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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
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 September 30, 2003 | ||||
OR | ||||
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. | |||
For the transition period from to |
Commission file number: 0-18391
ASPECT COMMUNICATIONS CORPORATION
California | 94-2974062 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
1320 Ridder Park Drive, San Jose, California 95131-2312
(Address of principal executive offices and zip code)
Registrant’s telephone number: (408) 325-2200
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. Yesx Noo
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yesx Noo
The number of shares outstanding of the Registrant’s Common Stock, $.01 par value, was 56,100,508 at October 31, 2003.
Table of Contents
TABLE OF CONTENTS
ASPECT COMMUNICATIONS CORPORATION
TABLE OF CONTENTS
Page Number | ||||
Part I: | Financial Information | |||
Item 1: | Financial Statements (unaudited) | |||
Condensed Consolidated Balance Sheets as of September 30, 2003 and December 31, 2002 | 3 | |||
Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2003 and 2002 | 4 | |||
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2003 and 2002 | 5 | |||
Notes to Condensed Consolidated Financial Statements | 6 | |||
Item 2: | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 14 | ||
Item 3: | Quantitative and Qualitative Disclosures About Market Risk | 28 | ||
Item 4: | Controls and Procedures | 28 | ||
Part II: | Other Information | |||
Item 1: | Legal Proceedings | 29 | ||
Item 6: | Exhibits and Reports on Form 8-K | 29 | ||
Signature | 30 |
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ASPECT COMMUNICATIONS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except par value and share amounts-unaudited)
September 30, 2003 | December 31, 2002 | |||||||||||
ASSETS | ||||||||||||
Current assets: | ||||||||||||
Cash and cash equivalents | $ | 58,468 | $ | 66,051 | ||||||||
Short-term investments | 68,262 | 80,049 | ||||||||||
Accounts receivable, net | 45,569 | 51,145 | ||||||||||
Inventories | 7,964 | 6,839 | ||||||||||
Other current assets | 14,761 | 13,664 | ||||||||||
Total current assets | 195,024 | 217,748 | ||||||||||
Property and equipment, net | 71,953 | 86,528 | ||||||||||
Intangible assets, net | 5,980 | 9,790 | ||||||||||
Goodwill, net | 2,707 | 2,707 | ||||||||||
Other assets | 7,962 | 8,949 | ||||||||||
Total assets | $ | 283,626 | $ | 325,722 | ||||||||
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS’ EQUITY | ||||||||||||
Current liabilities: | ||||||||||||
Convertible subordinated debentures | $ | 956 | $ | 124,983 | ||||||||
Short-term borrowings | 7,038 | 7,186 | ||||||||||
Accounts payable | 6,753 | 6,798 | ||||||||||
Accrued compensation and related benefits | 16,338 | 16,051 | ||||||||||
Other accrued liabilities | 61,744 | 67,370 | ||||||||||
Deferred revenues | 50,449 | 30,220 | ||||||||||
Total current liabilities | 143,278 | 252,608 | ||||||||||
Long term borrowings | 35,902 | 41,243 | ||||||||||
Other long-term liabilities | 12,263 | 10,174 | ||||||||||
Total liabilities | 191,443 | 304,025 | ||||||||||
Redeemable convertible preferred stock | 32,726 | — | ||||||||||
Shareholders’ equity: | ||||||||||||
Preferred stock, $.01 par value: 2,000,000 shares authorized, none outstanding | — | — | ||||||||||
Common stock, $.01 par value: 200,000,000 shares authorized, shares outstanding: | ||||||||||||
55,231,479 and 53,038,378 at September 30, 2003 and December 31, 2002, respectively | 552 | 530 | ||||||||||
Additional paid-in-capital | 220,627 | 197,747 | ||||||||||
Deferred stock compensation | — | (381 | ) | |||||||||
Accumulated other comprehensive loss | (781 | ) | (873 | ) | ||||||||
Accumulated deficit | (160,941 | ) | (175,326 | ) | ||||||||
Total shareholders’ equity | 59,457 | 21,697 | ||||||||||
Total liabilities, redeemable convertible preferred stock, and shareholders’ equity | $ | 283,626 | $ | 325,722 | ||||||||
See Notes to Condensed Consolidated Financial Statements
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ASPECT COMMUNICATIONS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data-unaudited)
Three Months Ended | Nine Months Ended | ||||||||||||||||||
September 30, | September 30, | ||||||||||||||||||
2003 | 2002 | 2003 | 2002 | ||||||||||||||||
Net revenues: | |||||||||||||||||||
Software license | $ | 18,710 | $ | 21,529 | $ | 49,992 | $ | 62,248 | |||||||||||
Hardware | 11,582 | 16,047 | 31,905 | 51,609 | |||||||||||||||
Services: | |||||||||||||||||||
Software license updates and product support | 54,558 | 49,742 | 160,518 | 154,046 | |||||||||||||||
Professional services and education | 7,779 | 9,183 | 24,047 | 31,214 | |||||||||||||||
Services | 62,337 | 58,925 | 184,565 | 185,260 | |||||||||||||||
Total net revenues | 92,629 | 96,501 | 266,462 | 299,117 | |||||||||||||||
Cost of revenues: | |||||||||||||||||||
Cost of software license revenues | 4,896 | 42,581 | 12,184 | 53,606 | |||||||||||||||
Cost of hardware revenues | 9,314 | 12,655 | 28,365 | 45,212 | |||||||||||||||
Cost of services revenues | 25,333 | 29,846 | 77,550 | 98,611 | |||||||||||||||
Total cost of revenues | 39,543 | 85,082 | 118,099 | 197,429 | |||||||||||||||
Gross margin | 53,086 | 11,419 | 148,363 | 101,688 | |||||||||||||||
Operating expenses: | |||||||||||||||||||
Research and development | 12,274 | 13,563 | 37,934 | 44,080 | |||||||||||||||
Selling, general and administrative | 26,809 | 36,319 | 77,271 | 118,774 | |||||||||||||||
Restructuring charges | — | 22,699 | 2,997 | 22,699 | |||||||||||||||
Total operating expenses | 39,083 | 72,581 | 118,202 | 185,553 | |||||||||||||||
Income (loss) from operations | 14,003 | (61,162 | ) | 30,161 | (83,865 | ) | |||||||||||||
Interest income | 650 | 1,013 | 2,468 | 2,941 | |||||||||||||||
Interest expense | (1,456 | ) | (2,805 | ) | (6,513 | ) | (9,145 | ) | |||||||||||
Other income (expense) | (376 | ) | 3,352 | (277 | ) | (1,467 | ) | ||||||||||||
Income (loss) before income taxes | 12,821 | (59,602 | ) | 25,839 | (91,536 | ) | |||||||||||||
Provision (benefit) for income taxes | 2,575 | 377 | 5,072 | (28,002 | ) | ||||||||||||||
Net income (loss) before cumulative effect of change in accounting principle | 10,246 | (59,979 | ) | 20,767 | (63,534 | ) | |||||||||||||
Cumulative effect of change in accounting principle | — | — | (777 | ) | (51,431 | ) | |||||||||||||
Net income (loss) | 10,246 | (59,979 | ) | 19,990 | (114,965 | ) | |||||||||||||
Accrued preferred stock dividend and accretion of redemption premium | (1,704 | ) | — | (4,647 | ) | — | |||||||||||||
Amortization of beneficial conversion feature | (349 | ) | — | (958 | ) | — | |||||||||||||
Net income (loss) attributable to common shareholders | $ | 8,193 | $ | (59,979 | ) | $ | 14,385 | $ | (114,965 | ) | |||||||||
Basic and diluted earnings (loss) per share attributable to common shareholders before cumulative effect of change in accounting principle (See Note 7) | $ | 0.11 | $ | (1.14 | ) | $ | 0.20 | $ | (1.21 | ) | |||||||||
Cumulative effect of change in accounting principle | — | — | $ | (0.01 | ) | $ | (0.98 | ) | |||||||||||
Basic and diluted earnings (loss) per share attributable to common shareholders | $ | 0.11 | $ | (1.14 | ) | $ | 0.19 | $ | (2.19 | ) | |||||||||
Basic and diluted weighted average shares outstanding | 54,612 | 52,678 | 53,834 | 52,381 |
See Notes to Condensed Consolidated Financial Statements
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ASPECT COMMUNICATIONS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands-unaudited)
Nine Months Ended | ||||||||||||
September 30, | ||||||||||||
2003 | 2002 | |||||||||||
Cash flows from operating activities: | ||||||||||||
Net income (loss) | $ | 19,990 | $ | (114,965 | ) | |||||||
Reconciliation of net income (loss) to cash provided by operating activities: | ||||||||||||
Depreciation | 18,549 | 26,814 | ||||||||||
Amortization of intangible assets and stock-based compensation | 4,256 | 11,982 | ||||||||||
Loss on disposal of assets | 297 | 2,460 | ||||||||||
Loss (gain) on extinguishment of debt | 17 | (7,249 | ) | |||||||||
Impairment of investments | — | 8,859 | ||||||||||
Non-cash interest expense on debentures | 4,409 | 6,983 | ||||||||||
Cumulative effect of change in accounting principle | 777 | 51,431 | ||||||||||
Impairment of intangible assets | 2,000 | 38,631 | ||||||||||
Deferred taxes | — | 8 | ||||||||||
Changes in operating assets and liabilities: | ||||||||||||
Accounts receivable, net | 7,645 | 19,852 | ||||||||||
Inventories | (882 | ) | 7,485 | |||||||||
Other current assets and other assets | (1,869 | ) | 4,165 | |||||||||
Accounts payable | 1,066 | 5,439 | ||||||||||
Accrued compensation and related benefits | 138 | (18 | ) | |||||||||
Other accrued liabilities | (7,429 | ) | 3,382 | |||||||||
Deferred revenues | 19,581 | 4,761 | ||||||||||
Cash provided by operating activities | 68,545 | 70,020 | ||||||||||
Cash flows from investing activities: | ||||||||||||
Purchases of investments | (134,215 | ) | (152,231 | ) | ||||||||
Proceeds from sales and maturities of investments | 145,484 | 135,519 | ||||||||||
Property and equipment purchases | (3,145 | ) | (9,463 | ) | ||||||||
Cash provided by (used in) investing activities | 8,124 | (26,175 | ) | |||||||||
Cash flows from financing activities: | ||||||||||||
Proceeds from issuance of common stock, net | 6,393 | 2,802 | ||||||||||
Proceeds from issuance of preferred stock, net | 43,564 | — | ||||||||||
Payments on capital lease obligations | (342 | ) | (592 | ) | ||||||||
Proceeds from borrowings | — | 27,000 | ||||||||||
Payments on borrowings | (5,147 | ) | (20,136 | ) | ||||||||
Payments on repurchase of convertible debentures | (128,439 | ) | (59,769 | ) | ||||||||
Cash used in financing activities | (83,971 | ) | (50,695 | ) | ||||||||
Effect of exchange rate changes on cash and cash equivalents | (281 | ) | 253 | |||||||||
Net decrease in cash and cash equivalents | (7,583 | ) | (6,597 | ) | ||||||||
Cash and cash equivalents: | ||||||||||||
Beginning of period | 66,051 | 72,564 | ||||||||||
End of period | $ | 58,468 | $ | 65,967 | ||||||||
Supplemental disclosure of cash flow information: | ||||||||||||
Cash paid for interest | $ | 2,195 | $ | 2,031 | ||||||||
Cash paid for income taxes | $ | 396 | $ | — | ||||||||
Supplemental schedule of noncash investing and financing activities: | ||||||||||||
Cancellation of restricted stock, net of issuances | $ | (56 | ) | $ | (139 | ) | ||||||
Accrued preferred stock dividend and amortization of redemption premium | $ | 4,647 | $ | — | ||||||||
Amortization of beneficial conversion feature | $ | 958 | $ | — | ||||||||
Beneficial conversion feature | $ | 17,583 | $ | — |
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See Notes to Condensed Consolidated Financial Statements
ASPECT COMMUNICATIONS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED
Note 1: Basis of Presentation
The condensed consolidated financial statements include the accounts of Aspect Communications Corporation (Aspect or the Company) and all of its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America for annual financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the nine months ended September 30, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s 2002 Annual Report on Form 10-K.
