 2013 | Thereafter | |||||||||||||||
Operating leases | $ | 9,616 | $ | 2,065 | $ | 2,105 | $ | 1,740 | $ | 1,749 | $ | 1,813 | $ | 144 | |||||||
Contingencies
In the event of a change of control and the subsequent termination of any of SumTotal Systems’ executive officers and certain key employees in a manner defined in the agreement as a termination event, the Company will be obligated to pay the officer or the key employee certain compensation and benefits, including: one year of the officer’s base salary to be paid over a one year period, 100% of the officer’s target bonus payable in one lump sum within five days, full acceleration of outstanding equity awards and continuing health coverage for up to one year, as more fully described in the Amended and Restated Change of Control Agreement. On April 3, 2009, SumTotal Systems entered into an Amended and Restated Change of Control Agreement with its Chief Executive Officer, which amended the term, benefits and obligations under the agreement, from one year to 18 months. In addition to this change of control agreement, the terms of SumTotal Systems’ Chief Executive Officer’s employment offer letter provides that if, prior to December 31, 2009, his employment is terminated other than for cause or good reason, he would be entitled to be paid one year’s base salary, 100% of his targeted annual bonus and other benefits as described in his offer letter.
From time-to-time, third-parties assert patent infringement claims against SumTotal Systems in the forms of letters, litigation, or other forms of communication. In addition without limitation, from time-to-time, SumTotal Systems is subject to other legal proceedings and claims in the ordinary course of business, including; claims of alleged infringement of trademarks, copyrights and other intellectual property rights, employment claims and general contract or other claims. Management does not believe that any of the foregoing claims are likely to have a material adverse effect on its financial position, results of operations or cash flows. However, SumTotal Systems’ analysis of whether a claim may proceed to litigation cannot be predicted with certainty, nor can the results of litigation be predicted with certainty. In addition, a purported class action lawsuit has been filed against SumTotal Systems and its directors with respect to the acquisition of Sumtotal Systems by affiliates of Accel-KKR, as described in Note 10,Legal Proceedings. Defending each of these actions, regardless of the outcome, may be costly, time-consuming, distract management personnel and have a negative effect on SumTotal Systems’ business. An adverse outcome in any of these actions, including a judgment or settlement, may cause a material adverse effect on its future business, operating results and/or financial condition.
For information regarding indemnifications, refer to Note 8,Guarantees, Warranties and Indemnification, and Note 10,Legal Proceedings, in the Notes to Condensed Consolidated Financial Statements.
NOTE 8: GUARANTEES, WARRANTIES AND INDEMNIFICATION
SumTotal Systems has adopted FIN No. 45,Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN No. 45 provides expanded accounting guidance surrounding liability recognition and disclosure requirements related to guarantees. In the ordinary course of business, SumTotal Systems is not subject to potential
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obligations under guarantees that fall within the scope of FIN No. 45 except for standard indemnification and warranty provisions that are contained within many of its customer license and service agreements and give rise only to the disclosure requirements prescribed by FIN No. 45.
Indemnification and warranty provisions contained within SumTotal Systems’ customer license and service agreements are generally consistent with those prevalent in the industry. The duration of product warranties are generally between 90 to 365 days following delivery of the solutions. Significant obligations under customer indemnification or warranty provisions have not been incurred historically and are not expected in the future. Accordingly, accruals for potential customer indemnification or warranty-related obligations are not maintained.
SumTotal Systems has entered into indemnification agreements with its directors and certain of its officers that will require SumTotal Systems, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers. SumTotal Systems has also agreed to indemnify certain former officers, directors and employees of acquired companies in connection with the acquisition of such companies. SumTotal Systems maintains director and officer insurance, which may cover certain liabilities arising from its obligation to indemnify its directors and officers and former directors, officers and employees of acquired companies, in certain circumstances.
NOTE 9: SEGMENT INFORMATION
SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information, requires that companies report separately in the financial statements certain financial and descriptive information about operating segments profit or loss, certain specific revenue and expense items and segment assets. The method for determining what information is reported is based on the way that management organizes the operating segments for making operational decisions and assessments of financial performance. SumTotal Systems’ chief operating decision maker is considered to be the Chief Executive Officer (“CEO”). The CEO reviews financial information presented on a consolidated basis for purposes of making operating decisions and assessing financial performance. The consolidated financial information reviewed by the CEO is similar to the information presented in the accompanying unaudited condensed consolidated financial statements of operations. Currently, the CEO does not use product line financial performance as a basis for business operating decisions. Therefore, SumTotal Systems has determined that it operates in a single reportable segment.
Revenue by international region is based on the direct billing location of the customer and is as follows (in thousands, except percentages):
Three-Months Ended March 31, | ||||||||||||
2009 | 2008 | |||||||||||
Revenue | Percent of Revenue | Revenue | Percent of Revenue | |||||||||
United States | $ | 18,007 | 76.0 | % | $ | 27,523 | 76.5 | % | ||||
Other Americas | 1,408 | 5.9 | % | 2,324 | 6.5 | % | ||||||
Total Americas | 19,415 | 81.9 | % | 29,847 | 83.0 | % | ||||||
Europe, Middle East and Africa | 3,078 | 13.0 | % | 4,906 | 13.6 | % | ||||||
Asia/Pacific | 1,207 | 5.1 | % | 1,239 | 3.4 | % | ||||||
Total revenue | $ | 23,700 | 100.0 | % | $ | 35,992 | 100.0 | % | ||||
Long-lived assets, which represent property, plant and equipment, goodwill and intangible assets, net of accumulated depreciation and amortization, by geographic location are as follows (in thousands):
March 31, 2009 | December 31, 2008 | |||||
United States | $ | 13,128 | $ | 12,972 | ||
Europe, Middle East and Africa | 135 | 151 | ||||
India | 1,466 | 1,703 | ||||
Asia/Pacific | 161 | 176 | ||||
Total long-lived assets | $ | 14,890 | $ | 15,002 | ||
NOTE 10: LEGAL PROCEEDINGS
From time-to-time, SumTotal Systems is involved in legal proceedings or threats of legal proceedings arising in the ordinary course of business. SumTotal Systems is not currently a party to any litigation or other legal proceeding that, in the opinion of management, is reasonably likely to have a material adverse effect on SumTotal Systems’ business, operating results or financial condition, except as noted below.
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Lief Irgens v. SumTotal Systems, Inc., et al., Case No. 109CV141073, Superior Court of Santa Clara County, California. A purported class action lawsuit was filed on April 28, 2009 against SumTotal Systems and each of its directors claiming, among other things, that the board of directors breached their fiduciary duties to the company’s stockholders by entering into the merger agreement on April 23, 2009 with affiliates of Accel-KKR, as described in Note 11,Subsequent Events, for an unfair price and failing to engage in a fair sale process with respect to the proposed merger. The complaint seeks damages and injunctive relief. SumTotal Systems intends to vigorously defend these claims.
SumTotal Systems may, from time to time, also be subject to various legal or government claims, disputes or investigations. Such matters may include, but not be limited to, claims, disputes or investigations related to warranty, refund, breach of contract, employment, intellectual property, government regulation or compliance or other matters such as a subpoena SumTotal Systems received on April 30, 2008 from the U.S. Department of Defense, Office of the Inspector General. The subpoena requests documents related to SumTotal Systems’ sale of products and services to the Department of Defense as well as other documents related to SumTotal Systems. SumTotal Systems is cooperating with the government’s request and is in the process of responding to the subpoena.
NOTE 11: SUBSEQUENT EVENTS
On April 3, 2009 Vista Equity Partners III, LLC (“Vista”) submitted a proposal to acquire the Company in a merger in which stockholders would receive $3.25 per share in cash (the “Proposal”). In addition, on April 6, 2009, Vista delivered notice to the Company in which it nominated three directors for election to the Company’s Board of Directors at the Company’s 2009 annual meeting of stockholders.
On April 23, 2009, and as described in the Company’s Current Report on Form 8-K filed with the SEC on April 24, 2009, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) by and among the Company, ST Software Holdings, LLC (“Newco”), and ST Mergersub, Inc., a wholly owned subsidiary of Newco (“Merger Sub”). Pursuant to the terms of the Merger Agreement, Merger Sub would be merged with and into the Company, and as a result the Company would continue as the surviving corporation and a wholly owned subsidiary of Newco (the “Merger”). Newco is controlled by a private equity fund associated with Accel-KKR. Pursuant to the Merger Agreement, at the effective time of the Merger, each issued and outstanding share of common stock of the Company will be canceled and extinguished and automatically converted into the right to receive $3.80 in cash.
In addition, on April 28, 2009, a purported class action lawsuit has been filed against us and our directors with respect to the acquisition of the company by affiliates of Accel-KKR, as described in Note 10,Legal Proceedings.
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Forward-Looking Statements
The following discussion and analysis should be read in conjunction with the unaudited Condensed Consolidated Financial Statements and related Notes contained elsewhere within this document. Operating results for the three-months ended March 31, 2009 are not necessarily indicative of the results that may be expected for any future periods, including the full fiscal year. Reference should also be made to the Annual Consolidated Financial Statements, Notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations and Risk Factors contained in the SumTotal Systems Annual Report on Form 10-K for the year ended December 31, 2008.
This Quarterly Report includes “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. This Act provides a “safe harbor” for forward-looking statements to encourage companies to provide prospective information so long as they identify these statements as forward-looking and provide meaningful cautionary statements identifying important factors that could cause actual results to differ from the projected results. All statements other than statements of historical fact we make in this Quarterly Report are forward-looking. Such forward-looking statements may be identified by the words “may”, “plans”, “expects”, “anticipates”, “intends”, “targets”, “goals”, “seeks”, “believes”, “potential”, “continue”, “predict”, “could”, “will”, “estimate” and similar language, including variations of such words and include, but are not limited to, statements regarding the following: the proposed acquisition of the Company by Accel-KKR, our belief that our available cash resources, combined with cash flows generated from revenues, will be sufficient to meet our presently anticipated working capital, capital expense and business expansion requirements for at least the next 12 months; our belief that any current disputes will not result in litigation, but if they do, they will not have a material adverse effect on our business, operating results and/or financial condition; statements about future business operations, including future product launches; marketing statements; industry leadership; internal controls and procedures; statements about our product, SumTotal 8 Series; revenue recognition; continued growth in our revenues from our professional service organization; financial performance including, but not limited to, estimated revenues, bookings, operating expenses, gross margins, and profit, and market conditions that include risks and uncertainties are based on information that is available to us at the date of this Quarterly Report on Form 10-Q and reflects management’s then current expectations, estimates, beliefs, assumptions and goals and objectives, and are subject to uncertainties that are difficult, if not impossible, to predict. Our actual results may differ significantly from those projected in the forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to those discussed in the section “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Factors That May Affect Future Results of Operations.” You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document.
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Executive Summary
Overview
We are a global provider of learning, performance, and talent development solutions. Our offerings include learning, performance, and compensation management software and services. Our markets are worldwide and include a broad range of industries. Our solutions automate the talent development processes within organizations, including aligning the individual’s goals with business objectives, developing the individual’s skills and competencies, assessing the individual’s performance, providing succession planning, and setting compensation based on performance. We sell our solutions to organizations primarily through our direct sales force, complemented by sales through our domestic and international partners. We offer our solutions on a subscription or perpetual license basis. Our solutions can be provided on an on-demand basis or deployed at the customer’s site. We have more than 1,500 customers and 18 million users worldwide across a variety of industries, including education, energy, financial services, government, healthcare, manufacturing, retail, services, and utilities.
We recorded total revenue of $23.7 million in the three-months ended March 31, 2009, a decrease from $36.0 million over the comparable period in 2008. Our net loss was $5.2 million in the three-months ended March 31, 2009, compared to net income of $1.5 million over the same period in 2008. Our deferred revenue was $35.6 million at March 31, 2009, a $1.0 million increase from $34.6 million at December 31, 2008. Our cash flow from operating activities increased to $4.1 million in the three-months ended March 31, 2009 from $3.6 million in the comparable period in 2008. Further, we ended the quarter with $44.8 million in cash, cash equivalents and short-term investment.
