Subsequent to the merger with HyperSpace, the Board of Directors approved a Management Incentive Plan for certain key MPC and HyperSpace employees for the remaining six months of fiscal 2005. No amounts are accrued as of July 2, 2005 as no amounts were earned. A final determination of the amount earned will be determinable after the close of results for fiscal 2005. Should the maximum amount be earned, HyperSpace and MPC will be liable for approximately $1.1 million in incentives.
After the consummation of the merger with HyperSpace, certain members of MPC’s management were awarded stock compensation. As part of this non-cash award, MPC will be liable for payroll withholding taxes as the amounts vest and stock is delivered to employees. MPC expects to incur approximately $125,000 in such costs in early 2006. MPC may agree to assist employees by paying all or a portion of their taxes due on such stock awards.
MPC is not party to any off balance sheet transactions, other than guarantees in the normal course of business or indemnities.
During MPC’s normal course of business, it has made certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. These include (i) intellectual property indemnities to its customers and licensees in connection with the use, sale and/or license of our products, (ii) indemnities to its lessors in connection with our facility leases for certain claims arising from such facilities or leases, (iii) indemnities to vendors and service providers pertaining to claims based on its negligence or willful misconduct, and (iv) indemnities involving the accuracy of representations in certain contracts. The duration of these indemnities and commitments in certain cases may be indefinite. The majority of these indemnities and commitments do not provide for any limitation of the maximum potential for future payments MPC could be obligated to make. MPC has not recorded any liability for these indemnities and commitments in the accompanying consolidated financial statements.
Under MPC’s Limited Liability Company Agreement, it has agreed to indemnify its officers and directors in connection with activities on behalf of MPC. The maximum potential amount of future payments MPC could be required to make under these indemnification agreements is unlimited. However, MPC has directors and officers’ liability insurance policies that limit exposure and enable it to recover a portion of any future amounts paid. As a result of MPC’s insurance policy coverage, MPC believes the estimated fair value of these indemnification agreements is minimal and has no liability recorded for these agreements as of July 2, 2005.
The preparation of MPC’s financial statements and related disclosures in conformity with generally accepted accounting principles and the discussion and analysis of MPC’s financial condition and results of operations requires MPC’s management to make judgments, assumptions and estimates that affect the amounts reported in its consolidated financial statements and accompanying notes. Note 2 to MPC’s consolidated financial statements, found elsewhere in the Form 8-K to which this document is a part, summarizes the significant accounting policies and methods used in the preparation of MPC’s consolidated financial statements.
MPC’s management believes the following to be critical accounting policies whose application has a material impact on MPC’s financial presentation. That is, they are both important to the portrayal of MPC’s financial condition and results and they require MPC’s management to make judgments and estimates about matters that are inherently uncertain. Accordingly, actual results could differ significantly from those estimates under different assumptions and conditions.
in future revenue periods. This is based on past historic trends and other factors likely to have a future impact on warranty claims. The actual rate of warranty claims could differ materially from managements’ estimates. For FOB destination agreements, which include all sales to the US Federal Government and some sales to State, Local and Education customers, the Company also defers the cost of product revenue for in-transit shipments until the goods are delivered and revenue is recognized. In-transit product shipments to customers are included in inventory on the Company’s consolidated statement of financial position.
MPC recognizes revenue on third party software products for which it is primarily obligated to perform in accordance with Statement of Position (SOP) 97-2, “Software Revenue Recognition,” as amended, and other authoritative guidance. MPC recognizes revenue on third party software products when all of the following criteria are met: there is persuasive evidence of an arrangement; the product has been delivered; MPC no longer has significant obligations with regard to implementation; the fee is fixed and determinable; and collectibility is probable. Delivery is considered to have occurred when title and risk of loss have been transferred to the customer, which generally occurs when media containing the licensed programs is provided to a common carrier. The value of maintenance is determined based on stated renewal rates and a comparison of the stated price of maintenance to any software sold in a related transaction. In those situations where licenses and maintenance are bundled, MPC uses the residual method.
Service revenues from software maintenance and support are recognized ratably over the maintenance term, which in most cases is one year. Term licenses are recognized ratably over the term of the related arrangement.
Receivables, Net. Accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is MPC’s best estimate of the amount of probable credit losses in MPC’s existing accounts receivable. MPC determines the allowance based on historical write-off experience. MPC reviews its allowance for doubtful accounts monthly. Past due balances over 60 days are reviewed individually for collectibility. Past due balances over 90 days are pooled into aging buckets and reserved against based on historical experience. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. If circumstances related to specific customers change, MPC’s estimates of the recoverability of receivables could materially change. MPC’s allowance for uncollectible accounts totaled $0.6 million as of July 2, 2005 and $0.8 million at January 1, 2005.