Note 2: Stock-Based Compensation
At September 30, 2003, the Company had six stock-based employee compensation plans. The Company accounts for those plans under the recognition and measurement principles of APB Opinion No. 25,Accounting for Stock Issued to Employees,and related Interpretations. The following table illustrates the effect on net income and earnings per share as if the Company had applied the fair value recognition provisions of SFAS No. 123,Accounting for Stock-Based Compensation,to stock-based employee compensation (in thousands, except per share amounts).
Three Months Ended | Nine Months Ended | |||||||||||||||
SFAS No. 123 | September 30, | September 30, | ||||||||||||||
2003 | 2002 | 2003 | 2002 | |||||||||||||
Net income (loss) attributable to common shareholders | $ | 8,193 | $ | (59,979 | ) | $ | 14,385 | $ | (114,965 | ) | ||||||
Deduct: | ||||||||||||||||
Total stock-based employee compensation expense determined under fair value method for all awards | (2,035 | ) | (2,787 | ) | (6,763 | ) | (12,476 | ) | ||||||||
Add back: | ||||||||||||||||
Amortization of deferred stock compensation | 173 | 122 | 446 | 443 | ||||||||||||
Pro forma net income (loss) attributable to common shareholders | $ | 6,331 | $ | (62,644 | ) | $ | 8,068 | $ | (126,998 | ) | ||||||
Basic and diluted earnings (loss) per share attributable to common shareholders: | ||||||||||||||||
As reported | $ | 0.11 | $ | (1.14 | ) | $ | 0.19 | $ | (2.19 | ) | ||||||
Pro forma | $ | 0.08 | $ | (1.19 | ) | $ | 0.11 | $ | (2.42 | ) |
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Note 3: Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market. Inventories consist of (in thousands):
September 30, | December 31, | ||||||||
2003 | 2002 | ||||||||
Raw materials | $ | 6,061 | $ | 4,643 | |||||
Work in progress | — | 31 | |||||||
Finished goods | 1,903 | 2,165 | |||||||
Total inventories | $ | 7,964 | $ | 6,839 | |||||
Note 4: Other Current Assets
Other current assets consist of (in thousands):
September 30, | December 31, | ||||||||
2003 | 2002 | ||||||||
Prepaid expenses | $ | 9,989 | $ | 8,821 | |||||
Restricted cash | 2,922 | 2,880 | |||||||
Other receivables | 1,850 | 1,963 | |||||||
Total other current assets | $ | 14,761 | $ | 13,664 | |||||
Note 5: Product Warranties
The Company generally warrants its products against certain manufacturing and other defects. These product warranties are provided for specific periods of time depending on the nature of the product, geographic location of its sale and other factors. The Company accrues for estimated product warranty claims for certain customers based primarily on historical experience of actual warranty claims as well as current information on repair costs. The product warranty reserve is not material at September 30, 2003.
The Company also indemnifies its customers against claims that its products infringe certain copyrights, patents or trademarks, or incorporate misappropriated trade secrets. The Company has not been subject to any material infringement claims by customers in the past and does not have any significant claims pending as of September 30, 2003.
Note 6: Comprehensive Income (Loss)
Comprehensive income (loss) for the three and nine months ended September 30 is calculated as follows (in thousands):
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2003 | 2002 | 2003 | 2002 | |||||||||||||
Net income (loss) | $ | 10,246 | $ | (59,979 | ) | $ | 19,990 | $ | (114,965 | ) | ||||||
Unrealized gain (loss) on investments, net | (297 | ) | 115 | (518 | ) | (14 | ) | |||||||||
Accumulated translation adjustments, net | (60 | ) | 368 | 610 | 159 | |||||||||||
Total comprehensive income (loss) | $ | 9,889 | $ | (59,496 | ) | $ | 20,082 | $ | (114,820 | ) | ||||||
Note 7: Earnings (Loss) Per Share
Basic earnings per common share (EPS) is generally calculated by dividing income available to common shareholders by the weighted average number of common shares outstanding. However, due to the Company’s issuance of redeemable convertible preferred stock (“Preferred Stock”) on January 21, 2003, which contains certain participation rights, EITF Topic D-95, “Effect of Participating Convertible Securities on the Computation of Basic Earnings” (“Topic D-95”) requires those securities to be included in the computation of basic EPS if the effect is dilutive. Furthermore, Topic D-95 requires that the dilutive effect to be included in basic EPS may be calculated using either the if-converted method or the two-class method.
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Under the basic if-converted method, the dilutive effect of the Preferred Stock’s participation rights on EPS cannot be less than the amount that would result from the application of the two-class method of computing EPS. The Company has elected to use the two-class method in calculating basic EPS.
Basic earnings per share for the three and nine months ended September 30, 2003 are calculated using the two-class method as follows (in thousands, except per share data):
Basic EPS – Two-Class Method
Three Months Ended | Nine Months Ended | |||||||||||||||||
September 30, 2003 | September 30, 2003 | |||||||||||||||||
EPS | EPS | |||||||||||||||||
Net income before cumulative effect of change in accounting principle | $ | 10,246 | $ | 20,767 | ||||||||||||||
Preferred Stock dividend accretion and amortization | (2,053 | ) | (5,605 | ) | ||||||||||||||
Net income attributable to common shareholders before cumulative effect of change in accounting principle | 8,193 | 15,162 | ||||||||||||||||
Amount allocable to common shareholders (1) | 71 | % | 72 | % | ||||||||||||||
Rights to undistributed income before cumulative effect of change in accounting principle | $ | 5,817 | $ | 0.11 | $ | 10,917 | $ | 0.20 | ||||||||||
Cumulative effect of change in accounting principle | — | $ | (777 | ) | ||||||||||||||
Amount allocable to common shareholders (1) | — | 72 | % | |||||||||||||||
Rights to undistributed cumulative effect of change in accounting principle | — | — | $ | (559 | ) | $ | (0.01 | ) | ||||||||||
Net income attributable to common shareholders | $ | 8,193 | $ | 14,385 | ||||||||||||||
Amount allocable to common shareholders (1) | 71 | % | 72 | % | ||||||||||||||
Rights to undistributed income | $ | 5,817 | $ | 0.11 | $ | 10,357 | $ | 0.19 | ||||||||||
Basic weighted average common shares outstanding | 54,612 | 53,834 | ||||||||||||||||
(1) | Weighted average common shares outstanding | 54,612 | 53,834 | |||||||||||||||
Weighted average additional common shares assuming conversion of Preferred Stock | 22,222 | 20,494 | ||||||||||||||||
Weighted average common equivalent shares assuming conversion of Preferred Stock | 76,834 | 74,328 | ||||||||||||||||
Amount allocable to common shareholders | 71 | % | 72 | % |
Diluted EPS
Three Months Ended | ||||
September 30, 2003 | ||||
Net income before cumulative effect of change in accounting principle | $ | 10,246 | ||
Preferred Stock dividend accretion and amortization | ||||
Net income attributable to common shareholders before cumulative effect of change in accounting principle | ||||
Weighted average common shares outstanding | 54,612 | |||
Dilutive effect of stock options | 5,133 | |||
Dilutive effect of Preferred Stock assuming conversion | 22,222 | |||
Diluted weighted average shares outstanding | 81,967 | |||
$ | 0.13 | * | ||
Diluted earnings per share before cumulative effect of change in accounting principle | ||||
Cumulative effect of change in accounting principle | ||||
Diluted earnings per share attributable to common shareholders | $ | 0.11 | ||
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Nine Months Ended | ||||
September 30, 2003 | ||||
Net income before cumulative effect of change in accounting principle | $ | 20,767 | ||
Preferred Stock dividend accretion and amortization | (5,605 | ) | ||
Net income attributable to common shareholders before cumulative effect of change in accounting principle | $ | 15,162 | ||
Weighted average common shares outstanding | 53,834 | |||
Dilutive effect of stock options | 2,513 | |||
Dilutive effect of Preferred Stock assuming conversion | — | |||
Diluted weighted average shares outstanding | 56,347 | |||
Diluted earnings per share before cumulative effect of change in accounting principle | $ | 0.20 | ||
Cumulative effect of change in accounting principle | $ | (0.01 | ) | |
Diluted earnings per share attributable to common shareholders | $ | 0.19 | ||
*Diluted earnings per share cannot be greater than basic earnings per share. Therefore, reported diluted earnings per share and basic earnings per share for the three and nine months ended September 30, 2003 were the same. The diluted earnings per share calculation for the three months ended September 30, 2003 excluded shares issuable from the convertible subordinated debentures, as the inclusion of these shares would have been anti-dilutive but included the shares issuable from the redeemable convertible preferred stock as the inclusion was dilutive. The diluted earnings per share calculation for the nine months ended September 30, 2003 excluded shares issuable from the conversion of redeemable convertible preferred stock and convertible subordinated debentures, as the inclusion of these shares would have been anti-dilutive. The Company had approximately 12 million common stock options outstanding at September 30, 2003 that could potentially dilute basic earnings per share.
For the three and nine months ended September 30, 2002, basic loss per share is computed using the weighted average number of common shares outstanding during the period. Diluted EPS includes the dilutive impact of convertible subordinated debentures, redeemable convertible preferred stock, stock options and restricted stock awards. Basic and diluted loss per share for the three and nine months ended September 30, 2002 are calculated as follows (in thousands, except per share data):
Three Months | Nine Months | |||||||
Ended | Ended | |||||||
September 30, 2002 | September 30, 2002 | |||||||
Net loss before cumulative effect of change in accounting principle | $ | (59,979 | ) | $ | (63,534 | ) | ||
Weighted average shares outstanding | 52,790 | 52,495 | ||||||
Weighted average shares of restricted common stock | (112 | ) | (114 | ) | ||||
Shares used in calculation, basic | 52,678 | 52,381 | ||||||
Basic and diluted loss per share before cumulative effect of change in accounting principle | $ | (1.14 | ) | $ | (1.21 | ) | ||
Cumulative effect of change in accounting principle | $ | (0.98 | ) | |||||
Basic and diluted loss per share attributable to common shareholders | $ | (1.14 | ) | $ | (2.19 | ) | ||
The Company had approximately 13.5 million common stock options outstanding as of September 30, 2002, which could potentially dilute basic earnings per share in the future. The dilutive effect of these options were excluded from the computation of diluted earnings per share for the three and nine months ended September 30, 2002 because inclusion of these shares would have had an anti-dilutive effect, as the Company had a net loss for the three and nine months ended September 30, 2002. Based on the accreted value of the convertible subordinated debentures of $123 million and the ending stock price of $1.47 on the last trading day for the period ended September 30, 2002, the Company also had 83.8 million shares of common stock issuable upon conversion of the convertible subordinated debentures which were excluded because inclusion of these shares had an anti-dilutive effect. In addition, the Company had 109,950 shares of restricted common stock outstanding at September 30, 2002. The dilutive effect of these shares was not included in the calculation for the three and nine months ended September 30, 2002 because this inclusion would have been anti-dilutive.
Note 8: Restructuring Charge
In fiscal years 2002 and 2001, the Company reduced its workforce by 22% and 28%, respectively, and consolidated selected facilities in its continuing effort to better optimize operations. As of September 30, 2003, the total restructuring accrual was $17.9 million, of which $7.8 million was recorded in other accrued liabilities, and $10.1 million was recorded as a long-term liability. Components of the restructuring accrual were as follows (in thousands):
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Severance and | Consolidation of | Other Restructuring | ||||||||||||||
Outplacement | Facilities Costs | Costs | Total | |||||||||||||
2001 provisions | $ | 12,854 | $ | 22,628 | $ | 733 | $ | 36,215 | ||||||||
2001 adjustments | (1,269 | ) | 9,525 | (489 | ) | 7,767 | ||||||||||
2001 property write-downs | — | (3,091 | ) | — | (3,091 | ) | ||||||||||
2001 payments | (9,428 | ) | (1,555 | ) | (143 | ) | (11,126 | ) | ||||||||
Balance at December 31, 2001 | 2,157 | 27,507 | 101 | 29,765 | ||||||||||||
2002 provisions | 7,120 | 1,744 | — | 8,864 | ||||||||||||
2002 adjustments | (534 | ) | 14,074 | — | 13,540 | |||||||||||
2002 property write-downs | — | (1,744 | ) | — | (1,744 | ) | ||||||||||
2002 payments | (7,459 | ) | (21,622 | ) | — | (29,081 | ) | |||||||||
Balance at December 31, 2002 | 1,284 | 19,959 | 101 | 21,344 | ||||||||||||
2003 adjustments | (346 | ) | 3,343 | — | 2,997 | |||||||||||
2003 payments | (791 | ) | (5,538 | ) | (101 | ) | (6,430 | ) | ||||||||
Balance at September 30, 2003 | $ | 147 | $ | 17,764 | $ | — | $ | 17,911 | ||||||||
Severance and outplacement costs are related to the termination of employees in 2001 and 2002. Employee separation costs include severance and other related benefits. Functions impacted by the restructuring included sales and sales infrastructure, support services, manufacturing, marketing, research and development, and corporate functions. In the second quarter of 2003, the Company reduced its estimate of remaining severance and outplacement costs. The remaining balance of $147,000 relates to the July 2002 and December 2002 provisions and will be paid by the end of 2003.
