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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended April 30, 2004
Or
[ ] 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: 000-28369
VA Software Corporation
(Exact name of Registrant as specified in its charter)
Delaware 77-0399299
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
46939 Bayside Parkway, Fremont, California, 94538
(Address, including zip code, of principal executive offices)
(510) 687-7000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value
(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. Yes [X] No [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Title Of Class Outstanding At June 9, 2004
Common Stock, $0.001 par value 61,142,292
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Table of Contents
Page No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)................................................................................ 3
Condensed Consolidated Balance Sheets at April 30, 2004 and July 31, 2003................................... 3
Condensed Consolidated Statements of Operations for the three and nine months ended April 30, 2004
and April 26, 2003.......................................................................................... 4
Condensed Consolidated Statements of Cash Flows for the nine months ended April 30, 2004 and April
26, 2003.................................................................................................... 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...................................................... 35
Item 4. Controls and Procedures......................................................................................... 36
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................................................................... 36
Item 6. Exhibits and Reports on Form 8-K................................................................................ 36
Signatures.................................................................................................................... 37
Certifications................................................................................................................ 38
2
PART I
VA SOFTWARE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, unaudited)
April 30, July 31,
2004 2003
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents .......................................................... $ 6,606 $ 6,303
Short-term investments ............................................................. 22,574 27,864
Restricted cash, current ........................................................... 450 450
Accounts receivable, net ........................................................... 3,083 1,928
Inventories ........................................................................ 677 388
Prepaid expenses and other assets .................................................. 1,574 1,232
--------- ---------
Total current assets ....................................................... 34,964 38,165
Property and equipment, net .......................................................... 1,334 4,267
Long-term investments ................................................................ 17,470 4,680
Restricted cash, non current ......................................................... 450 450
Other assets ......................................................................... 990 933
--------- ---------
Total assets ............................................................... $ 55,208 $ 48,495
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ................................................................... $ 983 $ 863
Accrued restructuring liabilities, current portion ................................. 4,023 4,117
Accrued compensation ............................................................... 1,264 1,346
Deferred revenue ................................................................... 1,513 751
Accrued liabilities and other ...................................................... 1,193 2,263
--------- ---------
Total current liabilities .................................................. 8,976 9,340
Accrued restructuring liabilities, net of current portion ............................ 8,475 10,772
Other long-term liabilities .......................................................... 1,247 1,181
--------- ---------
Total liabilities .......................................................... 18,698 21,293
Commitments and contingencies (Notes 7 and 9) ........................................ -- --
Stockholders' equity:
Common stock 62 56
Treasury stock ..................................................................... (4) (4)
Additional paid-in capital ......................................................... 783,077 766,765
Deferred stock compensation ........................................................ -- (20)
Accumulated other comprehensive gain (loss) ........................................ (122) 128
Accumulated deficit ................................................................ (746,503) (739,723)
--------- ---------
Total stockholders' equity .................................................. 36,510 27,202
--------- ---------
Total liabilities and stockholders' equity .................................. $ 55,208 $ 48,495
========= =========
<FN>
The accompanying notes are an integral part of these financial statements.
</FN>
3
VA SOFTWARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts, unaudited)
Three Months Ended Nine months ended
---------------------- ----------------------
April 30, April 26, April 30, April 26,
2004 2003 2004 2003
-------- -------- -------- --------
Total revenues:
Software revenues ....................................................... $ 1,379 $ 671 $ 3,377 $ 2,072
Online revenues ......................................................... 5,909 5,185 18,518 14,996
Other revenues .......................................................... 3 181 49 604
-------- -------- -------- --------
Total revenues ....................................................... 7,291 6,037 21,944 17,672
Cost of revenues:
Software cost of revenues ............................................... 360 450 1,496 1,513
Online cost of revenues ................................................. 3,153 2,658 10,581 8,392
Other cost of revenues .................................................. -- (14) -- (377)
-------- -------- -------- --------
Cost of revenues ..................................................... 3,513 3,094 12,077 9,528
-------- -------- -------- --------
Gross margin ......................................................... 3,778 2,943 9,867 8,144
-------- -------- -------- --------
Operating expenses:
Sales and marketing ..................................................... 2,639 2,614 7,623 7,260
Research and development ................................................ 1,667 1,987 5,210 5,987
General and administrative .............................................. 1,490 1,422 3,772 5,113
Restructuring costs and other special charges ........................... 3,244 101 3,209 (34)
Amortization of deferred stock compensation ............................. -- 37 20 116
Amortization of intangible assets ....................................... 3 644 9 1,932
-------- -------- -------- --------
Total operating expenses ........................................ 9,043 6,805 19,843 20,374
-------- -------- -------- --------
Loss from operations ...................................................... (5,265) (3,862) (9,976) (12,230)
Remeasurement of warrant liability ........................................ 925 -- 1,566 --
Interest income, net ...................................................... 223 258 708 886
Other income (expense) , net .............................................. (8) (6) 923 (71)
-------- -------- -------- --------
Net loss .................................................................. $ (4,125) $ (3,610) $ (6,779) $(11,415)
======== ======== ======== ========
Other comprehensive gain (loss):
Unrealized gain (loss) on marketable securities and investments ...... (152) 7 (258) 95
Foreign currency translation gain (loss) ............................. (3) 1 8 8
-------- -------- -------- --------
Comprehensive loss ........................................................ $ (4,280) $ (3,602) $ (7,029) $(11,312)
======== ======== ======== ========
Net loss .................................................................. $ (4,125) $ (3,610) $ (6,779) $(11,415)
======== ======== ======== ========
Basic and diluted net loss per share ...................................... $ (0.07) $ (0.07) $ (0.11) $ (0.21)
======== ======== ======== ========
Shares used in computing basic and diluted net loss per share ............. 60,882 53,935 59,186 53,835
======== ======== ======== ========
<FN>
The accompanying notes are an integral part of these financial statements.
</FN>
4
VA SOFTWARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, unaudited)
Nine Months Ended
---------------------------
April 30, April 26,
2004 2003
-------- --------
Cash flows from operating activities:
Net loss ..................................................................................... $ (6,779) $(11,415)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization of intangibles ............................................... 1,209 4,511
Remeasurement of warrant liability ......................................................... (1,566) --
Provision for bad debts .................................................................... 7 (42)
Provision for excess and obsolete inventory ................................................ (5) (15)
Loss on disposal of assets ................................................................. -- 4
Amortization of deferred stock compensation ................................................ 20 116
Non-cash restructuring expense ............................................................. 2,496 (256)
Changes in assets and liabilities:
Accounts receivable ...................................................................... (1,162) (502)
Inventories .............................................................................. (284) (43)
Prepaid expenses and other assets ........................................................ (408) (4)
Accounts payable ......................................................................... 120 (767)
Accrued restructuring liabilities ........................................................ (2,391) (2,150)
Deferred revenue ......................................................................... 762 (30)
Accrued liabilities and other ............................................................ (1,148) (1,340)
Other long-term liabilities .............................................................. 65 176
-------- --------
Net cash used in operating activities ................................................. (9,064) 11,757
-------- --------
Cash flows from investing activities:
Purchase of property and equipment ........................................................... (763) (125)
Purchase of marketable securities ............................................................ (39,806) (30,828)
Sale of marketable securities ................................................................ 32,306 15,171
Other, net ................................................................................... (258) 95
Net cash used in investing activities ................................................. (8,521) (15,687)
-------- --------
Cash flows from financing activities:
Payments on notes payable .................................................................... -- (42)
Proceeds from issuance of common stock, net .................................................. 17,884 249
-------- --------
Net cash provided by financing activities ............................................. 17,884 207
-------- --------
Effect of exchange rate changes on cash and cash equivalents .................................. 4 8
-------- --------
Net increase (decrease) in cash and cash equivalents .......................................... 303 (27,229)
-------- --------
Cash and cash equivalents, beginning of period ................................................ 6,303 35,148
-------- --------
Cash and cash equivalents, end of period ...................................................... $ 6,606 $ 7,919
======== ========
<FN>
The accompanying notes are an integral part of these financial statements.
</FN>
5
VA SOFTWARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The condensed consolidated financial statements included herein have been
prepared by VA Software Corporation ("VA," "VA Software" or the "Company"),
without audit, pursuant to the rules and regulations of the Securities and
Exchange Commission ("SEC"). Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to such
rules and regulations. In the opinion of management, the unaudited interim
financial statements reflect all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation of the financial
position, results of operations and other comprehensive loss and cash flows for
the interim periods presented. The financial statements and the accompanying
notes, however, should be read in conjunction with VA's audited consolidated
financial statements and the notes thereto included in VA's Annual Report on
Form 10-K for the fiscal year ended July 31, 2003, filed with the SEC on October
14, 2003. The condensed consolidated balance sheet as of July 31, 2003 has been
derived from the audited financial statements as of that date, but does not
include all disclosures required by generally accepted accounting principles for
complete financial statements.
The results of operations for the three and nine months ended April 30, 2004
are not necessarily indicative of the results that may be expected for any other
interim period or for the full fiscal year ending July 31, 2004.
2. Summary of Significant Accounting Policies
Use of Estimates in Preparation of Consolidated Financial Statements
The preparation of consolidated financial statements in conformity with
accounting principles 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 date of such financial statements, as well as the reported
amounts of revenue and expenses during the periods indicated. Actual results
could differ from those estimates.
Principles of Consolidation
These consolidated financial statements include the accounts of VA and its
wholly-owned and majority-owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation. In September
2000, the Company acquired 68% of the outstanding shares of common stock of VA
Linux Systems Japan, K.K. ("VA Linux Japan") for a cash purchase price of
approximately $6.9 million. Effective January 11, 2002, VA sold 13,500 shares of
VA Linux Japan stock to a third party for approximately $5.1 million, which
decreased the Company's investment in VA Linux Japan to approximately 11%. On
March 29, 2002, VA Linux Japan repurchased 10,000 shares of its outstanding
stock from a third party other than the Company, thereby decreasing the number
of shares outstanding and increasing the Company's investment to approximately
19%. As the Company holds less than 20% of the voting stock of VA Linux Japan
and does not otherwise exercise significant influence over it, VA Linux Japan
has been accounted for under the cost method of accounting since January 11,
2002. The minority interest included in the results of operations for VA Linux
Japan has not been significant for any period presented and has been recorded in
other income in the accompanying statements of operations.
Foreign Currency Translation
The functional currency of all the Company's foreign subsidiaries is the
country's local currency. Balance sheet accounts are translated into U.S.
dollars at exchange rates prevailing at balance sheet dates. Revenue and
expenses are translated into U.S. dollars at average rates for the period. Gains
and losses resulting from translation are charged or credited in comprehensive
income as a component of stockholders' equity. As of April 30, 2004, the Company
did not hold any foreign currency derivative instruments.
Segment and Geographic Information
Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures
about Segments of an Enterprise and Related Information," establishes standards
for reporting information regarding operating segments in annual financial
statements and requires selected information for those segments to be presented
in interim financial reports issued to stockholders. SFAS No. 131 also
6
establishes standards for related disclosures about products and services and
geographic areas. Operating segments are identified as components of an
enterprise about which separate discrete financial information is available for
evaluation by the chief operating decision-maker, or decision-making group, in
making decisions how to allocate resources and assess performance. The Company's
chief decision-making group, as defined under SFAS No. 131, is comprised of VA's
Chief Executive Officer and its executive team. The Company operates as two
reportable business segments: software and online. Due to the significant amount
of shared operating resources that are utilized by both of the business
segments, the Company only reports segment information for revenues and cost of
sales.
The Company markets its products in the United States through its direct
sales force. Revenues for each of the three and nine months ended April 30, 2004
and April 26, 2003 were primarily generated from sales to end users in the
United States.
Revenue Recognition
Software Revenues
Revenue consists principally of fees for licenses of the Company's software
products, maintenance, consulting and training. The Company recognizes revenue
using the residual method in accordance with Statement of Position ("SOP") 97-2,
"Software Revenue Recognition," as amended by SOP 98-9, "Modification of SOP
97-2, Software Revenue Recognition with Respect to Certain Transactions." Under
the residual method, the fair value of the undelivered elements is deferred and
the remaining portion of the arrangement fee is recognized as revenue. If
evidence of the vendor specific fair value of one or more undelivered elements
does not exist, revenues are deferred and recognized when delivery of those
elements occurs or when fair value can be established. Company-specific
objective evidence of fair value of maintenance and other services is based on
the Company's customary pricing for such maintenance and/or services when sold
separately. At the outset of the arrangement with the customer, the Company
defers revenue for the fair value of its undelivered elements (e.g.,
maintenance, consulting and training) and recognizes revenue for the remainder
of the arrangement fee attributable to the elements initially delivered in the
arrangement (i.e., software product) when the basic criteria in SOP 97-2 have
been met. If such evidence of fair value for each undelivered element of the
arrangement does not exist, all revenue from the arrangement is deferred until
such time that evidence of fair value does exist or until all elements of the
arrangement are delivered.
Under SOP 97-2, revenue attributable to an element in a customer arrangement
is recognized when (i) persuasive evidence of an arrangement exists, (ii)
delivery has occurred, (iii) the fee is fixed or determinable, (iv)
collectibility is probable and (v) the arrangement does not require services
that are essential to the functionality of the software.
Persuasive evidence of an arrangement exists. The Company determines that
persuasive evidence of an arrangement exists with respect to a customer when it
has a written contract, which is signed by both the customer and the Company, or
a purchase order from the customer when the customer has previously executed a
standard license arrangement with the Company. The Company does not offer
product return rights to resellers or end users.
Delivery has occurred. The Company's software may be either physically or
electronically delivered to the customer. The Company determines that delivery
has occurred upon shipment of the software pursuant to the billing terms of the
agreement or when the software is made available to the customer through
electronic delivery.
The fee is fixed or determinable. If at the outset of the customer
arrangement, the Company determines that the arrangement fee is not fixed or
determinable, revenue is recognized when the arrangement fee becomes due and
payable. Fees due under an arrangement are generally deemed not to be fixed or
determinable if a significant portion of the fee is beyond the Company's normal
payment terms, which are generally no greater than 120 days from the date of
invoice.
Collectibility is probable. The Company determines whether collectibility is
probable on a case-by-case basis. When assessing probability of collection, the
Company considers the number of years in business, history of collection, and
product acceptance for each customer. The Company typically sells to customers
for whom there is a history of successful collection. New customers are subject
to a credit review process, which evaluates the customer's financial position
and ultimately such customer's ability to pay. If the Company determines from
the outset of an arrangement that collectibility is not probable based upon its
review process, revenue is recognized as payments are received.
The Company allocates revenue on software arrangements involving multiple
elements to each element based on the relative fair value of each element. The
Company's determination of fair value of each element in multiple-element
arrangements is based on vendor-specific objective evidence ("VSOE"). The
Company limits its assessment of VSOE for each element to the price charged when
7
the same element is sold separately. The Company has analyzed all of the
elements included in its multiple-element arrangements and has determined that
it has sufficient VSOE to allocate revenue to the maintenance, support and
professional services components of its perpetual license arrangements. The
Company sells its professional services separately, and has established VSOE for
professional services on this basis. VSOE for maintenance and support is
determined based upon the customer's annual renewal rates for these elements.
Accordingly, assuming all other revenue recognition criteria are met, revenue
from perpetual licenses is recognized upon delivery using the residual method in
accordance with SOP 98-9.