On April 23, 2009, and as described in the Company’s Current Report on Form 8-K filed with the SEC on April 24, 2009, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) by and among us, ST Software Holdings, LLC (“Newco”), and ST Mergersub, Inc., a wholly owned subsidiary of Newco (“Merger Sub”). Pursuant to the terms of the Merger Agreement, Merger Sub would be merged with and into us, and as a result we would continue as the surviving corporation and a wholly owned subsidiary of Newco (the “Merger”). Newco is controlled by a private equity fund associated with Accel-KKR.
Pursuant to the Merger Agreement, each issued and outstanding share of our common stock will be canceled and extinguished and automatically converted into the right to receive $3.80 in cash. Options to purchase our common stock and restricted stock units, whether vested or unvested, will be converted into a right to receive cash consideration as described in the Merger Agreement. Consummation of the Merger is subject to customary conditions, including (i) adoption of the Merger Agreement by holders of a majority of our outstanding common stock and (ii) absence of any law or order prohibiting the consummation of the Merger. In addition, Newco’s obligation to consummate the merger is subject to our having at least $36.5 million of cash and cash equivalents at the closing of the merger.
Critical Accounting Policies and Estimates
Certain of our accounting policies require the application of significant judgment by management in selecting the appropriate assumptions for calculating financial estimates. By their nature, these judgments are subject to an inherent degree of uncertainty. These judgments reflect practices, information provided by our customers and other assumptions that we believe are reasonable under the circumstances. Our estimates and assumptions are reviewed periodically and the effects of revisions are reflected in the consolidated financial statements in the period in which they are determined to be necessary. Actual results may differ from these estimates under different assumptions or conditions. Our critical accounting policies and estimates include:
• | revenue recognition; |
• | allowances for sales returns and doubtful accounts; |
• | recoverability evaluation of our goodwill and intangible assets; |
• | valuation reserve for deferred tax assets; |
• | restructuring reserves; |
• | business combinations; and |
• | stock-based compensation. |
Our senior management has reviewed these critical accounting policies and related disclosures with our Disclosure Committee and the Audit Committee of our Board of Directors. The Notes to the Condensed Consolidated Financial Statements, contained elsewhere in this Report, contain additional information regarding our accounting policies and other disclosures required by generally accepted accounting principles.
We have made no significant changes in our critical accounting policies and estimates since our previous filing on our Annual Report on Form 10-K, as filed with the SEC on March 11, 2009.
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Comparison of Financial Data for the Three-Months Ended March 31, 2009 and 2008
Results of Operations
The following table presents our results of continuing operations as a percentage of total revenue for the three-months ended March 31, 2009 and 2008:
2009 | 2008 | |||||
Revenue: | ||||||
Subscriptions and support | 70.8 | % | 49.0 | % | ||
Service | 22.3 | 26.9 | ||||
License | 6.9 | 24.1 | ||||
Total revenue | 100.0 | 100.0 | ||||
Cost of revenue: | ||||||
Subscriptions and support | 23.6 | 16.6 | ||||
Service | 18.5 | 19.1 | ||||
License | 0.2 | 0.2 | ||||
Amortization of intangible assets | 4.6 | 4.7 | ||||
Total cost of revenue | 46.9 | 40.6 | ||||
Gross margin | 53.1 | 59.4 | ||||
Operating expenses: | ||||||
Research and development | 21.1 | 16.2 | ||||
Sales and marketing | 30.1 | 24.2 | ||||
General and administrative | 17.6 | 14.4 | ||||
Restructuring | 5.4 | 0.2 | ||||
Total operating expenses | 74.2 | 55.0 | ||||
Income (loss) from operations | (21.1 | ) | 4.4 | |||
Other income (expense), net | (0.4 | ) | 0.8 | |||
Income (loss) before income taxes | (21.5 | ) | 5.2 | |||
Provision for income taxes | 0.3 | 1.0 | ||||
Net income (loss) | (21.8 | )% | 4.2 | % | ||
Revenue
Revenue for the three-months ended March 31, 2009 and 2008 was as follows (in thousands, except percentages):
Three-Months Ended March 31, | Variance in Dollars | Variance in Percent | |||||||||||||
2009 | 2008 | ||||||||||||||
Subscriptions and support | $ | 16,774 | $ | 17,627 | $ | (853 | ) | (4.8 | )% | ||||||
Percentage of net revenue | 70.8 | % | 49.0 | % | |||||||||||
Service | 5,295 | 9,672 | (4,377 | ) | (45.3 | )% | |||||||||
Percentage of net revenue | 22.3 | % | 26.9 | % | |||||||||||
License | 1,631 | 8,693 | (7,062 | ) | (81.2 | )% | |||||||||
Percentage of net revenue | 6.9 | % | 24.1 | % | |||||||||||
Total revenue | $ | 23,700 | $ | 35,992 | $ | (12,292 | ) | (34.2 | )% | ||||||
Despite the sustained decline in the global economy, the decrease in subscriptions and support revenue in the three-months ended March 31, 2009 over the comparative period in 2008 is small. We attribute this to a number of factors, including the shift in our business focus and strategy to our on-demand solutions and increased investments in our sales and marketing efforts in international markets. Subscriptions and support revenue was also positively affected by the increase in the number of on-demand customers.
The decrease in our license revenue and increase in recurring on-demand subscriptions revenue reflected the shift in our business emphasis and strategy from our perpetual license products to on-demand subscriptions and a sustained decline in the global economy which has decreased the budgets of our customers for large license purchases and related services purchases.
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Subscriptions and support revenue. The decrease in subscriptions and support revenue in the three-months ended March 31, 2009 over the comparable period in 2008 was as follows (in thousands, except percentages):
Three-Months Ended March 31, | Variance in Dollars | Variance in Percent | |||||||||||
2009 | 2008 | ||||||||||||
Hosting subscriptions | $ | 3,423 | $ | 3,958 | $ | (535 | ) | (13.5 | )% | ||||
Term license rental arrangements | 1,638 | 1,722 | (84 | ) | (4.9 | )% | |||||||
On-demand subscriptions | 2,917 | 1,875 | 1,042 | 55.6 | % | ||||||||
Total subscriptions | 7,978 | 7,555 | 423 | 5.6 | % | ||||||||
Support maintenance | 8,796 | 10,072 | (1,276 | ) | (12.7 | )% | |||||||
Total subscriptions and support revenue | $ | 16,774 | $ | 17,627 | $ | (853 | ) | (4.8 | )% | ||||
The increase in on-demand subscriptions in the three-months ended March 31, 2009 over the comparative period in 2008 was the result of increased interest in on-demand solutions as a way for our global customers to manage costs effectively, and demonstrates continued growth within our installed base, and broad market interest in on-demand solutions for both Learning Management and Performance Management. The decrease in hosting subscriptions revenue, term license rental arrangements revenue and support maintenance revenue reflects the shift from our perpetual license products to on-demand subscriptions, as these products are typically included in the on-demand subscription. In addition, during the three-months ended March 31, 2008, we recognized a $0.7 million of support maintenance revenue from one of our global retail customers as we met certain revenue recognition criteria which allowed us to recognize previously deferred revenue.
Price changes in subscription and support had no material effect on our revenue in the three-months ended March 31, 2009 over the comparative period in 2008.
Service revenue.Service revenue was unfavorably affected by the difficult global economic environment, which has decreased the budgets of our customers for large license and related services purchases.
As our clients are purchasing more on-demand subscriptions, the size of our services contracts is smaller than comparable service contracts for perpetual licenses, as less customization services are needed for on-demand subscriptions.
The decrease in service revenue in the three-months ended March 31, 2009 over the comparable period in 2008 was also due to continued shift from recognizing professional services revenue as the services were performed under our perpetual license model, to recognizing the services over the subscription service period in our on-demand solution. The subscription services are provided pursuant to customer agreements with terms typically ranging from one to three years. The revenue for professional services associated with our on-demand deals is recognized ratably over the term of the agreement.
In three-months ended March 31, 2008, we recognized $1.2 million of consulting services revenue from one of our global retail customers as we met certain revenue recognition criteria which allowed us to recognize previously deferred revenue.
Price changes in service had no material effect on our revenue in the three-months ended March 31, 2009 over the comparative period in 2008.
License revenue.The decrease in license revenue in the three-months ended March 31, 2009 over the comparable period in 2008 was primarily due to $3.4 million in license revenue recognized in the three-months ended March 31, 2008 from one of our global retail customers as we met certain revenue recognition criteria which allowed us to recognize previously deferred revenue. The decrease in license revenue is also due to the decrease in sales of our perpetual license products as new small and medium business (“SMB”) customers purchased our subscription offerings rather than the perpetual products we sold historically.
Price changes in license had no material effect on our revenue in the three-months ended March 31, 2009 over the comparative period in 2008.
Geographic Region. We sell our product solutions in three geographic regions: Americas; Europe, Middle East and Africa; and Asia/Pacific. Revenues for each region, which include product and service revenue, are summarized in the following table (in thousands, except percentages):
Three-Months Ended March 31, | Variance in Dollars | Variance in Percent | |||||||||||||
2009 | 2008 | ||||||||||||||
United States | $ | 18,007 | $ | 27,523 | $ | (9,516 | ) | (34.6 | )% | ||||||
Percentage of net revenue | 76.0 | % | 76.5 | % | |||||||||||
Other Americas | 1,408 | 2,324 | (916 | ) | (39.4 | )% | |||||||||
Percentage of net revenue | 5.9 | % | 6.5 | % | |||||||||||
Total Americas | 19,415 | 29,847 | (10,432 | ) | (35.0 | )% | |||||||||
Percentage of net revenue | 81.9 | % | 83.0 | % | |||||||||||
Europe, Middle East and Africa | 3,078 | 4,906 | (1,828 | ) | (37.3 | )% | |||||||||
Percentage of net revenue | 13.0 | % | 13.6 | % | |||||||||||
Asia/Pacific | 1,207 | 1,239 | (32 | ) | (2.6 | )% | |||||||||
Percentage of net revenue | 5.1 | % | 3.4 | % | |||||||||||
Total revenue | $ | 23,700 | $ | 35,992 | $ | (12,292 | ) | (34.2 | )% | ||||||
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The decrease in Americas’ revenue for the three-months ended March 31, 2009 over the comparable period in 2008 was primarily due to $5.3 million in revenue recognized in the three-months ended March 31, 2008 from one of our global retail customers as we met certain revenue recognition criteria which allowed us to recognize previously deferred revenue. The decrease in Europe’s revenue was primarily due to revenue recognized in the three-months ended March 31, 2008 from a large sale and installation of an enterprise-wide solution for one of our global financial services customers. Revenue in Asia/Pacific remains about the same for the three-months ended March 31, 2009 over the comparable period in 2008. The decrease in total revenue was also due to the sustained decline in the global economy.
Price changes had no material effect on our revenue in any region or revenue type in the three-months ended March 31, 2009 over the comparable period in 2008.
No customers accounted for greater than 10% of total revenue in the three-months ended March 31, 2009. One customer accounted for 15% of total revenue in the three-months ended March 31, 2008.
