UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (mark one) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 For the transition period from ______________ to _______________ Commission File Number 0-23852 MRO SOFTWARE, INC. (Exact name of registrant as specified in its charter) MASSACHUSETTS 04-2448516 (State or other jurisdiction (I.R.S employer incorporation or organization) identification number) 100 CROSBY DRIVE, BEDFORD MASSACHUSETTS 01730 (Address of principal executive offices, including zip code) (781) 280-2000 (Registrant's telephone number, including area code) 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 Exchange Act). Yes [X] No [ ] Number of shares outstanding of the Registrant's common stock as of the latest practicable date: 25,683,098 shares of common stock, $.01 par value per share, as of August 8,2005. MRO SOFTWARE, INC. 10-Q INDEX PAGE PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Consolidated Balance Sheets (unaudited) as of June 30, 2005 and September 30, 2004. 2 Consolidated Statements of Operations (unaudited) for the three and nine months ended June 30, 2005 and June 30, 2004. 3 Consolidated Statements of Cash Flows (unaudited) for the nine months ended June 30, 2005 and June 30, 2004. 4 Notes to Consolidated Financial Statements (unaudited). 5 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 ITEM 3. Quantitative and Qualitative Disclosures about Market Risk 24 ITEM 4. Controls and Procedures 24 PART II. OTHER INFORMATION Item 1. Legal Proceedings 25 Item 2. Changes in Securities 25 Item 3. Defaults upon Senior Executives 25 Item 4. Submission of Matter to a Vote of Security Holders 25 Item 5. Other Information 25 Item 6. Exhibits 25 SIGNATURE 27 Page 1 MRO SOFTWARE, INC. CONSOLIDATED BALANCE SHEETS (UNAUDITED) JUNE 30, SEPTEMBER 30, (IN THOUSANDS, EXCEPT PER SHARE DATA) 2005 2004 --------- ------------- ASSETS Current assets: Cash and cash equivalents $ 82,263 $ 56,982 Marketable securities 31,154 36,152 Accounts receivable, trade, less allowance for doubtful accounts of $1,708 at June 30, 2005, and $2,324 at September 30, 2004, respectively 38,841 36,636 Prepaid expenses and other current assets 5,840 5,072 Deferred income taxes 1,337 1,470 --------- --------- Total current assets 159,435 136,312 --------- --------- Marketable securities 9,855 15,273 Property and equipment, net 7,560 7,227 Goodwill 46,337 46,768 Intangible assets, net 3,712 5,541 Deferred income taxes 6,798 7,611 Other assets 3,297 3,989 --------- --------- Total assets $ 236,994 $ 222,721 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses $ 13,419 $ 12,871 Accrued compensation 9,768 10,142 Income taxes payable 4,341 5,473 Deferred revenue 32,506 29,373 Deferred lease obligation 371 292 --------- --------- Total current liabilities 60,405 58,151 --------- --------- Deferred lease obligation 2,278 2,210 Deferred revenue 611 900 Other long term liabilities 303 325 Stockholders' equity Preferred stock, $.01 par value;1,000 authorized, none issued and outstanding Common stock, $.01 par value; 50,000 authorized; 25,628 and 24,983 issued and outstanding at June 30, 2005 and September 30, 2004, respectively 256 250 Additional paid-in capital 125,864 118,903 Deferred compensation (2,635) (370) Retained earnings 49,347 41,503 Accumulated other comprehensive income 565 849 --------- --------- Total stockholders' equity 173,397 161,135 --------- --------- Total liabilities and stockholders' equity $ 236,994 $ 222,721 ========= ========= The accompanying notes are an integral part of the consolidated financial statements. 2 MRO SOFTWARE, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, (IN THOUSANDS, EXCEPT PER SHARE DATA) 2005 2004 2005 2004 --------- --------- --------- --------- Revenues: Software $ 19,233 $ 12,996 $ 44,231 $ 36,658 Support and services 33,997 33,304 99,534 99,166 --------- --------- --------- --------- Total revenues 53,230 46,300 143,765 135,824 --------- --------- --------- --------- Cost of revenues: Software 2,608 1,582 5,087 5,289 Support and services 16,441 14,960 48,376 45,140 --------- --------- --------- --------- Total cost of revenues 19,049 16,542 53,463 50,429 --------- --------- --------- --------- Gross profit 34,181 29,758 90,302 85,395 Operating expenses: Sales and marketing 15,861 13,941 44,443 41,486 Product development 8,183 7,001 21,921 21,104 General and administrative 4,397 4,280 13,334 13,134 Amortization of other intangibles 89 165 272 574 --------- --------- --------- --------- Total operating expenses 28,530 25,387 79,970 76,298 --------- --------- --------- --------- Income from operations 5,651 4,371 10,332 9,097 Interest income, net 693 313 1,811 761 Other income/(expense), net 7 35 78 (292) --------- --------- --------- --------- Income before income taxes 6,351 4,719 12,221 9,566 Provision for income taxes 2,289 1,631 4,377 3,327 --------- --------- --------- --------- Net income $ 4,062 $ 3,088 $ 7,844 $ 6,239 ========= ========= ========= ========= Net income per share, basic $ 0.16 $ 0.12 $ 0.31 $ 0.25 --------- --------- --------- --------- Net income per share, diluted $ 0.16 $ 0.12 $ 0.31 $ 0.25 --------- --------- --------- --------- Shares used to calculate net income per share Basic 25,327 24,873 25,206 24,740 Diluted 25,936 25,409 25,687 25,342 The accompanying notes are an integral part of the consolidated financial statements. 3 MRO SOFTWARE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) NINE MONTHS ENDED JUNE 30, ------------------------- (IN THOUSANDS) 2005 2004 --------- --------- Cash flows from operating activities: Net income $ 7,844 $ 6,239 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 2,303 3,536 Amortization of other intangibles 1,829 2,459 Amortization of premium on marketable securities (57) 89 Loss on sale and disposal of property and equipment 62 --- Stock-based compensation 236 166 Deferred income taxes 1,659 785 Changes in operating assets and liabilities: Accounts receivable (2,385) (4,141) Prepaid expenses and other assets (42) 78 Accounts payable, accrued expenses and other liabilities 680 (3,766) Accrued compensation (247) (349) Income taxes payable (1,408) (1,344) Deferred revenue 2,922 1,027 --------- --------- Net cash provided by operating activities 13,396 4,779 --------- --------- Cash flows from investing activities: Acquisitions of property and equipment and other capital expenditures (2,669) (3,597) Purchase of marketable securities (183,178) (58,654) Sale of marketable securities 193,858 28,250 --------- --------- Net cash provided by/(used in) investing activities 8,011 (34,001) --------- --------- Cash flows from financing activities: Proceeds from exercise of employee stock options stock purchases 4,322 3,167 --------- --------- Net cash provided by financing activities 4,322 3,167 --------- --------- Effect of exchange rate changes on cash (448) 751 --------- --------- Net increase/(decrease) in cash and cash equivalents 25,281 (25,304) Cash and cash equivalents, beginning of period 56,982 73,662 --------- --------- Cash and cash equivalents, end of period $ 82,263 $ 48,358 ========= ========= The accompanying notes are an integral part of the consolidated financial statements. 4 MRO SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) A. BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements include the accounts of MRO Software, Inc. ("MRO") and its majority-owned subsidiaries (collectively, the "Company"), as of June 30, 2005 and have been prepared by the Company in accordance with generally accepted accounting principles for interim reporting and with the instructions to Form 10-Q and Article 10 of Regulation S-X. All intercompany accounts and transactions have been eliminated. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments, consisting only of those of a normal recurring nature, necessary for a fair presentation of the Company's financial position, results of operations and cash flows at the dates and for the periods indicated. The results of operations for the periods presented herein are not necessarily indicative of the results of operations to be expected for the entire fiscal year, which ends on September 30, 2005, or for any other future period. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended September 30, 2004 included in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission on December 14, 2004. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain prior year financial statement items have been reclassified to conform to the current year's format. B. INCOME PER SHARE Basic income per share is computed by dividing income or loss available to common shareholders by the weighted average number of common shares outstanding. Diluted income per share is computed by dividing income or loss available to common shareholders by the weighted average number of common shares outstanding plus dilutive potential common shares. For purposes of this calculation, stock options are considered dilutive potential common shares in periods in which they have a dilutive effect. Basic and diluted income per share are calculated as follows: THREE MONTHS ENDED (in thousands, except per share data) 06/30/05 06/30/04 -------- -------- Net income $ 4,062 $ 3,088 Denominator: Weighted average common shares outstanding-basic 25,327 24,873 Effect of dilutive securities (1) 609 536 ------- ------- Weighted average common shares outstanding-diluted 25,936 25,409 ======= ======= Net income per share, basic $ 0.16 $ 0.12 Net income per share, diluted $ 0.16 $ 0.12 Page 5 NINE MONTHS ENDED (in thousands, except per share data) 06/30/05 06/30/04 -------- -------- Net income $ 7,844 $ 6,239 Denominator: Weighted average common shares outstanding-basic 25,206 24,740 Effect of dilutive securities (1) 481 602 ------- ------- Weighted average common shares outstanding-diluted 25,687 25,342 ======= ======= Net income per share, basic $ 0.31 $ 0.25 Net income per share, diluted $ 0.31 $ 0.25 (1) The calculation of diluted earnings per common share excludes the impact of 1,476,000 shares and 1,567,000 shares for the three months ended June 30, 2005 and 2004, respectively, and 1,761,000 shares and 1,556,000 shares for the nine months ended June 30, 2005 and 2004, respectively, related to stock options and unvested restricted stock which are anti-dilutive. Common stock equivalents of 609,000 shares and 536,000 shares were included in the computation of diluted net income per share for the three months ended June 30, 2005 and 2004, respectively, and 481,000 shares and 602,000 shares for the nine months ended June 30, 2005 and 2004, respectively. C. ACCOUNTING POLICIES STOCK-BASED COMPENSATION AND PRO FORMA INFORMATION The Company complies with the pro forma disclosure requirements of the Financial