Item 1. Business
Overview
We develop and commercialize software for computation, simulation, management and mining of scientific data used by biologists, chemists and materials scientists, including nanotechnology researchers for product design as well as drug discovery and development. Our technology and services are designed to meet the needs of today’s leading research organizations. We are headquartered in San Diego, California and were incorporated in Delaware in 1993. Our company website is located at www.accelrys.com. Copies of our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports are available without charge on our website as soon as reasonably practicable after being filed with or furnished to the U.S. Securities and Exchange Commission (the “SEC”).
Restatement of Financial Statements
In this Report, we have restated our previously issued consolidated financial statements to reflect certain accounting adjustments. The decision to restate our consolidated financial statements was made by the Audit Committee of our Board of Directors on December 16, 2005, following consultation with, and upon the recommendation of, management and Ernst & Young LLP (“E&Y”), our independent registered public accounting firm. Our decision to restate was made in connection with a review of our Annual Report on Form 10-K for the year ended March 31, 2005 by the Corporation Finance Division of the SEC.
Our restated consolidated financial statements contained in this Report reflect changes to the timing of revenue recognized under term-based and perpetual software license arrangements which include multiple elements (typically software licenses and post-contract customer support, referred to as “PCS”) and a change in accounting for software development costs. Our restated consolidated financial statements also reflect the reclassification of general and administrative expenses and interest income between continuing and discontinued operations, the reclassification of cash flows from discontinued operations as
net cash provided by (used in) discontinued operating, investing and financing activities, as opposed to a single line item as previously reported, and the reclassification of investments in auction rate securities to marketable securities from cash and cash equivalents. The impact of the restatement on our previously issued consolidated financial statements is described more fully in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in Note 2 to our restated consolidated financial statements included elsewhere in this Report.
In connection with the restatement, management identified and reported to the Audit Committee certain control deficiencies that constituted material weaknesses in internal control over financial reporting. As a result of the identification of the material weaknesses, we have identified certain control enhancements and improvements that, once fully implemented, will strengthen our internal control over financial reporting. The material weaknesses and the identified control improvements and enhancements to be implemented are described more fully in “Controls and Procedures” included elsewhere in this Report.
We have not amended our previously filed Annual Reports on Form 10-K or Quarterly Reports on Form 10-Q for the restatement, and the financial statements and related financial statement information contained in those reports should no longer be relied upon. Throughout this Report, all amounts presented from prior periods and prior period comparisons are labeled as “restated” and reflect the balances and amounts on a restated basis.
Description of Our Industry
For companies in the pharmaceutical, biotechnology, chemical, petrochemical and materials industries, innovation in the discovery and development of new products and the rapid, cost-effective commercialization of these products can be crucial to success. Companies in these industries invest considerable resources in technologies that suggest productive new pathways for research projects, increase the efficiency of discovery and development processes, or enable them to maximize the use of corporate scientific data, information and knowledge. One such set of technologies is software-based computation, analysis, informatics, workflow and knowledge management tools. These tools allow users to simulate key chemical and biological systems, understand and predict fundamental properties, and assist in the design of new or improved products and processes. They also manage and mine scientific data, turning it into useful information and supporting decision processes and research and development workflows.
Description of Our Business
We design, develop, market, and support software and related services that facilitate the discovery and development of new and improved products and processes in the pharmaceutical, biotechnology, chemical, petrochemical and materials industries. Using our products, researchers may increase the speed and efficiency of the research and development cycle, thereby reducing product development costs and shortening the time to market for new product introductions and process improvements. Our customers include leading commercial, government and academic organizations. Many of the largest pharmaceutical, biotechnology, chemical, petroleum and semiconductor companies worldwide use our software. We market our products and services worldwide, principally through our direct sales force, augmented by the use of third-party distributors.
Business Strategy
Our objective is to strengthen our position as a leading provider of software-based scientific computation, analysis, informatics, knowledge management, workflow products and services worldwide. We plan to accomplish this objective by providing a comprehensive set of integrated solutions that are central to the enterprise-wide research and development activities of our customers, and by connecting
these tools within an information technology framework that makes it easier for research and development organizations to manage data, information, knowledge, and collaborative processes.
Products and Services
The following is a brief description of each of our product lines:
Modeling and Simulation Software. Many factors that affect a molecule, including activity, bioavailability, toxicity, shelf life and environmental impact, are governed by fundamental properties such as shape, structure and reactivity that are determined at the sub-atomic, molecular, or near-molecular levels. A spectrum of simulation technologies-quantum mechanical simulation, molecular simulation, and mesoscale simulation-predict these properties and help researchers discover new products, sharpen the focus of experimental activities and improve ultimate product performance. We are a leading provider of such modeling and simulation software.
We have a broad product suite consisting of over 100 application modules based on proprietary and licensed technologies that employ fundamental scientific principles, advanced computer visualization, molecular modeling techniques and computational chemistry. These products allow scientists to perform computations of chemical, biological and materials properties, to simulate, visualize and analyze chemical and biological systems, and to communicate the results to other scientists. We also offer open access to many of our core software development environments, within which customers and third-party licensees can develop, integrate and distribute their own software applications for computational chemistry, biology and materials research.
We plan to continue enhancing our product and service offerings for computational chemists and biologists, who are the principal users of modeling and simulation products. In addition, we plan to broaden our user base by enabling straightforward access to our modeling and simulation software from personal computers thereby making our products available to a much larger population of biologists, chemists and engineers. This also helps expert modelers to connect and communicate more effectively to the wider research organization. Further, these products assist organizations in capturing, managing, and sharing the critical knowledge developed in modeling.
Informatics Software. We are a leading provider of tools to capture, store, manage, and mine scientific data and information. Informatics is a well-established technology in life sciences, where bioinformatics tools are integral to genetic and biological research, and cheminformatics applications are widely used to manage chemical information.
Our bioinformatics solutions include a suite of programs enabling molecular biologists to search, edit, compare, map and align sequence data. Researchers use these tools to enable the analysis of DNA and protein sequences and structure, predict RNA secondary structure and annotate protein sequences. Such capabilities help them to use the genomic data that is being made available by projects such as the Human Genome Project. In addition, we provide enterprise-wide data management and analysis tools that assist in the management of this data. Data visualization and analysis capabilities allow this data to be viewed and understood on standard desktop computers.
Our cheminformatics software is based on standard database architectures such as Oracle® and Microsoft® Access®. We provide data visualization and analysis software to search, retrieve, and use chemical structures, biological and chemical data, experimental data, and registration information. Many of these tools use industry standard software components and are compliant with applications such as Microsoft Excel®, allowing chemists to interact with chemical data within familiar productivity tools. We also use this component technology and our database architectures to build enterprise-wide systems for our clients.
Workflow Software Solution. Our workflow software solution allows customers to analyze and mine extremely large data sets in real time. Informatics analyses generally require multiple computational steps. To address this issue, our solutions allow for automated data analysis protocols to be saved for re-use or shared with a broad community of users within the organization.
In addition to software modules, we also offer the following services:
Customer Support and Training. Expert telephone support, an Internet-based knowledge-base and request-tracking system, and on-site training, web-based training, and scheduled training workshops, are all designed to enhance customer success in the application of our technologies.
Contract Research. Our scientists can be contracted to work on specific projects. These services provide a high level of collaboration with the client and include mentoring and knowledge transfer related to the application of our modeling tools.
Consulting Services. We offer consulting services including installation, non-complex implementation and integration.
Customers
Our customer base consists of commercial, governmental and academic organizations. No single customer accounted for more than 10% of our revenue during any of the three most recently completed fiscal years.
Commercial Customers. Our commercial customers include many of the world’s largest pharmaceutical, biotechnology, chemical, petroleum and material science companies. In each of the past three fiscal years, a significant portion of our total revenue has been derived from pharmaceutical, biotechnology and chemical companies.
Governmental Customers. Many governmental institutions in the United States, Canada, Europe and the Asia/Pacific region use our products.
Academic Customers. Many universities in the United States, Europe and the Asia/Pacific region use our products. This use historically has been for purposes of academic research, but we believe our products increasingly may be used as a part of formal university teaching curricula.
Strategic and Academic Alliances
We have entered into a number of strategic alliances relating to product development, product distribution and joint marketing. We plan to continue to cultivate relationships with academic, governmental and commercial research organizations for purposes of identifying and licensing new technology to use in product development. In addition, we plan to maintain and expand our alliances focusing on the compatibility of our products with databases and database management systems, other computational chemistry and molecular simulation products, and products in related markets such as imaging and clinical informatics. We also intend to continue to enter into porting and joint marketing arrangements with hardware vendors on whose systems our products operate.
Sales and Marketing
We market our products and services worldwide. Historically, we have generated approximately 55%, 25% and 20% of our revenues from the United States, Europe and Asia-Pacific, respectively. Please refer to Note 3 to our restated consolidated financial statements included elsewhere in this Report for a breakdown of revenues and long-lived assets by geographic region. Our continuing reliance on sales in international markets exposes us to risks attendant to foreign sales, as described more fully in Item 1A
Item 1A. Risk Factors
You should carefully consider the risks described below before investing in our publicly-traded securities. The risks described below are not the only ones facing us. Our business is also subject to the risks that affect many other companies, such as competition, technological obsolescence, labor relations, general economic conditions, geopolitical changes and international operations. Additional risks not currently known to us or that we currently believe are immaterial also may impair our business operations and our liquidity. The risks described below could cause our actual results to differ materially from those contained in forward-looking statements we have made in this Report, the information incorporated herein by reference and those we may make from time to time.
Certain Risks Related to Our Marketplace and Environment
Our revenue from the sale of modeling, simulation and informatics software to the life science discovery research marketplace, which has historically constituted a significant portion of our overall revenue, has been declining over the past several years and may continue to decline in future years. Historically we have derived a significant portion of our revenue from the sale of modeling, simulation and informatics software to the discovery research departments in pharmaceutical and biotechnology companies. Such revenues have been declining over the past several years. We believe this decline is due to several factors, including industry consolidation, a general reduction in the level of discovery research activity by our customers, increased competition, including competition from open source software, and reductions in profit and related information technology spending by our customers, due in part to the expiration of patents on profitable drugs. If such declines continue and we do not increase the revenue we derive from our other product and service offerings, our business could be adversely impacted.
Our ability to sustain or increase revenues will depend upon our success in developing, marketing and selling software and service solutions to both our existing customers and to new customers. Our strategy involves transforming our product and service offerings by providing tools and components to our customers which allow our customers to integrate software applications and data more easily. A key enabler of this strategy is the data pipelining and workflow technology we acquired through the September 2004 acquisition of SciTegic, Inc. We are utilizing SciTegic’s Pipeline Pilot technology to enable our customers to build solutions which allow them to receive greater value from their data, information and knowledge. Selling this type of solution is fundamentally different than our historical sale of modeling and simulation products, and this type of offering is dependant upon our ability to build a successful services offering. Our sales and services management are focused on transforming our sales process to allow us to be successful with this type of sale. In addition, we are adding personnel and defining services offerings to enable our customers to successfully deploy these solutions. There can be no assurance that we will be successful in this transformation of our sales processes and in the building of our services capabilities. If we are not successful, our ability to sustain or increase revenue may be adversely impacted.
