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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934
(mark one)
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
for the quarter ended December 31, 2005
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number 0-23852
MRO SOFTWARE, INC.
(Exact name of registrant as specified in its charter)
MASSACHUSETTS | 04-2448516 | |
(State of Incorporation) | (I.R.S. Employer | |
Identification Number) |
100 CROSBY DRIVE, BEDFORD, MASSACHUSETTS 01730
(Address of principal executive offices) (Zip code)
(781) 280-2000
(Registrant’s telephone number, including area code)
(Address of principal executive offices) (Zip code)
(781) 280-2000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value per share
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value per share
(Title of Class)
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.
Yesþ Noo
Yesþ Noo
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yesþ Noo
Yesþ Noo
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filero Accelerated filero Non-accelerated filero
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.
Yeso Noþ
Yeso Noþ
Number of shares outstanding of the Registrant’s common stock as of the latest practicable date: 25,893,195 shares of common stock, $.01 par value per share, as of February 6, 2006.
MRO SOFTWARE, INC.
10-Q INDEX
10-Q INDEX
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MRO SOFTWARE, INC.
CONSOLIDATED BALANCE SHEETS
(unaudited)
(unaudited)
December 31, | September 30, | ||||||||
(in thousands, except per share data) | 2005 | 2005 | |||||||
ASSETS | |||||||||
Current assets: | |||||||||
Cash and cash equivalents | $ | 123,642 | $ | 120,301 | |||||
Marketable securities | 7,095 | 5,130 | |||||||
Accounts receivable, trade, less allowance for doubtful accounts of $1,413 at December 31, 2005 and $1,445 at September 30, 2005, respectively | 35,582 | 40,362 | |||||||
Prepaid expenses and other current assets | 6,457 | 4,715 | |||||||
Deferred income taxes | 1,871 | 1,963 | |||||||
Total current assets | 174,647 | 172,471 | |||||||
Marketable securities | 5,784 | 7,743 | |||||||
Property and equipment, net | 7,337 | 7,210 | |||||||
Goodwill, net | 46,337 | 46,337 | |||||||
Intangible assets, net | 2,689 | 3,118 | |||||||
Deferred income taxes | 6,013 | 6,412 | |||||||
Other assets | 2,999 | 3,079 | |||||||
Total assets | $ | 245,806 | $ | 246,370 | |||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||||
Current liabilities: | |||||||||
Accounts payable and accrued expenses | $ | 12,794 | $ | 15,481 | |||||
Accrued compensation | 7,315 | 12,805 | |||||||
Income taxes payable | 4,326 | 1,467 | |||||||
Deferred revenue | 30,515 | 31,718 | |||||||
Deferred lease obligation | 432 | 363 | |||||||
Total current liabilities | 55,382 | 61,834 | |||||||
Deferred lease obligation | 2,248 | 2,013 | |||||||
Deferred revenue | 475 | 577 | |||||||
Other long term liabilities | 3 | 240 | |||||||
Total liabilities | 58,108 | 64,664 | |||||||
Commitments and contingencies (Note H) | |||||||||
Stockholders’ equity | |||||||||
Preferred stock, $0.01 par value;1,000 shares authorized, none issued and outstanding | |||||||||
Common stock, $0.01 par value; 50,000 shares authorized; 25,866 and 25,738 shares issued and outstanding at December 31, 2005 and September 30, 2005, respectively | 259 | 257 | |||||||
Additional paid-in capital | 129,955 | 128,180 | |||||||
Deferred compensation | (2,204 | ) | (2,420 | ) | |||||
Retained earnings | 59,314 | 55,098 | |||||||
Accumulated other comprehensive income | 374 | 591 | |||||||
Total stockholders’ equity | 187,698 | 181,706 | |||||||
Total liabilities and stockholders’ equity | $ | 245,806 | $ | 246,370 | |||||
The accompanying notes are an integral part of the consolidated financial statements.
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MRO SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(unaudited)
Three Months Ended | ||||||||
December 31, | ||||||||
(in thousands, except per share data) | 2005 | 2004 | ||||||
Revenues: | ||||||||
Software | $ | 12,815 | 14,824 | |||||
Support and services | 36,317 | 32,532 | ||||||
Total revenues | 49,132 | 47,356 | ||||||
Cost of revenues: | ||||||||
Software | 1,383 | 1,280 | ||||||
Support and services | 16,174 | 15,615 | ||||||
Total cost of revenues | 17,557 | 16,895 | ||||||
Gross profit | 31,575 | 30,461 | ||||||
Operating expenses: | ||||||||
Sales and marketing | 13,601 | 15,231 | ||||||
Product development | 7,453 | 6,780 | ||||||
General and administrative | 4,628 | 4,570 | ||||||
Total operating expenses | 25,682 | 26,581 | ||||||
Income from operations | 5,893 | 3,880 | ||||||
Interest income, net | 1,225 | 471 | ||||||
Other (expense)/income, net | (191 | ) | 570 | |||||
Income before income taxes | 6,927 | 4,921 | ||||||
Provision for income taxes | 2,711 | 1,758 | ||||||
Net income | $ | 4,216 | $ | 3,163 | ||||
Net income per share, basic | $ | 0.16 | $ | 0.13 | ||||
Net income per share, diluted | $ | 0.16 | $ | 0.12 | ||||
Shares used to calculate net income per share | ||||||||
Basic | 25,594 | 25,041 | ||||||
Diluted | 26,591 | 25,392 |
The accompanying notes are an integral part of the consolidated financial statements.
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MRO SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(UNAUDITED)
Three Months ended | ||||||||
December 31, | ||||||||
(in thousands) | 2005 | 2004 | ||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 4,216 | $ | 3,163 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation | 737 | 775 | ||||||
Amortization of other intangibles | 429 | 611 | ||||||
Amortization of premium on marketable securities | 4 | 66 | ||||||
Stock-based compensation | 382 | 48 | ||||||
Deferred income taxes | 463 | 664 | ||||||
Changes in operating assets and liabilities: | ||||||||
Accounts receivable | 4,427 | 1,789 | ||||||
Prepaid expenses and other assets | (1,783 | ) | 142 | |||||
Accounts payable, accrued expenses and other liabilities | (2,445 | ) | (946 | ) | ||||
Accrued compensation | (5,421 | ) | (896 | ) | ||||
Income taxes payable | 2,883 | 281 | ||||||
Deferred revenue | (1,071 | ) | (1,806 | ) | ||||
Net cash provided by operating activities | 2,821 | 3,891 | ||||||
Cash flows from investing activities: | ||||||||
Acquisitions of property and equipment and other capital expenditures | (844 | ) | (1,105 | ) | ||||
Sale of marketable securities | — | 3,429 | ||||||
Purchase of marketable securities | — | (2,420 | ) | |||||
Net cash used in investing activities | (844 | ) | (96 | ) | ||||
Cash flows from financing activities: | ||||||||
Proceeds from exercise of employee stock options and stock purchases | 1,551 | 2,299 | ||||||
Tax benefit — stock based compensation | 53 | — | ||||||
Net cash provided by financing activities | 1,604 | 2,299 | ||||||
Effect of exchange rate changes on cash and cash equivalents | (240 | ) | 1,124 | |||||
Net increase in cash and cash equivalents | 3,341 | 7,218 | ||||||
Cash and cash equivalents, beginning of period | 120,301 | 56,982 | ||||||
Cash and cash equivalents, end of period | $ | 123,642 | $ | 64,200 | ||||
The accompanying notes are an integral part of the consolidated financial statements.