Accounting Standards Board ("FASB") SFAS No. 123, as amended by SFAS No. 148. The fair value of the Company's stock options was estimated using the Black-Scholes option-pricing model. This model was developed for use in estimating fair value of traded options that have no vesting restrictions and are fully transferable. This model requires the input of highly subjective assumptions including the expected stock price volatility. Because the Company's stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimates, in management's opinion, the Black-Scholes model may not necessarily provide a reliable single measure of the fair value of its stock options. The following table illustrates the effect on net income and earnings per share on a pro forma basis as if the Company had applied the fair value recognition provisions of SFAS No.123 to stock-based employee compensation. THREE MONTHS ENDED (in thousands, except per share amounts) 06/30/05 06/30/04 --------- --------- Net income As reported $ 4,062 $ 3,088 Add: Stock-based employee compensation expense included in net income 142 61 Deduct: Stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects (1,252) (1,610) Pro forma net income $ 2,952 $ 1,539 Earnings per share: Basic-as reported $ 0.16 $ 0.12 Basic-pro forma $ 0.12 $ 0.06 Diluted-as reported $ 0.16 $ 0.12 Diluted-pro forma $ 0.11 $ 0.06 Page 6 NINE MONTHS ENDED (in thousands, except per share amounts) 06/30/05 06/30/04 --------- --------- Net income As reported $ 7,844 $ 6,239 Add: Stock-based employee compensation expense included in net income 236 166 Deduct: Stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects (3,532) (5,413) Pro forma net income $ 4,548 $ 992 Earnings per share: Basic-as reported $ 0.31 $ 0.25 Basic-pro forma $ 0.18 $ 0.04 Diluted-as reported $ 0.31 $ 0.25 Diluted-pro forma $ 0.18 $ 0.04 With the exception of restricted stock awards to non-employee members of the board of directors and executive management, no stock-based compensation cost is reflected in net income, as all stock-based awards granted under the Company's plans consist of stock options that have an exercise price equal to the market value of the underlying common stock on the date of grant. D. COMPREHENSIVE INCOME: The following table reflects the components of comprehensive net income: THREE MONTHS ENDED (in thousands) 06/30/05 06/30/04 -------- -------- Net income $ 4,062 $ 3,088 Other comprehensive net income, Net of tax: Unrealized gain/(loss) on securities arising during period 70 (194) Foreign currency translation adjustment (950) (336) ------- ------- Comprehensive income $ 3,182 $ 2,558 ======= ======= NINE MONTHS ENDED (in thousands) 06/30/05 06/30/04 -------- -------- Net income $ 7,844 $ 6,239 Other comprehensive net income, Net of tax: Unrealized gain/(loss) on securities arising during period 146 (122) Foreign currency translation adjustment (430) 440 ------- ------- Comprehensive income $ 7,560 $ 6,557 ======= ======= E. SEGMENT INFORMATION, GEOGRAPHIC DATA AND MAJOR CUSTOMERS: The Company reports revenues and income under one reportable industry segment. The Company's management assesses operating results on an aggregate basis to make decisions about the allocation of resources. Page 7 The Company manages its business in the following geographic areas: United States, Other Americas (Canada and Latin America), Europe/Middle East and Africa, and Asia Pacific. A summary of the Company's revenues by geographical area is as follows: THREE MONTHS ENDED (in thousands) 06/30/05 06/30/04 -------- -------- Revenues: United States $ 31,089 $ 26,510 Other Americas 2,419 2,375 Intercompany 3,641 3,093 -------- -------- Subtotal $ 37,149 $ 31,978 Europe/Middle East and Africa 15,357 14,516 Asia/Pacific 4,365 2,899 Intercompany (3,641) (3,093) -------- -------- Total revenues $ 53,230 $ 46,300 ======== ======== NINE MONTHS ENDED (in thousands) 06/30/05 06/30/04 --------- -------- Revenues: United States $ 82,482 $ 77,010 Other Americas 7,438 7,469 Intercompany 8,874 9,205 --------- --------- Subtotal $ 98,794 $ 93,684 Europe/Middle East and Africa 42,268 42,581 Asia/Pacific 11,577 8,764 Intercompany (8,874) (9,205) --------- --------- Total revenues $ 143,765 $ 135,824 ========= ========= The Company has subsidiaries in foreign countries, which sell the Company's products and services in their respective geographic areas. Intercompany revenues reflect our transfer pricing policies and primarily represent shipments of software to international subsidiaries. Intercompany revenues are eliminated from consolidated revenues. F. GOODWILL AND OTHER INTANGIBLE ASSETS Changes in the amount of goodwill for the quarter ended June 30, 2005 are as follows: Balance as of September 30, 2004 $ 46,768 Utilization of acquired net operating losses (431) -------- Balance as of June 30, 2005 $ 46,337 ======== Intangible assets as of June 30, 2005 and September 30, 2004 consist of the following: (in thousands) 06/30/05 09/30/04 -------- -------- Goodwill, net $ 46,337 $ 46,768 Acquired technology 16,654 16,654 Page 8 Accumulated amortization (13,229) (11,673) -------- -------- Sub-total acquired technology 3,425 4,981 -------- -------- Other intangibles 2,611 2,711 Accumulated amortization (2,324) (2,151) -------- -------- Sub-total other intangibles 287 560 -------- -------- Total intangible assets, net $ 50,049 $ 52,309 ======== ======== Other intangibles consist of customer contracts, customer lists and non-compete agreements. Amortization expense of intangible assets was $608 thousand and $638 thousand for the three months ended June 30, 2005 and 2004, respectively, and $ 1.8 million and $2.5 million for the nine months ended June 30, 2005 and 2004, respectively. As of June 30, 2005, remaining amortization expense on existing intangibles for the next five years is as follows: (in thousands) - -------------- 2005 (remaining 3 mos) $ 593 2006 1,565 2007 659 2008 659 2009 236 -------- Total $ 3,712 -------- G. RECENT ACCOUNTING PRONOUNCEMENTS In May 2005, the Financial Accounting Standards Board ("FASB") issued SFAS No. 154, Accounting Changes and Error Corrections ("FAS 154"). FAS No. 154 replaces APB No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements, and establishes retrospective application as the required method for reporting a change in accounting principle. FAS No. 154 provides guidance for determining whether retrospective application of a change in accounting principle is impracticable and for reporting a change when retrospective application is impracticable. The reporting of a correction of an error by restating previously issued financial statements is also addressed. FAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not anticipate that the adoption of FAS No. 154 will have a material impact on its consolidated results of operations. In March 2005, the FASB issued FASB Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations (FIN 47). FIN 47 provides guidance relating to the identification and recognition of legal obligations to perform an asset retirement activity. FIN 47 requires recognition of a liability for the fair value of a conditional asset retirement obligation when incurred if the liability's fair value can be reasonably estimated. We are required to adopt the provisions of FIN 47 by September 30, 2006. We do not expect FIN 47 to have a material impact on our results of operations, financial position or cash flows. In December 2004, the FASB issued a revised Statement of Financial Accounting Standard (SFAS) No. 123, Share-Based Payment (FAS 123(R)). FAS 123(R) requires public entities to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award and recognize the cost over the period during which an employee is required to provide Page 9 service in exchange for the award. In addition, in March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107, Share-Based Payment (SAB 107). SAB 107 provides supplemental implementation guidance on FAS 123(R), including guidance on valuation methods, (including assumptions such as expected volatility and expected term), classification of compensation expense, inventory capitalization of share-based compensation cost, income tax effects, disclosures in Management's Discussion and Analysis, and several other issues. Currently, we follow APB No. 25 which does not require the recognition of compensation expense relating to the issuance of stock options so long as the quoted market price of our stock at the date of grant is less than or equal to the amount an employee must pay to acquire the stock. However, other share-based awards such as restricted share units and performance shares are currently expensed under the present rules. The original FAS 123 requires footnote disclosure only of pro forma net income as if a fair-value-based method had been used. In April 2005, the SEC amended the compliance dates for FAS 123(R) from fiscal periods beginning after June 15, 2005 to fiscal years beginning after June 15, 2005. We will continue to account for share-based compensation using the intrinsic value method set forth in APB No. 25, until adoption of FAS 123 (R) on October 1, 2005. We are currently assessing the impact of FAS 123(R) and SAB 107 on our financial statements. In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets (FAS 153) which eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets and replaces it with a general exception from fair value measurement for exchanges of nonmonetary assets that do not have commercial substance. We are required to adopt FAS 153 for nonmonetary asset exchanges occurring in the first quarter of fiscal year 2006 and its adoption is not expected to have a significant impact on our results of operations, financial condition or cash flows. In December 2004, the FASB issued Staff Position No. 109-1, Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004. The Act provides a deduction for income from qualified domestic production activities, which will be phased in from our fiscal year 2006 through 2011. In return, the Act also provides for a two-year phase-out of the existing extra-territorial income exclusion (ETI) for foreign sales that was viewed to be inconsistent with international trade protocols by the European Union. In this Staff Position, the FASB states that the deduction should be accounted for as a special deduction, meaning that it should not reduce our statutory rate but shall be recognized in the period when it is deductible on our tax return. We do not expect the Staff Position to materially impact the financial position, results of operations or cash flows for our fiscal year 2005. In December 2004, the FASB issued Staff Position No. 