Our ability to sustain or increase revenues will depend upon our success in entering new markets and in deriving additional revenues from our existing customers. Our products are currently used primarily by molecular modeling and simulation specialists in discovery research organizations. Our strategy is to expand usage of our products and services by marketing and distributing our software to a broader, more diversified group of biologists, chemists, engineers and informaticians within our existing pharmaceutical and biotechnology customers, as well as to new customers in other industries. However, our products and services may not achieve market acceptance or penetration in targeted new departments within our customers or in new industries. As a result, we may not be able to sustain or increase revenue.
We may be unable to develop strategic relationships with our customers. Our strategy is to expand usage of our products and services by marketing and distributing solutions to a broader, more diversified group of biologists, chemists, engineers and informaticians throughout our customers’ research and development organizations. A key component of our business strategy is to become a preferred provider of scientific
software and solutions. Becoming a preferred vendor will require substantial re-training and new skills development within our sales and service personnel and deployment of a successful account-management sales model. We believe that developing strategic relationships with our customers may lead to additional revenue opportunities. However, there can be no assurance that any such relationships will develop or that such relationships will produce additional revenue or profit opportunities.
Consolidation within the pharmaceutical and biotechnology industries may continue to lead to fewer potential customers for our products and services. A significant portion of our customer base consists of pharmaceutical and biotechnology companies. Continued consolidation within the pharmaceutical and biotechnology industries may result in fewer customers for our products and services. If one of the parties to a consolidation uses the products or services of our competitors, we may lose existing customers as a result of such consolidation.
Health care reform and restrictions on reimbursement may affect the ability of pharmaceutical, biotechnology and industrial chemical companies to purchase or license our products or services, which may affect our results of operations and financial condition. The continuing efforts of government and third-party payers in the markets we serve to contain or reduce the cost of health care may reduce the profitability of pharmaceutical, biotechnology and industrial chemical companies causing them to reduce research and development expenditures. Because our products and services depend on such research and development expenditures, our revenues may be significantly reduced. We cannot predict what actions federal, state or private payers for health care goods and services may take in response to any health care reform proposals or legislation.
We face strong competition in the scientific software sector. The market for our products is intensely competitive. We currently face competition from other scientific software providers, larger technology and solutions companies, in-house development by our customers, as well as academic and government institutions and the open source community.
Some of our competitors and potential competitors in this sector have longer operating histories than us and have greater financial, technical, marketing, research and development and other resources. Many of our competitors offer products and services directed at more specific markets than those we target, enabling these competitors to focus a greater proportion of their efforts and resources on these markets. Some offerings that compete with our products are developed and made available at lower cost by government organizations and academic institutions, and these entities may be able to devote substantial resources to product development and also offer their products to users for little or no charge. We also face competition from open source software initiatives, in which developers provide software and intellectual property free over the Internet. In addition, many of our customers spend significant internal resources in order to develop their own software.
There can be no assurance that our current or potential competitors will not develop products, services or technologies that are comparable to, superior to, or render obsolete, the products, services and technologies we offer. There can be no assurance that our competitors will not adapt more quickly than us to technological advances and customer demands, thereby increasing such competitors’ market share relative to ours. Any material decrease in demand for our technologies or services may have a material adverse effect on our business, financial condition and results of operations.
We are subject to pricing pressures in the markets we serve. We operate in an intensely competitive marketplace which has led to significant pricing pressure and declines in average selling price over the past several years. In response to competition and general adverse economic conditions in the markets we serve, we may be required to modify our pricing practices. Changes in our pricing model could lead to a decline or delay in revenue as our sales force and customers adjust to the new pricing policies. This development may adversely affect our revenue and earnings.
Our operations may be interrupted by the occurrence of a natural disaster or other catastrophic event at our primary facilities. Our research and development operations and administrative functions are primarily conducted at our facilities in San Diego, California, Cambridge, United Kingdom, and Bangalore, India. We also conduct sales and customer support activities at our facilities in Burlington, Massachusetts, Paris, France, and Tokyo, Japan. Although we have contingency plans in effect for natural disasters or other catastrophic events, catastrophic events could still disrupt our operations. For example, our San Diego and Tokyo facilities are located in areas that are particularly susceptible to earthquakes. Any natural disaster or catastrophic event in our facilities or the areas in which they are located could have a significant negative impact on our operations.
Our insurance coverage may not be sufficient to avoid material impact on our financial position or results of operations resulting from claims or liabilities against us, and we may not be able to obtain insurance coverage in the future. We maintain insurance coverage for protection against many risks of liability. The extent of our insurance coverage is under continuous review and is modified as we deem it necessary. Despite this insurance, it is possible that claims or liabilities against us may have a material adverse impact on our financial position or results of operations. In addition, we may not be able to obtain any insurance coverage, or adequate insurance coverage, when our existing insurance coverage expires. For example, we do not carry earthquake insurance for our facilities in Tokyo, Japan or San Diego, California, because we were unable to obtain such insurance on commercially reasonable terms.
Certain Risks Related to Our Operations
Defects or malfunctions in our products could hurt our reputation among our customers, result in delayed or lost revenue and expose us to liability. Our business and the level of customer acceptance of our products depend upon the continuous, effective and reliable operation of our software and related tools and functions. To the extent that defects cause our software to malfunction and our customers’ use of our products is interrupted, our reputation could suffer and our revenue could decline or be delayed while such defects are remedied. We may also be subject to liability for the defects and malfunctions of third-party technology partners and others with whom our products and services are integrated.
Delays in the release of new or enhanced products or services or undetected errors in our products or services may result in increased cost to us, delayed market acceptance of our products and delayed or lost revenue. To achieve market acceptance, new or enhanced products or services can require long development and testing periods, which may result in delays in scheduled introduction. Any delays in the release schedule for new or enhanced products or services may delay market acceptance of these products or services and may result in delays in new customer orders for these new or enhanced products or services or the loss of customer orders. In addition, new or enhanced products or services may contain a number of undetected errors or “bugs” when they are first released. Although we test each new or enhanced software product or service before being released to the market, there can be no assurance that significant errors will not be found in existing or future releases. As a result, in the months following the introduction of certain releases, we may need to devote significant resources to correct these errors. There can be no assurance, however, that all of these errors can be corrected.
We are subject to risks associated with the operation of a global business. Our non-U.S. operations are subject to risks inherent in the conduct of international business, including:
· unexpected changes in regulatory requirements;
· longer payment cycles;
· currency exchange rate fluctuations;
· import and export license requirements;
· tariffs and other barriers;
· political unrest, terrorism and economic instability;
· disruption of our operations due to local labor conditions;
· limited intellectual property protection;
· difficulties in collecting trade receivables;
· difficulties in managing distributors or representatives;
· difficulties in managing an organization spread over various countries;
· difficulties in staffing foreign subsidiary or joint venture operations; and
· potentially adverse tax consequences.
Our success depends, in part, on our ability to anticipate and address these risks. There can be no assurance that we will do so effectively, or that these or other factors relating to our international operations will not adversely affect our business or operating results.
In order to improve our financial position, we have reduced our headcount, which could negatively impact our business. We have undergone several reductions-in-force over the past few years, and our workforce has declined by approximately 200 people since March 2002. While we believe we have sufficient staff to operate our business, we do not have duplicative or redundant resources in many of our functions or operations. As a result, there can be no assurance that further attrition will not impact our ability to operate our business, or adversely impact our revenues.
Failure to attract and retain skilled personnel, including the personnel necessary to address the identified material weaknesses in our internal control over financial reporting, could have a material adverse effect on us. Our success depends in part on the continued service of key scientific, sales, business development, marketing, engineering, management and accounting personnel and our ability to identify, hire and retain additional personnel. There is intense competition for qualified personnel. Immigration laws may further restrict our ability to attract or hire qualified personnel. We may not be able to continue to attract and retain the personnel necessary for the development of our business. Failure to attract and retain key personnel could have a material adverse effect on our business, financial condition and results of operations. Further, we are highly dependent on the principal members of our technical, scientific and management staff. One or more of these key employees could retire or otherwise leave our employ within the foreseeable future, and the loss of any of these people could have a material adverse effect on our business, financial condition and results of operations. We do not intend to maintain key person life insurance on the life of any employee.
In addition to the foregoing, as described in greater detail elsewhere in this Report, we recently concluded that we had material weaknesses in our internal control over financial reporting as of March 31, 2006. These material weaknesses, which principally arose due to our lack of a sufficient number of employees with an appropriate level of accounting knowledge, experience and training in the application of generally accepted accounting principles relevant to our business, were at least partially responsible for our need to restate our previously issued consolidated financial statements as described elsewhere in this Report. While we have recruited additional qualified personnel since March 31, 2006, one or more of these qualified recruits or existing personnel could leave our employ within the foreseeable future. If not timely and adequately addressed, the loss of any of these individuals could impair our ability to maintain effective internal control over financial reporting and thereby cause a material adverse effect on our business.
If we choose to acquire businesses, products or technologies instead of developing them ourselves, we may be unable to complete these acquisitions or to successfully integrate an acquired business or technology in a cost-effective and non-disruptive manner. From time to time, we may choose to acquire businesses, products or technologies instead of developing them ourselves. We do not know if we will be able to complete any acquisitions, or whether we will be able to successfully integrate any acquired businesses, operate them profitably or retain their key employees. Integrating any business, product or technology we acquire could be expensive and time-consuming, disrupt our ongoing business and distract company management. In addition, in order to finance any acquisition, we might need to raise additional funds through public or private equity or debt financings. In that event, we could be forced to obtain financing on less than favorable terms and, in the case of equity financing that may result in dilution to our stockholders. If we are unable to integrate any acquired entities, products or technologies effectively, our business will suffer. In addition, under certain circumstances, amortization of assets or charges resulting from the costs of acquisitions could harm our business and operating results.
Certain Risks Related To Our Financial Performance
We have a history of losses and our future profitability is uncertain. We generated net losses for the years ended March 31, 2006 and 2005 and December 31, 2003, and the three months ended March 31, 2004. Continuing net losses may limit our ability to fund our operations and we may not generate income from operations in the future. Our future profitability depends upon many factors, including several that are beyond our control. These factors include without limitation:
· changes in the demand for our products and services;
· the introduction of competitive software;
· our ability to license desirable technologies;
· changes in the research and development budgets of our customers and potential customers; and
· our ability to successfully, cost effectively and timely develop, introduce and market new products, services and product enhancements.