Consolidation of facilities costs includes rent of unoccupied facilities, net of expected sublease income, and write-offs of abandoned internal use software assets. The Company revised its estimate of future facility related obligations and increased the accrual by approximately $3 million in the second quarter of 2003 due to an increase in the estimate of the period of time necessary to sublet abandoned facilities as a result of the then-current real estate market conditions. The remaining accrual balance relates primarily to facilities identified in the 2001 restructurings and will be paid over the next six years.
Note 9: Convertible Subordinated Debentures
In August 1998, the Company completed a private placement of approximately $150 million ($490 million principal amount at maturity) of zero coupon convertible subordinated debentures due 2018. The debentures are priced at a yield to maturity of 6% per annum and are convertible into the Company’s common stock anytime prior to maturity at a conversion rate of 8.713 shares per $1,000 principal amount at maturity. Holders could require the Company to repurchase the debentures on August 10, 2003, August 10, 2008, and August 10, 2013, for cash, or at the election of the Company, for the Company’s common stock, if certain conditions are met. The debentures are not secured by any of the Company’s assets and are subordinated in right of payment to all of the Company’s senior indebtedness and effectively subordinated to the debt of Aspect’s subsidiaries.
In 2002, the Company paid $59.8 million to repurchase convertible subordinated debentures in the open market, resulting in a gain on extinguishment of debt of approximately $7 million and reducing the principal amount of the convertible debentures due at maturity from $490 million to $314 million. In the first quarter of 2003 the Company paid $5.6 million to repurchase convertible debentures in the open market. These repurchases reduced the principal amount of the convertible debentures due at maturity from $314 million to $300 million. On July 15, 2003, the Company issued a repurchase notice to all holders of its currently outstanding zero coupon convertible subordinated debentures. Debenture holders had the option to surrender their debentures to the Company for repurchase. The repurchase price was $412 for each $1,000 principal amount at maturity, and holders were required to surrender their debentures to the trustee on or prior to August 11, 2003. On August 12, 2003, the business day following the repurchase date, the Company paid $122.8 million to repurchase the surrendered notes, which represented 99% of the outstanding convertible subordinated debentures. As of September 30, 2003 there was $2.3 million in principal amount at maturity of debentures outstanding with an aggregate cash repurchase price of approximately $1 million. Upon the terms of the debentures, the Company may redeem the remaining outstanding debentures in whole or in part at its option at any time on or after August 12, 2003, at a price equal to the issue price plus the accrued original issue discount up to the redemption date.
Note 10: Lines of Credit and Borrowings
On August 9, 2002, the Company entered into a Credit Agreement with Comerica Bank-California as administrative agent and CIT Business Credit as collateral agent that provides the Company with a $25 million revolving loan facility and a $25 million senior secured term loan. The revolver has a three-year term and is secured by all of the Company’s assets, a negative
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pledge of stock in the Company’s foreign and domestic subsidiaries. The Company’s borrowing options under the revolver include a Eurocurrency Rate and a Base Rate plus the applicable margins adjusted on a quarterly basis. Availability under the revolver also includes up to $5 million in the aggregate in stand-by letters of credit. As of September 30, 2003, the Company had no amounts outstanding under the revolver and had utilized $1.1 million in letters of credit. The term loan has a four-year term. The term loan is also secured by all of the Company’s assets, a negative pledge on the Company’s intellectual property and a pledge of stock in the Company’s foreign and domestic subsidiaries. The Company’s borrowing options under the term loan include a Eurocurrency Rate and Base Rate plus applicable margins. As of September 30, 2003, the Company had $18.8 million outstanding under the term loan with the applicable interest rate of 4.10%.
In the event that the Company terminates the term loan prior to the maturity date, the lenders will receive a prepayment penalty fee from the Company. Proceeds from certain financing transactions are required to be used to prepay the credit facilities. Transactions that require 100% of the proceeds to be used to prepay the credit facilities include permitted asset sales and future debt issuances. In addition, 50% of the proceeds from future equity issuances, excluding the proceeds from the Series B convertible preferred stock issuance described in Note 11, must be used to prepay the credit facilities. The facilities can be used for working capital, general corporate purposes and to repurchase the Company’s outstanding convertible subordinated debt. The Credit Agreement includes customary representations and warranties and covenants. The financial covenants include unrestricted cash, liquidity ratio, fixed charge coverage ratio, tangible net worth and earnings before interest expense, income taxes, depreciation and amortization (EBITDA). During the first quarter of 2003, the Company signed Amendment No. 1 to the Credit Agreement. This amendment clarified the accounting for the redeemable convertible preferred stock in the covenant computations, revised the liquidity ratio and the tangible net worth covenant requirements, and gave bank consent for the repurchase of 100% of the convertible subordinated debentures with cash. During the second quarter of 2003, the Company signed Amendment No. 2 to the Credit Agreement. This amendment extended the deadline by which the stock of certain subsidiaries of the Company was required to be pledged as collateral. The Company was in compliance with all related covenants and restrictions as of September 30, 2003.
In October 2001, the Company entered into a 5-year loan with Fremont Bank in the amount of $25 million which bears interest at an initial rate of 8% which is then re-measured semi-annually beginning May 2002 at the rate of LIBOR + 3.75% subject to a floor of 8% and a ceiling of 14%. During the third quarter of 2003, the Company signed a letter agreement to amend the Loan and Security Agreement. This amendment reduced the floor rate to 7% effective September 1, 2003. The loan is secured by a security interest in the Company owned buildings in San Jose. Borrowings are payable in equal monthly installments including interest computed on a 20-year amortization schedule until November 1, 2006, at which time the outstanding loan balance will become payable. At September 30, 2003, the Company had $24 million outstanding under this loan. The bank also required that the Company supply a $3 million letter of credit, which is recorded as restricted cash in other assets on the balance sheet as of September 30, 2003.
In addition to the line of credit, the Company has two outstanding bank guarantees with a European bank, which are required for daily operations such as payroll, import/export duties and facilities. As of September 30, 2003, approximately $3 million is recorded as restricted cash in other current assets on the balance sheet related to these bank guarantees.
Note 11: Convertible Preferred Stock
On January 21, 2003, the Company and Vista Equity Fund II, L.P. (“Vista”) closed a private placement for the sale of $50 million of the Company’s Series B convertible preferred stock. The shares of Series B convertible preferred stock were sold for $1,000 per share and the holders of the 50,000 outstanding shares of Series B convertible preferred stock are entitled to vote (on an as-converted basis) on all matters subject to a stockholder vote. On most issues, the holders of Series B preferred stock and common stock vote together as a single class; however, the holders of Series B convertible preferred stock have veto rights with respect to certain Company actions. The actions which require the affirmative vote of the holders of a majority of the outstanding shares of Series B convertible preferred stock are fully described in the Company’s Certificate of Determination of Rights, Preferences and Privileges of Series B Convertible Preferred Stock. The shares of Series B convertible preferred stock are initially convertible into 22.2 million shares of the Company’s common stock (subject to certain anti-dilution protection adjustments) and are mandatorily redeemable at 125% of the face value on January 21, 2013. Each holder of the Series B convertible preferred stock has the right, at any time, to convert all or a portion of its outstanding shares of Series B convertible preferred stock into shares of Common Stock. As more fully described in the Company’s Certificate of Determination of Rights, Preferences and Privileges of Series B Convertible Preferred Stock, the Company may elect to cause all, or under certain circumstances portions, of the outstanding shares of Series B convertible preferred stock to be converted into Common Stock. In order for the Company to cause such a conversion to occur, all the shares issued pursuant to such conversion must be sold pursuant to an underwritten public offering of Common Stock pursuant to an effective registration statement under the Securities Act in which the price per share paid by the public exceeds $8.00 (subject to adjustments to
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reflect any stock dividends, stock splits and the like) and the Company would need to notify each holder of Series B convertible preferred stock no later than ten business days prior to the conversion date. Prior to such offering, the holder could convert all or a portion of its shares into Common Stock to avoid selling such shares in such offering.
The shares of Series B convertible preferred stock have a liquidation preference over the shares of common stock such that (i) upon any liquidation, dissolution or winding up of the Company, the holders of Series B convertible preferred stock receive payments equal to 100% of their investment amount, plus unpaid dividends prior to payments to the holders of common stock, or (ii) in the event of a change of control of the Company, the holders of Series B convertible preferred stock receive payments equal to 125% of their investment amount, plus unpaid dividends prior to payments to the holders of common stock (or, in each case, if greater, the amount they would have received had the Series B convertible preferred stock converted to common stock immediately prior to such liquidation or change of control). Additionally, in the event that the Company declares a dividend or distribution to the holders of common stock, the holders of Series B convertible preferred stock shall be entitled to equivalent participation on an as if converted basis in such dividend or distribution.
Per the private placement agreement, the Company is now obligated to accrue dividends on each share of the Series B convertible preferred stock, compounded on a daily basis at the rate of 10% per annum. The undeclared preferred stock dividends are forfeited in the event of conversion. Accrued dividends were $1.3 million and $3.6 million for the three months and nine months ended September 30, 2003. In addition to the dividend accrual, the Company is recording accounting charges associated with the accretion of the 125% redemption premium and the amortization of the beneficial conversion feature. The redemption premium of $17.8 million is calculated based on a redemption value of $62.5 million. Accretion of the redemption premium was $382,000 and $1.1 million for the three months and nine months ended September 30, 2003. The beneficial conversion feature of $17.6 million is computed based on the difference between the conversion price of the preferred equity and the fair market value of the Company’s common stock on January 21, 2003. Amortization of the beneficial conversion feature was $349,000 and $1.0 million for the three months and nine months ended September 30, 2003. These amounts are being amortized using the net interest method.
The sale and issuance of the Series B convertible preferred stock to Vista followed the approval of the transaction by the Company’s shareholders at the Special Meeting of Shareholders on January 21, 2003. Pursuant to Vista’s contractual rights, following the sale and issuance of the Series B convertible preferred stock, Vista elected two new members to the Company’s Board of Directors.
Note 12: Accounting Change
On January 1, 2003, the Company adopted Statement of Financial Accounting Standard (SFAS) No. 143, “Accounting for Asset Retirement Obligations”. SFAS 143 applies to legal obligations associated with the retirement of long-lived assets resulting from the acquisition, construction, development and/or normal use of the underlying assets.
SFAS 143 requires the Company to recognize a liability for an asset retirement obligation in the period in which it is incurred, at its estimated fair value. The associated retirement costs are capitalized as part of the carrying amount of the underlying asset and depreciated over the estimated useful life of the asset. The liability is accreted through charges to operating expenses. If the asset retirement obligation is settled for other than the carrying amount of the liability, the Company will then recognize a gain or loss on settlement.
With the adoption of SFAS 143, the Company recorded all asset retirement obligations, at estimated fair value, for which the Company has legal obligations. Essentially all of these asset retirement obligations are related to the restoration and refurbishment of leasehold improvements for leased properties. This accounting change resulted in an increase in long-term assets of $0.5 million; an increase in long-term liabilities of $1.2 million and in short term liabilities of $0.2 million; and a cumulative effect of adoption that reduced shareholders’ equity and 2003 net earnings by $0.8 million. Additionally, SFAS 143 results in ongoing charges related to the depreciation of the assets and accretion of the liability. For the three and nine months ended September 30, 2003, the Company recognized SFAS 143 related operating charges totaling $118,000 and $192,000, respectively. For the three and nine months ended September 30, 2002, SFAS 143 related operating charges would have been immaterial and, therefore, pro forma amounts are not presented on the Statement of Operations. The balance of the Company’s asset retirement obligation at September 30, 2003 was $1.5 million.