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004. The Act contains a special one-time tax deduction of 85% of certain foreign earnings that are repatriated from foreign subsidiaries pursuant to new Internal Revenue Code Section 965. We may elect to apply the provisions of the new code section for either our fiscal year 2005 or 2006. The deduction is subject to a number of limitations and, as of today, uncertainty remains as to how to interpret numerous provisions in the Act. This Staff Position allows companies additional time beyond the financial reporting period of enactment to evaluate the effect of the Act. As such, we expect to complete our evaluation of the effects of the repatriation provision during the fourth quarter of fiscal year 2005 and have currently made no decisions on the amounts of potential dividend repatriation. Until the evaluation is completed, we will make no changes in our current intention to indefinitely reinvest accumulated earnings of our foreign subsidiaries. H. GUARANTOR ARRANGEMENTS We warrant that our software products will perform substantially in accordance with the product specifications as contained in certain associated documentation, which is provided with the products, for a period of ninety days from initial delivery of the products to the customer. Our sole obligation under this warranty is to use reasonable efforts to correct a verified problem that is brought to our attention during the warranty period, or if we are unable to provide a correction, we are obligated to accept the return of the product and refund the license fee paid. We warrant that our professional services will be provided in accordance with good professional practice, and that any software developed by our services organization will perform substantially in accordance with its approved specifications for a period of thirty days from Page 10 initial delivery of the services to the customer. Our sole obligation under this warranty is to use reasonable efforts to correct a verified problem that is brought to our attention during the warranty period, or if we are unable to provide a correction, we are obligated to accept the return of the deliverables and refund the fee paid for the services. If necessary, we would provide for the estimated cost of product and services warranties based on specific warranty claims and claim history. However, we have never incurred significant expense under our product or services warranties, our liability for breach of warranty is limited to the amount of the license or services fees actually paid, and we maintain insurance covering such claims in an amount sufficient to cover a refund of the license or services fees paid by any particular customer during the last 12 months. As a result, we believe the estimated fair value of these warranty obligations is minimal. Accordingly, we have no liabilities recorded for these warranty obligations as of June 30, 2005. Under our standard end-user license agreement, we agree to indemnify our customers against infringement claims that may be brought by third parties asserting that our products infringe on certain intellectual property rights. In our services agreements with customers, we will also, as a matter of standard practice, agree to indemnify customers (a) against claims that may be brought by third parties asserting that the results of our services infringe on certain intellectual property rights, (b) against damages caused by our breach of certain confidentiality provisions in the contract, and (c) against damages to personal property, and death, caused by our services personnel while on-site at customer premises. These indemnification provisions are generally based on our standard contractual terms. All such provisions, whether based on our standard contracts or negotiated with a given customer, are entered into in the normal course of business based on an assessment that the risk of loss is remote. The terms of the indemnifications as negotiated may vary in duration and nature, and our obligations to indemnify may be unlimited as to amount. There have been no demands for indemnity and the contingencies triggering the obligation to indemnify have not occurred to our knowledge and are not expected to occur. The Company maintains insurance that covers such indemnification obligations, and the amount of coverage that we maintain is sufficient to cover a refund of the license and services fees received from any particular customer during the last 12 months. Historically, the Company has not made any material payments pursuant to any such indemnity obligations. Accordingly, we have no liabilities recorded for any such indemnity obligations as of June 30, 2005. When we acquire a business or a company, we may assume liability for certain events or occurrences that took place prior to the date of acquisition. The maximum potential amount of future payments we could be required to make for such obligations is undeterminable at this time. All of these obligations were grand fathered under the provisions of FIN No. 45 as they were in effect prior to December 31, 2002. Accordingly, we have no liabilities recorded for the assumption of any such liabilities as of June 30, 2005. I. PROVISION FOR INCOME TAXES We are subject to continuous examinations of our income tax returns by the Internal Revenue Service. The Company is currently undergoing an income tax audit with the Internal Revenue Service. We believe that we have provided sufficiently for all audit exposures. A favorable settlement of this audit or the expiration of the statute of limitations on the assessment of income taxes for any tax year may result in a reduction of future tax provisions, which could be significant. The Company expects to recognize any such benefit upon expiration of the statute of limitations. Page 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS In addition to historical information, this Quarterly Report on Form 10-Q, as well as documents incorporated herein by reference, may contain forward-looking statements (within the meaning of section 27A of the Securities Act of 1933, as amended, and section 21E of the Securities Exchange Act of 1934, as amended). The following and similar expressions identify forward-looking statements: "expects," "anticipates," and "estimates." Forward-looking statements include, without limitation, statements related to: our plans, objectives, expectations and intentions; the timing of, availability and functionality of products under development or recently introduced; and market and general economic conditions. Important factors that could cause actual results to differ materially from those suggested by the forward-looking statements for various reasons, include those discussed under the heading "Factors Affecting Future Performance" below. These forward-looking statements speak only as of the date of this Quarterly Report, and we disclaim any obligation to update such forward looking statements as a result of any change in circumstances or otherwise. OVERVIEW MRO Software, Inc. is the leading global provider of strategic asset and service management solutions. In March 2005, we released our new generation of products, Maximo Enterprise Suite (MXES). MXES is a comprehensive suite of products built on a single, common platform. It combines enhanced Enterprise Asset Management (EAM) functionality with new service management capabilities (ITAM) that together improve the effectiveness of asset management strategies. MXES includes Maximo and Maximo Enterprise for traditional assets and service management and our ITAM products: Maximo Discovery for autodiscovery of IT assets, Maximo Asset Center for advanced IT asset management, and Maximo Service Center, a full-featured service desk based on the IT Infrastructure Library (ITIL) guidelines. Each product of MXES can be implemented separately as a stand-alone solution or deployed together. In addition, we also offer several industry specific solutions based on the Maximo platform and incorporating specific functionality delivered through either technology partnerships or integrations. Industry specific solutions include Nuclear Power, Transportation, Oil & Gas, Transmission and Distribution (Utilities) and Pharmaceuticals. The Company will continue to sell and support certain prior versions of Maximo Enterprise (EAM) and Maximo MainControl (ITAM). Using our products and services, our customers improve production reliability, labor efficiency, material optimization, software license compliance, lease management, warranty and service management and provisioning across their critical asset bases. We report all our revenues in one reportable business segment. Our management assesses operating results on an aggregate basis to make decisions about the allocation of resources. Our actual results are reported in United States dollars. International revenues accounted for 42% and 43% of total revenues for the three months ended June 30, 2005 and 2004, respectively, and 43% for both the nine months ended June 30, 2005 and 2004, respectively, and, therefore, the fluctuation in exchange rates can have a significant impact on our results of operations. In the three and nine months ended June 30, 2005, the fluctuation in the Euro dollar and the British pound, in particular, had a favorable impact on our revenue results. We assess the impact of foreign currency exchange rates on our business, primarily revenues, by recalculating the current period's financial results using the comparable period's exchange rates to devise a constant currency rate in order to compare period over period results. We believe that this non-GAAP financial measure provides useful information to management and investors since it reflects performance of our international territories without the effect of exchange rates. Total actual revenues increased 15% for the three months ended June 30, 2005 compared to the three months ended June 30, 2004, and 6% for the nine months ended June 30, 2005 as compared to the nine months ended June 30, 2004. However, in constant currency terms, the actual revenues increased approximately 13% for the three months ended June 30, 2005 and 3% for the Page 12 nine months ended June 30, 2005. The exchange rates had a similar impact on direct and operating expenses, and, therefore, the overall impact on net income was immaterial for the three and nine months ended June 30, 2005. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires that management make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. These estimates and assumptions are affected by management's application of accounting policies. Critical accounting policies, in which different judgments and estimates by our management could materially affect our reported condition and results of operations, include revenue recognition, estimating the allowance for doubtful accounts, deferred tax assets, and the valuation of long-lived assets. These critical accounting policies and estimates should be read in conjunction with the critical accounting policies and estimates included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC) on December 14, 2004. We include and update critical accounting policies and estimates in interim periods if a new critical accounting policy is adopted or amended or if there are material changes in related judgments or conditions underlying our estimates in the interim period. RESULTS OF OPERATIONS REVENUES Three Three Nine Nine Months Months Months Months Ended Change Ended Ended Change Ended (in thousands) 06/30/05 % 06/30/04 06/30/05 % 06/30/04 - -------------- -------- ------ --------- ------- ------- -------- Software licenses $19,233 48% $12,996 $44,231 21% $ 36,658 Percentage of total revenues 36% 28% 31% 27% Support revenues $18,732 6% $17,699 $56,186 6% $ 52,850 Percentage of total revenues 35% 38% 39% 39% Service revenues $15,265 (2)% $15,605 $43,348 (6)% $ 46,316 Percentage of total revenues 29% 34% 30% 34% Total revenues $53,230 15% $46,300 $143,765 6% $135,824 Our revenues are derived primarily from two sources: (i) software licenses, and (ii) fees for support and services. Software license revenues increased 48% for the three months ended June 30, 2005 compared to the three months ended June 30, 2004, and increased 21% for the nine months ended June 30, 2005 compared to the nine months ended June 30, 2004. Using constant currency rates, software license revenues increased approximately 47% for the three months ended June 30, 2005, and increased approximately 18% for the nine months ended June 30, 2005. The increases in software license revenues for the three and nine months ended June 30, 2005 are attributable to the successful penetration with the Maximo Industry solutions, (specifically the utilities vertical), early success with the new MXES product, and an increase in the average selling price. The increase in the average selling price is attributable to four large license sales over $1.0 million. Support revenues increased 6% for both the three and nine months ended June 30, 2005 compared to the three and nine months ended June 30, 2004. Using constant currency rates, support revenues increased Page 13 approximately 4% for both the three and nine months ended June 30, 2005. Support revenues have increased as a result of a cumulative increase in the number of Maximo licenses and a strong renewal rate (90%) for support contracts. Service revenues decreased 2% for the three months ended June 30, 2005 compared to the three months ended June 30, 2004 and decreased 6% for the nine months ended June 30, 2005 compared to the nine months ended June 30, 2004. Using constant currency rates, service revenues decreased approximately 3% for the three months ended June 30, 2005 and 9% for the nine months ended June 30, 2005. The decreases in service revenues for these periods were due to a decline in Maximo service revenues of 1% for the three months ended June 30, 2005 and 6% for the nine months ended June 30, 2005 due primarily to the conclusion of a multi-year engagement that had been generating $1 to $2 million of revenue per quarter for the previous two years. Overall, our services business operates in a highly competitive industry and there are numerous independent consulting firms who implement our Maximo products and compete for our services business. In addition, in connection with the delivery of the new MXES product, services personnel were utilized to support sales efforts. COST OF REVENUES Three Three Nine Nine Months Months Months Months Ended Change Ended Ended Change Ended (in thousands) 06/30/05 % 06/30/04 06/30/05 % 06/30/04 - -------------- -------- ------ -------- -------- ------ -------- Cost of software licenses revenues $ 2,608 65% $ 1,582 $ 5,087 (4)% $ 5,289 Percentage of software license revenues 14% 12% 12% 14% Cost of support revenues $ 3,084 15% $ 2,676 $ 8,929 12% $ 7,981 Percentage of support revenues 16% 15% 16% 15% Cost of services revenues $13,357 9% $12,284 $39,447 6% $37,159 Percentage of services revenues 88% 79% 91% 80% Total cost of revenues $19,049 15% $16,542 $53,463 6% $50,429 Percentage of total revenues 36% 36% 37% 37% Cost of software license revenues consists of software purchased for resale, royalties paid to vendors of third-party software, the cost of software product packaging and media, certain employee costs related to software duplication, packaging and shipping and amortization of acquired technology. The 65% increase in the cost of software license revenues for the three months ended June 30, 2005 compared to the three months ended June 30, 2004 was primarily due to an increase in purchases of third-party software related to our Maximo Mobile Suite product and royalties paid to vendors of third-party software. Costs for third party software can fluctuate quarter to quarter as it is heavily dependent on demand for this product. The 4% decrease in the cost of software license revenues for the nine months ended June 30, 2005 compared to the nine months ended June 30, 2004 was due primarily to the decrease in amortization of acquired technology due to the completion of amortization of fully amortized assets. Amortization of acquired technology amounted to $518 thousand and $473 thousand for the three months ended June 30, 2005 and 2004, respectively and $1.6 million and $1.9 million for the nine months ended June 30, 2005 and 2004, respectively. Partially offsetting the decrease was an increase in purchases of third-party software related to our Maximo Mobile Suite product. Cost of support and services consists primarily of personnel costs for employees and the related costs of benefits and facilities, costs for utilization of third-party consultants and costs to support the MRO Operations Center. Cost of support revenues increased 15% for the three months ended June 30, 2005 compared to the three months ended June 30, 2004 and increased 12% for the nine months ended June 30, 2005 compared to the nine months ended June 30, 2004. The increases for the three and nine months ended June 30, 2005 as compared to the three and nine months ended June 30, 2004 were primarily attributable to increases in renewals of third-party support contracts related to the Maximo Mobile Suite product and general increases in salaries and related benefits, partially offset by a decrease in general operating Page 14 expenses. Cost of support revenues, as a percentage of total support revenues, was 16% and 15% for both the three and nine months ended June 30, 2005 and 2004, respectively. Cost of service revenues increased 9% for the three months ended June 30, 2005 as compared to the three months ended June 30, 2004 and increased 6% for the nine months ended June 30, 2005 as compared to the nine months ended June 30, 2004. Cost of service revenues, as a percentage of total service revenues was 88% and 79% for the three months ended June 30, 2005 and 2004, respectively, and 91% and 80% for the nine months ended June 30, 2005 and 2004, respectively. The increases for the three and nine months ended June 30, 2005 as compared to the three and nine months ended June 30, 2004 were attributable to an increase in service incentives, an increase in the utilization of third party consultants implementing our products, salaries and related benefits, and travel and entertainment expenses related to worldwide professional services meetings, partially offset by decreases in reimbursable expenses. OPERATING EXPENSES Three Three Nine Nine Months Months Months Months Ended Change Ended Ended Change Ended (in thousands) 06/30/05 % 06/30/04 06/30/05 % 06/30/04 - -------------- -------- ------ -------- -------- ------- -------- Sales and marketing $15,861 14% $13,941 $44,443 7% $41,486 Percentage of total revenues 30% 30% 31% 31% Product development $ 8,183 17% $ 7,001 $21,921 4% $21,104 Percentage of total revenues 15% 15% 15% 16% General and administrative $ 4,397 3% $ 4,280 $13,334 2% $13,134 Percentage of total revenues 8% 9% 9% 10% Amortization of other intangibles $ 89 (46)% $ 165 $ 272 (53)% $ 574 Percentage of total revenues 1% 1% 1% 1% Sales and marketing expenses increased 14% for the three months ended June 30, 2005 compared to the three months ended June 30, 2004 and increased 7% for the nine months ended June 30, 2005 as compared to the nine months ended June 30, 2004. The increase for the three months ended June 30, 2005 as compared to the three months ended June 30, 2004 was primarily attributable to an increase in sales commissions due to an increase in software license sales, a general increase in salaries and related benefits, travel and entertainment expenses, and advertising expenses to market new products (MXES). The increase for the nine months ended June 30, 2005 as compared the nine months ended June 30, 2004 was primarily attributable to a general increase in salaries and related benefits, an increase in sales commissions due to an increase in software license sales, an increase in advertising expenses to market new products (MXES), and costs to recruit a new Vice President of Worldwide Sales, and travel and entertainment expenses, partially offset by a general decrease in overall sales and marketing expenses. Product development expenses increased 17% for the three months ended June 30, 2005 compared to the three months ended June 30, 2004 and increased 4% for the nine months ended June 30, 2005 as compared to the nine months ended June 30, 2004. The increases for the three and nine months ended June 30, 2005 as compared to the three and nine months ended June 30, 2004 were due to an increase in salaries and related benefits due to an increase in head count and an increase in expenditures for translation of our products in various foreign languages. We expended $1.2 million in translation expenses in the quarter ended June 30, 2005, however, this increase in translation expenses is expected to drop down to a lower level over the next few quarters. Partially offsetting these increases is a general decrease in overall product and development expenses. We have developed several industry specific solutions based on the Maximo platform and incorporating specific functionality delivered through either technology partnerships or integrations. Industry specific solutions include Nuclear Power, Transportation, Oil & Gas, Transmission and Distribution (Utilities) and Pharmaceuticals. In March 2005, we released our new generation of products, Maximo Enterprise Suite (MXES). MXES is a comprehensive suite of products that are built on Page 15 a single, common platform combining enhanced Enterprise