Our sales forecast and/or revenue projections may not be accurate. We use a “pipeline” system, a common industry practice, to forecast sales and trends in our business. Our sales personnel monitor the status of proposals, including the date when they estimate a customer will make a purchase decision and the potential size of the order. We aggregate these estimates on a quarterly basis in order to generate a sales pipeline. While the pipeline process provides us with some guidance in business planning and forecasting, it is based on estimates only and is therefore subject to risks and uncertainties. Any variation in the conversion of the pipeline into revenue or the pipeline itself could cause us to improperly plan or budget and thereby adversely affect our business, results of operations and financial condition.
If we are unable to license software to, or collect receivables from our customers our operating results may be adversely affected. The majority of our current customers are well-established, large pharmaceutical customers and universities, and other customers include smaller biotechnology companies. We have not experienced significant customer defaults during the past three fiscal years and have recorded a provision for bad debts of less than $0.5 million in each of those periods. Our financial success depends upon the creditworthiness and ultimate collection of amounts due from our customers. If we are not able to collect from our customers, we may be required to write-off significant accounts receivable and recognize bad debt expenses which could materially and adversely affect our operating results.
Our quarterly operating results, particularly our quarterly cash flows, will fluctuate. Quarterly operating results may fluctuate as a result of a number of factors, including lengthy sales cycles, market acceptance of new products and upgrades, timing of new product introductions, changes in pricing policies, changes in general economic and competitive conditions, and the timing and integration of acquisitions. We may also experience fluctuations in quarterly operating results due to general and industry specific economic conditions that may affect the research and development expenditures of pharmaceutical and biotechnology companies. In particular, we historically received approximately 40% of our annual orders in the fiscal quarter ended December 31. As a result, our cash flows from operations generally are positive in the fiscal quarter ended March 31, and we generally experience negative cash flows from operations in the other three fiscal quarters. Due to the possibility of fluctuations in our revenue and expenses, we believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance.
Changes in the accounting treatment of employee stock-based compensation will adversely affect our results of operations. In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard (“SFAS”) No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123R”), which revises SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123R requires that employee stock-based compensation is measured based on the grant-date fair value of the related employee equity award and is treated as an expense that is reflected in the financial statements over the related service period. SFAS No. 123R applies to all employee equity awards granted after adoption and to the unvested portion of employee equity awards outstanding as of adoption. We currently anticipate adopting SFAS No. 123R using the modified-prospective method effective April 1, 2006. Because employee stock-based compensation expense will be reflected in our financial statements, the adoption of the SFAS No. 123R is anticipated to have a significant adverse impact on our future reported results of operations, although at this time, we are unable to quantify such impact. However, the pro forma impact on our reported results of operations for prior periods of recognizing the fair value of employee stock-based compensation in accordance with SFAS No. 123 is described in Note 3 to our consolidated financial statements included elsewhere in this Report.
The recently completed restatement of our historical financial statements has already consumed, and may continue to consume, a significant amount of our resources and may have a material adverse effect on our business and stock price. In December 2005, we announced that our previously issued consolidated financial statements would be restated to reflect certain accounting adjustments. The restatement process was highly time and resource-intensive and involved substantial attention from management and significant legal and accounting costs. Although we have now completed the restatement, we cannot guarantee that we will have no further inquiries from the SEC or NASDAQ regarding our restated financial statements or matters relating thereto. Likewise, many companies that have been required to restate their historical financial statements have subsequently experienced stockholder lawsuits relating to their restatements. Any future inquiries from the SEC or NASDAQ as a result of the restatement of our historical financial statements will, regardless of the outcome, likely consume a significant amount of our resources in addition to those resources already consumed in connection with the restatement itself.
If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results, and current and potential stockholders may lose confidence in our financial reporting. We are required by the SEC to establish and maintain adequate internal control over financial reporting that provides reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements in accordance with generally accepted accounting principles. We are likewise required, on a quarterly basis, to evaluate the effectiveness of our internal controls and to disclose any changes, significant deficiencies or material weaknesses in those internal controls.
As described in greater detail elsewhere in this Report, in connection with the restatement process, we identified material weaknesses in our internal control over financial reporting. These material weaknesses
generally relate to our historical lack of a sufficient number of employees with appropriate levels of accounting knowledge, experience and training in the application of generally accepted accounting principles relevant to our business. Given these material weaknesses, management was unable to conclude that we maintained effective internal control over financial reporting as of March 31, 2006. Further, these material weaknesses resulted in an adverse opinion by our independent registered public accounting firm as to the effectiveness of our internal control over financial reporting.
Since the determination regarding our material weaknesses, we have devoted significant effort and resources to the remediation and improvement of our internal control over financial reporting. In particular, as described elsewhere in this Report, we have recruited a number of qualified individuals to assist in maintaining adequate internal controls, we have initiated a revenue recognition training program and we have implemented an enhanced quarterly and annual financial statement close, review and reporting process. Although we believe that these efforts and resources have strengthened our internal control over financial reporting and address the concerns that gave rise to the material weaknesses as of March 31, 2006, we cannot be certain that these measures will ensure that we maintain adequate internal control over our financial reporting in future periods. Any failure to maintain such internal controls could adversely impact our ability to report our financial results on a timely and accurate basis. If our financial statements are not accurate, investors may not have a complete understanding of our operations. Likewise, if our financial statements are not filed on a timely basis as required by the SEC and NASDAQ, we could face severe consequences from those authorities. In either case, there could result a material adverse affect on our business. Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our stock.
We may be required to indemnify Pharmacopeia Drug Discovery, Inc. (“PDD”), or may not be able to collect on indemnification rights from PDD. On April 30, 2004, we spun-off our drug discovery subsidiary, PDD, into an independent, separately traded, publicly held company through the distribution to our stockholders of a dividend of one share of PDD common stock for every two shares of our common stock. As part of the spin-off, we agreed to indemnify the indebtedness, liabilities and obligations of PDD. One such obligation includes a guarantee by us to the landlord of PDD’s obligations under the existing New Jersey laboratory and headquarters leases, with respect to which PDD will indemnify us should we be required to make any payment under the guarantee. These indemnification obligations could be as significant as the remaining future minimum lease payments, which totaled approximately $25 million as of March 31, 2006. PDD’s ability to satisfy any such indemnification obligations (including, without limitation, PDD’s commitment to indemnify us in the event of our payment under our guarantee of its leases) will depend upon PDD’s future financial strength. We cannot assure you that, if PDD becomes obligated to indemnify us for any substantial obligations, PDD will have the ability to do so. There also can be no assurance that we will be able to satisfy any indemnification obligations to PDD. Any failure by PDD to satisfy its obligations and any required payment by us could have a material adverse effect on our business.
Enacted and proposed changes in securities laws and regulations have increased our costs and may continue to increase our costs in the future. The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) required changes in some of our corporate governance and securities disclosure and compliance practices. Under Sarbanes-Oxley, publicly held companies, including us, are required to, among other things, furnish independent annual audit reports regarding the existence and reliability of their internal control over financial reporting and have their chief executive officer and chief financial officer certify as to the accuracy and completeness of their financial reports.
We expect continued compliance with Sarbanes-Oxley to remain costly. Further, Sarbanes-Oxley and the related SEC and NASDAQ compliance rules may make it more difficult and expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. These laws and regulations could also make it more difficult for us to attract and retain qualified members of our board of directors, or qualified executive officers. We
continually evaluate and monitor regulatory developments and cannot estimate the timing or magnitude of additional costs we may incur as a result.
Our business, financial condition and results of operations may be adversely impacted by fluctuations in foreign currency exchange rates. Our international sales generally are denominated in local currencies. Fluctuations in the value of currencies in which we conduct business relative to the United States dollar result in currency transaction gains and losses, and the impact of future exchange rate fluctuations cannot be accurately predicted. Future fluctuations in currency exchange rates may have a material adverse impact on revenue from international sales, and thus on our business, financial condition and results of operations. When deemed appropriate, we may engage in currency exchange rate hedging transactions in an attempt to mitigate the impact of adverse exchange rate fluctuations. However, currency hedging policies may not be successful, and they may increase the negative impact of exchange rate fluctuations.
If we consume cash more quickly than expected, we may be unable to raise additional capital and we may be forced to curtail operations. We anticipate that our existing capital resources will be adequate to fund our operations for at least the next twelve months. However, changes may occur that would consume available capital resources before that time. Our capital requirements will depend on numerous factors, including:
· costs associated with software sales;
· the purchase of additional capital equipment;
· acquisitions of other businesses or technologies;
· costs associated with the restatement of our historical financial statements as described elsewhere in this Report; and
· costs associated with addressing the material weaknesses in our internal control over financial reporting as described elsewhere in this Report.
If we determine that we must raise additional capital, we may attempt to do so through public or private financings involving debt or equity. However, additional capital may not be available on favorable terms, or at all. If adequate funds are not available, we may be required to curtail operations significantly or to obtain funds by entering into arrangements with collaborative partners or others that may require us to relinquish rights to certain of our technologies, products or potential markets that we would not otherwise relinquish.
Certain Risks Related to Owning Our Stock
We expect that our stock price will fluctuate significantly, and you may not be able to resell your shares at or above your investment price. The stock market, historically and in recent years, has experienced significant volatility particularly with technology company stocks. The volatility of technology company stock prices often does not relate to the operating performance of the companies represented by the stock. Factors that could cause volatility in the price of our common stock include without limitation:
· actual and anticipated fluctuations in our quarterly financial and operating results;
· market conditions in the technology and software sectors;
· issuance of new or changed securities analysts’ reports or recommendations;
· developments or disputes concerning our intellectual property or other proprietary rights or other legal claims;
· introduction of technological innovations or new commercial products by us or our competitors;
· market acceptance of our products and services;
· additions or departures of key personnel;
· public perception of the impact of the restatement of our historical consolidated financial statements as described elsewhere in this Report; and
· the disclosure of the material weaknesses in our internal control over financial reporting as described elsewhere in this Report.
These and other external factors may cause the market price and demand for our common stock to fluctuate substantially, which may limit or prevent investors from readily selling their shares of common stock and may otherwise negatively affect the liquidity of our common stock. In addition, in the past, when the market price of a stock has been volatile, holders of that stock have periodically instituted securities class action litigation against the issuer.
As institutions hold the majority of our common stock in large blocks, substantial sales by these stockholders could depress the market price for our shares. As of April 11, 2006, the top ten institutional holders of our common stock held approximately 48% of our outstanding common stock. As a result, if one or more of these major stockholders were to sell all or a portion of their holdings, or if the market were to perceive that such sale or sales may occur, the market price of our common stock may fall significantly.