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MRO SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
A. Basis of Presentation
The accompanying unaudited consolidated financial statements include the accounts of MRO Software, Inc. (“MRO”) and its majority-owned subsidiaries (collectively, the “Company”), as of and for the three month periods ended December 31, 2005 and December 31, 2004 and have been prepared by the Company in accordance with generally accepted accounting principles for interim reporting and with the instructions to Form 10-Q and Article 10 of Regulation S-X. All intercompany accounts and transactions have been eliminated. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments, consisting only of those of a normal recurring nature, necessary for a fair presentation of the Company’s financial position, results of operations and cash flows at the dates and for the periods indicated. The results of operations for the periods presented herein are not necessarily indicative of the results of operations to be expected for the entire fiscal year, which ends on September 30, 2006, or for any other future period.
These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended September 30, 2005 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on December 14, 2005.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
B. Net Income Per Share
Basic net income per share is computed by dividing net income or loss available to common shareholders by the weighted average number of common shares outstanding. Diluted net income per share is computed by dividing net income or loss available to common shareholders by the weighted average number of common shares outstanding plus dilutive potential common shares. For purposes of this calculation, stock options are considered dilutive potential common shares in periods in which they have a dilutive effect.
Basic and diluted net income per share are calculated as follows:
Three months ended | ||||||||
(in thousands, except per share data) | 12/31/05 | 12/31/04 | ||||||
Net income | $ | 4,216 | $ | 3,163 | ||||
Weighted average common shares outstanding-basic | 25,594 | 25,041 | ||||||
Effect of dilutive securities (primarily stock options) | 997 | 351 | ||||||
Weighted average common shares outstanding-diluted | 26,591 | 25,392 | ||||||
Net income per share, basic | $ | 0.16 | $ | 0.13 | ||||
Net income per share, diluted | $ | 0.16 | $ | 0.12 |
Options to purchase shares of the Company’s common stock of 1,424,589 and 1,764,959 for the three months ended December 31, 2005 and 2004, respectively, were outstanding but were not included in the computation of diluted net income per share because the exercise price of the options was greater than the weighted average market price of the common stock during the period.
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C. Accounting Policies
Stock Based Compensation and Pro Forma Information
Effective October 1, 2005, the Company adopted the revised Statement of Financial Accounting Standards (SFAS) No. 123, Shared-Based Payment (FAS123(R)) which establishes accounting for stock based equity awards exchanged for employee services. Pursuant to FAS 123(R), share based compensation cost is determined based on the grant-date fair value of equity awards and is recognized over the employee’s requisite service period. The Company has elected the modified prospective application transition method as provided by FAS 123(R). As a result, prior financial statements presented in this Form 10-Q have not been restated to reflect the application of FAS 123(R). The Company accelerated all outstanding unvested options as of September 30, 2005. There was no significant stock option related compensation charges recorded upon the adoption of FAS 123(R) and the impact on earnings per share, cash flows, and income taxes were immaterial to the Company for the three months ended December 31, 2005.
Consistent with FAS 123(R) and the Company’s prior period pro forma disclosures, the fair value of the Company’s stock options was estimated using the Black-Scholes option pricing model utilizing key assumptions including the exercise price of the option, expected term of the option, expected stock price volatility over the option’s expected term, annual risk free interest rate over the option’s expected term, and the Company’s expected dividend yield. The Company believes that the valuation technique utilized to calculate the fair values of the Company’s stock options granted during the three months ended December 31, 2005 are appropriate. It should be noted that estimates of fair value are not intended to predict the actual future events or the value ultimately realized by persons who receive the equity award.
The fair value of the Company’s stock options was estimated using the following assumptions pursuant to the Black-Scholes option pricing model:
Three months ended | ||||
December 31, 2005 | ||||
Expected life (1) | 4 years | |||
Expected volatility (2) | 47.36 | % | ||
Risk-free interest rate (3) | 4.02 | % | ||
Expected annual dividend yield (4) | 0.00 | % |
(1) | Expected life is based on expected exercise patterns. | |
(2) | Expected volatility is based on historical volatility of the Company’s stock. | |
(3) | Risk-free interest rate is based on U.S. Treasury rates corresponding to the grant date and expected term. | |
(4) | Based on management’s expectations with respect to payment of dividends during the option term. |
The total compensation cost recorded for the three months ended December 31, 2005 related to unvested stock options at the adoption of FAS 123(R) and for newly granted options was $15,000.
As of December 31, 2005, there was $159,521 of total gross unrecognized compensation cost related to non-vested stock options. In addition, there was $2,204,164 of total gross unrecognized compensation cost related to restricted stock awards to non-employee directors and certain executives. The unrecognized compensation cost is expected to be recognized over a weighted average period of 3 years.
At December 31, 2005, the Company had 4,943,714 stock options vested and outstanding with an average exercise price of $17.17. These stock options had no intrinsic value based on the December 30, 2005 closing share price of $14.04. The average remaining contractual life on these stock options is approximately 6 years.
Prior to October 1, 2005, the Company accounted for stock based compensation using the intrinsic value method under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations. The Company also complied with the pro forma disclosure requirements of SFAS 123, “Accounting for Stock Based Compensation” as amended by SFAS
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148, “Accounting for Stock Based Compensation — Transition and Disclosure — an amendment of FASB Statement No. 123”.
The table below illustrates the effect on net income and earnings per share on a pro forma basis for the three months ended December 31, 2004, as if the Company had applied the fair value recognition provisions of SFAS 123 to share based compensation. The fair value of the Company’s stock options was estimated using the following assumptions pursuant to the Black-Scholes option pricing model:
Three months ended | ||||
December 31, 2004 | ||||
Assumptions: | ||||
Expected life (1) | 4 years | |||
Expected volatility (2) | 75.00 | % | ||
Risk-free interest rate (3) | 3.24 | % | ||
Expected annual dividend yield (4) | 0.00 | % |
(1) | Expected life is based on expected exercise patterns. | |
(2) | Expected volatility is based on historical volatility of the Company’s stock. | |
(3) | Risk-free interest rate is based on U.S. Treasury rates corresponding to the grant date and expected term. | |
(4) | Based on management’s expectations with respect to payment of dividends during the option term. |
Three months ended | ||||
December 31, 2004 | ||||
Effect of FAS 123 | ||||
Net income as reported | $ | 3,163 | ||
Add: Stock-based employee compensation included in net income | 48 | |||
Deduct: Stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects | (1,299 | ) | ||
Pro forma net income | $ | 1,912 | ||
Net income per share: | ||||
Basic — as reported | $ | 0.13 | ||
Basic — pro forma | $ | 0.08 | ||
Diluted — as reported | $ | 0.12 | ||
Diluted — pro forma | $ | 0.08 |
Stock based plans — description
The Company maintains two incentive and non-qualified option plans. The 1994 Incentive and Nonqualified Stock Option Plan (the “1994 Option Plan”) and the 1999 Equity Incentive Plan (the “1999 Plan”) generally provide for the grant of non-qualified and incentive stock options, restricted stock and other awards to the Company’s non-employee directors and employees. The exercise price of incentive options must be at least equal to the fair market value on the date of grant. The exercise price of non-qualified options must not be less than 85% of the fair market value on the date of grant. Options generally are exercisable for ten years after the date of grant and vest over four years. The 1994 Option Plan was terminated in 1999. All unvested options, excluding non-employee director options, were accelerated on September 30, 2005.
The Company also maintains an employee stock purchase plan. Eligible participants of the 2002 Employee Stock Purchase Plan (the “2002 ESPP”) may purchase common stock of the Company through payroll deductions over six month offering periods. Effective with the offering period that commenced on June 1, 2005, shares are purchased at 85% of the fair market value of the Company’s common stock on the termination of the six month offerings. For the three months ended December 31, 2005, the Company
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recorded $150,695 in compensation cost related to common stock purchased under the 2002 ESPP for the offering period that ended on November 30, 2005.