Note 13: Recent Accounting Pronouncements
SFAS No. 149
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In April 2003, the Financial Accounting Standard Board (FASB) issued SFAS No. 149,Amendment of Statement 133 on Derivative Instruments and Hedging Activities.SFAS 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS 133,Accounting for Derivatives and Hedging Activities.SFAS 149 is generally effective for derivative instruments, including derivative instruments embedded in certain contracts, entered into or modified after June 30, 2003. The adoption of SFAS 149 did not have a material impact on the operating results or financial condition of the Company.
SFAS No. 150
In May 2003, the FASB issued SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity”. SFAS 150 clarifies the accounting for certain financial instruments with characteristics of both liabilities and equity and requires that those instruments be classified as liabilities in statements of financial position. Previously, many of those financial instruments were classified as equity. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. As the Company does not have any of these financial instruments, the adoption of SFAS 150 did not have any impact on the Company’s consolidated financial statements.
Note 14: Segment Information
Under SFAS No. 131,Disclosures about Segments of an Enterprise and Related Information,the Company’s operations are reported in two operating segments, which are product and services. All financial segment information required by SFAS No. 131 is disclosed in the consolidated financial statements.
Note 15: Contingencies
The Company is from time to time involved in litigation or claims that arise in the normal course of business. The Company does not expect that any current litigation or claims will have a material adverse effect on the Company’s business, operating results, or financial condition. However, litigation in general, and intellectual property litigation in particular, can be expensive and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. The Company believes that it has defenses to the case set forth below and is vigorously contesting this matter.
In December 2000, the Company entered into a Master Services Agreement (the “Master Agreement”) with Electronic Data Systems Corporation (EDS) pursuant to which the Company agreed to outsource certain of its information technology (IT) needs to EDS. A dispute has arisen between the parties over the services and charges to be performed and paid under the Master Agreement. In May 2003, the Company terminated the Master Agreement for EDS’ breach of the Master Agreement. On May 20, 2003, EDS made a demand for arbitration with the American Arbitration Association pursuant to the Master Services Agreement. EDS alleges that the Company breached the Master Agreement and implied warranties associated with the Master Agreement, committed fraud, engaged in negligent misrepresentation and therefore EDS is entitled to approximately $26 million in damages plus reasonable attorneys’ fees. On June 11, 2003, the Company filed its answer and counterclaims pursuant to which the Company denied every allegation made by EDS, denied that EDS is owed any amount in damages, and counterclaimed that EDS breached the Master Agreement, committed fraud, engaged in fraudulent and unfair business practices and therefore the Company is entitled to damages, restitution and disgorgement in an amount to be proven in the arbitration. The arbitration hearing is scheduled to begin February 17, 2004.
Note 16: Subsequent Events
On October 1, 2003, the Company and MCI WorldCom Communications, Inc. (“MCI”) executed an amendment of the Global Services Agreement between the parties pursuant to which MCI provides certain telecommunications and managed network services to the Company. Among other things, the amendment provided for the reduction of the Company’s minimum annual purchase commitment from $14 million to $7 million and extended the term of the agreement from an expiration of April 2006, to an expiration in 2009, six years from the amendment date. The reduction in the minimum annual purchase commitment will result in the reversal of $3.7 million in accrued expenses in the fourth quarter of 2003. Such amendment commenced effective as of September 30, 2003 after the official committee of unsecured creditors in MCI’s bankruptcy approved the terms of such amendment on October 14, 2003 and the order of the Bankruptcy Court became non-appealable on October 24, 2003.
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Item 2.Management’s Discussion And Analysis Of Financial Condition And Results Of Operations
The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto included in Part I-Item 1 of this Quarterly Report and the audited consolidated financial statements and notes thereto and Management’s Discussion and Analysis in the Company’s 2002 Annual Report on Form 10-K.
Forward-looking Statements
The matters discussed in this report including, but not limited to, statements relating to (i) the Company’s anticipated gross margin levels; (ii) changes in anticipated spending levels in capital expenditures, research and development, selling, general and administrative expenses; and (iii) the adequacy of our financial resources to meet currently anticipated cash flow requirements for the next twelve months are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended; Section 21E of the Securities and Exchange Act of 1934, as amended; and the Private Securities Litigation Reform Act of 1995; and are made under the safe-harbor provisions thereof. Forward-looking statements may be identified by phrases such as “we anticipate”, “are expected to”, and “on a forward-looking basis”, and are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in such forward-looking statements. Specific factors that could cause actual earnings per share results to differ include a potentially prolonged period of generally poor economic conditions that could impact our customers’ purchasing decisions; the hiring and retention of key employees; changes in product line revenues; insufficient, excess, or obsolete inventory and variations in valuation; and foreign exchange rate fluctuations. For a discussion of these and other risks related to our business, see the section entitled “Business Environment and Risk Factors” below. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date hereof. Aspect undertakes no obligation to publicly release any revision to these forward-looking statements that may be made to reflect events or circumstances after the date hereof.
Background
Aspect Communications Corporation (Aspect or the Company) is one of the world’s largest companies focused exclusively on contact center solutions, and one of the only ones that unifies workforce, information and communications to deliver exceptional customer service. The Aspect brand is trusted by more than 75 percent of the Fortune 50, and more than three million customer sales and service professionals worldwide rely on Aspect’s mission-critical business communications solutions. The Company’s leadership is based on 18 years of expertise gained from more than 8,000 successful implementations worldwide. Aspect is headquartered in San Jose, California, with 24 offices in 11 countries around the world.
Aspect has expertise in providing the software and hardware platforms that serve all customers, any place and through any wired or wireless media, by being able to connect them to the appropriate resource, functionality or application – even to those outside of the company. Aspect is a leader in building multi-channel contact centers that serve as the foundation of any successful Customer Relationship Management (CRM) strategy. With its mission-critical solution, Aspect offers a business communications platform today and a migration path that allows businesses to leverage their existing infrastructure as they move to the converged network of tomorrow.
Critical Accounting Policies
Note 1 of the Notes to the Consolidated Financial Statements in the Company’s 2002 Annual Report on Form 10-K includes a summary of the significant accounting policies and methods used in the preparation of Company’s Consolidated Financial Statements.
The preparation of financial statements in conformity with accounting standards generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. The most significant estimates and assumptions relate to the allowance for doubtful accounts, revenue reserves, excess and obsolete inventory, impairment of long-lived assets, valuation allowance and realization of deferred income taxes, and restructuring reserve. Actual amounts could differ significantly from these estimates.
Aspect’s critical accounting policies include revenue recognition, revenue reserves, allowance for doubtful accounts, accounting for income taxes, excess and obsolete inventory, impairment of long-lived assets and restructuring reserve. The following is a brief discussion of the critical accounting policies and methods used by the Company.
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Revenue recognition:The Company derives its revenue primarily from two sources (i) product revenues, which include software licenses and hardware, and (ii) service revenues, which include software license updates and product support, installation, consulting and education revenue.
The Company applies the provisions of Statement of Position 97-2, “Software Revenue Recognition”, as amended by Statement of Position 98-9, “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions” and certain provisions of Staff Accounting Bulletin (SAB) No. 101, “Revenue Recognition in Financial Statements” to all transactions involving the sale of software products and hardware.
The Company recognizes revenue from the sale of software licenses and hardware when persuasive evidence of an arrangement exists, the product has been delivered, title and risk of loss have transferred to the customer, the fee is fixed or determinable and collection of the resulting receivable is probable. Delivery generally occurs when product is delivered to a common carrier.
At the time of the transaction, the Company assesses whether the fee associated with its revenue transactions is fixed or determinable and whether collection is probable. The assessment of whether the fee is fixed or determinable is based partly on the payment terms associated with the transaction and financial strength of the customer. If a significant portion of a fee is due after its normal payment terms, which are 30 to 90 days from invoice date, the Company accounts for the fee as not being fixed or determinable; in which case, the Company recognizes revenue as the fees become due.
The Company assesses collection based on a number of factors, including past transaction history with the customer and the credit worthiness of the customer. The Company does not typically request collateral from its customers. If the Company determines that collection of a fee is not probable, then the Company will defer the fee and recognize revenue upon receipt of cash.
For arrangements with multiple elements, the Company allocates revenue to each component of the arrangement using the residual value method based on vendor specific objective evidence of the undelivered elements. This means that the Company defers the arrangement fee equivalent to the fair value of the undelivered elements until these elements are delivered. The fair value of each element is determined based on prices of stand-alone sales of these elements to third parties.
A key part of the Company’s overall strategy is to increase sales through indirect channels such as Value Added Resellers (VARs) and partnering with System Integrators (SIs) and Technology Alliances (TAs) on the direct sales efforts. In any sales transaction through a distributor or reseller, the Company recognizes revenue when the distributor or reseller sells to the end customer.
The Company recognizes revenue for maintenance services ratably over the contract term. The training and consulting services are billed based on hourly rates, and the Company generally recognizes revenue as these services are performed. However, at the time of entering into a transaction, the Company assesses whether any services included within the arrangement are essential to the functionality of other elements of the arrangement. If services are determined to be essential to other elements of the arrangement, the Company recognizes the license, consulting and training revenue using the percentage-of-completion method. The Company estimates the percentage of completion based on its estimate of the total costs estimated to complete the project as a percentage of the costs incurred to date and the estimated costs to complete. To date, the amount of revenue recognized under the percentage-of-completion method has not been significant.
Revenue reserves:An estimate of the revenue reserve for losses on receivables resulting from customer returns is recorded as a reduction in revenues. The revenue reserve is estimated based on an analysis of the historical rate of returns of product and services arrangements. The accuracy of the estimate is dependent on the rate of future returns being consistent with the historical rate. If the rate of actual returns is greater than the historical rate, then the revenue reserve may not be sufficient to provide for actual losses. The revenue reserve was $1.6 million as of September 30, 2003.
Allowance for doubtful accounts:The Company’s management must make estimates of the uncollectibility of accounts receivable. Management specifically analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. The accounts receivable balance was $46 million, net of allowance for doubtful accounts of $4.7 million as of September 30, 2003.
Accounting for income taxes:As part of the process of preparing its consolidated financial statements, the Company is required to estimate its income taxes in each of the tax jurisdictions in which the Company operates. This process involves management’s estimation of the Company’s actual current tax exposure together with an assessment of temporary differences resulting from different treatments in tax and accounting of certain items. These differences result in net deferred tax assets and liabilities, which are included within the consolidated balance sheet. The Company must then assess the likelihood that the
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deferred tax assets will be recovered from future taxable income and to the extent the Company believes that recovery is not likely, the Company must establish a valuation allowance. To the extent the Company establishes a valuation allowance or adjusts this allowance in a period, the Company must include a tax benefit or expense within the tax provision in the statement of operations.
Significant management judgment is required in determination of the provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against net deferred tax assets. The Company has a valuation allowance of $84 million as of September 30, 2003, due to uncertainties related to the Company’s ability to utilize all of its deferred tax assets, primarily consisting of certain net operating losses carried forward and research tax credits, before they expire. The valuation allowance is based on estimates of taxable income by jurisdiction in which the Company operates and the period over which the deferred tax assets will be recoverable. In the event that actual results differ from these estimates or the Company adjusts these estimates in future periods, the Company may need to adjust its valuation allowance, which could favorably impact its results of operations.
Excess and obsolete inventory:The Company values inventory at the lower of the actual cost or the current estimated net realizable value of the inventory. Management regularly reviews inventory quantities on hand and records a provision for excess and obsolete inventory based primarily on production and supply requirements. Management’s estimates of future production and supply requirements may prove to be inaccurate, in which case inventory may be understated or overstated. In the future, if the carrying value of the inventory were not realizable, the Company would be required to recognize write-downs to net realizable value as additional cost of goods sold at the time of such determination. Although management makes every effort to ensure the accuracy of its forecast of future production requirements and supply, any unanticipated changes in technological developments could have a significant impact on the value of our inventory and our reported operating results.
Impairment of long-lived assets:The Company’s long-lived assets include property and equipment, long term investments, goodwill and other intangible assets. The fair value of the long-term investments is dependent on the performance of the companies in which the Company has invested, as well as volatility inherent in the external markets for these investments. In assessing potential impairment for these investments, the Company considers these factors as well as the forecasted financial performance of its investees. The Company records an investment impairment charge when it believes an investment has experienced a decline in value that is other than temporary. During 2002, the Company recognized $9 million of impairment losses related to its long-term investments. As of September 30, 2003, the carrying value of the Company’s long-term investments was $150,000.
In assessing the recoverability of the Company’s property and equipment, goodwill and other intangible assets, the Company must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. If these estimates or their related assumptions change in the future, the Company may be required to record impairment charges for these assets.