Because we do not intend to pay dividends, our stockholders will benefit from an investment in our common stock only if our stock price appreciates in value. We have never declared or paid any cash dividends on our common stock. We currently intend to retain our future earnings, if any, to finance the expansion of our business and do not expect to pay any cash dividends in the foreseeable future. As a result, the success of an investment in our common stock will depend entirely upon any future appreciation in its value. There is no guarantee that our common stock will appreciate in value or even maintain the price at which it was purchased.
Anti-takeover provisions under the Delaware General Corporation Law, provisions in our certificate of incorporation and bylaws, and our adoption of a stockholder rights plan may render more difficult the accomplishment of mergers or the assumption of control by a principal stockholder, making more difficult the removal of management. Certain provisions of the Delaware General Corporation Law may delay or deter attempts to secure control of our company without the consent of our management. Also, our governing documents provide for a staggered board of directors, which will make it more difficult for a potential acquirer to gain control of our board of directors. In 2002, we adopted a stockholder rights plan, which is triggered upon commencement or announcement of a hostile tender offer or when any one person or group acquires 15% or more of our common stock. The rights plan, once triggered, enables our stockholders (other than the stockholder responsible for triggering the rights plan) to purchase our common stock at reduced prices. These provisions of our governing documents and stockholder rights plan, and of Delaware law, could have the effect of delaying, deferring or preventing a change of control, including without limitation a proxy contest, making more difficult the acquisition of a substantial block of our common stock. The provisions could also limit the price that investors might be willing to pay in the future for shares of our common stock. Further, the existence of these anti-takeover measures may cause potential bidders to look elsewhere, rather than initiating acquisition discussions with us.
Certain Risks Related to Intellectual Property
We may not be able to protect adequately the trade secrets and confidential information that we disclose to our employees. We rely upon trade secrets, technical know-how and continuing technological innovation to develop and maintain our competitive position. Competitors through their independent discovery (or improper means, such as unauthorized disclosure or industrial espionage) may come to know our proprietary information. We generally require employees and consultants to execute confidentiality and assignment-of-inventions agreements. These agreements typically provide that all materials and
confidential information developed by or made known to the employee or consultant during his, her or its relationship with us are to be kept confidential, and that all inventions arising out of the employee’s or consultant’s relationship with us are our exclusive property. Our employees and consultants may breach these agreements, and in some instances we may not have an adequate remedy. Additionally, in some instances, we may have failed to require that employees and consultants execute confidentiality and assignment-of-inventions agreements.
Foreign laws may not afford us sufficient protections for our intellectual property, and we may not seek patent protection outside the United States. We believe that our success depends, in part, upon our ability to obtain international protection for our intellectual property. However, the laws of some foreign countries may not be as comprehensive as those of the United States and may not be sufficient to protect our proprietary rights abroad. In addition, we generally do not pursue patent protection outside the United States because of cost and confidentiality concerns. Accordingly, our international competitors could obtain foreign patent protection for, and market overseas, products and technologies for which we are seeking patent protection in the United States.
A patent issued to us may not be sufficiently broad to protect adequately our rights in intellectual property to which the patent relates. Due to cost and other considerations, we generally do not rely on patent protection to enforce our intellectual property rights, and have filed only a limited number of patent applications. Even if patents are issued to us, these patents may not sufficiently protect our interest in our software or other technologies because the scope of protection provided by any patents issued to or licensed by us are subject to the uncertainty inherent in patent law. Third parties may be able to design around these patents or develop unique products providing effects similar to our products. In addition, others may discover uses for our software or technologies other than those uses covered in our patents, and these other uses may be separately patentable. A number of pharmaceutical and biotechnology companies, software organizations and research and academic institutions, have developed technologies, filed patent applications or received patents on various technologies that may be related to our business. Some of these technologies, patent applications or patents may conflict with our technologies, patent applications or patents. These conflicts could also limit the scope of patents, if any, that we may be able to obtain, or result in the denial of our patent applications.
We may be subject to claims of infringement by third parties. A number of patents may have been issued or may be issued in the future that could cover certain aspects of our technology or functionality of our products and could prevent us from using technology that we use or expect to use, or making or selling certain of our products. In addition, to the extent our employees are involved in research areas similar to those areas in which they were involved at their former employers, we may inadvertently use or disclose alleged trade secrets or other proprietary information of their former employer. Thus, our products may infringe patent or other intellectual property rights of third parties, and we may be subject to infringement claims by third parties. 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 licenses may not be available on terms acceptable to us, if at all. In the event of a successful claim of product infringement against us, our failure or inability to license or design around the infringed technology could have a material adverse effect on our business, financial condition and results of operations.
Third-party software codes incorporated into our products could subject us to liability or limit our ability to sell such products. Some of our products include software codes licensed from third parties, including the open source community. Some of these licenses impose certain obligations upon us, including royalty and indemnification obligations. In the case of codes licensed from the open source community, the licenses may also limit our ability to sell products containing such code. Though we generally review the applicable licenses prior to incorporating third party code into our software products, there can be no assurance that
such third party codes incorporated into our products would not subject us to liability or limit our ability to sell the products containing such code, thereby having a material adverse affect upon our business.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
The following is a summary of our principal business locations:
Item 3.
Item 3. Legal Proceedings
We are not a party to any legal proceedings the negative outcome of which would have a material adverse effect on our business, financial condition or results of operations.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters
Market for Common Stock
Our common stock trades on the NASDAQ National Market tier of The NASDAQ Stock Market under the symbol ACCL. The following table sets forth, for the periods indicated, the range of high and low sale prices per share of our common stock:
From the date of our initial public offering on December 5, 1995 until February 26, 2004, our stock traded under the symbol PCOP. Since February 27, 2004, our common stock has traded under the symbol ACCL.
Holders of Record
As of April 27, 2006, there were 441 holders of record of our common stock.
Dividends
No cash dividends have been paid on the common stock to date, nor do we anticipate paying dividends in the foreseeable future.
Equity Compensation Plan Information
The information required by Item 201(d) of Regulation S-K will be included in our definitive proxy statement (“Proxy Statement”) to be filed with the SEC within 120 days after our fiscal year ended March 31, 2006, and is incorporated in this Report by reference.
Item 6.
Item 6. Selected Consolidated Financial Data
The following selected consolidated financial data have been derived from our audited consolidated financial statements and give effect to the restatement described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in Note 2 to our consolidated financial statements. This data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes thereto included elsewhere in this Report. On April 1, 2004, we changed our fiscal year end from December 31 to March 31. The following table sets forth our selected consolidated financial data as of and for the years ended March 31, 2006 and 2005, the three months ended March 31, 2004, and the years ended December 31, 2003, 2002 and 2001.
(1) Amounts include the results of SciTegic, Inc. from September 27, 2004, the date of the acquisition. See Note 5 to our consolidated financial statements included elsewhere in this Report.
(2) Noncurrent liabilities primarily consist of non-cash long-term, lease-related liabilities.
(3) The decrease in our cash, cash equivalents, restricted cash and marketable securities and total stockholders’ equity from March 31, 2004 to March 31, 2005 resulted from our April 30, 2004 spin-off of PDD. In connection with the spin-off, we distributed to our stockholders a dividend of one share of PDD common stock for every two shares of our common stock and contributed to PDD $42.3 million of marketable securities and $5.4 million in cash.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Selected Consolidated Financial Data” and our consolidated financial statements and related notes thereto included elsewhere in this Report.
In addition to historical information, the following discussion contains forward-looking statements that are subject to certain risks and uncertainties, including those risks and uncertainties described in Item 1A of this Report. Actual results may differ substantially from those referred to herein due to a number of factors, including but not limited to those risks and uncertainties.
Restatement of Financial Statements
We have restated our previously issued consolidated financial statements to reflect certain accounting adjustments. Our restated consolidated financial statements reflect changes to the timing of revenue recognized under term-based and perpetual software license arrangements which include multiple elements (typically software licenses and PCS) and a change in accounting for software development costs. Our restated consolidated financial statements also reflect the reclassification of general and administrative expenses and interest income between continuing and discontinued operations, the reclassification of cash flows from discontinued operations as net cash provided by (used in) discontinued operating activities, investing activities and financing activities, as opposed to a single line item as previously reported, and the reclassification of investments in auction rate securities to marketable securities from cash and cash equivalents. The impact of the restatement on our previously issued financial statements is described more fully in Note 2 to our consolidated financial statements included elsewhere in this Report.
The following table sets forth the effect of the restatement on our previously reported selected consolidated financial data:
Overview
Our Business
We design, develop, market, and support software and related services that facilitate the discovery and development of new and improved products and processes in the pharmaceutical, biotechnology, chemical, petrochemical and materials industries. Using our products, researchers may increase the speed and efficiency of the research and development cycle, thereby reducing product development costs and shortening the time to market for new product introductions and process improvements. Our customers include leading commercial, government and academic organizations. Many of the largest pharmaceutical, biotechnology, chemical, and petroleum companies worldwide use our products. We market our products and services worldwide, principally through our direct sales force, augmented by the use of third-party distributors.
Our Marketplace
Historically, we have primarily sold molecular modeling and simulation software. The market for molecular modeling and simulation products in the pharmaceutical and biotechnology industries is challenging due to the maturity of the market, industry consolidation, reduction in the level of discovery research activity, and increased competition, including competition from open source software. We also sell modeling and simulation products to the chemical, petrochemical and materials industries. We believe these industries are in the early stages of adoption of these technologies. Thus we believe the market for our products within these industries is nascent and has experienced modest growth over the past several years. Following the acquisition of SciTegic, we began to offer data-pipelining and workflow software. This technology is widely applicable within our target industries and represents a significant growth opportunity. There is currently limited competition to this technology in our targeted industries, and we are experiencing strong adoption rates within our customer base.
Our Strategy
Our objective is to strengthen our position as a leading provider of software-based scientific computation, analysis, informatics, knowledge management, workflow products and services. We plan to accomplish our objective by providing a comprehensive set of integrated products and services that are central to the enterprise-wide research and development activities of our customers, and by connecting these tools within an information technology framework. This framework makes it easier for research and development organizations to manage data, information, knowledge, and collaborative processes.
Our strategy for growth is to expand usage of our products and services by marketing and distributing our solutions to a broader group of users, including scientists, engineers and information technology professionals, within our existing customers, as well as to new customers in other industries.
A key enabler of this strategy is the data pipelining and workflow technology we acquired through our SciTegic acquisition. We are utilizing this technology to enable our customers to build solutions which allow them to integrate scientific software and content from across the research and development spectrum. Selling solutions is fundamentally different than our traditional sale of stand-alone modeling and simulation products. We are focused on enhancing our sales processes to emphasize solutions selling and strategic account management. We are also expanding our professional services capabilities to enable our customers to deploy these solutions.
In addition to the activities underway in our sales and service functions, we continue to focus on the componentization of our entire suite of products on our Discovery Studio and Materials Studio platforms. In fiscal year 2007, we expect to continue the migration of our life sciences applications to the Discovery Studio platform with the expected launch of Discovery Studio 1.7 by the end of the fiscal year.