Services revenues consist of professional services and maintenance fees. In
general, the Company's professional services, which are comprised of software
installation and integration, business process consulting and training, are not
essential to the functionality of the software. The Company's software products
are fully functional upon delivery and implementation and do not require any
significant modification or alteration of products for customer use. Customers
purchase these professional services to facilitate the adoption of the Company's
technology and dedicate personnel to participate in the services being
performed, but they may also decide to use their own resources or appoint other
professional service organizations to provide these services. Software products
are billed separately from professional services, which are generally billed on
a time-and-materials basis. The Company recognizes revenue from professional
services as services are performed.
Maintenance agreements are typically priced based on a percentage of the
product license fee and have a one-year term, renewable annually. Services
provided to customers under maintenance agreements include technical product
support and unspecified product upgrades. Deferred revenues from advanced
payments for maintenance agreements are recognized ratably over the term of the
agreement, which is typically one year.
The Company expenses all manufacturing, packaging and distribution costs
associated with software license sales as cost of license revenues.
Online Revenues
Advertising revenues are derived from the sale of advertising space on our
various Web sites. Advertising revenues are recognized over the period in which
the advertisements are displayed, provided that no significant obligations
remain and collection of the receivable is reasonably assured. Our obligations
typically include guarantees of a minimum number of "impressions" (times that an
advertisement is viewed by users of our online services over a specified period
of time). To the extent that minimum guaranteed impressions are not met, the
Company does not recognize the corresponding revenues until the guaranteed
impressions are achieved. Barter revenue transactions are recorded at their
estimated fair value based on the Company's historical experience of selling
similar advertising for cash in accordance with Emerging Issues Task Force
("EITF") Issue 99-17, "Accounting for Advertising Barter Transactions." The
Company broadcasts banner advertising in exchange for similar banner advertising
on third party Web sites.
E-commerce revenues are derived from the online sale of consumer goods and
digital animations. E-commerce revenues from the sale of consumer goods are
recognized in accordance with SEC Staff Accounting Bulletin ("SAB") 104,
"Revenue Recognition." Under SAB 104, product revenues are recognized when
persuasive evidence of an arrangement exists, delivery has occurred, the sale
price is fixed or determinable and collectibility is reasonably assured. In
general, the Company recognizes e-commerce revenue upon the shipment of goods.
The Company does grant customers a right to return e-commerce products. Such
returns are recorded as incurred and have been immaterial for the periods
presented. The majority of the revenues derived from digital animation sales are
related to membership arrangements. As a result, we recognize the value ratably
over the term of the contract, normally 3 or 12 months.
Other Revenues
The Company's revenue recognition policy related to its former hardware
systems business follows SAB 104. Under SAB 104, the Company recognized product
revenues from the sale of Linux-based servers, components, and desktop computers
when persuasive objective evidence of an arrangement existed, delivery occurred,
the sales price was fixed or determinable and collectibility was reasonably
assured. In general, the Company recognized product revenue upon shipment of the
goods. The Company does not grant customers any rights to return these products.
The Company recognizes revenues from customer support services associated
with VA's former hardware business, including on-site maintenance and technical
support on a pro-rata basis over the term of the related service agreement. The
Company recognizes revenues from professional service contracts upon completion
of the project, or using the percentage of completion contract accounting method
where project costs can be reasonably estimated. The Company records any
payments received prior to revenue recognition as deferred revenue. For the
8
three and nine months ended April 30, 2004, revenues from customer support
services and professional service contracts associated with the Company's former
hardware business were not material.
Software Development Costs
In accordance with SFAS No. 86, "Accounting for the Cost of Computer
Software to be Sold, Leased, or Otherwise Marketed," development costs incurred
in the research and development of new software products are expensed as
incurred until technological feasibility in the form of a working model has been
established at which time such costs are capitalized, subject to a net
realizable value evaluation. Technological feasibility is established upon the
completion of an integrated working model. To date, the Company's software
development has been completed concurrent with the establishment of
technological feasibility and, accordingly, all software development costs have
been charged to research and development expense in the accompanying statements
of operations.
Stock Based Compensation
The Company accounts for its employee stock-based compensation plans in
accordance with Accounting Principles Board ("APB") Opinion No. 25, Accounting
for Stock Issued to Employees, and Financial Accounting Standards Board ("FASB")
Interpretation No. ("FIN") 44, "Accounting for Certain Transactions Involving
Stock Compensation--an Interpretation of APB Opinion No. 25," and complies with
the disclosure provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation." Accordingly, no compensation cost is recognized for any of the
Company's fixed stock options granted to employees when the exercise price of
the option equals or exceeds the fair value of the underlying common stock as of
the grant date for each stock option. The Company accounts for equity
instruments issued to non-employees in accordance with the provisions of SFAS
No. 123 and EITF No. 96-18, "Accounting for Equity Instruments That Are Issued
to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services." Deferred stock-based compensation is included as a component of
stockholders' equity and is being amortized by charges to operations over the
vesting period of the options and restricted stock consistent with the method
described in FIN 28, "Accounting for Stock Appreciation Rights and Other
Variable Stock Option or Award Plans."
Had compensation cost been recognized based on the fair value at the date of
grant for options granted and Employee Stock Purchase Plan issuances during the
three and nine months ended April 30, 2004, and April 26, 2003, the Company's
pro forma net loss and net loss per share would have been as follows (in
thousands, except per share amounts):
Three Months Ended Nine months ended
---------------------- ----------------------
April 30, April 26, April 30, April 26,
2004 2003 2004 2003
-------- -------- -------- --------
Net loss as reported ....................................................... $ (4,125) $ (3,610) $ (6,779) $(11,415)
Add back employee stock-based compensation expense related to
stock options included in reported net loss ............................. -- 37 20 116
Less employee stock-based compensation expense determined under fair
value based method for all employee stock option awards, net
of related tax effects .................................................. (1,773) (2,320) (4,780) (6,907)
-------- -------- -------- --------
Pro forma net loss ...................................................... $ (5,898) $ (5,893) $(11,539) $(18,206)
-------- -------- -------- --------
Shares used in computing basic and diluted net loss per share .............. 60,882 53,935 59,186 53,835
-------- -------- -------- --------
Reported basic and diluted net loss per share .............................. $ (0.07) $ (0.07) $ (0.11) $ (0.21)
======== ======== ======== ========
Pro forma basic and diluted net loss per share ............................. $ (0.10) $ (0.11) $ (0.19) $ (0.34)
======== ======== ======== ========
9
The Company calculated the fair value of each option grant using the
Black-Scholes option-pricing model as prescribed by SFAS No. 123 using the
following assumptions:
Stock Option Plans Stock Option Plans
For The Three Months Ended For The Nine months ended
---------------------------------- -------------------------------------
April 30, April 26, April 30, April 26,
2004 2003 2004 2003
---------------- ------------- ----------------- ---------------
Expected life (years).................. 4.7 4.7 5.0 4.7
Risk-free interest rate................ 2.9% 3.0% 3.3% 3.1%
Volatility............................. 105.7% 107.4% 109.7% 107.4%
Dividend yield......................... None None None None
ESPP Plans ESPP Plans
For The Three Months Ended For The Nine months ended
---------------------------------- -------------------------------------
April 30, April 26, April 30, April 26,
2004 2003 2004 2003
---------------- ------------- ----------------- ---------------
Expected life (years).................. 0.5 0.5 0.5 0.5
Risk-free interest rate................ 1.1% 1.0% 1.1% 1.1%
Volatility............................. 119.1% 92.5% 102.3% 95.2%
Dividend yield......................... None None None None
Goodwill and Intangibles
Intangible assets are amortized on a straight-line basis over three to five
years. The Company continually evaluates whether events or circumstances have
occurred that indicate the remaining estimated useful lives of these intangible
assets may not be recoverable. When events or circumstances indicate that the
intangible assets should be evaluated for possible impairment, the Company uses
an estimate of the related business segment's undiscounted net income over the
remaining useful life of the intangible assets in measuring whether they are
recoverable. No events or circumstances occurred during the three or nine months
ended April 30, 2004 that would indicate a possible impairment in the carrying
value of intangible assets at April 30, 2004.
The changes in the carrying amount of the intangible assets are as follows
(in thousands):
As of April 30, 2004 As of July 31, 2003
------------------------------ ------------------------------
Gross Carrying Accumulated Gross Carrying Accumulated
Amount Amortization Amount Amortization
-------- -------- -------- ---------
Domain and trade names ........................................... $ 5,922 $ (5,910) $ 5,922 $ (5,901)
Purchased technology ............................................. 2,534 (2,534) 2,534 (2,534)
-------- -------- -------- --------
Total intangible assets .................................... 8,456 (8,444) 8,456 (8,435)
Goodwill ......................................................... 60,362 (60,362) 60,362 (60,362)
-------- -------- -------- --------
Total changes in goodwill and intangible assets .................. $ 68,818 $(68,806) $ 68,818 $(68,797)
======== ======== ======== ========
The aggregate amortization expense of intangible assets, net of
restructuring charges were $3,183 and $644,000 for the three months ending April
30, 2004 and April 26, 2003, respectively and were $9,549 and $1,932,000 for the
nine months ending April 30, 2004 and April 26, 2003, respectively. The
estimated total amortization expense of acquired intangible assets is $12,700
and $9,500 for the fiscal years ending July 31, 2004 and July 31, 2005,
respectively.
Inventories
Inventories related to our online operations consist of finished goods that
are valued using the average cost method. Provisions, when required, are made to
reduce excess and obsolete inventories to their estimated net realizable values.
Concentrations of Credit Risk and Significant Customers
The Company's investments are held with two reputable financial
institutions. Both institutions are headquartered in the United States.
Financial instruments that potentially subject the Company to concentrations of
credit risk consist primarily of cash and trade receivables. The Company
provides credit, in the normal course of business, to a number of companies and
performs ongoing credit evaluations of its customers. At April 30, 2004, two
customers, Google Inc and Starcom IP Inc. accounted for 16.6% and 10.2% of gross
10
accounts receivable outstanding, respectively. These receivables are current and
the Company believes the receivables are fully collectable.
For the three and nine months ending April 30, 2004, no single customer
accounted for more than 10% of VA's total revenues. For the three and nine
months ending April 26, 2003 one customer, Intel Corporation, accounted for
approximately 16.6% and 17.0% of total revenues respectively.
3. Restructuring Costs and Other Special Charges
In fiscal 2001 and 2002, the Company adopted plans to exit the systems and
hardware-related software engineering and professional services businesses, as
well as exit a sublease agreement and reduce its general and administrative
overhead costs. The Company exited these activities to pursue its software and
online businesses and reduce its operating losses to improve cash flow. The
Company recorded restructuring charges of $180.2 million related to exiting
these activities, $160.4 million of which was included in restructuring charges
and other special charges in operating expenses and $19.8 million of which was
included in cost of sales. Included in the restructuring were charges related to
excess facilities from non-cancelable leases (with payments continuing until
fiscal 2010, unless sublet completely).
During the quarter ended April 30, 2004, in an effort to reduce its
operating expenses, the Company adopted a plan to relocate and relocated its
Fremont, California headquarters to a smaller building in the same complex. The
Company recorded net restructuring expenses of $2.9 million related to exiting
these facilities which was included in restructuring expense. Included in the
$2.9 million dollar restructuring expense was $2.5 million of expense related to
writing off leasehold improvements and fixed assets and $0.4 million in expenses
related to excess facilities from non-cancelable leases (with payments
continuing until fiscal 2010, unless sublet completely). In addition to the $2.9
million dollar restructuring expense, because the Company has reached agreement
in principal on subleases relating to unoccupied portions of properties that the
Company currently leases in Sunnyvale, California and Fremont, California and
expects to finalize these subleases during its fourth quarter of fiscal 2004,
the Company changed its assumptions of expected future sublease income from its
restructured idle office space that was previously restructured in fiscal year
2002 and recorded a restructuring charge of $0.3 million. The Company recorded
$3.2 million in restructuring expenses in the consolidated statement of
operations for the three and nine months ending April 30, 2004.
The accrual from non-cancelable lease payments includes management's
estimates of sublease income. These estimates are subject to change based on
actual events. The Company evaluates and updates, if applicable, these estimates
quarterly. As of April 30, 2004, the Company had an accrual of approximately
$12.5 million outstanding related to these non-cancelable leases, all of which
was originally included in operating expenses. The non-cancelable leases will
expire by the end of fiscal year 2010.
Below is a summary of the restructuring charges in operating expenses (in
thousands):
Total Charged Total
To Operations Nine Restructuring
Total Total months Liabilities
Total Charged Charged To Charged To ended Cash at
To Operations Operations Operations April 30, Receipts/ April 30,
Fiscal 2001 Fiscal 2002 Fiscal 2003 2004 (Payments) 2004
----------- ----------- ----------- -------- ---------- ----
Cash Provisions:
Other special charges relating to
restructuring activities .................... $ 2,159 $ (888) $ 78 $ -- $ (1,349) $ --
Facilities charges ............................ 6,584 9,401 191 713 (4,391) $ 12,498
Employee severance and other related charges .. 3,498 1,997 37 -- (5,532) --
-------- -------- -------- -------- -------- --------
Total cash provisions ..................... 12,241 10,510 306 713 $(11,272) $ 12,498
-------- -------- -------- -------- ======== ========
Non-cash:
Write-off of goodwill and intangibles ......... 59,723 30,632 -- --
Write-off of other special charges
relating to restructuring activities ......... 4,434 5,442 (553) 2,496
Write-off of accelerated options from
terminated employees ........................ 1,352 -- -- --
Acceleration of deferred stock
compensation ................................. 35,728 352 (16) --
-------- -------- -------- --------
Total non-cash provisions ................. 101,237 36,426 (569) --
-------- -------- -------- --------
Total provisions .......................... $113,478 $ 46,936 $ (263) $ 3,209
======== ======== ======== ========
11
Below is a summary of the changes to the restructuring liability (in thousands):
Balance at Charged to Balance at
Changes in the total accrued restructuring liability Beginning Costs and End
----------------------------------------------------- of Period Expenses Deductions of Period
--------- -------- ---------- ---------
For the year ended July 28, 2001 ............................. $ -- $12,241 $(2,728) $ 9,513
For the year ended July 27, 2002 ............................. $ 9,513 $10,510 $(2,029) $17,994
For the year ended July 31, 2003 ............................. $17,994 $ 306 $(3,411) $14,889
For the nine months ended April 26, 2003 ..................... $17,994 $ 222 $(2,372) $15,844
For the nine months ended April 30, 2004 ..................... $14,889 $ 713 $(3,104) $12,498
Components of the total accrued restructuring liability Short Long Total
------------------------------------------------------- Term Term Liability
---- ---- ---------
For the year ended July 28, 2001.............................. $ 3,135 $ 6,378 $ 9,513
For the year ended July 27, 2002.............................. $ 3,397 $14,597 $17,994
For the year ended July 31, 2003.............................. $ 4,117 $10,772 $14,889
For the nine months ended April 26, 2003...................... $ 4,277 $11,567 $15,844
For the nine months ended April 30, 2004...................... $ 4,023 $ 8,475 $12,498
4. Computation of Per Share Amounts
Basic net loss per common share has been calculated using the
weighted-average number of shares of common stock outstanding during the period,
less shares subject to repurchase. For all periods presented, the Company has
excluded all outstanding stock options from the calculation of diluted net loss
per common share because all such securities are anti-dilutive for those
periods.
