ITEM 1. BUSINESS
Our History
Since the company’s founding in 1995, Vignette has specialized in developing and marketing software for managing and delivering business content. Vignette’s initial technology offerings targeted Web content management and Web site construction. As the Internet grew in scale and complexity and as organizations sought new ways to leverage this evolving global business platform, the terms Web and Web content management expanded proportionately. Vignette expanded its portfolio of content management capabilities to keep pace with the evolving demands of organizations. In particular, as a result of both organic product development and acquisition, Vignette added Web-based analytics and personalization, application and data integration, interaction management, business portals, collaboration, documents and records management and video capabilities to its products.
Mission
Our objective is to maintain and extend our position as a leading global provider of Web Experience solutions. These solutions help enterprise organizations execute on their Web strategies, particularly as those strategies relate to the online experience organizations provide. The company offers a broad set of capabilities for improving online interactions with customers, prospects, employees, partners, citizens, patients and other key audiences. We will continue to focus on delivering profitable growth, expanding our customer base of global 2000 organizations, extending our technology leadership through investment in research and development, expanding our global sales capabilities and building upon our strategic alliances with leading companies.
Overview
Organizations globally are recommitting resources and dedicating strategic projects to the online experience they deliver in support of their broader business goals. In particular, our customers are concerned that they remain able to interact online with their key audiences in ways that are more personal, social, transactional and ubiquitous. We believe that Vignette is well positioned to capitalize on these market demands.
Our customers generally expect to augment any commercial software they acquire, either for purposes of customizing the behavior of that software or integrating it with their existing information technology investments. Our products are built with this audience requirement in mind. We rely on industry standard technologies and our capabilities are adaptable, allowing organizations to configure the business solutions to meet their unique requirements.
Our products and capabilities are supported by our professional services organization, Vignette Professional Services™ (“VPS™”). VPS™ offers pre-packaged and custom services to help organizations define their online business objectives and build and deploy applications in support of those objectives. Our education, consulting and customer care teams give customers the benefit of our experience gained from thousands of customer implementations.
Products
Vignette delivers the Web’s most dynamic user experiences. The Vignette Web Experience brings rich media and engaging content to life, powering the world’s greatest brands. Our solutions enable organizations to connect online with their key audiences and manage the content that fuels those connections. Together, these solutions comprise the Vignette Web Experience Platform.
Additionally, we allow organizations the flexibility to purchase products individually. Our product offerings are grouped into six solution families:
Web Content Management delivers dynamic web experiences that engage the customer’s audiences with rich content and multi-media across any channel.
Transactional Content Management manages the content that drives human or document centric business processes within healthcare, insurance, financial services, and public sectors.
Intranet Solutions enable organizations to optimize knowledge management, enable expertise location and leverage enterprise social media with portal and collaboration technologies.
Social Media Solutions enable organizations to build communities, enable participation and encourage online interaction with comments, ratings, tags, blogs, wikis, forums, video and recommendations.
Experience Optimization Solutions allow organizations to optimize the value of every online customer interaction using analytics, targeting and social search.
Video and Rich Media Solutions drive traffic, revenues and viewer engagement by efficient management and delivery of rich media and video experiences.
Organizations may purchase products individually from these six categories or pre-bundled into suites that meet their specific needs.
Services and Support
Vignette Professional Services (VPS™) offers consulting and education services to help customers identify their strategic application objectives, design applications and deliver solutions using our products. VPS™ provides services that are tailored to individual customers. VPS™ also works with strategic consulting partners to provide support for content management application development. VPS™ generally sells its services under time-and-materials agreements.
Our Customer Care, Maintenance and Support Services include a combination of account management and global technical support offerings that are tailored to meet customers’ specific needs. Vignette Global Support provides optional 24x7 access to skilled technical engineers in addition to telephone and Web resources.
Strategic Alliances
We establish strategic alliances to assist us in the marketing, selling, distribution and development of our enterprise content management applications and solutions. This approach is intended to increase the number of qualified personnel available to perform application design and development services for our customers. It also provides us with additional marketing and technical expertise and increased channels of distribution in certain vertical industry segments. Finally, our focus on vertical and horizontal solution offerings increases the importance of our relationships with technology partners, strategic consulting partners and other channels of distribution to the market.
We intend to invest in our existing strategic alliances as well as to form new partnerships with other market-leading systems integrators, technology vendors and distribution channels.
Business Combinations
The following is a listing of our acquisitions over the last five years:
MicroNets, Inc. (d/b/a “Vidavee”) Effective April 22, 2008, we acquired all of the outstanding stock of MicroNets, Inc. (d/b/a “Vidavee”), a leading provider of video publishing technology. We paid approximately $7.0 million for Vidavee, including transaction costs of $0.5 million.
TOWER Technology Pty Limited. Effective March 1, 2004, we acquired TOWER Technology Pty Limited (“Tower Technology”), a leading provider of enterprise document and records management solutions. We paid approximately $125 million for Tower Technology, consisting of approximately $49.8 million in cash and 2.7 million shares of common stock on a post split basis for all of the issued and outstanding shares of Tower Technology.
Intraspect Software, Inc. Effective December 11, 2003, we acquired all of the outstanding stock of Intraspect Software, Inc. (“Intraspect”), a leading provider of collaboration software, in exchange for $10 million in cash and approximately 0.42 million shares of stock on a post split basis. The total purchase price, including transaction costs of $0.5 million, was approximately $20 million.
In connection with each of our acquisitions, we incurred one-time acquisition costs and integration-related charges. Such charges relate to product integration, cross-training of employees and other merger-related items. In some acquisitions, a portion of the purchase price allocated to in-process research and development was expensed upon the consummation of the respective transaction. The Company recorded no acquisition related charges in 2008, 2007 or 2006.
Customers
Our customer list includes some of the world’s most successful organizations in the telecommunications, entertainment, new media and publishing, financial services, government, healthcare, high technology, higher education, life sciences, manufacturing, retail and travel industries worldwide. No single customer accounted for ten percent or more of our total revenues in 2008, 2007, or 2006.
Competition
The market for our products is intensely competitive and subject to rapid technological change. We can be significantly affected by new product introductions and other market activities of industry participants. We expect competition to persist and intensify in the future. We have three primary sources of competition: in-house development efforts by potential customers or partners; other vendors of software that directly target enterprise content management solutions; and developers of point solution software that address only certain technology components of the solution set that we provide (e.g., Web content management, transactional content management, intranet solutions, rich media and video solutions, social media solutions, and experience optimization).
Many of our competitors have longer operating histories and significantly greater financial, technical, marketing and other resources than we do and thus may be able to respond more quickly to new or changing opportunities, technologies and customer requirements. In particular, in some markets we compete against large integrated technology providers such as IBM, Microsoft, Oracle and SAP. There can be no assurance that we will be able to compete successfully with existing or new competitors or that competition will not have a material adverse effect on our business, financial condition and operating results. See “Risk Factors - Risks Related to Our Business - We Face Intense Competition from Other Software Companies, Which Could Make it Difficult to Compete Successfully.”
Research and Development
We have made substantial investments in research and development through both internal development and technology acquisitions. We have moved to a model where a significant portion of our research and development operations are maintained in India. There, third-party developers are acting as an extension of our primary development and information technology operations in Austin, Texas and Sydney, Australia. We expect this model to help us achieve significant efficiencies, including reduced operational costs and permit an around-the-clock development cycle. Also, See “Risk Factors - Risks Related to our Business - If We Are Unable to Manage the Transition of Our Significant Research and Development Operations in India from an Outsourced Third-Party Service Provider to a Direct Model, Our Business Could Be Adversely Affected.
The majority of our research and development activity has been directed towards future extensions to our family of products. This development consists primarily of adding new competitive product features and additional tools and products. We expect that we will continue to commit significant resources to research and development in the future. All of our research and development costs have been expensed as incurred. This is due to the fact that the time between achieving technological feasibility and the general availability of software has been short and internal costs qualifying for capitalization have been insignificant.
Research and development expenditures for 2008, 2007, and 2006 were approximately $32.8 million, $31.0 million, and $34.0 million, respectively.
While we believe we invest appropriate resources in our research and development, there is no assurance that our current spending will allow us to maintain our technology leadership. See “Risk Factors - Risks Related to Our Business - If We are Unable to Meet the Rapid Changes in Software Technology, Our Existing Products Could Become Obsolete.”
Sales and Marketing
We use a variety of marketing programs to build market awareness of our brand name and our solutions and products, in order to attract potential customers. We employ a broad mix of programs to accomplish these goals, including market research, product and strategy updates with industry analysts, public relations activities, advertising, direct marketing and relationship marketing programs, Webcasts, Podcasts, Web search engine marketing, Web search engine optimization, seminars, customer events, user group meetings, trade shows and speaking engagements. Our marketing organization also produces marketing materials in support of sales to prospective customers that include brochures, data sheets, white papers, presentations, Web site content and demonstrations.
We sell solutions and products through our direct sales force as well as through our indirect sales channel with systems integrators, value-added resellers and original equipment manufacturers. We generate leads from a variety of sources, including businesses seeking partners to develop next-generation Web initiatives. Initial sales activities typically include a demonstration of our product capabilities followed by one or more detailed technical reviews. As of December 31, 2008, the direct sales force consisted of 185 sales professionals and related support personnel.
We will continue to establish partnerships with major industry vendors and strategically selected regional partners that will add value to our products and expand distribution opportunities.
Proprietary Rights and Licensing
Our success and ability to compete are dependent on our ability to develop and maintain the proprietary aspects of our technology and operate without infringing on the proprietary rights of others. We rely on a combination of patent, trademark, trade secret and copyright laws and contractual restrictions to protect the proprietary aspects of our technology. These legal protections afford only limited protection for our technology. We presently own 47 patents, 46 of which are issued in the United States and, also, have a number of patent applications pending in the United States. We have 10 registered trademarks in the United States and 69 registered trademarks in foreign countries. We seek to protect our source code for our software, documentation and other written materials under trade secret and copyright laws. We license our software pursuant to signed license or “shrink-wrap” agreements, which impose certain restrictions on the licensee’s ability to utilize the software. Finally, we seek to avoid disclosure of our intellectual property by requiring employees and consultants with access to our proprietary information to execute confidentiality agreements with us and by restricting access to our source code. Due to rapid technological change, we believe that factors such as the technological and creative skills of our personnel, new product developments and enhancements to existing products are more important than the various legal protections of our technology to establishing and maintaining a technology leadership position.
Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. Policing unauthorized use of our products is difficult and while we are unable to determine the extent to which piracy of our software exists; software piracy can be expected to be a persistent problem. Litigation may be necessary in the future 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. However, the laws of many countries do not protect our proprietary rights to as great an extent as do the laws of the United States. Any such resulting litigation could result in substantial costs and diversion of resources and could have a material adverse effect on our business, operating results and financial condition. There can be no assurance that our means of protecting our proprietary rights will be adequate or that our competitors will not independently develop similar technology. Any failure by us to meaningfully protect our property could have a material adverse effect on our business, operating results and financial condition.
There can be no assurance that third parties will not claim infringement with respect to our current or future products. We expect that developers of commercial software products will increasingly be subject to infringement claims as the number of products and competitors in our industry segment grows and as the functionality of products in different segments of the software industry increasingly overlaps. Any such claims, with or without merit, could be time-consuming to defend, result in costly litigation, divert management’s attention and resources, cause product shipment delays or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to us or at all. A successful claim of product infringement against us and our failure or inability to license the infringed technology or develop or license technology with comparable functionality could have a material adverse effect on our business, financial condition and operating results. See “Risk Factors - Risks Related to Our Business - Our Business is Based on Our Intellectual Property and We Could Incur Substantial Costs Defending Our Intellectual Property from Infringement or a Claim of Infringement.”
We include certain third-party software in our products. This third-party software may not continue to be available on commercially reasonable terms. To the extent we could not maintain licenses to some or all of this third-party software, shipments of our products could be delayed until equivalent software could be developed or licensed and integrated into our products, which could materially adversely affect our business, operating results and financial condition.
Employees
As of December 31, 2008, we had 643 employees, including 127 in research and development, 185 in sales and marketing, 249 in professional services and customer support and 82 in general and administrative. Our future success will depend in part on our ability to attract, retain and motivate highly qualified technical and management personnel, for whom competition is intense. From time to time, we also employ independent contractors to support our professional services, product development, sales and marketing and finance organizations. We also outsource certain development, including a portion of product development and quality assurance. We believe our relations with our employees are good and we have never experienced a work stoppage.
ITEM 1A.
ITEM 1A. RISK FACTORS
You should carefully consider the following risks before making an investment decision. The risks described below are not the only ones that we face. Our business, operating results or financial condition could be materially adversely affected by any of the following risks. The trading price of our common stock could decline due to any of these risks and you as an investor may lose all or part of your investment. You should also refer to the other information set forth in this report, including our consolidated financial statements and the related notes.
Risks Related to Our Business
Our Profitability Has Been Inconsistent
Although we were profitable in 2005, 2006 and 2007 we were not profitable in 2008. We cannot be certain that we will generate sufficient revenues to achieve profitability. If we do achieve profitability, we cannot be certain that we can sustain or increase profitability on a quarterly or annual basis in the future. To achieve and sustain profitable operations and positive cash flows, we must increase our license and support services revenues. If our revenues do not grow at a rate greater than expenses required to fund our continuing operations, we will not be able to achieve profitability, which could cause the price of our common stock to decline.
We Expect Our Quarterly Revenues and Operating Results to Fluctuate
We base our forecast for expenses in part on future revenue projections (as opposed to historical data) due to the continued changes in our business. Many of these expenses are fixed in the short-term and we may not be able to quickly reduce spending if revenues are lower than we have projected. Our ability to accurately forecast our quarterly revenue is limited due to the long sales cycle of our software products, which makes it difficult to predict the quarter in which product implementation will occur and the variability of customer demand for professional services. We would expect our business, operating results and financial condition to be materially adversely affected if revenues do not meet projections and that net losses in a given quarter would be even greater than expected.
Our revenues and operating results have varied significantly from quarter to quarter in the past and we expect that our operating results will continue to vary significantly from quarter to quarter. A number of factors are likely to cause these variations, including:
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demand for our products and services;
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the timing of sales of our products and services;
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the timing of customer orders and product implementations;
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seasonal fluctuations in information technology purchasing;
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The general economic climate including a prolonged economic recession;
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unexpected delays in introducing new products and services;
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increased expenses, whether related to sales and marketing, product development, product migration and customer support, or administration;
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changes in the rapidly evolving market for Web-based applications;
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the mix of product license and services revenue, as well as the mix of products licensed;
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the mix of services provided and whether services are provided by our own staff or third-party contractors;
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the mix of domestic and international sales;
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attrition of key sales, professional services and other customer facing personnel;
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difficulties in collecting accounts receivable;
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costs related to possible acquisitions of technology or businesses;
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global events, including terrorist activities, military operations and widespread epidemics;
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changes to our licensing and pricing model; and
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difficulty in developing and maintaining an indirect sales channel.
Accordingly, we believe that quarter-to-quarter comparisons of our operating results are not necessarily meaningful. Investors should not rely on the results of one quarter as an indication of future performance.
We will continue to invest in our research and development, sales and marketing, professional services and general and administrative organizations. We expect such overall spending, in absolute dollars, will increase in future periods. If our revenue expectations are not achieved, our business, operating results or financial condition could be materially adversely affected.
Adverse changes in general economic or political conditions could adversely affect our operating results.
Our business is affected by a number of factors that are beyond our control such as general geopolitical and economic conditions, conditions in the financial markets and the overall demand for enterprise software and services. Unfavorable changes in economic conditions, including inflation, recession or other changes in economic conditions may result in lower corporate technology spending and adversely affect our revenue. In 2008 the weakening economy had a negative effect on demand for our products and services and this trend could well continue through 2009 or longer. Such unfavorable economic conditions could also result in longer sales cycles, slower adoption of new technologies and increased price competition. Challenging economic conditions may also impair the ability of our customers to pay for products and services they have already purchased. As a result, reserves for doubtful accounts and write-offs of accounts receivable may increase. In addition, we maintain an investment portfolio of various holdings, types and maturities (consistent with our investment policy) that are subject to general credit, liquidity, market and interest rate risks which too may be exacerbated by unusual events that have affected global financial markets. If the global credit market continues to deteriorate, our investment portfolio may be impacted and we could determine that some of our investments have experienced a decline in fair value, requiring an impairment charge that could adversely impact our financial results. Any of these events would likely harm our business, results of operations and financial condition.
Our Revenue for a Particular Period is Difficult to Forecast and a Shortfall in Revenue Would Harm Our Operating Results
Due to the nature of the market in which we compete, our revenue and earnings are difficult to forecast. We plan our operating expenses based on our historical results and, in part, on future revenue projections. Most of our expenses are fixed in the short term and we may not be able to quickly reduce spending if our revenues are
lower than we had forecasted. Our ability to accurately forecast our quarterly revenue is limited because our software products have a long sales cycle that makes it difficult to predict the quarter in which sales will occur. We would expect our business, operating results and financial condition to be materially adversely affected if our revenues do not meet our projections.
If We Are Unable to manage the transition of our Significant Research and Development Operations in India from an outsourced Third-Party Service Provider to a Direct model, our Business Could Be Adversely Affected.
We are currently using a third-party service provider in India to supply approximately half of our research and development operations. During the quarter ended September 30, 2008, we decided to establish a development center in India and entered into an amended vendor agreement (refer to the 8-K filed on August 28, 2008) to phase out our primary third-party service provider over a twelve month period. Currently we expect the transition to using our own employees in India to begin in the first quarter of 2009. We believe a direct presence in India will achieve significant efficiencies and reduced operational costs. However, for the new development center to achieve its anticipated benefits, we must successfully expand our operations in India and integrate this operation into our existing global organization. Common risks we face with this transition include:
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the possibility that the transition of this work from the current third party vendor will be more difficult and more expensive than anticipated;
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the possibility that the business cultures will not be compatible;
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unanticipated expenses related to integration of operations;
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the impairment of relationships with employees as a result of any integration of new personnel;
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costs and delays in implementing common systems and procedures, including financial accounting systems and customer information systems;
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potential inability to retain, integrate and motivate personnel; and
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risks related to remote development operations.
Establishing a development center in India can be a complex, time-consuming and expensive process and may result in revenue disruption and operational difficulties if not completed in a timely and efficient manner. We may be required to spend additional time or money on integration that would otherwise be spent on developing our business or on other matters. If we do not integrate our operations and technology smoothly or if management spends too much time on integration issues, it could harm our business, financial condition and results of operations and diminish the benefits of bringing the operation in-house.
Once established, we must operate as a combined organization, utilizing common information communication systems, operating procedures, financial controls and human resource practices, including benefits, training and professional development programs. There may be substantial difficulties, costs and delays involved in the integration. There can be no assurance that we will succeed in addressing these risks or any other problems encountered in connection with the integration.
In addition, although to date, the dispute between India and Pakistan involving the Kashmir region and the incidents of terrorism in India have not adversely affected our ability to utilize a third-party service provider in India, such disputes and acts of terrorism could potentially affect our ability to obtain research and development operations from third-party providers. Should we be unable to use a third-party service provider in India for a portion of our research and development in the future, we believe that our business could be adversely affected.