Asset Management (EAM) functionality, new service management capabilities and IT Asset and Service Management that together improve the effectiveness of asset management strategies. General and administrative expenses increased 3% for the three months ended June 30, 2005 as compared to the three months ended June 30, 2004 and increased 2% for the nine months ended June 30, 2005 as compared to the nine months ended June 30, 2004. General and administrative costs have mainly increased due to the costs for the assessment of internal controls in order to comply with the Sarbanes Oxley Act of 2002. General and administrative expenses, as a percentage of total revenues, was 8% and 9% for the three months ended June 30, 2005 and 2004, respectively and 9% and 10% for the nine months ended June 30, 2005 and 2004, respectively. The decrease in amortization of other intangibles expense for the three and nine months ended June 30, 2005 and 2004, respectively, was due to cessation of amortization for fully amortized assets. NON-OPERATING INCOME/EXPENSES Three Three Nine Nine Months Months Months Months Ended Change Ended Ended Change Ended (in thousands) 06/30/05 % 06/30/04 06/30/05 % 06/30/04 - --------------- -------- ------ -------- -------- ------ -------- Interest income, net $ 693 121% $ 313 $ 1,811 138% $ 761 Other income/(expense), net $ 7 (80)% $ 35 $ 78 (127)% $ (292) Interest income is attributable to interest earned on marketable securities and cash and cash equivalents. We invest a large portion of our cash in marketable securities such as United States treasury and treasury-backed instruments, municipal bonds and highly rated conservative corporate bonds. We were able to earn more income in the three and nine months ended June 30, 2005 as compared to the three and nine months ended June 30, 2004 because we invested more cash into higher yielding securities, mostly higher yielding U.S. bonds. The change in other income was primarily due to a swing in foreign currency transaction gains and losses. We reported net currency transaction losses of $71 thousand for the three months ended June 30, 2005 compared to net currency transaction losses of $21 thousand for the three months ended June 30, 2004 and net currency transaction gains of $67 thousand for the nine months ended June 30, 2005 compared to net currency transaction losses of $597 thousand for the nine months ended June 30, 2004. We have no foreign exchange contracts at the present time. Transaction gains and losses are primarily attributable to settlement of foreign intercompany account balances. INCOME TAXES Our effective tax rate was 36% for both the three and nine months ended June 30, 2005 and 35% for the three and nine months ended June 30, 2004. The tax provision was calculated on income generated in domestic and foreign tax jurisdictions and on changes in our net deferred tax assets and liabilities. LIQUIDITY AND CAPITAL RESOURCES As of June 30, 2005, we had cash and cash equivalents of $82.3 million and marketable securities of $41.0 million. The Company's working capital was $99.0 million. Cash provided by operations was $13.4 million for the nine months ended June 30, 2005 primarily attributable to income generated from operations and collection of accounts receivable. Cash provided by investing activities was $8.0 million for the nine months ended June 30, 2005 and was primarily provided by the sales and maturities of marketable securities, offset by the purchase of marketable securities and capital expenditures. Page 16 Cash provided by financing activities was $4.3 million for the nine months ended June 30, 2005 and represents proceeds from our employee stock option and purchase plans. As of June 30, 2005, our principal commitments consist primarily of office space and equipment operating leases for our U.S. and European headquarters. Our corporate headquarters are under a lease through December 31, 2009. We lease our other facilities and certain equipment under non-cancelable operating lease agreements that expire at various dates through June 30, 2019. We may use a portion of our cash to acquire additional businesses, products or technologies complementary to our business. We also plan to make investments over the next year in our products and technology. We expect that our cash flow from operations, together with our current cash and marketable securities, will be sufficient to meet our working capital and capital expenditure requirements through at least June 30, 2006. Our liquidity and working capital requirements, including the current portions of any long-term commitments, are satisfied through cash flow from operations, leaving our cash reserves available for acquisitions, other investments and unanticipated expenditures. We have no long-term debt obligations. The factors that might impact our cash flows include those that might impact our business and operations generally, as described below under the heading "Factors Affecting Future Performance." NEW ACCOUNTING PRONOUNCEMENTS In May 2005, the Financial Accounting Standards Board ("FASB") issued SFAS No. 154, Accounting Changes and Error Corrections ("FAS 154"). FAS No. 154 replaces APB No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements, and establishes retrospective application as the required method for reporting a change in accounting principle. FAS No. 154 provides guidance for determining whether retrospective application of a change in accounting principle is impracticable and for reporting a change when retrospective application is impracticable. The reporting of a correction of an error by restating previously issued financial statements is also addressed. FAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not anticipate that the adoption of FAS No. 154 will have a material impact on its consolidated results of operations. In March 2005, the FASB issued FASB Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations (FIN 47). FIN 47 provides guidance relating to the identification and recognition of legal obligations to perform an asset retirement activity. FIN 47 requires recognition of a liability for the fair value of a conditional asset retirement obligation when incurred if the liability's fair value can be reasonably estimated. We are required to adopt the provisions of FIN 47 by September 30, 2006. We do not expect FIN 47 to have a material impact on our results of operations, financial position or cash flows. In December 2004, the FASB issued a revised Statement of Financial Accounting Standard (SFAS) No. 123, Share-Based Payment (FAS 123(R)). FAS 123(R) requires public entities to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award and recognize the cost over the period during which an employee is required to provide service in exchange for the award. In addition, in March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107, Share-Based Payment (SAB 107). SAB 107 provides supplemental implementation guidance on FAS 123(R), including guidance on valuation methods, (including assumptions such as expected volatility and expected term), classification of compensation expense, inventory capitalization of share-based compensation cost, income tax effects, disclosures in Management's Discussion and Analysis, and several other issues. Currently, we follow APB No. 25 which does not require the recognition of compensation expense relating to the issuance of stock options so long as the quoted market price of our stock at the date of grant is less than or equal to the amount an employee must pay to acquire the stock. However, other share-based awards such as restricted share units and performance shares are currently expensed under the present rules. The original FAS 123 requires footnote disclosure only of pro forma net income as if a fair-value-based method had been used. In April 2005, the SEC amended the compliance dates for FAS 123(R) from fiscal periods beginning after June 15, 2005 to Page 17 fiscal years beginning after June 15, 2005. We will continue to account for share-based compensation using the intrinsic value method set forth in APB No. 25, until adoption of FAS 123 (R) on October 1, 2005. We are currently assessing the impact of FAS 123(R) and SAB 107 on our financial statements. In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets (FAS 153) which eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets and replaces it with a general exception from fair value measurement for exchanges of nonmonetary assets that do not have commercial substance. We are required to adopt FAS 153 for nonmonetary asset exchanges occurring in the first quarter of fiscal year 2006 and its adoption is not expected to have a significant impact on our results of operations, financial condition or cash flows. In December 2004, the FASB issued Staff Position No. 109-1, Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004. The Act provides a deduction for income from qualified domestic production activities, which will be phased in from our fiscal year 2006 through 2011. In return, the Act also provides for a two-year phase-out of the existing extra-territorial income exclusion (ETI) for foreign sales that was viewed to be inconsistent with international trade protocols by the European Union. In this Staff Position, the FASB states that the deduction should be accounted for as a special deduction, meaning that it should not reduce our statutory rate but shall be recognized in the period when it is deductible on our tax return. We do not expect the Staff Position to materially impact the financial position, results of operations or cash flows for our fiscal year 2005. In December 2004, the FASB issued Staff Position No. 