Finally, in addition to our focus on revenue growth, we continuously evaluate our personnel requirements and cost structure. Over the past several years we have significantly reduced our operating costs through workforce reductions and other cost-savings measures. We will continue our focus on cost control, as well as working capital management as we strive to improve our financial performance.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of the consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and the related disclosure of contingent assets and liabilities. We review our estimates on an on-going basis, including those related to revenue recognition, income taxes and the valuation of goodwill, intangibles and other long-lived assets. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. Our accounting policies are described in more detail in Note 3 to our consolidated financial statements included elsewhere in this annual report. We have identified the following as the most critical accounting policies and estimates used in the preparation of our consolidated financial statements.
Revenue Recognition
We recognize revenues in accordance with the American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) No. 97-2, Software Revenue Recognition, as amended, SEC Staff Accounting Bulletin (“SAB”) No. 104, Revenue Recognition, and Emerging Issues Task Force (“EITF”) Issue No. 00-21, Revenue Arrangements with Multiple Deliverables.
We generate revenue from the following primary sources:
· software licenses,
· provision of support and maintenance services on licensed software, referred to as PCS, and
· training, installation and implementation services.
Customer payments received in connection with our revenue-generating activities are recorded as deferred revenue. We recognize revenue as set forth below and when all of the following criteria are met:
· a fully executed written contract and/or purchase order has been obtained from the customer (i.e., persuasive evidence of an arrangement exists),
· the contractual price of the product or services has been defined and agreed to in the contract (i.e., price is fixed or determinable),
· delivery of the product or service has occurred and no material uncertainties regarding customer acceptance of the delivered product or service exist, and
· collection of the purchase price from the customer is deemed probable.
Software Licenses
We license software either perpetually or on a term basis. Our standard perpetual software licensing arrangements include twelve months of bundled PCS, while our standard term-based software licensing arrangements typically include PCS for the full duration of the term license. Because we do not have vendor specific objective evidence (“VSOE”) of the fair value of these elements, we recognize as revenue the entire fee for such licenses ratably over the term of the bundled PCS. Certain of our term-based licenses also allow the customer to substitute purchased products for other products of equal value throughout the term. We account for these arrangements as in-substance subscriptions and, accordingly, we recognize as revenue the entire fee for such licenses ratably over the contractual term of the arrangement, which is typically the same as the term of the bundled PCS.
Renewal of PCS under Perpetual Software Licenses
Our PCS includes the right to receive unspecified upgrades or enhancements and technical support. Fees from customer renewals of PCS related to previously purchased perpetual licenses are recognized ratably over the term of the PCS.
Training, Installation and Implementation Services
We provide certain services to our customers, including product training, non-complex product installation and non-complex implementation services which are non-essential to the operation of the software. When sold separately, revenue from these services is generally recognized as the services are delivered, according to the contractual terms. Amounts billed but not yet recognized as revenue, and other payments received prior to the recognition of revenue, are recorded as deferred revenue.
Multi-Element Arrangements
For multi-element arrangements which include software licenses, PCS and non-complex training, installation and implementation services which are non-essential to the operation of the software, the entire fee for such arrangements is recognized as revenue ratably over the term of the PCS or delivery of the services, whichever is longer.
Software Development Costs
We account for costs incurred to develop our software products in accordance with SFAS No. 86, Accounting for the Cost of Computer Software to be Sold, Leased or Otherwise Marketed. Accordingly, costs incurred in the research and development of new software products and significant enhancements to existing software products are expensed as incurred, until the technological feasibility of the product has been established. Technological feasibility occurs shortly before our software products are available for
general release, and we have determined that costs eligible for capitalization are not material. Accordingly, there were no capitalized software development costs as of March 31, 2006 and 2005.
Valuation of Goodwill
Our goodwill resulted from acquisitions made in fiscal years 1999, 2000, 2001 and 2005. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets, we review goodwill for impairment at least annually in our fiscal fourth quarter and more frequently if events or changes in circumstances occur that indicate a potential reduction in the fair value of the reporting unit to which the goodwill has been assigned below its carrying value. Examples of such events or circumstances include: a significant adverse change in legal factors or in the business climate, a significant decline in our stock price, a significant decline in our projected revenue or cash flows, an adverse action or assessment by a regulator, unanticipated competition, a loss of key personnel, or the presence of other indicators that would indicate a reduction in the fair value of a reporting unit.
Our goodwill is considered to be impaired if we determine that the carrying value of the reporting unit to which the goodwill has been assigned exceeds its estimated fair value. In the fourth quarter of fiscal year 2006, we completed our annual goodwill impairment test and concluded that our goodwill was not impaired. Based on the guidance provided by SFAS No. 142 and SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, management has determined that our company consists of only one reporting unit given the similarities of economic characteristics between the operations and the common nature of the products, services and customers. Because we have only one reporting unit, and we are publicly traded, we determine the fair value of the reporting unit based on our market capitalization as we believe this represents the best evidence of fair value. Our conclusion that goodwill was not impaired was based on a comparison of our net assets as of March 31, 2006 to our market capitalization.
Because we determine the fair value of our reporting unit based on our market capitalization, our future reviews of goodwill for impairment may be impacted by changes in the price of our common stock. For example, a significant decline in the price of our common stock may cause the fair value of our goodwill to fall below its carrying value. Therefore, we cannot assure you that when we complete our future reviews of goodwill for impairment that a material impairment charge will not be recorded.
Valuation of Indefinite-Lived Intangible Asset
In connection with our acquisition of SciTegic in September 2004, we acquired the SciTegic trade name which was determined to be indefinitely lived. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, we review our indefinite-lived intangible asset for impairment at least annually in our fiscal fourth quarter and more frequently if events or changes in circumstances occur that indicate a potential reduction in the fair value of the asset below its carrying value. Examples of such events or circumstances include: a significant adverse change in legal factors or in the business climate, a significant decline in our stock price, a significant decline in our projected revenue or cash flows, an adverse action or assessment by a regulator, unanticipated competition, a loss of key personnel, or the presence of other indicators that would indicate a reduction in the fair value of an asset.
Our indefinite-lived intangible asset is considered to be impaired if we determine that the carrying value of the asset exceeds its estimated fair value. In the fourth quarter of fiscal year 2006, we completed our annual indefinite-lived intangible asset impairment test and concluded that our indefinite-lived intangible asset was not impaired. We estimated the fair value of our indefinite-lived intangible asset utilizing a discounted cash flow analysis which considers the potential royalties that would otherwise be paid to an independent third party for use of the trade name. Key assumptions included in the discounted cash flow analysis include projections of future revenue growth, market royalty rates for similar assets and the after-tax rate of return on the asset.
We cannot assure you that the underlying assumptions used to forecast the cash flows will materialize as estimated. For example, if our projections of future revenue growth do not materialize, the fair value of our indefinite-lived intangible asset may fall below its carrying value. Therefore, we cannot assure you that when we complete our future reviews of our indefinite-lived intangible asset for impairment that a material impairment charge will not be recorded.
Impairment of Long-Lived Assets
In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, we review long-lived assets to be held and used, including acquired intangible assets subject to amortization and property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable. Conditions that would necessitate an impairment assessment include a significant decline in the market price of an asset or asset group, a significant adverse change in the extent or manner in which an asset or asset group is being used, the loss of legal ownership or title to the asset, significant negative industry or economic trends or the presence of other indicators that would indicate that the carrying amount of an asset or asset group is not recoverable.
A long-lived asset is considered to be impaired if the estimated undiscounted future cash flows resulting from the use of the asset and its eventual disposition are not sufficient to recover the carrying value of the asset. In order to estimate an asset’s undiscounted future cash flows, we utilize our internal forecast of our future operating results and cash flows, our strategic business plans and anticipated future economic and market conditions. There are inherent estimates and assumptions underlying this information and management’s judgment is required in the application of this information to the determination of an asset’s undiscounted future cash flows. No assurance can be given that the underlying estimates and assumptions utilized in our determination of an asset’s undiscounted future cash flows will materialize as anticipated. During fiscal year 2006, we did not identify any conditions that would necessitate an impairment assessment of our long-lived assets.
Income Taxes
Significant judgment is required in determining our worldwide provision for income taxes. In the ordinary course of a global business, there are many transactions for which the ultimate tax outcome is uncertain. Some of these uncertainties arise as a consequence of intercompany arrangements to share revenue and costs. In such arrangements there are uncertainties about the amount and manner of such sharing which could ultimately result in changes once the arrangements are reviewed by taxing authorities. Although we believe that our approach to determining the amount of such arrangements is reasonable, no assurance can be given that the final resolution of these matters will not be materially different than that which is reflected in our historical income tax provisions and accruals. Such differences could have a material effect on our income tax expense or benefit in the period in which such determination is made.
We establish a valuation allowance against our net deferred tax assets to reduce deferred tax assets to the amount expected to be realized. The likelihood of a material change in the expected realization of our deferred tax assets depends on our ability to generate sufficient future taxable income. Our ability to generate enough taxable income to utilize our deferred tax assets depends on many factors, among which are our ability to deduct tax loss carryforwards against future taxable income, the effectiveness of our tax planning strategies, reversing deferred tax liabilities and any significant changes in the tax treatment received on our business combinations. Since our inception, we have provided a full valuation allowance against our net U.S. deferred tax assets as we do not believe the ultimate realization of our deferred tax assets is more likely than not.
Results of Operations
Our results of operations give effect to the restatement of our previously issued consolidated financial statements as more fully described above.
On April 1, 2004, we changed our fiscal year end from December 31 to March 31. The first fiscal year affected by this change ended on March 31, 2005. Included in Item 8 of this Report are the consolidated balance sheets at March 31, 2006 and 2005 and the consolidated statements of operations, consolidated statements of stockholders’ equity and consolidated statements of cash flows for the years ended March 31, 2006 and 2005 and December 31, 2003, and the three months ended March 31, 2004. In order to provide the reader meaningful comparison, the following analysis provides comparison of our results of operations for the audited year ended March 31, 2006 with the audited year ended March 31, 2005, the audited year ended March 31, 2005 with the audited year ended December 31, 2003, and the audited three months ended March 31, 2004 with the unaudited three months ended March 31, 2003.
Our results of operations include the results of operations of SciTegic from September 27, 2004, the date of the acquisition.
Comparison of the Years Ended March 31, 2006 and 2005
Revenue
Revenue increased $3.0 million or 4% to $82.0 million for the year ended March 31, 2006 compared to $79.0 million for the year ended March 31, 2005. The increase in revenue was primarily attributable to the additive effect of a full year of revenue recognized by our SciTegic subsidiary included in fiscal year 2006, as compared to SciTegic revenues from the date of the acquisition included in fiscal year 2005 and modest growth in product sales of materials science applications, partially offset by continued declines in sales of modeling and simulation products to biopharmaceutical companies.