In June 2001, the FASB issued SFAS No. 142,Goodwill and Other Intangible Assets. SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 provides that intangible assets with finite useful lives will be amortized and that goodwill and intangible assets with indefinite lives will not be amortized, but will rather be tested at least annually for impairment. The Company adopted SFAS No. 142 for its fiscal year beginning January 1, 2002. Upon adoption of SFAS No. 142, the Company discontinued the amortization of its recorded goodwill, identified its reporting units based on its current segment reporting structure and allocated all recorded goodwill, as well as other assets and liabilities, to the reporting units.
The Company determined the fair value of its reporting units utilizing discounted cash flow models and relative market multiples for comparable businesses. The Company compared the fair value of each of its reporting units to its carrying value. This evaluation indicated that an impairment might exist for the Company’s Products reporting unit. The Company then performed Step 2 under SFAS No. 142 during the second quarter of 2002 and compared the carrying amount of goodwill in the Products reporting unit to the implied fair value of the goodwill and determined that an impairment loss existed. This impairment is primarily attributable to the change in the evaluation criteria for goodwill from an undiscounted cash flow approach, which was previously utilized under the guidance in Accounting Principle Board Opinion No. 17Intangible Assets,to the fair value approach, which is stipulated in SFAS No. 142 and the requirement under SFAS No. 142 to evaluate goodwill impairment at the reporting unit level. A non-cash charge totaling $51.4 million was recorded as a change in accounting principle effective January 1, 2002, to write-off the goodwill related to the Products segment. The remaining recorded goodwill for the Services segment is $2.7 million as of September 30, 2003. In the first quarter of 2003, the Company performed an annual test on the remaining goodwill per SFAS No. 142 requirements and found no additional impairment existed.
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During the third quarter of 2002, the Company identified indicators of impairment of acquired assets relating to previous acquisitions. These indicators included the deterioration in the business outlook, recent changes in strategic plans and revised future net cash flow for certain acquired intangible assets. Therefore, the Company compared these future net cash flows to the respective carrying amounts attributable to the acquired intangible assets and determined that an impairment existed. As a result, during the third quarter of 2002, the Company recorded a total impairment charge of $38.6 million. Of this charge, $37.6 million related to acquired technology and was recorded within cost of revenues, while $1.0 million related to customer base and sales channels acquired and was recorded within selling, general and administrative expenses.
During the third quarter of 2003, the Company recorded an impairment charge of $2.0 million related to a software license agreement that had been identified as having no future viability within the Company’s product line. The charge was recorded within cost of revenues.
Restructuring reserve:In fiscal years 2002 and 2001, the Company reduced its workforce by 22% and 28%, respectively, and consolidated selected facilities in its continuing effort to better optimize operations. At that time a restructuring reserve was established based on estimated costs for severance and outplacement, consolidation of facilities, legal and other. Due to the decline in the commercial real estate market, it was expected that the abandoned leased facilities would be vacant for several quarters or through the end of the lease term. If the facilities were subleased, it would be at rates below current contractual requirements. The Company recorded a charge related to the facilities abandonment, based on the difference between the expected cash outflows and the expected cash inflows related to these vacated properties. The Company periodically reviews factors such as further declines in the commercial real estate markets and its ability to terminate leases, and based on these reviews, the Company adjusts its restructuring reserve, as necessary. The restructuring reserve balance was $17.9 million as of September 30, 2003.
Results of Operations
The following table sets forth statements of operations data for the three and six months ended September 30, 2003 and 2002 expressed as a percentage of total revenues:
Three Months Ended | Nine Months Ended | ||||||||||||||||||
September 30, | September 30, | ||||||||||||||||||
2003 | 2002 | 2003 | 2002 | ||||||||||||||||
Net revenues: | |||||||||||||||||||
Software license | 20 | % | 22 | % | 19 | % | 21 | % | |||||||||||
Hardware | 13 | % | 17 | % | 12 | % | 17 | % | |||||||||||
Services: | |||||||||||||||||||
Software license updates and product support | 59 | % | 51 | % | 60 | % | 52 | % | |||||||||||
Professional services and education | 8 | % | 10 | % | 9 | % | 10 | % | |||||||||||
Services | 67 | % | 61 | % | 69 | % | 62 | % | |||||||||||
Total net revenues | 100 | % | 100 | % | 100 | % | 100 | % | |||||||||||
Cost of revenues: | |||||||||||||||||||
Cost of software license revenues | 5 | % | 44 | % | 5 | % | 18 | % | |||||||||||
Cost of hardware revenues | 10 | % | 13 | % | 10 | % | 15 | % | |||||||||||
Cost of services revenues | 28 | % | 31 | % | 29 | % | 33 | % | |||||||||||
Total cost of revenues | 43 | % | 88 | % | 44 | % | 66 | % | |||||||||||
Gross margin | 57 | % | 12 | % | 56 | % | 34 | % | |||||||||||
Operating expenses: | |||||||||||||||||||
Research and development | 13 | % | 14 | % | 15 | % | 15 | % | |||||||||||
Selling, general and administrative | 29 | % | 38 | % | 29 | % | 40 | % | |||||||||||
Restructuring charges | — | 23 | % | 1 | % | 7 | % | ||||||||||||
Total operating expenses | 42 | % | 75 | % | 45 | % | 62 | % | |||||||||||
Income (loss) from operations | 15 | % | (63 | %) | 11 | % | (28 | %) | |||||||||||
Interest income | 1 | % | 1 | % | 1 | % | 1 | % | |||||||||||
Interest expense | (2 | %) | (3 | %) | (2 | %) | (3 | %) | |||||||||||
Other income (expense) | 0 | % | 3 | % | 0 | % | (1 | %) | |||||||||||
Income (loss) before income taxes | 14 | % | (62 | %) | 10 | % | (31 | %) | |||||||||||
Provision (benefit) for income taxes | 3 | % | 0 | % | 2 | % | (10 | %) | |||||||||||
Net income (loss) before cumulative effect of change in accounting principle | 11 | % | (62 | %) | 8 | % | (21 | )% |
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Three Months Ended | Nine Months Ended | ||||||||||||||||||
September 30, | September 30, | ||||||||||||||||||
2003 | 2002 | 2003 | 2002 | ||||||||||||||||
Cumulative effect of change in accounting principle | — | — | (1 | )% | (17 | %) | |||||||||||||
Net income (loss) | 11 | % | (62 | %) | 7 | % | (38 | %) | |||||||||||
Accrued preferred stock dividend, accretion of redemption premium, and amortization of beneficial conversion feature | (2 | %) | — | (2 | %) | — | |||||||||||||
Net income (loss) attributable to common shareholders | 9 | % | (62 | %) | 5 | % | (38 | %) | |||||||||||
Revenues
Net revenuesdecreased by 4% to $92.6 million in the third quarter of 2003, from $96.5 million in the corresponding period of 2002. Net revenues for the first nine months of 2003 decreased by 11% to $266.5 million from $299.1 million in the first nine months of 2002. The decrease primarily related to a decline in net hardware sales and associated professional services, resulting from unfavorable global economic conditions. The protracted economic and business uncertainty has led to reluctance by many of our customers to resume capital spending to historical levels in 2003.
Net revenues in the Americas, which include the United States, Canada, Mexico, and Latin America, decreased by 2% to $59.8 million in the third quarter of 2003, from $61.0 million in the corresponding period of 2002 and represented 65% and 63% of the Company’s total revenue, respectively. For the first nine months of 2003, net revenues in the Americas decreased by 11% to $177.2 million, from $199.8 million in the corresponding period of 2002, both representing 67% of the Company’s total revenue. The slowdown in the U.S. economy, over-capacity, and related constraints on capital spending have led to lower capital spending in the telecommunications, financial, travel, retail, and government industries as compared with historical levels. Sales outside the Americas decreased by 8% to $32.8 million in the third quarter of 2003 from $35.5 million in the corresponding period of 2002. For the first nine months of 2003, sales outside the Americas decreased by 10% to $89.3 million from $99.4 million in the corresponding period of 2002. The decline in revenues outside the Americas was due to a weakened global economy.
Software license revenuesdecreased by 13% to $18.7 million in the third quarter of 2003, from $21.5 million in the corresponding period of 2002. Software license revenues for the first nine months of 2003 decreased by 20% to $50.0 million from $62.2 million in the first nine months of 2002. The decrease in license revenues was primarily due to a global economic downturn and business uncertainty resulting in an overall reduction in capital spending by customers.
Hardware revenuesdecreased by 28% to $11.6 million in the third quarter of 2003 from $16.0 million in the corresponding period of 2002. Hardware revenues for the first nine months of 2003 decreased 38% to $31.9 million from $51.6 million in the corresponding period of 2002. The decrease in hardware revenues was primarily due to a weakened global economy and a declining demand for traditional call center solutions.
Services revenuesoverall increased 6% to $62.3 million in the third quarter of 2003 from $58.9 million in the corresponding period of 2002. Software license updates and product support increased 10% while professional services and education decreased 15% from the corresponding period in 2002. Overall services revenues for the first nine months of 2003 remained relatively constant at approximately $185 million compared to the corresponding period of 2002. Software license updates and product support increased 10% and 4% for the third quarter and first nine months of 2003 while professional services and education decreased 15% and 23%, respectively. The increase in software license updates and product support was driven by increased contract renewals. The decrease in professional services and education services revenues resulted, primarily, from lower consulting and installation in 2003 as compared to 2002 which corresponds with lower license sales and lower product sales.
Gross Margin
Gross margin on total revenuesincreased to 57% in the third quarter of 2003 from 12% in the corresponding period of 2002. Gross margin increased to 56% for the first nine months of 2003 from 34% in the corresponding period of 2002. The decline in gross margin in 2002 was primarily due to $38 million of intangible assets impairment charges. Other changes in the Company’s gross margins generally resulted from revenue mix and from continued operating efficiencies.
Gross margin on software license revenuesincreased to 74% in the third quarter of 2003 from negative 98% in the corresponding period of 2002. Gross margin on software license revenues increased to 76% for the first nine months of 2003 from 14% in the first nine months of 2002. Cost of software license revenues includes third party software royalties, product packaging, and documentation. The increases were due to lower intangible asset amortization and impairment costs in the
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third quarter and first nine months of 2003, as compared to the same periods in 2002, partially offset by lower revenue volumes with fixed cost components. Impairment of intangible assets was $2.0 million for the three and nine months ended September 30, 2003 and $37.6 million for the same periods in 2002. Amortization of intangible assets was $1.2 million and $2.9 million for the three months ended September 30, 2003 and 2002, respectively and $3.7 million and $10.5 million for the nine months ended September 30, 2003 and 2002, respectively. On a forward-looking basis, the Company expects overall license margins to increase.
Gross margin on hardware revenuesdecreased to 20% in the third quarter of 2003 from 21% in the corresponding period of 2002. Gross margins on hardware revenues decreased to 11% for the first nine months of 2003 from 12% in the corresponding period of 2002. Cost of hardware revenues include labor, materials, overhead, and other directly allocated costs involved in the manufacture and delivery of the products. On a forward-looking basis, the Company expects hardware margins to decrease.
Gross margin on services revenuesincreased to 59% in the third quarter of 2003 from 49% in the corresponding period of 2002. Gross margin on services revenues increased to 58% for the first nine months of 2003 from 47% for the first nine months of 2002. Cost of services revenues consists primarily of employee salaries and benefits, facilities, systems costs to support maintenance, consulting and education. The increase in services margin was primarily due to a decrease in employee salaries and benefits as a result of workforce adjustments and other cost reduction activities implemented throughout 2002. On a forward-looking basis, the Company expects overall service margins to increase slightly.
Operating Expenses
Research and development(“R&D”) expenses relate to the development of new products, enhancements of existing products and quality assurance activities. These costs consist primarily of employee salaries and benefits, facilities, systems costs, and consulting expenses. R&D expenses decreased by 10% to $12.3 million in the third quarter of 2003, from $13.6 million in the corresponding period of 2002. R&D expenses decreased 14% to $37.9 million for the first nine months of 2003 from $44.1 million in the first nine months of 2002. The decline in R&D expenses was due to a decrease in employee salaries and benefits as a result of workforce reductions in the latter part of 2002, representing approximately 9% of its workforce, and a decrease in depreciation expense due to reduced capital spending. As a percentage of net revenues, R&D expenses were 13% and 14% for the third quarter of 2003 and 2002, respectively and 15% for the first nine months of 2003 and 2002. The Company anticipates, on a forward-looking basis, that R&D expenses in dollars will decrease slightly.