D. Comprehensive Income:
The following table reflects the components of comprehensive net income:
Three months ended | ||||||||
(in thousands) | 12/31/05 | 12/31/04 | ||||||
Net income | $ | 4,216 | $ | 3,163 | ||||
Other comprehensive income, | ||||||||
Net of tax: | ||||||||
Unrealized gain/(loss) on securities arising during period | 11 | (9 | ) | |||||
Foreign currency translation adjustment | (228 | ) | 1,198 | |||||
Comprehensive income | $ | 3,999 | $ | 4,352 | ||||
E. Segment Information, Geographic Data and Major Customers:
The Company reports revenues and income under one reportable industry segment. The Company’s management assesses operating results on an aggregate basis to make decisions about the allocation of resources.
The Company manages its business in the following geographic areas: United States, Other Americas (Canada and Latin America), Europe/Middle East and Africa, and Asia/Pacific. A summary of the Company’s revenues by geographical area is as follows:
Three months ended | ||||||||
(in thousands) | 12/31/05 | 12/31/04 | ||||||
Revenues: | ||||||||
United States | $ | 26,530 | $ | 26,495 | ||||
Other Americas | 2,510 | 2,805 | ||||||
Intercompany | 4,807 | 3,478 | ||||||
Subtotal | $ | 33,847 | $ | 32,778 | ||||
Europe/Middle East and Africa | 15,110 | 14,437 | ||||||
Asia/Pacific | 4,982 | 3,619 | ||||||
Intercompany | (4,807 | ) | (3,478 | ) | ||||
Total revenues | $ | 49,132 | $ | 47,356 | ||||
The Company has subsidiaries in foreign countries, which sell the Company’s products and services in their respective geographic areas. Intercompany revenues reflect the Company’s transfer pricing policies and primarily represent shipments of software to international subsidiaries. Intercompany revenues are eliminated from consolidated revenues.
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F. Goodwill and Other Intangible Assets
Goodwill and intangible assets as of December 31, 2005 and September 30, 2005 consist of the following:
(in thousands) | 12/31/05 | 09/30/05 | ||||||
Goodwill, net | $ | 46,337 | $ | 46,337 | ||||
Acquired technology | 16,654 | 16,654 | ||||||
Accumulated amortization | (14,102 | ) | (13,748 | ) | ||||
Sub-total acquired technology | 2,552 | 2,906 | ||||||
Other intangibles | 1,911 | 1,911 | ||||||
Accumulated amortization | (1,774 | ) | (1,699 | ) | ||||
Sub-total other intangibles | 137 | 212 | ||||||
Total intangible assets, net | $ | 49,026 | $ | 49,455 | ||||
Other intangibles consist of customer contracts and customer lists. |
Amortization expense of intangible assets was $429 thousand and $611 thousand for the three months ended December 31, 2005 and 2004, respectively.
As of December 31, 2005, remaining amortization expense on existing intangibles is as follows:
(in thousands) | ||||
2006 (remaining 9 months) | $ | 1,135 | ||
2007 | 659 | |||
2008 | 659 | |||
2009 | 236 | |||
Total | $ | 2,689 | ||
G. Recent Accounting Pronouncements
The FASB has issued FASB Staff Position (FSP) FIN 45-3, Application of FASB Interpretation No. 45 to Minimum Guarantees Granted to a Business or Its Owners. The guidance in the FSP amends FASB Interpretation No. 45 Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Other’s.
FSP FIN 45-3 states that a guarantor should apply the recognition, measurement and disclosure provisions of FIN 45 to a guarantee granted to a business or its owners that the revenue of the business (or a specific portion of the business) for a specified period of time will be at least a specified minimum amount (minimum revenue guarantee).
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The FSP is effective for new minimum guarantees issued or modified on or after the beginning of the first quarter following November 10, 2005. Earlier application is permitted, however, the 45-3’s initial application should not be revised or restated.
The disclosure requirements of FIN 45 should be applied to all minimum revenue guarantees in the financial statements of interim or annual periods ending after the beginning of the first fiscal quarter following November 10, 2005. Thus the disclosure requirements should be applied to any minimum revenue guarantees issued prior to the initial application of this staff position, regardless of whether those guarantees were recognized and measured under FIN 45. The Company does not anticipate that FIN 45-3 will have a material impact on its consolidated results of operations.
The FASB has issued FASB Staff Position (FSP) FAS 123(R)-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards. Certain entities do not have, and may not be able to recreate, information about net excess tax benefits required for implementation of FAS 123(R). This FSP provides a one-time election to adopt a practical transition method that may be used when adopting FAS 123(R).
The guidance in this FSP was effective on November 10, 2005. An entity that adopts FAS 123(R) using either modified retrospective or modified prospective application, as described in paragraphs 44-78 of that Statement, may make a one-time election to adopt the transition method described in FSP FAS 123(R)-3. An entity may take up to one year from the later of its initial adoption of FAS No. 123(R) or the effective date of this FSP to evaluate its available transition alternatives and make its one-time election. The Company is in the process of evaluating its transition alternatives.
H. Guarantor Arrangements
The Company warrants that the Company’s software products will perform substantially in accordance with the product specifications as contained in certain associated documentation, which is provided with the products, for a period of ninety days from initial delivery of the products to the customer. The Company’s sole obligation under this warranty is to use reasonable efforts to correct a verified problem that is brought to the Company’s attention during the warranty period, or if the Company is unable to provide a correction, the Company is obligated to accept the return of the product and refund the license fee paid. The Company warrants that the Company’s professional services will be provided in accordance with good professional practice, and that any software developed by the Company’s services organization will perform substantially in accordance with its approved specifications for a period of thirty days from initial delivery of the services to the customer. The Company’s sole obligation under this warranty is to use reasonable efforts to correct a verified problem that is brought to the Company’s attention during the warranty period, or if the Company is unable to provide a correction, the Company is obligated to accept the return of the deliverables and refund the fee paid for the services. If necessary, the Company would provide for the estimated cost of product and services warranties based on specific warranty claims and claim history. However, the Company has never incurred a significant expense under the Company’s product or services warranties. The Company’s liability for breach of warranty is limited to the amount of the license or services fees actually paid, and the Company maintains insurance covering such claims in an amount sufficient to cover a refund of the license or services fees paid by any particular customer during the last 12 months. As a result, the Company believes the estimated fair value of these warranty obligations is minimal. Accordingly, the Company has no liabilities recorded for these warranty obligations as of December 31, 2005.
Under the Company’s standard end-user license agreement, the Company agrees to indemnify the Company’s customers against infringement claims that may be brought by third parties asserting that the Company’s products infringe on certain intellectual property rights. In the Company’s services agreements with customers, the Company will also, as a matter of standard practice, agree to indemnify customers (a) against claims that may be brought by third parties asserting that the results of the Company’s services infringe on certain intellectual property rights, (b) against damages caused by the Company’s breach of certain confidentiality provisions in the contract, and (c) against damages to personal property, and death caused by the Company’s services personnel while on-site at customer premises. These indemnification
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provisions are generally based on the Company’s standard contractual terms. All such provisions, whether based on the Company’s standard contracts or negotiated with a given customer, are entered into in the normal course of business based on an assessment that the risk of loss is remote. The terms of the indemnification as negotiated may vary in duration and nature, and the Company’s obligations to indemnify may be unlimited as to amount. There have been no demands for indemnity and the contingencies triggering the obligation to indemnify have not occurred to the Company’s knowledge and are not expected to occur. The Company maintains insurance that covers such indemnification obligations, and the amount of coverage that the Company maintains is sufficient to cover a refund of the license and services fees received from any particular customer during the last 12 months. Historically, the Company has not made any material payments pursuant to any such indemnity obligations. Accordingly, the Company has no liabilities recorded for any such indemnity obligations as of December 31, 2005.