Operating Costs and Expenses
Cost of Revenue. Cost of revenue increased $2.8 million or 19% to $17.1 million for the year ended March 31, 2006, as compared to $14.3 million for the year ended March 31, 2005. As a percentage of revenue, cost of revenue increased to 21% for the year ended March 31, 2006, as compared to 18% for the year ended March 31, 2005. The increase in cost of revenue was primarily attributable to a $1.8 million increase in client services costs resulting from an increase in personnel as we transition to more of a solutions-based sales model that includes software and scientific services and a $0.6 million increase in intangible asset amortization resulting from a full year of amortization of the intangible assets resulting from the acquisition of SciTegic in September 2004.
Product Development Expenses. Product development expenses decreased $1.0 million or 4% to $21.7 million for the year ended March 31, 2006, as compared to $22.7 million for the year ended March 31, 2005. As a percentage of revenue, product development expenses decreased to 26% for the year ended March 31, 2006, as compared to 29% for the year ended March 31, 2005. The decrease in product development expenses was primarily attributable to lower personnel expenses resulting from headcount reductions during fiscal year 2006 and improved cost management.
Sales and Marketing Expenses. Sales and marketing expenses decreased $4.2 million or 12% to $32.7 million for the year ended March 31, 2006, as compared to $36.9 million for the year ended March 31, 2005. As a percentage of revenue, sales and marketing expenses decreased to 40% for the year ended March 31, 2006, as compared to 47% for the year ended March 31, 2005. The decrease in sales and marketing expenses was primarily attributable to lower personnel expenses resulting from headcount reductions during fiscal year 2006 as we took measures to improve the efficiency of our salesforce.
General and Administrative Expenses. General and administrative expenses decreased $1.2 million or 7% to $16.1 million for the year ended March 31, 2006, as compared to $17.3 million for the year ended March 31, 2005. As a percentage of revenue, general and administrative expenses decreased to 20% for the year ended March 31, 2006, as compared to 22% for the year ended March 31, 2005. The decrease in general and administrative expenses was primarily attributable to lower personnel expenses resulting from headcount reductions during fiscal year 2006, a $0.2 million decrease in outside legal fees, a $0.3 million decrease in outside consulting fees related to compliance with Section 404 of Sarbanes-Oxley resulting from efficiencies gained in the second year of compliance and a $0.4 million decrease in bad debt expense, offset by $1.1 million of outside consulting and accounting fees incurred during fiscal year 2006 related to the restatement of our previously issued consolidated financial statements.
Severance and Lease Abandonment Charges. Severance and lease abandonment charges were $3.2 million for the year ended March 31, 2006, as compared to $5.1 million for the year ended March 31, 2005. In March 2006, we implemented various actions designed to realign our resources with our portfolio of products and services, eliminate redundancies in our workforce and streamline our operations through workforce reductions and abandoning a portion of a leased facility in the United Kingdom. As a result of the implementation of these actions, we recognized a charge of $3.2 million, consisting of $1.8 million in severance benefits from the termination of approximately 50 employees and $1.4 million for our future lease obligations related to the abandoned facility, net of estimated future sublease income. We anticipate completing the workforce reductions and payment of severance benefits in the first quarter of fiscal year 2007. The lease obligation for the abandoned facility terminates in fiscal year 2016.
During the year ended March 31, 2005, we incurred a severance charge of $1.4 million and a lease abandonment charge of $3.9 million. These charges were offset by the recovery of previously recognized lease abandonment charges of $0.2 million, resulting in a net charge of $5.1 million for the period. During fiscal year 2005, we implemented various actions designed to improve the efficiency of our sales department and eliminate duplicative general and administrative personnel through workforce reductions and abandoning a leased facility in Germany. As a result of the implementation of these actions, we recognized a charge of $1.7 million, consisting of $1.4 million in severance benefits from the termination of 42 employees and $0.3 million related to the abandonment of the leased facility. Additionally, during fiscal year 2005, as a result of the relocation of our corporate headquarters, we recorded a lease abandonment charge of $3.6 million representing our future lease obligations, net of sublease income. The $0.2 million recovery of a previously recognized lease abandonment charge resulted from the completion of a sublease for an abandoned facility in the United Kingdom.
Acquired In-Process Product Development. In connection with our acquisition of SciTegic on September 27, 2004, we recorded a non-cash charge of $0.5 million for the estimated fair value of acquired in-process product development.
Net Interest and Other Income
Net interest and other income was $1.9 million for the year ended March 31, 2006, as compared to $1.7 million for the year ended March 31, 2005. The increase in net interest and other income was primarily attributable to foreign exchange gains resulting from the strengthening of the U.S. dollar during fiscal year 2006.
Income Tax Expense (Benefit)
We recognized income tax expense of $0.9 million for the year ended March 31, 2006, as compared to an income tax benefit of $0.6 million for the year ended March 31, 2005. The income tax expense recognized for fiscal year 2006 results from taxable income generated by certain of our foreign operations. The income tax benefit recognized for fiscal year 2005 was primarily attributable to a $0.9 million income tax benefit related to a refund of taxes previously withheld in Japan and the release of a $1.0 million income tax reserve related to a transfer-pricing matter, offset by income tax expense resulting from taxable income generated by certain of our foreign operations.
Loss from Discontinued Operations
On April 30, 2004, we spun-off our drug discovery subsidiary, PDD, into an independent, separately traded, publicly held company through the distribution to our stockholders of a dividend of one share of PDD common stock for every two shares of our common stock. In accordance with SFAS No. 144, we have reported PDD’s results of operations, assets and liabilities, and cash flows as discontinued operations in our consolidated financial statements for all periods presented. There were no discontinued operations reported during the year ended March 31, 2006 as PDD was spun-off prior to the start of the fiscal year. During the year ended March 31, 2005, we recognized a loss from discontinued operations of $1.1 million, or $0.04 per share, which consisted of revenue of $1.3 million and expenses of $2.4 million.
Comparison of the Years Ended March 31, 2005 and December 31, 2003
Revenue
Revenue decreased $7.2 million or 8% to $79.0 million for the year ended March 31, 2005, as compared to $86.2 million for the year ended December 31, 2003. The decrease in revenue was primarily attributable to continued declines in sales of modeling and simulation software to biopharmaceutical companies as well the completion of several consortia and consulting agreements during 2003.
Operating Costs and Expenses
Cost of Revenue. Cost of revenue decreased $3.0 million or 17% to $14.3 million for the year ended March 31, 2005, as compared to $17.3 million for the year ended December 31, 2003. As a percentage of revenue, cost of revenue decreased to 18% for the year ended March 31, 2005, as compared to 20% for the year ended December 31, 2003. The decrease in cost of revenue was primarily attributable to a $1.6 million decrease in intangible asset amortization due to the full amortization during fiscal year 2003 of intangible assets acquired in previous periods and a $1.1 million decrease in client services costs resulting from workforce reductions.
Product Development Expenses. Product development expenses increased $0.3 million or 1% to $22.7 million for the year ended March 31, 2005, as compared to $22.4 million for the year ended December 31, 2003. As a percentage of revenue, product development expenses increased to 29% for the year ended March 31, 2005, as compared to 26% for the year ended December 31, 2003. The increase in product development expenses was attributable to additional product development activities resulting from our acquisition of SciTegic during fiscal year 2005, offset by decreases in personnel costs due to workforce reductions and additional cost efficiencies realized during fiscal year 2005 as our Bangalore, India operations ramped-up.
Sales and Marketing Expenses. Sales and marketing expenses increased $2.4 million or 7% to $36.9 million for the year ended March 31, 2005, as compared to $34.5 million for the year ended December 31, 2003. As a percentage of revenue, sales and marketing expenses increased to 47% for the year ended March 31, 2005, as compared to 40% for the year ended December 31, 2003. The increase in sales and marketing expenses was attributable to additional personnel and other costs resulting from the establishment of a business development function in fiscal year 2005, and the increase in sales personnel resulting from our acquisition of SciTegic in fiscal year 2005.
General and Administrative Expenses. General and administrative expenses increased $0.7 million or 4% to $17.3 million for the year ended March 31, 2005, as compared to $16.6 million for the year ended December 31, 2003. As a percentage of revenue, general and administrative expenses increased to 22% for the year ended March 31, 2005, as compared to 19% for the year ended December 31, 2003. The increase in general and administrative expenses was attributable to a $0.7 million increase in outside consulting and accounting fees incurred in relation to our initial compliance with Section 404 of Sarbanes-Oxley, partially offset by decreased general and administrative expenses due to headcount and other cost reductions resulting from the spin-off of PDD.
Severance and Lease Abandonment Charges (Recoveries). Severance and lease abandonment charges were $5.1 million for the year ended March 31, 2005, as compared to a recovery of previously recognized severance and lease abandonment charges of $0.4 million for the year ended December 31, 2003. During fiscal year 2005, we incurred a severance charge of $1.4 million and a lease abandonment charge of $3.9 million, offset by the recovery of previously recognized lease abandonment charges of $0.2 million. During fiscal year 2005, we implemented various actions designed to improve the efficiency of our sales department and eliminate duplicative general and administrative personnel through workforce reductions and abandoning a leased facility in Germany. As a result of the implementation of these actions, we recognized a charge of $1.7 million, consisting of $1.4 million in severance benefits from the termination of 42 employees and $0.3 million related to the abandonment of the leased facility. Additionally, during fiscal year 2005, as a result of the relocation of our corporate headquarters, we recorded a lease abandonment charge of $3.6 million representing our future lease obligations, net of sublease income. The $0.2 million recovery of a previously recognized lease abandonment charge resulted from the completion of a sublease for an abandoned facility in the United Kingdom.
During fiscal year 2003, we recovered $0.4 million of previously recognized severance and lease abandonment charges initially recognized in fiscal year 2002. The recovery consisted of $0.3 million resulting from the termination of the lease on an abandoned facility, and $0.1 million related to certain severance obligations.
Acquired In-Process Product Development. In connection with our acquisition of SciTegic on September 27, 2004, we recorded a non-cash charge of $0.5 million for the estimated fair value of acquired in-process product development.
Spin-Off Transaction Costs. During the year ended December 31, 2003, we incurred $0.7 million of transaction costs associated with our spin-off of PDD.
Net Interest and Other Income
Net interest and other income was $1.7 million for the year ended March 31, 2005, as compared to $4.2 million for the year ended December 31, 2003. The decrease in net interest and other income is attributable to lower interest income resulting from lower average investment balances as well as higher foreign exchange gains recognized in fiscal year 2003 resulting from the weakening of the U.S. dollar in fiscal year 2005.