Inventory, Net. Inventory balances are stated at the lower of cost or market, with cost being determined on an average cost basis approximating first in first out (FIFO). MPC regularly evaluates the realizability of its inventory based on a combination of factors including the following: historical usage rates, forecasted sales or usage, estimated service period, product end-of-life dates, estimated current and future market values, service inventory requirements and new product introductions, as well as other factors. If circumstances related to MPC’s inventories change, MPC’s estimates of the realizability of inventory could materially change. At July 2, 2005 MPC’s inventory valuation allowance totaled $9 million, and at January 1, 2005 MPC’s inventory valuation allowance totaled $8.5 million and is recorded as a reduction of inventory on MPC’s consolidated financial statements.
Acquired Intangibles, Net. Other intangible assets are accounted for in accordance with Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets,” which requires that intangible assets with estimable useful lives be amortized over their estimated useful lives, and be reviewed for impairment when changes in circumstances indicate that their carrying amounts may not be recoverable in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” Acquired intangibles are amortized on a straight-line basis over their estimated useful lives that generally range from 1 to 5 years with a majority being amortized over a period of 5 years.
Long-Lived Assets. Equipment and software are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives, primarily three to five years. Additions, improvements and major renewals are capitalized. Maintenance, repairs and minor renewals are expensed as incurred. Leasehold improvements are depreciated over the life of the lease or the asset, whichever is shorter. Equipment held for lease is depreciated over the initial term of the lease to the equipment’s estimated residual value.
MPC assesses the recoverability of its long-lived assets whenever adverse events or changes in circumstances or business climate indicate that expected undiscounted future cash flows related to such long-lived assets may not be sufficient to support the net book value of such assets. If undiscounted cash flows are not sufficient to support the recorded assets, impairment is recognized to reduce the carrying value of the long-lived assets to their estimated fair value. Cash flow projections, although subject to a degree of uncertainty, are based on trends of historical performance and management’s estimate of future performance, giving consideration to existing and anticipated competitive and economic conditions. Additionally, in conjunction with the review for impairment, the remaining estimated lives of certain of MPC’s long-lived assets are assessed. No provision for impairment has been recorded in these consolidated financial statements.
Deferred Revenue. Deferred revenue includes amounts billed to or received from customers for which revenue has not been recognized. This generally results from deferred software maintenance sold by MPC to its customers, which are provided by MPC’s third party vendors, and which include term-based licenses, which are recognized over the term of the contract, which generally range from 1-4 years. Also included in deferred revenue is revenue from the sale of enhanced and extended warranties, which are recognized as the related services are provided, which generally range from 3-5 years. These enhanced/extended warranties are deferred based on guidance provided in Technical Bulletin 90-1 and are deferred based on the list price, net of any discounts offered to the customer.
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Prepaid Maintenance and Warranty Costs. Prepaid maintenance and warranty costs include amounts paid to third party software vendors, outsourced providers of warranty fulfillment services and technology insurance vendors for which the related revenue has been deferred. These costs are recognized ratably with the related revenue.
Royalties. MPC has royalty-bearing license agreements allowing it to sell certain hardware and software products and to use certain patented technology. Royalty costs are accrued and included in cost of goods sold when the related sale is recognized.
Accrued Warranties. MPC records warranty liabilities at the time of sale for the estimated costs that may be incurred under its basic limited warranty. The specific warranty terms and conditions vary depending upon the product sold, but generally include technical support, repair parts, labor and a period ranging from 90 days to five years. Factors that affect MPC’s warranty liability include the number of installed units currently under warranty, historical and anticipated rates of warranty claims on those units, and cost per claim to satisfy MPC’s warranty obligation. MPC regularly reevaluates its estimate to assess the adequacy of its recorded warranty liabilities and adjust the amounts as necessary. If circumstances change, or a dramatic change in the failure rates were to occur, MPC’s estimate of the warranty accrual could change significantly.