Our Business May Become Increasingly Susceptible to Numerous Risks Associated with International Operations
International operations are generally subject to a number of risks, including:
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expenses associated with customizing and localizing products for foreign countries;
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protectionist laws and business practices that favor local competition;
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changes in jurisdictional tax laws including laws regulating intercompany transactions;
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difficulties in developing and maintaining relationships with international vendors;
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multiple, conflicting and changing governmental laws and regulations;
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longer sales cycles;
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difficulties in collecting accounts receivable;
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seasonality of operations;
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difficulties in staffing and managing foreign operations;
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licenses, tariffs and other trade barriers;
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loss of proprietary information due to piracy, misappropriation or weaker laws regarding intellectual property protection;
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foreign currency exchange rate fluctuations;
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political and economic instability; and
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difficulties in communication of and monitoring compliance with Company controls and policy
A significant percentage of our total revenues are generated through licenses and services sold to customers located outside of the United States. We expect international revenue to remain a large percentage of total revenue and we believe that we must continue to expand our international sales activities to be successful. Our international sales growth will be limited if we are unable to establish appropriate foreign operations, expand international sales channel management and support organizations, hire additional personnel, customize products for local markets, develop relationships with international service providers and establish relationships with additional distributors and third-party integrators. In that case, our business, operating results and financial condition could be materially adversely affected. Even if we are able to successfully expand international operations, we cannot be certain that we will be able to maintain or increase international market demand for our products.
Historically, a majority of our international revenues and costs have been denominated in foreign currencies and we expect future international revenues and costs will be denominated in foreign currencies. We utilize foreign currency forward contracts to hedge foreign currency-denominated payables and receivables. To date, we have not hedged forecasted transactions or firm commitments denominated in foreign currencies and therefore, financial reporting of our foreign operations is subject to foreign currency risk. Gains and losses on hedging contracts are reflected currently in other income, net. Under our policy, we may enter into foreign currency forward contracts for a term of up to one year. We do not invest in contracts for speculative purposes. Our foreign exchange exposures are monitored regularly to ensure the overall effectiveness of our foreign currency hedge positions. Our program is not designed to hedge all currency risk, but is designed to mitigate large foreign currency exposures recorded on our balance sheet. As part of this monitoring program, in order to evaluate the effectiveness of our hedging practices, in the second quarter of 2007 we did not replace foreign currency hedge positions which expired and re-engaged our foreign currency hedge program in the fourth quarter of 2008. For the year ended December 31, 2008, 2007 and 2006, the Company realized a loss on foreign currency contracts of $0.2 million, $0.3 million and $13,000, respectively. At December 31, 2008, the notional value of open foreign currency contracts was $1.3 million and, based on the applicable exchange rates, the fair value of derivative financial instruments was a liability of $99,000. At December 31, 2007 we had no foreign currency contracts outstanding.
We Must Overcome Significant Challenges in Integrating Businesses Operations and Product Offerings to Realize the Benefits of our Business Combinations
As part of our overall strategy, we have acquired or invested in, complementary companies, products and technologies. The Company will continue to consider strategic acquisitions. Risks commonly associated with such transactions include:
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the potential difficulties of integrating international and domestic operations;
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the potential disruption of our ongoing business and diversion of management resources;
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the possibility that the business cultures will not be compatible;
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the difficulty of incorporating acquired technology and rights into our products and services;
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unanticipated expenses related to integration of operations;
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the impairment of relationships with employees and customers as a result of any integration of new personnel;
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potential unknown liabilities associated with the acquired business and technology;
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costs and delays in implementing common systems and procedures, including financial accounting systems and customer information systems;
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potential inability to retain, integrate and motivate key management, marketing, technical sales and customer support personnel;
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risks related to remote development operations; and
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risks related to adoption of new business models such as software as a service (SAAS), pricing and licensing methods.
For such transactions to achieve their anticipated benefits, we must successfully combine and integrate products in a timely manner. Integrating can be a complex, time-consuming and expensive process and may result in revenue disruption and operational difficulties if not completed in a timely and efficient manner. We may be required to spend additional time or money on integration that would otherwise be spent on developing our business or on other matters. If we do not integrate our operations and technology smoothly or if management spends too much time on integration issues, it could harm our business, financial condition and results of operations and diminish the benefits of the acquisition as well as harm our content management business.
Prior to an acquisition, the acquired company operates independently, with its own business, culture, markets, clients, employees and systems. Following the acquisitions, we must operate as a combined organization, utilizing common information communication systems, operating procedures, financial controls and human resource practices, including benefits, training and professional development programs. There may be substantial difficulties, costs and delays involved in the integration. There can be no assurance that we will succeed in addressing these risks or any other problems encountered in connection with the acquisition.
We Must Succeed in the Portal, Collaboration and Content Management Market as Well as the Document and Records Management Market if We Are to Realize the Expected Benefits of Our Product Strategy and Business Combinations.
Our long-term strategic plan depends upon the successful development and introduction of products and solutions that address the needs of the portal, collaboration and content management market as well as the enterprise content management and the document and records management markets. For us to succeed in these markets, we must align strategies and objectives and diversify the focus of our resources to succeed in these various markets.
Our success in these new markets will depend on several factors, many of which are outside our control including:
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continued growth of the portal, collaboration and content management market;
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continued growth of the enterprise content management and document and records management markets;
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deployment of the combined company’s products by enterprises;
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barriers to entry for the emergence of substitute technologies and products; and
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ability to adapt to different sales and marketing techniques required for the various markets.
If we are unable to succeed in these markets, our business may be harmed and we may be prevented from realizing the anticipated benefits of our business strategy and our acquisitions.
Acquisitions Could Disrupt Our Business, Adversely Affect Our Operating Results and Harm our Stockholder Value
The Company will continue to consider strategic acquisitions. We may acquire other businesses in the future, which would complicate our management tasks. We may need to integrate widely dispersed operations that have different and unfamiliar corporate cultures. These integration efforts may not succeed or may distract management’s attention from existing business operations. Failure to successfully integrate acquisitions could seriously harm our business, our operating results and adversely impact our existing stockholders value.
In addition, the market price of our common stock could decline as a result of future acquisitions, based on the occurrence of a number of events, including:
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delays or failure in the integration of technology, products or operations;
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the belief that we have not realized the perceived benefits of the acquisitions in a timely manner or at all;
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the dilution of our existing stockholders resulting from issuance of our shares to the acquired company’s shareholders;
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the potential negative effect of the acquisition on our operating results, including the impact of amortization of intangible assets, other than goodwill, created by the acquisition and claims that may arise for which we are not indemnified; and
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the impact of impairment of goodwill or other acquisition-related intangible assets.
Our Quarterly Results May Depend on a Small Number of Large Orders
In previous quarters, we derived a significant portion of our software license revenues from a small number of relatively large orders. Our operating results could be materially adversely affected if we are unable to complete a significant order that we expected to complete in a specific quarter.
If We Experienced a Product Liability Claim, We Could Incur Substantial Litigation Costs
Since our customers use our products for mission-critical applications, errors, defects or other performance problems could result in financial or other damages to our customers. They could seek damages for losses from us, which, if successful, could have a material adverse effect on our business, operating results and financial condition. Although our license agreements typically contain provisions designed to help limit our exposure to product liability claims, existing or future laws or unfavorable judicial decisions could negate or alter such limitation of liability provisions. Such claims, if brought against us, even if not successful, would likely be time consuming and costly.
Our Ability to Use Net Operating Losses to Offset Future Taxable Income may be Subject to Certain Limitations.
In general, under Section 382 of the Internal Revenue Code, a corporation that undergoes an “ownership change” is subject to limitations on its ability to utilize its pre-change net operating losses (NOLs) and other tax attributes to offset future taxable income. Based upon a review of historical stock ownership, we do not believe we have undergone an “ownership change” as of December 2008 that will limit our ability to utilize these tax attributes prior to their expiration. However, recent volatility in the stock market has resulted in significant changes in ownership positions of large shareholders, putting the Company at a meaningful risk of triggering this limitation in the future. If a limitation is triggered from an ownership change it will significantly impact our ability to realize the benefit from our deferred tax asset, potentially resulting in impairment of substantially our entire domestic deferred tax asset of $9.0 million at December 31, 2008 and increasing our income tax expense and taxes payable in future periods.
Changes in the Company’s Tax Rates Could Affect its Future results.
The Company’s future effective tax rates could be favorably or unfavorably affected by changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of the Company’s deferred tax assets and liabilities, or by changes in tax laws or their interpretation. In addition, the Company is routinely subject to the examination of its income tax returns. The Company regularly assesses the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of its provision for income taxes. There can be no assurance the outcomes from these continuous examinations will not have an adverse effect on the Company’s results of operations and financial condition.
We Face Intense Competition from Other Software Companies, Which Could Make it Difficult to Compete Successfully
Our market is intensely competitive. Our customers’ requirements and the technology available to satisfy those requirements continually change. We expect competition to persist and intensify in the future, including competition resulting from consolidations in the software industry.
Our principal competitors include: in-house development efforts by potential customers or partners; other vendors of software that directly address elements of Web-based applications; and developers of software that address only certain technology components of Web-based applications (e.g., content management, portal management, document management, process, collaboration, integration or analytics). In addition, we face increased competition from large companies with capabilities similar to our software in larger integrated product offerings.
Many of these companies have longer operating histories and significantly greater financial, technical, marketing and other resources than we do. Many of these companies can also leverage extensive customer bases and adopt aggressive pricing policies to gain market share. Potential competitors may bundle or license their products in a manner that may discourage users from purchasing our products. It is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. In addition, this competition may impact existing revenue generating partners which could result in reductions in our ability to generate future revenue from these companies.
Competitive pressures may make it difficult for us to acquire and retain customers and may require us to reduce the price of our software. We cannot be certain that we will be able to compete successfully with existing or new competitors. If we fail to compete successfully against current or future competitors, our business, operating results and financial condition would be materially adversely affected.
We Depend on Increased Business from Our Current and New Customers and, if We Fail to Grow Our Customer Base or Generate Repeat Business, Our Operating Results Could Be Harmed
If we fail to grow our customer base or generate repeat and expanded business from our current and new customers, our business and operating results would be seriously harmed. Many of our customers initially make a limited purchase of our products and services. Some of these customers may not choose to purchase additional licenses to expand their use of our products. Some of these customers have not yet developed or deployed initial applications based on our products. If these customers do not successfully develop and deploy such initial applications, they may choose not to purchase deployment licenses or additional development licenses. Our business model depends on the expanded use of our products within our customers’ organizations.
In addition, as we introduce new versions of our products or new products, our current customers may not require the functionality of our new products and may not ultimately license these products. Because the total amount of maintenance and support fees we receive in any period depends in large part on the size and number of licenses that we have previously sold, any downturn in our software license revenue would negatively impact our future services revenue. In addition, if customers elect not to renew their maintenance agreements, our services revenue could be significantly adversely affected.
Our Future Revenue is Dependent Upon Our Ability to Successfully Market Our Existing and Future Products and Solutions
We expect that our future financial performance will depend significantly on revenue from existing and future software products and the related tools that we plan to develop. There are significant risks inherent in a product introduction. Market acceptance of our products will depend on continued market development for Web applications and services and the continued commercial adoption of our existing and future products. We cannot be certain this will occur. We cannot be certain that our existing or future products will meet customer performance needs or expectations when released or that they will be free of significant software defects or bugs. If our products do not meet customer needs or expectations, for whatever reason, upgrading or enhancing the product could be costly and time-consuming.
Our Operating Results May Be Adversely Affected by Small Delays in Customer Orders or Product Implementations
Small delays in customer orders or product implementations can cause significant variability in our license revenues and operating results for any particular period. We derive a substantial portion of our revenue from the sale of products with related services. In certain cases, our revenue recognition policy requires us to substantially complete the implementation of our product before we can recognize all revenues in a contract and any end-of-quarter delays in product implementation could materially adversely affect operating results for that quarter.
To Increase Market Awareness of Our Products and Generate Increased Revenue, We Need to Continue to Strengthen Our Sales and Distribution Capabilities
Our direct and indirect sales operations must increase market awareness of our products to generate increased revenue. In 2009, we plan to implement, among other things, new territory assignments, an enhanced reseller model, a new sales force automation system, a new lead management system, and a shift in marketing spend towards more online marketing. It is our intention that these changes will lead to more effective distribution, but there are many changes being implemented at the same time and they may not be successful or could be successful in the long term but lead to weaker performance in the short term.
Our products and services require a sophisticated sales effort targeted at the senior management of our prospective customers. The market for talented sales resources is very competitive. We have experienced attrition
in our sales force. To continue to strengthen sales and distribution, we must continue to hire a significant number of sales personnel. All new hires will require training and will take time to achieve full productivity. We cannot be certain that our new hires will become as productive as necessary or that we will be able to hire enough qualified individuals or retain existing employees in the future. We plan to expand our relationships with systems integrators and certain third-party resellers to build an indirect influence and sales channel. In addition, we will need to manage potential conflicts between our direct sales force and any third-party reselling efforts.
Failure to Maintain the Support of Third-Party Systems Integrators May Limit Our Ability to Penetrate Our Markets
A significant portion of our sales are influenced by the recommendations of our products made by systems integrators, consulting firms and other third parties that help develop and deploy Web-based applications for our customers. Losing the support of these third parties may limit our ability to penetrate our markets. These third parties are under no obligation to recommend or support our products. These companies could recommend or give higher priority to the products of other companies or to their own products. A significant shift by these companies toward favoring competing products could negatively affect our license and services revenue. Additionally, these organizations may acquire or distribute software products that compete with our products in future periods. If they become our competitors, this could negatively affect our license and services revenue.
Our Lengthy Sales Cycle and Product Implementation Makes It Difficult to Predict Our Quarterly Results
We have a long sales cycle because we generally need to educate potential customers regarding the use and benefits of Web-based applications. Our long sales cycle makes it difficult to predict the quarter in which sales may fall. In addition, since we recognize some of our revenue from product sales upon implementation of our product, the timing of product implementation could cause significant variability in our license revenues and operating results for any particular period. The implementation of our products requires a significant commitment of resources by our customers, third-party professional services organizations or our professional services organization, which makes it difficult to predict the quarter when implementation will be completed.
We May Be Unable to Adequately Sustain a Profitable Professional Services Organization, Which Could Affect Both Our Operating Results and Our Ability to Assist Our Customers with the Implementation of Our Products
Customers that license our software often engage our professional services organization to assist with support, training, consulting and implementation of their Web solutions. We believe that growth in our product sales depends in part on our continuing ability to provide our customers with these services and to educate third-party resellers on how to use our products.
Historically, services costs related to professional services have frequently exceeded, or had been substantially equal to, professional services-related revenue. In this current economic climate, we make periodic capacity decisions based on estimates of future sales, anticipated existing customer needs and general market conditions. Although we expect that our professional services-related revenue will continue to exceed professional services-related costs in future periods, we cannot be certain that this will occur.
Our services organization depends on highly skilled technical resources and managers. Our ability to maintain our revenue and margins for this organization could be adversely impacted if we are unable to retain such resources or if we experience difficulties in hiring such resources in the future.
We generally bill our customers for our services on a time-and-materials basis. However, from time to time we enter into fixed-price contracts for services, which may include terms and conditions that may extend the recognition of revenue for work performed into subsequent quarters. On occasion, the costs of providing the services have exceeded our fixed price from these contracts and such contracts have negatively impacted our operating results.
We May Be Unable to Attract or Retain Necessary Third-Party Service Providers, Which Could Affect Our Ability to Provide Sufficient Support, Consulting and Implementation Services for Our Products
We are actively supplementing the capabilities of our services organization by contracting with and educating third-party service providers and consultants to also provide these services to our customers. We may not be successful in attracting additional third-party providers or in educating or maintaining the interest of current third-party providers. In addition, these third parties may not devote sufficient resources to these activities to meet customers’ demands to adequately supplement our services. Additionally, these organizations may acquire or distribute software products that compete with our products in future periods. If they become our competitors, this could negatively affect our revenue.
To Properly Manage Future Growth, We Need to Continue to Improve Our Operational Systems on a Timely Basis
We have experienced periods of rapid expansion and contraction. We have multiple locations in dispersed geographies around the world. Rapid fluctuations and distributed operations place a significant demand on management and operational resources. To manage such fluctuations effectively, we must continue to improve our operational systems, procedures and controls on a timely basis. If we fail to continue to improve these systems, our business, operating results and financial condition will be materially adversely affected.
We May Be Adversely Affected if We Lose Key Personnel
Our success depends largely on the skills, experience and performance of some key technical, sales, managerial and executive personnel throughout all areas of our business. If we lose one or more of our key employees, our business, operating results and financial condition could be materially adversely affected. As we continue to manage with an offshore research and development operations model, it is particularly important that our intellectual property is protected and retained during this transfer. In addition, our future success will depend largely on our ability to continue to attract and retain highly skilled personnel. In particular, hiring and retaining qualified engineers, skilled solutions providers and qualified sales representatives are critical to our future. Like other software companies, we face competition for qualified personnel. If we are unable to continue to attract and retain skilled and experienced personnel, our growth may be limited.
If We are Unable to Meet the Rapid Changes in Software Technology, Our Existing Products Could Become Obsolete
The market for our products is marked by rapid technological change, frequent new product introductions and Internet-related technology enhancements, uncertain product life cycles, changes in customer demands, changes in packaging and combinations of existing products and evolving industry standards. We cannot be certain that we will successfully develop and market new products, new product enhancements or new products compliant with present or emerging Internet technology standards. New products based on new technologies, new industry standards or new combinations of existing products as bundled products can render existing products obsolete and unmarketable. To succeed, we will need to enhance our current products and develop new products on a timely basis to keep pace with developments related to Internet technology and to satisfy the increasingly sophisticated requirements of our customers. Internet commerce technology, particularly Web-based applications technology, is complex and new products and product enhancements can require long development and testing periods. Any delays in developing and releasing enhanced or new products could have a material adverse effect on our business, operating results and financial condition.
We Develop Complex Software Products Susceptible to Software Errors or Defects that Could Result in Lost Revenues, or Delayed or Limited Market Acceptance
Complex software products such as ours often contain errors or defects, particularly when first introduced or when new versions or enhancements are released. Despite internal testing and testing by current and potential
customers, our current and future products may contain serious defects. Serious defects or errors could result in lost revenues or a delay in market acceptance, which would have a material adverse effect on our business, operating results and financial condition.
The Company is Subject to Risks Associated with the Availability and Coverage of Insurance
Although the Company maintains insurance for certain risks, such coverage does not cover all risks and is limited in coverage amounts and is subject to various policy terms. Because of these limits and because the Company does not maintain insurance coverage for certain risks, unforeseen or catastrophic losses in excess of insured limits may have a material adverse effect on the Company’s results of operations and financial position.
Our Business is Based on Our Intellectual Property and We Could Incur Substantial Costs Defending Our Intellectual Property from Infringement or a Claim of Infringement
In recent years, there has been significant litigation in the United States involving patents and other intellectual property rights. We could incur substantial costs to prosecute or defend any such litigation. Future litigation to either protects our intellectual property or as a result of an alleged infringement of other’s intellectual property may require us to do one or more of the following:
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cease selling, incorporating or using products or services that incorporate the challenged intellectual property;
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obtain from the holder of the infringed intellectual property right a license to sell or use the relevant technology, which license may not be available on reasonable terms;
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redesign those products or services that incorporate such technology; and
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refund a pro-rata portion of the original license consideration paid by the customer.
We rely on a combination of patent, trademark, trade secret and copyright law and contractual restrictions to protect our technology. These legal protections provide only limited protection. If we litigated to enforce our rights, it would be expensive, divert management resources and may not be adequate to protect our business.
Our Product Shipments Could Be Delayed if Third-Party Software Incorporated in Our Products is No Longer Available
We integrate third-party software as a component of our software. The third-party software may not continue to be available to us on commercially reasonable terms. If we cannot maintain positive relationships and licenses to key third-party software, shipments of our products could be delayed or disrupted until equivalent software could be developed or licensed and integrated into our products, which could materially adversely affect our business, operating results and financial condition.