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004. The Act contains a special one-time tax deduction of 85% of certain foreign earnings that are repatriated from foreign subsidiaries pursuant to new Internal Revenue Code Section 965. We may elect to apply the provisions of the new code section for either our fiscal year 2005 or 2006. The deduction is subject to a number of limitations and, as of today, uncertainty remains as to how to interpret numerous provisions in the Act. This Staff Position allows companies additional time beyond the financial reporting period of enactment to evaluate the effect of the Act. As such, we expect to complete our evaluation of the effects of the repatriation provision during the fourth quarter of fiscal year 2005 and have currently made no decisions on the amounts of potential dividend repatriation. Until the evaluation is completed, we will make no changes in our current intention to indefinitely reinvest accumulated earnings of our foreign subsidiaries. FACTORS AFFECTING FUTURE PERFORMANCE The nature of forward-looking information is that such information involves significant assumptions, risks and uncertainties. Certain of our public documents and statements made by our authorized officers, directors, employees, agents and representatives acting on our behalf may include forward-looking information which will be influenced by the factors described below and by other assumptions, risks and uncertainties. Forward-looking information is based on assumptions, estimates, forecasts and projections regarding our future results as well as the future effectiveness of our strategic plans and our operational decisions. Forward-looking statements made by or on behalf of us are subject to the risk that the forecasts, projections and expectations of management, or assumptions underlying such forecasts, projections and expectations, may prove to be inaccurate. Accordingly, actual results and our implementation of our plans and operations may differ materially from forward-looking statements made by or on behalf of us. The following discussion identifies certain important factors that could affect our actual results and actions and could cause such results and actions to differ materially from forward-looking statements. WE DEPEND SUBSTANTIALLY ON OUR MAXIMO EAM PRODUCT. Most of our revenues are derived from the licensing of our Maximo EAM family of products and sales of related services and support. Our financial performance depends largely on continued market acceptance of these products. We believe that continued market acceptance and our revenue stability and growth will largely depend on our ability to continue to enhance and broaden the capabilities of these products. If we are unable to continue to enhance and improve Maximo EAM so that it delivers the capabilities required by existing and potential customers and remains competitive with other products in the market, or if a trend Page 18 emerges such that customers decide to consolidate their IT systems and eliminate their standalone or "best-of-breed" EAM application software altogether, our revenues, margins and results of operations and financial condition may be materially and adversely affected. THE TRADITIONAL MARKET FOR OUR MAXIMO EAM PRODUCT IS MATURE AND SATURATED AND MAY PRESENT LIMITED OPPORTUNITY FOR GROWTH. Maximo has been the industry-leading plant floor capital asset maintenance product for a number of years, and we have acquired a large number of customers in this market. However, most large industrial organizations have made significant investments in systems that support the maintenance of their capital assets, and opportunities for new Maximo sales in the EAM market are in a state of continuous decline. In addition, the emergence and growth of this market have attracted a large number of competitors, and most of the largest software companies that sell into complementary markets have developed competing asset maintenance products. It is likely that this market will continue to mature, there will be fewer sales opportunities for the Company, and competitive forces will put downward pressure on our average sales prices and rates of success. To be competitive in the EAM market, we have made significant investments in Maximo EAM to meet the needs of specific industries in which we have a presence, such as the nuclear, transportation, power generation, transmission and distribution, and other industries. We refer to these industry-specific Maximo offerings as "Industry Solutions." While we continue to strengthen our Maximo EAM offering, these efforts may not be sufficient to overcome the effects of maturity and saturation in our traditional market, and our revenues, margins, results of operation and financial condition may be materially and adversely affected. OUR EFFORTS TO REACH INTO NEW MARKETS WITH NEW PRODUCTS MAY NOT BE SUCCESSFUL. Given the maturity and saturation of the traditional EAM market, in order to maintain revenues at their current levels and to grow our business, we have recently broadened our product offerings in order to develop additional sources of revenues, and we continue to do so. We are attempting, through acquisitions and internal development, to deliver products that address markets that are new to us, such as the ITAM and Help Desk and Service Desk markets. These efforts reached a significant milestone with the initial release of Maximo Enterprise Suite (MXES), in March 2005. We are planning significant enhancements to this initial release, and will continue to broaden this offering. Our continuing development of MXES and of our Maximo EAM Industry Solutions, and our ability to derive revenue and grow, is subject to the following risks, among others: - We may not be able to develop and market our new products on time, with acceptable quality or with functions and features that meet the requirements of customers in these markets. - The MXES products may not contain all of the functionality deemed necessary by prospective buyers in these markets. - It is possible that our sales, service or support personnel may not be adequately trained and/or staffed to sell, implement or support the new products. Newly developed products require a higher level of development, distribution and support expenditures in the early stages of their product life cycles. - In the event that our development efforts are not progressing as intended, or if our new product releases or technologies are not successful in the markets they are intended to address, we may increase our rate of expenditure in this area over and above the level of investment experienced in the past or previously projected, which could have a material adverse affect on our results of operation or financial condition. - We may not derive revenues from MXES in proportion to our investment and sales efforts, and those efforts may serve as a significant distraction from our efforts to maintain revenues at current levels in our traditional EAM market. Page 19 - Our positioning of the combination of our traditional EAM products and our ITAM products in a single offering as a logical suite of products may not be accepted in the marketplace. As a result of this and other factors, we may not be able to benefit from the trend among customers to consolidate their information technology (IT) systems, and we may not be successful in our attempts to sell our new products into our existing accounts, or our traditional EAM products to customers primarily interested in our new products. If any of our newly developed products do not gain market acceptance and generate revenues from new industries or markets, we may not be able to grow our business or maintain revenues at current levels, and our revenues, margins, results of operations and financial condition may be materially and adversely affected. OUR SALES EFFORTS DEPEND IN PART ON STRATEGIC RELATIONSHIPS AND RESELLER ARRANGEMENTS WITH OTHER COMPANIES. We have entered into strategic relationships with various larger companies, such as HP, IBM and SAIC. In order to generate revenue through these relationships, each party must coordinate with and support the other's sales and marketing efforts, and each party must make significant sales and marketing investments. Our ability to generate revenues through these relationships depends in large part upon the efforts of these other companies, which are outside of our control. The efforts of these companies may in turn be influenced by factors internal to these companies, or by developments in their respective industries or markets, that we fail to anticipate. In addition, we are renewing our focus on generating software license sales through value-added resellers, systems integrators and other indirect sales channels. The Company may have difficulty in establishing the infrastructure necessary to initiate, maintain and support these channel relationships, and these relationships may either not materialize or they may fail to produce additional sales. We may not derive revenues from in proportion to our investment in channel sales, and those efforts may serve as a significant distraction from our direct sales efforts. IF WE ARE UNABLE TO KEEP PACE WITH THE RAPID CHANGES IN TECHNOLOGY AND CUSTOMER DEMAND THAT CHARACTERIZE OUR INDUSTRY, OUR COMPETITIVE POSITION COULD BE IMPAIRED. The computer software industry is characterized by rapid technological advances, changes in customer requirements and frequent product introductions and enhancements by us and by our competitors. Our success depends on our abilities to enhance our current products, to develop and introduce new products that keep pace with technological developments, to respond to evolving customer requirements and changing industry standards, to offer functionality and other innovations that are unique to our products and superior to those of our competitors, and ultimately to achieve market acceptance. In particular, we believe that we must continue to innovate and develop new functionality, to respond quickly to users' needs for new functionality and to advances in hardware and operating systems, and that we must continue to create products that conform to industry standards regarding the communication and interoperability among software, hardware and communications products of many different vendors. If we fail to anticipate or respond adequately to technological developments and changes in market definitions or changes in customer requirements within particular market segments, or if we have any significant delays in product development or introduction, then we could lose competitiveness and revenues. OUR QUARTERLY OPERATING RESULTS ARE SUBJECT TO FLUCTUATIONS AND TO SEASONAL VARIATION. We have experienced, and may in the future experience, significant period-to-period fluctuations in revenues and operating results. In addition, our quarterly revenues and operating results have fluctuated historically due to the number and timing of product introductions and enhancements, customers delaying their purchasing decisions in anticipation of new product releases, the budgeting and purchasing cycles of customers, the timing of product shipments and the timing of marketing and product development expenditures. We typically realize a significant portion of our revenue from sales of software licenses in the last two weeks of each quarter, frequently even in the last few days of a quarter. Failure to close a small Page 20 number of large software license contracts may have a significant impact on revenues for the quarter and could, therefore, result in significant fluctuations in quarterly revenues and operating results, and divergence of those results from our expectations. Accordingly, we believe that period-to-period comparisons of results of operations are not necessarily