Cost of Revenue
The following table is a summary of cost of revenue between subscriptions and support, service, license, and amortization of intangible assets (in thousands, except percentages):
Three-Months Ended March 31, | Variance in Dollars | Variance in Percent | |||||||||||||
2009 | 2008 | ||||||||||||||
Subscriptions and support | $ | 5,581 | $ | 5,961 | $ | (380 | ) | (6.4 | )% | ||||||
Percentage of total revenue | 23.6 | % | 16.6 | % | |||||||||||
Service | 4,391 | 6,891 | (2,500 | ) | (36.3 | )% | |||||||||
Percentage of total revenue | 18.5 | % | 19.1 | % | |||||||||||
License | 52 | 64 | (12 | ) | (18.8 | )% | |||||||||
Percentage of total revenue | 0.2 | % | 0.2 | % | |||||||||||
Amortization of intangible assets | 1,085 | 1,684 | (599 | ) | (35.6 | )% | |||||||||
Percentage of total revenue | 4.6 | % | 4.7 | % | |||||||||||
Total cost of revenue | $ | 11,109 | $ | 14,600 | $ | (3,491 | ) | (23.9 | )% | ||||||
Cost of subscriptions and support.The decrease in the cost of subscriptions and support for the three-months ended March 31, 2009 over the comparable period in 2008 was partially due to $0.2 million in savings from decreased performance-based compensation. The remaining decrease is attributed to a $0.1 million reduction in expenses associated with the use of third party vendors and a $0.1 million decrease in travel.
Cost of services.The decrease in the cost of services for the three-months ended March 31, 2009 over the comparable period in 2008 was partially due to $0.7 million in savings from decreased performance-based compensation and decreased head count associated with our workforce rebalancing efforts. The cost decrease was also due to $1.0 million in costs deferrals for such projects where revenue is deferred. The remaining decrease is attributed to a $0.4 million reduction in expenses associated with outside services, a $0.3 million decrease in travel and a $0.1 million reduction in equipment and software purchased or depreciated.
Cost of license. The decrease in the cost of license for the three-months ended March 31, 2009 over the comparable period in 2008 was due to reduced usage of third party content preparation and shipping costs.
Amortization of intangible assets. The decrease in amortization of intangible assets for the three-months ended March 31, 2009 over the comparable period in 2008 was primarily due to a $0.3 million elimination of certain intangible assets recorded from prior acquisitions as they became fully amortized in 2008, and a scheduled $0.3 million decrease in the amortization of other intangible assets from prior acquisitions.
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Gross Margin
The following table is the summary of gross margin between subscriptions and support, service, license and amortization of intangible assets (in thousands, except percentages):
Three-Months Ended March 31, | ||||||||
2009 | 2008 | |||||||
Gross margin | ||||||||
Subscriptions and support | $ | 11,193 | $ | 11,666 | ||||
Percentage of subscriptions and support revenue | 66.7 | % | 66.2 | % | ||||
Services | 904 | 2,781 | ||||||
Percentage of services revenue | 17.1 | % | 28.8 | % | ||||
License | 1,579 | 8,629 | ||||||
Percentage of license revenue | 96.8 | % | 99.3 | % | ||||
Amortization of intangible assets | (1,085 | ) | (1,684 | ) | ||||
Percentage of license revenue | (66.5 | )% | (19.4 | )% | ||||
Total gross margin | $ | 12,591 | $ | 21,392 | ||||
Percentage of net revenue | 53.1 | % | 59.4 | % | ||||
Gross margin percent for subscriptions and support in the three-months ended March 31, 2009 increased over the comparable period in 2008. This increase is attributed to a gain in efficiencies, resulting from our workforce rebalancing efforts, as well as improved delivery efficiencies, despite a decrease in revenue.
Gross margin percent for services in the three-months ended March 31, 2009 decreased over the comparable period in 2008 due to a decrease associated with unfavorable changes in sales mix and volume. This decrease was only partially offset by an increase in improved delivery efficiencies. Decreases in our customer installed base were primarily due to both the difficult economic environment globally and a shift in the demand of perpetual licensed software to subscription, which generally provide less opportunity for services sales.
Gross margin percent for license, exclusive of amortization of intangible assets, in the three-months ended March 31, 2009, decreased slightly over the comparable period in 2008 due to a large decrease in license revenue from a global retail customer for which there was no corresponding third party license cost. Gross margin percent for license, including amortization of intangible assets, also decreased for the same reason.
Operating Expenses
The following table is a summary of research and development, sales and marketing, general and administrative and restructuring expenses (in thousands, except percentages):
Three-Months Ended March 31, | Variance in Dollars | Variance in Percent | |||||||||||||
2009 | 2008 | ||||||||||||||
Research and development | $ | 5,003 | $ | 5,830 | $ | (827 | ) | (14.2 | )% | ||||||
Percentage of net revenue | 21.1 | % | 16.2 | % | |||||||||||
Sales and marketing | 7,127 | 8,728 | (1,601 | ) | (18.3 | )% | |||||||||
Percentage of net revenue | 30.1 | % | 24.2 | % | |||||||||||
General and administrative | 4,167 | 5,176 | (1,009 | ) | (19.5 | )% | |||||||||
Percentage of net revenue | 17.6 | % | 14.4 | % | |||||||||||
Restructuring | 1,295 | 85 | 1,210 | 1,423.5 | % | ||||||||||
Percentage of net revenue | 5.4 | % | 0.2 | % | |||||||||||
Total operating expenses | $ | 17,592 | $ | 19,819 | $ | (2,227 | ) | (11.2 | )% | ||||||
Percentage of net revenue | 74.2 | % | 55.0 | % | |||||||||||
Research and development.The decrease in research and development expense in the three-months ended March 31, 2009 over the comparable period in 2008 was due to a decrease of $0.4 million in employee and related costs, a decrease of $0.2 million in facility and equipment expenses, a $0.1 million decrease in travel expenses and a $0.1 million decrease in stock-based compensation expense.
Sales and marketing. The decrease in sales and marketing expense in the three-months ended March 31, 2009 over the comparable period in 2008 was due to a decrease of $1.4 million in employee and related costs and commissions, including; $1.1 million in North America and $0.3 million internationally, a $0.3 million decrease in travel expenses, a $0.1 million decrease in other miscellaneous expenses and a $0.2 decrease in stock-based compensation expense offset by a $0.4 million increase in marketing programs.
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General and administrative.The decrease in general and administrative expense in the three-months ended March 31, 2009 over the comparable period in 2008 was due to a decrease of $0.6 million in expenses relating to general and administrative personnel, a $0.2 million decrease related to facility and other expenses, a $0.1 million decrease in accounting, legal and consulting fees associated with Sarbanes-Oxley Section 404 compliance and a decrease of $0.2 million in stock-based compensation expense.
Restructuring. During the three-months ended March 31, 2009, we recorded a restructuring charge of $1.3 million in employee severance and other related costs. Employee severance and other related costs consist of severance and other benefits resulting from our first quarter 2009 reduction in force. The restructuring charge in 2008 was due to employee severance and other related costs from our fourth quarter 2007 reduction in force.
Stock-based compensation expense. The following table summarizes stock-based compensation expense related to employee stock options, shares issued pursuant to the employee stock purchase plan and restricted stock units under SFAS No. 123R for the three-months ended March 31, 2009 and 2008 which was allocated as follows (in thousands):
Three-Months Ended March 31, | ||||||
2009 | 2008 | |||||
Stock-based compensation expense: | ||||||
Subscriptions and support | $ | 60 | $ | 70 | ||
Service | 154 | 150 | ||||
Research and development | 52 | 175 | ||||
Sales and marketing | 139 | 355 | ||||
General and administrative | 286 | 469 | ||||
Restructuring | 115 | — | ||||
Total stock-based compensation expense | $ | 806 | $ | 1,219 | ||
The decrease in stock-based compensation expense in the three-months ended March 31, 2009 over the comparable period in 2008 was primarily due to a higher forfeiture rate, cancellations of restricted stock awards of certain senior management and a decrease in stock option grants.
Non-Operating Income (Expense), Net
The following table is a summary of interest expense, interest income, other expense, net and provision for income taxes (in thousands, except percentages):
Three-Months Ended March 31, | Variance in Dollars | Variance in Percent | |||||||||||||
2009 | 2008 | ||||||||||||||
Interest expense | $ | (139 | ) | $ | (222 | ) | $ | 83 | 37.4 | % | |||||
Percentage of net revenue | (0.6 | )% | (0.6 | )% | |||||||||||
Interest income | 103 | 493 | (390 | ) | (79.1 | )% | |||||||||
Percentage of net revenue | 0.4 | % | 1.4 | % | |||||||||||
Other income (expense), net | (48 | ) | 21 | (69 | ) | (328.6 | )% | ||||||||
Percentage of net revenue | (0.2 | )% | 0.0 | % | |||||||||||
Provision for income taxes | (80 | ) | (363 | ) | 283 | 78.0 | % | ||||||||
Percentage of net revenue | (0.3 | )% | (1.0 | )% | |||||||||||
Total non-operating income (expense) | $ | (164 | ) | $ | (71 | ) | $ | (93 | ) | (131.0 | )% | ||||
Percentage of net revenue | (0.7 | )% | (0.2 | )% | |||||||||||
Interest expense. The decrease in interest expense in the three-months ended March 31, 2009 over the comparable period in 2008 was attributable to lower principal balance and interest rates on the Wells Fargo Foothill credit facility.
Interest income. Interest income decreased in the three-months ended March 31, 2009 over the comparable period in 2008 due to lower interest rates.
Other income expense, net. The decrease in other income in the three-months ended March 31, 2009 over the comparable period in 2008 was primarily due to foreign currency exchange activity.
Provision for income taxes.The tax provision for the three-months ended March 31, 2009 was $0.1 million compared to $0.4 million for the three-months ended March 31, 2008. As a result of a pre-tax loss in the current quarter compared to a pre-tax income in the comparable period in the prior year, the expected alternative minimum federal tax was reduced for the current quarter as well as tax reductions in some foreign jurisdictions. Our effective tax rates differ from the statutory rate of 34% primarily due to the tax impact of foreign operations for which no tax benefit is provided for foreign losses, research and development tax credits, state taxes, non-deductible stock-based compensation and amortization of intangible assets. We are subject to income taxes in both the U.S. and numerous foreign jurisdictions.
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Liquidity and Capital Resources
At March 31, 2009, our principal sources of liquidity were $34.8 million of cash and cash equivalents, $10.0 million of short-term investments and a revolving credit facility with Wells Fargo Foothill pursuant to which we may borrow a maximum of $5.0 million, adjusted as described in the following paragraph, to meet the working capital requirements of the business in excess of our cash provided by operations. Our short-term investment portfolio increased from $3.8 million at December 31, 2008 to $10.0 million at March 31, 2009 primarily as a result of investing cash and cash equivalents into short-term investments of higher credit quality, primarily treasury bills during the quarter.
Under our revolving credit facility (the “Revolver”) with Wells Fargo Foothill, we have an agreement with Wells Fargo Foothill in which we will enter into forward foreign exchange contracts to mitigate certain foreign exchange exposures we have related to foreign trade receivables. As part of this agreement, the credit facility provides for a 5% reserve against the Revolver. As a result of the 5% reserve requirement, we have $250,000 less in funds available for use from the Revolver including debt covenant compliance and, accordingly, only $4,750,000 was available for borrowings at March 31, 2009.
On June 1, 2006, we filed a universal shelf registration statement on Form S-3 with the SEC which was declared effective October 2, 2006. Our shelf registration statement allows us to offer and sell an aggregate of $75.0 million in debt and equity securities, the terms of which will be established at the time of the offering by means of a written prospectus or prospectus supplement.
On May 23, 2007, we completed the sale of $35.1 million of our common stock in a registered direct offering, in which approximately 5.4 million shares of common stock were sold at a purchase price of $6.50 per share through a prospectus supplement to our shelf registration statement. The shares were sold to accredited institutional investors with RBC Capital Markets Corporation acting as sole placement agent for the transaction. The net proceeds raised from the offering provided us with greater working capital and which has been, and may be, used for general corporate purposes, to repay or prepay our debt, and/or investments and acquisitions. As of March 31, 2009, $39.9 million in debt and equity securities remained eligible to be sold through the shelf registration statement.