Anti-Takeover Provisions in Our Corporate Documents and Delaware Law Could Prevent or Delay a Change in Control of Our Company
Certain provisions of our certificate of incorporation and bylaws may discourage, delay or prevent a merger or acquisition that a stockholder may consider favorable. Such provisions include:
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authorizing the issuance of “blank check” preferred stock;
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providing for a classified Board of Directors with staggered, three-year terms;
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prohibiting cumulative voting in the election of directors;
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requiring super-majority voting to effect certain amendments to our certificate of incorporation and bylaws;
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limiting the persons who may call special meetings of stockholders;
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prohibiting stockholder action by written consent; and
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establishing advance notice requirements for nominations for election to the Board of Directors or for proposing matters that can be acted on by stockholders at stockholder meetings.
Certain provisions of Delaware law and our stock incentive plans may also discourage delay or prevent someone from acquiring or merging with us.
Further, in April 2002, our Board of Directors approved, adopted and entered into a shareholder rights plan referred to as the Plan. The Plan was not adopted in response to any attempt to acquire us, nor were we aware of any such efforts at the time of adoption.
The Plan was designed to enable our stockholders to realize the full value of their investment by providing for fair and equal treatment of all stockholders in the event that an unsolicited attempt is made to acquire us. Adoption of the Plan was intended to guard shareholders against abusive and coercive takeover tactics.
Under the Plan, stockholders of record as of the close of business on May 6, 2002, received one right to purchase a one one-hundredth of a share of Series A Junior Participating Preferred Stock, par $0.01 per share, at a price of $300.00 per one one-hundredth, subject to adjustment. The rights were issued as a non-taxable dividend and will expire 10 years from the date of the adoption of the Plan, unless earlier redeemed or exchanged. The rights are not immediately exercisable; however, they will become exercisable upon the earlier to occur of (i) the close of business on the tenth day after a public announcement that a person or group has acquired beneficial ownership of 15 percent or more of our outstanding common stock or (ii) the close of business on the tenth day (or such later date as may be determined by the Board of Directors prior to such time as any person becomes an acquiring person) following the commencement of, or announcement of an intention to make, a tender offer or exchange offer that would result in the beneficial ownership by a person or group of 15 percent or more of our outstanding common stock. If a person or group acquires 15 percent or more of our common stock, then all rights holders except the acquirer will be entitled to acquire our common stock at a significant discount. The intended effect will be to discourage acquisitions of 15 percent or more of our common stock without negotiation with the Board of Directors.
Terrorist Activities and Resulting Military and Other Actions Could Adversely Affect Our Business
The continued threat of terrorism within the United States and abroad, military action in other countries and heightened security measures may cause significant disruption to commerce throughout the world. To the extent that such disruptions result in delays or cancellations of customer orders, a general decrease in corporate spending on information technology, or our inability to effectively market, sell and deploy our software and services, our business and results of operations could be materially and adversely affected. We are unable to predict whether the threat of terrorism or the responses thereto will result in any long-term commercial disruptions or if such activities or responses will have a long-term material adverse effect on our business, results of operations or financial condition.
Changes in Accounting Rules Could Affect the Company’s Future Operating Results.
Our financial statements are prepared in accordance with U.S. generally accepted accounting principles. A change from current accounting standards could have a significant effect on the Company’s results of operations. For example, in December 2007, the Financial Accounting Standards Board issued Statement 141 (revised 2007), Business Combinations (Statement 141R) to change how an entity accounts for the acquisition of a business. That statement, which became effective for the Company in January 2009, changes how an entity accounts for the acquisition of a business.
Through fiscal year December 2008, the Company recorded all changes to a valuation allowance for acquired deferred tax assets or the effect of changes in an acquired tax position that occur after the acquisition date by initially reducing the related goodwill to zero, next by reducing other noncurrent intangible assets related to the acquisition to zero and lastly by reducing income tax expense. However, Statement 141R amends Statement 109 and Interpretation 48 to require the Company to recognize changes to the valuation allowance for an acquired deferred tax asset or the effect of changes to an acquired tax position as adjustments to income tax expense or contributed capital, as appropriate, and not as adjustments to goodwill. This change in accounting applies to valuation allowances and tax positions related to acquisitions accounted for originally under Statement 141 as well as those accounted for under Statement 141R. The Company had a $21.0 million valuation allowance at December 31, 2008 related to deferred tax assets acquired in business combinations. Any change in the valuation allowance subsequent to December 31, 2008 will be recorded as an adjustment to income tax expense rather than as an adjustment to goodwill or other noncurrent intangible assets.
Statement 141R also amends the goodwill impairment test requirements in Statement 142. For a goodwill impairment test as of a date after the effective date of Statement 141R, the value of the reporting unit and the amount of implied goodwill, calculated in the second step of the test, will be determined in accordance with the measurement and recognition guidance on accounting for business combinations under Statement 141R. This change could affect the determination of what amount, if any, should be recognized as an impairment loss for goodwill recorded before the effective date of Statement 141R.
Finally, State 141R also amends the accounting of transaction costs associated with acquisitions, requiring immediate expensing rather than capitalizing as part of the purchase accounting adjustments. This could result in an adverse impact on our future operating results.
Our Financial Statements Could be Impacted by Unauthorized and Improper Actions of Our Personnel
Our financial statements could be adversely impacted by our employees’ errant or improper actions. For instance, revenue recognition depends on, among other criteria, the terms negotiated in our contracts with our customers. Our personnel may act outside of their authority and negotiate additional terms without our knowledge. We have implemented policies to prevent and discourage such conduct, but there can be no assurance that such policies will be followed. For instance, in the event that our sales personnel have negotiated terms that do not appear in the contract and of which we are unaware, whether the additional terms are written or oral, we could be prevented from recognizing revenue in accordance with our plans.
Furthermore, depending on when we learn of unauthorized actions and the size of transactions involved, we may have to restate our financial statements for a previously reported period, which would seriously harm our business, operating results and financial condition.
We Have Incurred Significant Costs in Response to Ongoing Laws and Regulations
Laws and regulations affecting public companies, including but not limited to the Sarbanes-Oxley Act of 2002, have caused us to incur costs as we evaluate and respond to the resulting requirements. The rules could make it more difficult for us to obtain certain types of insurance and we may incur higher costs to obtain coverage similar to our existing policies. Additionally, we have incurred and expect to incur on an ongoing basis increased accounting, audit and legal fees to assist us assess, implement and comply with such rules. The ongoing and proposed rules could also make it more difficult for us to attract and retain qualified persons to serve on our Board of Directors.
Charges to earnings resulting from asset impairments may adversely affect the market value of our common stock.
In accordance with Statement of Financial Accounting Standard No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”) , the Company assesses its goodwill for impairment on October 1 of each year or more
frequently if events or changes in circumstances indicate that goodwill might be impaired. As required by SFAS 142, the impairment test is accomplished using a two-stepped approach. The first step screens for impairment by comparing the fair value of the Company with its carrying amount, including goodwill. To determine the Company’s fair value, the Company employs a market capitalization approach, comparing the net book value of the Company to its market capitalization, adjusted to reflect market observed control premiums. If, under the first step, an, impairment is indicated, a second step is performed which applies additional valuation techniques to determine if there is an impairment and how much the impairment would be. This second step compares the implied fair value of the goodwill with the carrying amount of the goodwill. The implied fair value of goodwill is determined based on a variety of valuation techniques including discounted cash flows and earnings or revenue multiples. As of October 1, 2008, the Company determined the market capitalization, after considering market observed control premiums, exceeded net book value and that the remaining net goodwill balance of $121.1 million at October 1, 2008 was not considered to be impaired.
In accordance with SFAS 142, goodwill of a reporting unit shall be tested for impairment on an annual basis and between annual tests in certain circumstances. Driven by the significant decline in the market capitalization of public companies in its peer group in the fourth quarter of 2008, the Company concluded that it should again test its goodwill for impairment on December 31, 2008. In accordance with paragraph 25 of SFAS 142 the company considered a variety of industry standard revenue multiples, probability weighted, its available cash balances and market capitalization, after considering market observed control premiums. Using these reference points, the Company has determined that the remaining net goodwill balance of $121.1 million at December 31, 2008 was not considered to be impaired.
The company recognizes that, over the longer term, the market price for our stock plus an appropriate control premium should represent fair value and, if market conditions fail to improve, we may incur charges for goodwill impairment in the future, which could be significant and could have a material negative effect on our results of operations.
In addition, we periodically review the estimated useful lives of our identifiable intangible assets, taking into consideration any events or circumstances that might result in either a diminished fair value or revised useful life. The events and circumstances include significant changes in the business climate, legal factors, operating performance indicators and competition. Any impairment or revised useful life could have a material impact on our consolidated operating results and financial position, and could harm the trading price of our common stock. Based on this assessment no such impairment charges were recorded in 2008, 2007 or 2006.
Our Business is Sensitive to the Overall Economic Environment; a Slowdown in Information Technology Spending Could Harm Our Operating Results
The primary customers for our products are enterprises seeking to launch or expand Web-based initiatives. Due to the current economic environment, a significant downturn in our customers’ markets and in general economic conditions has resulted in reduced information technology spending budgets, thus resulting in a decreased demand for our products and services, therefore, harming our business. This significant downturn could continue or even get worse in 2009 or beyond. Industry downturns like these have been, and may continue to be, characterized by diminished product demand, erosion of average selling prices, lower than expected revenues and difficulty making collections from existing customers.
Our Performance Will Depend on the Market for Web Based Application Software
The market for Web-based applications software is rapidly evolving. We expect that we will continue to need intensive marketing and sales efforts to educate prospective customers about the uses and benefits of our products and services. Accordingly, we cannot be certain that a viable market for our products will emerge or be sustainable or that market campaigns will result in increased demand for our products and services. Enterprises
that have already invested substantial resources in other methods of conducting business may be reluctant or slow to adopt a new approach that may replace, limit or compete with their existing systems. Similarly, individuals have established patterns of purchasing goods and services. They may be reluctant to alter those patterns. They may also resist providing the personal data necessary to support our existing and potential product uses. Any of these factors could inhibit the growth of online business generally and the market’s acceptance of our products and services in particular.
There is Substantial Risk that Future Regulations Could Be Enacted that Either Directly Restrict Our Business or Indirectly Impact Our Business by Limiting the Growth of Internet Commerce
As Internet commerce evolves, we expect that federal, state or foreign agencies will adopt regulations covering issues such as user privacy, pricing, content and quality of products and services. If enacted, such laws, rules or regulations could limit the market for our products and services, which could materially adversely affect our business, financial condition and operating results. Although many of these regulations may not apply to our business directly, we expect that laws regulating the solicitation, collection or processing of personal and consumer information could indirectly affect our business. The Telecommunications Act of 1996 prohibits certain types of information and content from being transmitted over the Internet. The prohibition’s scope and the liability associated with a Telecommunications Act violation are currently unsettled. In addition, although substantial portions of the Communications Decency Act were held to be unconstitutional, we cannot be certain that similar legislation will not be enacted and upheld in the future. It is possible that such legislation could expose companies involved in Internet commerce to liability, which could limit the growth of Internet commerce generally. Legislation like the Telecommunications Act and the Communications Decency Act could dampen the growth in Web usage and decrease its acceptance as a communications and commercial medium.
The United States government also regulates the export of encryption technology, which our products incorporate. If our export authority is revoked or modified, if our software is unlawfully exported or if the United States government adopts new legislation or regulation restricting export of software and encryption technology, our business, operating results and financial condition could be materially adversely affected. Current or future export regulations may limit our ability to distribute our software outside the United States. Although we take precautions against unlawful export of our software, we cannot effectively control the unauthorized distribution of software across the Internet.
Risks Related to the Securities Markets
Our Stock Price May Be Volatile
The market price of our common stock has been highly volatile and has fluctuated significantly in the past. We believe that it may continue to fluctuate significantly in the future in response to the following factors, some of which are beyond our control:
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variations in quarterly operating results;
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the impact of stock option expensing;
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changes in financial estimates by securities analysts;
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changes in market valuations of web based software companies;
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announcements by us of significant contracts, acquisitions, restructurings, strategic partnerships, joint ventures or capital commitments;
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loss of a major customer or failure to complete significant license transactions;
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additions or departures of key personnel;
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difficulties in collecting accounts receivable;
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large percentage of stock held by a few large shareholders; and
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fluctuations in stock market price and volume, which are particularly common among highly volatile securities of Internet and software companies.
Our Business May Be Adversely Affected by Class Action Litigation Due to Stock Price Volatility
In the past, securities class action litigation has often been brought against a company following periods of volatility in the market price of its securities. We are a party to the securities class action litigation described in “Legal Proceedings” of this Report. The defense of this litigation may increase our expenses and divert our management’s attention and resources and an adverse outcome could harm our business and results of operations. Additionally, we may in the future be the target of similar litigation. Future securities litigation could result in substantial costs and divert management’s attention and resources, which could have a material adverse effect on our business, operating results and financial condition.
We May Be Unable to Meet Our Future Capital Requirements
Although we expect our cash balances to be sufficient to manage our operations, it is possible that we may need to raise additional funds and we cannot be certain that we would be able to obtain additional financing on favorable terms, if at all. If we cannot raise funds, if needed, on acceptable terms, we may not be able to develop or enhance our products, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements, which could have a material adverse effect on our business, operating results and financial condition.
We May Need to Raise Additional Capital, Which May Be Dilutive to Our Stockholders
We may need to raise additional funds to meet our future capital requirements. If we issue equity securities, stockholders may experience additional dilution or the new equity securities may have rights, preferences or privileges senior to those of existing holders of common stock.
If Our Internal Controls Over Financial Reporting Do Not Comply With the Requirements of the Sarbanes-Oxley Act, Our Business and Stock Price Could Be Adversely Affected
Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate the effectiveness of our internal controls over financial reporting as of the end of each year and to include a management report assessing the effectiveness of our internal controls over financial reporting in all annual reports.
Our management, including our CEO and CFO, does not expect that our internal controls over financial reporting will prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, involving the company have been, or will be, detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events and we cannot assure you that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
Although our management has determined and our independent registered public accounting firm has attested, that our internal control over financial reporting was effective as of December 31, 2008, we cannot provide assurance that we or our independent registered public accounting firm will not identify a material weakness in our internal controls in the future. A material weakness in our internal controls over financial reporting would require management and our independent registered public accounting firm to evaluate our internal controls as ineffective. If our internal controls over financial reporting are not considered adequate, we may experience a loss of public confidence, which could have an adverse effect on our business and our stock price.
Our Business is Subject to Changing Regulation of Corporate Governance and Public Disclosure That Has Increased Both Our Costs and the Risk of Noncompliance
Because our common stock is publicly traded, we are subject to certain rules and regulations of federal, state and financial market exchange entities charged with the protection of investors and the oversight of companies whose securities are publicly traded. These entities, including the Securities Exchange Commission and NASDAQ, have issued requirements and regulations and continue to develop additional regulations and requirements in response to recent laws enacted by Congress, most notably the Sarbanes-Oxley Act. Our efforts to comply with these new regulations have resulted in, and are likely to continue to result in, increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities. In particular, our efforts to comply with Section 404 of the Sarbanes-Oxley Act and the related regulations regarding our required assessment of our internal controls over financial reporting has required, and continues to require, the commitment of significant financial and managerial resources.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
Our principal research, development, sales, marketing and administrative headquarter offices are located in Austin, Texas. We do not own any real estate or facilities. As of December 31, 2008, we leased direct office space in: Austin, Texas; San Francisco, California; New York City, New York; Sao Paulo, Brazil; Sydney, Australia; Hyderabad, India; Maidenhead, United Kingdom; Cluj-Napoca, Romania; and Madrid, Spain. Such leases have remaining terms of up to nine years. All offices listed above support sales and services activity and we have research and development activity in our Austin, Texas; Cluj-Napoca, Romania; and Sydney, Australia offices.
Additionally, we lease several full-service managed suites and executive suites as small sales offices across the United States and around the world. These small offices generally have lease terms of less than one year, allowing us to adjust to changing business and customer support requirements. As of December 31, 2008, we leased office space in 13 countries outside of the United States.
Throughout 2008, we consolidated our leased office portfolio. Some of the resulting excess lease space expired in 2008, or will expire in the near term and we successfully negotiated early terminations of some leases, in part or in whole. We currently sublease some surplus office space in Austin, Texas and New York City, New York to unrelated third-parties. We are actively marketing and attempting to sublease or negotiate early terminations of our remaining surplus space, including, but not limited to, space in Austin, Texas for the respective remaining lease terms. The Company occupies or subleases approximately 98% of the leased office space leaving approximately 2% of the leased space unoccupied.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Securities Class Action
On October 26, 2001, a class action lawsuit was filed against the Company and certain of its current and former officers and directors in the United States District Court for the Southern District of New York seeking unspecified damages on behalf of a purported class that purchased Vignette common stock between February 18, 1999 and December 6, 2000. Also named as defendants were four underwriters involved in the Company’s initial public offering of Vignette stock in February 1999 and the Company’s secondary public offering of Vignette stock in December 1999. A Consolidated Amended Complaint, which is now the operative complaint, was filed on April 19, 2002. The complaint alleges violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated there under, based on, among other things, claims that the four underwriters awarded material portions of the shares in the Company’s initial and secondary public offerings to certain customers in exchange for excessive commissions. The plaintiff also asserts that the underwriters engaged in “tie-in arrangements” whereby certain customers were allocated shares of Company stock sold in its initial and secondary public offerings in exchange for an agreement to purchase additional shares in the aftermarket at pre-determined prices. With respect to the Company, the complaint alleges that the Company and its officers and directors failed to disclose the existence of these purported excessive commissions and tie-in arrangements in the prospectus and registration statement for the Company’s initial public offering and the prospectus and registration statement for the Company’s secondary public offering.
The action is being coordinated with approximately 300 other nearly identical actions filed against other companies. On October 9, 2002, the Court dismissed the Individual Defendants from the case without prejudice. On December 5, 2006, the Second Circuit vacated a decision by the district court granting class certification in six of the other nearly identical actions (the “focus cases”), which are intended to serve as test cases. The plaintiffs selected these six cases, which do not include the Company. On April 6, 2007, the Second Circuit denied a petition for rehearing filed by the plaintiffs, but noted that the plaintiffs could ask the district court to certify more narrow classes than those that were rejected.
On August 14, 2007, the plaintiffs filed amended complaints in the six focus cases. The six focus case issuers and the underwriters named as defendants in the focus cases filed motions to dismiss the amended complaints against them on November 14, 2007. On September 27, 2007, the plaintiffs filed a motion for class certification in the six focus cases. On March 26, 2008, the District Court dismissed the Section 11 claims of those members of the putative classes in the focus cases who sold their securities for a price in excess of the initial offering price and those who purchased outside the previously certified class period. With respect to all other claims, the motions to dismiss were denied. On October 10, 2008, at the request of the plaintiffs, the plaintiffs’ motion for class certification was withdrawn, without prejudice. The parties in the approximately 300 coordinated class actions, including Vignette, the underwriter defendants in the Vignette class action, and the plaintiffs in the Vignette class action, have reached agreements in principle to settle, under which the insurers for the issuer defendants in the coordinated cases will make the settlement payment on behalf of the issuers, including Vignette. The settlement is subject to approval by the parties, termination by the parties under certain circumstances, and Court approval. There is no assurance that the settlement will be concluded or that the Court will approve the settlement. Due to the inherent uncertainties of litigation, we cannot accurately predict the ultimate outcome of the matter. The Company is unable to determine whether the outcome of the litigation will have a material impact on its results of operations or financial condition in any future period if the settlement is not concluded, is terminated, or is not approved. The Company will continue to defend itself vigorously against this lawsuit.
