As of May 31, 2005, we held $496.0 million in cash, cash equivalents, and short-term investments, a decrease of $26.9 million from February 28, 2005. This decrease is primarily attributable to cash payments for compensation related to our fiscal 2005 performance, certain tax liabilities, and the repurchase of our shares on the open market. Cash and cash equivalents include investments which are highly liquid and held to maturity. Cash equivalents typically include commercial paper and term deposits, banker’s acceptances and bearer deposit notes issued by major North American banks. All cash equivalents have terms to maturity of ninety days or less. Short-term investments are investments that are highly liquid and held to maturity with terms to maturity greater than ninety days, but less than twelve months. Short-term investments typically consist of commercial paper and corporate bonds.
We group cash and cash equivalents with short-term investments when analyzing our total cash position. These balances may fluctuate from quarter to quarter depending on the renewal terms of the investments.
Working Capital
Working capital represents our current assets less our current liabilities. As of May 31, 2005, working capital was $354.3 million, an increase of $10.0 million from February 28, 2005. The increase in working capital can be attributed to a net decrease in current liabilities, especially salaries, commissions, and related items and income taxes payable. Offsetting this increase were decreases in accounts receivable and short-term investments.
Days sales outstanding was 63 days at May 31, 2005, which is within our expected range, as compared to 55 days as at May 31, 2004. We calculate our days sales outstanding based on ending accounts receivable balances and quarterly revenue.
Long-term Debt
As at February 28, 2005 and May 31, 2005, we had no long-term debt.
Cash Used in Operating Activities
Cash used in operating activities (after changes in non-cash working capital items) for the three months ended May 31, 2005 was $5.3 million, as compared to cash provided by operating activities of $33.1 million in the comparative period last year. This represents an increased use of $38.4 million and is primarily attributable to changes in working capital compared to the same quarter last year.
Cash Provided by Investing Activities
Cash provided by investing activities was $21.3 million for the three months ended May 31, 2005, a decrease of $49.7 million compared to prior fiscal year. During the quarters ended May 31, 2005 and May 31, 2004, we had a decrease in the net investment in short-term investments from the comparative quarter in the prior fiscal year as many of the Corporation’s short-term investments matured during the quarter. The decrease however was greater in the prior fiscal year. In the quarter ended May 31, 2005, the proceeds on the maturity of our short-term investments were in excess of purchases of short-term investments by $25.9 million. In comparison, during the quarter ended May 31, 2004, our proceeds on the maturity of short-term investments, net of investments, were $74.2 million.
During the three month periods ended May 31, 2005 and May 31, 2004, we made fixed asset additions in the amount of $4.8 million and $3.1 million, respectively. The fixed asset additions in both periods related primarily to computer equipment and software, office furniture, and leasehold improvements.
Cash Used in Financing Activities
Cash used in financing activities was $12.9 million for the three months ended May 31, 2005, a decrease in financing activities of $13.2 million compared to the same period of the prior fiscal year. We issued 527,000 common shares, for proceeds of $12.3 million, during the three months ended May 31, 2005, compared to the issue of 635,000 shares for proceeds of $10.3 million during the corresponding period in the prior fiscal year. The issuance of shares in the three months ended May 31, 2005 was pursuant to our stock purchase plan and the exercise of stock options by employees, officers, and directors whereas the issuance of shares in the three months ended May 31, 2004 was pursuant to our stock purchase plan and the exercise of stock options by employees and officers.
We also paid $25.3 million during the quarter to repurchase 617,000 shares on the open market. Comparatively, for the three months ended May 31, 2004 we repurchased 300,000 shares at a value of $10.0 million. The share repurchases made during both periods were part of distinct open market share repurchase programs through The Nasdaq National Market or The Toronto Stock Exchange. The share repurchase programs have historically been adopted in October of each year and run for one year. They allow the Corporation to purchase no more than 5% of the issued and outstanding shares of the Corporation on the date the plan is adopted. These programs do not commit the Corporation to make any share repurchases. Purchases can be made on The Nasdaq National Market or The Toronto Stock Exchange at prevailing open market prices and are paid out of general corporate funds. All shares repurchased under the completed share repurchase programs were cancelled and all shares repurchased under the current share repurchase program will be cancelled.
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Contracts and Commitments
We have an unsecured credit facility subject to annual renewal. The credit facility permits us to borrow funds or issue letters of credit or guarantee up to Cdn $12.5 million (U.S. $10.0 million), subject to certain covenants. As of May 31, 2005 and 2004, there were no direct borrowings under this facility.
We do not enter into off-balance sheet financing as a matter of practice except for the use of operating leases for office space, computer equipment, and vehicles. In accordance with GAAP, neither the lease liability nor the underlying asset is carried on the balance sheet, as the terms of the leases do not meet the thresholds for capitalization.
During fiscal 2005, the Corporation entered into cash flow hedges in order to offset the risk associated with the effects of certain foreign currency exposures related to an intercompany loan and the corresponding interest payments between subsidiaries with different functional currencies. As of May 31, 2005, the Corporation had cash flow hedges, with maturity dates between February 28, 2006 and January 14, 2008, to exchange the U.S. dollar equivalent of $78.8 million in foreign currency. The estimated fair value of these contracts at May 31, 2005 was not material. We entered into these foreign currency exchange forward contracts with major Canadian chartered banks, and therefore we do not anticipate non-performance by these counterparties. The amount of the exposure on account of any non-performance is restricted to the unrealized gains in such contracts.
In connection with the acquisition of Frango, we undertook a restructuring plan in conjunction with the business combination. The restructuring primarily relates to involuntary employee separations of approximately 20 employees of Frango and accruals for vacating leased premises of Frango. During the quarter ended May 31, 2005, the total cash payments made in relation to the accrual were $0.9 million, and cash payments remaining at May 31, 2005 were $4.0 million. The remaining accrual is included in the balance sheet as accrued charges and salaries, commissions, and related items. All amounts excluding lease payments are expected to be paid during fiscal 2006. Outstanding balances for the lease payments will be paid over the lease term unless settled earlier.