On August 20, 2007, our Board of Directors authorized the repurchase up to $15.0 million of our outstanding shares of common stock. Stock repurchases will be made in the open market, in block purchase transactions, or in structured Rule 10b5-1 share repurchase plans, and may be made from time to time or in one or more larger repurchases. We intend to conduct the repurchase in compliance with Rule 10b-18 of the Securities Exchange Act of 1934. The program does not obligate us to acquire any particular amount of common stock and the program may be modified, suspended or terminated any time at in the discretion of the Board of Directors. As of March 31, 2009, we have purchased 2,016,690 shares of common stock for an aggregate cost of $8.3 million, and have $6.7 million available for further purchases under the plan.
We believe that our available cash resources, combined with cash flows generated from operations will be sufficient to meet our presently anticipated working capital and capital expense requirements for at least the next year. We have borrowing capacity available to us in the form of our credit facility with Wells Fargo Foothill that expires on October 5, 2009. We may also consider raising additional capital in the public markets as a means to meet our capital needs and to invest in our business. Our future liquidity and capital requirements will depend on numerous factors, including our future revenue, the timing and extent of spending to support product and solution development efforts and expansion of sales and marketing and general and administrative activities, the success of our existing and new product and service offerings and competing technological and market developments. Although we may need to return to the capital markets, establish new credit facilities, or raise capital in private transactions in order to meet our capital requirements, we can offer no assurances that we will be able to access these potential sources of funds on terms acceptable to us, or at all.
Three-months ended March 31, 2009
Net cash provided by operating activities was $4.2 million during the three-months ended March 31, 2009. The cash provided during the period primarily relates to collections of our trade receivables resulting in a net decrease in accounts receivable of $5.5 million and net increases in accounts payable and deferred revenue of $1.4 million and $0.9 million, respectively. The increase in deferred revenue is primarily associated with the increase in multiple year contracts. Offsetting these increases in operating cash was a decrease in other accrued compensation of $1.9 million. The decline in accrued compensation and benefits is primarily associated with year-end sales commissions, bonuses and severance that were paid in the three-months ended March 31, 2009. Also included in cash provided by operating activities are adjustments to net income for non-cash items which included intangible assets amortization of $1.1 million, stock-based compensation of $0.8 million and depreciation and amortization of $1.0 million.
Net cash used by investing activities was $8.1 million in the three-months ended March 31, 2009. The cash provided during the period primarily relates to short-term investments maturities of $3.8 million in the three-months ended March 31, 2009, which was offset by purchases of $10.0 million of short-term investments and $1.9 million in purchases of property and equipment to increase our infrastructure. At March 31, 2009, short-term investments had a carrying value of $10.0 million.
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Net cash used by financing activities included a repayment of indebtedness under the Wells Fargo Foothill credit facility of $4.4 million to fully settle our outstanding Term Loan, a payment of $0.3 million for notes payable related to our settlement with IpLearn, $0.5 million for purchases of treasury stock and a payment of $0.1 million for taxes withheld in connection with restricted stock issuances. Offsetting these uses was $0.3 million in net proceeds from the issuance of common stock through our employee stock purchase plan.
Commitments
Future payments under operating lease obligations at March 31, 2009 are presented in the table below (in thousands):
Payments Due by Period | |||||||||||||||||||||
Total | Remainder of 2009 | 2010 | 2011 | 2012 | 2013 | Thereafter | |||||||||||||||
Operating leases | $ | 9,616 | $ | 2,065 | $ | 2,105 | $ | 1,740 | $ | 1,749 | $ | 1,813 | $ | 144 | |||||||
Contingencies
In the event of a change of control and the subsequent termination of any of our executive officers and certain employees in a manner defined in the agreement as a termination event, we will be obligated to pay the officer or the key employee certain compensation and benefits, including: one year of the officer’s base salary to be paid over a one year period, 100% of the officer’s target bonus payable in one lump sum within five days, full acceleration of outstanding equity awards and continuing health coverage for up to one year, as more fully described in our Amended and Restated Change of Control Agreement. On April 3, 2009, we entered into an Amended and Restated Change of Control Agreement with our Chief Executive Officer, which amended the term, benefits and obligations under the agreement, from one year to 18 months. In addition to this change of control agreement, the terms of our Chief Executive Officer’s employment offer letter provides that if, prior to December 31, 2009, his employment is terminated other than for cause or good reason, he would be entitled to be paid one year’s base salary, 100% of his targeted annual bonus and other benefits as described in his offer letter.
From time-to-time, third parties assert patent infringement claims against us in the forms of letters, litigation, or other forms of communication. In addition, without limitation from time-to-time, we are subject to other legal proceedings and claims in the ordinary course of business, including claims of alleged infringement of trademarks, copyrights and other intellectual property rights, employment claims and general contract or other claims. Management does not believe that any of the foregoing claims are likely to have a material adverse effect on our financial position, results of operations or cash flows. However, our analysis of whether a claim may proceed to litigation cannot be predicted with certainty, nor can the results of litigation be predicted with certainty. In addition, a purported class action lawsuit has been filed against us and our directors with respect to the acquisition of the company by affiliates of Accel-KKR, as described in Note 10,Legal Proceedings. Defending each of these actions, regardless of the outcome, may be costly, time-consuming, distract management personnel and have a negative effect on our business. An adverse outcome in any of these actions, including a judgment or settlement, may cause a material adverse effect on our future business, operating results and/or financial condition.
For information regarding indemnifications, refer to Note 8,Guarantees, Warranties and Indemnification, in the Notes to Condensed Consolidated Financial Statements.
Equity Incentive Awards
Our equity incentive plan is a key component of the compensation package we provide to attract and retain talented employees and we believe equity awards, such as stock options and other equity grants, provides our employees a strong link to our long term performance and the interests of our stockholders. The trading price of our common stock has been and is likely to continue to be highly volatile. As a result of this volatility, the trading price of our common stock may be lower than the exercise price of options held by some of our employees or the value of our common stock may decline from the value of such stock at the time of grant of other equity awards and the effectiveness of our equity incentive plan may be adversely impacted. For example, at March 31, 2009, 85% of our outstanding stock options and restricted stock units and awards had exercise prices in excess of the current market price of our common stock.
Off-Balance Sheet Arrangements
As of March 31, 2009, we did not have any significant off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.
Recent Accounting Pronouncements
Refer to the discussion of recent accounting pronouncements in Note 2, Summary of Significant Accounting Policies, in the Notes to the Condensed Consolidated Financial Statements.
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Item 3. | Quantitative and Qualitative Disclosures about Market Risk |
Market Rate Risk. We are exposed to market risk related to changes in interest rates and foreign currency exchange rates. We do not use derivative financial instruments for speculative or trading purposes. We held no auction-rate securities as of March 31, 2009 and December 31, 2008.
Interest Rate Risk. We hold our assets primarily in cash and cash equivalents, such as short-term marketable debt securities, money market funds and other cash equivalents and short-term investments such as commercial paper, publicly traded common stock and treasury bills. We minimize risk by investing in financial instruments with original maturities of less than one year. As a result, if market interest rates were to increase immediately and uniformly by 10% from levels at March 31, 2009, the fair value of cash and cash equivalents and short-term investments would not change by a material amount.
Concurrent with the closing of the Pathlore acquisition on October 4, 2005, we entered into a credit facility with Wells Fargo Foothill, principally to fund a portion of the acquisition price, and to provide for our ongoing working capital requirements. Under the terms of the facility, Wells Fargo Foothill loaned us $17.5 million to complete the acquisition of Pathlore and provided a revolving credit facility to a maximum of $5.0 million to meet the working capital requirements of the business. Prior to the amendment of the credit facility on June 19, 2007, outstanding loan balances would bear interest at Wells Fargo Foothill’s base rate plus 2%, unless we elected to be charged at the London Intrabank Offered Rate (“LIBOR”) rate plus 3.5%. On June 19, 2007, we entered into an amendment of our credit facility in which, among other things, the determination of the interest rate was changed from the description above to a scalable schedule of the base rate, based on earnings before interest, taxes, depreciation and amortization (“EBITDA”), as defined in the agreement On August 26, 2008, we entered into an amendment of our credit facility to remove the contractual 6% minimum rate. We agreed to perform an initial transfer of $25.0 million to a Wells Fargo investment account, and maintain at least 50% of our total aggregate amount of invested cash and cash equivalents at all times thereafter until the loan is fully repaid. In January 2009, we made total payments of $4.5 million to Wells Fargo Foothill to fully pay off our outstanding Term Loan, of which $4.4 million and $0.1 million were principal and interest, respectively. Included in the $4.4 million principal payments were a $1.1 million quarterly installment and a $3.3 million prepayment of the remaining principal. As a result of the loan payoff, we did not have any outstanding principal or interest payments at March 31, 2009.
Foreign Currency Exchange Risk. We have foreign currency risk as a result of sales by our foreign subsidiaries denominated in currencies other than the United States dollar. In the three-months ended March 31, 2009 and 2008, international revenue from our foreign subsidiaries accounted for approximately 24% and 24% of total revenue, respectively. All foreign subsidiaries use the local currency as their functional currency.
Our exposure to foreign exchange rate fluctuations arises in part from inter-company accounts in which costs incurred in the U.S. are charged to the foreign subsidiaries. These inter-company accounts are typically denominated in the functional currency of the foreign subsidiary in order to centralize foreign exchange risk with the parent company in the U.S. We are also exposed to foreign exchange rate fluctuations as the financial results of foreign subsidiaries are translated in U.S. dollars in consolidation. As exchange rates vary, certain transaction gains and losses may vary from expectations and adversely impact overall expected profitability. In addition, during the third quarter 2006, we began entering into 30 day forward contracts for USD and GBP to hedge anticipated cash flows from our U.K. subsidiary. As a result of the recapitalization of significant inter-company debt from our U.K. subsidiary to the parent company in the U.S. in August 2008, which reduced our foreign exchange rate exposure, we did not have any forward currency contracts at March 31, 2009.
The effect of foreign exchange rate fluctuations accounted for in accumulated other comprehensive income in the three-months ended March 31, 2009 was a foreign translation loss of $254,000, as compared to a gain of $58,000 in the comparable period in 2008. Due to the substantial volatility of currency exchange rates, among other factors, we cannot predict the effect of exchange rate fluctuations on our future operating results.
Item 4. | Controls and Procedures |
Evaluation of disclosure controls and procedures.
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this quarterly report on Form 10-Q.
Based upon their evaluation of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this quarterly report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer have concluded that, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms and (ii) accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
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A control system, no matter how well conceived and operated, can provide only reasonable assurance that the objectives of the control system are met. Our management, including our chief executive officer and chief financial officer, does not expect that our disclosure controls and procedures or internal control over financial reporting will prevent all errors and fraud. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues within the company have been detected. These inherent limitations include the reality that judgments in decision-making can be incorrect, and that breakdowns can occur because of simple errors or mistakes. The design of any control system is also based, in part, upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a control system, misstatements due to error or fraud may occur and not be detected.
Changes in internal controls.
There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 1. | Legal Proceedings |
From time-to-time, we are involved in legal proceedings or threats of legal proceedings arising in the ordinary course of business. We are not currently a party to any litigation or other legal proceeding that, in the opinion of management, is reasonably likely to have a material adverse effect on our business, operating results or financial condition, except as noted below.
Lief Irgens v. SumTotal Systems, Inc., et al., Case No. 109CV141073, Superior Court of Santa Clara County, California. A purported class action lawsuit was filed on April 28, 2009 against us and each of our directors claiming, among other things, that our board of directors breached their fiduciary duties to our stockholders by entering into the merger agreement on April 23, 2009 with affiliates of Accel-KKR, as described in Note 11,Subsequent Events, for an unfair price and failing to engage in a fair sale process with respect to the proposed merger. The complaint seeks damages and injunctive relief. We intend to vigorously defend these claims.
We may, from time to time, also be subject to various legal or government claims, disputes or investigations. Such matters may include, but not be limited to, claims, disputes or investigations related to warranty, refund, breach of contract, employment, intellectual property, government regulation or compliance or other matters such as a subpoena we received on April 30, 2008 from the U.S. Department of Defense, Office of the Inspector General. The subpoena requests documents related to our sale of products and services to the Department of Defense as well as other documents related to us. We are cooperating with the government’s request and are in the process of responding to the subpoena.