Litigation and Other Claims
We are also subject to various legal proceedings and claims arising in the ordinary course of business. Our management does not expect that the outcome in any of these legal proceedings, individually or collectively, will have a material adverse effect on our financial condition, results of operations or cash flows.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this Report.
PART II.
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is listed on the NASDAQ Global Market under the symbol “VIGN”. Public trading of the common stock commenced on February 19, 1999. Prior to that, there was no public market for the common stock. The following table sets forth the high and low closing sale price per share of our common stock on the NASDAQ Global Market in each of the last eight fiscal quarters.
At February 27, 2009, there were approximately 428 holders of record and approximately 28,000 total shareholders of our common stock and the closing price of our common stock was $6.61 per share.
We have never declared or paid any cash dividends on our common stock or other securities and do not anticipate paying cash dividends in the foreseeable future.
STOCK PERFORMANCE GRAPH
The graph set forth below compares the cumulative total stockholder return on the Company’s Common Stock between December 31, 2003 and December 31, 2008 with the cumulative total return (i) The Total Return Index for the NASDAQ Stock Market (US Companies) (The “NASDAQ Stock Market-US Index”) and (ii) Standard and Poor’s Information Technology Index (“S&P IT Index”), over the same period. This graph assumes $100 investment at the beginning of such period and the reinvestment of all dividends. The comparisons shown on the graph below are based on historical data. The historical data for the Company has been retroactively restated for the one-for-ten reverse split that became effective as of June 10, 2005. The Company cautions that the stock performance shown in the graph below is not indicative of, nor is it intended to forecast, the potential future performance of the Company’s common stock.
Cumulative Total Return
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction with our consolidated financial statements and notes thereto, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other financial data included elsewhere in this Annual Report on Form 10-K. The consolidated statements of operations data for the years ended December 31, 2008, 2007 and 2006 and the consolidated balance sheet data at December 31, 2008 and 2007 are derived from audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The consolidated statements of operations data for the years ended December 31, 2005 and 2004 and the consolidated balance sheet data at December 31, 2006, 2005 and 2004 are derived from audited consolidated financial statements not included in this Annual Report on Form 10-K. All share and per share data has been restated for the one-for-ten reverse stock split of the Company that became effective on June 10, 2005.
(1) Includes stock based compensation as follows:
Actual compensation cost for the years ended December 31, 2008, 2007, and 2006 has been recognized using the fair value method as required by Statement 123R and has been included in the determination of net income and net income per share. Prior to the adoption of Statement 123R in 2006, the only stock based compensation expense related to restricted stock and not stock options.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This section and other parts of this Form 10-K contain forward-looking statements that involve risks and uncertainties. Forward-looking statements can also be identified by words such as “anticipates,” “expects,” “believes,” “plans,” “predicts,” and similar terms. Forward-looking statements are not guarantees of future performance and the Company’s actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in the subsection entitled “Risk Factors” above. The following discussion should be read in conjunction with the consolidated financial statements and notes thereto included in this Form 10-K. All information presented herein is based on the Company’s fiscal calendar. Unless otherwise stated, references in this report to particular years or quarters refer to the Company’s fiscal years ended in December and the associated quarters of those fiscal years. The Company assumes no obligation to revise or update any forward-looking statements for any reason, except as required by law.
Overview
Vignette develops and sells software for managing and delivering content. Our software products, which fall into various standard industry categories, including Web content management, transactional content management, intranet solutions, social media solutions, web experience optimization and rich media and video solutions, enable organizations to build, manage and deploy information-based applications. Vignette’s software helps organizations improve their interactions with key audiences, including customers, prospects, employees, partners, patients and citizens, by making it possible for them to deliver online experiences that support their larger business goals. We place particular emphasis on supporting online experiences that are personal, social, transactional and ubiquitous. Our early content management and delivery tools laid the groundwork for some of the Web’s most influential and popular sites. Today, our award-winning solutions continue to power some of the world’s most prominent online brands and enable organizations to have more meaningful interactions with all of their important constituencies.
Organizations in virtually every industry are undertaking next-generation Web initiatives. In general, a renewed focus on growth has led these organizations to re-examine, among other things, the quality of the online experience they provide to their key audiences. From Vignette’s perspective, improving the online experience demands better management and delivery of business content. Vignette’s best customers derive the greatest value from this content at the point of customer interaction, particularly when that point of interaction is online.
Vignette’s Web Experience Platform helps our customers improve the way they connect with their key audiences online. It gives them tools for building great online experiences that support the organizations larger goals (creating a more social online experience, for example, where visitors spend more time on a site or are encouraged to provide product feedback can serve an organization’s desire to grow online product sales or to shorten product development cycles). Vignette’s platform also provides numerous ways to improve the organization’s management of the content that fuels the online experience (and that online visitors create).
Vignette’s platform helps organizations create online experiences that are more personal. It helps them create large, feature-rich online communities with the interactivity and content contribution that today’s audiences expect and the performance and scalability that global enterprises require. Vignette’s platform also supports the creation of Web experiences that are of consistently high quality regardless of location, time of day, or device (computer, television, mobile phone, PDA, kiosk, etc.).
Some of our customers also want to use the online channel to connect customers and other key audiences with internal business processes. In particular, public sector organizations and commercial organizations in the financial services, insurance and healthcare industries are making technology investments that allow them to
extend business activities - loan origination, case processing, customer service and similar processes - to the Web. Vignette’s Transactional Content Management solution, a component of the Vignette Web Experience Platform is expressly designed to provide these capabilities.
Vignette’s software products are brought together in various combinations to deliver solutions to the common content management challenges above. Following is a brief description of most of our software products:
Vignette Content Management manages business content of virtually any type (text, images, video, compound content types, etc.) and ensures the delivery of that content to Web sites. It is especially suited to large organizations that maintain many separate Web sites for distinct sets of constituents because it eliminates the inevitable issues of versioning, redundancy, currency, and so on, that are common to complex Web environments. It is designed to separate content from its delivery, which makes it easy to repurpose content across multiple sites that may look and behave very differently. This separation of content and delivery also makes it easy for Vignette customers to offer Web experiences that are of consistent quality regardless of Web device. A great deal of design effort has gone into making Vignette Content Management accessible to non-technical people, which means that much of the day-to-day responsibility for an organization’s online experience can reside with customer-focused business people, not technical personnel.
Vignette High Performance Delivery provides a unique, integrated combination of real-time caching and intelligent cache management capabilities that can help improve dynamic Web site performance, make Web sites more scalable, and in many cases reduce costs and manual overhead.
Vignette Portal lets organizations build and deliver highly customizable Web experiences tailored to the requirements of audiences such as employees, partners and customers. Portal applications typically combines in a single view or screen a number of visual objects, each of which can be linked to an application or another Web page. Vignette Portal lets organizations create such composite applications particularly rapidly.
Vignette Collaboration supports improved productivity through collaborative workspaces, where teams can share, capture and search information. This helps organizations reduce the risk of knowledge being lost. It breaks down many of the communication and collaboration barriers that exist in geographically dispersed organizations. Encouraging fluid online collaboration can also improve business relationships across departments and between organizations and their key constituencies.
Vignette Business Integration Studio is a graphical application integration environment for collecting and integrating content and applications from a wide selection of sources with minimal coding. Vignette Business Integration Studio allows users to readily and dynamically map content from disparate schemes, remote repositories and applications to an aggregated destination. We offer over fifty pre-built application and technology adapters that can be used by Vignette Business Integration Studio to integrate with enterprise, desktop, database and proprietary content sources existing throughout an enterprise. Adapters are plug-ins to Vignette Business Integration Studio that provides prepackaged integration capabilities to common technology applications.
Vignette Community Applications provides organizations with tools for delivering blogs, wikis, forums and social microsites to build communities and launch products, brands and campaigns.
Vignette Community Services is an enterprise-class social computing and online community solution that leverages user generated content and supports popular new ways to deliver the compelling user experiences that can help you engage and connect with your demanding online audiences. Vignette Community Services enables Web 2.0 tools including ratings, reviews, commenting and tagging of content in a single offering that can be added to virtually any Web site.
Vignette Recommendations gives users the most relevant content and products based on social search. By analyzing the behavior and the most useful resources for similar users, Vignette Recommendations makes it easier to find the right content. It helps deliver a better online experience by providing content recommendations, product recommendations and social search functionality.
Vignette Dialog augments everyday email by delivering highly personalized content to the intended recipients at the designated time through online and offline touch points. A simple, graphical environment allows business users to create planned, multi-step conversations that can be triggered by virtually any type of event, including opening an email, failing to open an email, filling out a form on a Web site, completing a purchase, attending an event or placing a customer service call.
Vignette Video Services is a set of video management services, accessible through industry-standard APIs that can be integrated into virtually any framework, such as Enterprise Content Management and Web Content Management systems, to provide advanced video capabilities offered via a hosted solution.
Vignette Rich Media Module is of particular value to organizations that must manage large volumes of images, podcasts, Adobe Flash files and video content. These and other types of rich media pose special challenges for editors responsible for managing libraries of this content and for the approval, categorizations, tagging and publishing of these assets. Rich Media Services helps organizations get their rich media assets under control and productively incorporated into each organization’s particular online experience.
Vignette Media is a digital publishing platform; the first completely integrated content, rich media, and video management solution designed specifically for the business needs of Telecommunications, Media and Entertainment companies. Vignette Media allows marketing and media professionals to add, manage, and publish rich media and video assets to their Web experience in an easy, relevant and engaging way through a single user interface; a single solution for all online content needs.
Vignette Records & Documents is an enterprise document and records management solution that manages fixed assets, automates document based workflows, manages casework through a process and implements important archival and disposition of records. Vignette Records & Documents facilitates risk and compliance management and implements important document management capabilities including metadata search, query by example, indexed full text search, check in/out and ACL security.
Vignette Case Manager enables organizations to automate and manage high value, customer-facing business transactions. Case Manager gives an organization’s customers control over when and how they want to interact, whether in person in a branch during business hours, on the phone, or via the Web or e-mail at a time and place of the customer’s choosing. Vignette Case Manager makes this innovation possible by allowing organizations to deliver their back-office business processes directly to customers, across multiple channels and in a personalized and consistent way.
Vignette WebCapture is a secure Web transaction capture and playback risk management solution that archives transactions on a customer’s site and creates a permanent record of them for dispute resolution.
Vignette IDM is an integrated document management, archive and retrieval solution that addresses document capture, production imaging supporting forms OCR/ICR, high-performance image viewing, printing and storage management; business process automation and workflow supporting case management, business process management and Web services; output report management for capturing, mining, linking, distribution and statement presentment; and Computer Output to Laser Disc (“COLD”) storage and records management supporting electronic and physical records, retention management, e-mail archiving and regulatory compliance.
Our solutions and products are supported by our professional services organization, Vignette Professional Services (VPS). VPS offers pre-packaged and custom services to help organizations define their online business
objectives and deploy their applications. Our education, consulting and customer care teams give customers the benefit of our experience with thousands of customer implementations. We partner with a number of leading consulting firms and system integrators to implement our software for their clients. In many cases, we work in blended teams to implement solutions. To ensure that we provide support to our customers on their chosen platform and infrastructure, we have long-standing relationships with key technology providers such as Microsoft, BEA Systems, Hewlett Packard and Sun Microsystems.
2008 Highlights
NOTE: Period over period changes and percentages are calculated based on actual numbers and not the rounded numbers presented in this Form 10-K. As such, rounding differences could occur when recalculating the numbers stated throughout the Form 10-K.
Operating Results
The company reported a net loss of $6.3 million for fiscal year 2008 compared to net income of $24.8 million for fiscal year 2007, a decrease of 125%. The Company also posted an operating loss of $12.0 million for fiscal year 2008 compared to operating income of $7.3 million for fiscal year 2007, a decrease of 265%. Operating margins fell to 61.0% for fiscal 2008 from 64.2% for fiscal 2007. In the fourth quarter of 2008, the Company generated an operating loss of $2.9 million as compared to operating income of $3.0 million for the fourth quarter of 2007, a decrease of 197%. The decrease was due primarily to lower revenues in license and services.
Total revenue for fiscal year 2008 was $169.5 million compared to $191.8 million for fiscal year 2007, a decrease of 11.6%. License revenue of $34.6 million decreased $21.5 million as compared to 2007 or 38.3% and total services revenue of $135 million decreased $0.8 million or 0.6%. More specifically, maintenance and support revenue of $81.1 million decreased $1.2 million as compared to 2007 or 1.5%. Professional services revenues of $53.2 million declined $0.2 million as compared to 2007 or 0.4%. In the fourth quarter of 2008, the Company generated license revenue of $7.3 million as compared to $18.0 million for the fourth quarter of 2007, a decrease of 59.8%. The Company attributes the decline in license revenue to a number of factors including a challenging economic environment, intense competition and a need to improve sales and marketing effectiveness. Total services revenue of $29.9 million decreased $4.7 million as compared to the fourth quarter of 2007, a decrease of 13.6%. More specifically, maintenance and support revenue of $18.9 million decreased $1.7 million as compared to 2007 or 8.2%. Professional services revenue of $10.7 million decreased $3.3 million as compared to 2007 or 23.7%. International revenue comprised 40% and 37% of total revenue for the year and quarter ended December 31, 2008, respectively. No single customer accounted for more than 10% of our annual or quarterly revenues.
The gross profit margin in fiscal 2008 of 61% decreased $19.7 million or 3% from fiscal 2007 as a result of the lower license revenue. Total costs of revenue of $66.0 million decreased $2.6 million as compared to 2007 or 3.8%. The decline in gross profit on a percentage basis and in absolute dollars for both periods is primarily driven by the decrease in high margin license revenue.
Total expenses, including both cost of revenue and operating expenses, for fiscal 2008 and fiscal year 2007 were $181.6 million and $184.5 million, respectively. The primary driver for the decrease in expenses for fiscal 2008 was a decrease of $4.8 million in sales and marketing expenses and $1.1 million in general and administrative expenses. Cost of revenue also decreased $2.6 million driven out of the professional services business. These decreases were offset by an increase of $1.8 million in research and development and $3.8 million related to business restructuring charges. During the fourth quarter of 2008, total expenses decreased to $40.1 million compared to $49.7 million during the fourth quarter of 2007 or 19.3%.
Liquidity decreased during the year with cash, cash equivalents and investments in marketable securities reducing by $37.0 million to a total of $138.3 million at December 31, 2008 versus $175.3 million at December 31, 2007. The decrease is as a result of the share repurchase program the company initiated in November 2006, and the Vidavee acquisition completed in the second quarter of 2008, offset by $7.9 million of cash generated from operations. During the year the Company paid $33.5 million to repurchase its common stock and continues to carry no debt.
Headcount was 643 employees at December 31, 2008 as compared to 667 employees at December 31, 2007 and September 30, 2008.
Further analysis of the 2008 operating results can be found under the ‘Results of Operations’ section below.
Outlook
Our objective is to maintain and extend our position as a leading global provider of Next-Generation Web solutions. These solutions enable organizations to harness the power of their business content and the Web to deliver rich, personalized online interactions in direct or indirect support of customer acquisition and retention and revenue growth. We will continue to focus on delivering profitable growth, expanding our customer base of global 2000 organizations, extending our technology leadership through investment in research and development, expanding our global sales capabilities and building upon our strategic alliances with leading companies.
was a challenging year for the company and for the global economy and we saw lower revenues and lower profits than in 2007. In an attempt to reverse that trend in 2009, we plan to implement, among other things, new territory assignments, an enhanced reseller model, a new sales force automation system, a new lead management system, and a shift in marketing spend towards more online marketing. We believe this may help improve direct and indirect sales channel productivity. We will strive to encourage cross-functional team selling through enhanced team realignment around customer accounts and regions and meet market-specific needs for designated solution areas such as healthcare, transactional content management, next generation web presence and collaborative records and document management. We will continue to focus on the indirect channel as a means to better distribute and expose our software and solutions to the marketplace. We will also continue to focus on realizing efficiencies and cost-savings across our business.
In 2008 the weakening economy had a negative effect on demand for our products and services and this trend may continue through 2009 or longer. Given the impact that the ongoing uncertainty in the economy can have on our business we have suspended giving detailed quarterly guidance in 2009. Instead, we plan to provide directional annual guidance for key elements of the P&L but not specifically for total revenues or EPS metrics.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which were prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Estimates and assumptions are reviewed periodically. Actual results may differ from these estimates under different assumptions or conditions.
Management has discussed with and agreed upon the development and selection of the following critical accounting policies with the Audit Committee of the Board of Directors:
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Revenue recognition;
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Estimating the allowance for doubtful accounts;
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Stock based compensation;
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Accounting for income taxes;
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Estimating business restructuring accruals; and
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Valuation of goodwill and identifiable intangible assets.
Revenue recognition. Revenue consists of product and service fees. Product fee income is earned through the licensing or right to use our software and from the sale of specific software products. Service fee income is earned through the sale of maintenance and support services, subscription services, consulting services and training services.
We do not recognize revenue for agreements with rights of return, refundable fees, cancellation rights or acceptance clauses until such rights to return, refund or cancel have expired or acceptance has occurred.
We recognize revenue in accordance with Statement of Position (“SOP”) 97-2, Software Revenue Recognition, as amended by SOP 98-4 and SOP 98-9, Securities and Exchange Commission Staff Accounting Bulletin (“SAB”) 101, Revenue Recognition in Financial Statements as revised by SAB 104 and Emerging Issues Task Force (“EITF”) 00-21, Revenue Arrangements with Multiple Deliverables.
Where software licenses are sold with maintenance and support or other services, we allocate the total fee to the various elements based on the fair values of the elements specific to us. We determine the fair value of each element in the arrangement based on vendor-specific objective evidence (“VSOE”) of fair value. VSOE of fair value is based upon the normal pricing and discounting practices for those products and services when sold separately and, for support services, is measured by the renewal rate. For all of our multiple element contracts where software license is one of the delivered elements we use the residual method. Under the residual method, the arrangement fee is first allocated to the undelivered elements based upon their VSOE of fair value and the remaining arrangement fee, including any discount, is then allocated to the delivered element. If the residual method is not used, discounts, if any, are applied proportionately to each element included in the arrangement based on each element’s fair value without regard to the discount.
Revenue allocated to product license fees is recognized when persuasive evidence of an agreement exists, delivery of the product has occurred, no significant remaining obligations with regard to implementation are outstanding and collection of a fixed or determinable fee is reasonably assured. We consider all payments outside our normal payment terms, including all amounts due in excess of one year, to not be fixed and determinable and such amounts are recognized as revenue as they become due. If collectibility is not considered reasonably assured, revenue is recognized when the fee is collected. For software arrangements where we are obligated to perform professional services for implementation of the product, we evaluate whether delivery has occurred upon shipment of software or upon completion of services and if the customer payment is reasonably assured. This evaluation is made based on various factors such as the nature of the services work, order type (e.g. initial vs. follow-on), customer’s payment history, if such services are available from other vendors, if we have sufficient experience in providing such services, etc. In the instances where delivery is deemed not to have occurred upon shipment based on the aforementioned factors, license revenue is recognized as our obligations under the implementation are met.
Revenue from perpetual licenses that include unspecified, additional software products is recognized ratably over the term of the arrangement, beginning with the delivery of the first product.
Revenue allocated to maintenance and support services is recognized ratably over the maintenance term.
Revenue allocated to subscription services, including implementation and set-up fees, is recognized ratably over the term of the arrangement beginning on the commencement dates of each contract. We recognize professional services sold with an initial subscription order over the term of the related subscription contract as these services are considered to be inseparable from the subscription service.
Revenue allocated to training and consulting service elements is recognized as the services are performed.
We follow very specific and detailed guidelines, discussed above, in determining revenues; however, certain judgments and estimates are made and used to determine revenue recognized in any accounting period. Material differences may result in the amount and timing of revenue recognized for any period if different conditions were to prevail.