Our contractual obligations have not changed materially from those included in our Annual Report on Form 10-K for the year ended February 28, 2005.
We have never declared or paid any cash dividends on our common shares. Our current policy is to retain our earnings to finance expansion and to develop, license, and acquire new software products, and to otherwise reinvest in Cognos.
Given our historical profitability and our ability to manage expenses, we believe that our current resources are adequate to meet our requirements for working capital and capital expenditures through the foreseeable future.
Inflation has not had a significant impact on our results of operations.
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CRITICALACCOUNTINGESTIMATES
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. The estimates form the basis for making judgments about the carrying values of assets and liabilities that may not be readily apparent from other sources. Actual results may differ from these estimates under different assumptions, conditions, and experience.
The following critical accounting policies and significant estimates are used in the preparation of our consolidated financial statements:
| • | | Allowance for Doubtful Accounts |
| • | | Accounting for Income Taxes |
| • | | Impairment of Goodwill and Long-lived Assets |
Revenue Recognition— We recognize revenue in accordance with Statement of Position (“SOP”) No. 97-2,Software Revenue Recognitionas amended by SOP No. 98-9,Software Revenue Recognition with Respect to Certain Arrangements(collectively “SOP 97-2”). As such, we exercise judgment and use estimates in connection with the determination of the amount of software license, maintenance and professional services revenue to be recognized in each accounting period.
Under the residual method prescribed by SOP 97-2, a portion of the arrangement fee is first allocated to undelivered elements included in the arrangement based on vendor specific objective evidence with the remainder of the arrangement fee being allocated to the delivered elements of the arrangement. Cognos contracts commonly include product license, product support, and services (e.g. education, consulting, etc.). Each product license arrangement requires careful analysis to ensure that all of the individual elements in the transaction have been identified, along with the fair value of each element.
We allocate revenue to each undelivered element based on its respective fair value, with the fair value determined by the price charged when that element is sold separately. The fair value of the services portion of the arrangement is established according to our standard price list. Quantity discounts are built into this price list and reflect fees charged when services are sold separately from a product license. We determine the fair value of the product support portion of the arrangement based on the product support renewal rate if product support is negotiated separately and the rate is reflective of the expected renewal rate for the first support period not covered by the arrangement. If product support is not separately negotiated in the agreement, product support is separated based on a percentage of negotiated product license fees that is consistent with similar transactions. If evidence of fair value cannot be established for the undelivered elements of a product license agreement, the entire amount of revenue from the arrangement is deferred and recognized over the period that these elements are delivered.
We sell off-the shelf software, however SOP 97-2 requires that judgment be applied to distinguish whether multiple elements in an arrangement can be treated as separate accounting units. In order to account separately for the services element of an arrangement that includes both product license and services, the services (a) must not be essential to the functionality of any other element of the transaction and (b) must be stated separately such that the total price of the arrangement can be expected to vary as the result of the inclusion or exclusion of the services. If these two criteria are not met, the entire arrangement is accounted for using the percentage of completion method in accordance with SOP 81-1,Accounting for Performance of Construction Type and Certain Production Type Contracts. While the service element must be stated separately, the service element does not have to be priced separately in the contract in order to separately account for the services as a separate element of the transaction.
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We recognize revenue for resellers, value added resellers, original equipment manufacturers, and strategic system integrators (collectively “third-parties”) in a similar manner to our recognition of revenue for end-users.
For substantially all of our software arrangements, we defer revenue for the fair value of the product support and services to be provided to the customer and recognize revenue for the product license when persuasive evidence of an arrangement exists and delivery of the software has occurred, provided the fee is fixed or determinable and collection is deemed probable.
We evaluate each of these criteria as follows:
| • | | Persuasive evidence of an arrangement exists: Our standard business practice is that persuasive evidence exists when we have a binding contract between ourselves and a customer for the provision of software or services. |
| • | | Delivery has occurred: Delivery is considered to occur when media containing the licensed programs is provided to a common carrier or, in the case of electronic delivery, the customer is given access to download the licensed program. Our typical end user license agreement does not include customer acceptance provisions. We recognize revenue from third-parties in the same fashion as end-user licenses unless fee payments are based upon the number of copies made or ordered. In cases where the fees are linked to the number of copies, revenue is recognized upon sell-through to the end customer. |
| • | | The fee is fixed or determinable: A fee is fixed or readily determinable if it is a fixed amount of money or an amount that can be determined at the commencement of the contract, and is payable on Cognos standard payment terms. Fees are generally considered fixed and determinable unless a significant portion (more than 10%) of the licensing fee is due more that 12 months after delivery. In addition, we only consider the fee to be fixed or determinable if the fee is not subject to refund or adjustment. Our typical end user and third-party license agreement does not allow for refunds, returns, or adjustments. However, in the rare circumstances where this might occur and these provisions are agreed upon, revenue is recognized upon the expiration of the rights of exchange or return. For third-parties, if they are newly formed, undercapitalized, or in financial difficulty, or if uncertainties about the number of copies to be sold by the partner exist, fees are not considered fixed and determinable. If the arrangement fee is not fixed or determinable, we recognize the revenue as amounts become due and payable. |
| • | | Collectibility is probable: We extend credit to credit worthy customers in order to facilitate our business. Credit is extended through the process of risk identification, evaluation, and containment. In practical terms, this process will take the form of: customer credit checks; established credit limits for customers (where necessary); and predetermined terms of sale. Collection is deemed probable if we expect that the customer will be able to pay amounts under the arrangement as payments become due. If we determine that collection is not probable, we defer the revenue and recognize the revenue upon cash collection. |
Our customers typically pre-pay product support for the first year in connection with a new product license, and the related revenue is deferred and recognized ratably over the term of the initial product support contract. Product support is renewable by the customer on an annual basis thereafter. Rates for product support, including subsequent renewal rates, are typically established based upon a specified percentage of net product license fees as set forth in the arrangement. Services revenue primarily consists of implementation services related to the installation of our products and training revenue. Our software is ready to use by the customer upon receipt. While many of our customers may choose to configure the software to fit their specific needs, our implementation services do not involve significant customization to or development of the underlying software code. Substantially all of our services arrangements are billed on a time and materials basis and, accordingly, are recognized as the services are performed.