New Accounting Pronouncements
In December 2004, the FASB issued SFAS 123R “Share-Based Payment,” a revision to FASB No. 123, SFAS 123R replaces existing requirements under SFAS No. 123 and APB Opinion NO. 25 and requires public companies to recognize a compensation expense an amount equal to the fair value of share-based payments granted, such as employee stock options. This is based on the grant-date fair value of those instruments. SFAS 123R also affects the pattern in which compensation cost is recognized, the accounting for employee share purchase plans and the accounting for income tax effects of share-based payment transactions. For non-public entities, SFAS 123R will be effective for interim periods beginning after December 15, 2005. MPC is currently determining what impact the proposed statement would have on its results of operations and financial position. The impact will largely be due to the selection of either the Black-Scholes or the binominal lattice model for valuing options. The adoption of this standard will have no impact on MPC’s cash flows.
In November 2004, the FASB issued SFAS No. 151, “Inventory Costs: an amendment of ARB No. 43, Chapter 4,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material. SFAS No. 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. We do not believe the provision of SFAS No. 151, when applied, will have a material impact on our financial position, results of operations or cash flows.
In December 2004, the FASB issued SFAS No. 153, “Exchanges of Non-monetary Assets,” which amends a portion of the guidance in Accounting Principles Board Opinion (APB) No. 29, “Accounting for Non-monetary Transactions.” Both SFAS no. 153 and APB No. 29 require that exchanges of non-monetary assets should be measured based on fair value of the assets exchanged. APB No. 29, however, allowed for non-monetary exchanges of similar productive assets. SFAS No. 153 eliminates that exception and replaces with a general exception for exchanges of non-monetary assets that do not have commercial substance. A non-monetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 is effective for non-monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Any non-monetary asset exchanges will be accounted for under SFAS No. 153; however we do not expect SFAS No. 153 to have a material impact on our financial position, results of operations or cash flows.
Quantitative and Qualitative Disclosures About Market Risk
MPC is subject to interest rate risk on its credit facility. MPC’s obligations under the new facility is a floating rate based on LIBOR plus 3%. As interest rates rise MPC will be subject to higher interest payments if outstanding balances remain unchanged.
Currently most sales are in the United States. All of MPC’s foreign sales and purchases of product are denominated in U.S. Dollars minimizing its foreign currency risk. All of MPC’s international suppliers, mostly from Asia, denominate contracts in U.S. Dollars thereby eliminating foreign currency risk. In the future MPC may not be successful in negotiating most of its international supply agreements in U.S. Dollars thereby increasing MPC’s
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foreign currency risk. Amounts MPC pays for components from international suppliers could be affected by a continued weakening of the U.S. Dollar as compared with other foreign currencies. MPC currently has no foreign exchange contracts, option contracts or other foreign currency hedging arrangements. Management continues to evaluate MPC’s risk position on an ongoing basis to determine whether foreign exchange hedging strategies may need to be employed.
As of July 2, 2005, MPC had an account due from an agency of the U.S. government that represented approximately 20% of its trade account receivables. Historically, U.S. government agencies have paid amounts due to MPC, though delays in payment are not uncommon. MPC has never had a write-off of a U.S. government receivable. No other customer accounts for more than 10% of MPC’s receivable balance.
MPC depends on third party suppliers for substantially all the components in its PC systems. For example, MPC relies on Intel for its processors and motherboards and Microsoft for its operating systems and other software. Additionally, MPC maintains several single-source supplier relationships primarily to increase its purchasing power with these suppliers. If shortages or delays arise, the prices of these components may increase or the components may not be available at all. MPC currently does not have long-term supply contracts with any of its suppliers that would require them to supply products to MPC for any specific period or in any specific quantities, which could result in shortages or delays. Supplier risks may in addition be affected by liquidity restraints.
Related Party Transactions
For the three and six-month periods, MPC sells its products to companies affiliated with Gores Technology Group; these transactions are considered arms length on a basis no less favorable than could be obtained from an unaffiliated third party. Net sales to GTG affiliated companies were less than $0.1 million for each of the three months period ended April 2, 2005 and the six-month period ended July 2, 2005.
MPC provides various administrative services to GTG affiliated companies. Those services include payroll processing, legal, sales tax, human resources consulting and information technology services. Charges for these services are determined on an arms-length basis at cost plus 10%. Administrative services invoiced to GTG affiliated companies, net of expenses were less than $0.1 million for each of the three months period ended April 2, 2005 and the six-month period ended July 2, 2005. MPC ceased performing these functions upon consummation of the merger with HyperSpace.
MPC has paid management fees to GTG for management support and oversight until the end of Fiscal 2004. MPC did not pay related party management fees for the three or six month periods in 2005 and will not pay any such fees to Gores after the merger with HyperSpace.
In March 2005, MPC entered into a distribution agreement for the sale of HyperSpace’s software products to its customers. There have been no material sales to date.
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