Estimating the allowance for doubtful accounts. We continuously assess the collectibility of outstanding customer invoices and in doing so; we maintain an allowance for estimated losses resulting from the non-collection of customer receivables. In estimating this allowance, we consider factors such as: historical collection experience, a customer’s current credit-worthiness, customer concentrations, age of the receivable balance, both individually and in the aggregate and general economic conditions that may affect a customer’s ability to pay. Actual customer collections could differ from our estimates. For example, if the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.
Stock based compensation. The Company measures all share-based payment awards at fair value on the date of grant and recognizes compensation expenses for all share-based payments on a straight-line basis over the service period that the awards are expected to vest pursuant to the guidance of Statement of Financial Accounting Standards 123R, Share-Based Payment (“Statement 123R”) and Staff Accounting Bulletin 107 (“SAB 107”) of the Securities and Exchange Commission. Restricted stock and stock options issued under equity plans as well as well as stock purchases under our employee stock purchase plans are subject to the provisions of Statement 123R and the interpretive guidance of SAB 107.
We estimate the fair value of stock options using a Black-Scholes valuation model. Option-pricing models require the input of highly subjective assumptions, including the option’s expected life and the price volatility of the underlying stock. Judgment is also required in estimating the number of stock-based awards that are expected to be forfeited. If actual results or future changes in estimates differ significantly from our current estimates, stock-based compensation expense and our results of operations could be materially impacted.
Accounting for income taxes. We account for the effect of income taxes in accordance with Statement of Financial Accounting Standards 109, Accounting for Income Taxes (“SFAS No. 109”) and the various interpretations thereof. At the end of each interim period we make our best estimate of the effective tax rate expected to be applicable for the full fiscal year. This estimated effective tax rate is used to determine income taxes on a current year-to-date basis from ordinary operations. Estimating an effective tax rate involves estimates and forecasts by management in arriving at an estimated full year tax liability on a legal entity basis. In each successive interim period, to the extent our estimates need to be revised, we expect that our effective tax rate will change accordingly, affecting tax expense (or benefit) for both that successive interim period as well as year-to-date interim results. In addition to the tax provision attributable to ordinary operations, the income tax expense recorded will also reflect the impact of discrete adjustments for each interim period. Our effective tax rate computation assumes that the company will achieve profitability in the future however, the company incurred a loss in 2008 and should the company continue to make losses our effective tax rate would increase.
Deferred tax assets and liabilities result from temporary differences between the GAAP and tax treatment of certain income and expense. We must assess and make estimates regarding, the likelihood that our deferred tax assets will be recovered. To the extent that we determine that the deferred tax assets will not be recovered, we
must establish a valuation allowance against such assets. In making such a determination, we must take into account positive and negative evidence including projections of future taxable income and assessments of potential tax planning strategies.
In 2007, we released a portion of the valuation allowance we had recorded against our deferred tax assets based on the determination that it is more likely than not that part of the net operating loss carryforward will be realized. Recognition of the deferred tax asset was primarily based on Management’s conclusions regarding our ability to utilize net operating losses and other deferred tax assets to offset income in future periods. Although we anticipate the company will achieve profitability in the future and that some portion of the valuation allowance will subsequently be reduced, future losses might require an increase to the valuation allowance resulting in a potentially material charge to income tax expense in future periods.
Tax contingencies are provided for in accordance with the requirements of FASB Interpretation No. 48, Accounting for Uncertainties in Income Taxes (“FIN 48”). Although we believe that we have appropriate support for the positions taken on our tax filings across all of the jurisdictions in which we operate, we must evaluate potential uncertainties and record a liability for our best estimate of the probable loss on these positions. We believe that our accruals related to such uncertainties are adequate for all open years, based on our assessment of many factors including past experience and interpretations of tax law applied to the facts of each matter. However, the final determination of tax audits and any related litigation could be materially different than that which is reflected in historical income tax provisions and recorded assets and liabilities, necessitating a material adjustment to our income tax provision, net income, or cash flows in the period or periods in which such determination is made. The balance of unrecognized tax benefits was $10.9 million and $10.8 million at December 31, 2008 and December 31, 2007, respectively.
Estimating business restructuring accruals. We vacated excess leased facilities as a result of the restructuring plan we initiated in 2001 and subsequently expanded in 2002, 2003 and 2004. We recorded an accrual for the remaining lease liabilities of such vacated properties as well as brokerage commissions, partially offset by estimated sublease income. We estimated the costs of these excess leased facilities, including estimated costs to sublease and sublease income, based on market information and trend analysis. We continually assess our real estate portfolio and may vacate or occupy other leased space as dictated by our analysis. Actual results could differ from these estimates. In particular, actual sublease income attributable to the consolidation of excess facilities might deviate from the assumptions used to calculate our accrual for facility lease commitments if one, or more, of the Company’s subtenants default on their executed lease agreement(s) with the Company. In addition, actual operating expenses could differ from current estimates. In the third and fourth quarters of 2008, we recorded an accrual as a result of the implementation of a restructuring plan to reallocate certain employee related investments. The actual costs of the plan could differ from the estimates used to record the accrual.
Valuation of goodwill and identifiable intangible assets. In accordance with Statement of Financial Accounting Standard No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”) , the Company assesses its goodwill for impairment on October 1 of each year or more frequently if events or changes in circumstances indicate that goodwill might be impaired. As required by SFAS 142, the impairment test is accomplished using a two-stepped approach. The first step screens for impairment by comparing the fair value of the Company with its carrying amount, including goodwill. To determine the Company’s fair value, the Company employs a market capitalization approach, comparing the net book value of the Company to its market capitalization, adjusted to reflect market observed control premiums. If, under the first step, an, impairment is indicated, a second step is performed which applies additional valuation techniques to determine if there is an impairment and how much the impairment would be. This second step compares the implied fair value of the goodwill with the carrying amount of the goodwill. The implied fair value of goodwill is determined based on a variety of valuation techniques including discounted cash flows and earnings or revenue multiples. As of October 1, 2008, the Company determined the market capitalization, after considering market observed control premiums, exceeded net book value and that the remaining net goodwill balance of $121.1 million at October 1, 2008 was not considered to be impaired.
In accordance with SFAS 142, goodwill of a reporting unit shall be tested for impairment on an annual basis and between annual tests in certain circumstances. Driven by the significant decline in the market capitalization of public companies in its peer group in the fourth quarter of 2008, the Company concluded that it should again test its goodwill for impairment on December 31, 2008. In accordance with paragraph 25 of SFAS 142 the company considered a variety of industry standard revenue multiples, probability weighted, its available cash balances and market capitalization, after considering market observed control premiums. Using these reference points, the Company has determined that the remaining net goodwill balance of $121.1 million at December 31, 2008 was not considered to be impaired.
The company recognizes that, over the longer term, the market price for our stock plus an appropriate control premium should represent fair value and, if market conditions fail to improve, we may incur charges for goodwill impairment in the future, which could be significant and could have a material negative effect on our results of operations.
Results of Operations
The following table sets forth, for the periods indicated, certain items from our consolidated statements of operations, expressed as a percentage of total revenues:
Comparison of fiscal years ended December 31, 2008, 2007 and 2006 (in thousands, unless otherwise noted)
Revenue
Total revenue decreased 12% in 2008 and decreased 3% in 2007. The majority of the decline in 2008 is attributable to a decline in license revenue. The decrease in revenue in 2007 is due to decreased license revenue offset by increases in both maintenance and support and professional services.
Product license. Product license revenue decreased 38% in 2008 and decreased 16% in 2007. The decrease in 2008 is due to a number of factors including a challenging economic environment, a competitive landscape and a need to improve sales and marketing effectiveness. Despite the economic uncertainty in 2009, the changes to our sales and marketing organizations discussed in the “outlook” section above will, we hope, lead to increased productivity from the sales and marketing organization and we therefore expect license revenue to be flat to up 20% year over year for the full year 2009,
Services. Services revenue decreased 1% in 2008 and increased 3% in 2007. The decrease in 2008 is primarily attributable to maintenance and support. The decrease in maintenance and support is attributable to a stronger dollar versus last year with the remainder due to lower license revenue over the past few years. The increase in 2007 is attributable to both maintenance and support and professional services. The increase in maintenance and support is attributable to good renewal rates and price increases across our customer base. The increase in professional services is due to our continued focus on providing additional capacity via third party resources. Maintenance revenue is expected to decline up to 10% year over year in 2009, primarily because maintenance from new license customers is not expected to exceed the amount of maintenance revenue decline due to customer attrition. Professional services revenue is expected to decline up to 20% compared to 2008 due to the impact of lower license sales in 2008.
During fiscal years 2008, 2007, and 2006, no single customer accounted for more than 10% of our total revenues. International revenue was $68.6 million, $67.2 million, and $74.8 million, or 40%, 35%, and 38% of total revenues, in 2008, 2007, and 2006, respectively.
Gross Profit
Cost of revenue consists of the costs of licensing third-party software incorporated into our products, the amortization of certain acquired technology and personnel and other expenses related to providing professional and maintenance and support services.
Gross profit amounts and percentages are as follows:
As a percent of sales, gross profit represented 61%, 64% and 66% in 2008, 2007 and 2006, respectively. The decline in gross profit on a percentage basis and in absolute dollars for both periods is primarily driven by the decrease in license revenues in 2008 and 2007, which have higher margins than service revenues. The decrease in gross profit, which was $19.7 million or 16% lower than 2007, is consistent with the 12% decrease in total revenue in 2008.
Operating expenses
Research and development. Research and development expenses consist primarily of personnel costs to support product development. Research and development expenses increased 6% in 2008 and decreased 9% in 2007. The increase in research and development in 2008 is due to increased investment in product innovation and enhancement in order to drive long-term license revenue growth coupled with increased headcount costs following the Vidavee acquisition during Q2 2008. The decrease in research and development in 2007 is due to lower headcount related expenses as we continued to invest more heavily in our overseas development resource.
The Company did not capitalize any software development costs in accordance with Statement of Financial Accounting Standards No. 86, Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed, for fiscal years 2008, 2007 and 2006, respectively.
During 2008, we used a third-party service provider in India to supply approximately half of our research and development operations. During the quarter ended September 30, 2008, we decided to establish a development center in India and entered into an amended vendor agreement to phase out our primary third-party service provider over a twelve month period. We believe a direct presence in India will achieve significant efficiencies and reduced operational costs. In addition, as a result of building out our development center we expect to incur approximately $2.5 million in additional capital expenditures.
Sales and marketing. Sales and marketing expenses consist primarily of salaries and other related costs for sales and marketing personnel, sales commissions, public relations, marketing materials and tradeshows as well as bad debt charges. Sales and marketing expenses decreased 8% in 2008 and decreased 12% in 2007. The decrease in 2008 is as a result of decreased headcount during the third and fourth quarters of 2008, lower commissions due to lower license revenue and lower expenses due to foreign currency movements in Q3 2008 and Q4 2008. The decrease in 2007 is as a result of the attrition we experienced at the end of 2006 and the early part of 2007.
General and administrative. General and administrative expenses consist primarily of salaries and other related costs for human resources, finance, accounting, facilities, information technology and legal employees. General and administrative expenses decreased 6% in 2008 and increased 9% in 2007. The decrease in 2008 is due to lower professional services fees and bonus amounts. We expect general and administrative expenses in future periods to fluctuate as a percentage of total revenue from period to period based on seasonality, sales cycles, regulatory requirements, legal proceedings and fees paid to outside professional service providers. The increase in 2007 is due to increased investment in outside professional services.
Business restructuring charges (benefits). Business restructuring charges (benefits) consist primarily of costs relating to a restructuring plan that took place during the third and fourth quarters of 2008, including $2.9 million in employee severance costs together with a $1 million contract termination fee associated with an amended vendor agreement executed during the third quarter (refer to the 8-K filed on August 28, 2008). These changes were offset slightly by small adjustments to facility lease commitments of which the remaining maximum lease commitment extends out to 2011. The actions taken during 2008 were designed to reallocate certain employee related investments and reduce our costs in line with our reduced revenues. These actions should drive up to a 10% reduction in our operating expenses for 2009. We anticipate cash outflow of approximately $1.4M in Q1 2009 in relation to this action which we plan to fund from operating activities. There can be no assurance that the estimated costs of our restructuring efforts will not change. These are management’s best estimates based on currently available information and are subject to change should one, or more, of the Company’s subtenants default on their executed lease agreement with the Company or actual operating expenses differ from current estimates.
Amortization of other intangible assets. Amortization of other intangible assets includes amortization of customer relationships and non-compete contracts. Amortization expenses related to acquired technology are recorded in cost of revenue. Amortization expense is recorded ratably over the estimated useful lives of the other intangible assets, which range from one to six years. Components of other intangible assets are presented in Note 4 - Intangible Assets in our Notes to Consolidated Financial Statements.
Other income, net.
Other income, net for the years ended December 31, 2008, 2007 and 2006 were as follows (in thousands):
Other income (expense), net is composed of recognized investment gains, foreign currency exchange realized and unrealized gains/ (losses), gains on sale of intellectual property and/or disposed equipment and purchase accounting credits.
Other income (expense), net increased in 2008 as compared to 2007 due to a $0.1 million foreign currency exchange realized and unrealized gains, a $0.1 million one-time gain on the sale of patent, and a $1.8 million one-time accrual adjustment in the fourth quarter of 2008 relating to the release of accumulated credit balances from prior acquisitions and historical provisions no longer required.
Interest income decreased in 2008 as compared to 2007 due to the lower investment fund balances and lower yields on these funds.
Provision for (benefit from) income taxes
Income tax expense consists primarily of estimated withholdings and income taxes due in certain foreign jurisdictions.
Our accounting for deferred taxes under SFAS 109 involves the evaluation of a number of factors concerning the realizability of our deferred tax assets. In 2007, we released $9.8 million of the valuation allowance we had recorded against our net deferred tax asset based on the determination that it is now more likely than not that part of the benefit related to the net operating loss carryforward will be realized. Approximately $7.4 million of the benefit from release of the valuation allowance was recorded as a benefit to our income tax provision and the remaining $2.4 million related to assets of acquired companies and was recorded as a reduction of goodwill. In concluding that releasing part of the valuation allowance was appropriate, we have considered such factors as our operating history and our ability, based on a projection, to generate sufficient taxable income of the appropriate character within the relevant jurisdictions in future years.
As of December 31, 2008, we had domestic federal net operating loss, research and development credit and capital loss carry forwards of approximately $754.0 million, $16.3 million and $15.8 million, respectively. These domestic net operating loss, research and development credit and capital loss carry forwards will expire at various dates, between 2009 and 2027, if not utilized. The Company also had foreign net operating loss carry forwards of approximately $12.8 million that are not subject to expiration.
Internal Revenue Code Section 382 and similar foreign statutes impose substantial restrictions on the utilization of net operating losses, tax credits and capital loss carry forwards in the event of an “ownership change” of a corporation. Domestic net operating loss carry forwards of approximately $184.9 million and tax credit carry forwards of $4.4 million at December 31, 2008 were incurred by businesses we acquired and are subject to annual limitation. The remaining tax attributes that would be subject to annual limitations upon an “ownership change” include domestic net operating loss carry forwards of $569.2 million, capital loss carry forwards of $15.8 million and research and development credit carry forwards of $11.9 million. Based upon a review of historical stock ownership, we do not believe we have undergone an “ownership change” that will limit our ability to utilize these tax attributes prior to their expiration. We do not have actual information of any ownership shifts that may cause an “ownership change” but due to the volatility in the stock market, if there is such change, application of the change in ownership statutes may severely limit our ability to utilize these tax attributes prior to their expiration. If a limitation is triggered from an ownership change it will significantly impact our ability to realize the benefit from our deferred tax asset, potentially resulting in impairment of substantially our entire domestic deferred tax asset of $9.0 million at December 31, 2008.
Further discussion of our provision for income taxes and our deferred tax asset and valuation allowance are presented in Note 9 - Income Taxes in our Notes to Consolidated Financial Statements.
Liquidity and Capital Resources
The following table presents selected financial statistics and information, (dollars in thousands):
At December 31, 2008, we had $138.9 million in cash, cash equivalents and short-term investments and no debt. We invest cash exceeding our operating requirements in short or long-term, investment-grade securities and classify these investments as available-for-sale.
Net cash provided by (used in) operating activities was $7.9 million, $29.9 million, and $27.7 million, in 2008, 2007, and 2006, respectively. The significant decrease in cash provided by operating activities in 2008 is primarily due to a net loss of $6.3 million in 2008 vs. net income of $17.4 million in 2007 (not including the $7.4 million deferred tax valuation allowance adjustment recorded in 2007). Although the net change in operating assets and liabilities remained relatively flat from 2007 to 2008, certain working capital items fluctuated significantly year over year, including accounts receivable, accounts payable and accrued expenses. The significant year over year decrease in accounts receivable is due to lower license sales in 2008 vs. 2007. The significant year over year decrease in accounts payable is due to the timing of payments, particularly large rent and OEM payments. The significant year over year decrease in accrued expenses is primarily due to lower employee accruals for commissions and bonuses (due to weaker company performance in 2008), lower OEM accrual balances and the one-time accrual adjustment of $1.8 million recorded during the fourth quarter of 2008. For 2009, we expect that cash flow from operations will be modestly positive.
Net cash provided by (used in) investing activities was $54.2 million, $34.5 million, and $(46.4) million, in 2008, 2007, and 2006, respectively. The increase in investing inflows is driven by a move in 2007 to hold more of our cash in shorter term assets offset slightly with the Vidavee acquisition in the second quarter of 2008. We expect that our future investing activities will generally consist of capital expenditures to support our future needs, investment in securities to maximize investment yields while preserving cash flow for operational purposes and acquisition of intellectual property or complementary businesses to expand our market share. The increase in investing cash flows for 2007 was due to the maturity of short-term investments, the proceeds from which were utilized in our share repurchase program.
Net cash provided by (used in) financing activities was $(32.2) million, $(70.3) million, and $(7.7) million in 2008, 2007, and 2006, respectively. Our financing activities consisted of purchases of our common stock in the open market in accordance with our stock repurchase program and proceeds from issuing shares to meet the requirements of employee stock option exercises and the employee stock purchase plan. The decrease in net cash used in financing activities in 2008 is the results of a decline in share repurchase activity, offset slightly by a decrease in proceeds received from the issuance of common stock.
Even after considering the current economic environment, we believe that we have sufficient capital resources to meet our working capital, capital expenditure and investment requirements for at least the next 12 months.
Contractual Obligations
The following table summarizes our significant contractual obligations (in thousands) at December 31, 2008 and the effect such obligations are expected to have on our liquidity and cash flows in future periods. This table excludes amounts already recorded on our balance sheet as current liabilities.
The expected timing of payment of the obligations detailed above is estimated based on current information. Timing of payments and actual amounts paid may differ from our estimates.
Lease Commitments
The Company leases its office facilities and various equipment under operating lease agreements having expiration dates through 2017. The Company has operating leases for facilities with escalating rents. Pursuant to SFAS 13 - Accounting for Leases, the Company recognizes rent expense on a straight line basis over the lease term. Rent expense, excluding vacated properties, for the years ended December 31, 2008, 2007 and 2006 was $3.6 million, $3.5 million, and $5.0 million, respectively. At December 31, 2008, estimated future rents receivable from signed sublease agreements are $2.0 million through 2011. Future minimum payments as of December 31, 2008 under our lease obligations, including operating lease commitments for all vacated properties, are included in the table above (in thousands).
Third Party Royalty Obligations
The Company’s business practice, in part, is to resell bundled or un-bundled third party software. All of our resell items are based on OEM agreements signed between the third party and Vignette having expiration dates through 2013. Future minimum third party royalty obligation as of December 31, 2008 under our current OEM agreements, are included in the table above (in thousands).