The following table presents the calculation of basic and diluted net loss
per share (in thousands, except per share data):
Three Months Ended Nine months ended
--------------------- ---------------------
April 30, April 26, April 30, April 26,
2004 2003 2004 2003
-------- -------- -------- --------
Net loss ......................................................... $ (4,125) $ (3,610) $ (6,779) $(11,415)
-------- -------- -------- --------
Basic and diluted:
Weighted average shares of common stock outstanding ............ 60,882 53,935 59,186 53,843
Less: Weighted average shares subject to repurchase ............ -- -- -- (8)
-------- -------- -------- --------
Shares used in computing basic and diluted net loss per share .. 60,882 53,935 59,186 53,835
======== ======== ======== ========
Basic and diluted net loss per share ........................... $ (0.07) $ (0.07) $ (0.11) $ (0.21)
======== ======== ======== ========
The following potential common shares have been excluded from the
calculation of diluted net loss per share for all periods presented because they
are anti-dilutive (in thousands):
Three Months Ended Nine months ended
---------------------- ------------------------
April 30, April 26, April 30, April 26,
2004 2003 2004 2003
------ ------ ------ ------
Anti-dilutive securities:
Options to purchase common stock............................. 9,448 12,148 9,448 12,148
Warrants..................................................... 731 -- 731 --
------ ------ ------ ------
Total................................................... 10,179 12,148 10,179 12,148
====== ====== ====== ======
12
5. Comprehensive Loss
Comprehensive loss is comprised of net loss and other non-owner changes in
stockholders' equity, including foreign currency translation gains or losses and
unrealized gains or losses on available-for sale marketable securities. The
Company follows SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130
requires unrealized gains or losses on the Company's available-for-sale
securities and foreign translation adjustments, which have been included in
stockholders' equity and excluded from net income, to be included in
comprehensive income. Total comprehensive loss for the three and nine months
ended April 30, 2004 was approximately $4.3 million and $7.0 million,
respectively. Total comprehensive loss for the three and nine months ended April
26, 2003 was approximately $3.6 million and $11.3 million, respectively.
6. Segment and Geographic Information
The accounting policies of the Company's segments are the same as those
described in the summary of significant accounting polices above. There are no
intersegment sales. The Company's chief operating decision-maker evaluates
performance based on each segment's revenue and gross margin rather than profit
or similar measure. The Company's assets and liabilities are not discretely
allocated or reviewed by segment.
Total
(in thousands) Software Online Other Company
------- ------- ------- -------
Three Months Ended April 30, 2004
Revenue from external customers ............... $ 1,379 $ 5,909 $ 3 $ 7,291
Cost of revenues .............................. $ 360 $ 3,153 $ -- $ 3,513
------- ------- ------- -------
Gross margin .................................. $ 1,019 $ 2,756 $ 3 $ 3,778
Three Months Ended April 26, 2003
Revenue from external customers ............... $ 671 $ 5,185 $ 181 $ 6,037
Cost of revenues .............................. $ 450 $ 2,658 $ (14) $ 3,094
------- ------- ------- -------
Gross margin .................................. $ 221 $ 2,527 $ 195 $ 2,943
Nine months ended April 30, 2004
Revenue from external customers ............... $ 3,377 $18,518 $ 49 $21,944
Cost of revenues .............................. $ 1,496 $10,581 $ -- $12,077
------- ------- ------- -------
Gross margin .................................. $ 1,881 $ 7,937 $ 49 $ 9,867
Nine months ended April 26, 2003
Revenue from external customers ............... $ 2,072 $14,996 $ 604 $17,672
Cost of revenues .............................. 1,513 $ 8,392 $ (377) $ 9,528
------- ------- ------- -------
Gross margin .................................. $ 559 $ 6,604 $ 981 $ 8,144
7. Litigation
The Company, two of its former officers (the "Former Officers"), and the
lead underwriter in its initial public offering ("IPO") were named as defendants
in a consolidated shareholder lawsuit in the United States District Court for
the Southern District of New York, captioned In re VA Software Corp. Initial
Public Offering Securities Litigation, 01-CV-0242. This is one of a number of
actions coordinated for pretrial purposes as In re Initial Public Offering
Securities Litigation, 21 MC 92 with the first action filed on January 12, 2001.
Plaintiffs in the coordinated proceeding are bringing claims under the federal
securities laws against numerous underwriters, companies, and individuals,
alleging generally that defendant underwriters engaged in improper and
undisclosed activities concerning the allocation of shares in the IPOs of more
than 300 companies during late 1998 through 2000. Among other things, the
plaintiffs allege that the underwriters' customers had to pay excessive
brokerage commissions and purchase additional shares of stock in the aftermarket
in order to receive favorable allocations of shares in an IPO. The consolidated
amended complaint in the Company's case seeks unspecified damages on behalf of a
purported class of purchasers of its common stock between December 9, 1999 and
December 6, 2000. Pursuant to a tolling agreement, the individual defendants
were dismissed without prejudice. On February 19, 2003, the court denied the
Company's motion to dismiss the claims against it. The litigation is now in
discovery. A proposal has been made for the settlement and release of claims
against the issuer defendants, including the Company. The settlement is subject
to a number of conditions, including approval of the proposed settling parties
and the court. If the settlement does not occur, and litigation against the
Company continues, the Company believes it has meritorious defenses and intends
to defend the case vigorously.
The Company is subject to various claims and legal actions arising in the
ordinary course of business. The Company has accrued for estimated losses in the
accompanying consolidated financial statements for those matters where it
believes that the likelihood that a loss will occur is probable and the amount
of loss is reasonably estimable.
13
8. Recent Accounting Policies
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
addresses certain financial instruments that, under previous guidance, could be
accounted for as equity, but now must be classified as liabilities in statements
of financial position. These financial instruments include: 1) mandatory
redeemable financial instruments; 2) obligations to repurchase the issuer's
equity shares by transferring assets; and 3) obligations to issue a variable
number of shares. SFAS No. 150 is effective for all financial instruments
entered into or modified after May 31, 2003, and otherwise effective at the
beginning of the first interim period beginning after June 15, 2003. The
implementation of SFAS No. 150 is not expected to have a material effect on the
Company's consolidated financial statements.
In December 2003, the SEC issued SAB 104, "Revenue Recognition," which
supercedes SAB 101, "Revenue Recognition in Financial Statements." SAB 104's
primary purpose is to rescind accounting guidance contained in SAB 101 related
to multiple element revenue arrangements, which was superceded as a result of
the issuance of EITF 00-21, Accounting for Revenue Arrangements with Multiple
Deliverables. While the wording of SAB 104 has changed to reflect the issuance
of EITF 00-21, the revenue recognition principles of SAB 101 remain largely
unchanged by the issuance of SAB 104. The adoption of SAB 104 did not a material
impact on the Company's consolidated financial statements.
9. Guarantees and Indemnifications
As permitted under Delaware law, the Company has agreements whereby the
Company's officers and directors are indemnified for certain events or
occurrences while the officer or director is, or was, serving at the Company's
request in such capacity. The maximum potential amount of future payments the
Company could be required to make under these indemnification agreements is
unlimited; however, the Company has director and officer liability insurance
designed to limit the Company's exposure and to enable the Company to recover a
portion of any future amounts paid. As a result of the Company's insurance
policy coverage, the Company believes the estimated fair value of these
indemnification agreements is minimal. All of these indemnification agreements
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
these agreements as of April 30, 2004.
The Company enters into standard indemnification agreements in the ordinary
course of business. Pursuant to these agreements, the Company indemnifies, holds
harmless, and agrees to reimburse the indemnified party for losses suffered or
incurred by the indemnified party, generally, the Company's business partners,
subsidiaries and/or customers, in connection with any patent , copyright or
other intellectual property infringement claim by any third party with respect
to the Company's products. The term of these indemnification agreements is
generally perpetual any time after execution of the agreement. The maximum
potential amount of future payments the Company could be required to make under
these indemnification agreements is unlimited. The Company has not incurred
significant costs to defend lawsuits or settle claims related to these
indemnification agreements. As a result, the Company believes the estimated fair
value of these agreements is insignificant. Accordingly, the Company has no
liabilities recorded for these agreements as of April 30, 2004.
The Company warrants that its software products will perform in all material
respects in accordance with the Company's standard published specifications in
effect at the time of delivery of the licensed products to the customer for a
specified period, which generally does not exceed ninety days. Additionally, the
Company warrants that its maintenance services will be performed consistent with
generally accepted industry standards through the completion of the agreed upon
services. If necessary, the Company would provide for the estimated cost of
product and service warranties based on specific warranty claims and claim
history, however, the Company has not incurred significant expense under its
product or services warranties. As a result, the Company believes the estimated
fair value of these agreements is minimal. Accordingly, the Company has no
liabilities recorded for these agreements as of April 30, 2004.
The Company warrants that its hardware products related to its previous
hardware business will perform in all material respects in accordance with the
Company's standard published specifications in effect at the time of delivery of
the products to the customer for the life of the product, typically 36 months.
The remaining estimated fair value of these agreements related to the Company's
previous hardware business is minimal at April 30, 2004. Accordingly, the
Company has a liability of approximately $12,000 recorded for these agreements
as of April 30, 2004
14
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Special Note Regarding Forward-Looking Statements
This Form 10-Q contains forward-looking statements that involve risks and
uncertainties. Words such as "intend," "expect," "believe," "in our view," and
variations of such words and similar expressions, are intended to identify such
forward-looking statements, which include, but are not limited to, statements
regarding our expectations and beliefs regarding future revenue growth; gross
margins; financial performance and results of operations; technological trends
in, and emergence of the market for collaborative software development
applications; the future functionality, business potential, demand for,
efficiencies created by and adoption of SourceForge; demand for online
advertising; management's strategy, plans and objectives for future operations;
the impact of our restructuring and the amount of cash utilized by operations;
our intent to continue to invest significant resources in development;
competition, competitors and our ability to compete; liquidity and capital
resources; the outcome of any litigation to which we are a party; our accounting
policies; and sufficiency of our cash resources, cash generated from operations
and investments to meet our operating and working capital requirements. Actual
results may differ materially from those expressed or implied in such
forward-looking statements due to various factors, including those set forth in
the Risk Factors contained in the section of this Form 10-Q entitled
"Management's Discussion and Analysis of Financial Condition and Results of
Operations." We undertake no obligation to update the forward-looking statements
to reflect events or circumstances occurring after the date of this Form 10-Q.
Overview
We were incorporated in California in January 1995 and reincorporated in
Delaware in December 1999. From the date of our incorporation through October
2001, we sold Linux-based hardware systems and services under the name VA Linux
Systems, Inc. On June 27, 2001, we announced our decision to exit our
Linux-based hardware business. Today, we do business under the name VA Software
Corporation and we develop market and support a software application known as
SourceForge Enterprise Edition ("SourceForge") and also own and operate the Open
Source Development Network, Inc. ("OSDN"), a network of Internet Web sites.
SourceForge is a proprietary, Web-based software application designed for
corporate and public-sector information technology ("IT") professionals and
software engineering organizations. SourceForge combines software development
and collaboration tools with the ability to track, measure, and report on
software project activity in real-time. SourceForge improves the software
development process by capturing and archiving software development code,
documentation and communication in a central location. It enables managers to
gain insight and improved visibility into software development activity, thereby
providing better resource and requirements management, defect tracking and the
ability to resolve critical problems earlier in the development cycle.
Organizations with distributed, offshore and/or outsourced software development
teams can achieve improved productivity, communication, coordination,
collaboration, project clarity and insight through SourceForge's standard set of
development tools and secure, centralized code, documentation and communication
repository.
OSDN is a network of media and e-commerce Internet Web sites serving the IT
professional and software development communities. As of June 1, 2004, OSDN
reaches approximately 16 million unique visitors and serves more than 250
million page views per month. We believe that OSDN is the most dynamic
community-driven media network on the Web and a cornerstone of the open source
software development community. OSDN attracts IT decision-makers and buyers,
from chief technology officers to project managers. Technologists, developers
and system administrators turn to OSDN sites to create debate and make IT news.
OSDN is supported by sponsors and advertisers who want to reach the unique
demographic of IT professionals and developers that visit our OSDN Web sites
monthly. In addition, OSDN runs e-commerce sites to allow its visitors to buy a
variety of retail goods of interest to the software development and IT
communities. Our OSDN Web sites include:
o SourceForge.net, our flagship Web site and software development center. As
of June 1, 2004, SourceForge.net was the development home for more than
81,000 software development projects and had more than 850,000 registered
users.
15
o Slashdot.org, our leading discussion site for technologically-inclined
individuals. Slashdot is dedicated to providing the IT and software
development communities with cutting-edge technology, science and culture
news and interactive commentary.
o ThinkGeek.com, our e-commerce site, which provides online sales of a variety
of retail products of interest to the software development and IT
communities.
o Linux.com, our comprehensive Web site for Linux and open source news and
information. Linux.com caters to business and IT managers looking for
migration strategies to Linux.
o freshmeat.net, one of the Internet's most comprehensive indices of
downloadable Linux, Unix and cross-platform software.
o NewsForge.com, the online newspaper of record for Linux and open source
software.
o ITManagersJournal.com, a Web site delivering strategic and technical
information to help top-level IT professionals implement enterprise-level
open source and proprietary architecture, applications, and infrastructure
solutions.
o AnimationFactory.com, a source for three-dimensional art, animations and
presentations. Animation Factory offers its subscribers a dynamic collection
of easy to use animations that work in email, Web pages and presentations.
Critical Accounting Policies
Software Revenues
Software revenue consists principally of fees for licenses of our software
products, maintenance, consulting and training. We recognize revenue using the
residual method in accordance with Statement of Position ("SOP") 97-2, "Software
Revenue Recognition," as amended by SOP 98-9, "Modification of SOP 97-2,
Software Revenue Recognition with Respect to Certain Transactions." Under the
residual method, the fair value of the undelivered elements is deferred and the
remaining portion of the arrangement fee is recognized as revenue. If evidence
of the vendor specific fair value of one or more undelivered elements does not
exist, revenues are deferred and recognized when delivery of those elements
occurs or when fair value can be established. Company-specific objective
evidence of fair value of maintenance and other services is based on our
customary pricing for such maintenance and/or services when sold separately. At
the outset of the arrangement with the customer, we defer revenue for the fair
value of its undelivered elements (e.g., maintenance, consulting and training)
and recognize revenue for the remainder of the arrangement fee attributable to
the elements initially delivered in the arrangement (i.e., software product)
when the basic criteria in SOP 97-2 have been met. If such evidence of fair
value for each undelivered element of the arrangement does not exist, we defer
all revenue from the arrangement until such time that evidence of fair value
does exist or until all elements of the arrangement are delivered.
Under SOP 97-2, revenue attributable to an element in a customer arrangement
is recognized when (i) persuasive evidence of an arrangement exists, (ii)
delivery has occurred, (iii) the fee is fixed or determinable, (iv)
collectibility is probable and (v) the arrangement does not require services
that are essential to the functionality of the software.
Persuasive evidence of an arrangement exists. We determine that persuasive
evidence of an arrangement exists with respect to a customer when we have a
written contract, which is signed by both us and the customer, or a purchase
order from the customer when the customer has previously executed a standard
license arrangement with us. We do not offer product return rights.
Delivery has occurred. Our software may be either physically or
electronically delivered to the customer. We determine that delivery has
occurred upon shipment of the software pursuant to the billing terms of the
agreement or when the software is made available to the customer through
electronic delivery.
The fee is fixed or determinable. If at the outset of the customer
engagement we determine that the fee is not fixed or determinable, we recognize
revenue when the fee becomes due and payable. Fees due under a contract are
generally deemed not to be fixed or determinable if a significant portion of the
fee is beyond our normal payment terms, which are generally no greater than 120
days from the date of invoice.
Collectibility is probable. We determine whether collectibility is probable
on a case-by-case basis. When assessing probability of collection, we consider
16
the number of years in business, history of collection, and product acceptance
for each customer. We typically sell to customers, for whom there is a history
of successful collection. New customers are subject to a credit review process,
which evaluates the customer's financial position and ultimately such customer's
ability to pay. If we determine from the outset that collectibility is not
probable based upon our review process, revenue is recognized as payments are
received.