Income Tax Expense (Benefit)
We recognized an income tax benefit of $0.6 million for the year ended March 31, 2005, as compared to income tax expense of $1.0 million for the year ended December 31, 2003. The income tax benefit recognized for the year ended March 31, 2005 was primarily attributable to a $0.9 million refund of taxes previously withheld in Japan and the release of $1.0 million of an income tax reserve related to a transfer-pricing matter, offset by taxable income generated by our foreign operations. The income tax expense recognized for fiscal year 2006 results from taxable income generated by certain of our foreign operations.
Loss From Discontinued Operations
As a result of our spin-off of PDD, we recognized a loss from discontinued operations of $1.1 million, or $0.04 per share, for the year ended March 31, 2005, which consisted of revenue of $1.3 million and expenses of $2.4 million. This loss compared to a loss from discontinued operations of $2.8 million, or $0.12 per share, for the year ended December 31, 2003, which consisted of $29.5 million in revenue and $32.3 million in expenses.
Comparison of the Three-Month Periods Ended March 31, 2004 and March 31, 2003
Revenue
Revenue decreased $3.8 million or 16% to $19.4 million for the three months ended March 31, 2004, as compared to $23.2 million for the three months ended March 31, 2003. The decrease in revenue was primarily attributable to continued declines in sales of modeling and simulation software to biopharmaceutical companies as well the completion of several consortia and consulting agreements during 2003.
Operating Costs and Expenses
Cost of Revenue. Cost of revenue decreased $1.4 million or 29% to $3.2 million for the three months ended March 31, 2004, as compared to $4.6 million for the three months ended March 31, 2003. As a percentage of revenue, cost of revenue decreased to 17% for the three months ended March 31, 2004, as compared to 20% for the three months ended March 31, 2003. The decrease in cost of revenue was primarily attributable to a $1.1 million decrease in intangible asset amortization due to the full amortization in fiscal year 2003 of intangible assets acquired in previous periods.
Product Development Expenses. Product development expenses decreased $0.7 million or 11% to $5.2 million for the three months ended March 31, 2004, as compared to the $5.9 million for the three months ended March 31, 2003. As a percentage of revenue, product development expenses increased to 27% for the three months ended March 31, 2004, as compared to 25% for the three months ended March 31, 2003. The decrease in product development expenses was primarily attributable to decreased personnel expenses resulting from headcount reductions in January 2004.
Sales and Marketing Expenses. Sales and marketing expenses decreased $0.5 million or 5% to $8.4 million for the three months ended March 31, 2004, as compared to $8.9 million for the three months ended March 31, 2003. As a percentage of revenue, sales and marketing expenses increased to 44% for the three months ended March 31, 2004, as compared to 38% for the three months ended March 31, 2003. The decrease in sales and marketing expenses was primarily attributable to lower commissions paid to sales personnel as a result of a decrease in orders.
General and Administrative Expenses. General and administrative expenses increased $0.1 million or 4% to $4.4 million for the three months ended March 31, 2004, as compared to $4.3 million for the three months ended March 31, 2003. As a percentage of revenue, general and administrative expenses increased to 23% for the three months ended March 31, 2004, as compared to 18% for the three months ended March 31, 2003. The increase in general and administrative costs was primarily attributable to an increase in personnel costs and outside consulting and accounting fees incurred in relation to our initial compliance with Section 404 of Sarbanes-Oxley.
Severance and Lease Abandonment Charges (Recoveries). Severance and lease abandonment charges were $5.2 million for the three months ended March 31, 2004, as compared to a recovery of previously recognized severance and lease abandonment charges of $0.4 million for the three months ended March 31, 2003. During the three months ended March 31, 2004, we implemented a workforce reduction of 73 employees designed to improve the efficiency of our product development activities and reduce general and administrative costs. As a result of the implementation of this workforce reduction, we incurred a charge of $2.8 million for severance benefits for the terminated employees. The remaining severance and lease abandonment expenses incurred during the three months ended March 31, 2004 related to costs arising from the retirement of our former chief executive officer.
During the three months ended March 31, 2003, we recovered $0.4 million of severance and lease abandonment charges initially recognized in fiscal year 2002, consisting of $0.3 million resulting from the termination of the lease on an abandoned facility and $0.1 million related to certain severance obligations.
Spin-Off Transaction Costs. During the three months ended March 31, 2004, we incurred transaction costs of $2.3 million associated with our spin-off of PDD.
Net Interest and Other Income
Net interest and other income was $0.9 million for the three months ended March 31, 2004, as compared to $1.1 million for the three months ended March 31, 2003. The decrease was due to lower foreign exchange gains in the three months ended March 31, 2004, as compared to the three months ended March 31, 2003 resulting from the weakening of the U.S. dollar, partially offset by an increase in interest income.
Income Tax Expense
Income tax expense was $0.1 million for the three months ended March 31, 2004, as compared to $0.3 million for the three months ended March 31, 2003. The decrease in income tax expense was due to a decrease in taxable income generated by our foreign operations.
Loss From Discontinued Operations
As a result of our spin-off of PDD, we recognized a loss from discontinued operations of $9.9 million, or $0.41 per share, for the three months ended March 31, 2004, which consisted of $5.4 million in revenue and $15.3 million in expenses. This compared to a loss from discontinued operations of $0.9 million, or $0.04 per share, for the three months ended March 31, 2003, which consisted of $7.5 million in revenue and $8.4 million in expenses.
Liquidity and Capital Resources
We had cash, cash equivalents, restricted cash, and marketable securities of $66.0 million as of March 31, 2006, as compared to $63.3 million as of March 31, 2005, an increase of $2.7 million. Significant components of this increase include cash provided by operations of $5.8 million, offset by net purchases of property and equipment of $3.0 million.
Net cash provided by operating activities was $5.8 million for the year ended March 31, 2006, as compared to net cash used in operating activities of $14.2 million for the year ended March 31, 2005. The increase in cash flows from operating activities was primarily attributable to reduced operating expenditures, improved collections processes for outstanding accounts receivable balances and the prepayment in fiscal year 2006 by a significant customer of future software license fees of approximately $3 million.
Net cash used in investing activities was $2.1 million for the year ended March 31, 2006, as compared to net cash provided by investing activities of $0.1 million for the year ended March 31, 2005. Significant components of cash flows from investing activities for the year ended March 31, 2006 included net purchases of property and equipment of $3.0 million and a net decrease in our marketable securities portfolio of $0.9 million. Significant components of cash flows from investing activities for the year ended March 31, 2005 included a $16.6 million net decrease in our marketable securities portfolio, $11.0 million in cash paid to acquire SciTegic and $5.1 million of net purchases of property and equipment. The $2.1 million decrease in net purchases of property and equipment for the year ended March 31, 2006, as compared to the year ended March 31, 2005, is primarily attributable to investments in leasehold improvements for our corporate headquarters in San Diego, California in fiscal year 2005.
Net cash provided by financing activities was $0.9 million for the year ended March 31, 2006, compared to net cash used in financing activities of $3.8 million for the year ended March 31, 2005. Cash flows from financing activities for the year ended March 31, 2006 consisted of proceeds from the issuance of our common stock under our employee stock plans. Significant components of cash flows from financing activities for the year ended March 31, 2005 included $1.7 million in proceeds from the issuance of our common stock under our employee stock plans and $5.5 million in cash contributed to PDD in the spin-off.
We have funded our activities to date primarily through the sales of software licenses and related services, the issuance of equity securities, and, prior to the spin-off of PDD, drug discovery services.
We anticipate that our capital requirements may increase in future periods as a result of seasonal sales trends, additional product development activities, and the acquisition of additional equipment. Our capital requirements may also increase in future periods as we seek to expand our technology platform through investments, licensing arrangements, technology alliances, or acquisitions.
We anticipate that our existing capital resources will be adequate to fund our operations at least through fiscal year 2007. However, there can be no assurance that changes will not occur that would consume available capital resources before then. Our capital requirements depend on numerous factors, including our ability to continue to generate software sales, the purchase of additional capital equipment and acquisitions of other businesses or technologies. There can be no assurance that additional funding, if necessary, will be available to us on favorable terms, if at all. Our forecast for the period of time through which our financial resources will be adequate to support our operations is forward looking information, and actual results could vary.
At March 31, 2006, our remaining liability for severance and lease abandonment charges was $4.3 million. Of the liability, $1.1 million represents severance benefits for terminated employees that will be paid in the first quarter of fiscal year 2007. The remaining liability of $3.2 million represents lease abandonment obligations that will be paid through 2016. See Note 10 to our consolidated financial statements included elsewhere in this Report for further information regarding our severance and lease abandonment liability.
Contractual Obligations
Our long-term contractual obligations as of March 31, 2006 are as follows (in thousands):
(1) For purposes of the contractual obligations table, we have included indefinite-lived contractual minimum royalty payments due in the ten fiscal years following fiscal year 2006.
We are obligated to pay royalties for licenses to enhance and market certain software used in connection with our product offerings. In addition to the contractual minimum royalties included in the table above, we have several royalty agreements that are long term or perpetual in nature and the royalty obligations are generally based on a percentage of revenues derived from certain software license sales including associated sales of PCS. The royalty agreements require quarterly payments and generally do not limit the maximum royalties owed. During the years ended March 31, 2006 and 2005 and December 31, 2003, we incurred royalty expenses of $3.0 million, $2.8 million, and $2.8 million, respectively. Our future annual royalty obligations will vary based on the volume and mix of our product sales and, as a result, may increase in the future.
On April 30, 2004, relating to the spin-off of PDD, the landlords of our New Jersey facilities, which were used by our PDD operations, consented to the assignment of the leases to PDD. Despite the assignment, the landlords required us to guarantee the remaining lease obligations, which totaled approximately $25 million as of March 31, 2006. In accordance with Financial Accounting Standards Board (“FASB”) Interpretation (“FIN”) No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, we recognized a liability and corresponding charge to stockholders’ equity for the probability-weighted fair market value of the guarantee. Changes to the fair market value of the liability are recognized in stockholders’ equity. At March 31, 2006 and 2005, the liability for our guarantee of the lease obligation was $0.6 million and $0.7 million, respectively.
Off-Balance Sheet Arrangements and Related Party Transactions
As of March 31, 2006, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.
We do not have relationships or transactions with persons or entities that derive benefits from their non-independent relationship with us or our related parties other than what is disclosed in Note 12 to our consolidated financial statements included elsewhere in this Report.