Product Warranties
The Company offers warranties to its customers, requiring that the Company replace defective products within a specified time period from the date of sale. The Company records warranty costs as incurred and historically, such costs have not been material.
Off-Balance Sheet Arrangements
As of December 31, 2008, we did not have any significant off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.
Recent Accounting Pronouncements
See Note 2 - Summary of Significant Accounting Policies in our Notes to Consolidated Financial Statements for details of recently issued accounting pronouncements and their expected impact on our financial statements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Currency Exchange Rate Risk
The majority of our operations are based in the United States of America and accordingly, the majority of our transactions are denominated in U.S. Dollars. We have operations throughout the Americas, Europe, Asia and Australia where transactions are denominated in the local currency of each location. Fluctuations in the exchange rates between the local currencies of Europe, Latin America, Asia Pacific, and the United States, particularly the Brazilian Real, Euro, British Pound and Australian Dollar, may harm our business. We are exposed to movements in foreign currency exchange rates because we translate foreign currency balances into United States Dollars for financial reporting purposes. Our primary exposures relate to sales, operating expenses, cash and intercompany balances that are not United States Dollar-denominated. To the extent our international operations continue to grow, currency fluctuations could have a material adverse impact on our consolidated financial condition and results of operations. During 2008, the Company’s consolidated cash balance decreased $3.8 million as a result of translating foreign currency balances into U.S. Dollars. During 2008, the impact on operations was immaterial as the negative impact to revenue was offset by the positive impact to expenses.
We utilize foreign currency forward contracts to hedge foreign currency-denominated payables and receivables. To date, we have not hedged forecasted transactions or firm commitments denominated in foreign currencies and therefore, financial reporting of our foreign operations is subject to foreign currency risk. Gains and losses on hedging contracts are reflected currently in other income, net. Under our policy, we may enter into foreign currency forward contracts for a term of up to one year. We do not invest in contracts for speculative purposes. Our foreign exchange exposures are monitored regularly to ensure the overall effectiveness of our foreign currency hedge positions. Our program is not designed to hedge all currency risk, but is designed to mitigate large foreign currency exposures recorded on our balance sheet. As part of this monitoring program, in order to evaluate the effectiveness of our hedging practices, in the second quarter of 2007 we did not replace foreign currency hedge positions which expired. After a period of monitoring our unhedged positions, we re-engaged our foreign currency hedge program in the fourth quarter of 2008 to focus on individual significant foreign currency exposures. For the year ended December 31, 2008, 2007 and 2006, the Company realized a loss on foreign currency contracts of $0.2 million, $0.3 million and $13,000, respectively. At December 31, 2008, the notional value of the foreign currency contracts was $1.3 million and, based on the applicable exchange rates, the fair value of derivative financial instruments was a liability of $99,000. At December 31, 2007 we had no foreign currency contracts outstanding.
Interest Rate Risk
Cash, cash equivalents and short-term investments. Our interest income is sensitive to changes in the general level of U.S. interest rates, particularly since the majority of our investments are in short-term instruments. Due to the nature of our short-term investments, we have concluded that we do not have material interest risk exposure. Our investment policy requires us to invest funds in excess of current operating requirements in:
•
obligations of the U.S. government and its agencies;
•
investment grade state and local government obligations;
•
securities of U.S. corporations rated A1 or P1 by Standard & Poors or the Moody’s equivalents; and
•
money market funds, deposits or notes issued or guaranteed by U.S. and non-U.S. commercial banks meeting certain credit rating and net worth requirements with maturities of less than two years.
Our cash and cash equivalents consisted primarily of commercial paper and money market funds. Short-term investments consist of cash collateral pledged for certain lease and tax obligations and marketable securities including corporate notes, corporate bonds and medium-term notes in large U.S. institutions and governmental agencies. Our marketable securities that are classified as short-term investments will mature in less than one year
from the Company’s balance sheet date. These securities are classified as available-for-sale and are recorded at their estimated fair value. The Company held no auction rate securities at December 31, 2008 or December 31, 2007.
Long-term investments. At December 31, 2008 long-term investments consisted of cash collateral pledged for certain lease and tax obligations and a limited partnership interest in a technology incubator. We periodically analyze our long-term investments for impairments that could be considered other than temporary. In performing this analysis, the Company evaluates whether general market conditions which reflect prospects for the economy as a whole or information pertaining to the specific investment’s industry, or that individual company, indicates that an other than temporary decline in value has occurred. If so, the Company considers specific factors, including the financial condition and near-term prospect of each investment, any specific events that may affect the investee company and the intent and ability of the Company to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. As a result of such review, the Company recognized no impairment charges during 2008, 2007, or 2006.
We held $3.8 million and $5.3 million in restricted investments at December 31, 2008 and December 31, 2007, respectively. At December 31, 2007, restricted investments consisted of a certificate of deposit and investment grade securities placed with a high credit quality financial institution. Such restricted investments collateralize letters of credit related to certain leased office space security deposits and tax obligations. These investments will remain restricted to the extent that the security requirements exist or until the tax obligations are settled. The average yield of these investments is approximately 2.31%.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements and supplementary data required by this item are included in Part IV, Item 15 of this Form 10-K and are presented beginning on page.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management, under supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures, as defined under Exchange Act Rule 13a-15(e). Based upon this evaluation, our management, including, the Chief Executive Officer and Chief Financial Officer, concluded that, as of December 31, 2008, the disclosure controls and procedures were effective to ensure that information required to be disclosed in the Company’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission’s rules and forms.
Management’s Report On Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined under Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States.
All internal control systems, no matter how well designed, have inherent limitations and may not prevent or detect misstatements. Therefore even those systems determined to be effective can only provide reasonable assurance with respect to financial reporting reliability and financial statement preparation and presentation. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls become inadequate because of changes in conditions and that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2008. In making this assessment, management used the criteria issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on its assessment, management concluded that, as of December 31, 2008, the Company’s internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States.
Our independent registered accounting firm, Grant Thornton LLP, audited our consolidated financial statements, and independently assessed the effectiveness of our internal control over financial reporting. Grant Thornton LLP has issued their report, which is included in the Reports of Independent Registered Public Accounting Firm in this Form 10-K.
Changes in Internal Control Over Financial Reporting
There have been no changes in our internal controls over financial reporting that occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None
PART III.
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this item is incorporated herein by reference to the information under the sections entitled “Proposal No. 1 - Election of Directors,” “Executive Officers”, “Section 16(a) Beneficial Ownership Reporting Compliance” “Code of Ethics” and “Statement on Corporate Governance” of our definitive Proxy Statement (the “Proxy Statement”) to be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, for our Annual Meeting of Stockholders to be held on May 22, 2009. We anticipate filing the Proxy Statement within 120 days of the end of our fiscal year ended December 31, 2008.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information regarding executive compensation is incorporated herein by reference from the section entitled “Executive Compensation” of the Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information regarding security ownership of certain beneficial owners and management is incorporated herein by reference from the section entitled “Share Ownership of Certain Beneficial Owners and Management” of the Proxy Statement.
The information regarding related stockholder matters in incorporated herein by reference from the section entitled “Related Shareholder Matters” of the Proxy Statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information regarding certain relationships and related transactions is incorporated herein by reference from the section entitled “Certain Relationships and Related Transactions” of the Proxy Statement.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information related to audit fees and services paid to Grant Thornton LLP appearing in the Proxy Statement is incorporated herein by reference.
PART IV.
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
The following documents are filed as part of this Annual Report on Form 10-K:
(a) 1. Financial Statements
Index
Page
Reports of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at December 31, 2008 and December 31, 2007
Consolidated Statements of Operations for the years ended December 31, 2008, December 31, 2007 and December 31, 2006
Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2008, December 31, 2007 and December 31, 2006
Consolidated Statements of Cash Flows for the years ended December 31, 2008, December 31, 2007 and December 31, 2006
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
All financial statement schedules have been omitted as the information required to be set forth therein is either not applicable or is included in the consolidated financial statements or the notes thereto.
3. Exhibits
Exhibits submitted with this Annual Report on Form 10-K, as filed with the Securities and Exchange Commission and those incorporated by reference to other filings, are listed in the accompanying index below.
(b) Exhibits
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.
Vignette Corporation
(Registrant)
BY:
/s/ T. PATRICK KELLY
T. Patrick Kelly
Chief Financial Officer
Dated: March 10, 2009
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated:
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
Vignette Corporation
We have audited the accompanying consolidated balance sheet of Vignette Corporation and subsidiaries (a Delaware Corporation) as of December 31, 2008 and December 31, 2007, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Vignette Corporation as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008 in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Vignette Corporation’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 10, 2009 expressed an unqualified opinion.
/s/ GRANT THORNTON LLP
Dallas, TX
March 10, 2009
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
Vignette Corporation
We have audited Vignette Corporation and subsidiaries (a Delaware Corporation) internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Vignette Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on Vignette Corporation’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Vignette Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control - Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the accompanying consolidated financial statements of Vignette Corporation as of December 31, 2008 and 2007 and for each of the three years in the period ended December 31, 2008 and our report dated March 10, 2009 expressed an unqualified opinion.
/s/ GRANT THORNTON LLP
Dallas, TX
March 10, 2009
VIGNETTE CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
The accompanying notes are an integral part of these consolidated financial statements.
VIGNETTE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
VIGNETTE CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(in thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements.
VIGNETTE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
VIGNETTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008
NOTE 1 - Business
Vignette Corporation, along with its wholly-owned subsidiaries (collectively, the “Company” or “Vignette”), provides Web content management, intranet solutions, social media, experience optimization, video, rich media and transactional content management solutions. Our solutions give organizations the capability to provide a personalized and highly engaging Web experience. In addition to creating high-value interactions through their Web presence, Vignette customers are also able to integrate systems and information from inside and outside the organization; manage the lifecycle of enterprise information; and collaborate by supporting ad-hoc and process-based information sharing. Together, our products and expertise help companies harness the power of their information and the Web to deliver high-value interactions, build communities online and meet users’ demands for any content, at anytime, anywhere, on the device of the user’s choosing.
The Company was incorporated in Delaware on December 19, 1995. Vignette currently markets its products and services throughout the Americas, Europe, Asia and Australia. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated upon consolidation.
NOTE 2 - Summary of Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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 periods. Actual results could differ from those estimates and such differences could be material to the financial statements. In particular, actual sublease income attributable to the consolidation of excess facilities might deviate from the assumptions used to calculate the Company’s accruals for facility lease commitments vacated as a result of both its business restructuring and business acquisitions. During the year ended December 31, 2008, the Company continued to execute on its existing business restructuring plan. It is reasonably possible that sublease assumptions could change further in the near term, requiring adjustments to future income.
The Company periodically reviews the valuation and amortization of its identifiable intangible assets, taking into consideration any events or circumstances that might result in a diminished fair value or useful life. During the years ended December 31, 2008 and December 31, 2007, no changes to the established estimated lives for identifiable intangible assets were made and no impairment charges were deemed necessary.
Revenue recognition. Revenue consists of product and service fees. Product fee income is earned through the licensing or right to use our software and from the sale of specific software products. Service fee income is earned through the sale of maintenance and support services, subscription services, consulting services and training services.
We do not recognize revenue for agreements with rights of return, refundable fees, cancellation rights or acceptance clauses until such rights to return, refund or cancel have expired or acceptance has occurred.
We recognize revenue in accordance with Statement of Position (“SOP”) 97-2, Software Revenue Recognition, as amended by SOP 98-4 and SOP 98-9, Securities and Exchange Commission Staff Accounting Bulletin (“SAB”) 101, Revenue Recognition in Financial Statements as revised by SAB 104 and Emerging Issues Task Force (“EITF”) 00-21, Revenue Arrangements with Multiple Deliverables.
VIGNETTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Where software licenses are sold with maintenance and support or other services, we allocate the total fee to the various elements based on the fair values of the elements specific to us. We determine the fair value of each element in the arrangement based on vendor-specific objective evidence (“VSOE”) of fair value. VSOE of fair value is based upon the normal pricing and discounting practices for those products and services when sold separately and, for support services, is measured by the renewal rate. For all of our multiple element contracts where software license is one of the delivered elements we use the residual method. Under the residual method, the arrangement fee is first allocated to the undelivered elements based upon their VSOE of fair value and the remaining arrangement fee, including any discount, is then allocated to the delivered element. If the residual method is not used, discounts, if any, are applied proportionately to each element included in the arrangement based on each element’s fair value without regard to the discount.
Revenue allocated to product license fees is recognized when persuasive evidence of an agreement exists, delivery of the product has occurred, no significant remaining obligations with regard to implementation are outstanding and collection of a fixed or determinable fee is reasonably assured. We consider all payments outside our normal payment terms, including all amounts due in excess of one year, to not be fixed and determinable and such amounts are recognized as revenue as they become due. If collectibility is not considered reasonably assured, revenue is recognized when the fee is collected. For software arrangements where we are obligated to perform professional services for implementation of the product, we evaluate whether delivery has occurred upon shipment of software or upon completion of services and if the customer payment is reasonably assured. This evaluation is made based on various factors such as the nature of the services work, order type (e.g. initial vs. follow-on), customer’s payment history, if such services are available from other vendors, if we have sufficient experience in providing such services, etc. In the instances where delivery is deemed not to have occurred upon shipment based on the aforementioned factors, license revenue is recognized as our obligations under the implementation are met.
Revenue from perpetual licenses that include unspecified, additional software products is recognized ratably over the term of the arrangement, beginning with the delivery of the first product.
Revenue allocated to maintenance and support services is recognized ratably over the maintenance term.
Revenue allocated to subscription services, including implementation and set-up fees, is recognized ratably over the term of the arrangement beginning on the commencement dates of each contract. We recognize professional services sold with an initial subscription order over the term of the related subscription contract as these services are considered to be inseparable from the subscription service.
Revenue allocated to training and consulting service elements is recognized as the services are performed.
We follow very specific and detailed guidelines, discussed above, in determining revenues; however, certain judgments and estimates are made and used to determine revenue recognized in any accounting period. Material differences may result in the amount and timing of revenue recognized for any period if different conditions were to prevail.
Cash, Cash Equivalents and Short-Term Investments
The Company considers all highly liquid investment securities with an original maturity of three months or less at the date of purchase to be cash equivalents.
Short-term investments consist of a restricted investment, and marketable securities that have remaining maturities of less than one year from the balance sheet date, excluding cash equivalents as described above.
VIGNETTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. SFAS No. 157 classifies the inputs used to measure fair value into the following hierarchy:
1. Level 1 Inputs - quoted prices in active markets for identical assets and liabilities that the reporting entity has the ability to obtain at the measurement date. This level provides the most reliable evidence of fair value.
2. Level 2 Inputs - inputs other than quoted prices included within Level 1 that are directly or indirectly observable for the asset or liability (i.e. default rates, credit risks, loss severities).
3. Level 3 Inputs - Used to measure fair value assets and liabilities that little, if any, market activity exists at the measurement date. These inputs reflect the reporting entity’s own assumptions about the assumptions that market participants would use in pricing the asset or liability.
Short-term investments consisted of the following (in thousands):
The Company holds restricted investments in the form of a certificate of deposit placed with high credit quality financial institutions. Such restricted investments collateralize letters of credit related to certain leased office space security deposits. These investments will remain restricted to the extent that the security requirements exist. Based on the inputs used to estimate fair values for restricted investments, the Company has determined that our restricted investments are Level 1 in the fair value hierarchy.
Short-term marketable securities are classified as “available-for-sale” and are presented at estimated fair value with any unrealized gains or losses included in other comprehensive income (loss). Realized gains and losses are computed based on the specific identification method. Realized gains and losses were not material for the periods presented. Short-term marketable securities consist of the following (in thousands):
Accounts Receivable
Accounts receivable are recorded at cost. We continuously assess the collectibility of outstanding customer invoices and, in doing so, we maintain an allowance for estimated losses resulting from the non-collection of customer receivables. In estimating this allowance, we consider factors such as: historical collection experience, a customer’s current credit-worthiness, customer concentrations, age of the receivable balance, both individually and in the aggregate and general economic conditions that may affect a customer’s ability to pay. Actual
VIGNETTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
customer collections could differ from our estimates. For example, if the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.
We write off accounts receivable when they become uncollectible and payments subsequently received on such receivables are credited to the allowance for doubtful accounts.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist of short-term investments; trade accounts receivable and restricted investments. The Company’s short-term investments and restricted investments are placed with high credit quality financial institutions.
The Company performs periodic credit evaluations of its customers’ financial condition and generally does not require collateral. The Company maintains an allowance for estimated losses resulting from the non-collection of customer receivables. In estimating this allowance, the following factors are considered: historical collection experience, a customer’s current credit-worthiness, customer concentrations, age of the receivable balance, both individually and in the aggregate and general economic conditions that may affect a customer’s ability to pay. The following table summarizes the changes in allowance for doubtful accounts for trade receivables (in thousands):
No customers accounted for more than 10% of the Company’s total revenue or accounts receivable during the years ended December 31, 2008, 2007, or 2006.
Long-Term Investments
Long-term investments consisted of the following (in thousands):
The Company holds restricted investments in the form of a certificate of deposit and investment grade securities placed with high credit quality financial institutions. Such restricted investments collateralize letters of credit related to certain leased office space security deposits and tax obligations. These investments will remain restricted to the extent that the security requirements exist or until the tax obligations are settled. The average yield of these investments is approximately 2.31%.
Long-term marketable securities are classified as “available-for-sale”, have remaining maturities of greater than one year from the balance sheet date and are presented at estimated fair value with any unrealized gains or
VIGNETTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
losses included in other comprehensive income (loss). Realized gains and losses are computed based on the specific identification method. Realized gains and losses were not material for the periods presented.
Long-term marketable securities consist of the following (in thousands):
The Company holds a less than 20% interest in, and does not exert significant influence over, a limited partnership interest in a technology incubator. The Company, therefore, applies the cost method.
The Company periodically analyzes its long-term investments for impairments considered other than temporary. In performing this analysis, the Company evaluates whether general market conditions that reflect prospects for the economy as a whole or information pertaining to the specific investment’s industry, or that individual company, indicates that an other than temporary decline in value has occurred. If so, the Company considers specific factors, including the financial condition and near-term prospect of each investment, any specific events that may affect the investee company, and the intent and ability of the Company to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. As a result of these reviews, the Company recognized no impairment charges in fiscal 2008, 2007, and 2006.
Financial Instruments
The reported amounts of certain of the Company’s financial instruments, including cash and cash equivalents, short-term investments, accounts receivables, accounts payable and accrued liabilities approximate fair value based on the short term nature of these items. We utilize foreign currency forward contracts to hedge foreign currency-denominated payables and receivables. To date, we have not hedged forecasted transactions or firm commitments denominated in foreign currencies and therefore, financial reporting of our foreign operations is subject to foreign currency risk. Gains and losses on hedging contracts are reflected currently in other income, net. Under our policy, we may enter into foreign currency forward contracts for a term of up to one year. We do not invest in contracts for speculative purposes. Our foreign exchange exposures are monitored regularly to ensure the overall effectiveness of our foreign currency hedge positions. Our program is not designed to hedge all currency risk, but is designed to mitigate large foreign currency exposures recorded on our balance sheet. As part of this monitoring program, in order to evaluate the effectiveness of our hedging practices, in the second quarter of 2007 we did not replace foreign currency hedge positions which expired and re-engaged our foreign currency hedge program in the fourth quarter of 2008. For the year ended December 31, 2008, 2007 and 2006, the Company realized a loss on foreign currency contracts of $0.2 million, $0.3 million and $13,000, respectively. At December 31, 2008, the notional value of the foreign currency contracts was $1.3 million and, based on the applicable exchange rates, the fair value of derivative financial instruments was a liability of $99,000. At December 31, 2007 we had no foreign currency contracts outstanding.