When the Company acquires a business or a company, the Company may assume liability for certain events or occurrences that took place prior to the date of acquisition. The maximum potential amount of future payments the Company could be required to make for such obligations is undeterminable at this time. All of these obligations were grandfathered under the provisions of FIN 45 as they were in effect prior to December 31, 2002. Accordingly, the Company has no liabilities recorded for the assumption of any such liabilities as of December 31, 2005.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
In addition to historical information, this Quarterly Report on Form 10-Q, as well as documents incorporated herein by reference, may contain forward-looking statements (within the meaning of section 27A of the Securities Act of 1933, as amended, and section 21E of the Securities Exchange Act of 1934, as amended). The following and similar expressions identify forward-looking statements: “expects,” “anticipates,” and “estimates.” Forward-looking statements include, without limitation, statements related to: our plans, objectives, expectations and intentions; the timing of, availability and functionality of products under development or recently introduced; and market and general economic conditions. Important factors that could cause actual results to differ materially from those suggested by the forward-looking statements for various reasons, include those discussed under the heading “Risk Factors” below. These forward-looking statements speak only as of the date of this Quarterly Report, and we disclaim any obligation to update such forward looking statements as a result of any change in circumstances or otherwise.
OVERVIEW
MRO Software, Inc. is the leading global provider of asset and service management solutions. In March 2005, we released our new generation of products, Maximo Enterprise Suite (MXES). MXES is a comprehensive suite of products all built on a single, common, web-architected platform. MXES combines enhanced Enterprise Asset Management (EAM) functionality with service management capabilities that together improve the effectiveness of asset management strategies. MXES includes all the functionality required to provide IT Service Management (ITSM) capabilities, which includes advanced IT Asset Management (ITAM), service management, and a full-featured service desk, all based on the IT Infrastructure Library (ITIL) guidelines. We market our MXES solution under several product names: Maximo and Maximo Enterprise for EAM applications, Maximo Discovery for autodiscovery of IT assets, Maximo IT Asset Management (ITAM) for advanced IT Asset Management (ITAM), and Maximo Service Desk, a full-featured service desk. Most products within MXES can each be implemented separately as a stand-alone solution, or they can readily be deployed together. MXES enables compliance with contracts, service level agreements, internal corporate standards, and government regulations. Our solutions enhance asset management and ensure service performance of production, facility, transportation and IT assets. In addition, the Company offers Online Commerce Service (“OCS”). OCS is a suite of hosted technologies and applications that enable Maximo Buyer and other purchasing systems to view supplier catalogs, procure electronically, receive acknowledgements, view real-time price and stock availability, and check orders online. This service also enables suppliers of industrial goods and services to host an on-line searchable electronic catalog, and provides them with tools to manage, customize and publish electronic catalog content.
We report all our revenues and operating results in one reportable business segment. Our management assesses operating results on an aggregate basis to make decisions about the allocation of resources. Our actual results are reported in United States dollars. International revenues accounted for 46% of total revenues for the three months ended December 31, 2005, and, therefore, the fluctuation in exchange rates can have a significant impact on our results of operations. In the three months ended December 31, 2005, the fluctuation in the Euro dollar and the British pound, in particular, had an unfavorable impact on our revenue results. We assess the impact of foreign currency exchange rates on our business, primarily revenues, by recalculating the current period’s financial results using the comparable period’s exchange rates to devise a constant currency rate in order to compare period over period results. We believe that this non-GAAP financial measure provides useful information to management and investors since it reflects performance of our international territories without the effect of changes in exchange rates. Total actual revenues increased 4% for the three months ended December 31, 2005, as compared to the three months ended December 31, 2004, however, in constant currency terms the increase is estimated to be 7%. The exchange rates had a similar impact on direct and operating expenses and, therefore, the overall impact on net income was immaterial for the three months ended December 31, 2005.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires
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that management make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. These estimates and assumptions are affected by management’s application of accounting policies.
Critical accounting policies, in which different judgments and estimates by our management could materially affect our reported financial condition and results of operations, include revenue recognition, estimating the allowance for doubtful accounts, deferred tax assets, and the valuation of long-lived assets. These critical accounting policies and estimates should be read in conjunction with the critical accounting policies and estimates included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on December 14, 2005. The Company believes that at December 31, 2005, there has been no material change to this information except as follows:
The Company adopted FAS 123(R), “Share-Based Payment”, in the first quarter of fiscal 2006, using the modified prospective application method and the Black-Scholes option price model to determine the fair value for stock options. The Black-Scholes option pricing model incorporates certain assumptions, such as risk-free interest rate, expected volatility, expected dividend yield and expected life of options, in order to arrive at a fair value estimate. While the risk-free interest rate and dividend yield are less subjective assumptions, typically based on factual data derived from public sources, the expected stock-price volatility and option life assumptions require a greater level of judgment.
While the Company believes that its estimates are based on outcomes that are reasonably likely to occur, if actual results significantly differ from those estimated or if future changes are made to the Company’s assumptions, the amount of recognized compensation expense could change significantly. For additional information refer to Footnote C of this Quarterly Report on Form 10-Q.
REVENUES
Our revenues are derived primarily from two sources: (i) software licenses, and (ii) fees for support and services.
Three | Three | |||||||||||
Months | Months | |||||||||||
Ended | Change | Ended | ||||||||||
(in thousands) | 12/31/05 | % | 12/31/04 | |||||||||
Software licenses | $ | 12,815 | (14 | %) | $ | 14,824 | ||||||
Percentage of total revenues | 26 | % | 31 | % | ||||||||
Support revenues | $ | 20,270 | 9 | % | $ | 18,590 | ||||||
Percentage of total revenues | 41 | % | 39 | % | ||||||||
Services revenues | $ | 16,047 | 15 | % | $ | 13,942 | ||||||
Percentage of total revenues | 33 | % | 30 | % | ||||||||
Total revenues | $ | 49,132 | 4 | % | $ | 47,356 |
Software license revenues decreased 14% for the three months ended December 31, 2005 compared to the three months ended December 31, 2004, and decreased approximately 10% using constant currency rates. The decrease in software license revenues was attributable to lower than expected sale of software licenses due to unfavorable timing of closing software sales during the quarter. There was only one software license sold over $1 million for the three months ended December 31, 2005 as compared to three software licenses sold over $1 million for the three months ended December 31, 2004.
Support revenues increased 9% for the three months ended December 31, 2005 compared to the three months ended December 31, 2004, and increased approximately 11% using constant currency rates. Support revenues have increased as a result of a cumulative increase in the number of Maximo licenses and a strong renewal rate (90%) for support contracts.
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Service revenues increased 15% for the three months ended December 31, 2005 compared to the three months ended December 31, 2004, and increased approximately 20% using constant currency rates. The increase in service revenues was primarily attributable to the recognition of services revenues on fixed priced services arrangements and an increase in services opportunities resulting from previous large software deals.
COST OF REVENUES
Three | Three | |||||||||||
Months | Months | |||||||||||
Ended | Change | Ended | ||||||||||
(in thousands) | 12/31/05 | % | 12/31/04 | |||||||||
Cost of software licenses | $ | 1,383 | 8 | % | $ | 1,280 | ||||||
Percentage of software licenses revenues | 11 | % | 9 | % | ||||||||
Cost of support revenues | $ | 3,152 | 9 | % | $ | 2,881 | ||||||
Percentage of support revenues | 16 | % | 15 | % | ||||||||
Cost of services revenues | $ | 13,022 | 2 | % | $ | 12,734 | ||||||
Percentage of services revenues | 81 | % | 91 | % | ||||||||
Total cost of revenues | $ | 17,557 | 4 | % | $ | 16,895 | ||||||
Percentage of total revenues | 36 | % | 36 | % |
Cost of software license revenues consists of software purchased for resale, royalties paid to vendors of third-party software, the cost of software product packaging and media, certain employee costs related to software duplication, packaging and shipping and amortization of acquired technology. The 8% increase in the cost of software license revenues for the three months ended December 31, 2005 compared to the three months ended December 31, 2004 was primarily due to an increase in royalties paid to vendors of third-party software and an increase in purchases of third-party software related to our Maximo Mobile Suite product. Partially offsetting this increase was a decrease in amortization of acquired technology due to the completion of amortization of fully amortized assets. Amortization of acquired technology was $354 thousand and $519 thousand for the three months ended December 31, 2005 and 2004, respectively.