Item 1A. | Risk Factors |
Factors That May Affect Future Results of Operations
Set forth below and elsewhere in this report and in other documents we file with the SEC are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this report. These risks and uncertainties may not be the only ones facing us. Furthermore, new risks and uncertainties arise from time to time, and we cannot predict those events or how they may affect us. All forward-looking statements included in this document are based on information available to us on the date hereof. We assume no obligation to update any forward-looking statement.
Our business and results of operations may be affected by the announcement of our proposed acquisition by ST Software Holdings, LLC, an affiliate of Accel-KKR Capital Partners III, L.P.
On April 23, 2008, we entered into a merger agreement with ST Software Holdings, LLC, an affiliate of Accel-KKR. The pending merger could have an adverse effect on our revenue in the near term if customers delay, defer, or cancel purchases pending completion of the merger. While we are attempting to mitigate this risk through communications with our customers, current and prospective customers could be reluctant to purchase our software and/or services due to potential uncertainty about the direction of the combined company’s product offerings and the combined company’s support and service of existing products. To the extent that the pending merger creates uncertainty among customers or our employees such that any significant number of customers delay purchase decisions pending completion of the merger, or employees depart SumTotal Systems or become distracted, our results of operations and ability to operate profitably could be negatively affected. Decreased revenue and a failure to be profitable could have a variety of adverse effects, including negative consequences to our relationships with, and ongoing obligations to, customers, suppliers, employees, business partners, and others with whom we have business relationships. In addition, our quarterly operating results could be substantially below the expectations of market analysts, which could cause a decline in our stock price.
Additionally, we are subject to additional risks in connection with the pending merger, including: (1) the occurrence of an event, change or circumstance that could give rise to the payment of a termination fee by us pursuant to the terms of the merger agreement, (2) the pendency and outcome of any legal proceedings that have been or may be instituted against us, our directors and others relating to the transactions contemplated by the merger agreement, including but not limited to the purported class action lawsuit
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described in Item 1,Legal Proceedings, (3) the failure of the pending merger to close for any reason, (4) the restrictions imposed on our business, properties and operations pursuant to the affirmative and negative covenants set forth in the merger agreement and the potential impact of such covenants on our business, (5) the risk that the proposed transaction will divert management’s attention resulting in a potential disruption of our current business plan, and (6) potential difficulties in employee retention arising from the pending merger.
We may suffer additional consequences if the acquisition by Accel-KKR is not completed.
If the merger is not completed, we could suffer a number of consequences that may adversely affect our business, results of operations and stock price, including the following:
• | Activities relating to the merger and related uncertainties may divert our management’s attention from our day-to-day business and cause disruptions among our employees and to our relationships with customers and business partners, thus detracting from our ability to grow revenue and minimize costs and possibly leading to a loss of revenue and market position that we may not be able to regain if the transaction does not occur; |
• | The market price of our common stock could decline following an announcement that the merger has been abandoned, to the extent that the current market price reflects a market assumption that the merger will be completed; |
• | We could, depending on the timing and circumstances, be required to pay a termination fee to Accel-KKR and provide reimbursement to Accel-KKR for certain expenses incurred by them, up to a maximum fee of $4.95 million; |
• | We would remain liable for our costs related to the merger, such as legal and accounting fees and a portion of the investment banking fees; |
• | We may not be able to continue our present level of operations and therefore would have to scale back our present level of business and consider additional reductions in force; |
• | We may experience the departure of employees from SumTotal Systems; |
• | We may be subject to legal proceedings related to the transaction; and |
• | We may not be able to take advantage of alternative business opportunities or effectively respond to competitive pressures. |
Completion of the merger is subject to customary conditions, including (i) adoption of the merger agreement by holders of a majority of the SumTotal Systems common stock outstanding and (ii) absence of any law or order prohibiting the consummation of the merger. In addition, Accel-KKR’s obligation to complete the merger is subject to our having cash and cash equivalents at the closing of the merger of at least $36.5 million. We will manage our business in the ordinary course of business, but we can provide no assurance that we will have the requisite amount of cash and cash equivalents at closing.
We have filed with the Securities and Exchange Commission a preliminary proxy statement and intend to file a definitive proxy statement and other relevant materials in connection with our proposed business combination with Accel-KKR. The definitive proxy statement will be sent or given to our stockholders. We urge our investors and stockholders to read the proxy statement and the other relevant materials when they become available because they will contain important information about the merger.
We have a history of losses and we may not achieve profitability under generally accepted accounting principles on a consistent basis.
We expect to continue to derive substantially all of our revenue from the licensing of our learning, performance and talent development solutions, the recently introduced SumTotal 8 Series, and our predecessor solutions and related services, including without limitation, maintenance, professional services, on-demand subscriptions and hosting. Historically, we have not been profitable under GAAP in the U.S. and we may not consistently achieve or sustain GAAP profitability. If we fail to generate adequate revenue from the SumTotal 8 Series, predecessor solutions and related services, we will continue to incur losses.
In the future, we expect to continue to incur additional non-cash expenses relating to the amortization of purchased intangible assets that will contribute to our net losses. In addition, charges related to stock-based compensation awards, including grants of stock options, are recorded as an expense in our reported results of operations in accordance with SFAS No. 123R,Share-Based Payment, which has the result of increasing our reported expenses and our GAAP losses. We expect to incur additional GAAP expenses related to stock based compensation awards for the foreseeable future and these future expenses will adversely impact our ability to achieve profitability on a GAAP basis.
We are currently increasing our emphasis on subscription-based, on-demand offerings and accelerating this transition, which could slow our short term revenue growth and affect our revenue derived from perpetual license sales.
While we continue to offer and support our software on a perpetual license model, we have increased, and are continuing to increase, our emphasis on a subscription revenue model by offering our solutions as on-demand subscriptions services, and are in the process of accelerating this transition. We anticipate that our future financial performance and revenue growth will depend upon the acceptance and growth of our on-demand solutions. Offering on-demand subscription solutions represents a significant departure from traditional software delivery strategies. The relatively short history and continued evolution of this business model makes our business
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operations and prospects difficult to evaluate. As we increase our focus on offering our solutions on-demand, we have incurred, and expect to continue to incur, a reduction in our traditional perpetual software license revenues and associated services revenues, which may not be offset by our on-demand revenues. Moreover, our short term financial results could be affected by upfront investments required to grow our on-demand offerings.
Additionally, we recognize revenue for our on-demand solutions over the term of the agreement instead of in the quarter in which the agreement is signed, as is typically the case with our perpetual software licenses. As a result, the sale of our on-demand offerings will result in less revenue recognized in the quarter the agreement was signed as compared to a comparable sale of our perpetual software license and our operating results may not immediately reflect any increases or decreases in sales of our on-demand offerings. Accordingly, our short term financial results could be impacted if customers choose our on-demand solutions instead of our perpetual software offerings. Furthermore, continued revenue from these services requires our customers to renew such subscriptions. Unexpected customer cancelations or low renewal rates of subscriptions could adversely impact our financial results.
Current adverse economic conditions, including reduced information technology spending or increased unemployment, or a reduction in corporate confidence in the economy may adversely impact our business, operating results and financial condition.
Our business depends on the overall demand for learning, performance and talent development systems solutions, and on the economic health of our current and prospective customers. The purchase of our solutions is often discretionary and may involve a significant commitment of capital and other resources. Furthermore, the market for our solutions and services may be disproportionately affected by a weakening or a decline in corporate confidence, in the economy in general or in the broader market for information technology. Moreover, if the unemployment rate increases materially and training and retention of employees becomes less critical, our existing and potential clients may no longer consider improvement of their learning, performance, and talent development systems a priority. As a result, if the current worldwide economic conditions continue, many of our customers may delay or reduce purchases of our solutions or not purchase such solutions at all, which could reduce demand for our solutions and adversely impact our business, operating results and financial condition.
The current economic conditions and market instability and their impact on us and our customers also make it increasingly difficult for us to forecast accurately both future demand for our own solutions and overall demand in the markets in which we compete. In addition, any adverse financial or economic impact on our customers may impact their ability to pay timely, or result in their inability to pay, the amounts owed for work or services contractually agreed to or previously provided to the customer, which may result in a reduction in revenue, accounts receivables and allowance for sales returns and doubtful accounts. Even if economic conditions remain stable, weak economic conditions, reduced corporate confidence in the economy or a reduction in information technology spending would likely adversely impact our business, operating results and financial condition in a number of ways, including longer sales cycles, lower prices, or possible delays or cancelations of purchases, for our solutions and services, reduced sales and possible delays in payment of, or inability to pay, amounts owed to us. If this trend in economic conditions continues or deteriorates further, it could adversely affect our results in future periods.
If we fail to successfully manage our product transition, adapt to rapidly changing technology and evolving industry standards, or deploy upgrades to our solutions successfully and on a timely basis, our business and financial results will be harmed.
The learning, performance and talent development markets are characterized by rapidly changing technologies, frequent new product and service introductions, short development cycles and evolving industry standards. The introduction of new solutions and services embodying new technologies and the emergence of new industry standards may render our solutions and services obsolete. Additionally, although our software solutions can be licensed for use with a variety of popular industry standard relational database management system platforms, specific operating systems, or other combinations of licensed software, there may be existing or future platforms or user interfaces that achieve popularity in the marketplace which may not be architecturally compatible with our software product design. Our success depends on our ability to adapt to a rapidly changing landscape, to offer new solutions and services to address our customers’ changing demands and to develop and maintain consistent software product performance characteristics across different combinations of licensed software. We may also experience difficulties that delay or prevent the successful design, development, introduction or marketing of our solutions and services, which may harm our ability to attract new customers and retain existing customers.
Since the formation of SumTotal Systems in 2004, we have introduced major product upgrades in December 2004, April 2005, June 2006, December 2006, June 2007 and June 2008. We face numerous risks relating to product transitions and introductions, including customers delaying their purchasing decision until they have confidence in our new product and until we have proven we can successfully install and implement new solutions or upgrades. Due to the product transition, we may be unable to forecast revenue from product sales and related services accurately, the number and severity of defects and increased support requirements due to the complexity of the new product. In order to market and sell the product successfully, we must ensure broad-based cooperation from and coordination between multiple departments, including engineering and marketing, and from multiple geographic regions, including Bellevue, Washington; Mountain View, California; Gainesville, Florida; Hyderabad, India; and Datchet, United Kingdom. In addition, our implementations may be very complicated and require more time and resources than originally forecasted. As a result, we may not be able to complete the requisite work necessary in order to gain customer acceptance, which may delay or prevent us from recognizing revenue on deals we have signed. If we fail to manage the transition to new product and solution offerings successfully, our business and financial results may be adversely affected, which may cause a decline in the price of our common stock.
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Further, we have plans to discontinue supporting certain legacy solutions and encourage customers of these solutions to upgrade to a newer version of our software. However, if these customers chose not to upgrade or there are delays or complications in such upgrades causing a decrease in customer satisfaction with our solutions, our financial results may be harmed.
Our operating results may fluctuate significantly from quarter to quarter and year to year and are difficult to predict, which could negatively affect the value of your investment.