We allocate revenue on software arrangements involving multiple elements to
each element based on the relative fair value of each element. Our determination
of fair value of each element in multiple-element arrangements is based on
vendor-specific objective evidence ("VSOE"). We align our assessment of VSOE for
each element to the price charged when the same element is sold separately. We
have analyzed all of the elements included in our multiple-element arrangements
and determined that we have sufficient VSOE to allocate revenue to the
maintenance, support and professional services components of our perpetual
license arrangements. We sell our professional services separately, and have
established VSOE for professional services on that basis. VSOE for maintenance
and support is determined based upon the customer's annual renewal rates for
these elements. Accordingly, assuming all other revenue recognition criteria are
met, we recognize revenue from perpetual licenses upon delivery using the
residual method in accordance with SOP 98-9.
Services revenues consist of professional services and maintenance fees. In
general, our professional services, which are comprised of software installation
and integration, business process consulting and training, are not essential to
the functionality of the software. Our software products are fully functional
upon delivery and implementation and do not require any significant modification
or alteration of products for customer use. Customers purchase these
professional services to facilitate the adoption of our technology and dedicate
personnel to participate in the services being performed, but they may also
decide to use their own resources or appoint other professional service
organizations to provide these services. Software products are billed separately
from professional services, which are generally billed on a time-and-materials
basis. We recognize revenue from professional services as services are
performed.
Maintenance agreements are typically priced based on a percentage of the
product license fee and have a one-year term, renewable annually. Services
provided to customers under maintenance agreements include technical product
support and unspecified product upgrades. Deferred revenues from advanced
payments for maintenance agreements are recognized ratably over the term of the
agreement, which is typically one year.
We expense all manufacturing, packaging and distribution costs associated
with software license sales as cost of license revenues.
Online Revenues
Advertising revenues are derived from the sale of advertising space on our
various Web sites. We recognize advertising revenues over the period in which
the advertisements are displayed, provided that persuasive evidence of an
arrangement exists, no significant obligations remain, the fee is fixed or
determinable, and collection of the receivable is reasonably assured. Our
obligations typically include guarantees of a minimum number of "impressions"
(times that an advertisement is viewed by users of our online services). To the
extent that minimum guaranteed impressions are not met in the specified time
frame, we do not recognize the corresponding revenues until the guaranteed
impressions are achieved. We record barter revenue transactions at their
estimated fair value based on our historical experience of selling similar
advertising for cash in accordance with Emerging Issues Task Force ("EITF")
Issue 99-17, "Accounting for Advertising Barter Transactions." We broadcast
banner advertising in exchange for similar banner advertising on third-party Web
sites. Our barter arrangements are documented with our standard customer
insertion order (and accompanying terms and conditions) or, in certain limited
instances, via an alternative written contract negotiated between the parties.
The standard terms and conditions include, but are not limited to, the Web sites
for each company that will display the impressions, the time frame that the
impressions will be displayed, the number, type and size of impressions to be
delivered.
E-commerce revenues are derived from the online sale of consumer goods and
digital animations. We recognize e-commerce revenues from the sale of consumer
goods in accordance with SEC Staff Accounting Bulletin ("SAB") No. 104, "Revenue
Recognition." Under SAB 104, product revenues are recognized when persuasive
evidence of an arrangement exists, delivery has occurred, the sale price is
fixed or determinable, and collectibility is reasonably assured. In general, we
recognize e-commerce revenue upon the shipment of goods. We do grant customers a
right to return e-commerce products. Such returns are recorded as incurred and
have been immaterial for the periods presented. The majority of the revenues
derived from digital animation sales are related to membership arrangements. We
offer two Animation Factory membership agreement options, Gold and Platinum.
Both Gold and Platinum memberships are available for either a three-month or
one-year term. During a Gold or Platinum membership term, a member has access to
200,000 animations, 50,000 Web designs, three-dimensional clipart, and tiled
backgrounds via unlimited Internet downloads. A Platinum member also receives
access to extra large animations, presentation elements and PowerPoint
presentations. As a result, we recognize the value ratably over the term of the
contract, normally 3 or 12 months.
17
Other Revenues
Our revenue recognition policy related to our former hardware systems
business follows SAB 104, "Revenue Recognition." Under SAB 104, we recognized
product revenues from the sale of Linux-based servers, components, and desktop
computers when persuasive evidence of an arrangement existed, delivery occurred,
the sales price was fixed or determinable and collectibility was reasonably
assured. In general, we recognized product revenue upon shipment of the goods.
We did not grant our customers any rights to return these products.
We recognize revenues from customer support services, including on-site
maintenance and technical support on a pro-rata basis over the term of the
related service agreement. We recognized revenues from professional service
contracts upon completion of the project, or using the percentage of completion
method of the project where project costs could be reasonably estimated. We
recorded any payments received prior to revenue recognition as deferred revenue.
Results of Operations
We review our annual and quarterly results, along with key accounting
policies, with our audit committee prior to the release of financial results. In
addition, we have not entered into any significant transactions with related
parties. We do not use off-balance-sheet arrangements with unconsolidated
related parties, nor do we use other forms of off-balance-sheet arrangements
such as research and development arrangements.
We have completed eleven quarters of operations focused on building our
application software business, and accordingly have a limited operating history
in this business. While we believe that we are making good progress in our
application software business, a substantial majority of our revenues continue
to be derived from our online business and we face numerous risks and
uncertainties that commonly confront new and emerging businesses in emerging
markets, some of which we have identified in the "Risk Factors" section below.
The following table sets forth our operating results for the periods
indicated as a percentage of total revenues, represented by selected items from
the unaudited condensed consolidated statements of operations. This table should
be read in conjunction with the consolidated financial statements and the
accompanying notes included in this Form 10-Q.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended Nine Month Ended
---------------------- ----------------------
April 30, April 26, April 30, April 26,
2004 2003 2004 2003
---- ---- ---- ----
(unaudited) (unaudited)
Total revenues
Software revenues ......................................... 18.9% 11.1% 15.4% 11.7%
Online revenues ........................................... 81.0% 85.9% 84.4% 84.9%
Other revenues ............................................ 0.0% 3.0% 0.2% 3.4%
------- ------- ------- -------
Total revenues .......................................... 100.0% 100.0% 100.0% 100.0%
Cost of revenues
Software cost of revenues ................................. 4.9% 7.5% 6.8% 8.5%
Online cost of revenues ................................... 43.2% 44.0% 48.2% 47.5%
Other cost of revenues .................................... 0.0% (0.2)% 0.0% (2.1)%
------- ------- ------- -------
Cost of revenues ......................................... 48.2% 51.3% 55.0% 53.9%
------- ------- ------- -------
Gross margin ............................................. 51.8% 48.7% 45.0% 46.1%
Operating expenses:
Sales and marketing ...................................... 36.2% 43.3% 34.7% 41.1%
Research and development ................................. 22.9% 32.9% 23.7% 33.9%
General and administrative ............................... 20.4% 23.6% 17.2% 28.9%
Restructuring costs and other special charges ............ 44.5% 1.7% 14.6% (2.0)%
Amortization of deferred stock compensation .............. 0.0% 0.6% 0.1% 0.7%
Amortization of goodwill and intangible assets ........... 0.0% 10.7% 0.0% 10.9%
------- ------- ------- -------
Total operating expenses ............................. 124.0% 112.8% 90.3% 115.3%
------- ------- ------- -------
Loss from operations ....................................... (72.2)% (64.1)% (45.3)% (69.2)%
Remeasurement of warrant liability ......................... 12.7% 0.0% 7.1% 0.0%
Interest income, net ....................................... 3.0% 4.3% 3.2% 5.0%
Other income (expense), net ................................ (0.1)% (0.1)% 4.2% (0.4)%
------- ------- ------- -------
Net loss ................................................... (56.6)% (59.9)% (30.8)% (64.6)%
======= ======= ======= =======
18
Total revenues
During the fourth quarter of fiscal 2003, two separate businesses emerged
and as of July 31, 2003, we operate as two reportable business segments:
software and online.
Our total revenues increased to $7.3 million and $21.9 million for the three
months and nine months ended April 30, 2004, respectively, from $6.0 million and
$17.7 million for the three and nine months ended April 26, 2003, respectively.
The $1.3 million and $4.2 million increase in total revenues for the three and
nine months ended April 30, 2004 was due primarily to increases in our online
and software businesses, offset by a decrease in other revenue derived from our
exited hardware business.
For the three and nine months ending April 30, 2004, no single customer
accounted for more than 10% of our total revenues. For the three and nine months
ending April 26, 2003 one customer, Intel Corporation, accounted for
approximately 16.6% and 17.0% of our total revenues respectively.
Software Revenues
Software revenues are derived from our application software business and
include software licenses, professional services, maintenance, support and
training. Software revenues represent $1.4 million, or 18.9%, and $0.7 million,
or 11.1%, of total revenues for the three months ended April 30, 2004 and April
26, 2003, respectively. The $0.7 million increase in software revenues was due
to an increase in the licensing component of software revenue. During the
quarter ended April 30, 2004, we signed six contracts with values exceeding
$100,000 with a variety of new and existing customers. Additionally during the
quarter we released the next generation of our SourceForge commercial
application, and added 11 new SourceForge customers.
Software revenues represent $3.4 million, or 15.4%, and $2.1 million, or
11.7%, of total revenues for the nine months ended April 30, 2004 and April 26,
2003, respectively. The year-over-year $1.3 million increase in software revenue
was due to the increased number of new customers that were added during the nine
months ended April 30, 2004 compared with the nine months ended April 26, 2003,
coupled with a larger installed base for maintenance revenue and follow-on
sales. We began fiscal year 2004 with an installed base of 55 customers and
added 31 new customers during the nine months ended April 30, 2004 compared to
beginning fiscal year 2003 with an installed base of 24 customers and adding 17
new customers during the nine months ended April 26, 2003.
Online Revenues
Online revenues include online advertising and e-commerce revenues. Total
online revenues of $5.9 million and $5.2 million represented 81.0% and 85.9% of
total revenues for the three months ended April 30, 2004 and April 26, 2003,
respectively. Total online revenues of $18.5 million and $15.0 million
represented 84.4% and 84.9% of total revenues for the nine months ended April
30, 2004 and April 26, 2003, respectively.
Online advertising revenues of $2.6 million and $2.7 million represented
35.6% and 45.0% of total revenues for the three months ended April 30, 2004 and
April 26, 2003, respectively. Online advertising revenues included $0.3 million
and $0.5 million of barter revenue for the three months ended April 30, 2004 and
April 26, 2003, respectively. Online advertising revenues of $7.1 million and
$7.3 million represented 32.4% and 41.2% of total revenues for the nine months
ended April 30, 2004 and April 26, 2003, respectively. Online advertising
revenues included $1.2 million and $1.5 million of barter revenue for the nine
months ended April 30, 2004 and April 26, 2003, respectively. For the three and
nine months ended April 26, 2003 respectively, online advertising revenues
included $1.0 million and $3.0 million of Intel sponsorship revenue. Because
sponsorships are not tied to delivery of a specific number of banner advertising
impressions, sponsorship revenues are not included in the average CPM rate or
impression rate calculations discussed below. The average CPM rate (i.e., the
average rate at which we receive revenue per 1,000 banner advertisements we
19
display to users of our online services) for the three months ended April 30,
2004 increased by 10%, when compared to the three months ended April 26, 2003.
The number of impressions delivered for the three months ended April 30, 2004
increased by 41% when compared to the three months ended April 26, 2003. The CPM
rate for the nine months ended April 30, 2004 decreased by 20%, when compared to
the nine months ended April 26, 2003. The number of impressions delivered for
the nine months ended April 30, 2004 increased by 61% when compared to the nine
months ended April 26, 2003. The increase in the number of impressions was
primarily due to general improvement in demand for our online advertising
coupled with sales generated by an additional sales representative that we added
in the second quarter of fiscal year 2004 we expect the growth of our online
advertising revenue to outpace that of the general online advertising market. We
believe that our prominent position in serving the growing open source software
and Linux markets, along with our favorable online visitor demographics, make us
an attractive advertising vehicle for advertising customers.
E-commerce revenues of $3.4 million and $2.5 million represented 45.8% and
41.2% of total revenues for the three months ended April 30, 2004 and April 26,
2003, respectively. E-commerce revenues of $11.5 million and $7.7 million
represented 52.5% and 43.8% of total revenues for the nine months ended April
30, 2004 and April 26, 2003, respectively. The $0.9 million and $3.8 million
increases in e-commerce revenues for the three and nine months ended April 30,
2004 were primarily due to increased consumer awareness of our site due to
expanded advertising, a broader product offering which attracted a larger
customer base, web site enhancements and affiliate programs that drove more
traffic to our site. As a result of our effort we had a 59.3% and 53.7%
year-over-year increase in the number of orders placed for the three and nine
months ended April 30, 2004, respectively. We expect continued growth in our
e-commerce revenue, including the continued seasonal impact from online holiday
shoppers in our second fiscal quarter.
Other Revenues
Other revenues are derived from our former hardware, customer support, and
professional services businesses. Other revenues represent $3,000, or 0.0%, of
total revenues for the three months ended April 30, 2004 and $0.2 million, or
3.0%, for the three months ended April 26, 2003. Other revenues represent
$49,000 or 0.2%, of total revenues for the nine months ended April 30, 2004 and
$0.6 million, or 3.4%, for the nine months ended July 25, 2003.
Cost of Revenues
Cost of software revenues include direct material and production costs for
CDs and manuals, professional services cost and support department costs. Cost
of software revenues were $0.4 million and $0.5 million for each of the three
months ended April 30, 2004 and April 26, 2003, respectively. The $0.1 million
decrease in cost of software revenues was primarily related to a reduction of
costs associated with our professional service department. Cost of software
revenues were $1.5 million for each of the nine months ended April 30, 2004 and
April 26, 2003. Cost of software revenues were 4.9% and 7.5% of total revenues
for the three months ended April 30, 2004 and April 26, 2003, respectively and
were 6.8% and 8.6% of total revenues for the nine months ended April 30, 2004
and April 26, 2003, respectively. The three and nine month percentage of total
revenue decreases were primarily due to the increase in total revenue We
anticipate that cost of software revenues will increase in absolute dollars and
decrease as a percentage of total revenues through the end of our fiscal year
2005.
Software gross margin increased $0.8 million to $1.0 million for the three
months ended April 30, 2004 from $0.2 million for the three months ended April
26, 2003. The software gross margin was 14.0% and 3.6% of total revenues for the
three months ended April 30, 2004 and April 26, 2003, respectively. The $0.8
million increase in gross margin was due to a $0.7 million increase in software
revenue, coupled with a $0.1 million decrease in the cost in the services and
support department cost structure. The software gross margin increased $1.3
million to $1.9 million for the nine months ended April 30, 2004 from $0.3
million for the nine months ended April 26, 2003. The software gross margin was
8.6% and 3.1% of total revenues for the nine months ended April 30, 2004 and
April 26, 2003, respectively. The $1.3 million increase in gross margin was due
to the $1.3 million increase in software revenue coupled with no significant
year-over-year increase in the services and support department cost structure.
We anticipate that software gross margins in absolute dollars will increase in
direct relationship to revenue increases.