Cost of support consists primarily of personnel costs for employees and the related costs of benefits and facilities and costs for operating our OCS business. Cost of support revenues increased 9% for the three months ended December 31, 2005 compared to the three months ended December 31, 2004. The increase was primarily attributable to an increase in renewals of third-party support contracts related to the Maximo Mobile Suite product and an increase in travel expenses due to a worldwide support meeting held in October 2005. Partially offsetting these increases was a decrease in indirect allocated operating expenses. Cost of support revenues, as a percentage of total support revenues, was 16% and 15% for the three months ended December 31, 2005 and 2004, respectively.
Cost of service revenues consists primarily of personnel costs for employees and the related costs of benefits and facilities and costs for utilization of third-party consultants. Cost of service revenues increased 2% for the three months ended December 31, 2005 compared to the three months ended December 31, 2004. Cost of service revenues, as a percentage of total service revenues was 81% and 91% for the three months ended December 31, 2005 and 2004, respectively. The increase in the cost of services was attributable to an increase in the utilization of third-party consultants implementing our products, an increase in reimbursable expenses and an increase in salaries and related benefits. Partially offsetting this increase was a decrease in service incentives and travel and entertainment expenses. There were worldwide professional services meetings that were held in the three months ended December 31, 2004 that were not held in the three months December 31, 2005. The decrease in the cost of service revenues, as a
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percentage of total service revenues, was due to the recognition of services revenues on fixed priced services arrangements with the corresponding expenses recorded in previous periods (timing).
OPERATING EXPENSES
Three | Three | |||||||||||
Months | Months | |||||||||||
Ended | Change | Ended | ||||||||||
(in thousands) | 12/31/05 | % | 12/31/04 | |||||||||
Sales and marketing | $ | 13,601 | (11 | %) | $ | 15,231 | ||||||
Percentage of total revenues | 28 | % | 32 | % | ||||||||
Product development | $ | 7,453 | 10 | % | $ | 6,780 | ||||||
Percentage of total revenues | 15 | % | 14 | % | ||||||||
General and administrative | $ | 4,628 | 1 | % | $ | 4,570 | ||||||
Percentage of total revenues | 9 | % | 10 | % |
Sales and marketing expenses decreased 11% for the three months ended December 31, 2005 as compared to the three months ended December 31, 2004. The decrease was primarily attributable to a decrease in sales commissions due to a decrease in software license sales and a decrease in travel and entertainment expenses related to the postponement of a worldwide sales meeting to the second quarter of fiscal 2006. Partially offsetting this decrease was a general increase in salaries and related benefits.
Product development expenses increased 10% for the three months ended December 31, 2005 as compared to the three months ended December 31, 2004. The increases were due to an increase in salaries and related benefits due to an increase in head count and an increase in expenditures for translation of our products in various languages.
General and administrative expenses increased 1% for the three months ended December 31, 2005 as compared to the three months ended December 31, 2004. General and administrative costs have mainly increased due to the costs of internal controls in order to maintain compliance with the Sarbanes Oxley Act of 2002. This includes external consultants and increased audit fees. General and administrative expenses, as a percentage of total revenues, was 9% and 10% for the three months ended December 31, 2005 and 2004, respectively.
NON-OPERATING EXPENSES
Three | Three | |||||||||||
Months | Months | |||||||||||
Ended | Change | Ended | ||||||||||
(in thousands) | 12/31/05 | % | 12/31/04 | |||||||||
Interest income, net | $ | 1,225 | 160 | % | $ | 471 | ||||||
Other (expense)/ income, net | $ | (191 | ) | (134 | )% | $ | 570 |
Interest income is attributable to interest earned on marketable securities and cash and cash equivalents. We invest a large portion of our cash in marketable securities such as United States treasury and treasury-backed instruments and highly rated conservative corporate bonds. We were able to earn more income for the three months ended December 31, 2005 as compared to the three months ended December 31, 2004 because we invested more cash in higher yielding securities, mostly higher yielding U.S. bonds.
Other (expense)/income, net includes foreign currency transaction gains and losses. We reported net currency transaction losses of $134 thousand for the three months ended December 31, 2005 and net currency transaction gains of $672 thousand for the three months ended December 31, 2004. We did not enter into any foreign exchange contracts during the three months ended December 31, 2005 or 2004.
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Transaction gains and losses are primarily attributable to settlement of foreign intercompany account balances.
INCOME TAXES
Our effective tax rate was 39% and 36% for the three months ended December 31, 2005 and 2004, respectively. The tax provision was calculated on income generated in domestic and foreign tax jurisdictions and on changes in our net deferred tax assets and liabilities. The increase in the effective tax rate was primarily attributable to a higher forecast mix of domestic versus international income for the three months ended December 31, 2005 and the expiration of the research and development credit.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2005, we had cash and cash equivalents of $123.6 million and marketable securities of $12.9 million. Our working capital was $119.3 million.
Cash provided by operations was $2.9 million for the three months ended December 31, 2005 and primarily attributable to income generated from operations and collection of accounts receivable.
Cash used in investing activities was $844 thousand for the three months ended December 31, 2005 and was used for the purchase of capital assets.
Cash provided by financing activities was $1.6 million for the three months ended December 31, 2005 and represents proceeds from our employee stock option and stock purchase plans.
As of December 31, 2005, our principal commitments consist primarily of office space and equipment operating leases for our U.S. and European headquarters. Our corporate headquarters are under a lease through December 31, 2009. We lease our other facilities and certain equipment under non-cancelable operating lease agreements that expire at various dates through June 30, 2019. We pay all insurance, utilities, and pro rated portions of any increase in certain operating expenses and real estate taxes. We have also entered into sub-lease agreements for our UK facility through May 2010.
We may use a portion of our cash to acquire additional businesses, products or technologies complementary to our business. We also plan to make investments over the next year in our products and technology.
We expect that our cash flow from operations, together with our current cash and marketable securities, will be sufficient to meet our working capital and capital expenditure requirements through at least December 31, 2006. Our liquidity and working capital requirements, including the current portions of any long-term commitments, are satisfied through cash flow from operations, leaving our cash reserves available for acquisitions, other investments and unanticipated expenditures. We have no long-term debt obligations. The factors that might impact our cash flows include those that might impact our business and operations generally, as described under the heading “Risk Factors”.
RECENT ACCOUNTING PRONOUNCEMENTS
The FASB has issued FASB Staff Position (FSP) FIN 45-3, Application of FASB Interpretation No. 45 to Minimum Guarantees Granted to a Business or Its Owners. The guidance in the FSP amends FASB Interpretation No. 45 Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Other’s.
FSP FIN 45-3 states that a guarantor should apply the recognition, measurement and disclosure provisions of FIN 45 to a guarantee granted to a business or its owners that the revenue of the business (or a specific portion of the business) for a specified period of time will be at least a specified minimum amount (minimum revenue guarantee).
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The FSP is effective for new minimum guarantees issued or modified on or after the beginning of the first quarter following November 10, 2005. Earlier application is permitted, however, the 45-3’s initial application should not be revised or restated.