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Allowance for Doubtful Accounts — We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We regularly review our accounts receivable and use our judgment to assess the collectibility of specific accounts and, based on this assessment, an allowance is maintained for 100% of all accounts over 360 days and specific accounts deemed to be uncollectible. For those receivables not specifically identified as uncollectible, an allowance is maintained for 2% of those receivables at May 31, 2005. In order to determine the percentage used, we analyze, on an annual basis, the geographical aging of the accounts, the nature of the receivables (i.e. license, maintenance, consulting), our historical collection experience, and current economic conditions.
In the past, changes in these factors have resulted in adjustments to our allowance for doubtful accounts. These adjustments have been accounted for as changes in estimates, the effect of which has not been significant on our results of operations and financial condition. As these factors change, the estimates made by management will also change, which will impact our provision for doubtful accounts in the future. Specifically, if the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, an additional provision for doubtful accounts may be required.
Accounting for Income Taxes — As an entity which operates globally, we calculate our income tax liabilities in each of the jurisdictions in which we conduct business. Our tax rate is therefore affected by the relative profitability of our operations in various geographic regions. We employ tax planning strategies which, by their nature, involve complicated transactions. Those transactions are subject to review or audit by taxation authorities and the ultimate tax outcome bears a measure of uncertainty. We must therefore make estimates and judgments based on our knowledge and understanding of local and international tax legislation in determining our worldwide tax provision and it may take a considerable period of time for the ultimate tax outcome to be known. In the past, we have made adjustments as a result of these changes in circumstance. These adjustments have been accounted for as changes in estimates. The effect of these changes has not been significant on our results of operations and financial condition. We believe our estimates are reasonable, however, we will continue to adjust our estimates as circumstances change. Therefore, the ultimate tax outcome could differ materially from the amounts recorded in our financial statements. These differences could have a material effect on our financial position and our net income in the period such determination is made.
We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. Although we have considered forecasted taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance, there is no assurance that the valuation allowance will not need to be increased to cover additional deferred tax assets that may not be realized.
Our valuation allowance pertains primarily to net operating loss carryforwards resulting from acquisitions. In the event we were to subsequently determine that we would be able to realize deferred tax assets related to acquisitions in excess of the net purchase price allocated to those deferred tax assets, we would record a credit to goodwill.
If we were to determine that we would be able to realize deferred tax assets unrelated to acquisitions in excess of the net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Should we determine that we would not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the deferred tax asset would reduce income in the period such determination was made.
We provide for withholding taxes on the undistributed earnings of our foreign subsidiaries where applicable. The ultimate tax liability related to the undistributed earnings could differ materially from the liabilities recorded in our financial statements. These differences could have a material effect on our income tax liabilities and our net income.
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Business Combinations — We account for acquisitions of companies in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141,Business Combinations. We allocate the purchase price to tangible assets, intangible assets, and liabilities based on fair values with the excess of purchase price amount being allocated to goodwill.
Historically, our acquisitions have resulted in the recognition of significant amounts of goodwill and acquired intangible assets. In order to allocate a purchase price to these intangible assets and goodwill, we make estimates and judgments based on assumptions about the future income producing capabilities of these assets and related future expected cash flows. We also make estimates about the useful life of the acquired intangible assets. Should different conditions prevail, we could incur write-downs of goodwill, write-downs of intangible assets, or changes in the estimation of useful life of those intangible assets. In the past, we have made adjustments to the valuation allowance on deferred tax assets related to loss carry forwards acquired through acquisitions and the restructuring accrual related to acquisitions. These adjustments did not affect our result of operations. Instead, these adjustments were applied to goodwill.
In accordance with SFAS No.142,Goodwill and Other Intangible Assets (“SFAS 142”), goodwill is not amortized, but is subject to annual impairment testing which is discussed in greater detail below underImpairment of Goodwill and Long-lived Assets.
Intangible assets currently include acquired technology, contractual relationships, and trademarks and patents. Acquired technology is initially recorded at fair value based on the present value of the estimated net future income-producing capabilities of the software products acquired. Acquired technology is amortized over its estimated useful life on a straight-line basis. Contractual relationships represent contractual and separable relationships that we have with certain customers and partners that we acquired through acquisitions. These contractual relationships were initially recorded at their fair value based on the present value of expected future cash flows and are amortized over their estimated useful life. Trademarks and patents are initially recorded at cost. Cost includes legal fees and other expenses incurred in order to obtain these assets. They are amortized over their estimated useful life on a straight-line basis.
In accordance with SFAS 142, we continuously evaluate the remaining useful life of our intangible assets being amortized to determine whether events or circumstances warrant a revision to the estimated remaining amortization period.
Other estimates associated with the accounting for acquisitions include restructuring costs. Restructuring costs primarily relate to involuntary employee separations and accruals for vacating duplicate premises. Restructuring costs associated with the pre-acquisition activities of an entity acquired are accounted for in accordance with Emerging Issues Task Force No. 95-3,Recognition of Liabilities in Connection with a Business Combination (“EITF 95-3”). To calculate restructuring costs accounted for under EITF 95-3, management estimates the number of employees that will be involuntarily terminated and the associated costs and the future costs to operate and sublease duplicate facilities once they are vacated. Changes to the restructuring plan could result in material adjustments to the restructuring accrual.