meaningful and should not be relied upon as an indication of future performance. WE FACE INTENSE COMPETITION IN THE MARKETS WE SERVE. The markets for strategic asset management software such as Maximo EAM, Maximo ITAM and Maximo Enterprise Suite (MXES) are fragmented by geography, by market and industry segments, by hardware platform and by industry orientation, and are characterized by a large number of competitors including both independent software vendors and certain ERP vendors. Independent software vendors include DataStream Systems, Inc. and Indus International, Inc. We also compete with integrated ERP systems, which include maintenance modules offered by several large vendors, such as SAP and Oracle. In the ITAM market we compete with companies such as Peregrine Systems, Computer Associates and BMC Software. MXES will compete with all of these companies, plus additional companies, in the Help Desk and Service Desk markets, such as HP. Maximo also encounters competition from vendors of low cost maintenance management systems designed initially for use by a single user or limited number of users as vendors of these products upgrade their functionality and performance to enter the enterprise market. Certain of our competitors have greater financial, marketing, service and support and technological resources than we do. To the extent that such competitors increase their focus on the asset maintenance, planning and cost systems markets, or on the industrial supply chain market, we could be at a competitive disadvantage. Current or potential competitors may make strategic acquisitions, thereby increasing their ability to deliver products that better address the needs of our customers. There is no assurance that we will be able to compete successfully should this occur and this could have a material adverse effect on our financial condition and results of operations. OUR INTERNATIONAL OPERATIONS SUBJECT US TO SPECIAL RISKS. A significant portion of our total revenues and expenses are derived and incurred from operations outside the U.S. Our ability to sell our products internationally is subject to a number of risks. General economic and political conditions in each country could adversely affect demand for our products and services. Exposure to currency fluctuations and greater difficulty in collecting accounts receivable could affect our sales. We could be affected by the need to comply with a wide variety of foreign import laws, U.S. export laws and regulatory requirements. Trade protection measures and import and export licensing requirements subject us to additional regulation and may prevent us from shipping products to a particular market and increase our operating costs. OUR SOFTWARE PRODUCTS ARE DEPENDENT ON THIRD-PARTY PROVIDERS OF SOFTWARE AND SERVICES, AND FAILURE OF THESE PARTIES TO PERFORM AS EXPECTED, OR TERMINATION OF OUR RELATIONSHIPS WITH THEM, COULD HARM OUR BUSINESS. We have entered into nonexclusive license agreements with other software vendors, pursuant to which we incorporate into our products and solutions software providing certain application development, hardware and network discovery, user interface, mobile technology, report writing, application servers, business intelligence, content and graphics capabilities developed by these companies. If we cannot renew these licenses (at all or on commercially reasonable terms), or if any of such vendors were to become unable to support and enhance their products, we could be required to devote additional resources to the enhancement and support of these products or to acquire or develop software providing equivalent capabilities, which could cause delays in the development and introduction of products incorporating such capabilities. Page 21 WE MAY HAVE EXPOSURE TO ADDITIONAL TAX LIABILITIES. We are subject to income taxes and non-income taxes (e.g., import/export duties, and payroll, sales, use, value-added, net worth, property, and goods and services taxes) in both the U.S. and various foreign jurisdictions. The amount of taxes paid is subject to our interpretation of applicable tax laws in the jurisdictions in which we file. We are regularly subject to examinations of our tax returns by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision and accruals for taxes. While we believe that we have properly interpreted applicable tax laws, there can be no assurance that a governing tax authority will not have a different interpretation of the law and assess us with additional taxes. Should we be assessed with additional taxes, there could be a material and adverse effect on our results of operations or financial condition. CHANGES IN REGULATIONS OR CRITICAL ACCOUNTING POLICIES COULD MATERIALLY AND ADVERSELY AFFECT US. New laws, regulations or standards related to us or our products, and new accounting pronouncements, could be implemented or changed in a manner that could adversely affect our business, results of operations or financial condition. In particular, the FASB recently enacted SFAS 123(R), which requires compensation costs related to share-based payment transactions to be recognized in the financial statements. We believe that SFAS 123(R) will have a significant adverse effect on our reported financial results and may impact the way in which we conduct our business. We may be eligible for several tax benefits provided for under the American Jobs Creation Act of 2004, which was signed into law on October 22, 2004. The potential tax benefits include a temporary 85% foreign dividends received deduction for certain dividends received from controlled foreign corporations. There are several statutory requirements, which must be met if we determine that the 85% dividends received deduction is advantageous. However, if we do not appropriately comply with the statutory requirements then the 85% foreign dividends received deduction could be forfeited resulting in a potentially adverse affect on our results of operations. WE MAY PERFORM MORE FIXED PRICE SERVICES CONTRACTS. A trend has emerged and is continuing among customers in our market towards demanding consulting and implementation services on a fixed-price basis, whereby we agree to deliver the contract requirements for a fixed fee regardless of the number of person-hours actually provided, as opposed to our traditional services arrangements where we deliver services on a time-and-materials basis. In cases where services are provided either for the future delivery of functionality or on a fixed price basis and our standard software is licensed at the same time, and if the services are essential to the overall solution desired by the customer or if we cannot determine the fair value of the services being delivered, then we may not be able to recognize the software license revenue from such transactions at the time the agreements are signed, but rather may be required to recognize such license revenue under the contract method of accounting, or to recognize a greater portion (or all) of the revenue from these transactions as services revenue. This would likely result in a postponement of recognition of, or even a reduction in, software license revenues, and have an adverse affect on our results of our operations. WE MAY BE UNABLE TO EFFECTIVELY PROTECT OUR INTELLECTUAL PROPERTY. Our success is dependent upon our proprietary technology. We currently have two U.S. patents (and other corresponding patents or applications pending in various foreign countries), and we protect our technology primarily through copyrights, trademarks, trade secrets and employee and third-party nondisclosure agreements. Our software products are sometimes licensed to customers under "shrink-wrap" or "click- wrap" licenses included as part of the product packaging or acknowledged by customers who register online. Although, in larger sales, our shrink-wrap and click-wrap licenses may be accompanied by specifically negotiated agreements signed by the licensee, in many cases our shrink-wrap and click-wrap licenses are not negotiated with or signed by individual licensees. Certain provisions of our shrink-wrap and click-wrap licenses, including provisions protecting against unauthorized use, copying, transfer and disclosure of the licensed program, and limitations or liabilities and exclusions of remedies, may be unenforceable under the laws of certain jurisdictions. In addition, the laws of some foreign countries do not Page 22 protect our proprietary rights to the same extent as do the laws of the U.S. Finally, we sell our products through distributors and resellers, and are therefore dependent on those companies to take appropriate steps to adequately implement our contractual protections and to enforce and protect our rights. We cannot give any assurance that the steps that we have taken to protect our proprietary rights will be adequate to prevent misappropriation of our technology or development by others of similar technology. Although we believe that our products and technology do not infringe on any valid claim of any patent or any other proprietary rights of others, we cannot give any assurance that third parties will not assert infringement claims in the future. Litigation may be necessary to enforce our intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Such litigation could result in substantial costs and diversion of resources, could result in the deterioration or outright loss of our patent rights, copyrights or other intellectual property, and could potentially have a material adverse affect on our operating results and financial condition. LOSS OF THE SERVICES OF ONE OR MORE OF OUR KEY EXECUTIVE OFFICERS OR INABILITY TO RECRUIT NEEDED SALES, SERVICES AND TECHNICAL PERSONNEL COULD ADVERSELY AFFECT OUR BUSINESS. We are highly dependent on certain key executive officers, technical and sales employees, and the loss of one or more of such employees could have an adverse impact on our future operations. We do not have employment contracts with any personnel, and we do not maintain any so-called "key person" life insurance policies on any personnel. We continue to hire additional sales, services and technical personnel. Competition for hiring of such personnel in the software industry is intense, and from time to time we may experience difficulty in locating candidates with the appropriate qualifications within the desired geographic locations, or with certain industry specific expertise. There can be no assurance that we will be able to retain our existing personnel or attract additional qualified employees. WE ARE EXPOSED TO FLUCTUATIONS IN THE MARKET VALUES OF OUR PORTFOLIO INVESTMENTS AND IN INTEREST RATES. We invest a significant portion of our cash in marketable securities. These securities are classified as