The disclosure requirements of FIN 45 should be applied to all minimum revenue guarantees in the financial statements of interim or annual periods ending after the beginning of the first fiscal quarter following November 10, 2005. Thus the disclosure requirements should be applied to any minimum revenue guarantees issued prior to the initial application of this staff position, regardless of whether those guarantees were recognized and measured under FIN 45. The Company does not anticipate that FIN 45-3 will have a material impact on its consolidated results of operations.
The FASB has issued FASB Staff Position (FSP) FAS 123(R)-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards. Certain entities do not have, and may not be able to recreate, information about net excess tax benefits required for implementation of FAS 123(R). This FSP provides a one-time election to adopt a practical transition method that may be used when adopting FAS 123(R).
The guidance in this FSP was effective on November 10, 2005. An entity that adopts FAS 123(R) using either modified retrospective or modified prospective application, as described in paragraphs 44-78 of that Statement, may make a one-time election to adopt the transition method described in FSP FAS 123(R)-3. An entity may take up to one year from the later of its initial adoption of FAS No. 123(R) or the effective date of this FSP to evaluate its available transition alternatives and make its one-time election. The Company is in the process of evaluating its transition alternatives.
RISK FACTORS
The nature of forward-looking information is that such information involves significant assumptions, risks and uncertainties. Certain of our public documents and statements made by our authorized officers, directors, employees, agents and representatives acting on our behalf may include forward-looking information which will be influenced by the factors described below and by other assumptions, risks and uncertainties. Forward-looking information is based on assumptions, estimates, forecasts and projections regarding our future results as well as the future effectiveness of our strategic plans and our operational decisions. Forward-looking statements made by or on behalf of us are subject to the risk that the forecasts, projections and expectations of management, or assumptions underlying such forecasts, projections and expectations, may prove to be inaccurate. Accordingly, actual results and our implementation of our plans and operations may differ materially from forward-looking statements made by or on behalf of us. The following discussion identifies certain important factors that could affect our actual results and actions and could cause such results and actions to differ materially from forward-looking statements.
We depend substantially on our Maximo EAM product.
Most of our revenues are derived from the licensing of our Maximo EAM family of products and sales of related services and support. Our financial performance depends largely on continued market acceptance of these products. We believe that continued market acceptance and our revenue stability and growth will largely depend on our ability to continue to enhance and broaden the capabilities of these products. If we are unable to continue to enhance and improve Maximo EAM so that it delivers the capabilities required by existing and potential customers and remains competitive with other products in the market, our revenues, margins and results of operations and financial condition may be materially and adversely affected.
The markets for our products are mature and saturated and may present limited opportunity for growth, and are crowded with larger competitors that may have significant advantages.
Maximo has been the industry-leading plant floor capital asset maintenance product for a number of years, and we have acquired a large number of customers in this market. However, most large industrial organizations have made significant investments in systems that support the maintenance of their capital assets, and opportunities for new Maximo sales in the EAM market are in a state of continuous decline. In
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addition, our new ITAM and service desk products represent new entrants into mature markets that are currently served by larger competitors, and that are not growing.
• | The emergence and growth of the EAM, ITAM and service desk markets have attracted a large number of strong competitors, and most of the largest software companies that sell into complementary markets have developed competing EAM, ITAM or service desk products. | ||
• | In the EAM market, large ERP vendors have developed products that compete with Maximo EAM and that are tightly integrated with the rest of their ERP product suites. In the ITAM and service desk markets, larger companies than ours have developed competing products that are delivered as part of a broader product offering. While our products may have technical or functional advantages over those of our competition, these companies are all larger than ours, they may have the ability to quickly eliminate our competitive advantages, and they are able to market their products as part of a larger solution and take advantage of customers’ desire to consolidate their information technology (IT) systems onto fewer platforms. |
It is likely that these markets will continue to mature, there will be fewer sales opportunities for us within the EAM market, and competitive forces will put downward pressure on our average sales prices and rates of success.
To be competitive in the EAM market, we have made significant investments in Maximo EAM to meet the needs of specific industries in which we have a presence, such as the nuclear energy, transportation, power generation, transmission and distribution, and other industries. We refer to these industry-specific Maximo offerings as “Industry Solutions.” To address the ITAM and service desk markets, we have invested heavily in the development and release of MXES. While we continue to strengthen our Maximo EAM offering, and while we offer our products as an integrated suite that manages all of our customers’ critical assets in a manner that none of our competitors are able, these efforts may not be sufficient to overcome the effects of maturity, saturation and intense competition in our markets, and our revenues, margins, results of operation and financial condition may be materially and adversely affected.
Our efforts to reach into new markets with new products may not be successful.
Given the maturity and saturation of the traditional EAM market, in order to maintain revenues at their current levels and to grow our business, we have recently broadened our product offerings in order to develop additional sources of revenues, and we continue to do so. With the initial release of Maximo Enterprise Suite (MXES) in March 2005, we have delivered products that address the Help Desk and Service Desk markets, new markets for us. We are planning significant enhancements to this initial release, and will continue to broaden this offering. Our continuing development of MXES and of our Maximo EAM Industry Solutions, and our ability to derive revenue and grow, is subject to the following risks, among others:
• | We may not be able to develop and market our new products on time, with acceptable quality or with functions and features that meet the requirements of customers in these markets. | ||
• | The MXES products may not contain all of the functionality deemed necessary by prospective buyers in these markets, and certain of our competitors in these new markets also offer complementary and sometimes fully integrated products that we do not offer. It may take longer than we anticipate for us to establish our presence in new markets, develop a robust and dependable flow of sales opportunities and establish predictable closure rates and revenue streams. | ||
• | It is possible that our sales, service or support personnel may not be adequately trained and/or staffed to sell, implement or support the new products. Newly developed products require a higher level of development, distribution and support expenditures in the early stages of their product life cycles. |
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• | In the event that our development efforts do not progress as intended, or if our new product releases or technologies are not successful in the markets they are intended to address, we may increase our rate of expenditure in this area over and above the level of investment experienced in the past or previously projected, which could have a material adverse affect on our results of operation or financial condition. | ||
• | We may not derive revenues from MXES in proportion to our development investment and sales efforts, and those efforts may serve as a significant distraction from our efforts to maintain revenues at current levels in our traditional EAM market. | ||
• | Our positioning of the combination of our traditional EAM products and our ITAM and service desk products in a single offering as a logical suite of products may not be accepted in the marketplace. As a result of this and other factors, we may not be able to benefit from the trend among customers to consolidate their IT systems, and we may not be successful in our attempts to “cross-sell” our new products into our existing accounts, or our traditional EAM products to customers primarily interested in our new products. |
If any of our newly developed products do not gain market acceptance and generate revenues from new industries or markets, we may not be able to grow our business or maintain revenues at current levels, and our revenues, margins, results of operations and financial condition may be materially and adversely affected.
Our sales efforts depend in part on strategic relationships and reseller arrangements with other companies.
We have entered into strategic relationships with various larger companies such as IBM, SAIC, BearingPoint and Accenture LLP. In order to generate revenue through these relationships, each party must coordinate with and support the other’s sales and marketing efforts, and each party must make significant sales and marketing investments. Our ability to generate revenues from these relationships depends in large part upon the efforts of these other companies, which are outside of our control. The efforts of these companies may in turn be influenced by factors internal to these companies that impact their desire or ability to execute, by changes in their strategies, or by developments in their respective industries or markets, that we fail to anticipate.
In addition, we are renewing our focus on generating software license sales through value-added resellers, systems integrators and other indirect sales channels. We may have difficulty or we may experience delays in establishing the infrastructure necessary to initiate, maintain and support these channel relationships, and these relationships may either not materialize or they may fail to produce additional sales at all or within the timeframe that we currently anticipate. To the extent that these channels are focused on our new product offerings, they are vulnerable to unknown problems with our new products or gaps in our new offerings. As a company, we do not have experience in supporting channel relationships in this new market, and we may fail to develop the infrastructure or deliver the resources necessary to successfully support them. We may not derive revenues in proportion to our investment in channel sales, and those efforts may serve as a significant distraction from our direct sales efforts.