Impairment of Goodwill and Long-lived Assets — In accordance with SFAS 142, goodwill is subject to annual impairment tests, or on a more frequent basis if events or conditions indicate that goodwill may be impaired. Goodwill is tested for impairment at a level of reporting referred to as a reporting unit. The Corporation as a whole is considered one reporting unit. Quoted market prices in active markets are considered the best evidence of fair value. Therefore, the first step of our annual test is to compare the fair value of our shares on The Nasdaq Stock Market to the carrying value of our net assets. If we determine that our carrying value exceeds our fair value, we would conduct a second step to the goodwill impairment test. The second step compares the implied fair value of the goodwill (determined as the excess fair value over the fair value assigned to our other assets and liabilities) to the carrying amount of goodwill. To date, we have not needed to perform the second step in testing goodwill impairment. If the carrying amount of goodwill were to exceed the implied fair value of goodwill, an impairment loss would be recognized.
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We evaluate all of our long-lived assets, including intangible assets other than goodwill and fixed assets, periodically for impairment in accordance with SFAS No. 144,Accounting for the Impairment or Disposal of Long-lived Assets(“SFAS 144”). SFAS 144 requires that long-lived assets be evaluated for impairment when events or changes in facts and circumstances indicate that their carrying value may not be recoverable. Events or changes in facts or circumstances can include a strategic change in business direction, decline or discontinuance of a product line, a reduction in our customer base, or a restructuring. If one of these events or circumstances indicates that the carrying value of an asset may not be recoverable, the amount of impairment will be measured as the difference between the carrying value and the fair value of the impaired asset as calculated using a net realizable value methodology. An impairment will be recorded as an operating expense in the period of the impairment and as a reduction in the carrying value of that asset.
NEWACCOUNTINGPRONOUNCEMENTS
In December 2004, the FASB issued SFAS No. 123 (Revised),Share-based Payment (“SFAS 123R”) which is a revision of SFAS 123 and supersedes Accounting Principles Board (“APB”) Opinion 25,Accounting for Stock Issued to Employees, (“APB 25”) and SFAS No. 148,Accounting for Stock-based Compensation – Transition and Disclosure. This revised standard addresses the accounting for share-based payment transactions in which a company receives employee services in exchange for either equity instruments of the company or liabilities that are based on the fair value of the company’s equity instruments or that may be settled by the issuance of such equity instruments. Under the new standard, companies will no longer be able to account for share-based compensation transactions using the intrinsic method in accordance with APB 25. Instead, companies will be required to account for such transactions using a fair value method and recognize the expense in the consolidated statement of income. SFAS 123R will be effective for fiscal years beginning after June 15, 2005. Early adoption is permitted. We are currently examining the different changes contemplated by the new rules and we have yet to determine which transitional provision we will follow. The impact on our financial statements of applying one of the acceptable fair value based methods of accounting for stock options is disclosed in Note 3 “Stock-based Compensation”.
In March 2005, the Securities and Exchange Commission (“SEC”) released SEC Staff Accounting Bulletin No. 107,Share-Based Payment(“SAB 107”). SAB 107 provides the SEC staff position regarding the application of SFAS 123R. SAB 107 contains interpretive guidance related to the interaction between SFAS 123R and certain SEC rules and regulations, as well as provides the staff’s views regarding the valuation of share-based payment arrangements for public companies. SAB 107 also highlights the importance of disclosures made related to the accounting for share-based payment transactions. We are currently evaluating SAB 107 and we will be incorporating it as part of our adoption of SFAS 123R.
In May 2005, the FASB issued SFAS No. 154,Accounting Changes and Error Corrections(“SFAS 154”) which supersedes APB Opinion No. 20,Accounting Changes and SFAS No. 3,Reporting Accounting Changes in Interim Financial Statements. SFAS 154 changes the requirements for the accounting for and reporting of changes in accounting principle. The statement requires the retroactive application to prior periods’ financial statements of changes in accounting principles, unless it is impracticable to determine either the period specific effects or the cumulative effect of the change. SFAS 154 does not change the guidance for reporting the correction of an error in previously issued financial statements or the change in an accounting estimate. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. We do not expect the adoption of SFAS 154 to have a material impact on our consolidated results of operations and financial condition.
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CERTAINFACTORSTHATMAYAFFECTFUTURERESULTS
This report contains forward-looking statements, including statements regarding the future success of our business and technology strategies, and future market opportunities. These statements are neither promises nor guarantees, but involve known and unknown risks and uncertainties that may cause our actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed in or implied by these forward-looking statements. These risks include risks related to our revenue growth, operating results, industry, products, and litigation, as well as the other factors discussed below and elsewhere in this report. Readers should not place undue reliance on any such forward-looking statements, which speak only as of the date they were made. We disclaim any obligation to publicly update or revise any such statements to reflect any change in our expectations or in events, conditions, or circumstances on which any such statements may be based, or that may affect the likelihood that actual results will differ from those set forth in the forward-looking statements.
We face intense competition and we may not compete successfully.
We face substantial competition throughout the world, primarily from software companies located in the United States, Europe, and Canada. We expect our competitors to continue to improve the performance of their current products and to introduce new products (or integrated products) or new technologies. The software market may continue to consolidate by merger or acquisition. If one or more of our competitors merges or partners with another of our competitors or if we were to become the subject of an unsolicited acquisition initiative by another enterprise, any such change in the competitive landscape could adversely affect our ability to compete. As well, competition may increase by the entry or expansion of other large software vendors, including enterprise resource planning vendors, into this market. These competitors may have substantially greater financial and other resources with which to pursue research and development, manufacturing, marketing, and distribution of their products. New product announcements or introductions by our competitors could cause a decline in sales, a reduction in the sales price, or a loss of market acceptance of our existing products. To the extent that we are unable to effectively compete against our current and future competitors, our ability to sell products could be harmed and our market share reduced. Any erosion of our competitive position could have a material adverse effect on our business, results of operations, and financial condition.