We have experienced substantial fluctuations in operating results on a quarterly and annual basis and expect these fluctuations to continue in the future. Our operating results may be affected by a number of other factors, including, but not limited to:
• | the speed and success with which we are able to transition offering our solutions as on-demand subscriptions; |
• | the size and timing of product and solution orders and the timing and execution of professional services engagements; |
• | the mix of revenue from solutions and services; |
• | our ability to meet customer project milestones; |
• | market acceptance of our solutions and services, especially the SumTotal 8 Series and predecessor solutions, related services and our on-demand subscriptions; |
• | our ability to complete fixed-price professional services engagements within budget, on time and to our customers’ satisfaction; |
• | the timing of revenue and expense recognition, including the recognition of a significant portion of revenue or expenses in a single quarter from large and/or long-term contracts; |
• | industry consolidation among both our competitors and our customers; |
• | recognition of impairment of existing assets; |
• | our ability to execute on our strategy and operating plans; and |
• | general economic and business conditions of our industry and industries of our customers. |
Our limited operating history with performance management and compensation management solutions, and the rapidly evolving nature of our market make prediction of future revenue and expenses difficult. Expense levels are based, in part, on expectations as to future revenue and are essentially fixed in the short-term. To the extent our future revenue is difficult to predict, we may not be able to adjust spending in response to revenue shortfalls. Other expenses, as a result of changes in the law or otherwise, such as expenses related to litigation or compliance with government regulations, may also increase and cause us to fall short of our forecasts. Failure to meet our forecasts would likely cause a decline in the price of our common stock.
We have experienced and may continue to experience turnover of senior management and key personnel, which could harm our business or operations.
Our success depends to a significant degree on the performance of the senior management team and other key employees, and there is no guarantee that such officers or key employees will remain employed with us. We do not have employment agreements other than offer letters with any key employee, and we do not maintain key person life insurance. As a result of the departure of any of our key employees, there is a risk that we would be unable to effectively manage ourselves and successfully meet operational and other challenges, which could harm our business. If our senior management team, including any new hires, fails to work effectively together and execute our plans and strategies, our business could be harmed.
Our success also depends on our ability to attract, integrate, motivate and retain highly skilled technical, sales and marketing and professional services personnel. Competition for qualified personnel in the software industry, particularly engineering and other technical personnel, is intense and is increasing, and there can be no assurance that we will be able to attract and retain highly skilled employees in sufficient numbers to sustain our current business or to support future growth. In addition, we announced a restructuring in the first quarter of 2009 which included the termination of employment of a number of our employees. While most terminated employees signed release agreements, there is no assurance that such employees or any other former employee will not sue us for wrongful termination or other employment related claims. Even if such suits are meritless, such suits may divert management resources and will be costly to defend. The results of such litigation, if any, may be difficult to predict, and a judgment or settlement may adversely affect our operating results, which may result in a lower stock price.
Our sales cycles in our traditional perpetual license business line are lengthy, making the timing of sales difficult to predict and also requiring considerable resources and expense with no assurance that such sales will occur.
For our traditional perpetual license business line, the period between our initial contact with a potential customer and a customer’s purchase of our solutions and services is lengthy and often extends over several fiscal quarters or a fiscal year. To sell our solutions and services successfully, we generally must educate our potential customers regarding the use and benefits of our solutions
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and services, which typically requires significant time, capital and other resources. Also, as we offer both on-demand solutions and perpetual licenses, this might create customer confusion regarding our offerings, which may delay purchases of our perpetual licensed solutions and lengthen our sales cycle. The delay or failure to complete sales in a particular quarter could reduce our revenue for that quarter, as well as subsequent quarters over which revenue for the sale would likely be recognized. If the sales cycle unexpectedly lengthens in general or for one or more large orders, it would negatively affect the timing of a significant portion of our revenue, and our revenue growth would be harmed. Many of our potential customers for perpetual licenses are large organizations which generally take more time to make significant business decisions, and the formation and execution of even a relatively small number of large contracts with these large organizations may have a significant impact on our revenue. In addition, we must expend and allocate resources prior to completing a sales transaction, with no guarantee that such transaction will result in an actual sale. Furthermore, the lengthening of our sales cycles may create increased difficulties in negotiating such sales on terms favorable to us. This may result in a delay or failure to generate revenue from our sales efforts and may adversely affect our stock price.
Undetected product and solution defects may require us to halt sales or shipments of our solutions, delay introduction of new solutions, or account for warranty claims.
Our solutions are highly technical and complex and have contained and may contain undetected errors, bugs, security vulnerabilities or defects, some of which may only be discovered after a product has been installed and used by customers. Our product and solution offerings, both current and future and including our recently introduced SumTotal 8 Series, are complex and often contain undetected errors or bugs, despite internal and third-party testing. New product and solution offerings, such as the SumTotal 8 Series, contain new features and functionality which result in a greater likelihood of errors, bugs, security vulnerabilities and frequently these are undetected until the period immediately following introduction and initial shipment of new solutions or enhancements to existing solutions. For example in the SumTotal 7 Series, our predecessor product, although we attempted to discover and resolve all such defects in our product line that we believed would be considered serious by our customers before shipment to them, the SumTotal 7 Series was not error-free and some customers notified us that they considered some of the defects to be serious. In addition, our solutions include third-party software, and any defects in third-party software that we incorporate into our solutions may compromise our solutions. It may be difficult for us to determine the source of the problem and correct any errors in third-party software because such software is not within our control.
Any bugs, errors, defects or security vulnerabilities discovered in our solutions after commercial release could result in loss of revenue or delay in revenue recognition, loss of customers and increased service and warranty costs, any of which could adversely affect our business, operating results and financial condition. In addition, we could face claims for product liability, tort or breach of warranty, including claims relating to changes to our solutions made by our channel partners. Our contracts with customers contain provisions relating to warranty disclaimers and liability limitations, which may not be upheld. Defending a lawsuit, regardless of its merit, is costly and may divert management’s attention and adversely affect the market’s perception of us and our solutions. In addition, if our business liability insurance coverage proves inadequate or future coverage is unavailable on acceptable terms or at all, our business, operating results and financial condition could be adversely impacted.
We rely on partnerships, alliances and other relationships to conduct our business, including internationally, and our business may be adversely affected if they do not perform as expected.
Our business relies on a variety of partnerships, alliances and other relationships, such as those with content partners, resellers, original equipment manufacturers, solution integrators, human resource outsourcers and technology partners, to develop, market and sell our solutions, including in many foreign countries. We also use independent third parties to provide engineering services, including customer implementation and product development, including customer implementation and product development. As our business grows and evolves, through adding new solutions or possible third party or product acquisitions, we have relied, and in the future, we may rely more heavily, on these types of partnerships globally. As a result, we have had to, and may in the future, have to renegotiate or terminate existing relationships. There can be no assurance that we will be able to enter into new contracts, or amend or terminate our existing contracts on favorable terms, or at all. In addition, if we amend or terminate any of our contracts, our former partners may become our competitors in the future. These former partners may be unhappy with their new relationships, and may, as a result, commence litigation against us, regardless of the merits of such litigation. Litigation is expensive to defend, and even the threat of legal proceedings diverts resources, and management attention from operating our business and causes increases in our expense levels, all of which may negatively affect the price of our common stock.
Moreover, our success in international markets will depend to a large degree on the success of these independent partners, with whom we have a limited working experience and over whom we have little control. If they are unwilling or unable to dedicate sufficient resources to our relationships, our international operations will suffer so our future success will depend in part on our ability to attract, train and motivate new distributors, resellers, alliance partners and systems integrators and expand our relationships with current independent partners.
Our lack of product diversification, and our reliance on the SumTotal 8 Series and its predecessor solutions, means that any decline in price or demand for our solutions and services would seriously harm our business.
We expect the SumTotal 8 Series and predecessor solutions and related services to continue to account for a significant majority of our revenue for the foreseeable future. Consequently, a decline in the price of, or demand for, the SumTotal 8 Series and predecessor solutions or services, or their failure to achieve broad market acceptance, would seriously harm our business and would likely result in a decline in the price of our common stock.
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The anticipated benefits of our entry into the Performance Management industry may be delayed or may not be realized as we integrate solutions and employees and adapt to a new market with different competitors.
We expect to continue to enhance our position in the performance management industry through the further integration of our performance and compensation management technologies, solutions, services, partnerships, and customer contacts into our current product and solution offerings. Nevertheless, we may not realize all of the anticipated benefits associated with our entry into the performance management market in a timely manner or at all. Additionally, we had limited experience competing in this space and now face new and different competitors with more experience selling and delivering such software and services. If we are unable to generate greater growth and acceptance of our performance management offering, our business and financial results may be harmed.
Third parties have claimed, and may claim in the future, that we are infringing their intellectual property which could diminish the value of our solutions and services or deter customers from purchasing our solutions regardless of whether these claims are successful.
From time-to-time, we are involved in legal proceedings or threats of legal proceedings. Litigation is expensive to defend and even the threat of legal proceedings, regardless of their merit, diverts management attention from operating our business and causes increases in our expense levels. We have received, and may in the future receive, threatening letters and notice of claims of infringement of other parties’ proprietary rights. In addition, there are patent-holding companies, entities that do not make or sell solutions, which may threaten or bring claims against us alleging that our solutions infringe upon their proprietary rights. Such claims could result in costly litigation and could divert management and technical resources. They could also delay product shipment, deter potential customers from purchasing our solutions and services, or require us to develop non-infringing technology or enter into royalty or licensing agreements, which agreements may not be available on reasonable terms, or at all. In the event of an adverse judgment against us (including a judgment or settlement which may impose adverse conditions on us), we may be required to cease shipping, to pay damages, to license technology on terms that may not be favorable to us or to alter our technology, website or software solutions, any of which may adversely affect our operating results and cause us to miss our forecasts or industry analysts’ forecasts, thereby causing a possible decline in the price of our common stock.
If third parties infringe our intellectual property or if we are unable to secure and protect our intellectual property, we may expend significant resources enforcing our rights or suffer competitive harm.
Our success depends in large part on our proprietary technology. We rely on a combination of copyrights, trade secret and trademark laws, contractual restrictions, restrictions on disclosure and other methods to protect our proprietary technology. In addition, our “Drag and Drop” patent is part of our performance management offering and, as a result, patent protection may become a more important component of the methods we use to protect our proprietary technology. These legal protections afford only limited protection for our technology. Furthermore, effective protection of intellectual property rights is unavailable or limited in certain foreign countries. It may also be possible for third parties to copy or otherwise obtain and use our intellectual property or trade secrets without our authorization and it may be possible for third parties to independently develop substantially equivalent intellectual property. We cannot assure that the protection of our proprietary rights will be adequate or that our competitors will not independently develop similar technology, duplicate our solutions and services or design around any patents or other intellectual property rights we hold. Consequently the value of our solutions and services to our customers could diminish substantially.
Our solutions include third-party technology, the loss of which could materially harm our business.
We use licensed third-party technology components in our solutions. Future licenses to this technology may not be available to us on commercially reasonable terms, or at all. The loss of or inability to obtain or maintain any of these technology licenses could result in delays in the introduction of new solutions or could force us to discontinue offering portions of our learning, performance, and talent development solutions until equivalent technology, if available, is identified, licensed and integrated.
Any future acquisitions we make, or attempt to make, will need to be integrated into our business and require significant time and effort from our management team, which may disrupt our business and harm our operating results or financial condition.
We have made and may continue to make acquisitions of businesses and technologies to enhance our existing business. Acquisitions involve numerous risks, including problems combining the purchased operations and key employees, technologies or solutions, unanticipated costs, diversion of management’s attention from our core business, adverse effects on existing business relationships with suppliers and customers, risks associated with entering markets in which we have no or limited prior experience and potential loss of key employees. The integration of businesses that we have acquired or that we may acquire in the future into our business has been and will continue to be a complex, time consuming and expensive process. Failure to operate as a combined organization utilizing common information and communication systems, operating procedures, financial controls and human resources practices could adversely impact the success of any business combination as evidenced in previous combination and acquisition transactions.
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Our operating results may suffer because of acquisition-related expenses, amortization of intangible assets and impairment of intangible assets. Furthermore, we may have to incur debt or issue equity securities to pay for any future acquisitions, or to provide for additional working capital requirements, the issuance of which could be dilutive to our existing shareholders.