Selling, general and administrative(“SG&A”) expenses consist primarily of employee salaries and benefits, commissions, facilities, systems costs, certain reserves and administrative support. SG&A expenses decreased by 26% to $26.8 million in the third quarter of 2003, from $36.3 million in the corresponding period of 2002. SG&A expenses decreased by 35% to $77.3 million in the first nine months of 2003 from $118.8 million in the first nine months of 2002. The decline in SG&A expenses was primarily due to a decrease in headcount and sales support infrastructure, both of which resulted from workforce adjustments in the latter part of 2002 representing approximately 22% of its workforce. Additionally the third quarter and first nine months of 2002 included $1.1 million in intangible assets impairment charges. Depreciation, amortization and bad debt expenses decreased in 2003. Depreciation expense decreased due to reduced capital spending and amortization expense decreased due to the impairment of intangibles in 2002. The third quarter of 2003 included a reversal of bad debt reserves of $478,000 compared to $2.9 million bad debt expense in the same period in 2002. The first nine months of 2003 included a bad debt reserve release of $4.1 million compared to $5.7 million of bad debt expense in the corresponding period of 2002. The release of bad debt reserves was the result of collection of previously reserved receivables. SG&A expenses as a percentage of net revenues were 29% in the third quarter of 2003 and 38% in the corresponding period of 2002 and 29% and 40% for the first nine months of 2003 and 2002, respectively. On a forward-looking basis, the Company anticipates that SG&A expenses in dollars will remain relatively flat.
Interest and Other Income (Expense)
Interest incomerepresents, primarily, earnings on short-term investments. Interest income for the third quarter of 2003 decreased by 36% to $650,000 from $1.0 million in the corresponding period in 2002. In the first nine months of 2003 interest income decreased by 16% to $2.5 million from $2.9 million in the first nine months of 2002. The decrease is the result of lower rates of return in 2003 and lower cash and short-term investment balances in the third quarter of 2003 due to the repurchase of substantially all of the convertible subordinated debentures.
Interest expensedecreased by 48% to $1.5 million in the third quarter of 2003, from $2.8 million in corresponding period of 2002. Interest expense decreased by 29% to $6.5 million in the first nine months of 2003 compared to $9.1 million in the corresponding period of 2002. Interest expense represents interest on the Company’s convertible subordinated debentures as
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well as interest resulting from additional short-term and long-term borrowings. The decrease in interest expense was due to fewer outstanding convertible subordinated debentures in the first nine months of 2003 as compared to the same period in 2002 due to the repurchase of substantially all of the convertible subordinated debentures.
Net other income (expense)decreased to $376,000 expense in the third quarter of 2003 from $3.4 million income in the corresponding period of 2002, due to a $3.1 million gain on extinguishment of debt in the third quarter of 2002 resulting from the repurchase of convertible subordinated debentures. For the first nine months of 2003,net other expensedecreased to $277,000 from $1.5 million in 2002, due to a second quarter 2002, non-cash $8.9 million write down of a long-term investment for which the Company determined a decline in value that was other than temporary, partially offset by $7.2 million gain on extinguishment of debt resulting from the repurchase of convertible subordinated debentures.
Provision (Benefit) for Income Taxes
The Company recorded an income tax provision of $2.6 million for the third quarter of 2003 compared with a $377,000 provision for the corresponding period of 2002. For the first nine months of 2003, the Company recorded a total income tax provision of $5.1 million compared to a tax benefit of $28.0 million for the first nine months of 2002. Since the Company has a full valuation allowance against its deferred tax assets, the tax provision for the nine months of 2003 is the result of current tax expense in foreign and state jurisdictions. The Company has sufficient federal net operating losses to offset current U.S. taxable income. The tax benefit for the third quarter and first nine months of 2002 was due to a change in the tax law during the quarter that extended the net operating loss carryback period for federal income tax purposes from 2 years to 5 years for losses incurred in 2001 and 2002. As a result of the tax law change, the Company received a current tax benefit for the carryback of its tax loss incurred in 2001.
Cumulative Effect of Change in Accounting Principle
The cumulative effect of change in accounting principle of $0.8 million and $51.4 million for the nine months ended September 30, 2003 and 2002, respectively, relates to the Company’s adoption of SFAS 143,Accounting for Asset Retirement Obligationand adoption of SFAS No. 142,Goodwill and Other Intangible Assets.
Liquidity and Capital Resources
As of September 30, 2003, cash, cash equivalents, and short-term investments totaled $126.7 million, which represented 45% of total assets and the Company’s principal source of liquidity. In addition, the Company had restricted cash of $5.9 million related to certain bank guarantees and letter of credit agreements.
The net cash provided by operating activities was $68.5 million for the first nine months of 2003, and $70.0 million in the corresponding period of 2002. In 2002, significant non-cash adjustments contributing to the cash provided by operating activities were $51.4 million for the cumulative effect of change in accounting principle, depreciation, amortization and impairment charges of $86.3 million and interest expense on convertible subordinated debentures of $7.0 million. The main contributors to net cash provided by operating activities in the first nine months of 2003 were improved profitability and improved cash collection of outstanding account receivable balances. Significant non-cash adjustments contributing to the cash provided by operating activities were depreciation, amortization and impairment totaling $24.8 million, interest expense on convertible subordinated debentures of $4.4 million and $0.8 million for the cumulative effect of change in accounting principle.
The net cash provided by investing activities was $8.1 million in the first nine months of 2003, while net cash used in investing activities was $26.2 million in the corresponding period of 2002. Net cash provided by investing activities in the first nine months of 2003 related to net short-term investment sales and maturities of $11.3 million, offset by property and equipment purchases of $3.1 million.
The net cash used in financing activities was $84.0 million in the first nine months of 2003 compared to $50.7 million in the corresponding period of 2002. Net cash used in financing activities in the first nine months of 2003 was due to the repurchase of $128.4 million of convertible subordinated debentures and payments on borrowings of $5.1 million offset by net proceeds of $43.6 million related to the issuance of Series B preferred stock and $6.4 million proceeds from issuance of common stock relating to the employee stock purchase plan and the exercise of employee stock options.
The Company incurred $150 million of principal indebtedness ($490 million principal at maturity) from the sale of convertible subordinated debentures in August 1998. In the first quarter of 2003 the Company paid $5.6 million to repurchase convertible debentures in the open market. These repurchases reduced the principal amount of the convertible debentures
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due at maturity from $314 million to $300 million. On July 15, 2003, the Company issued a repurchase notice to all holders of its currently outstanding zero coupon convertible subordinated debentures. Debenture holders had the option to surrender their debentures to the Company for repurchase. The Company was obligated to purchase all debentures properly tendered on August 11, 2003 at a repurchase price of $412 for each $1,000 principal amount at maturity. In connection with the repurchase, the Company paid $122.8 million in cash to repurchase $298 million in principal amount at maturity of the Company’s outstanding debentures due in 2018. The payment of the repurchase price on repurchased notes was made entirely in cash on August 12, 2003, the business day following the repurchase date. As of September 30, 2003 there was $2.3 million in principal amount at maturity of debentures outstanding with an aggregate cash repurchase price of approximately $1 million. Under the terms of the debentures, the Company may redeem the remaining outstanding debentures in whole or in part at its option at any time on or after August 12, 2003, at a price equal to the issue price plus the accrued original issue discount up to the redemption date. The repurchase of the zero coupon convertible subordinated debentures significantly reduced the Company’s cash balance.
On August 9, 2002, the Company entered into a Credit Agreement with Comerica Bank-California as administrative agent and CIT Business Credit as collateral agent that provides the Company with a $25 million revolving loan facility and a $25 million senior secured term loan. The revolver has a three-year term and is secured by all of the Company’s assets, a negative pledge on the Company’s intellectual property and a pledge of stock in the Company’s foreign and domestic subsidiaries. The Company’s borrowing options under the revolver include a Eurocurrency Rate and a Base Rate plus the applicable margins adjusted on a quarterly basis. Availability under the revolver also includes up to $5 million in the aggregate in stand-by letters of credit. As of September 30, 2003, the Company had no amounts outstanding under the revolver and has utilized $1 million in letters of credit. The term loan has a four-year term. The term loan is also secured by all of the Company’s assets, a negative pledge on the Company’s intellectual property and a pledge of stock in the Company’s foreign and domestic subsidiaries. The Company’s borrowing options under the term loan include a Eurocurrency Rate and Base Rate plus applicable margins. As of September 30, 2003, the Company had $18.8 million outstanding under the term loan with the applicable interest rate of 4.10%.
In the event that the Company terminates the term loan prior to the maturity date, the lenders will receive a prepayment penalty fee from the Company. Mandatory prepayment of the facilities is required from 100% of permitted asset sales, 100% of the proceeds from future debt issuances and 50% of the proceeds from future equity issuances, excluding the proceeds from the Series B convertible preferred stock issuance described in Note 11. The facilities can be used for working capital, general corporate purposes and to repurchase the Company’s outstanding convertible subordinated debt. The Credit Agreement includes customary representations and warranties and covenants. The financial covenants include unrestricted cash, liquidity ratio, fixed charge coverage ratio, tangible net worth and earnings before interest expense, income taxes, depreciation and amortization (EBITDA). During the first quarter of 2003, the Company signed Amendment No. 1 to the Credit Agreement. This amendment clarified the accounting for the redeemable convertible preferred stock in the covenant computations, revised the liquidity ratio and the tangible net worth covenant requirements, and gave bank consent for the repurchase of 100% of the convertible subordinated debentures with cash. During the second quarter of 2003 the Company signed Amendment No. 2 to the Credit Agreement. The agreement extended the deadline by which the stock of certain subsidiaries of the Company was required to be pledged as collateral. The Company was in compliance with all related covenants and restrictions as of September 30, 2003.
In October 2001, the Company entered into a 5-year loan with Fremont Bank in the amount of $25 million which bears interest at an initial rate of 8% which is then re-measured semi-annually beginning May 2002 at the rate of LIBOR + 3.75% subject to a floor of 8% and a ceiling of 14%. During the third quarter of 2003, the Company signed a letter agreement to amend the Loan and Security Agreement. This amendment reduced the floor rate to 7% effective September 1, 2003. The loan is secured by a security interest in the Company owned buildings in San Jose. Borrowings are payable in equal monthly installments including interest computed on a 20-year amortization schedule until November 1, 2006, at which time the outstanding loan balance will become payable. At September 30, 2003, the Company had $24 million outstanding under this loan. The bank also required that the Company supply a $3 million letter of credit, which is recorded as restricted cash in other assets on the balance sheet as of September 30, 2003.
In addition to the line of credit, the Company has two outstanding bank guarantees with a European bank that are required for daily operations such as payroll, import/export duties and facilities. As of September 30, 2003, approximately $3 million is recorded as restricted cash in other current assets on the balance sheet related to these bank guarantees.
On January 21, 2003, the Company entered into a Preferred Stock Purchase Agreement with Vista Equity Partners L.P. pursuant to which Vista agreed to purchase $50 million of the Company’s Series B convertible preferred stock, which represents approximately 30% of the Company’s outstanding shares on a fully diluted basis, assuming conversion at the initial conversion price. This equity entitles the holders to receive cumulative dividends, which accrue daily at 10% per annum. On or after the tenth anniversary of the closing, the Company will have an obligation to redeem each share of unconverted Series
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B convertible preferred stock for cash at a redemption price equal to 125% of the original purchase price plus accrued and unpaid dividends. Additionally, in the event that the Company declares a dividend or distribution to the holders of common stock, the holders of Series B convertible preferred stock shall be entitled to equivalent participation on an as if converted basis in such dividend or distribution.
The Company believes that cash, cash equivalents, and short-term investments will be sufficient to meet our operating cash needs for at least the next twelve months. However, the Company continually evaluates opportunities to improve its cash position by selling additional equity, debt securities, obtaining and re-negotiating credit facilities, and restructuring our long-term debt. The sale of additional equity or convertible debt securities could result in additional dilution to the Company’s stockholders. In addition, the Company will, from time to time, consider the acquisition of or investment in complementary businesses, products, services and technologies, and the repurchase and retirement of debt, which might affect the Company’s liquidity requirements or cause us to issue additional equity or debt securities. There can be no assurance that financing will be available in amounts or on terms acceptable to us, if at all.