The length of time required to complete a sales cycle may be lengthy and unpredictable.
As our business continues to evolve toward larger transactions at the enterprise level, the presence or absence of one or more of these large transactions in a particular period may have a material positive or negative effect on our revenue estimates in that period. These significant transactions require a considerable effort on the part of customers to assess alternative products and require additional levels of management approvals before being concluded. They are also often more complex than smaller transactions. These factors could lengthen the typical sales cycle and increase the risk that the customer’s purchasing decision may be postponed or delayed from one period to another subsequent or later period or that the customer will alter its purchasing requirements. The sales effort and service delivery scope for larger transactions also require additional resources to execute the transaction. These factors, along with any other foreseen or unforeseen event, could result in lower than anticipated revenue for a particular period or in the reduction of estimated revenue in future periods. For example, in the first quarter of fiscal year 2006, we closed six contracts greater than $1 million, compared to eight in the first quarter of fiscal year 2005, which contributed to lower than expected growth in revenues.
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Our sales forecasts may not match actual revenues in a particular period.
The basis of our business budgeting and planning process is the estimation of revenues that we expect to achieve in a particular quarter and is based on a common industry practice known as the “pipeline” system. Under this system, information relating to sales prospects, the anticipated date when a sale will be completed and the potential dollar amount of the sale are tracked and analyzed to provide a “pipeline” of future business. These pipeline estimates are not necessarily reliable predictors of revenues in a particular quarter because of, among other things, the events identified in these risk factors, as well as the subjective nature of the estimates themselves. In particular, a slowdown in technology spending or a deterioration in economic conditions is likely to result in the delay or cancellation of prospective orders in our pipeline. A variation from our historical or expected conversion rate of the pipeline could adversely affect our budget or planning and could consequently materially affect our operating results and our stock price could suffer.
Currency fluctuations may adversely affect us.
A substantial portion of both our revenues and expenditures are generated in currencies other than the U.S. dollar, such as the Canadian dollar and the euro. Fluctuations in the exchange rate between the U.S. dollar and other currencies, particularly the euro and the Canadian dollar, may have a material adverse effect on our business, financial condition, and operating results. Please see further discussion on foreign currency risk included in the Quantitative and Qualitative Disclosure on Market Risk in Item 3 of this Form 10-Q.
We operate internationally and face risks attendant to those operations.
We earn a significant portion of our total revenues from international sales generated through our foreign direct and indirect operations. These sales operations face risks arising from local political, legal and economic factors such as the general economic conditions in each country or region, varying regulatory requirements, compliance with international and local trade, labor and other laws, and reduced intellectual property protections in certain jurisdictions. We may also face difficulties in managing our international operations, collecting receivables in a timely fashion, and repatriating earnings. Any of these factors, either individually or in combination, could materially impact our international operations and adversely affect our business as a whole.
If we do not respond effectively to rapid technological change, our products may become obsolete.
The markets for our products are characterized by: rapid and significant technological change; frequent new product introductions and enhancements; changing customer demands; and evolving industry standards. We cannot provide assurance that our products and services will remain competitive in light of future technological change or that we will be able to respond to market demands and developments or new industry standards. If we are unable to identify a shift in market demand or industry standards quickly enough, we may not be able to develop products to meet those new demands or standards, or to bring them to market in a timely manner. In addition, failure to respond successfully to technological change may render our products and services obsolete and thus harm our ability to attract and retain customers.
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We may not be able to hire, integrate, or retain key personnel essential to our business.
We believe that our success depends on senior management and other key employees to develop, market, and support our products and manage our business. The loss of their services could have a material adverse effect on our business. Our success is also highly dependent on our continuing ability to hire, integrate, and retain highly qualified personnel as well as our ability to train and develop personnel. The failure to attract and retain or to train and develop key personnel could adversely affect our future growth and profitability.
Our total revenue and operating results may fluctuate, which could affect the price of our common stock.
We have experienced revenue growth from our products in the past. We cannot, however, provide assurance that revenue from these products will continue to grow, or grow at previous rates or rates projected by management. Anticipated revenue may be reduced by any one, or a combination of, unforeseen market, economic, or competitive factors some of which are discussed in this section. We have experienced and in the future may experience a shortfall in revenue or earnings or otherwise fail to meet public market expectations, which could materially and adversely affect our business and the market price of our common stock.
Our quarterly and annual operating results may vary between periods.
Historically, our quarterly operating results have varied from quarter to quarter, and we anticipate this pattern will continue. We typically realize a larger percentage of our annual revenue and earnings in the fourth quarter of each fiscal year, and lower revenue and earnings in the first quarter of the following fiscal year. As well, in each quarter we typically close a larger percentage of sales transactions near the end of that quarter. As a result, it is difficult to anticipate the revenue and earnings that we will realize in any particular quarter until near the end of the quarter. Some of the causes of this difficulty are explained in other risk factors – in particular those entitled ‘Our sales forecasts may not match actual revenues in a particular period’, ‘The length of time required to complete a sales cycle may be lengthy and unpredictable’ and‘Our expenses may not match anticipated revenues’.
Our expenses may not match anticipated revenues.
We base our operating expenses on anticipated revenue trends. Since a high percentage of these expenses are relatively fixed, a delay in completing license transactions could cause significant variations in operating results from quarter to quarter and could result in operating losses. If these expenses precede, or are not subsequently followed by, increased revenues, our business, financial condition, or results of operations could be materially and adversely affected.
Economic conditions could adversely affect our revenue growth and ability to forecast revenue.