If we are unable to keep pace with the rapid changes in technology and customer demand that characterize our industry, our competitive position could be impaired.
The computer software industry is characterized by rapid technological advances, changes in customer requirements and frequent product introductions and enhancements by us and by our competitors. Our success depends on our abilities to enhance our current products, to develop and introduce new products that keep pace with technological developments, to respond to evolving customer requirements and changing industry standards, to offer functionality and other innovations that are unique to our products and superior to those of our competitors, and ultimately to achieve market acceptance. In particular, we believe that we must continue to innovate and develop new functionality, to respond quickly to users’ needs for new functionality and to advances in hardware and operating systems, and that we must continue to create
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products that conform to industry standards regarding the communication and interoperability among software, hardware and communications products of many different vendors. If we fail to anticipate or respond adequately to technological developments and changes in market definitions or changes in customer requirements within particular market segments, or if we have any significant delays in product development or introduction, then we could lose competitiveness and revenues.
Our quarterly operating results are subject to fluctuations and to seasonal variation.
We have experienced, and may in the future experience, significant period-to-period fluctuations in revenues and operating results. In addition, our quarterly revenues and operating results have fluctuated historically due to the number and timing of product introductions and enhancements, customers delaying their purchasing decisions in anticipation of new product releases, the budgeting and purchasing cycles of customers, the timing of product shipments and the timing of marketing and product development expenditures. We typically realize a significant portion of our revenue from sales of software licenses in the last two weeks of each quarter, frequently even in the last few days of a quarter. Failure to close a small number of large software license contracts may have a significant impact on revenues for the quarter and could, therefore, result in significant fluctuations in quarterly revenues and operating results, and divergence of those results from our expectations. Accordingly, we believe that period-to-period comparisons of results of operations are not necessarily meaningful and should not be relied upon as an indication of future performance.
We face intense competition in the markets we serve.
The markets for strategic asset management software such as Maximo EAM, Maximo ITAM and Maximo Enterprise Suite (MXES) are fragmented by geography, by market and industry segments, by hardware platform and by industry orientation, and are characterized by a large number of competitors including both independent software vendors and certain ERP vendors. Independent software vendors include DataStream Systems, Inc. and Indus International, Inc. We also compete with integrated ERP systems, which include maintenance modules offered by several large vendors, such as SAP and Oracle. In the ITAM market, we compete with companies such as Peregrine Systems (which has agreed to be acquired by Hewlett-Packard Company), Computer Associates and BMC Software. MXES will compete with all of these companies, and in the Help Desk and Service Desk markets, MXES competes with BMC Software (which recently acquired the Remedy help desk product) and Hewlett-Packard. Maximo also encounters competition from vendors of low cost maintenance management systems designed initially for use by a single user or limited number of users as vendors of these products upgrade their functionality and performance to enter the enterprise market.
Certain of our competitors have greater financial, marketing, service and support and technological resources than we do. To the extent that such competitors increase their focus on the asset maintenance, planning and cost systems markets, or on the industrial supply chain market, we could be at a competitive disadvantage.
Current or potential competitors may combine with each other or make strategic acquisitions, thereby increasing their ability to deliver products that better address the needs of our customers. There is no assurance that we will be able to compete successfully should this occur and this could have a material adverse effect on our financial condition and results of operations.
Our international operations subject us to special risks.
A significant portion of our total revenues and expenses are derived and incurred from operations outside the U.S. Our ability to sell our products internationally is subject to a number of risks. General economic and political conditions in each country could adversely affect demand for our products and services. Exposure to currency fluctuations and greater difficulty in collecting accounts receivable could affect our sales. We could be affected by the need to comply with a wide variety of foreign import laws, U.S. export laws and regulatory requirements. Trade protection measures and import and export licensing requirements
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subject us to additional regulation and may prevent us from shipping products to a particular market and increase our operating costs.
Our software products are dependent on third-party providers of software and services, and failure of these parties to perform as expected, or termination of our relationships with them, could harm our business.
We have entered into nonexclusive license agreements with other software vendors, pursuant to which we incorporate into our products and solutions software providing certain application development, hardware and network discovery, user interface, mobile technology, report writing, application servers, business intelligence, content and graphics capabilities developed by these companies. If we cannot renew these licenses (at all or on commercially reasonable terms), or if any of such vendors were to become unable to support and enhance their products, we could be required to devote additional resources to the enhancement and support of these products or to acquire or develop software providing equivalent capabilities, which could cause delays in the development and introduction of products incorporating such capabilities.
We may have exposure to additional tax liabilities.
We are subject to income taxes and non-income taxes (e.g., import/export duties, and payroll, sales, use, value-added, net worth, property, and goods and services taxes) in both the U.S. and various foreign jurisdictions. The amount of taxes paid is subject to our interpretation of applicable tax laws in the jurisdictions in which we file. We are regularly subject to examinations of our tax returns by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision and accruals for taxes. While we believe that we have properly interpreted applicable tax laws, there can be no assurance that a governing tax authority will not have a different interpretation of the law and assess us with additional taxes. Should we be assessed with additional taxes, there could be a material and adverse effect on our results of operations or financial condition.
Changes in regulations or critical accounting policies could materially and adversely affect us.
New laws, regulations or standards related to us or our products, and new accounting pronouncements, could be implemented or changed in a manner that could adversely affect our business, results of operations or financial condition.
We may be eligible for several tax benefits provided for under the American Jobs Creation Act of 2004, which was signed into law on October 22, 2004. The potential tax benefits include a temporary 85% foreign dividends received deduction for certain dividends received from controlled foreign corporations. There are several statutory requirements, which must be met if we determine that the 85% dividends received deduction is advantageous. However, if we do not appropriately comply with the statutory requirements then the 85% foreign dividends received deduction could be forfeited resulting in a potentially adverse affect on our results of operations.
We may perform more fixed price services contracts.
A trend has emerged and is continuing among customers in our market towards demanding consulting and implementation services on a fixed-price basis, whereby we agree to deliver the contract requirements for a fixed fee regardless of the number of person-hours actually provided, as opposed to our traditional services arrangements where we deliver services on a time-and-materials basis. In cases where services are provided either for the future delivery of functionality or on a fixed price basis and our standard software is licensed at the same time, and if the services are essential to the overall solution desired by the customer or if we cannot determine the fair value of the services being delivered, then we may not be able to recognize the software license revenue from such transactions at the time the agreements are signed, but rather may be required to recognize such license revenue under the contract method of accounting, or to recognize a greater portion (or all) of the revenue from these transactions as services revenue. This would likely result
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in a postponement of recognition of, or even a reduction in, software license revenues, and have an adverse affect on our results of our operations.
We may be unable to effectively protect our intellectual property.
Our success is dependent upon our proprietary technology. We currently have two U.S. patents (and other corresponding patents or applications pending in various foreign countries), and we protect our technology primarily through copyrights, trademarks, trade secrets and employee and third-party nondisclosure agreements. Our software products are sometimes licensed to customers under “shrink-wrap” or “click- wrap” licenses included as part of the product packaging or acknowledged by customers who register online. Although, in larger sales, our shrink-wrap and click-wrap licenses may be accompanied by specifically negotiated agreements signed by the licensee, in many cases our shrink-wrap and click-wrap licenses are not negotiated with or signed by individual licensees. Certain provisions of our shrink-wrap and click-wrap licenses, including provisions protecting against unauthorized use, copying, transfer and disclosure of the licensed program, and limitations or liabilities and exclusions of remedies, may be unenforceable under the laws of certain jurisdictions. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as do the laws of the U.S. Finally, we sell our products through distributors and resellers, and are therefore dependent on those companies to take appropriate steps to adequately implement our contractual protections and to enforce and protect our rights. We cannot give any assurance that the steps that we have taken to protect our proprietary rights will be adequate to prevent misappropriation of our technology or development by others of similar technology. Although we believe that our products and technology do not infringe on any valid claim of any patent or any other proprietary rights of others, we cannot give any assurance that third parties will not assert infringement claims in the future. Litigation may be necessary to enforce our intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Such litigation could result in substantial costs and diversion of resources, could result in the deterioration or outright loss of our patent rights, copyrights or other intellectual property, and could potentially have a material adverse affect on our operating results and financial condition.