Cost of online revenues includes cost of e-commerce materials, shipping and
fulfillment costs, and employee costs associated with the editorial, operations
and merchandising functions. Cost of online revenues increased $0.5 million to
$3.2 million for the three months ended April 30, 2004 from $2.7 million for the
three months ended April 26, 2003. Cost of online revenues were 43.2% and 44.0%
of total revenues for the three months ended April 30, 2004 and April 26, 2003,
respectively. The $0.5 million increase in online cost of revenues was primarily
due to a $0.4 million increase in e-commerce material costs and $0.2 million
increase in shipping and fulfillment costs associated with e-commerce partially
offset by a $0.1 million reduction in our online advertising business cost of
20
revenues. Cost of online revenues increased $2.2 million to $10.6 million for
the nine months ended April 30, 2004 from $8.4 million for the nine months ended
April 26, 2003. Cost of online revenues were 48.2% and 47.5% of total revenues
for the nine months ended April 30, 2004 and April 26, 2003 respectively. The
$2.2 million increases in online cost of revenues were primary due to the $1.9
million increase in material costs and the $0.9 million in shipping and
fulfillment costs associated with e-commerce partially offset by a $0.6 million
reduction in our online advertising cost of revenues. The increase in e-commerce
materials, shipping and fulfillment costs for both the three- and nine-month
periods was directly related to increases in revenue.
Online gross margin increased $0.3 million to $2.8 million for the three
months ended April 30, 2004 from $2.5 million for the three months ended April
26, 2003. Online gross margin increased $1.3 million to $7.9 million for the
nine months ended April 30, 2004 from $6.6 million for the nine months ended
April 26, 2003. The three and nine month increases in online gross margin
dollars are related to increases in total online revenue partially offset by an
increase in cost of online revenues.
Online gross margin was 37.8% and 41.9% of total revenues for the three
months ended April 30, 2004 and April 26, 2003, respectively. Online gross
margin was 36.2% and 37.4% of total revenues for the nine months ended April 30,
2004 and April 26, 2003, respectively. We expect to see continued quarterly
variations in online gross margins as a percent of online revenues due to the
mix of our higher margin advertising revenue with lower margin, seasonal
e-commerce revenue.
Sales and Marketing Expenses
Sales and marketing expenses consist primarily of salaries, commissions and
related expenses for personnel engaged in sales, marketing and sales support
functions, as well as costs associated with trade shows, advertising and
promotional activities.
Sales and marketing expenses were $2.6 million for each of the three months
ended April 30, 2004 and April 26, 2003. Sales and marketing expenses increased
$0.3 million to $7.6 million for the nine months ended April 30, 2004 from $7.3
million for the nine months ended April 26, 2003. The $0.3 million increase was
due to a $0.1 million increase in commission expense associated with the
increased revenue, a $0.1 million increase in outside contractor expense and a
$0.1 million increase in other miscellaneous expense categories.
Sales and marketing expenses were 36.2% and 43.3% of total revenues for the
three months ended April 30, 2004 and April 26, 2003, respectively. Sales and
marketing expenses were 34.7% and 41.1% of total revenues for the nine months
ended April 30, 2004 and April 26, 2003, respectively. These decreases as a
percentage of total revenues were primarily related to our increase in revenue.
Going forward, we expect sales and marketing expenses to increase in absolute
dollars but decrease as a percentage of total revenues through our fiscal year
2005.
Research and Development Expenses
Research and development expenses consist primarily of salaries and related
expenses for software engineers. Total research and development expenses related
to our software business were $1.1 million and $1.6 million for the three months
ended April 30, 2004 and April 26, 2003, respectively. Total research and
development expenses related to our software business were $3.6 million and $4.8
million for the nine months ended April 30, 2004 and April 26, 2003,
respectively. Software research and development expenses are primarily related
to the development of new products and enhancements to our current products.
Total research and development expenses for our online business were $0.6
million and $0.4 million for the three months ended April 30, 2004 and April 26,
2003, respectively. Total online research and development expenses were $1.6
million and $1.2 million for the nine months ended April 30, 2004 and April 26,
2003, respectively. Online research and development is directed toward the
improvement of existing products and services.
Total research and development expenses decreased by $0.3 million to $1.7
million for the three months ended April 30, 2004 from $2.0 million for the
three months ended April 26, 2003. The $0.3 million decrease was primarily due
to a $0.1 million decrease in employee labor expense, a $0.1 million decrease in
allocated overhead expenses such as rent and utilities and a $0.1 million
decrease in outside contractor expense as we decreased our usage of outside
contractors. The salary and allocated overhead expenses were lower due to a 12%,
or 5 person decrease in average headcount.
Total research and development expenses decreased by $0.8 million to $5.2
million for the nine months ended April 30, 2004 from $6.0 million for the nine
months ended April 26, 2003. The $0.8 million decrease was due to a $0.4 million
decrease in employee labor expenses, a $0.2 million decrease in outside
contractor expense and a $0.2 million decrease in allocated overhead expenses
such as rent and utilities. The salary and allocated overhead expenses were
lower due to a 13%, or 6 person decrease in average headcount.
21
Research and development expenses were 22.9% and 32.9% of total revenues for
the three months ended April 30, 2004 and April 26, 2003, respectively. Research
and development expenses were 23.7% and 39.9% of total revenues for the nine
months ended April 30, 2004 and April 26, 2003, respectively. These decreases as
a percentage of total revenues were primarily related to our increase in revenue
and the year-over-year reduction in headcount. Going forward we expect research
and development expenses to increase slightly in absolute dollars and decrease
as a percentage of total revenues through our fiscal year 2005.
General and Administrative Expenses
General and administrative expenses consist of salaries and related expenses
for finance and administrative personnel and professional fees for accounting
and legal services.
General and administrative expenses increased $0.1 million to $1.5 million
for the three months ended April 30, 2004 from $1.4 million for the three months
ended April 26, 2003. The $0.1 million dollar increase was due to an increase in
recruiting fees. General and administrative expenses decreased $1.3 million to
$3.8 million for the nine months ended April 30, 2004 from $5.1 million for the
nine months ended April 26, 2003. The $1.3 million dollar decrease was due to a
$0.9 million reversal of accrued legal expenses reserved for securities
litigation expenses that were ultimately paid by one of our insurers, a $0.3
million reversal of legal expenses related to a lawsuit that was favorably
resolved during our first fiscal quarter, a $0.3 million dollar decrease in
facilities expense resulting from a $0.2 million dollar restructuring charge
included in the nine month ended April 26, 2003 coupled with a 16% decrease in
headcount offset by a $0.2 million increase in recruiting fees.
General and administrative expenses were 20.4% and 23.6% of total revenues
for the three months ended April 30, 2004 and April 26, 2003, respectively.
General and administrative expenses were 17.2% and 28.9% of total revenues for
the nine months ended April 30, 2004 and April 26, 2003, respectively. These
decreases as a percentage of total revenues were primarily related to our
increase in revenue and due to the expense reduction reasons noted above. Going
forward we expect general and administrative expenses to increase slightly in
absolute dollars but decrease as a percentage of total revenues through our
fiscal year 2005.
Restructuring Costs and Other Special Charges
In fiscal 2001 and 2002, we adopted plans to exit the systems and
hardware-related software engineering and professional services businesses, as
well as exit a sublease agreement and reduce our general and administrative
overhead costs. We exited these activities to pursue our software and online
businesses and reduce our operating losses to improve cash flow. We recorded
restructuring charges of $180.2 million related to exiting these activities,
$160.4 million of which was included in restructuring charges and other special
charges in operating expenses and $19.8 million of which was included in cost of
sales. Included in the restructuring were charges related to excess facilities
from non-cancelable leases (with payments continuing until fiscal 2010, unless
sublet completely). The accrual from non-cancelable lease payments includes
management's estimates of sublease income. These estimates are subject to change
based on actual events. We evaluate and update, if applicable, these estimates
quarterly. As of April 30, 2004, we had an accrual of approximately $12.5
million outstanding related to these non-cancelable leases, all of which was
originally included in operating expenses
During the quarter ended April 30, 2004, in an effort to reduce our
operating expenses, we adopted a plan to relocate and relocated our Fremont,
California headquarters to a smaller building in the same complex. We recorded
net restructuring expenses of $2.9 million related to exiting these activities.
Included in the $2.9 million dollar restructuring expense was $2.5 million of
expense related to a writing off of leasehold improvements and fixed assets and
$0.4 million in expenses related to excess facilities from non-cancelable leases
(with payments continuing until fiscal 2010, unless sublet completely). In
addition to the $2.9 million dollar restructuring expense. Based upon
anticipated sublease commitments relating to our remaining idle space, during
the quarter ended April 30, 2004 we updated our assumptions as to expected
future sublease income for certain restructured idle office space previously
restructured in fiscal year 2002 and, as a result, recorded a restructuring
charge of $0.3 million.
22
Below is a summary of the restructuring charges in operating expenses (in
thousands):
Total Charged Total
To Operations Nine Restructuring
Total Total months Liabilities
Total Charged Charged To Charged To ended Cash at
To Operations Operations Operations April 30, Receipts/ April 30,
Fiscal 2001 Fiscal 2002 Fiscal 2003 2004 (Payments) 2004
----------- ----------- ----------- -------- ---------- ----
Cash Provisions:
Other special charges relating to
restructuring activities .................... $ 2,159 $ (888) $ 78 $ -- $ (1,349) $ --
Facilities charges ............................ 6,584 9,401 191 713 (4,391) $ 12,498
Employee severance and other related charges .. 3,498 1,997 37 -- (5,532) --
-------- -------- -------- -------- -------- --------
Total cash provisions ..................... 12,241 10,510 306 713 $(11,272) $ 12,498
-------- -------- -------- -------- ======== ========
Non-cash:
Write-off of goodwill and intangibles ......... 59,723 30,632 -- --
Write-off of other special charges
relating to restructuring activities ......... 4,434 5,442 (553) 2,496
Write-off of accelerated options from
terminated employees ........................ 1,352 -- -- --
Acceleration of deferred stock
compensation ................................. 35,728 352 (16) --
-------- -------- -------- --------
Total non-cash provisions ................. 101,237 36,426 (569) --
-------- -------- -------- --------
Total provisions .......................... $113,478 $ 46,936 $ (263) $ 3,209
======== ======== ======== ========
Below is a summary of the changes to the restructuring liability (in thousands):
Balance at Charged to Balance at
Changes in the total accrued restructuring liability Beginning Costs and End
----------------------------------------------------- of Period Expenses Deductions of Period
--------- -------- ---------- ---------
For the year ended July 28, 2001 ............................. $ -- $12,241 $(2,728) $ 9,513
For the year ended July 27, 2002 ............................. $ 9,513 $10,510 $(2,029) $17,994
For the year ended July 31, 2003 ............................. $17,994 $ 306 $(3,411) $14,889
For the nine months ended April 26, 2003 ..................... $17,994 $ 222 $(2,372) $15,844
For the nine months ended April 30, 2004 ..................... $14,889 $ 713 $(3,104) $12,498
Components of the total accrued restructuring liability Short Long Total
------------------------------------------------------- Term Term Liability
---- ---- ---------
For the year ended July 28, 2001.............................. $ 3,135 $ 6,378 $ 9,513
For the year ended July 27, 2002.............................. $ 3,397 $14,597 $17,994
For the year ended July 31, 2003.............................. $ 4,117 $10,772 $14,889
For the nine months ended April 26, 2003...................... $ 4,277 $11,567 $15,844
For the nine months ended April 30, 2004...................... $ 4,023 $ 8,475 $12,498
Amortization of Deferred Stock Compensation
In connection with the grant of stock options to employees during fiscal
1999 and prior to our initial public offering in fiscal 2000, we expensed
deferred stock compensation of $0 and $20,000 during the three and nine months
ended April 30, 2004, respectively, compared to $37,000 and $116,000 during the
three and nine months ended April 26, 2003, respectively. We do not expect any
further expenses associated with deferred stock compensation through fiscal year
2004.
Amortization of Intangible Assets
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets." Under SFAS No. 142, goodwill and intangible assets with indefinite
lives are not amortized but are subject to at least an annual assessment for
impairment applying a fair-value based test. Upon adoption of SFAS No. 142 on
July 29, 2001, we no longer amortize goodwill. In connection with the
acquisition of OSDN, we amortized $3,183 and $0.6 million of intangibles for the
three months ended April 30, 2004 and April 26, 2003, respectively. We amortized
$9,549 and $1.9 million of intangibles for the nine months ended April 30, 2004
and April 26, 2003, respectively. The estimated total amortization expense of
acquired intangible assets is $12,700 and $9,500 for the fiscal years ending
July 31, 2004 and July 31, 2005, respectively.
23
We periodically evaluate the carrying amount of our long-lived assets and
apply the provisions of SFAS No. 144, "Accounting for the Impairment or Disposal
of Long-Lived Assets." SFAS No. 144 requires that long-lived assets and certain
identifiable intangibles to be held and used or disposed of by an entity be
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. No changes occurred
during the three or nine months ended April 30, 2004 that would indicate a
possible impairment in the carrying value of intangible assets at April 30,
2004.
Remeasurement of Warrant Liability, Interest and Other Income, Net
On November 6, 2003, we entered into a securities purchase agreement in
which we completed a private placement of 3,529,412 shares of our common stock
with The Riverview Group LLC ("Riverview") at an issue price of $4.25 per share
for aggregate proceeds of approximately $15 million (the "Private Placement").
In connection with the Private Placement, the Company retained Wharton Capital
Partners Ltd. ("Wharton") to act as a financial consultant and placement agent.
Also in connection with the Private Placement, Riverview and Wharton received
three-year warrants to purchase a total of 705,883 and 25,000 shares of our
common stock, respectively, at an exercise price of $6.00 and $6.14 per share,
respectively (collectively, the "Warrants"). We entered into a registration
rights agreement with Riverview on November 6, 2003 (the "Registration Rights
Agreement") in which we agreed to provide certain registration rights under the
Securities Act of 1933, as amended and the rules and regulations promulgated
thereunder, and applicable state securities laws with respect to the common
stock and the warrants issued to Riverview.
Pursuant to the terms of the Registration Rights Agreement, we filed a
registration statement (the "Registration Statement") on Form S-3 in order to
register the common stock and warrants issued in the Private Placement. The SEC
declared the Registration Statement effective on April 30, 2004. Before the
effective date of the Registration Statement, the shares of our common stock
sold in the Private Placement and the shares of our common stock underlying the
Warrants did not have the same rights as the other shares which were included in
the Equity section of the Consolidated Balance sheet. Therefore, the shares of
our common stock sold in the Private Placement and the shares of our common
stock underlying the Warrants were classified as liabilities on the Consolidated
Balance sheet. Liabilities must be reported at fair value as of the balance
sheet date. We initially valued the Warrants as of November 6, 2003 and revalued
them on January 31, 2004 using the Black-Scholes valuation model and then, on
April 30, 2004, the effective date of the Registration Statement, revalued them
again using the same Black-Scholes valuation model. Based on our remeasurement
at January 31, 2004, our net warrant liability for the Warrants decreased by
$0.8 million to $1.7 million. Based on our remeasurement at April 30, 2004, our
net warrant liability for the Warrants decreased by $1.1 million to $0.6
million. For the three months ended January 31, 2004 and April 30, 2004,
respectively, the $0.8 million and $1.1 million decreases in warrant liability
were partially offset by a $0.2 million non-cash expense associated with not
having the shares of common stock associated with the Private Placement
registered. We present the net $0.6 million and net $0.9 million for the three
months ended January 31, 2004 and April 30, 2004, respectively, on our income
statement as remeasurement of warrant liability income.
Interest income, net, includes income from our cash investments net of
interest expense. Net interest income decreased $0.1 million to $0.2 million for
the three months ended April 30, 2004 from $0.3 million for the three months
ended April 26, 2003. Net interest income decreased $0.2 million to $0.7 million
for the nine months ended April 30, 2004 from $0.9 million for the nine months
ended April 26, 2003. These decreases were primarily related to the
year-over-year interest rate decline.