The revenue growth and profitability of our business depends on the overall demand for BI and CPM products and services. Because our sales are primarily to major corporate customers in the high technology, telecommunications, financial services (including insurance), pharmaceutical, utilities, and consumer packaged goods industries, our business depends on the overall economic conditions and the economic and business conditions within these industries. A weakening of one or more of the global economy, the information technology industry, or the business conditions within the industries listed above may cause a decrease in our software license revenues. A decrease in demand for computer software caused, in part, by a continued weakening of the economy, domestically or internationally, may result in a decrease in revenues and growth rates.
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Natural or other disasters and hostilities or terrorist attacks may disrupt our operations.
Natural or other disasters and hostilities or terrorist attacks may disrupt our operations or those of our customers, distributors, and suppliers, which could adversely affect our business, financial condition, or results of operations. The threat of future outbreak or continued escalation of hostilities involving the United States or other countries could adversely affect the growth rate of our software license revenue and have an adverse effect on our business, financial condition, or results of operations.
Making and integrating acquisitions could impair our operating results.
We have acquired and, if appropriate, will continue to seek to acquire additional products or businesses that we believe are complementary to ours. Acquisitions, including but not limited to our acquisition of Frango AB, involve a number of other risks, including: diversion of management’s attention; disruption of our ongoing business; difficulties in integrating and retaining all or part of the acquired business and its personnel; assumption of disclosed and undisclosed liabilities; dealing with unfamiliar laws, customs and practices in foreign jurisdictions; and the effectiveness of the acquired company’s internal controls and procedures. The individual or combined effect of these risks could have a material adverse effect on our business. As well, in paying for an acquisition we may deplete our cash resources or dilute our shareholder base by issuing additional shares. Furthermore, there is the risk that our valuation assumptions and or models for an acquired product or business may be erroneous or inappropriate due to foreseen or unforeseen circumstances and thereby cause us to overvalue an acquisition target. There is also the risk that the contemplated benefits of an acquisition may not materialize as planned or may not materialize within the time period or to the extent anticipated.
If we introduce a new product, revenue from existing products may be eroded.
We may develop technology or a product that constitutes a marked advance over both our own products and those of our competitors, such as in the case of Cognos 8 Business Intelligence. If we introduce such a product, we may experience a decline in revenues of our existing products that is not fully matched by the new product’s revenue. In addition, we may lose existing customers who choose a competitor’s product rather than migrate to our new product. This could result in a temporary or permanent revenue shortfall and materially affect our business.
We may have exposure to greater or lower than anticipated tax liabilities.
We are subject to income taxes and non-income taxes in a variety of jurisdictions and our tax structure is subject to review by both domestic and foreign taxation authorities. The determination of our worldwide provision for income taxes and other tax liabilities requires significant judgment. Although we believe our estimates are reasonable, the ultimate tax outcome may differ from the amounts recorded in our financial statements and may materially affect our financial results, positively or negatively, in the quarter or quarters for which such determination is made. For example, in the first quarter of fiscal 2006, the estimated effective tax rate for the fiscal year was adjusted downward for the recognition of one-time benefits resulting from (i) a tax court decision that allowed corporations to claim investment tax credits on stock-based compensation for research and development personnel relating to fiscal years 2004 and 2005 and (ii) a change in tax withholding legislation relating to one of the Corporation’s subsidiaries.
Our intellectual property may be misappropriated or we may have to defend ourselves against other parties’ claims.
We rely on various intellectual property protections, including contractual provisions, patents, copyright, trademark, and trade secret laws, to preserve our intellectual property rights. Despite our precautions, our intellectual property may be misappropriated causing us to lose potential revenue and competitive advantage. As well, we may ourselves from time to time become subject to claims by third parties that our technology infringes their intellectual property rights. In either case, we may incur expenditures to police, protect, and defend our interests and may become involved in litigation that could divert the attention of our management. Responding to such claims could result in substantial expense and result in damages, royalties, or injunctive relief, or require us to enter into licensing agreements on unfavorable terms, or redesign or stop selling affected products which could materially disrupt the conduct of our business.
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We may face liability claims if our software products or services fail to perform as intended.
The sale, servicing, and support of our products entails the risk of product liability, performance or warranty claims, which may be substantial in light of the use of our products in business-critical applications. A successful product liability claim could seriously disrupt our business and adversely affect our financial results. Software products are complex and may contain errors or defects, particularly when first introduced, or when new versions or enhancements are released, or when configured to individual customer requirements. Although we currently have in place procedures and staff to exercise quality control over our products and respond to defects and errors found in current versions, new versions, or enhancements of our products, defects and errors may still occur. We also attempt to contractually limit our liability in accordance with industry practices. However, defects and errors in our products could inhibit or prevent customer deployment and cause us to lose customers or require us to pay penalties or damages.
Our share price may fluctuate.
The market price of our common shares may be volatile and could be subject to wide fluctuations due to a number of factors, including: actual or anticipated fluctuations in our results of operations; changes in estimates of our future results of operations by us or securities analysts; announcements of technological innovations or new products by us or our competitors; general industry changes in the BI and CPM tools or related markets; or other events or factors.
New accounting pronouncements may require us to change the way in which we account for our operational or business activities.
The FASB and other bodies that have jurisdiction over the form and content of our accounts are constantly discussing proposals designed to ensure that companies best display relevant and transparent information relating to their respective businesses. The effect of the pronouncements of FASB and other bodies may have the effect of requiring us to account for revenues and/or expenses in a different manner than the manner in which we have had experience. For example, beginning with fiscal years starting after June 15, 2005, a new FASB pronouncement will require us to expense the fair value of stock options. As a result, we will likely report increased expenses in our income statement and a reduction of our net income and earnings per share. The impact on Cognos’ current financial statements of applying a fair value method of accounting for stock options is disclosed in Note 3 of the Condensed Notes to the Consolidated Financial Statements.
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| Item 3. | | Quantitative and Qualitative Disclosure about Market Risk |
Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of fluctuations in interest rates and foreign currency exchange rates. We do not hold or issue financial instruments for trading purposes.