There can be no assurance that we will be able consummate or expand future business combinations, if any, on favorable terms or on a timely basis, or that we will be able to integrate successfully businesses, solutions, technologies or personnel that we might acquire. Failure to do so may negatively affect our financial results, customer, employee and investor confidence, and ultimately, the price of our common stock. Further, we might be required to invest significant additional resources in order to expand these relationships, and the cost of this investment may exceed the revenue generated from this investment.
Security and privacy breaches could subject us to litigation and liability.
We host certain of our customers’ learning, performance, and talent development software implementations and provide access to that software using the Internet, and also use the Internet to deliver our on-demand subscription services to our customers. Computer viruses could be introduced into our systems or those of our customers which could disrupt the operation of our hosting systems or make them inaccessible to users. We also depend on third parties to provide key components of our networks and systems and Internet service providers and telecommunications companies and the efficient operation of their computer networks and other computer equipment to enable customers to access and use hosted software implementations.
We could become subject to litigation and liability if third parties penetrate security for our hosting systems or otherwise misappropriate our users’ confidential information or personal data, or if customers are unable to access and use hosted software implementations. Advances in computer capabilities, new discoveries in the field of cryptography or other technological events or developments could result in compromises or breaches of our security systems. Anyone who circumvents our security measures could misappropriate proprietary information or personal data, or could cause interruptions in our services or operations. We may be required to expend significant capital and other resources to protect against the threat of security breaches or service interruptions or to alleviate problems caused by breaches or service interruptions. Each of our key third-party networks and systems component providers, Internet service providers and telecommunications companies partners have experienced significant outages in the past and could, in the future, experience outages, delays and other difficulties due to system failures unrelated to our systems, which could require us to pay service level credits to our customers or cause our customers to believe we were at fault and withhold payments due to us or sue us for breach of contract, which would result in decreased revenue and a possible decline in the price of our common stock.
Our disaster recovery plan might be insufficient if a major interruption occurs, and a disaster could severely damage our operations.
Our disaster recovery plan covers redundant back-up computer systems and data at an alternate site for our primary business applications hosted in our Mountain View headquarters. A disaster could severely harm our business because our computer systems could be interrupted for an indeterminate length of time. Our operations, including software solutions we host for some of our customers, depend on our ability to maintain and protect the computer systems needed for our day-to-day operations. For instance, a number of these computer systems are located in Mountain View, California on or near known earthquake fault zones and flood plains, or in Hyderabad, India where the infrastructure is not as robust as in the United States. Although these systems are designed to be fault tolerant, they are vulnerable to damage from fire, floods, earthquakes, power loss, telecommunications failures and other events. Any damage to our facility could lead to interruptions in the services we provide to our customers and loss of customer information, and could impair our ability to operate our business, leading us to pay service level credits or customers to withhold payments due to us and decreased revenue. The business interruption insurance we maintain may not be adequate to cover our losses resulting from disasters or other business interruptions, which would result in increased expenses and a possible decline in the price of our common stock.
The learning, performance and talent development systems market is highly competitive, and we may be unable to compete successfully.
The market for our solutions and services is intensely competitive, dynamic and subject to rapid technology change. Our competitors vary in size, scope and the breadth of solutions and services offered. We face competition from:
• | other developers of learning, performance and talent development systems; |
�� | • | providers of other learning, performance and talent development systems solutions; |
• | vendors of other enterprise software applications that are beginning to offer solutions with learning, performance and talent development functionality; |
• | large professional consulting firms and in-house information technology departments; and |
• | developers of web authoring tools. |
Additionally, companies may choose to develop their own learning, performance, and talent development software internally rather than acquiring it from third parties.
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There are relatively low barriers to entry in the learning, performance and talent development systems market, and we expect the intensity of competition to increase in the future. Additionally, some of our existing and potential competitors, such as Oracle Corporation and SAP AG, have longer operating histories and significantly greater financial, technical, marketing and other resources. These companies not only have more resources to develop their own solutions and technologies internally but can also use such resources to acquire competing solutions and technologies through acquisitions or other strategic transactions and quickly enter the learning, performance and talent development market and compete with us on both solutions offerings and pricing. Increased competition may result in price reductions, reduced gross margins or loss of market share, any of which would seriously harm our business and financial results.
Our core offering, the SumTotal 8 Series and predecessor solutions, integrates solutions addressing the learning management, performance management and compensation management segments of our market; however, our performance management solution was acquired in our acquisition of MindSolve and has only recently been integrated into our offering. Additionally, we had limited experience competing in the performance management space prior to our acquisition of MindSolve and now face new and different competitors with more experience selling and delivering performance management software and services. Furthermore, our compensation management offering is not as fully developed and does not have the same market acceptance as the other modules of the SumTotal 8 Series and predecessor solutions. As a result, we may have difficulty competing against companies which focus on these segments rather than the entire learning, performance, and talent development market, or selling to customers who only need solutions in a specific segment.
The learning, performance and talent development systems software markets may not grow to a sufficient size or at a sufficient rate to sustain our business.
Corporate training and education historically have been conducted primarily through classroom instruction and performance management solutions have traditionally been done using paper-based systems, desktop applications, spreadsheets, classroom settings, and human resource management systems. Although technology-based training applications have been available for many years, they currently account for only a small portion of the overall corporate learning market. Accordingly, our success depends on the extent to which companies implement learning, performance and talent development software solutions for the design, development, delivery and management of their corporate learning needs and performance management solutions for rating, reviewing, evaluating, developing and compensating individuals.
Many companies that have already invested substantial resources in traditional training methods may be reluctant to adopt a new strategy that may limit or compete with their existing investments. Even if companies implement learning, performance and talent development software solutions or performance management solutions, they may still choose to develop such solutions internally. If the use of learning, performance and talent development software does not become widespread, or if companies choose to develop such software or solutions internally rather than acquiring them from third parties, then our learning, performance and talent development software and solutions will not be commercially successful.
Our operating results could be harmed by economic, political, regulatory and other risks associated with international sales and operations.
We, as well as our customers and our partners, are increasingly doing business outside of the United States. Accordingly, our business is subject to a number of risks inherent in international operations, including:
• | difficulties and costs of recruiting and retaining qualified personnel in our offices outside of the United States; |
• | difficulties managing a geographically dispersed workforce and sales organization with different learning styles and cultures; |
• | export controls, import tariffs and other barriers to trade; |
• | changes in laws or regulatory requirements, including tax laws; |
• | reduced protection of intellectual property rights; |
• | political and economic instability; |
• | reliability of infrastructure; |
• | potential difficulties in collecting accounts in foreign countries; and |
• | fluctuations in currency exchange rates. |
While we sell our solutions worldwide and we have experienced international partners, we have limited experience with sales and marketing in some countries. There can be no assurance that we will be able to market and sell our solutions in all of our targeted international markets. If our international efforts are not successful, our business and results of operations could be harmed.
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Due to our significant operations in India, which has a rapidly growing technology market, our business is subject to certain risks that are not typically experienced to the same degree in the United States or elsewhere abroad.
We rely significantly on our research and development, professional services and technical support operations in Hyderabad, India to enable us to develop new solutions, complete customer implementation projects and new releases of our solutions on time and within established budgets and provide technical support. In recent years, increased growth and development of the technology market in general, and in Hyderabad specifically, has made it more difficult for us to hire and retain qualified technical employees and other personnel. In addition, it may be difficult to acquire additional space to support future growth.
Our efforts in Hyderabad are subject to a number of risks inherent in international operations. However, certain risks are particularly acute in India, such as:
• | employee turnover; |
• | increasing salaries; |
• | increasing tax rates; |
• | increased expenses due to fluctuations in currency exchange rates; and |
• | less reliable infrastructure. |
If our India operations fail, for any reason, to provide adequate and timely product enhancements, updates and fixes to us or customer implementations, our ability to fix defects in our SumTotal 8 Series, our ability to develop new versions of our SumTotal 8 Series and successor solutions, and our ability to respond to customer or competitive demands would be harmed and we would lose sales opportunities and customers and might negatively impact our customer satisfaction.
In addition, our engineering efforts are based primarily out of three offices: Bellevue, Washington; Gainesville, Florida and Hyderabad, India. If the offices fail to work together successfully, we may experience delays in fixing defects in our solutions, customer implementations, or in developing and releasing future versions of our product.
Our stock price has been and may continue to be volatile.
The trading price of our common stock has been and is likely to continue to be highly volatile. Our stock price is subject to continued fluctuations in response to a number of factors, including:
• | actual or anticipated variations in our operating results; |
• | changes in the estimates of our operating results or changes in recommendations by securities analysts; |
• | changes in conditions or trends in the learning, performance, and talent development market; |
• | announcements by us or our competitors of significant customer wins, technological innovations, new solutions or services, significant acquisitions, strategic partnerships, joint ventures or capital commitments; |
• | our growing emphasis on selling subscription-based, on-demand solutions; |
• | fluctuations in demand for our solutions, including due to seasonality; |
• | additions or departures of key personnel; |
• | foreign currency, interest rate, and fixed income risks; and |
• | market conditions in our industry, the industries of our customers and the economy as a whole. |
Fluctuations in the price and trading volume of our common stock may prevent stockholders from selling their shares above the price at which they purchased their shares.
In addition, companies that have experienced volatility in the market price of their stock have been subject to securities class action litigation, and we may be the target of this type of litigation in the future. Securities litigation, like other litigation against us could result in substantial costs, negative publicity and divert our management’s attention, which could seriously harm our business and stock price.
We may need additional financing in the future, which we may be unable to obtain on favorable terms or at all.
If our business does not generate the cash needed to finance our operations or growth, including potential business acquisitions, we may need to obtain additional financing or take steps to restrict our operations in order to conserve existing cash. In addition, poor financial results or unanticipated expenses could give rise to additional financing requirements. We may be unable to obtain financing on terms favorable to us or at all. If we need to obtain financing and adequate funds are not available or are not available on acceptable terms, we may be required to make further expense reductions, which could significantly restrict our operations and limit our ability to enhance our solutions, fund expansion, respond to competitive pressures or take advantage of business opportunities, thereby resulting in a decrease in our revenue and stock price.
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Our internal controls and procedures may not be adequate to prevent or detect misstatements or errors.
A control system, no matter how well conceived or operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Our management does not expect that our internal controls and procedures will prevent all errors and all fraud, if any, because, in addition to resource constraints, there are inherent limitations of all control systems, including the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls and procedures can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of a control or procedure. The design of any system of controls and procedures is also based in part on certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a control system, misstatements due to error or fraud may occur and not be detected. In such event, we may not be able to recognize revenue we expected to recognize; we may not be able to meet our forecasts or industry analysts’ projections; or we may be the subject of litigation, each of which would likely harm our financial results and may result in a decline in the price of our common stock.
The insolvency or failure of any of the financial institutions which holds our cash, cash equivalents and short-term investments could have a material adverse affect on our financial condition.
Our cash, cash equivalents and short-term investments, which collectively totaled $44.8 million as of March 31, 2009, are deposited with several financial institutions, and may, at times, exceed federally insured limits. If any of such financial institutions were to become insolvent or unable to satisfy its obligations to us, such insolvency or failure could materially adversely affect our financial condition.
Standards for compliance with Sarbanes-Oxley Section 404 are burdensome and uncertain, and if we fail to comply in a timely manner, our business could be harmed and our stock price could decline.
Pursuant to Sarbanes-Oxley Section 404, our management is required to report on, and our independent registered public accounting firm to attest to, the effectiveness of our internal controls over financial reporting, at least annually. The rules governing the standards that must be met for management to assess our internal controls over financial reporting are new, complex and subject to proposed changes. Currently, the rules require significant documentation, testing and possible remediation of our internal controls over financial reporting. The process of reviewing, documenting and testing our internal controls over financial reporting will likely continue to result in increased expenses and the devotion of significant management and other internal resources. We may encounter problems or delays in completing the implementation of any changes necessary to retain a favorable assessment of our internal controls over financial reporting during fiscal 2009. If we are unable to remediate effectively any future material weaknesses identified by us or our independent registered public accounting firm, we will be unable to assert that our internal controls are effective, and we may not be able to timely file, or file at all, our periodic financial reports. Even if we are able to file such reports, there may be a loss of stockholder confidence, leading to an adverse effect on the price of our stock.