Interest income, net, was 3.0% and 4.3% of total revenues for the three
months ended April 30, 2004 and April 26, 2003, respectively. Interest income,
net, was 3.2% and 5.0% of total revenues for the nine months ended April 30,
2004 and April 26, 2003, respectively. These decreases as a percentage of total
revenues were primarily related to our increase in revenue and due to lower
interest rates. Going forward we expect interest income to decrease as a
percentage of total revenues.
Other expense, net, includes items such as legal settlement proceeds net of
other expenses. Other expense, net, was $8,000 and $6,000 for the three months
ended April 30, 2004 and April 26, 2003, respectively. Other expense, net,
decreased by $1.0 million to $0.9 million income for the nine months ended April
30, 2004 from an $71,000 expense for the nine months ended April 26, 2003. The
$1.0 million increase in other income was due to a $1.0 million legal settlement
and a $0.3 million business recovery payment related to the World Trade Center
disaster, partially offset by a decrease $0.3 million of other expenses related
to our exited hardware business.
Other expense, net was 0.1% of total revenues for each of the three months
ended April 30, 2004 and April 26, 2003, respectively. Interest expense, net,
was 4.2% and 0.4% of total revenues for the nine months ended April 30, 2004 and
April 26, 2003, respectively.
24
Income Taxes
As of April 30, 2004, we had federal and state net operating loss
carry-forwards for tax reporting purposes available to offset future taxable
income. A valuation allowance has been recorded for the total deferred tax
assets as a result of uncertainties regarding realization of the assets based on
the lack of consistent profitability to date and the uncertainty of future
profitability. The federal and state net operating loss carry-forwards expire at
various dates through fiscal year 2021 and fiscal year 2012, respectively, to
the extent that they are not utilized. We have not recognized any benefit from
these net operating loss carry-forwards because of uncertainty surrounding their
realization. The amount of net operating losses that we can utilize is limited
under tax regulations because we have experienced a cumulative stock ownership
change of more than 50% over the last three years.
Liquidity and Capital Resources
As of April 30, 2004, our available capital resources totaled $46.7 million,
comprised of marketable securities of $40.1 million and cash and cash
equivalents of $6.6 million. As of July 31, 2003, our available capital
resources totaled $38.8 million, comprised of $32.5 million in marketable
securities and $6.3 million in cash and cash equivalents. Our average net
monthly cash flow shortfall during the three months ended April 30, 2004 was
approximately $0.9 million. The cash flow shortfall is primarily due to
operating lease commitments that were entered into while we were operating our
hardware business and employee costs associated with our software business. We
believe that at our current cash flow shortfall rates we have enough cash to
operate through fiscal year 2005. We expect to continue to invest significant
resources in an effort to grow our software business.
Net cash used in operating activities was $9.1 million for the nine months
ended April 30, 2004 and $11.8 million for the nine months ended April 26, 2003.
Net cash used in operating activities during the nine months ended April 30,
2004 primarily reflected a net loss of $6.8 million, a decrease in accrued
liabilities of $3.5 million, including a $2.4 million reduction in accrued
restructuring accruals as we make lease payments on restructured space and a
$0.9 million reduction in legal expenses due to the agreement by our insurers to
pay the legal expenses associated with the initial public offering securities
litigation; an increase in accounts receivable of $1.1 million, related to the
higher level of sales in the three months ending April 30, 2004 compared to the
three months ending July 31, 2003; net remeasurement of warrant liability of
$1.6 million, associated with the Private Placement; and an increase in prepaid
assets and inventories of $0.7 million, due to the payment of insurance premiums
and seasonal inventory needs for our e-commerce business, respectively;
partially offset by restructuring expenses of $2.5 million, depreciation expense
of $1.2 million, an increase in deferred revenue of $0.8 million, and an
increase in accounts payable of $0.1 million. Net cash used in operating
activities during the nine months ended April 26, 2003 of $11.8 million
primarily reflected a net loss of $11.4 million, a decrease in accrued
liabilities of $3.5 million, a decrease in accounts payable of $0.8 million, and
an increase in accounts receivable of $0.5 million, partially offset by
depreciation and amortization of intangible asset expense of $4.5 million, and a
increase in long-term liabilities of $0.2 million.
A significant portion of our cash inflows have historically been generated
by our sales. These inflows may fluctuate significantly from period to period. A
decrease in customer demand or decrease in the market acceptance of our products
would jeopardize our future ability to generate positive cash flows from
operations.
For the nine months ended April 30, 2004, we used $8.5 million in cash for
investing activities, compared to the use of $15.7 million for the nine months
ended April 26, 2003. During the nine months ended April 30, 2004 we purchased
$0.7 million in fixed assets and $39.8 million in marketable securities and sold
$32.3 million in marketable securities. Cash used for investing activities was
significantly higher for the nine months ended April 26, 2003 when we purchased
$30.8 million in marketable securities and sold $15.1 million in marketable
securities, due to implementing our strategic decision to increase our short-
and long-term investments and decrease our cash equivalent investments in an
effort to maximize our rate of return.
For the nine months ended April 30, 2004, we generated $17.9 million in cash
from financing activities, compared to $0.2 million for the nine months ended
April 26, 2003. Net proceeds from the Private Placement generated $14.5 million
during the nine months ended April 30, 2004 and cash generated from the issuance
of common stock to our employees increased to $3.4 million during the nine
months ended April 30, 2004 compared to the $0.2 million for the nine months
ended April 26, 2003. We do not anticipate entering into additional private
placement transactions in the foreseeable future and the level of cash, if any,
that will be generated in the future from the issuance of common stock to our
employees from the exercising of options is dependant upon several factors,
including the market price of our common stock and the number of employees
participating in our stock option plans.
For the nine months ended April 30, 2004 and April 26, 2003, exchange rate
changes had an immaterial effect on cash and cash equivalents. We expect that
exchange rate changes will have an immaterial effect on cash and cash
equivalents in the near future due to our focus on US-based business.
25
As of April 30, 2004 and July 31, 2003, we had outstanding letters of credit
issued under a line of credit of approximately $0.9 million related to the
corporate facility lease. The amount related to this letter of credit is
recorded in the "Restricted cash" section of the condensed consolidated balance
sheet. We anticipate that this balance will decline by $0.5 million in the
fourth quarter of each fiscal year through 2005 under our existing lease
agreement.
Future payments due under debt and lease obligations as of April 30, 2004
are as follows (in thousands)
Gross Net
Operating Sublease Operating
Leases Income Leases
------- ------- -------
2004 ................................. $ 1,263 $ 184 $ 1,079
2005 ................................. 5,014 661 4,353
2006 ................................. 3,741 153 3,588
2007 ................................. 3,511 -- 3,511
2008 ................................. 3,616 -- 3,616
Thereafter ........................... 6,905 -- 6,905
------- ------- -------
Total minimum lease payments $24,050 $ 998 $23,052
======= ======= =======
Our liquidity and capital requirements depend on numerous factors, including
market acceptance of our products, the resources we devote to developing,
marketing, selling and supporting our products, the timing and expense
associated with expanding our distribution channels, potential acquisitions and
other factors. We expect to devote capital resources to continue our research
and development efforts, to invest in our sales, support, marketing and product
development organizations, to enhance and introduce marketing programs, and for
other general corporate activities. We believe that our existing cash balances
will be sufficient to fund our operations through fiscal 2005 under our current
business strategy, however, if we fail to adequately monitor and minimize our
use of existing cash, we may need additional capital to fund continued
operations beyond fiscal year 2005. We expect to continue to experience negative
cash flow from operations for at least the foreseeable future. Unless we monitor
and minimize the level of use of our existing cash, cash equivalents and
marketable securities, we may require additional capital to fund continued
operations beyond our fiscal year 2005. See "Risks Related to our Financial
Results" in the Risk Factors section of this Form 10-Q.
Financial Risk Management
As a primarily US-based company, we face limited exposure to adverse
movements in foreign currency exchange rates and we do not engage in hedging
activity. We do not anticipate significant currency gains or losses in the near
term. These exposures may change over time as business practices evolve and
could have a material adverse impact on our financial results.
We maintain investment portfolio holdings of various issuers, types and
maturities. These securities are classified as available-for-sale, and
consequently are recorded on the condensed consolidated balance sheet at fair
value with unrealized gains and losses reported as a separate component of
accumulated other comprehensive income (loss). These securities are not
leveraged and are held for purposes other than trading.
Critical Accounting Policies
There have been no material changes to our critical accounting policies and
estimates from those disclosed in our report on Form 10-K for our fiscal year
ended July 31, 2003.
Recent Accounting Pronouncements
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
addresses certain financial instruments that, under previous guidance, could be
accounted for as equity, but now must be classified as liabilities in statements
of financial position. These financial instruments include: 1) mandatory
redeemable financial instruments, 2) obligations to repurchase the issuer's
equity shares by transferring assets, and 3) obligations to issue a variable
number of shares. SFAS No. 150 is effective for all financial instruments
entered into or modified after May 31, 2003, and otherwise effective at the
beginning of the first interim period beginning after June 15, 2003. The
implementation of SFAS No. 150 is not expected to have a material effect on our
consolidated financial statements.
26
In December 2003, the SEC issued SAB 104, "Revenue Recognition," which
supercedes SAB 101, "Revenue Recognition in Financial Statements." SAB 104's
primary purpose is to rescind accounting guidance contained in SAB 101 related
to multiple element revenue arrangements, which was superceded as a result of
the issuance of EITF 00-21, Accounting for Revenue Arrangements with Multiple
Deliverables. While the wording of SAB 104 has changed to reflect the issuance
of EITF 00-21, the revenue recognition principles of SAB 101 remain largely
unchanged by the issuance of SAB 104. We do not believe the adoption of SAB 104
will have a material impact on the financial statements.
Risk Factors
PROSPECTIVE INVESTORS IN VA SOFTWARE SECURITIES SHOULD CAREFULLY CONSIDER THE
RISKS DESCRIBED BELOW BEFORE MAKING AN INVESTMENT DECISION. IN ADDITION, THESE
RISKS ARE NOT THE ONLY ONES FACING OUR COMPANY. ADDITIONAL RISKS OF WHICH WE ARE
NOT PRESENTLY AWARE OR THAT WE CURRENTLY BELIEVE ARE IMMATERIAL MAY ALSO IMPAIR
OUR BUSINESS OPERATIONS. OUR BUSINESS COULD BE HARMED BY ANY OF THESE RISKS. THE
TRADING PRICE OF OUR COMMON STOCK COULD DECLINE DUE TO ANY OF THESE RISKS, AND
INVESTORS MAY LOSE ALL OR PART OF THEIR INVESTMENT.
Risks Related To Our Software Business
Because the market for our SourceForge application software is relatively new
and rapidly evolving, we do not know whether existing and potential customers
will license SourceForge in sufficient quantities for us to achieve
profitability.
Our future growth and financial performance will depend on market acceptance of
SourceForge and our ability to license our software in sufficient quantities and
under acceptable terms. The number of customers using SourceForge is still
relatively small. We expect that we will continue to need intensive marketing
and sales efforts to educate prospective clients about the uses and benefits of
SourceForge. Various factors could inhibit the growth of the market for and
market acceptance of SourceForge. In particular, potential customers may be
unwilling to make the significant capital investment needed to license
SourceForge. Many of our customers have licensed only limited quantities of
SourceForge, and these or new customers may decide not to broadly implement our
software by licensing additional copies from us. We cannot be certain that a
viable market for SourceForge will emerge or, if it does emerge, that it will be
sustainable. If a sustainable viable market for SourceForge fails to emerge,
this would have a significant, adverse effect upon our software business and
operating results.
We are devoting the majority of our research and development spending on our
SourceForge application, so if this software does not achieve market acceptance
we are likely to experience continued operating losses.
Although in the third quarter of our fiscal year 2004, which ended on April 30,
2004, approximately 19% of our revenue was derived from our software business,
we devoted 67.6%, or $1.1 million, of our research and development spending to
research and development associated with our SourceForge software application.
Given that SourceForge remains a relatively new enterprise software application,
we expect to continue to allocate the majority of our research and development
resources to SourceForge for the foreseeable future. There can be no assurance,
however, that we will be sufficiently successful in marketing, licensing,
upgrading and supporting SourceForge to offset our substantial software research
and development expenditures. A failure to grow SourceForge revenue sufficiently
to offset SourceForge's significant research and development costs will
materially and adversely affect our business and operating results.
If we fail to attract and retain larger corporate and enterprise-level
customers, our revenues will not grow and may decline.
We have focused our sales and marketing efforts upon larger corporate and
enterprise-level customers. This strategy may fail to generate sufficient
revenue to offset the substantial demands that this strategy will place on our
business, in particular the longer sales cycles, higher levels of service and
support and volume pricing and terms that larger corporate and enterprise
accounts often demand. In addition, these larger customers generally have
significant financial and personnel resources. As a result, rather than license
SourceForge, our target customers may develop collaborative software development
applications internally, including ad hoc development of applications based on
open source code. A failure to successfully obtain revenues from larger
corporate or enterprise-level customers will materially and adversely affect our
operating results.
27
If we fail to anticipate or respond adequately to technology developments,
industry standards, or practices and customer requirements, or if we experience
any significant delays in product development, introduction, or integration,
SourceForge may become obsolete or unmarketable, our ability to compete may be
impaired, and our software revenues may not grow or may decline.
Rapid technological advances, changes in customer requirements, and frequent new
product introductions and enhancements characterize the software industry
generally. We must respond rapidly to developments related to hardware
platforms, operating systems, and software development tools. These developments
will require us to make substantial product development investments. We believe
the success of our software business will become increasingly dependent on our
ability to:
o support multiple platforms, including Linux, commercial UNIX and Microsoft
Windows;
o use the latest technologies to continue to support Web-based collaborative
software development; and
o continually support the rapidly changing standards, tools and technologies
used in software development.
Our application software has a long and unpredictable sales cycle, which makes
it difficult to forecast our future results and may cause our operating results
to vary significantly.
The period between initial contact with a prospective customer and the licensing
of our software varies and has often exceeded three and occasionally exceeded
twelve months. Additionally, our sales cycle is complex because customers
consider a number of factors before committing to license SourceForge. Factors
that our customers and potential customers have informed us that they considered
when evaluating SourceForge included product benefits, cost and time of
implementation, and the ability to operate with existing and future computer
systems and applications. We have found that customer evaluation, purchasing and
budgeting processes vary significantly from company to company. As a result, we
spend significant time and resources informing prospective customers about our
software products, which may not result in completed transactions and associated
revenue. Even if SourceForge has been chosen by a customer, completion of the
transaction is subject to a number of contingencies, which make our quarterly
revenues difficult to forecast. These contingencies include but are not limited
to the following:
o Our ability to sell SourceForge licenses may be impacted by changes in
the strategic importance of software projects due to our customers'
budgetary constraints or changes in customer personnel;
o A customer's internal approval and expenditure authorization process can
be difficult and time consuming. Delays in approvals, even after we are
selected as a vendor, could impact the timing and amount of revenues
recognized in a quarterly period; and
o The number, timing and significance of enhancements to our software
products and future introductions of new software by our competitors and
us may affect customer-purchasing decisions.
If we do not continue to receive repeat business from existing software
customers, our revenue will not grow and may decline.
We generate a significant amount of our software license revenues from existing
customers. Most of our current customers initially purchased a limited number of
licenses as they implemented and adopted SourceForge. Even if customers
successfully use SourceForge, such customers may not purchase additional
licenses to expand the use of our product. Purchases of additional licenses by
these customers will depend on their success in deploying SourceForge, their
satisfaction with our product and support services and their use of competitive
alternatives. A customer's decision to widely deploy SourceForge and purchase
additional licenses may also be affected by factors that are outside of our
control or which are not related to our product or services. In addition, as we
deploy new versions of SourceForge, or introduce new products, our current
customers may not require the functionality of our new versions or products and
may decide not to license these products.