available-for-sale and are recorded at fair value on the Consolidated Balance Sheet with unrealized gains or losses reported as a separate component of accumulated other comprehensive income (loss), net of tax. Economic downturns and other factors subject these securities to volatility in the market place. As a result, we may recognize the decline in fair value of these investments. OTHER RISKS The foregoing is not a complete description of all risks relevant to our future performance, and the foregoing should be read and understood together with and in the context of similar discussions which may be contained in the documents that we file with the SEC in the future. We undertake no obligation to release publicly any revision to the foregoing or any update to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. Page 23 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our primary exposure to market risk is the effect of fluctuations in interest rates earned on our cash equivalents and marketable securities and exposures to foreign currency exchange rate fluctuations. At June 30, 2005, we held $123.3 million in cash equivalents and marketable securities consisting of taxable and tax exempt municipal securities. Interest rate movements affect the interest income we earn. We place our investments with high quality issuers and limits risk by purchasing only investment-grade securities. A hypothetical 10 percent increase in interest rates would not have a material impact on the fair market value of these instruments due to their short maturity. We develop our products in the United States and market them in North America, Europe, Middle East and Africa, Australia, Asia Pacific and Latin America. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. As of June 30, 2005, we did not engage in foreign currency hedging activities. ITEM 4. CONTROLS AND PROCEDURES We carry out periodic evaluations, under the supervision of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon such evaluations, the Chief Executive Officer and the Chief Financial Officer concluded that, as of June 30, 2005, our disclosure controls and procedures were effective to timely alert them to any material information relating to our (including our consolidated subsidiaries) that would be required to be included in our periodic filings with the Securities and Exchange Commission. While there have been no significant changes in our internal controls over financial reporting or in other factors that could significantly affect internal controls over financial reporting subsequent to their evaluation, we are currently undergoing a comprehensive effort to comply with Section 404 of the Sarbanes-Oxley Act of 2002. Compliance is required for our fiscal year ended September 30, 2005. This effort includes documenting and testing of internal controls over financial reporting. During the quarter ended June 30, 2005, we have not identified any material weaknesses in our internal controls over financial reporting as defined by the Public Company Accounting Oversight Board. We will continue with our efforts of compliance and will modify or improve our internal controls over financial reporting as needed. The matters noted herein have been discussed with our Audit Committee. Page 24 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS NONE ITEM 2 RECENT SALES OF UNREGISTERED SECURITIES, USE OF PROCEEDS FROM REGISTERED SECURITIES CHANGES IN SECURITIES NONE ITEM 3 DEFAULTS UPON SENIOR SECURITIES NONE ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS NONE ITEM 5. OTHER INFORMATION NONE ITEM 6. EXHIBITS EXHIBIT NO. DESCRIPTION 3. Instruments Defining the Rights of Security-Holders 3.1 Amended and Restated Articles of Organization of the Company (included as Exhibit 3.3 to the Company's Registration Statement on Form S-1, Registration No. 33-76420, and incorporated herein by reference) 3.2 Restated By-Laws of the Company, as amended (included as Exhibit 3.2 to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1996, File No. 0-23852, and incorporated herein by reference) 3.3 Amendment to By-Laws adopted on February 1, 2001 (included as Exhibit 3.3 to the Company's Current Report on Form 10-Q for the quarter ended March 31, 2001, File No. 0-23852 and incorporated herein by reference) 3.4 Form of Certificate of Designation of Series A Junior Participating Preferred Stock of MRO Software, Inc. (which is attached as Exhibit A to the Rights Agreement included as Exhibit 4 (b) to the Company's Current Report on Form 8-K dated February 2, 1998, File No. 0-23852, and incorporated herein by reference) 3.5 Amendment to Articles of Organization adopted on December 15, 1999 (included as Exhibit 3.4 to the Company's Form 10-Q for the quarter ended December 31, 1999, File No. 0-23852, and incorporated herein by reference) 3.6 Amendment to Articles of Organization, dated March 6, 2001 (included as Exhibit 3.4 to the Company's Current Report on Form 8-K dated March 9, 2001, File No. 0-23852, and incorporated herein by reference) 3.7 Nonstatutory Stock Option Agreement Form (included as Exhibit 3.7 to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2004, File No. 0-23852, and incorporated herein by reference) Page 25 3.8 Stock Option Agreement Form for Employees (included as Exhibit 3.8 to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2004, File No. 0-23852, and incorporated herein by reference) 4. Instruments Defining the Rights of Security Holders, Including Indentures 4.1 Specimen certificate for the Common Stock, $.01 par value, of the Company (included as Exhibit 4.1 to the Company's Current Report on Form 10-Q for the quarter ended December 31, 2001, File No. 0-23852 and incorporated herein by references) 4.2 Article 4B of the Amended and Restated Articles of Organization of the Company (included as Exhibit 4.1 to the Company's Registration Statement on Form S-1, Registration No. 33-76420, and incorporated herein by reference) 4.3 Rights Agreement dated as of January 27, 1998, between the Company and BankBoston, N.A. as Rights Agent (included as Exhibit 4 (a) to the Company's Current Report on Form 8-K dated February 2, 1998, File No. 0-23852, and incorporated herein by reference) 4.4 Form of Certificate of Designation of Series A Junior Participating Preferred Stock of the Company (included as Exhibit 4 (b) to the Company's Current report on Form 8-K dated February 2, 1998, File No. 0-23852, and incorporated herein by reference) 4.5 Form of Rights Certificate (included as Exhibit 4 (c) to the Company's Current Report on Form 8-K dated February 2, 1998, File No. 0-23852, and incorporated herein by reference) 9. Voting Trust Agreements 9.1 Shareholders Agreement between Robert L. Daniels and Susan H. Daniels dated August 1, 2001 (included as Exhibit 9.1 to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2001 File No. 0-23852, and incorporated herein by reference) 31. Rule 13a-14(a)/15(d)-14(a) Certifications 31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32. Section 1350 Certifications 32.1 Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. The Company will furnish a copy of any exhibit listed to requesting stockholders upon payment of the Company's reasonable expense in furnishing those materials. Page 26 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. MRO SOFTWARE, INC. Date: August 9, 2005 By: /s/ Peter J. Rice ----------------- Peter J. Rice Executive Vice President - Finance and Administration, Chief Financial Officer and Treasurer (Principal Financial Officer) Page 27 EXHIBIT INDEX EXHIBIT NO. DESCRIPTION - ------- ----------- 3.1 Amended and Restated Articles of Organization of the Company (included as Exhibit 3.3 to the Company's Registration Statement on Form S-1, Registration No. 33-76420, and incorporated herein by reference) 3.2 Restated By-Laws of the Company, as amended (included as Exhibit 3.2 to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1996 File No. 0-23852 and incorporated herein by reference) 3.3 Amendment to By-Laws adopted on February 1, 2001 (included as Exhibit 3.3 to the Company's Current Report on Form 10-Q for the quarter ended March 31, 2001, File No. 0-23852 and incorporated herein by reference) 3.4 Form of Certificate of Designation of Series A Junior Participating Preferred Stock of MRO Software, Inc. (which is attached as Exhibit A to the Rights Agreement included as Exhibit 4 (b) to the Company's Current Report on Form 8-K dated February 2, 1998, File No. 0-23852, and incorporated herein by reference) 3.5 Amendment to Articles of Organization adopted on December 15, 1999 (included as Exhibit 3.4 to the Company's Form 10-Q for the quarter ended December 31, 1999, File No. 0-23852, and incorporated herein by reference) 3.6 Amendment to Articles of Organization dated March 6, 2001 (included as Exhibit 3.4 to the Company's Current Report on Form 8-K dated March 9, 2001, File No. 0-23852, and incorporated herein by reference) 3.7 Nonstatutory Stock Option Agreement Form (included as Exhibit 3.7 to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2004, File No. 0-23852, and incorporated herein by reference) 3.8 Stock Option Agreement Form for Employees (included as Exhibit 3.8 to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2004, File No. 0-23852, and incorporated herein by reference) 4.1 Specimen certificate for the Common Stock, $.01, of the Company (included as Exhibit 4.1 to the Company's Current Report on Form 10-Q for the quarter ended December 31, 2001, File No. 0-23852 and incorporated herein by reference) 4.2 Article 4B of the Amended and Restated Articles of Organization of the Company (included as Exhibit 4.1 to the Company's Registration Statement on Form S-1, Registration No. 33-76420, and incorporated herein by reference) 4.3 Rights Agreement dated as of January 27, 1998, between the Company and BankBoston, N.A. as Rights Agent (included as Exhibit 4 (a) to the Company's Current Report on Form 8-K dated February 2, 1998, File No.0-23852, and incorporated herein by reference) 4.4 Form of Certificate of Designation of Series A Junior Participating Preferred Stock of MRO Software, Inc. (included as Exhibit 4 (b) to the Company's Current Report on Form 8-K dated February 2, 1998, File No. 0-23852, and incorporated herein by reference) 4.5 Form of Rights Certificate (included as Exhibit 4 (c) to the Company's Current Report on Form 8-K dated February 2, 1998, File No. 0-23852, and incorporated herein by reference) 9.1 Shareholders Agreement between Robert L. Daniels and Susan H. Daniels dated August 1, 2001 (included as Exhibit 9.1 to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2001 File No. 0-23852, and incorporated herein by reference) 31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Page 28