At December 31, 2008 we had no foreign currency contracts outstanding. Foreign currency contracts are classified on the balance sheet in “Prepaid expenses and other” or in “Other current liabilities.”
VIGNETTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Property and Equipment
Property and equipment are stated at cost. Depreciation of assets is computed using the straight-line method over the estimated useful lives of the assets, ranging from three to five years.
Major improvements are capitalized, while maintenance and repairs that do not substantially enhance or extend the estimated useful life of the assets benefited are charged to expense in the period incurred. Upon asset retirement or disposal, any resulting gain or loss is included in the results of operations.
During 2008, the Company disposed of approximately $11.4 million of fully depreciated assets as part of its annual inventory and useful life evaluation. In addition, during the second quarter of 2008, the Company added $0.8 million of assets as part of its acquisition of Vidavee - see Note 3 for further details.
Impairment of Long-Lived Assets
The Company periodically reviews the carrying amounts of long-lived assets to determine whether current events or circumstances, as defined in Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, (“Statement 144”), warrant adjustment to such carrying amounts. In reviewing the carrying amounts of long-lived assets, the Company considers, among other factors, the future cash inflows expected to result from the use of the asset and its eventual disposition less the future cash outflows expected to be necessary to obtain those inflows. Based on this review no such impairment charges were recorded in 2008, 2007 or 2006.
Goodwill and Other Intangible Assets
Goodwill represents the excess purchase price over the fair value of net assets acquired, or net liabilities assumed, in a business combination.
Other intangible assets are being amortized over the assets’ estimated useful lives using the straight-line method. Estimated useful lives range from one to six years. Amortization of acquired technology is considered a cost of revenue and is presented as “Amortization of acquired technology” in the consolidated statements of operations. Amortization of non-compete contracts, customer relationships, trademarks and capitalized research is considered operating expense and included in “Amortization of intangible assets” in the consolidated statements of operations. The Company periodically reviews the estimated useful lives of its other intangible assets, taking into consideration any events or circumstances that might result in a diminished fair value or revised useful life.
The Company periodically assesses its intangible assets, including goodwill, for indications of impairment. Based on this assessment no such impairment charges were recorded in 2008, 2007 or 2006.
Comprehensive Income
The Company’s comprehensive income is included as a component of shareholders’ equity and is composed of net income, foreign currency translation adjustments and unrealized gains and losses on investments designated as available-for-sale. See the components of comprehensive income for the years ended December 31, 2006, 2007 and 2008, including their ending balances and period changes, included in the Consolidated Statements of Changes in Shareholders’ Equity at page of this Form 10-K.
VIGNETTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Research and Development
Research and development expense consists primarily of personnel costs to support product development and is expensed as incurred.
The Company evaluates costs related to certain software development activities in accordance with Statement of Financial Accounting Standards 86, Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed (“Statement 86”). Under Statement 86, capitalization commences when technological feasibility has been established and ceases when the product is available for general release to customers. Based on the Company’s product development process, technological feasibility is established upon completion of a working model. To date, the time between achieving technological feasibility and the general availability of software has been short and internal costs qualifying for capitalization have been insignificant. During fiscal years 2008, 2007 and 2006 no such costs were capitalized.
Foreign Currency
The functional currency of the Company’s foreign subsidiaries is the respective local currency. Assets and liabilities of these foreign subsidiaries are translated to U.S. dollars at year-end exchange rates. Income statement items are translated to U.S. dollars at average exchange rates prevailing during the period. Accumulated net translation adjustments are recorded in “Accumulated other comprehensive income,” a separate component of stockholders’ equity. Gains and losses from foreign currency denominated transactions are included in other income, net in the consolidated statements of operations. Gains and losses from foreign currency denominated transactions amounted to a $0.1 million gain, a $0.2 million gain and a $0.6 million loss for the years ended December 31, 2008, 2007 and 2006, respectively.
Share Based Payments
At December 31, 2008, the Company has five stock based compensation plans which are described more fully in Note 5. The fair value method has been applied using the modified prospective method, under which compensation cost has been recognized beginning January 1, 2006 for all share-based payments granted or modified after that date and for all awards granted to employees prior to that date that were unvested on January 1, 2006.
For the year ended December 31, 2008, the Company recognized $5.9 million for stock based compensation. The expense includes $2.5 million for stock options, $3.0 million for restricted stock awards and $0.4 million for the employee stock purchase plan (“ESPP”). For the year ended December 31, 2007, the Company recognized $4.2 million for stock based compensation. The expense includes $2.0 million for stock options, $1.8 million for restricted stock awards and $0.4 million for the employee stock purchase plan. The Company recognized $3.2 million in the year ended December 31, 2006, for stock based compensation. This expense includes $1.7 million for stock options, $1.1 million for restricted stock awards and $0.4 million for the employee stock purchase plan. The tables below present the costs recorded related to stock based compensation and the effect of stock based compensation on earnings per share for the years ended December 31, 2008, 2007 and 2006, respectively:
VIGNETTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Stock compensation expense is attributable to the following cost categories (in thousands):
Product Warranties
The Company offers warranties to its customers which require the Company to replace defective products within a specified time period from the date of sale. The Company records warranty costs as incurred and historically such costs have not been material.
Advertising Costs
Advertising costs are expensed as incurred. The company did not recognize any material advertising expenses for the years ended December 31, 2008, 2007, and 2006, respectively.
Taxes Collected from Customers
In the course of doing business the Company collects various taxes from customers including, but not limited to, sales taxes and value added taxes and goods and services taxes. It is the Company’s policy to record these on a net basis in the consolidated statement of operations and, therefore, we do not include taxes collected from customers as a component of revenue.
Income Taxes
The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes. SFAS 109 requires the use of the asset and liability method whereby deferred tax asset and liability account balances are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. These differences result in deferred tax assets and liabilities, which are included in the Company’s consolidated balance sheet.
The Company then assesses the likelihood of realizing benefits related to such assets by considering factors such as historical taxable income and our ability to generate sufficient taxable income of the appropriate character within the relevant jurisdictions in future years. If the realization of these assets is not likely based on these factors, a valuation allowance is established against our deferred tax assets.
VIGNETTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The Company adopted FASB Interpretation No. (FIN) 48, Accounting for Uncertainty in Income Taxes, on January 1, 2007. FIN 48 provides specific guidance for recognition, measurement and disclosure of uncertain tax positions that meet a more-likely-than-not threshold.
Earnings Per Share
Basic net income (loss) per share is computed by dividing the net income available to common stockholders for the period by the weighted average number of common shares outstanding during the period, excluding shares subject to repurchase or forfeiture. Diluted earnings per share is computed by dividing net income available to common stockholders for the period by the weighted average number of common shares outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if the dilutive potential shares of common stock had been issued. The dilutive effect of outstanding options, shares to be purchased under the employee stock purchase plan, and unvested restricted stock is reflected in diluted earnings per share by application of the treasury stock method. Under the treasury stock method, an increase in the fair market value of the Company’s common stock can result in a greater dilutive effect from outstanding options and restricted stock (RSA). Additionally, the exercise of common stock options and the vesting of restricted stock can increase shares outstanding and has a dilutive effect on earnings per share. The Company excludes outstanding stock options from the computation of diluted earnings per share when such inclusion would be anti-dilutive. The Company excluded 2.4 million outstanding out-of-the-money stock options for the year ended December 31, 2008. For the years ended December 31, 2007 and 2006 the Company excluded 0.8 million and 1.4 million out-of-the-money outstanding stock options, respectively.
For the year ended December 31, 2008, diluted net loss per share is presented at the basic net loss per share amount as the effect of the assumed RSA vesting, stock option exercises and ESPP purchases are anti-dilutive. For the year ended December 31, 2008, the Company had in-the-money outstanding RSA grants and common stock options of 193,605 calculated under the treasury stock method. Such outstanding in-the-money RSA grants and common stock options have been excluded from the calculation of diluted net loss per share, as their inclusion would be anti-dilutive.
The following table sets forth the computation of basic and diluted earnings per share for the years ended December 31, 2008, 2007 and 2006, respectively (in thousands except per share data):
VIGNETTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Segments
The Company applies Statement of Financial Accounting Standards (SFAS) No. 131, Disclosures about Segments of an Enterprise and Related Information, and considers its business activities to constitute a single segment.
Employee 401(k) Plan
In 1997, the Company established a voluntary defined contribution retirement plan qualifying under Section 401(k) of the Internal Revenue Code of 1986 (“The Plan”). Participants are allowed to make voluntary contributions to the Plan up to 25% of compensation. The Company can make discretionary contributions to the Plan of amounts determined and authorized by the Company’s Board of Directors up to the maximum amounts permitted by the Internal Revenue Service (“IRS”). Participants direct the investment allocation of all contributions. Contributions are subject to limitations imposed by the Internal Revenue Code (the “Code”). For the year ended December 31, 2006, the Company chose to match the first one thousand dollars of each participant’s contributions for a total company contribution of $286,000. For the years ended December 31, 2008 and 2007, the Company chose to match 50% of the first four thousand dollars of each participant’s contributions for a total company contribution of $576,000 and $528,000, respectively.
Recent Accounting Pronouncements
In February 2008, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) Financial Accounting Standard (FAS) 157-1 “Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13” removing leasing transactions accounted for under Statement 13 and related guidance from the scope of SFAS No. 157. Also in February 2008, FSP FAS 157-2 “Partial Deferral of the Effective Date of Statement 157” (FSP FAS 157-2) was issued, deferring the effective date of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008. The Company is currently assessing the impact of SFAS No. 157 for nonfinancial assets and nonfinancial liabilities on our consolidated balance sheet and statement of operations.
In December 2007, the Financial Accounting Standards Board issued Statement 141 (revised 2007), Business Combinations (Statement 141R) to change how an entity accounts for the acquisition of a business. When effective, Statement 141R will replace existing Statement 141 in its entirety, will amend Statement 109 and Interpretation 48 and will also amend the goodwill impairment test requirements in Statement 142. Statement 141R is effective for fiscal years and interim periods within those fiscal years beginning on or after December 15, 2008. Early adoption is prohibited.
Through fiscal year December 2008, the Company currently recorded all changes to a valuation allowance for acquired deferred tax assets or the effect of changes in an acquired tax position that occur after the acquisition date by initially reducing the related goodwill to zero, next by reducing other noncurrent intangible assets related to the acquisition to zero and lastly by reducing income tax expense. However, Statement 141R amends Statement 109 and Interpretation 48 to require the Company to recognize changes to the valuation allowance for an acquired deferred tax asset or the effect of changes to an acquired tax position as adjustments to income tax expense or contributed capital, as appropriate, and not as adjustments to goodwill. This accounting under Statement 141R becomes effective January 1, 2009 for the Company and applies to valuation allowances and tax positions related to acquisitions accounted for originally under Statement 141 as well as those accounted for under Statement 141R. The Company had a $21.0 million valuation allowance at December 31, 2008 related to deferred tax assets acquired in business combinations. Any change in the valuation allowance subsequent to
VIGNETTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2008 will be recorded as an adjustment to income tax expense rather than as an adjustment to goodwill or other noncurrent intangible assets.
Statement 141R amends the goodwill impairment test requirements in Statement 142. For a goodwill impairment test as of a date after the effective date of Statement 141R, the value of the reporting unit and the amount of implied goodwill, calculated in the second step of the test, will be determined in accordance with the measurement and recognition guidance on accounting for business combinations under Statement 141R. This change could affect the determination of what amount, if any, should be recognized as an impairment loss for goodwill recorded before the effective date of Statement 141R. This accounting under Statement 141R becomes effective January 1, 2009 for the Company and applies to goodwill related to acquisitions accounted for originally under Statement 141 as well as those accounted for under Statement 141R. The Company has $121.1 million of goodwill at December 31, 2008 related to previous business combinations. The Company has not determined what effect, if any, Statement 141R will have on the results of its impairment testing subsequent to December 31, 2008.
From time to time, new accounting pronouncements applicable to the Company are issued by the FASB or other standards setting bodies, which we will adopt as of the specified effective date. Unless otherwise discussed, we believe the impact of recently issued standards that are not effective will not have a material impact on our consolidated financial statements upon adoption.
NOTE 3 - Business Combinations and Acquired In-Process Research and Development
Acquisition of Micronets, Inc. (d/b/a “Vidavee”)
On April 22, 2008, the Company completed its acquisition of all of the issued and outstanding stock of MicroNets, Inc. (d/b/a “Vidavee”), a leading provider of video publishing technology. Vidavee is a Web services company that enables Web publishers to easily upload, share, analyze and monetize Internet video content. The strategic acquisition and integration of Vidavee’s advanced video publishing technology provides video management and publishing capabilities to help advertisers and publishers generate new traffic, improve customer engagement and increase revenues, thus differentiating Vignette from its competitors.
In accordance with SFAS 141, Business Combinations, the total purchase consideration of $7.0 million, including transaction costs of $0.5 million, has been allocated to the assets acquired and liabilities assumed, including identifiable intangible assets, based on their respective fair values at the date of acquisition. Such allocation resulted in goodwill of $5.3 million. Goodwill is assigned at the enterprise level and is not expected to be deductible for income tax purposes.
VIGNETTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following unaudited condensed consolidated balance sheet data presents the fair value of the assets acquired and liabilities assumed on the date of acquisition (in thousands):
NOTE 4 - Intangible Assets
Goodwill
The changes in the carrying amount of goodwill, net of accumulated amortization and impairment charges, are as follows (in thousands):
The net goodwill balance of $121.1 million at December 31, 2008 relates to the MicroNets (d/b/a Vidavee) business combination completed in April 2008, the Tower Technology business combination completed in March 2004, the Intraspect business combination completed in December 2003 and the Epicentric business combination completed in December 2002.
The acquisition and purchase price adjustments in 2008 are associated with the Vidavee acquisition completed in April 2008 - See “Note 3 - Business Combinations and Acquired In-Process Research and Development” for further details.
VIGNETTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The purchase price adjustments in 2007 are associated with the Company realizing the benefit of previously unrecognized tax assets, acquired as part of these business combinations. See “Note 9 - Income Taxes” for further detail regarding the purchase price adjustments.
Goodwill Impairment Tests
In accordance with Statement of Financial Accounting Standard No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”) , the Company assesses its goodwill for impairment on October 1 of each year or more frequently if events or changes in circumstances indicate that goodwill might be impaired. As required by SFAS 142, the impairment test is accomplished using a two-stepped approach. The first step screens for impairment by comparing the fair value of the Company with its carrying amount, including goodwill. To determine the Company’s fair value, the Company employs a market capitalization approach, comparing the net book value of the Company to its market capitalization, adjusted to reflect market observed control premiums. If, under the first step, an, impairment is indicated, a second step is performed which applies additional valuation techniques to determine if there is an impairment and how much the impairment would be. This second step compares the implied fair value of the goodwill with the carrying amount of the goodwill. The implied fair value of goodwill is determined based on a variety of valuation techniques including discounted cash flows and earnings or revenue multiples. As of October 1, 2008, the Company determined the market capitalization, after considering market observed control premiums, exceeded net book value and that the remaining net goodwill balance of $121.1 million at October 1, 2008 was not considered to be impaired.
In accordance with SFAS 142, goodwill of a reporting unit shall be tested for impairment on an annual basis and between annual tests in certain circumstances. Driven by the significant decline in the market capitalization of public companies in its peer group in the fourth quarter of 2008, the Company concluded that it should again test its goodwill for impairment on December 31, 2008. In accordance with paragraph 25 of SFAS 142 the company considered a variety of industry standard revenue multiples, probability weighted, its available cash balances and market capitalization, after considering market observed control premiums. Using these reference points, the Company has determined that the remaining net goodwill balance of $121.1 million at December 31, 2008 was not considered to be impaired.
The company recognizes that, over the longer term, the market price for our stock plus an appropriate control premium should represent fair value and, if market conditions fail to improve, we may incur charges for goodwill impairment in the future, which could be significant and could have a material negative effect on our results of operations.
For 2007 and 2006, no impairment of goodwill was indicated based on the Company’s market capitalization at those dates.
VIGNETTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Intangible Assets with Definite Lives
Following is a summary of the Company’s intangible assets that are subject to amortization (in thousands):
The Company’s intangible assets with definite lives with remaining net carrying amounts are being amortized over the assets’ estimated useful lives using the straight-line method. The weighted average useful life for intangible assets in total with definite lives is 65 months and 36 months for Tower and Vidavee, respectively. The Company periodically reviews the estimated useful lives of its identifiable intangible assets, taking into consideration any events or circumstances that might result in either a diminished fair value or revised useful life. Total amortization expense for the years ended December 31, 2008, 2007 and 2006 was $8.6 million, $8.4 million, and $8.7 million, respectively. Of these amounts, $3.4 million, $3.4 million, and $3.7 million, was recorded as “Amortization of intangible assets” in operating expenses, respectively and the remaining $5.2 million, $5.0 million, and $5.0 million, respectively, was recorded as a cost of revenue.
Estimated annual amortization expense (in thousands) over the remaining amortization period is as follows:
NOTE 5 - Shareholders’ Equity
Common Stock
The Company authorized the issuance of 500,000,000 shares of $0.01 par value common stock. A portion of the shares issued are restricted and are subject to forfeiture, until the respective vesting requirement is achieved, which is generally one to three years from grant or issuance. As of December 31, 2008, 653,854 shares were subject to forfeiture under restricted stock awards.
VIGNETTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
As of December 31, 2008, the Company reserved shares of its common stock for the following purposes:
Preferred Stock
The number of shares authorized to be designated as preferred stock was 10,000,000 at December 31, 2008. There were no preferred shares outstanding at December 31, 2008 or 2007.
Shareholder Rights Plan
In April 2002, the Board adopted a shareholder rights plan (the “Plan”). The Plan was not adopted in response to any attempt to acquire the Company, nor was the Company aware of any such efforts at the time of adoption. The Plan was designed to enable the Company’s stockholders to realize the full value of their investment by providing for fair and equal treatment of all stockholders in the event that an unsolicited attempt is made to acquire the company. Adoption of the Plan was intended to guard shareholders against abusive and coercive takeover tactics.
Under the Plan, stockholders on May 6, 2002 received one right to purchase a one one-hundredth of a share of Series A Junior Participating Preferred Stock, par $0.01 per share, at a price of $300.00 per one one-hundredth, subject to adjustment. The rights were issued as a non-taxable dividend and will expire 10 years from the date of the adoption of the Plan, unless earlier redeemed or exchanged. The rights are not immediately exercisable. However, they will become exercisable upon the earlier to occur of (i) the close of business on the tenth day after a public announcement that a person or group has acquired beneficial ownership of 15 percent or more of the Company’s outstanding common stock or (ii) the close of business on the tenth day (or such later date as may be determined by the Board of Directors prior to such time as any person becomes an acquiring person) following the commencement of, or announcement of an intention to make, a tender offer or exchange offer that would result in the beneficial ownership by a person or group of 15 percent or more of the Company’s outstanding common stock. If a person or group acquires 15 percent or more of the Company’s common stock, then all rights holders except the acquirer will be entitled to acquire the Company’s common stock at a significant discount. The intended effect will be to discourage acquisitions of 15 percent or more of the Company’s common stock without negotiation with the Board of Directors.