Loss of the services of one or more of our key executive officers or inability to recruit needed sales, services and technical personnel could adversely affect our business.
We are highly dependent on certain key executive officers, technical and sales employees, and the loss of one or more of such employees could have an adverse impact on our future operations. We do not have employment contracts with any personnel, and we do not maintain any so-called “key person” life insurance policies on any personnel. We continue to hire additional sales, services and technical personnel. Competition for hiring of such personnel in the software industry is intense, and from time to time we may experience difficulty in locating candidates with the appropriate qualifications within the desired geographic locations, or with certain industry specific expertise. There can be no assurance that we will be able to retain our existing personnel or attract additional qualified employees.
We are exposed to fluctuations in the market values of our portfolio investments and in interest rates.
We invest a portion of our cash in marketable securities. These securities are classified as available-for-sale and are recorded at fair value on the consolidated balance sheet with unrealized gains or losses reported as a separate component of accumulated other comprehensive income (loss), net of tax. Economic downturns and other factors subject these securities to volatility in the market place. Any resulting decline in fair value of these investments could adversely affect our financial condition.
Recently issued regulations related to equity compensation could adversely affect our ability to attract and retain key personnel.
We have used stock options and other long-term equity incentives as a fundamental component of our employee compensation packages. We believe that stock options and other long-term equity incentives directly motivate our employees to maximize long-term stockholder value and, through the use of vesting,
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encourage employees to remain with the Company. The FASB issued changes to U.S. GAAP that requires companies to record a charge to earnings for new and unvested employee stock option grants for the first annual fiscal period beginning after July 1, 2005. This regulation could have a negative impact on our earnings. In addition, regulations of the Nasdaq National Market that require shareholder approval for all stock option plans, and regulations implemented by the New York Stock Exchange that prohibit NYSE member organizations from giving a proxy to vote on equity-compensation plans unless the beneficial owner of the shares has given voting instructions, could make it more difficult for us to grant options to employees in the future. To the extent that new regulations make it more difficult or expensive to grant stock options to employees, we may incur increased compensation costs, change our equity compensation strategy or find it difficult to attract, retain and motivate employees, each of which could materially and adversely affect our business.
We face costs and risks associated with compliance with Section 404 of the Sarbanes-Oxley Act.
We continue to evaluate our internal control systems in order to allow our management to report on, and our independent auditors to attest to, our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. As a result, we continue to incur expenses and management’s time continues to be diverted which could adversely affect our financial results and the market price of our common stock.
Other Risks
The foregoing is not a complete description of all risks relevant to our future performance, and the foregoing should be read and understood together with and in the context of similar discussions which may be contained in the documents that we file with the SEC in the future. We undertake no obligation to release publicly any revision to the foregoing or any update to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary exposure to market risk is the effect of fluctuations in interest rates earned on our marketable securities and exposures to foreign currency exchange rate fluctuations.
At December 31, 2005, we held $12.9 million in marketable securities consisting of taxable securities. Interest rate movements affect the interest income we earn. We place our investments with high quality issuers and limits risk by purchasing only investment-grade securities. A hypothetical 10 percent increase in interest rates would not have a material impact on the fair market value of these instruments due to their short maturity.
We develop our products in the United States and market them in North America, Europe, Middle East and Africa, Australia, Asia Pacific and Latin America. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. As of December 31, 2005, we did not engage in foreign currency hedging activities.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective.
Changes in internal control over financial reporting
During the most recent fiscal quarter covered by this report, there has been no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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Part II. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 1A. Risk Factors
Information regarding risk factors appears in Part I, Item 2 “MD&A–Risk Factors” of this Quarterly Report on Form 10-Q. In addition, risk factors are included in Part I of our 2005 Annual Report on Form 10-K. There have been no material changes from the risk factors previously disclosed in our 2005 Annual Report on Form 10-K.
Item 2 Unregistered Sales of Equity Securities & Use of Proceeds
None
Item 3 Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
On February 8, 2006, the Compensation Committee of the Board of Directors of MRO Software, Inc. (the “Committee”) approved a change to the vesting of restricted stock grants issued to executive officers on May 10, 2005. Rather than vesting 25% one year after the date of grant and thereafter on a monthly basis over the next three years, the shares will now vest 25% one year from the date of grant, and thereafter 25% on March 14, 2007, 2008 and 2009, respectively.
This change was effected for administrative reasons, as the Company has an obligation to withhold taxes each time that restricted shares vest, and the change will reduce the occurrence of these obligations from twelve times to once per year. There is no material affect on the equity-based compensation expense to be recorded by the Company, and no material benefit to holders of the restricted stock.
This change will be effected pursuant to written agreements with each officer in which each officer will have the option of satisfying his or her tax liability upon each vesting date by surrendering to the Company the appropriate number of shares valued at fair market value on each such date. To the extent that officers elect this option, their execution of these agreements will be intended to satisfy the criteria for the establishment of an affirmative defense contemplated under Rule 10b5-1(c) as promulgated under the Securities Exchange Act of 1934 by the Securities and Exchange Commission.
Item 6. Exhibits
We have listed the exhibits as part of this Quarterly Report on Form 10-Q in the accompanying exhibit index; which follows the signature page to this Quarterly Report on Form 10-Q.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
MRO SOFTWARE, INC. | ||||
Dated: February 09, 2006 | By: /s/ Peter J. Rice | |||
Peter J. Rice | ||||
Executive Vice President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer) | ||||
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EXHIBIT LIST
Exhibit | Filed with this | Incorporated by Reference | ||||||||||
No. | Description | Form 10-Q | Form | Filing Date | Exhibit No. | |||||||
3.1 | Amended and Restated Articles of Organization | S-1 | April 21, 1994 | 3.3 | ||||||||
3.2 | Amendment to Articles of Organization | 10-Q | February 14, 2000 | 3.4 | ||||||||
3.3 | Amendment to Articles of Organization | 8-K | March 9, 2001 | 3.4 | ||||||||
3.4 | Certificate of Vote of Directors Establishing Series A Junior Participating Preferred Stock | 8-K | February 3, 1998 | 4 | (b) | |||||||
3.5 | By-laws | 10-Q | February 14, 2001 | 3.5 | ||||||||
3.6 | Amendment to By-laws | 10-Q | May 15, 2001 | 3.3 | ||||||||
4.1 | Specimen stock certificate for common stock | S-1 | April 21, 1994 | 4.1 | ||||||||
4.2 | Form of rights certificate | 8-K | February 3, 1998 | 4 | (c) | |||||||
10.1* | Form of Option Amendment for executive officers | 8-K | October 6, 2005 | 10.1 | ||||||||
10.2* | Executive Bonus Plan Fiscal Year Ended September 30, 2006 | X | ||||||||||
10.3* | Amended Stock Restriction Agreement | X | ||||||||||
31.1 | Certification of the chief executive officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | X | ||||||||||
31.2 | Certification of the chief financial officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | X | ||||||||||
32.1 | Certification of the chief executive officer and the chief financial officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | X |
* | Management contract or compensatory plan. |
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