If we fail to maintain our strategic relationship with IBM, the market
acceptance of our products and our financial performance may suffer.
To date, the majority of our SourceForge revenue has come from our direct sales
efforts. To offer products and services to a larger customer base, we entered
into a commercial relationship with IBM. If we are unable to maintain our
existing strategic relationship with IBM, our ability to increase our sales may
be harmed. We would also lose anticipated customer introductions and
co-marketing benefits. In addition, IBM could terminate its relationship with
28
us, pursue other relationships, or attempt to develop or acquire products or
services that compete with our products and services. Even if we succeed in
maintaining or expanding our relationship with IBM, the relationship may not
result in additional customers or revenues. We have begun exploring other
possible relationships and marketing alliances to obtain customer leads,
referrals and distribution opportunities. Even if we succeed in securing such
additional strategic relationships, the relationships may not result in
additional customers or revenues.
Increased utilization and costs of our technical support services may adversely
affect our financial results.
Over the short term, we may be unable to respond to fluctuations in customer
demand for support services. We may also be unable to modify the format of our
support services to compete with changes in support services provided by
competitors. Further, customer demand for these services could cause increases
in the costs of providing such services and adversely affect our operating
results.
Contractual issues may arise during the negotiation process that may delay the
anticipated closure of a transaction and our ability to recognize revenue as
anticipated. The occurrence of such issues might cause our software revenue and
operating results to fall below our publicly-stated expectations, the
expectations of securities analysts or the expectations of investors. Failure to
meet public expectations is likely to materially and adversely affect the
trading price of our common stock.
Because we focus on selling enterprise solutions, the process of contractual
negotiation is critical and may be lengthy. Additionally, several factors may
require us to defer recognition of license revenue for a significant period of
time after entering into a license agreement, including instances where we are
required to deliver either unspecified additional products or specified upgrades
for which we do not have vendor-specific objective evidence of fair value. While
we have a standard software license agreement that provides for revenue
recognition provided that delivery has taken place, collectibility from the
customer is reasonably assured and assuming no significant future obligations or
customer acceptance rights exist, customer negotiations and revisions to these
terms could impact our ability to recognize revenues at the time of delivery.
Many enterprise customers negotiate software licenses near the end of each
quarter. In part, this is because enterprise customers are able, or believe that
they are able, to negotiate lower prices and more favorable terms at that time.
Our reliance on a large portion of software revenue occurring at the end of the
quarter and the increase in the dollar value of transactions that occur at the
end of a quarter can result in increased uncertainty relating to quarterly
revenues. Due to end-of-period variances, forecasts may not be achieved, either
because expected sales do not occur or because they occur at lower prices or on
terms that are less favorable to us. In addition, slowdowns in our quarterly
license contracting activities may impact our service offerings and may result
in lower revenues from our customer training, professional services and customer
support organizations. Our ability to maintain or increase service revenues is
highly dependent on our ability to increase the number of license agreements we
enter into with customers.
Risks Related To Our Online Business
If our online business fails to continue to deliver original and compelling
content and services, we will be unable to attract and retain users, which will
adversely affect our financial results.
The successful development and production of content and services is subject to
numerous uncertainties, including our ability to:
o anticipate and successfully respond to rapidly changing consumer tastes
and preferences;
o fund new program development; and
o attract and retain qualified editors, writers and technical personnel.
We cannot assure you that our online content and services will be attractive to
a sufficient number of users to generate revenues consistent with our estimates
or sufficient to sustain operations. In addition, we cannot assure you that any
new content or services will be developed in a timely or cost-effective manner.
If we are unable to develop content and services that allow us to attract,
retain and expand a loyal user base that is attractive to advertisers, we will
be unable to generate sufficient revenue to grow our online business.
Decreases or delays in advertising spending due to general economic conditions
could harm our ability to generate advertising revenue, which would adversely
affect our financial results.
29
Expenditures by advertisers tend to be cyclical, reflecting overall economic
conditions as well as budgeting and buying patterns. The overall market for
advertising, including Internet advertising, has been generally characterized in
recent quarters by modest growth of marketing and advertising budgets. Because
we derive a large part of our revenues from advertising fees, the decreases in
or delays of advertising spending could reduce our revenues or negatively impact
our ability to grow our revenues. Even if economic conditions continue to
improve, marketing budgets and advertising spending may not increase from
current levels.
We cannot predict our e-commerce customers' preferences with certainty and such
preferences may change rapidly. If we fail to accurately assess and predict our
e-commerce customers' preferences, it will adversely impact our financial
results.
Our e-commerce offerings on our ThinkGeek.com Web site are designed to appeal to
IT professionals, software developers and others in technical fields. Misjudging
either the market for our products or our customers' purchasing habits will
cause our sales to decline, our inventories to increase and/or require us to
sell our products at lower prices, all of which would have a negative effect on
our business.
We are exposed to significant inventory risks as a result of seasonality, new
product launches, rapid changes in product cycles and changes in consumer tastes
with respect to our products offered at our ThinkGeek e-commerce Web site.
Failure to properly assess our inventory needs will adversely affect our
financial results.
In order to be successful, we must accurately predict our consumer tastes and
avoid overstocking or under-stocking products. Demand for products can change
significantly between the time inventory is ordered and the date of sale. In
addition, when we begin selling a new product, it is particularly difficult to
forecast product demand accurately. The acquisition of certain types of
inventory, or inventory from certain sources, may require significant lead-time
and prepayment, and such inventory may not be returnable. We carry a broad
selection and significant inventory levels of certain products and we may be
unable to sell products in sufficient quantities or during the relevant selling
seasons.
If we do not maintain sufficient e-commerce inventory levels, or if we are
unable to deliver our e-commerce products to our customers in sufficient
quantities, our online business operating results will be adversely affected.
We must be able to deliver our merchandise in sufficient quantities to meet the
demands of our customers and deliver this merchandise to customers in a timely
manner. We must be able to maintain sufficient inventory levels, particularly
during the peak holiday selling seasons. If we fail to achieve these goals, we
may be unable to meet customer demand, and our financial results will be
adversely affected.
Our ThinkGeek e-commerce Web site is dependent upon a single third party
fulfillment and warehouse provider. The satisfaction of our e-commerce customers
is highly dependent upon fulfillment of orders in a professional and timely
manner, so any decrease in the quality of service offered by our fulfillment and
warehouse provider will adversely affect our reputation and the growth of our
e-commerce business.
Our ThinkGeek e-commerce Web site's ability to receive inbound inventory and
ship completed orders efficiently to our customers is substantially dependent on
a third-party contract fulfillment and warehouse provider. We previously
utilized the services of efillit Inc., a third-party contract fulfillment and
warehouse provider located in Baltimore, Maryland. However, effective June 4,
2004, we transitioned from efillit to a new provider, Dotcom Distribution, Inc.
("Dotcom Distribution"), located in Edison, New Jersey, whom we believe will be
able to satisfactorily accommodate ThinkGeek's future growth. If Dotcom
Distribution fails to meet our future distribution and fulfillment needs, our
relationship with and reputation among our e-commerce customers will suffer and
this will adversely affect our e-commerce growth. Additionally, if Dotcom
Distribution cannot meet our distribution and fulfillment needs, or our contract
with Dotcom Distribution terminates, we may fail to secure a suitable
replacement or second-source distribution and fulfillment provider on comparable
terms, which would adversely affect our e-commerce financial results.
Risks Related To Our Financial Results
If we fail to adequately monitor and minimize our use of existing cash, we may
need additional capital to fund continued operations beyond fiscal year 2005.
Since becoming a public company, we have experienced negative cash flow from
operations and expect to experience negative cash flow from operations for
fiscal year 2004 and all or part of fiscal year 2005. Our average net monthly
cash flow shortfall during the quarter ended April 30, 2004 was approximately
$0.9 million. Although this average net monthly cash flow shortfall
approximation should not be relied upon as an indicator of our average net
monthly cash flow shortfall in the future, it further illustrates that unless we
30
monitor and minimize the level of use of our existing cash, cash equivalents and
marketable securities, we may require additional capital to fund continued
operations beyond our fiscal year 2005. While we believe we will not require
additional capital to fund continued operations through fiscal year 2005, we may
require additional funding within this time frame, and this additional funding,
if needed, may not be available on terms acceptable to us, or at all. A slowdown
in technology or advertising spending, as well as other factors that may arise,
could affect our future capital requirements and the adequacy of our available
funds. As a result, we may be required to raise additional funds through private
or public financing facilities, strategic relationships or other arrangements.
Any additional equity financing would likely be dilutive to our stockholders.
Debt financing, if available, may involve restrictive covenants on our
operations and financial condition. Our inability to raise capital when needed
could seriously harm our business.
Because we have a limited operating history selling SourceForge, we may not
accurately forecast our sales and revenues, which will cause quarterly
fluctuations in our total revenues and financial results.
We have a limited operating history as a provider of SourceForge, our
proprietary software application. As a result, our historical financial
information is of limited value in projecting future operating results. On June
27, 2001, we announced our plan to exit our hardware business. In the first
quarter of our fiscal year 2002, we made the strategic decision to exit, and
exited, the hardware-related software engineering and professional services
fields to focus on SourceForge. These changes required us to adjust our business
processes and make a number of significant personnel changes, including changes
and additions to our engineering and management teams. Therefore, in evaluating
our business you must consider the risks and difficulties frequently encountered
by early stage companies in new and rapidly evolving markets. In addition, most
of our operating costs are fixed and based on our revenue expectations.
Therefore, if we have a shortfall in revenues, we may be unable to reduce our
expenses quickly enough to avoid lower quarterly operating results.
Certain factors specific to our businesses over which we have limited or no
control may nonetheless adversely impact our quarterly total revenues and
financial results.
The primary factors over which we have limited or no control that may adversely
impact our quarterly total revenues and financial results include the following:
o specific economic conditions relating to IT spending;
o the discretionary nature of our software customers' purchase and budget
cycles;
o the size and timing of software customer orders;
o long software sales cycles;
o our ability to retain skilled software engineers and sales personnel;
o the timing of announcements and releases of new or enhanced versions of
our products and product upgrades;
o the possibility that software development delays will result from our
outsourcing of certain SourceForge research and development efforts to
Cybernet Software Systems, Inc., an independent contractor located
primarily in India;
o economic conditions relating to online advertising and sponsorship, and
e-commerce;
o our ability to demonstrate and maintain attractive online user
demographics;
o our ability to retain a skilled online advertising and sponsorship sales
force;
o the addition or loss of specific online advertisers or sponsors, and the
size and timing of advertising or sponsorship purchases by individual
customers; and
o our ability to keep our Web sites operational at a reasonable cost.
31
If our revenues and operating results fall below our expectations, the
expectations of securities analysts or the expectations of investors, the
trading price of our common stock will likely be materially and adversely
affected. You should not rely on the results of our business in any past periods
as an indication of our future financial performance.
Future guidelines and interpretations regarding software revenue recognition
could cause delays in our ability to recognize revenue, which will adversely
impact our quarterly financial results.
From time to time, the American Institute of Certified Public Accountants
(AICPA), the Public Company Accounting Oversight Board (PCAOB) and the SEC will
issue guidelines and interpretations regarding the recognition of revenue from
software and other activities. These new guidelines and interpretations could
result in a delay in our ability to recognize revenue. If the company has to
delay the recognition of a significant amount of revenue in the future, this
will have a material impact on the company's reported financial results.
We have a history of losses and expect to continue to incur net losses for the
foreseeable future. Failure to become and remain profitable may materially and
adversely affect the market price of our common stock and our ability to raise
capital and continue operations.
We incurred a loss of $4.1 million for our fiscal third quarter ended April 30,
2004, and we had an accumulated deficit of $746.5 million as of April 30, 2004.
We expect to continue to incur net losses for at least the foreseeable future.
If we do achieve profitability, we may not be able to sustain it. Failure to
become and remain profitable may materially and adversely affect the market
price of our common stock and our ability to raise capital and continue
operations beyond our fiscal year 2005.
Despite reductions in the size of our workforce, our business may fail to grow
rapidly enough to offset our ongoing operating expenses.
During fiscal years 2001, 2002 and 2003, we substantially reduced the size of
our workforce. As of April 30, 2004, we had 121 employees. Despite these
reductions in our workforce, our business may fail to grow rapidly enough to
offset our ongoing operating expenses. As a result, our quarterly operating
results could fluctuate, and such fluctuation could adversely affect the market
price of our common stock.
Risks Related To Competition
If we do not effectively compete with new and existing competitors, our revenues
will not grow and may decline, which will adversely impact our financial
results.
We believe that the newly emerging collaborative software development market is
fragmented, subject to rapid change and highly sensitive to new product
introductions and marketing efforts by industry participants. Competition in
related markets is intense. If our products gain market acceptance, we expect
the competition to rapidly intensify as new competitors enter the marketplace.
Our potential competitors include companies entrenched in closely related
markets who may choose to enter and focus on collaborative software development.
Although we do not believe that we presently have an entrenched competitor, we
expect competition to intensify in the future if the market for collaborative
software development applications continues to expand. Our potential competitors
include providers of software and related services as well as providers of
hosted application services. Many of our potential competitors have
significantly more resources, more experience, longer operating histories and
greater financial, technical, sales and marketing resources than we do. We
cannot guarantee that we will be able to compete successfully against current
and future competitors or that competitive pressure will not result in price
reductions, reduced operating margins and loss of market share, any one of which
could seriously harm our business. Because individual product sales often lead
to a broader customer relationship, our products must be able to successfully
compete with and complement numerous competitors' current and potential
offerings. Moreover, we may be forced to compete with our strategic partners,
and potential strategic partners, and this may adversely impact our relationship
with an individual partner or a number of partners. Consolidation is underway
among companies in the software industry as firms seek to offer more extensive
suites of software products and broader arrays of software solutions. Changes
resulting from this consolidation may negatively impact our competitive position
and operating results.
Online competition is intense. Our failure to compete successfully could
adversely affect our revenue and financial results.
The market for Internet content and services is intensely competitive and
rapidly evolving. It is not difficult to enter this market and current and new
competitors can launch new Internet sites at relatively low cost. We derive
revenue from online advertising and sponsorships, for which we compete with
various media including newspapers, radio, magazines and various Internet sites.
We also derive revenue from e-commerce, for which we compete with other
e-commerce companies as well as traditional, "brick and mortar" retailers. We
32
may fail to compete successfully with current or future competitors. Moreover,
increased competition could result in price reductions, reduced margins or loss
of market share, any of which could have a material adverse effect on our future
revenue and financial results. If we do not compete successfully for new users
and advertisers, our financial results may be materially and adversely affected.
Risks Related To Intellectual Property
We are vulnerable to claims that our products infringe third-party intellectual
property rights. Any resulting claims against us could be costly to defend or
subject us to significant damages.
We expect that our software products will increasingly be subject to
infringement claims as the number of products and competitors in our industry
segment grows and the functionality of products in different industry segments
overlaps. In addition, we may receive patent infringement claims as companies
increasingly seek to patent their software. Our developers may fail to perform
patent searches and may therefore unwittingly infringe on third-party patent
rights. We cannot prevent current or future patent holders or other owners of
intellectual property from suing us and others seeking monetary damages or an
injunction against shipment of our software offerings. A patent holder may deny
us a license or force us to pay royalties. In either event, our operating
results could be seriously harmed. In addition, employees hired from competitors
might utilize proprietary and trade secret information from their former
employers without our knowledge, even though our employment agreements and
policies clearly prohibit such practices.