Recent Developments
On October 1, 2003, the Company and MCI WorldCom Communications, Inc. (“MCI”) executed an amendment of the Global Services Agreement between the parties pursuant to which MCI provides certain telecommunications and managed network services to the Company. Among other things, the amendment provided for the reduction of the Company’s minimum annual purchase commitment from $14 million to $7 million and extended the term of the agreement from an expiration of April 2006, to an expiration in 2009, six years from the amendment date. The reduction in the minimum annual purchase commitment will result in the reversal of $3.7 million in accrued expenses in the fourth quarter of 2003. Such amendment commenced effective as of September 30, 2003 after the official committee of unsecured creditors in MCI’s bankruptcy approved the terms of such amendment on October 14, 2003 and the order of the Bankruptcy Court became non-appealable on October 24, 2003.
Effect of Recent Accounting Pronouncements
SFAS No. 149
In April 2003, the FASB issued SFAS No. 149,Amendment of Statement 133 on Derivative Instruments and Hedging Activities.SFAS 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS 133,Accounting for Derivatives and Hedging Activities.SFAS 149 is generally effective for derivative instruments, including derivative instruments embedded in certain contracts, entered into or modified after June 30, 2003. The adoption of SFAS 149 did not have a material impact on the operating results or financial condition of the Company.
SFAS No. 150
In May 2003, the FASB issued SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”. SFAS 150 clarifies the accounting for certain financial instruments with characteristics of both liabilities and equity and requires that those instruments be classified as liabilities in statements of financial position. Previously, many of those financial instruments were classified as equity. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. As the Company does not have any of these financial instruments, the adoption of SFAS 150 did not have any impact on the Company’s consolidated financial statements.
Business Environment and Risk Factors
The Overall Economic Climate Continues to Be Weak:Our products typically represent substantial capital commitments by customers, involving a potentially long sales cycle. As a result, customer purchase decisions may be significantly affected by a variety of factors including trends in capital spending for telecommunications and enterprise software, market competition, and the availability or announcement of alternative technologies. Continued weakness in global economic conditions has resulted in many of our customers delaying and/or reducing the size of their capital spending decisions. If the economy continues to be weak, demand for the Company’s products and services could decrease resulting in lower revenues.
The Convergence of Voice and Data Networks Creates a Technology Inflection Point in which Incumbent Vendors May Be Displaced:Historically, we have supplied the hardware, software, and associated support services for implementing call center solutions. Our approach to this convergence has been to provide migration and integration of existing telephony environments
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with networks in which voice traffic is routed through data networks. This integration is provided by a software infrastructure that requires enterprise-level selling and deployment of enterprise-wide solutions that integrate a company’s voice and data infrastructure. The risks involved in this industry transition include the following:
• | Changes in management and technical personnel; | |
• | Changes in sales and distribution models; | |
• | Inability to continue to sell into accounts where we have traditionally sold; | |
• | Modifications to the pricing and positioning of our products which could impact revenues and operating results; | |
• | Expanded or differing competition; and/or | |
• | An increased reliance on systems integrators to develop, deploy, and/or manage our applications. |
Our Product Revenues Are Dependent on Continued Innovation and Evolution of a Small Number of Product Lines:Historically, sales of a small number of our products accounted for a substantial portion of product revenues. Demand for our products could be adversely affected by not meeting customer specifications and/or by problems with system performance, system availability, installation or service delivery commitments, or market acceptance. We need to develop new products and to manage product transitions in order to succeed. If we fail to introduce new versions and releases of functional products in a timely manner, or enhancements to our existing products, customers may license competing products and we may suffer lost sales and could fail to achieve anticipated results. Our future operating results will depend on the demand for the product suite by future customers, including new and enhanced releases that are subsequently introduced. If our competitors release new products that are superior to our products in performance or price, or if we fail to enhance our products or introduce new features and functionality in a timely manner, demand for our products may decline. New versions of our products may not be released on schedule or may contain defects when released.
Our Service Revenues Are Dependent on Our Installed Base of Customers:We derive a significant portion of our revenues from services, which include software upgrades, support, consulting, and training. As a result, if we lose a major customer or if a support contract is delayed, reduced or cancelled, our revenues would be adversely affected. In addition, customers who have accounted for significant service revenues in the past may not generate revenues in future periods. Our failure to obtain new customers or additional orders from existing customers could also materially affect our operating results.
Our Gross Margins Are Substantially Dependent on Our Product Mix:It is difficult to predict the exact blended mix of products.
Our Market Is Intensely Competitive:The market for our products is intensely competitive, and competition is likely to intensify as companies in our industry consolidate to offer integrated solutions. Our principal competitors currently include companies in the Contact Center market and companies that market traditional telephony products and services.
As the market develops for converged voice data networks and products and the demand for PSTN based call centers diminishes, companies in these markets are merging and obtaining significant positions in the CRM and traditional telephony products market. Many current and potential competitors, including Avaya Inc., Nortel Networks Corporation, Rockwell International Corporation, Alcatel SA, Siemens AG, Cisco Systems Inc., IEX Corporation and Blue Pumpkin, Inc. may have considerably greater resources, larger customer bases and broader international presence than Aspect. Consequently, the Company expects to encounter substantial competition from these and other sources.
We Are Involved in Litigation:We are involved in litigation for a variety of matters. Any claim brought against us will likely have a financial impact, potentially affecting our common stock performance, generating costs associated with the disruption of business, and diverting management’s attention. In our industry, there has been extensive litigation regarding patents and other intellectual property rights, and we are periodically notified of such claims by third parties. We have been sued for alleged patent infringement. We expect that software product developers and providers of software in markets similar to our markets will increasingly be subject to infringement claims as the number of products and competitors in our industry grows and the functionality of products overlap. Any claims, with or without merit, could be costly and time-consuming to defend, divert our management’s attention, cause product delays and have an adverse effect on our revenues and operating results. If any of our products were found to infringe a third party’s proprietary rights, we could be required to enter into royalty or licensing agreements to be able to sell our products, which may not be available on terms acceptable to us or at all. Moreover,
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even if we negotiate license agreements with a third party, future disputes with such parties are possible. If we are unable to resolve an intellectual property dispute through a license, settlement, or successful litigation, we could be subject to damage assessments and be prevented from making, using, or selling certain products or services.
In the future, we could become involved in other types of litigation, such as shareholder lawsuits for alleged violations of securities laws, claims by employees, and product liability claims.
Doing Business Globally Involves Significant Risk:We market our products and services worldwide and anticipate entering additional countries in the future. If we fail to enter certain major international markets successfully, our competitive position could be impaired and we may be unable to compete on a global scale. The financial resources required to enter, establish, and grow new and existing international markets may be substantial, and international operations are subject to additional risks including:
• | The cost and timing of the multiple governmental approvals and product modifications required by many countries; | |
• | Market acceptance; | |
• | Exchange rate fluctuations; | |
• | Delays in market deregulation; | |
• | Difficulties in staffing and managing foreign subsidiary operations; and/or | |
• | Global economic climate considerations including potentially negative tax and foreign and domestic trade legislation, which could result in the creation of trade barriers such as tariffs, duties, quotas, and other restrictions. |
Acts of Terrorism and War May Impact our Business:The threat of terrorist attacks continued international violence and war in various locations around the world have increased uncertainty with the worldwide economic environment. Such uncertainty may impact our business in that customers may be less likely to make purchases under these circumstances. Additionally, should a future act of terrorism, war or violence occur, the impact on our sales and business is unknown.
Regulatory Changes and Changes Made to Generally Accepted Accounting Practices Principles May Impact Our Business:The electronic communications industry in general is subject to a wide range of regulations throughout various markets and throughout various countries in which we currently operate or may wish to operate in the future. In addition, new products and services may involve entering into different or newly regulated areas. Changes in these environments may impact our business and could affect our ability to operate in certain markets or certain regions from time to time.
Revisions to generally accepted accounting principles will require us to review our accounting and financial reporting procedures in order to ensure continued compliance with required policies. From time to time, such changes may have a short-term impact in the reporting that we do, and these changes may impact market perception of our financial condition:
• | Pending or new legislation may lead to an increase in our costs related to audits in particular and regulatory compliance generally; | |
• | Pending or new legislation may force us to seek other service providers for non-audit related services, which may raise costs; and/or | |
• | Changes in the legal climate may lead to additional liability fears, which may result in increased costs. |
We 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 revenue and operating results may fluctuate significantly because of a number of facts, many of which are outside of our control. Some of these factors include:
• | Product and price competition; | |
• | Our ability to develop and market new products and control costs; | |
• | Our ability to renew existing support/maintenance agreements in a timely fashion, if at all; |
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• | Timing of new product introductions and product enhancements; | |
• | Further deterioration and changes in domestic and foreign markets and economies; | |
• | Success in expanding our global services organization, direct sales force and indirect distribution channels; | |
• | Activities of and acquisitions by competitors; | |
• | Appropriate mix of products licensed and services sold; | |
• | Level of international transactions; | |
• | Delay or deferral of customer implementations of our products; | |
• | Size and timing of individual license transactions; | |
• | Length of our sales cycle; and/or | |
• | Performance by outsourced service providers, and the costs of the underlying contracts of these providers, that are critical to our operations. |
One or more of the foregoing factors may cause our operating expenses to be disproportionately high during any given period or may cause our revenues and operating results to fluctuate significantly. Based upon the preceding factors, we may experience a shortfall in revenues or earnings or otherwise fail to meet public market expectations, which could materially and adversely affect our business, financial condition, results of operations and the market price of our common stock.
Our failure to grow and maintain our relationships with systems integrators or value-added resellers could impact our ability to market and implement our products and reduce future revenues:Failure to establish or maintain relationships with systems integrators or value-added resellers would significantly harm our ability to license our products. Systems integrators and value added resellers install and deploy our products, and perform custom integration of systems and applications. If these relationships fail, we will have to devote substantially more resources to the sales and marketing, implementation and support of our products than we would have had to otherwise. In addition, there could be channel conflict among our varied sales channels, which could harm our business, financial condition or results of operations.
Because competition for qualified personnel could again become intense, we may not be able to retain or recruit personnel, which could impact the development and sales of our products:If we are unable to hire or retain qualified personnel, or if newly hired personnel fails to develop the necessary skills or fails to reach expected levels of productivity, our ability to develop and market our products will be impacted. Our success depends largely on the continued contributions of our key management, research and development, sales, service, operations and marketing personnel.
Technology Risks
Our Intellectual Property May Be Copied, Obtained, or Developed by Third Parties:Our success depends in part upon our internally developed technology. Despite the precautions we take to protect our intellectual property, unauthorized third parties may copy or otherwise obtain and use our technology. In addition, third parties may develop similar technology independently.
Technology Is Rapidly Changing:The market for our products and services is subject to rapid technological change and new product introductions. Current competitors or new market entrants may develop new, proprietary products with features that could adversely affect the competitive position of our products. We may not successfully anticipate market demand for new products or services, or introduce them in a timely manner.
The convergence of voice and data networks, and wired and wireless communications could require substantial modification and customization of our current products and business models, as well as the introduction of new products. Further, customer acceptance of these new technologies may be slower than we anticipate. We may not be able to compete effectively in these markets. In addition, Aspect’s products must readily integrate with major third party security, telephony,
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front-office, and back-office systems. Any changes to these third party systems could require us to redesign our products, and any such redesign might not be possible on a timely basis or achieve market acceptance.