Interest Rate Risk
Our exposure to market rate risk for changes in interest rates relates primarily to our investment portfolio. The investment of cash is regulated by our investment policy of which the primary objective is security of principal. Among other selection criteria, the investment policy states that the term to maturity of investments cannot exceed two years in length. We do not use derivative financial instruments in our investment portfolio.
Interest income on our cash, cash equivalents, and short-term investments is subject to interest rate fluctuations, but we believe that the impact of these fluctuations does not have a material effect on our financial position due to the short-term nature of these financial instruments. We have no long-term debt. Our interest income and interest expense are most sensitive to the general level of interest rates in Canada and the United States. Sensitivity analysis is used to measure our interest rate risk. For the quarter ending May 31, 2005, a 100 basis-point adverse change in interest rates would not have had a material effect on our consolidated financial position, earnings, or cash flows.
Foreign Currency Risk
We operate internationally. Accordingly, a substantial portion of our financial instruments are held in currencies other than the U.S. dollar. Our policy with respect to foreign currency exposure as it relates to financial instruments, is to manage financial exposure to certain foreign exchange fluctuations with the objective of neutralizing some of the impact of foreign currency exchange movements. Sensitivity analysis is used to measure our foreign currency exchange rate risk. As of May 31, 2005, a 10% adverse change in foreign exchange rates versus the U.S. dollar would have decreased our reported cash, cash equivalents, and short-term investments by approximately one percent.
Also, as we conduct a substantial portion of our business in foreign currencies other than the U.S. dollar, our results are affected, and may be affected in the future, by exchange rate fluctuations of the U.S. dollar relative to the Canadian dollar, to various European currencies, and, to a lesser extent, other foreign currencies. Revenues and expenses generated in foreign currencies are translated at exchange rates during the month in which the transaction occurs. We cannot predict the effect foreign exchange fluctuations will have on our results going forward; however, if significant foreign exchange losses are experienced, they could have a material adverse effect on our business, results of operations, and financial condition.
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| Item 4. | | Controls and Procedures |
| a) | | Evaluation of disclosure controls and procedures. |
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we have evaluated the disclosure controls and procedures as of a date within 90 days before the filing date of this quarterly report. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer conclude that the disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) effectively ensure that information required to be disclosed in our filings and submissions under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure, and is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
| b) | | Changes in internal controls |
There have been no changes in our internal controls over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during our most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially effect, our internal control over financial reporting.
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PART II — OTHER INFORMATION
| Item 2. | | Unregistered Sales of Equity Securities and Use of Proceeds |
| PURCHASES OF EQUITY SECURITIES |
|---|
| |
|
| Period | Total Number
of Shares
Purchased | Average Price
Paid per
Share | Total Number of
Shares Purchased
as Part of Publicly
Announced Plans | Approximate Number of Shares
or Dollar Value of Shares that
May Yet Be Purchased Under
the Plans |
|---|
|
| Restricted Share
Unit Plan
(# of shares) | Share
Repurchase
Program |
|---|
|
| March 1 to March 31, 2005 | | Nil | | Nil | | Nil | | 1,946,500 | | $30,738,926 | |
| April 1 to April 30, 2005 | | 504,870 | | $41.27 | | 504,870 | | 1,946,500 | | $ 9,903,733 | |
| May 1 to May 31, 2005 | | 112,000 | | $39.46 | | 112,000 | | 1,946,500 | | $ 5,484,667 | |
| |
|
| Total | | 616,870 | | $40.94 | | 616,870 | |
| |
|
On October 6, 2004, Cognos announced that it had adopted a stock repurchase program authorizing the repurchase of up to 4,530,256 common shares (not more than 5% of the common shares outstanding on that date) up to a maximum of $50,000,000 between October 9, 2004 and October 8, 2005 (the “2004 Stock Repurchase Program”). On June 22, 2005, the Board of Directors of Cognos approved additional purchases up to a total of $100,000,000 with no increase in the number of shares. During the quarter ended May 31, 2005, Cognos repurchased 616,870 shares at an average price of $40.94 under the 2004 Stock Repurchase Program.
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| Item 4. | | Submission of Matters to a Vote of Security Holders |
| a) | | The Corporation held its Annual and Special Meeting of Shareholders on June 23, 2005. |
| b) | | At the Annual and Special Meeting, shareholders elected the persons listed below as directors of the Corporation and approved the appointment of Ernst & Young LLP as the Corporation’s independent auditors for the fiscal year ending February 28, 2006 and authorized the Audit Committee of the Board to fix their remuneration. Shareholders also approved (i) an amendment to the Cognos Incorporated 2003-2008 Stock Option Plan to increase the shares of common stock reserved for awards thereunder by 1.8 million shares, (ii) an amendment to the Cognos Incorporated 2002-2005 Restricted Share Unit Plan to extend its term to 2015, to increase the number of authorized shares to 3,000,000, and to delete Section 4B, and (iii) an amendment to the Cognos Employee Stock Purchase Plan to extend its term to 2008. The voting results of the meeting are presented in the following table: |
Voting Results
Annual and Special Meeting of Shareholders
June 23, 2005
| | FOR | WITHHELD | AGAINST |
|---|
|
| Election of Directors | | | | | |
|
| Robert G. Ashe | | 73,689,521 | | 279,834 | | -- | |
|
| John E. Caldwell | | 72,508,159 | | 1,461,196 | | -- | |
|
| Paul D. Damp | | 73,688,511 | | 280,844 | | -- | |
|
| Pierre Y. Ducros | | 73,136,728 | | 820,203 | | -- | |
|
| Robert W. Korthals | | 73,642,637 | | 326,718 | | -- | |
|
| John J. Rando | | 73,688,940 | | 280,415 | | -- | |
|
| Bill V. Russell | | 73,558,211 | | 411,144 | | -- | |
|
| James M. Tory | | 73,504,695 | | 452,236 | | -- | |
|
| Renato Zambonini | | 73,546,237 | | 410,694 | | -- | |
|
| Appointment of Auditors | | 72,077,438 | | 301,091 | | -- | |
|
| Amendment to the 2003-2008 Stock Option Plan to increase the shares of common stock reserved for awards thereunder by 1.8 million shares | | 54,502,803 | | -- | | 13,859,312 | |
|
| Amendment to the 2002-2005 Restricted Share Unit Plan to extend its term to 2015, to increase the number of authorized shares to 3,000,000, and to delete Section 4B | | 54,976,770 | | -- | | 13,382,251 | |
|
| Amendment to the Employee Stock Purchase Plan to extend its term to 2008 | | 66,607,563 | | -- | | 1,729,285 | |
|
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| Item 5. | | Other Information |
In order to provide more information regarding the process of nominating directors to the Corporation’s Board of Directors, the Corporation offered the following information in its Proxy Statement for the most recent Annual and Special Meeting of Shareholders.