Stock Plans
The Company has established five stock plans: (i) the 1995 Stock Option/Stock Issuance Plan (the “1995 Plan”); (ii) the 1999 Equity Incentive Plan (the “1999 Plan”); (iii) the 1999 Supplemental Stock Option Plan (the “1999 Supplemental Plan”); (iv) the 1999 Non-Employee Directors Option Plan (the “Directors’ Plan”) and (v) the Employee Stock Purchase Plan and the International Employee Stock Purchase Plan (the “ESPP”). Of these plans, the 1995 Plan, the 1999 Plan, the Directors’ Plan and the ESPP have been approved by the Company’s shareholders. The 1999 Supplemental Plan did not require approval by the Company’s shareholders.
Under the 1995 Plan, certain employees, members of the Board and independent advisors were granted options to purchase shares of the Company’s common stock and were issued shares of the Company’s common stock. Options are immediately exercisable. The Company also has the right of first refusal for any proposed
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
disposition of shares issued under the 1995 Plan. The stock options and the related exercised stock will generally vest over a four-year cumulative period. The term of each option is no more than ten years from the date of grant. Stock issuance may be for purchase or as a bonus for services rendered to the Company. Options may not be granted from the 1995 Plan subsequent to the Company’s initial public offering, therefore, no shares were available for future grant under the 1995 Plan at December 31, 2008. Options that expire and shares reacquired under the 1995 Plan will be available for future grants under the 1999 Plan.
Under the 1999 Plan, employees, non-employee members of the Board and consultants may be granted options to purchase shares of common stock, stock appreciation rights, restricted shares and stock units. Options are exercisable in accordance with each stock option agreement. The term of each option is no more than ten years from the date of grant. The compensation committee of the board of directors determines the vesting for each grant. All outstanding options as of December 31, 2008 vest over a period of three to four years. At December 31, 2008, there were 7,239,387 shares authorized for issuance, including shares assumed from the 1995 Plan, of which 902,114 were available for future grant.
Under the 1999 Supplemental Plan, only employees and consultants who are common-law employees of the corporation are eligible for the grant of options. Employees who are officers of the corporation are not eligible for the grant of options under this Plan. The compensation committee of the board of directors determines the vesting for each grant. At December 31, 2008, there were 3,300,000 shares authorized for issuance of which 2,310,292 were available for future grant.
Under the Directors’ Plan, non-employee members of the Board may be granted non-qualified options to purchase shares of common stock. Vesting for options granted prior to April 2004 occurs over a four-year cumulative period. Vesting of options granted after April 2004 occurs over a one-year period. The term of each option is no more than ten years from the date of grant. At December 31, 2008, there were 150,000 shares authorized for issuance of which 73,500 were available for future grant.
Under the ESPP, as amended, the Company has reserved 2,157,286 shares of common stock for issuance to participating employees. The plan is considered compensatory by the Company. Under the terms of the ESPP, there are two, six-month offerings per year. Employees may direct the Company to withhold up to 15% of their salary to purchase the Company’s common stock. An employee may purchase a maximum of 200 shares per six-month offering period. As of December 31, 2008, 1,236,782 shares were issued under the ESPP. This plan has 920,504 shares available for future issuance.
In addition to the aforementioned plans, the Company assumed several plans through its business combinations. These assumed plans have not been approved by the Company’s shareholders; however, upon assumption, these plans terminated and no further options may be granted. Options previously granted under these plans that have not yet expired continue to be administered under the governing plan and any portions that expire or become unexercisable for any reason shall be cancelled and be unavailable for future issuance.
VIGNETTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following table summarizes stock option activity and related information through December 31, 2008.
The following table summarizes options outstanding and exercisable as of December 31, 2008:
Fair Value Disclosures for Stock Options
Actual compensation cost for the years ended December 31, 2008, 2007 and 2006 has been recognized using the fair value method as required by Statement 123R and has been included in the determination of net income and net income per share. The Company bases expected volatility on historical volatility. The expected term is calculated based on an analysis of historical exercises of stock options. The Company bases the estimate of the risk-free rate on the U.S. Treasury rates in effect at the time of the grant. The Company has never paid cash dividends and does not currently intend to pay cash dividends and has assumed a 0% dividend yield. Fair value
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
was estimated using the Black-Scholes option-pricing model, with the following assumptions, for stock options and the ESPP granted in the years ended December 31, 2008, 2007 and 2006, respectively:
As of December 31, 2008 the unamortized cost for outstanding stock options is approximately $6.0 million. The estimated unamortized cost is net of estimated forfeitures used in computing compensation expense. The Company will adjust the estimate of forfeitures over the requisite service period based on the extent to which actual forfeitures differ from such estimates. Changes in estimated forfeitures will be recognized with a cumulative catch-up adjustment in the period of change and will also impact the amount of compensation expense to be recognized in future periods. The Company expects to recognize that expense over a weighted average period of approximately 1.4 years. The aggregate intrinsic value of stock options exercised for the year ended December 31, 2008 was $0.1 million.
Fair Value Disclosure for Restricted Stock Awards
All outstanding restricted stock awards (RSAs) were issued with a zero exercise price. Therefore, the fair value of RSAs is generally equal to their intrinsic value at date of grant. The total intrinsic value at date of grant for the RSAs outstanding at December 31, 2008 is approximately $9.3 million with an unamortized cost of approximately $4.2 million, net of estimated forfeitures.
Share Repurchase Program
On November 12, 2006, the Board of Directors of the Company approved a stock repurchase program of up to $75 million of the Company’s common stock over the following 12 months. In addition, on November 2, 2007, the Board of Directors of the Company approved an extension to the stock repurchase program approved on November 12, 2006 authorizing the purchase of up to an additional $75 million of the Company’s common stock over an indefinite period. Purchases are made from time to time as market and business conditions warrant, in the open market, negotiated or block transactions, in accordance with applicable laws, rules and regulations. As of December 31, 2008 the Company has repurchased 7,469,076 shares under the programs at an average market price of $16.09 per share. The Company paid cash of approximately $120.2 million for these repurchases.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
During July 2008, the Company suspended the share repurchase program as Management felt that the capital structure of the Company was well balanced at that point. The Company retains the right to repurchase the remaining $30 million. The Company uses the cost method to account for treasury stock.
NOTE 6 - Business Restructuring
In 2001, we initiated a restructuring program to align our expense and revenue levels and to better position us for growth and profitability. In 2002, 2003 and 2004, we expanded those restructuring efforts. In the third and fourth quarters of 2008, we implemented a restructuring plan to reallocate certain employee related investments and reduce our costs.
There can be no assurance that the estimated costs of our restructuring efforts will not change. Components of business restructuring charges and the remaining restructuring accruals as of December 31, 2008 are as follows (in thousands):
Consolidation of Excess Facilities
Facility lease commitments relate to lease obligations for excess office space that the Company has vacated as a result of various restructuring plans implemented between 2001 and 2004. The Company continues to actively pursue mitigation strategies to dispose of all excess office space through subleasing and/or early termination negotiations where possible. The total lease commitments include the estimated lease buyout fees or the remaining lease liabilities and estimated associated mitigation costs including, but not limited to, brokerage
VIGNETTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
commissions, legal fees, repairs, restoration costs and sublease incentives, offset by estimated sublease income. The estimated costs of vacating these leased facilities, including estimated costs to sublease and any resulting sublease income, were based on market information and trend analysis as estimated by the Company. The Company continually assesses its real estate portfolio and may vacate and/or occupy other leased space as dictated by its analysis and by the needs of the business. It is reasonably possible that actual results could differ from these estimates in the near term and such differences could be material to the financial statements. In particular, actual sublease income attributable to the consolidation of excess facilities might deviate from the assumptions used to calculate the Company’s accrual for facility lease commitments. Facility lease commitments relate to the Company’s departure from certain office space in Austin, Texas and New York City, New York. The maximum lease commitment of such vacated properties extends through November 2011.
Employee Separation and Other Costs
Employee separation and other costs include severance, related taxes, outplacement and other restructuring charges together with a $1 million contract termination fee associated with an amended vendor agreement executed during the year, which allows the Company to solicit for hire personnel who are currently performing subcontractor services (refer to the 8-K filed on August 28, 2008). As a result of the restructuring activities, the Company severed approximately 92 employees during the third and fourth quarters of 2008. Employee groups impacted by the restructuring efforts include personnel in the sales, marketing, engineering and general and administrative functions.
NOTE 7 - Commitments and Contingencies
The Company leases its office facilities and various equipment under operating lease agreements having expiration dates through 2017. The Company has operating leases for facilities with escalating rents. Pursuant to SFAS 13 - Accounting for Leases, the Company recognizes rent expense on a straight line basis over the lease term. Rent expense, excluding vacated properties, for the years ended December 31, 2008, 2007 and 2006 was $3.6 million, $3.5 million, and $5.0 million, respectively. At December 31, 2008, estimated future rents receivable from signed sublease agreements are $2.0 million through 2011. Future minimum rental payments as of December 31, 2008 under our lease obligations, including operating lease commitments for all vacated properties, are as follows (in thousands):
Software License Indemnifications
Financial Accounting Standards Board Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (“Interpretation 45”), requires that the Company recognize the fair value for certain guarantee and indemnification arrangements issued or modified by the Company after December 31, 2002. Some of the software licenses granted by the Company contain provisions that indemnify customers of the Company’s software from damages and costs resulting from claims alleging that the Company’s software infringes on the intellectual property rights of a third party. The
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Company records resulting costs as incurred and historically, such costs have not been material. Accordingly, the Company has not recorded a liability related to these indemnification provisions.
We cannot guarantee that the steps we have taken to protect our proprietary rights will be adequate to deter misappropriation of our intellectual property and we may not be able to detect unauthorized use and take appropriate steps to enforce our intellectual property rights. If third parties infringe on or misappropriate our copyrights, trademarks, trade secrets or infringe on the intellectual property rights of others, other parties may assert infringement claims against us or claim that we have violated their intellectual property rights. In certain instances we indemnify our customers against these claims. Although we have never had to make payment on a claim, claims against us, either successful or unsuccessful could result in significant legal and other costs and may be a distraction to management.
While we have primarily focused on intellectual property protection within the United States of America (“United States”), we have expanded that scope to selected international markets. Protection of intellectual property outside of the United States will sometimes require additional filings with local patent, trademark, or copyright offices, as well as implementation of contractual or license terms different from those used in the United States. Protection of intellectual property in many foreign countries is weaker and less reliable than in the United States. As our business expands into foreign countries, costs and risks associated with protecting our intellectual property abroad will increase.
NOTE 8 - Legal Matters
Securities Class Action
On October 26, 2001, a class action lawsuit was filed against the Company and certain of its current and former officers and directors in the United States District Court for the Southern District of New York seeking unspecified damages on behalf of a purported class that purchased Vignette common stock between February 18, 1999 and December 6, 2000. Also named as defendants were four underwriters involved in the Company’s initial public offering of Vignette stock in February 1999 and the Company’s secondary public offering of Vignette stock in December 1999. A Consolidated Amended Complaint, which is now the operative complaint, was filed on April 19, 2002. The complaint alleges violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated there under, based on, among other things, claims that the four underwriters awarded material portions of the shares in the Company’s initial and secondary public offerings to certain customers in exchange for excessive commissions. The plaintiff also asserts that the underwriters engaged in “tie-in arrangements” whereby certain customers were allocated shares of Company stock sold in its initial and secondary public offerings in exchange for an agreement to purchase additional shares in the aftermarket at pre-determined prices. With respect to the Company, the complaint alleges that the Company and its officers and directors failed to disclose the existence of these purported excessive commissions and tie-in arrangements in the prospectus and registration statement for the Company’s initial public offering and the prospectus and registration statement for the Company’s secondary public offering.
The action is being coordinated with approximately 300 other nearly identical actions filed against other companies. On October 9, 2002, the Court dismissed the Individual Defendants from the case without prejudice. On December 5, 2006, the Second Circuit vacated a decision by the district court granting class certification in six of the other nearly identical actions (the “focus cases”), which are intended to serve as test cases. The plaintiffs selected these six cases, which do not include the Company. On April 6, 2007, the Second Circuit denied a petition for rehearing filed by the plaintiffs, but noted that the plaintiffs could ask the district court to certify more narrow classes than those that were rejected.
VIGNETTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
On August 14, 2007, the plaintiffs filed amended complaints in the six focus cases. The six focus case issuers and the underwriters named as defendants in the focus cases filed motions to dismiss the amended complaints against them on November 14, 2007. On September 27, 2007, the plaintiffs filed a motion for class certification in the six focus cases. On March 26, 2008, the District Court dismissed the Section 11 claims of those members of the putative classes in the focus cases who sold their securities for a price in excess of the initial offering price and those who purchased outside the previously certified class period. With respect to all other claims, the motions to dismiss were denied. On October 10, 2008, at the request of the plaintiffs, the plaintiffs’ motion for class certification was withdrawn, without prejudice. The parties in the approximately 300 coordinated class actions, including Vignette, the underwriter defendants in the Vignette class action, and the plaintiffs in the Vignette class action, have reached agreements in principle to settle, under which the insurers for the issuer defendants in the coordinated cases will make the settlement payment on behalf of the issuers, including Vignette. The settlement is subject to approval by the parties, termination by the parties under certain circumstances, and Court approval. There is no assurance that the settlement will be concluded or that the Court will approve the settlement. Due to the inherent uncertainties of litigation, we cannot accurately predict the ultimate outcome of the matter. The Company is unable to determine whether the outcome of the litigation will have a material impact on its results of operations or financial condition in any future period if the settlement is not concluded, is terminated, or is not approved. The Company will continue to defend itself vigorously against this lawsuit.
Litigation and Other Claims
We are also subject to various legal proceedings and claims arising in the ordinary course of business. Our management does not expect that the outcome in any of these legal proceedings, individually or collectively, will have a material adverse effect on our financial condition, results of operations or cash flows.
NOTE 9 - Income Taxes
Deferred Tax Asset and Valuation Allowance
As of December 31, 2008, we had domestic federal net operating loss, research and development credit and capital loss carry forwards of approximately $754.0 million, $16.3 million and $15.8 million, respectively. These domestic net operating loss, research and development credit and capital loss carry forwards will expire at various dates, between 2009 and 2027, if not utilized. The Company also had foreign net operating loss carry forwards of approximately $12.1 million that are not subject to expiration.
Internal Revenue Code Section 382 and similar foreign statutes impose substantial restrictions on the utilization of net operating losses, tax credits and capital loss carry forwards in the event of an “ownership change” of a corporation. Domestic net operating loss carry forwards of approximately $184.9 million and tax credit carry forwards of $4.4 million at December 31, 2008 were incurred by businesses we acquired and are subject to annual limitation. The remaining tax attributes that would be subject to annual limitations upon an “ownership change” include domestic net operating loss carry forwards of $569.2 million, capital loss carry forwards of $15.8 million and research and development credit carry forwards of $11.9 million. Based upon a review of historical stock ownership, we do not believe we have undergone an “ownership change” that will limit our ability to utilize these tax attributes prior to their expiration. We do not have actual information of any ownership shifts that may cause an “ownership change” but due to the volatility in the stock market, if there is such change, application of the change in ownership statutes may severely limit our ability to utilize these tax attributes prior to their expiration. If a limitation is triggered from an ownership change it will significantly impact our ability to realize the benefit from our deferred tax asset, potentially resulting in impairment of substantially all of our domestic deferred tax asset of $9.0 million at December 31, 2008.
VIGNETTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred taxes as of December 31, 2008 and 2007 are as follows (in thousands):
Our accounting for deferred taxes under SFAS 109 involves the evaluation of a number of factors concerning the realizability of our deferred tax assets. In 2007, we released $9.8 million of the valuation allowance we had recorded against our net deferred tax asset based on the determination that it is now more likely than not that part of the benefit related to the net operating loss carryforward will be realized. Approximately $7.4 million of the benefit from release of the valuation allowance was recorded as a benefit to our income tax provision and the remaining $2.4 million related to assets of acquired companies and was recorded as a reduction of goodwill. In concluding that releasing part of the valuation allowance was appropriate, we have considered such factors as our operating history and our ability, based on a projection, to generate sufficient taxable income of the appropriate character within the relevant jurisdictions in future years. The deferred tax asset recognized in 2007, consisted of $9.0 million and $0.8 million related to domestic and foreign temporary differences. No deferred income tax expense or benefit was recorded in 2006 or 2008. Although we anticipate the company will be profitable in the future and that some portion of the valuation allowance will be reduced in future periods, a subsequent decrease in profitability in future periods might require an increase to the valuation allowance resulting in a potentially material charge to income tax expense.
Approximately $143.8 million of the valuation allowance relates to net operating loss carry forwards generated by the deduction of stock option compensation. The initial recognition of these deferred tax assets will be credited directly to additional paid-in capital.
Undistributed earnings of the Company’s foreign subsidiaries were immaterial as of December 31, 2008, 2007, and 2006. Those earnings are considered to be permanently reinvested and, accordingly, no provision for U.S. federal or state income taxes has been provided thereon.
Provision for Income Taxes
Income/(loss) before income taxes included approximately ($6.9) million, ($6.8) million and ($4.1) million related to foreign operations in fiscal 2008, 2007 and 2006, respectively. These amounts include amortization of purchased intangible assets of $8.1 million, $8.4 million, and $8.4 million for 2008, 2007 and 2006, respectively.
VIGNETTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The Company’s provision for income taxes for 2008, 2007 and 2006 consists primarily of foreign income taxes and withholdings on income generated in foreign countries. The provision for income taxes differs from the expected tax benefit amount computed by applying the statutory federal income tax rate of 34% to income before income taxes as a result of the following:
The Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes on January 1, 2007. As a result of the implementation, the Company did not recognize any change in the liability for unrecognized tax benefit and, accordingly, recorded no adjustment to the January 1, 2007 balance of retained earnings. A reconciliation of the change in our unrecognized tax benefits, excluding interest and penalties, for the year ended December 31, 2008 is as follows:
At both January 1, 2008 and December 31, 2008 approximately $1.9 million and $2.0 million, respectively, of unrecognized tax benefits are attributed to uncertain tax positions that, if recognized, would have an effective tax rate effect after consideration of any valuation allowance.
The Company accrues and recognizes interest and penalties related to unrecognized tax benefits as a component of income tax expense. As of December 31, 2008, the balance of accrued interest and penalties related to unrecognized tax benefits was approximately $0.4 million and $0.3 million, respectively.
With few exceptions, the Company and all of its major filing subsidiaries are no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2002.
It is reasonably possible that within 12 months of December 31, 2008 the balance of unrecognized tax benefits could increase by up to $0.3 million or decrease by up to $0.4 million due to the following:
i. a ruling from the Indian court of appeals on the Company’s protest of a tax assessment; and
ii. reaching a final agreement in the United Kingdom regarding deduction of interest paid to the U.S. parent company.
VIGNETTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
NOTE 10 - Segments of Business and Geographic Area Information
The Company considers its business activities to constitute a single segment. A summary of the Company’s operations by geographic area follows (in thousands):
The income (loss) from domestic U.S. operations before income taxes, excluding intercompany transactions, was a loss of approximately $5.4 million for the year ended December 31, 2008, and a profit of $20.0 million, and $12.1 million for the years ended December 31, 2007 and 2006, respectively.
VIGNETTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
NOTE 11 - Supplemental Financial Information (Unaudited)
The following tables set forth certain unaudited consolidated statements of operations data, both in absolute dollars and as a percentage of total revenue, for each of our last eight quarters. This data has been derived from unaudited condensed consolidated financial statements that have been prepared on the same basis as the annual audited consolidated financial statements and, in the opinion of the Company’s management, include all normal recurring adjustments necessary for a fair presentation of such information. These unaudited quarterly results should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this Form 10-K. The consolidated results of operations for any quarter are not necessarily indicative of the results for any future period.
(1) Basic and diluted net income per share is computed independently for each of the quarters presented. Therefore, the sum of the quarterly net income per common share information may not equal the annual net income per share.
VIGNETTE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)