Future changes in securities laws and regulations may increase our expenses.
Past changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and the listing standards of the Nasdaq Global Market, have increased our expenses as we devote resources to respond to the requirements. Although recent changes to the Sarbanes-Oxley Act of 2002 are intended to reduce the costs of compliance, compliance is costly due to the necessity of hiring additional personnel and external consultants and our independent registered public accounting firm. The securities laws and regulations may also make it more difficult and more expensive for us to obtain director and officer liability insurance in the future, and we may be required to accept reduced coverage or incur substantially higher costs to maintain coverage. Further, our directors and executive officers could face an increased risk of personal liability in connection with the performance of their duties. As a result, we may have difficulty attracting and retaining qualified directors and executive officers, which could adversely affect our business.
We have incurred, and may incur impairment charges which may adversely affect our results of operations and financial condition.
In the fourth quarter of fiscal 2008, we recorded a non-cash, after-tax charge of $68.5 million for impairment of goodwill in accordance with the provisions of SFAS No. 142,Goodwill and Other Intangible Assets,primarily caused by the effects of adverse market conditions that caused a decrease in our stock price and market capitalization, which approximates the fair value of the Company at December 31, 2008. This charge represented the entire balance of our goodwill. As a part of our annual goodwill impairment testing in accordance with the provisions of SFAS No. 142, SumTotal Systems also evaluated possible impairment of our other intangible assets in accordance with the provisions of SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets,based on the future discounted cash flows projections of each intangible asset. There was no impairment of our other intangible assets on the balance sheet at December 31, 2008.
Intangible assets with estimable useful lives are amortized over their respective estimated useful lives using straight-line and accelerated methods designed to match the amortization to the benefits received where applicable. They are reviewed for impairment in accordance with SFAS No. 144. If the carrying amount of an intangible asset exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the unit exceeds its fair value.
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Purchased intangible assets subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset group to the estimated undiscounted future cash flows expected to be generated by the asset group. If the carrying amount of an asset group exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset group exceeds the fair value of the asset group.
Any significant adverse changes to the key assumptions about acquired businesses and their prospects or an adverse change in market conditions could result in a change to the estimation of fair value that could result in an impairment charge. Given the significance of the intangible assets, which had a carrying value of $6.0 million on March 31, 2009, as a percentage of our total asset balance, an adverse change to the estimated fair value of intangible assets could result in an impairment charge that would be material to our reported assets and results of operations.
Changes in accounting regulations and related interpretations and policies, particularly those related to revenue recognition and income taxes, could cause us to recognize lower revenue or to report lower earnings per share.
While we believe that we are in compliance with the accounting rules and guidance provided by the AICPA, FASB, SEC and the Public Company Accounting Oversight Board (“PCAOB”), these bodies continue to issue implementation guidelines for their standards and the accounting profession continues to discuss a wide range of potential interpretations of such rules and guidance. Additional implementation guidelines, and changes in interpretations of such guidelines, including the possible adoption of international financial reporting standards, could lead to unanticipated changes in our current revenue and accounting practices that could cause us to recognize lower revenue or increased expenses. In addition, policies, guidelines and interpretations related to accounting for acquisitions, income taxes, foreign taxes, allowance for doubtful accounts and other financial reporting matters require different judgments on complex matters that are often subject to multiple sources of authoritative guidance. If our determination of these matters is subsequently changed or updated, such changes or updates could result in an adverse impact on our financial statements.
Adverse litigation, disputes or investigations could affect our business.
We may, from time to time, be subject to various legal or government claims, disputes or investigations. Such matters may include, but not be limited to, claims, disputes or investigations related to warranty, refund, breach of contract, employment, intellectual property, government regulation or compliance or other matters such as the subpoena we received on April 30, 2008 from the U.S. Department of Defense, as described in Item 1,Legal Proceedings. These matters can be lengthy, expensive, and disruptive to our operations and results cannot be predicted with certainty. An adverse decision could result in monetary damages or injunctive relief that could affect our business, operating results or financial condition. Even if such matters do not result in litigation or such matters are resolved in our favor, such matters and the time and resources necessary to resolve or litigate them, could have a material adverse impact on our financial condition, results of operations, our reputation, or the market value of our common stock.
We may be limited in our use of net operating losses carry forwards.
Our ability to benefit from our deferred tax assets depends on us having sufficient future earnings to utilize our net operating loss (“NOL”) carryforwards before they expire. We have established a valuation allowance against the future tax benefit for our federal and state NOL carryforwards. We could be required to record an additional valuation allowance against our foreign deferred tax assets if market conditions change materially and, as a result, our future earnings are, or are projected to be, significantly less than we currently estimate. Our ability to utilize net operating losses and credits may be subject to a substantial limitation due to the change in ownership, as defined in the Internal Revenue Code Section 382 and similar state provisions and changes to federal and state law with respect to the use of NOLs. Our NOL carryforwards are subject to review and potential disallowance upon audit by the tax authorities of the jurisdictions where the NOLs were incurred.
We may become subject to government regulation and legal uncertainties that could result in liability or increase the cost of doing business, thereby adversely affecting our financial result.
We are not currently subject to direct regulation by any domestic or foreign governmental agency, other than regulations applicable to businesses generally, such as export control laws. However, due to the increasing popularity and use of the Internet, it is possible that a number of laws and regulations may become applicable to us or may be adopted in the future with respect to the Internet covering issues such as taxation, user privacy, content, right to access personal data, copyrights, distribution and characteristics and quality of services.
The applicability of existing laws governing issues such as taxation, property ownership, copyrights, and other intellectual property issues, encryption, libel, export or import matters and personal privacy to the Internet is uncertain. The vast majority of these laws were adopted prior to the broad commercial use of the Internet and related technologies. As a result, they do not contemplate or address the unique issues of the Internet and related technologies. Changes to these laws, including some recently proposed changes, could create uncertainty in the Internet marketplace. Such uncertainty could reduce demand for our services or increase the cost of doing business due to increased costs of litigation or increased service delivery costs.
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In addition, we could be liable for the misuse or unauthorized disclosure of personal data. The Federal Trade Commission, the European Union and certain state and local authorities have been investigating certain Internet companies regarding their use of personal information. Further, the European Union has adopted various data protection regulations related to the confidentiality of personal data. While we are certified under the European Union Safe Harbor which regulates the collection, disclosure and use of personal data, failure to comply with these various regulations could subject us to fines, and cause customers to lose confidence in our software solutions and related services, thereby negatively affecting our revenue and expense.
Terrorism and United States military actions may adversely affect our business.
As a result of terrorist activity, political and military instability, and existing and possible United States military actions, significant instability and uncertainty in the world may continue to have a material adverse effect on world financial markets, including financial markets in the United States. In addition, such adverse political effects may have an adverse impact on economic conditions in the United States. Unfavorable economic conditions in the United States may have an adverse effect on our business operations including, but not limited to, our ability to expand the market for our solutions, obtain financing as needed, enter into strategic relationships and compete effectively in the learning, performance, and talent development markets. Such consequences may lead to a decrease in demand for our solutions and services and as a result our stock price may suffer.
Anti-takeover provisions in our charter documents could make the sale of the company more difficult.
Our certificate of incorporation and bylaws contain provisions that could make it harder for a third party to acquire us without the consent of our board of directors. For example, no potential acquirer would be able to call a special meeting of stockholders to remove our board of directors. A potential acquirer would also not be able to act by written consent without a meeting. In addition, our board of directors has staggered terms that make it difficult to remove all directors at once. The acquirer would also be required to provide advance notice of its proposal to remove directors at an annual meeting. The acquirer would not be able to cumulate votes at a meeting, which would require the acquirer to hold more shares to gain representation on our board of directors than if cumulative voting were permitted. In addition, our certificate of incorporation authorizes our Board of Directors, without stockholder approval, to issue up to 5,000,000 shares of undesignated preferred stock, which could be used to dilute the stock ownership of a potential hostile acquirer.
Subject to its fiduciary duties, our board of directors may in the future adopt a stockholder rights plan. If the board adopts a stockholder rights plan, it may discourage a merger or tender offer involving our securities that is not approved by our board of directors by increasing the cost of effecting any such transaction and, accordingly, could have an adverse impact on stockholders who may want to vote in favor of such merger or participate in such tender offer.
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
Purchases of Equity Securities. On August 20, 2007, our Board of Directors authorized the repurchase up to $15 million of our outstanding shares of common stock. Stock repurchases will be made in the open market, in block purchase transactions, or in structured Rule 10b5-1 share repurchase plans, and may be made from time to time, in one or more larger repurchases at prices and no terms satisfactory to us. We intend to conduct the repurchase in compliance with Rule 10b-18 of the Securities Exchange Act of 1934. The program does not obligate us to acquire any particular amount of common stock. It does not have an expiration date and may be modified, suspended or terminated at any time at our discretion. As of March 31, 2009, we have purchased 2,016,690 shares of common stock for an aggregate cost of approximately $8.3 million as follows:
Period | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Average Price Paid Per Share | Total Value of Shares Purchased as Part of Publicly Announced Plans or Programs | Approximate Dollar Value of Shares that May Yet be Purchased Under the Programs | |||||||
Through December 31, 2008 | 1,670,272 | $ | 4.64 | $ | 7,743,716 | $ | 7,256,284 | ||||
January 1-31, 2009 | — | — | — | 7,256,284 | |||||||
February 1-28, 2009 | 17,686 | 1.78 | 31,507 | 7,224,777 | |||||||
March 1-31, 2009 | 328,732 | 1.52 | 498,307 | 6,726,470 | |||||||
Total | 2,016,690 | $ | 4.10 | $ | 8,273,530 | $ | 6,726,470 | ||||
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Item 6. | Exhibits |
(a) Exhibits
3.1 | Amended and Restated Certificate of Incorporation, filed with the Secretary of State of Delaware on March 18, 2004 (incorporated by reference to Form 8-K filed on March 19, 2004) | |
3.2 | Amended and Restated Bylaws (incorporated by reference to Form 8-K filed on December 9, 2008) | |
10.1* | 2009 Executive and Management Bonus Plan | |
10.2* | Separation Agreement between Ray Villareal and SumTotal Systems, Inc. dated February 15, 2009 | |
10.3* | Form of Change of Control Agreement, amended on March 17, 2009 | |
31.1 | Certifications of Chief Executive Officer Pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.2 | Certifications of Chief Financial Officer Pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
32.1 | Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
* | Each exhibit marked with a (*) is a compensatory contract, plan or other arrangement in which one or more directors and/or executive officers are eligible to participate. |
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Pursuant to the requirements 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.
SUMTOTAL SYSTEMS, INC. | ||||
May 5, 2009 | /s/ NEIL J. LAIRD | |||
Date | Neil J. Laird | |||
Chief Financial Officer | ||||
(Duly Authorized Officer and | ||||
Chief Financial and Chief Accounting Officer) |
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Exhibit Index
3.1 | Amended and Restated Certificate of Incorporation, filed with the Secretary of State of Delaware on March 18, 2004 (incorporated by reference to Form 8-K filed on March 19, 2004) | |
3.2 | Amended and Restated Bylaws (incorporated by reference to Form 8-K filed on December 9, 2008) | |
10.1* | 2009 Executive and Management Bonus Plan | |
10.2* | Separation Agreement between Ray Villareal and SumTotal Systems, Inc. dated February 15, 2009 | |
10.3* | Form of Change of Control Agreement, amended on March 17, 2009 | |
31.1 | Certifications of Chief Executive Officer Pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.2 | Certifications of Chief Financial Officer Pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
32.1 | Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
* | Each exhibit marked with a (*) is a compensatory contract, plan or other arrangement in which one or more directors and/or executive officers are eligible to participate. |
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