Director Nomination Transparency
The Corporate Governance and Nominating Committee (“CGN Committee”) of the Board assesses the need for additional directors on a regular basis and retains advisors to assist it in that regard. The CGN Committee’s objective is to have a Board of the highest caliber with diverse backgrounds, experience, strengths and competencies. In evaluating the suitability of new nominees (“Nominees”), the CGN Committee takes into account many factors, including; understanding of the Corporation’s business, technology and marketplace; general understanding of marketing, finance, law and other disciplines relevant to a large publicly traded company’s success; educational and professional background; personal accomplishment and attributes; as well as cultural and gender diversity. The CGN Committee evaluates each individual Nominee in the context of the overall Board and its current competencies, with the objective of maintaining or augmenting its competencies and overall strengths. The CGN Committee has identified the following criteria to guide the CGN Committee in selecting Nominees:
| • | | Nominees should have high ethical character, and personal and professional reputations that complement and enhance the image and standing of the Corporation; |
| • | | Each Nominee should have the ability to exercise sound, independent business judgment; |
| • | | The Committee should generally seek Nominees that include current and/or former executive officers and/or directors of companies and leaders of major organizations, demonstrating a public image and adherence to principles consistent with those of the Corporation; |
| • | | The CGN Committee should seek Nominees who are recognized for their professional excellence or as leaders in their respective fields, particularly in areas relevant to the Corporation such as software, research and development, sales, marketing, finance, human resources, governance and law; |
| • | | Nominees should, in the aggregate, have varied educational and professional backgrounds to provide meaningful counsel to management; |
| • | | Nominees should have a commitment to (a) prepare for, regularly attend, and actively participate in, meetings of the Board and (b) understand the Corporation, its business, and its industry; |
| • | | Nominees should understand and be committed to the Board/Committee Mandates of the Corporation including the requirements of the Board Mandate that Directors should (a) generally not serve on the Board of more than 6 publicly traded companies and should have sufficient time to devote to the Corporation; (b) generally be under the age of 75; and (c) be dedicated to attending the requisite Director continuing education; |
| • | | The CGN Committee must adhere to any requirements applicable to the Corporation relating to Director independence and financial literacy/expertise and should ensure that Nominees do not have any real or apparent conflicts of interest in serving as a Director; and |
| • | | Where possible, the CGN Committee should seek to satisfy the foregoing criteria while at the same time fostering gender and cultural diversity on the Board. |
The foregoing criteria may, from time to time, be changed by the CGN Committee to reflect a change in circumstances.
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Shareholders wishing to suggest Nominees to the CGN Committee may do so by submitting the Nominee’s name, experience and other relevant information to the Cognos Corporate Governance & Nominating Committee, C/O the Vice-President, Chief Legal Officer and Secretary, 3755 Riverside Drive, P.O. Box 9707, Station T, Ottawa, Ontario, Canada, K1G 4K9. The Committee applies the same criteria to all Nominees irrespective of the source of such Nominee.
| a) | | Exhibits | | | |
| | 3.1 | | Articles of Incorporation and Amendments thereto (incorporated by reference to Exhibit 3.1 of the Corporation’s Form 10-Q filed for the quarter ended November 30, 2002 and Exhibit 3.1 (i) of Cognos’ Form 10-Q filed for the quarter ended May 31, 2004) | |
| | 3.2 | | By-Laws of the Corporation (incorporated by reference to Exhibit 3.2 of the Corporation's Form 10-K filed for the year ended February 28, 1997) |
| | 31.1 | | Certification of Chief Executive Officer Pursuant to Rule 13a - 14(a) and 15d - 14(a) of the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | 31.2 | | Certification of Chief Financial Officer Pursuant to Rule 13a - 14(a) and 15d - 14(a) of the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | 32 | | Certification 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 |
| | 99.1 | | Management’s Discussion and Analysis of Financial Condition and Results of Operations — Canadian Supplement |
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SIGNATURE
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.
| | | COGNOS INCORPORATED |
| | (Registrant) |
|
| June 30, 2005 | | /s/ Tom Manley |
| |
|
| Date | | Tom Manley
Senior Vice President, Finance & Administration and
Chief Financial Officer (Principal Financial Officer and
Chief Accounting Officer) |
54
EXHIBIT INDEX
| EXHIBIT NO. | | DESCRIPTION | | PAGE | |
| |
| 31.1 | | Certification of Chief Executive Officer Pursuant to Rule 13a - 14(a) and 15d - 14(a) of the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | | 56 | |
| |
| 31.2 | | Certification of Chief Financial Officer Pursuant to Rule 13a - 14(a) and 15d - 14(a) of the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | | 57 | |
| |
| 32 | | Certification 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 | | 58 | |
| |
| 99.1 | | Management’s Discussion and Analysis of Financial Condition and Results of Operations — Canadian Supplement | | 59-61 | |
| |
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