Any litigation regarding our intellectual property, with or without merit, could
be costly and time consuming to defend, divert the attention of our management
and key personnel from our business operations and cause product shipment
delays. Claims of intellectual property infringement may require us to enter
into royalty and licensing agreements that may not be available on terms
acceptable to us, or at all. In addition, parties making claims against us may
be able to obtain injunctive or other equitable relief that could effectively
block our ability to sell our products in the United States and abroad and could
result in an award of substantial damages against us. Defense of any lawsuit or
failure to obtain any required license could delay shipment of our products and
increase our costs. If a successful claim is made against us and we fail to
develop or license a substitute technology, our business, results of operations,
financial condition or cash flows could be immediately and materially adversely
affected.
If we fail to adequately protect our intellectual property rights, competitors
may use our technology and trademarks, which could weaken our competitive
position, reduce our revenues, and increase our costs.
We rely on a combination of copyright, trademark and trade-secret laws, employee
and third-party nondisclosure agreements, and other arrangements to protect our
proprietary rights. Despite these precautions, it may be possible for
unauthorized third parties to copy our products or obtain and use information
that we regard as proprietary to create products that compete against ours. Some
license provisions protecting against unauthorized use, copying, transfer, and
disclosure of our licensed programs may be unenforceable under the laws of
certain jurisdictions and foreign countries.
In addition, the laws of some countries do not protect proprietary rights to the
same extent as do the laws of the United States. To the extent that we increase
our international activities, our exposure to unauthorized copying and use of
our products and proprietary information will increase.
Our collection of trademarks is important to our business. The protective steps
we take or have taken may be inadequate to deter misappropriation of our
trademark rights. We have filed applications for registration of some of our
trademarks in the United States and internationally. Effective trademark
protection may not be available in every country in which we offer or intend to
offer our products and services. Failure to protect our trademark rights
adequately could damage our brand identity and impair our ability to compete
effectively. Furthermore, defending or enforcing our trademark rights could
result in the expenditure of significant financial and managerial resources.
The scope of United States patent protection in the software industry is not
well defined and will evolve as the United States Patent and Trademark Office
grants additional patents. Because patent applications in the United States are
not publicly disclosed until the patent is issued, applications may have been
filed that would relate to our products.
Our software business success depends significantly upon our proprietary
technology. Despite our efforts to protect our proprietary technology, it may be
possible for unauthorized third parties to copy certain portions of our products
or to reverse engineer or otherwise obtain and use our proprietary information.
We do not have any software patents, and existing copyright laws afford only
limited protection. In addition, we cannot be certain that others will not
develop substantially equivalent or superseding proprietary technology, or that
equivalent products will not be marketed in competition with our products,
thereby substantially reducing the value of our proprietary rights. We cannot
33
assure you that we will develop proprietary products or technologies that are
patentable, that any patent, if issued, would provide us with any competitive
advantages or would not be challenged by third parties, or that the patents of
others will not adversely affect our ability to do business. Litigation may be
necessary to protect our proprietary technology. This litigation may be
time-consuming and expensive.
Other Risks Related To Our Business
We may be subject to claims as a result of information published on, posted on
or accessible from our Internet sites, which could be costly to defend and
subject us to significant damage claims.
We may be subject to claims of defamation, negligence, copyright or trademark
infringement (including contributory infringement) or other claims relating to
the information contained on our Internet sites, whether written by third
parties or us. These types of claims have been brought against online services
in the past and can be costly to defend regardless of the merit of the lawsuit.
Although federal legislation protects online services from some claims when
third parties write the material, this protection is limited. Furthermore, the
law in this area remains in flux and varies from state to state. We receive
notification from time to time of potential claims, but have not been named as a
party to litigation involving such claims. While no formal complaints have been
filed against us to date, our business could be seriously harmed if one were
asserted.
We may be subject to product liability claims if people or property are harmed
by the products we sell on our e-commerce web sites, which could be costly to
defend and subject us to significant damage claims.
Some of the products we offer for sale on our e-commerce Web sites, such as
consumer electronics, toys, computers and peripherals, toiletries, beverages and
clothing, may expose us to product liability claims relating to personal injury,
death or property damage caused by such products, and may require us to take
actions such as product recalls. Although we maintain liability insurance, we
cannot be certain that our coverage will be adequate for liabilities actually
incurred or that insurance will continue to be available to us on economically
reasonable terms, or at all. In addition, some of our vendor agreements with our
suppliers do not indemnify us from product liability.
If we are unable to implement appropriate systems, procedures and controls, we
may not be able to successfully offer our services and grow our software
business.
Our ability to successfully offer our services and grow our software business
requires an effective planning and management process. We updated our operations
and financial systems, procedures and controls following our strategic decision
to focus on our application software and online businesses. Our systems will
continue to require additional modifications and improvements to respond to
current and future changes in our business. If we cannot grow our software and
online businesses, and manage that growth effectively, or if we fail to timely
implement appropriate internal systems, procedures, controls and necessary
modifications and improvements to these systems, our businesses will suffer.
Our stock price has been volatile historically and may continue to be volatile.
The trading price of our common stock has been and may continue to be subject to
wide fluctuations. During the third quarter of fiscal year 2004, the closing
sale prices of our common stock on the Nasdaq ranged from $1.98 to $4.03 per
share and the closing sale price on April 30, 2004 was $1.98 per share. Our
stock price may fluctuate in response to a number of events and factors, such as
quarterly variations in operating results, announcements of technological
innovations or new products and media properties by us or our competitors,
changes in financial estimates and recommendations by securities analysts, the
operating and stock price performance of other companies that investors may deem
comparable to us, and news reports relating to trends in our markets or general
economic conditions.
In addition, the stock market in general, and the market prices for
Internet-related companies in particular, have experienced volatility that often
has been unrelated to the operating performance of such companies. These broad
market and industry fluctuations may adversely affect the price of our stock,
regardless of our operating performance. Additionally, volatility or a lack of
positive performance in our stock price may adversely affect our ability to
retain key employees, all of whom have been granted stock options.
Sales of our common stock by significant stockholders may cause the price of our
common stock to decrease.
Several of our stockholders own significant portions of our common stock. If
these stockholders were to sell significant amounts of their holdings of our
common stock, then the market price of our common stock could be negatively
impacted. The effect of such sales, or of significant portions of our stock
being offered or made available for sale, could result in strong downward
34
pressure on our stock. Investors should be aware that they could experience
significant short-term volatility in our stock if such stockholders decide to
sell a substantial amount of their holdings of our common stock at once or
within a short period of time.
Our networks may be vulnerable to unauthorized persons accessing our systems,
which could disrupt our operations and result in the theft of our proprietary
information.
A party who is able to circumvent our security measures could misappropriate
proprietary information or cause interruptions or malfunctions in our Internet
operations. We may be required to expend significant capital and resources to
protect against the threat of security breaches or to alleviate problems caused
by breaches in security.
Increasing regulation of the Internet or imposition of sales and other taxes on
products sold or distributed over the internet could harm our business.
The electronic commerce market on the Internet is relatively new and rapidly
evolving. While this is an evolving area of the law in the United States and
overseas, currently there are relatively few laws or regulations that directly
apply to commerce on the Internet. Changes in laws or regulations governing the
Internet and electronic commerce, including, without limitation, those governing
an individual's privacy rights, pricing, content, encryption, security,
acceptable payment methods and quality of products or services could have a
material adverse effect on our business, operating results and financial
condition. Taxation of Internet commerce, or other charges imposed by government
agencies or by private organizations, may also be imposed. Any of these
regulations could have an adverse effect on our future sales and revenue growth.
Business disruptions could affect our future operating results.
Our operating results and financial condition could be materially and adversely
affected in the event of a major earthquake, fire or other catastrophic event.
Our corporate headquarters, the majority of our research and development
activities and certain other critical business operations are located in
California, near major earthquake faults. A catastrophic event that results in
the destruction of any of our critical business or information technology
systems could severely affect our ability to conduct normal business operations
and as a result our future operating results could be adversely affected.
System disruptions could adversely affect our future operating results.
Our ability to attract and maintain relationships with users, advertisers,
merchants and strategic partners will depend on the satisfactory performance,
reliability and availability of our Internet channels and network
infrastructure. Our Internet advertising revenues relate directly to the number
of advertisements delivered to our users. System interruptions or delays that
result in the unavailability of Internet channels or slower response times for
users would reduce the number of advertisements and sales leads delivered to
such users and reduce the attractiveness of our Internet channels to users,
strategic partners and advertisers or reduce the number of impressions delivered
and thereby reduce revenue. In the past twelve months, some of our sites have
experienced a small number of brief service interruptions. We will continue to
suffer future interruptions from time to time whether due to natural disasters,
telecommunications failures, other system failures, rolling blackouts, viruses,
hacking or other events. System interruptions or slower response times could
have a material adverse effect on our revenues and financial condition.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The primary objective of our investment activities is to preserve principal
while at the same time maximizing the income we receive from our investments
without significantly increasing risk. Some of the securities that we have
invested in may be subject to market risk. This means that a change in
prevailing interest rates may cause the principal amount of the investment to
fluctuate. For example, if we hold a security that was issued with a fixed
interest rate at the then-prevailing rate and the prevailing interest rate later
rises, the principal amount of our investment will probably decline. To minimize
this risk, we maintain a portfolio of cash equivalents and short-term
investments in a variety of securities, including commercial paper, money market
funds and government and non-government debt securities. In general, money
market funds are not subject to market risk because the interest paid on such
funds fluctuates with the prevailing interest rate.
The following table presents the amounts of our cash equivalents and
short-term investments (in thousands) that are subject to market risk and
weighted-average interest rates, categorized by expected maturity dates, as of
April 30, 2004. This table does not include money market funds because those
funds are not subject to market risk.
35
Maturing Maturing within Maturing
(in thousands) within three months three months to one year Greater than one year
------------------- ------------------------ ---------------------
As of April 30, 2004
Cash equivalents $6,158
Weighted-average interest rate 1.07%
Short-term investments $22,574
Weighted-average interest rate 2.93%
Long-term investments $17,470
Weighted-average interest rate 2.37%
We have operated primarily in the United States, and virtually all sales
have been made in U.S. dollars. Accordingly, we have not had any material
exposure to foreign currency rate fluctuations.
The estimated fair value of our cash, cash equivalents and investments
approximate carrying value. We do not currently hold any derivative instruments
and do not engage in hedging activities.
Item 4. Controls and Procedures
a) Evaluation of disclosure controls and procedures. Our management
evaluated, with the participation of our Chief Executive Officer and our
Chief Financial Officer, the effectiveness of our disclosure controls
and procedures as of the end of the period covered by this Quarterly
Report on Form 10-Q. Based on this evaluation, our Chief Executive
Officer and our Chief Financial Officer have concluded that our
disclosure controls and procedures are effective to ensure that
information we are required to disclose in reports that we file or
submit under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in Securities
and Exchange Commission rules and forms.
b) Changes in internal controls over financial reporting. There was no
change in our internal control over financial reporting (as defined in
Rule 13a-15(f) of the Securities Exchange Act of 1934) that occurred
during the period covered by this Quarterly Report on Form 10-Q that has
materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.
PART II
Item 1. Legal Proceedings
The Company, two of its former officers (the "Former Officers"), and the
lead underwriter in its initial public offering ("IPO") were named as defendants
in a consolidated shareholder lawsuit in the United States District Court for
the Southern District of New York, captioned In re VA Software Corp. Initial
Public Offering Securities Litigation, 01-CV-0242. This is one of a number of
actions coordinated for pretrial purposes as In re Initial Public Offering
Securities Litigation, 21 MC 92 with the first action filed on January 12, 2001.
Plaintiffs in the coordinated proceeding are bringing claims under the federal
securities laws against numerous underwriters, companies, and individuals,
alleging generally that defendant underwriters engaged in improper and
undisclosed activities concerning the allocation of shares in the IPOs of more
than 300 companies during late 1998 through 2000. Among other things, the
plaintiffs allege that the underwriters' customers had to pay excessive
brokerage commissions and purchase additional shares of stock in the aftermarket
in order to receive favorable allocations of shares in an IPO. The consolidated
amended complaint in the Company's case seeks unspecified damages on behalf of a
purported class of purchasers of its common stock between December 9, 1999 and
December 6, 2000. Pursuant to a tolling agreement, the individual defendants
were dismissed without prejudice. On February 19, 2003, the court denied the
Company's motion to dismiss the claims against it. The litigation is now in
discovery. A proposal has been made for the settlement and release of claims
against the issuer defendants, including the Company. The settlement is subject
to a number of conditions, including approval of the proposed settling parties
and the court. If the settlement does not occur, and litigation against the
Company continues, the Company believes it has meritorious defenses and intends
to defend the case vigorously.
36
The Company is subject to various claims and legal actions arising in the
ordinary course of business. The Company has accrued for estimated losses in the
accompanying consolidated financial statements for those matters where it
believes that the likelihood that a loss will occur is probable and the amount
of loss is reasonably estimable.
Item 6. Exhibits and Reports On Form 8-K
(a) Exhibits
--------------------- ---------------------------------------------------------------------------------------------------------
Exhibit No. Description
--------------------- ---------------------------------------------------------------------------------------------------------
31.1 Rule 13a-14(a) Certification of Chief Executive Officer.
--------------------- ---------------------------------------------------------------------------------------------------------
31.2 Rule 13a-14(a) Certification of Chief Financial Officer.
--------------------- ---------------------------------------------------------------------------------------------------------
32.1 Certification Of Chief Executive Officer Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant
To Section 906 Of The Sarbanes-Oxley Act Of 2002.
--------------------- ---------------------------------------------------------------------------------------------------------
32.2 Certification Of Chief Financial Officer Pursuant To 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
On February 24, 2004, the Company furnished a Current Report on Form 8-K
under Item 12 (Results of Operations and Financial Condition) disclosing the
issuance of a February 24, 2004 press release announcing its financial results
for the quarter ended January 31, 2004.
On May 25, 2004, the Company furnished a Current Report on Form 8-K under
Item 12 (Results of Operations and Financial Condition) disclosing the issuance
of a May 25, 2004 press release announcing its financial results for the quarter
ended April 30, 2004.
On June 10, 2004, the Company filed a Current Report on Form 8-K under Item
4 (Changes in Registrant's Certifying Accountant) disclosing a change in
registered public accounting firms. On June 3, 2004, VA Software's Audit
Committee appointed BDO Seidman, LLP ("BDO"), subject to the completion of BDO's
normal client acceptance procedures, as VA Software's independent registered
public accounting firm for the Company's fiscal year ending July 31, 2004, and
dismissed PricewaterhouseCoopers LLP, with such dismissal to be effective upon
the completion of services related to the Company's consolidated financial
statements for the third quarter ended April 30, 2004.
37
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
VA SOFTWARE CORPORATION
By: /s/ ALI JENAB
----------------------------------------------
Ali Jenab
President and Chief Executive Officer
By: /s/ KATHLEEN R. MCELWEE
----------------------------------------------
Kathleen R. McElwee
Vice President and Chief Financial Officer
Date: June 14, 2004
38
EXHIBIT INDEX
Exhibit
Number
- ------
31.1 -- Rule 13a-14(a) Certification of Chief Executive Officer.
31.2 -- Rule 13a-14(a) Certification of Chief Financial Officer.
32.1 -- Certification Of Chief Executive Officer Pursuant To 18
U.S.C. Section 1350, As Adopted Pursuant To
Section 906 Of The Sarbanes-Oxley Act Of 2002
32.2 -- Certification Of Chief Financial Officer Pursuant To 18
U.S.C. Section 1350, As Adopted Pursuant To
Section 906 Of The Sarbanes-Oxley Act Of 2002
39