Transaction Risks
Acquisitions and Investments May Be Difficult and Disruptive:We have made a number of acquisitions and have made minority equity investments in other companies. Acquisitions or investments we make may experience significant fluctuations in market value or may result in significant write-offs or the issuance of additional equity or debt securities. These acquisitions and investments can, therefore, be costly and disruptive, and we may be unable to successfully integrate a new business or technology into our business. We may continue to make such acquisitions and investments, and there are a number of risks that future transactions could entail. These risks include:
• | Inability to successfully integrate or commercialize acquired technologies or otherwise realize anticipated synergies or economies of scale on a timely basis; | |
• | Diversion of management attention; | |
• | Adverse impact on our annual effective tax rate; | |
• | Dilution of existing equity holders; | |
• | Disruption of our ongoing business; | |
• | Inability to assimilate and/or retain key technical and managerial personnel for both companies; | |
• | Inability to establish and maintain uniform standards, controls, procedures, and processes; | |
• | Potential legal liability for pre-acquisition activities; | |
• | Permanent impairment of our equity investments; | |
• | Governmental, regulatory, or competitive responses to the proposed transactions; and/or | |
• | Impairment of relationships with employees, vendors, and/or customers including, in particular, acquired original equipment manufacturer and value-added reseller relationships. |
Operational/Performance Risks
Our Revenues and Operating Results Are Uncertain and May Fluctuate:Our revenues may fluctuate significantly from period to period. There are many reasons for this variability, including the shift from telecommunications equipment to business communications software, and associated software applications; reduced demand for some of our products and services; a limited number of large orders accounting for a significant portion of product revenues in any particular quarter; the timing of consulting projects and completion of project milestones; the size and timing of individual software license transactions; dependence on new customers for a significant percentage of product revenues; the ability of our sales force to achieve quarterly revenue objectives; fluctuations in the results of existing operations, recently acquired subsidiaries, or distributors of our products or services; seasonality and mix of products and services and channels of distribution; our ability to sell support agreements and subsequent renewal agreements for support of our products; our ability to develop and market new products and control costs; and/or changes in market growth rates for different products and services.
We May Experience Difficulty Managing Changes in Our Business:The changes in our business may place a significant strain on our operational and financial resources. We may experience substantial disruption from changes and could incur significant expenses and write-offs. We must carefully manage accounts receivables to limit credit risk. We must also maintain inventories at levels consistent with product demand. Inaccurate data (for example, credit histories or supply/demand forecasts) could quickly result in excessive balances or insufficient reserves.
We May Experience Difficulty Expanding Our Distribution Channels:We have historically sold our products and services through our direct sales force and a limited number of distributors. Changes in customer preferences, the competitive
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environment, or other factors may require us to expand third party distributor, value added resellers, systems integrator, technology alliances, electronic, and other alternative distribution channels. We may not be successful in expanding these distribution channels.
We Are Dependent on Key Personnel:We depend on certain key management and technical personnel and on our ability to attract and retain highly qualified personnel in labor markets characterized by high turnover among, high demand for, and limited supply of, qualified people. We have recently undergone significant changes in senior management and other personnel and may experience additional changes as a result of our shift from supplying telecommunications equipment to becoming a provider of contact server software, and associated software applications. For example, we announced in August 2003 the transition of our chairman, president and chief executive officer to pursue other interests and the appointment of an interim chairman and an interim president and chief executive officer while a formal internal and external search for a president and chief executive officer is conducted. Our failure to appoint a qualified chief executive officer, or to recruit, retain and motivate qualified personnel, could be disruptive to our operations, which could have a material adverse effect on our operating results.
We Are Dependent on Third Parties:We have outsourced our manufacturing capabilities to third parties and are dependent upon those suppliers to execute the following activities on-time and to an extremely high level of quality: order component level materials; build, configure and test systems and subassemblies; and ship products to meet our customers delivery requirements. Failure to ship product on time or failure to meet our rigid quality standards would result in delays to customers, customer dissatisfaction or cancellation of customer orders.
Should we have on-going performance issues with our manufacturing sub-contractors, the process to move from one sub-contractor to another is a lengthy and costly process that could affect our ability to execute customer shipment requirements and/or might negatively affect revenue and/or costs. We depend on certain critical components in the production of our products and services. Some of these components are obtained only from a single supplier and only in limited quantities. In addition, some of our major suppliers use proprietary technology and software code that could require significant redesign of our products in the case of a change in vendor. Further, suppliers could discontinue their products, or modify them in manners incompatible with our current use, or use manufacturing processes and tools that could not be easily migrated to other vendors.
We also outsource certain of our information technology activities to third parties. We rely heavily on these vendors to provide day-to-day support. We may experience disruption in our business if these vendors or we have difficulty meeting our requirements, or if we need to transition the activities to other vendors or ourselves, which could negatively affect our revenue and/or costs.
We Intend to Upgrade and/or Replace Certain Parts of Our Information Systems and May Not Be Successful in Implementing the Changes:We intend to upgrade and/or replace certain information systems that support our operations, including systems to manage order processing, shipping, support entitlement, accounting and internal computing operations. Many of these systems are proprietary to us and are very complex. We may not be successful in implementing these new systems and transitioning data from our old to the new systems. Any failure or significant downtime in our information systems could prevent us from taking customer orders, shipping products, providing services or billing customers and could harm our business. In addition, our information systems require the services of personnel with extensive knowledge of these information systems and the business environment in which we operate. In order to successfully implement and operate our systems, we must be able to attract and retain a significant number of highly skilled employees. If we fail to attract and retain the highly skilled personnel required to implement, maintain and operate our information systems, our business could suffer.
We May Experience Difficulty Subleasing our Facilities:The real estate market for office space is weak. This has reduced and may continue to reduce our ability to sublease our excess office space and to charge reasonable lease rates.
Our Operations Are Geographically Concentrated and We Are Subject to Business Interruption Risk:Significant elements of our product development, manufacturing, information technology systems, corporate offices, and support functions are concentrated at a single location in the Silicon Valley area of California. We also concentrate sales, administrative, and support functions and related infrastructure to support our international operations at our U.K. offices. In the event of a natural disaster, such as an earthquake or flood, or localized extended outages of critical utilities or transportation systems, that affects us, our customers or our suppliers, we could experience a significant business interruption.
Financial/Capital Market Risks
We Have Debt and Debt Service Obligations:We entered into a credit agreement in August 2002, which provides the Company with a $25 million revolving loan facility and a $25 million senior secured term loan. We had $18.8 million outstanding under the term loan and no amounts outstanding under the revolver and have utilized $1.1 million in letters of credit at September 30, 2003. We obtained a loan totaling $25 million in October 2001 secured by our buildings in San Jose. We had $24 million outstanding under the loan at September 30, 2003.
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The recently concluded repurchase of the convertible subordinated debentures for $122.8 million has reduced our cash position substantially. A reduced cash position could force us to forego using cash for other corporate purposes, or to forego other corporate opportunities of interest, that previously we might have exploited with a greater cash position. Our ability to meet our debt service obligations will depend on our future performance, which will be subject to financial, business, and other factors affecting our operations, many of which are beyond our control.
We Are Exposed to Fluctuations in Foreign Currency Exchange Rates, Interest and Investment Income, and Debt Interest Rate Expense:We perform sensitivity analysis studies on portions of our foreign currency exchange rate exposure, and on our interest and investment income exposure to U.S. interest rates, both using a 10% threshold. These exposures could impact our financial performance. For further details, you should refer to the full detailed discussion in the “Quantitative and Qualitative Disclosures About Market Risk” section.
The Price of Our Common Stock Is Volatile:We operate in a rapidly changing high-technology industry that exhibits significant stock market volatility. Accordingly, the price of our common stock may be subject to significant volatility. Our past financial performance is not necessarily a reliable indicator of future performance and historical data should not be used to predict future results or trends. For any given quarter, a shortfall in our operating results from the levels expected by securities analysts or others could immediately and adversely affect the price of our common stock. If we do not learn of such shortfalls until late in a fiscal quarter, there could be an even more immediate and adverse effect on the price of our common stock. In addition, the relatively low trading volume of our common stock could exacerbate this volatility.
Our Private Placement Equity Financing Carries Inherent Risks Regarding Cash and Dilution:We entered into a Preferred Stock Purchase Agreement with Vista Equity Partners L.P. on January 21, 2003. Pursuant to this agreement, Vista agreed to purchase $50 million of our Series B convertible preferred stock which represents approximately 30% of our outstanding shares on a fully diluted basis, assuming conversion at the initial conversion price. This equity entitles the holders to receive cumulative dividends that accrue daily at 10% per annum. On or after the tenth anniversary of the closing, we will have an obligation to redeem each share of unconverted Series B convertible preferred stock for cash at a redemption price equal to 125% of the original purchase price plus accrued and unpaid dividends.
Item 3.Quantitative and Qualitative Disclosures About Market Risk
Reference is made to the information appearing under the caption “Quantitative and Qualitative Disclosures About Market Risk” of the Registrant’s 2002 Annual Report on Form 10-K, which information is hereby incorporated by reference. The Company believes there were no material changes in the Company’s exposure to financial market risk during the third quarter of 2003.
Item 4.Controls and Procedures
The Company evaluated the design and operation of its disclosure controls and procedures to determine whether they are effective in ensuring that the disclosure of required information is timely and made in accordance with the Exchange Act and the rules and forms of the Securities and Exchange Commission. This evaluation was made under the supervision and with the participation of management, including the Company’s principal executive officer and principal financial officer as of the end of the period being reported on of this Quarterly Report on Form 10-Q. The Company believes its pre-existing disclosure controls and procedures are adequate to enable it to comply with its disclosure obligations. The Company also has established a Disclosure Committee, which consists of certain members of the Company’s senior management. The Company’s disclosure controls and procedures, as defined at Exchange Act Rules 13a-15(e) and 15d-15(e), are effective to ensure that information required to be disclosed by the Company in reports that it files under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. Since the date of the evaluation of internal controls, no significant changes have been made that could significantly affect these controls.
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Part II: Other Information
Item 1.Legal Proceedings
The Company is subject to various legal proceedings and claims that arise in the normal course of business. While the outcome of these proceedings and claims cannot be predicted with certainty, management does not believe that the outcome of any of these legal matters will have a material adverse effect on the Company’s business, operating results or financial condition. However, litigation in general, and intellectual property litigation in particular, can be expensive and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. The Company believes that it has defenses to the case set forth below and is vigorously contesting this matter.
In December 2000, the Company entered into a Master Services Agreement (the “Master Agreement”) with Electronic Data Systems Corporation (EDS) pursuant to which the Company agreed to outsource certain of its information technology (IT) needs to EDS. A dispute has arisen between the parties over the services and charges to be performed and paid under the Master Agreement. In May 2003, the Company terminated the Master Agreement for EDS’ breach of the Master Agreement. On May 20, 2003 EDS made a demand for arbitration with the American Arbitration Association pursuant to the Master Services Agreement. EDS alleges that the Company breached the Master Agreement and implied warranties associated with the Master Agreement, committed fraud, engaged in negligent misrepresentation and therefore EDS is entitled to approximately $26 million in damages plus reasonable attorneys’ fees. On June 11, 2003, the Company filed its answer and counterclaims pursuant to which the Company denied every allegation made by EDS, denied that EDS is owed any amount in damages, and counterclaimed that EDS breached the Master Agreement, committed fraud, engaged in fraudulent and unfair business practices and therefore the Company is entitled to damages, restitution and disgorgement in an amount to be proven in the arbitration. The arbitration hearing is scheduled to begin February 17, 2004.
Item 6.Exhibits and Reports on Form 8-K
A. Exhibits
10.98a | Separation Agreement and Mutual Release dated as of September 26, 2003 between the Registrant and Beatriz Infante | |
10.101 | Letter Agreement dated as of August 12, 2003 between the Registrant and Fremont Bank regarding an amendment to the Loan and Security Agreement dated September 28, 2001 | |
31.1 | Certification of Chief Executive Officer required by Exchange Act Rules 13a-14(a) [Section 302] | |
31.2 | Certification of Chief Financial Officer required by Exchange Act Rules 13a-14 (a) [Section 302] | |
32.1 | Certifications required by 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
B. Reports on Form 8-K
The Company filed two reports on Form 8-K during the quarter ended September 30, 2003 as follows:
Date | Item Reported On | |
July 17, 2003 | Item 9. On July 17, 2003, the Company announced its earnings results for the second quarter of 2003 | |
July 31, 2003 | Item 12. On July 31, 2003, the Company filed a current report relating to an August 2003 presentation |
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ASPECT COMMUNICATIONS CORPORATION | ||
(Registrant) | ||
By: /s/ GARY A. WETSEL | ||
Gary A. Wetsel | ||
Executive Vice President, Finance, Chief Financial Officer, and | ||
Chief Administrative Officer |
Date: November 10, 2003
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EXHIBIT INDEX
10.98a | Separation Agreement and Mutual Release dated as of September 26, 2003 between the Registrant and Beatriz Infante | |
10.101 | Letter Agreement dated as of August 12, 2003 between the Registrant and Fremont Bank regarding an amendment to the Loan and Security Agreement dated September 28, 2001 | |
31.1 | Certification of Chief Executive Officer required by Exchange Act Rules 13a-14(a) [Section 302] | |
31.2 | Certification of Chief Financial Officer required by Exchange Act Rules 13a-14(a) [Section 302] | |
32.1 | Certifications required by 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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