New Accounting Standards
In November 2005, the FASB issued FASB Staff Position Nos. FAS 115-1 and FAS 124-1 (“FSP Nos. 115-1 and 124-1”), The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, which provide guidance on determining when investments in certain debt and equity securities are considered impaired and whether that impairment is other-than-temporary, and on the measurement of such impairment loss. FSP Nos. 115-1 and 124-1 also include accounting considerations subsequent to the recognition of other-than-temporary impairments and require certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. We will adopt
FSP Nos. 115-1 and 124-1 as of April 1, 2006. While we are currently evaluating the impact on our consolidated financial statements of the adoption of FSP Nos. 115-1 and 124-1, we do not anticipate that they will have a significant impact on our results of operations and financial position.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and SFAS No. 3. Although SFAS No. 154 carries forward the guidance in APB No. 20 and SFAS No. 3 with respect to accounting for changes in estimates, changes in reporting entities, and the correction of errors, SFAS No. 154 establishes new standards for accounting for changes in accounting principles, whereby all such changes must be accounted for by retrospective application to the financial statements of prior periods unless it is impracticable to do so. SFAS No. 154 is effective for accounting changes and error corrections made in fiscal years beginning after December 15, 2005, with early adoption permitted for changes and corrections made in years beginning after May 2005. We will adopt SFAS No. 154 as of April 1, 2006. We are currently evaluating the impact of this new standard, but believe that it will not have a material impact on our financial position, results of operations or cash flows.
In December 2004, the FASB issued SFAS No. 123R. SFAS No. 123R requires that employee stock-based compensation is measured based on the grant date fair value of the related employee equity awards and is treated as an expense that is reflected in the financial statements over the related service period. SFAS No. 123R applies to all employee equity awards granted after adoption and to the unvested portion of employee equity awards outstanding as of adoption. We will adopt SFAS No. 123R using the modified-prospective method effective April 1, 2006. While we are currently evaluating the impact on our consolidated financial statements of the adoption of SFAS No. 123R, we anticipate that it will have a significant adverse impact on our future reported results of operations because employee stock-based compensation expense will be charged directly against our reported results, but will not affect our financial position or cash flows.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We have operations in Europe and Asia-Pacific. As a result, our financial position, results of operations and cash flows can be affected by fluctuations in foreign currency exchange rates, particularly fluctuations in the pound sterling, euro and yen exchange rates. Many of our reporting entities conduct a portion of their business in currencies other than the entity’s functional currency. These transactions give rise to receivables and payables that are denominated in currencies other than the entity’s functional currency. The value of these receivables and payables is subject to changes in exchange rates because they may become worth more or less than they were worth at the time we entered into the transaction due to changes in currency exchange rates. Both realized and unrealized gains or losses on the value of these receivables and payables are included in the determination of net income. We analyze our exposure to currency fluctuations and may engage in financial hedging techniques in the future to reduce the effect of these potential fluctuations. We do not currently have hedging contracts in effect since exchange rate fluctuations have had little impact on our operating results and cash flows. The majority of our subscription agreements are denominated in U.S. dollars.
Our investment portfolio is maintained in accordance with our investment policy that defines allowable investments, specifies credit quality standards and limits the credit exposure of any single issuer. None of our investments are held for trading or speculative purposes. The fair value of our cash equivalents and marketable securities is subject to change as a result of changes in market interest rates and investment risk related to the issuers’ credit worthiness. We do not utilize financial contracts to manage our exposure in our investment portfolio to changes in interest rates. A hypothetical 100 basis point increase or decrease in market interest rates would not have a material impact on the fair value of our cash equivalents and marketable securities due to the relatively short maturities of these investments. While changes in interest rates may affect the fair value of our investment portfolio, any gains or losses will not be recognized in our results of operations until the investment is sold or if the reduction in fair value was determined to be a permanent impairment.
Item 8.
Item 8. Financial Statements and Supplementary Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Accelrys, Inc.
We have audited the accompanying consolidated balance sheets of Accelrys, Inc. as of March 31, 2006 and March 31, 2005 (restated), and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the years ended March 31, 2006 and March 31, 2005 (restated) and December 31, 2003 (restated), and the three month period ended March 31, 2004 (restated). Our audits also included the financial statement schedule listed in the index at Item 15(a)(2). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Accelrys, Inc. at March 31, 2006 and March 31, 2005 (restated), and the consolidated results of its operations and its cash flows for each of the years ended March 31, 2006 and March 31, 2005 (restated) and December 31, 2003 (restated), and the three month period ended March 31, 2004 (restated), in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As described in Note 2, Restatement of Prior Periods Presented, the Company has restated its previously issued consolidated financial statements as of March 31, 2005 and for the years ended March 31, 2005 and December 31, 2003 and the three month period ended March 31, 2004, to correct the accounting for revenue recognition and software development costs, and to correct the classification of expenses, interest income, cash flows from discontinued operations and investments in auction rate securities.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Accelrys, Inc.’s internal control over financial reporting as of March 31, 2006, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated May 5, 2006, expressed an unqualified opinion on management’s assessment and an adverse opinion on the effectiveness of internal control over financial reporting thereon.
/s/ ERNST & YOUNG Llp
San Diego, California
May 5, 2006
Accelrys, Inc.
Consolidated Balance Sheets
(In thousands, except per share amounts)
(1) We have restated our previously issued consolidated financial statements for all reporting periods beginning January 1, 2000 through September 30, 2005 to reflect certain accounting adjustments, as described more fully in Note 2.
See accompanying notes to these consolidated financial statements.
Accelrys, Inc.
Consolidated Statements of Operations
(In thousands, except per share amounts)
(1) We have restated our previously issued consolidated financial statements for all reporting periods beginning January 1, 2000 through September 30, 2005 to reflect certain accounting adjustments, as described more fully in Note 2.
See accompanying notes to these consolidated financial statements.
Accelrys, Inc.
Consolidated Statements of Stockholders’ Equity
(In thousands)
Accelrys, Inc.
Consolidated Statements of Stockholders’ Equity (Continued)
(In thousands)
(1) We have restated our previously issued consolidated financial statements for all reporting periods beginning January 1, 2000 through September 30, 2005 to reflect certain accounting adjustments, as described more fully in Note 2.
See accompanying notes to these consolidated financial statements.
Accelrys, Inc.
Consolidated Statements of Cash Flows
(In thousands)
(1) We have restated our previously issued consolidated financial statements for all reporting periods beginning January 1, 2000 through September 30, 2005 to reflect certain accounting adjustments, as described more fully in Note 2.
See accompanying notes to these consolidated financial statements.
Accelrys, Inc.
Notes to Consolidated Financial Statements
1. Organization and Description of Business
We develop and commercialize software for computation, simulation, management and mining of scientific data used by biologists, chemists and materials scientists, including nanotechnology researchers for product design as well as drug discovery and development.
On April 1, 2004, we changed our fiscal year end from December 31 to March 31. For comparative purposes, we have included in our accompanying consolidated financial statements the consolidated statements of operations, consolidated statements of stockholders’ equity and consolidated statements of cash flows for the years ended March 31, 2006 and 2005 and December 31, 2003, and the three months ended March 31, 2004.
2. Restatement of Prior Periods Presented
We have restated our previously issued consolidated financial statements to reflect certain accounting adjustments. The decision to restate our consolidated financial statements was made by the Audit Committee of our Board of Directors on December 16, 2005, following consultation with, and upon the recommendation of, management and Ernst & Young LLP (“E&Y”), our independent registered public accounting firm. Our decision to restate was made in connection with a review of our Annual Report on Form 10-K for the year ended March 31, 2005 by the Corporate Finance Division of the Securities and Exchange Commission (the “SEC”).
Our restated consolidated financial statements reflect the following accounting adjustments:
Timing of Revenue Recognition. Prior to January 2004, we generally recognized revenues from our term-based software license arrangements, which include both a software license and post-contract customer support (“PCS”), as follows: 64% of the total sales value attributed to the software license was recognized as revenue upon product shipment and the remaining 36%, which was associated with PCS, was recognized as revenue over the PCS term. We have since determined that the fee for such arrangements cannot be unbundled and accounted for separately because we do not have vendor-specific objective evidence (“VSOE”) of the fair value of the PCS. Rather, the entire arrangement fee should be recognized as revenue ratably over the term of the PCS.
Historically, we generally recognized revenues from our perpetual software license arrangements, which include both a software license and PCS, as follows: 85% of the total sales value attributed to the software license was recognized as revenue upon product shipment and the remaining 15%, which was attributed to PCS, was recognized as revenue over the PCS term. We have since determined that the fee for such arrangements cannot be unbundled and accounted for separately because we do not have VSOE of the fair value of the PCS. Rather, the entire arrangement fee should be recognized as revenue ratably over the term of the PCS.
Accordingly, we have restated our previously issued consolidated financial statements to reflect these changes in the timing of the revenue recognized associated with these software license arrangements.
Accounting for Software Development Costs. Historically, we capitalized a portion of our product development costs in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 86, Accounting for the Cost of Computer Software to be Sold, Leased or Otherwise Marketed. As a result of an internal review of our historical accounting for software development costs, we determined that we did not have contemporaneous evidence of the achievement of technological feasibility of our software development projects as required for capitalization under SFAS No. 86. As a result, we historically
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
capitalized software development costs prior to the achievement of technological feasibility. Based on this review, we have determined that technological feasibility occurs shortly before our software products are available for general release. Using this revised methodology, we have determined that costs eligible for capitalization under SFAS No. 86 would not be material. Therefore, we have restated our previously issued consolidated financial statements to remove all historical capitalization of product development costs and related assets and amortization.
Classification of Expenses, Interest Income and Cash Flows From Discontinued Operations. We have restated our previously issued consolidated statements of operations to correct certain misclassifications of general and administrative expenses and interest income between continuing and discontinued operations. These misclassifications resulted in an understatement of our loss from discontinued operations and a corresponding overstatement of our loss from continuing operations. We have also restated our previously issued consolidated statements of cash flows to report net cash provided by operating, investing and financing activities related to discontinued operations as separate line items in the statements of cash flows, as opposed to a single line item as previously reported.
Classification of Investments in Auction Rate Securities. We have restated our previously issued consolidated balance sheets and statements of cash flows to reflect the reclassification of investments in auction rate securities to marketable securities from cash and cash equivalents.
The financial information presented in the accompanying consolidated financial statements and these notes to the consolidated financial statements give effect to the restatement.
The effect of the restatement on our previously reported revenue, operating expenses, net loss and basic and diluted net loss per share for the historical periods presented in the accompanying consolidated financial statements was as follows:
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
The following tables summarizes the effect of the restatement on line items presented in our consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2006:
Consolidated Balance Sheets as of March 31, 2005 and 2004
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
Consolidated Statements of Operations for the years ended March 31, 2005 and December 31, 2003, and the three months ended March 31, 2004 and 2003
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
Consolidated Statements of Cash Flows for the years ended March 31, 2005 and December 31, 2003, and the three months ended March 31, 2004 and 2003
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
The following tables summarizes the effect of the restatement on line items presented in our unaudited condensed consolidated financial statements included in our Quarterly Reports on Form 10-Q for the three months ended September 30, 2005 and June 30, 2005:
Unaudited Condensed Consolidated Balance Sheets as of September 30, 2005 and June 30, 2005
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
Unaudited Condensed Consolidated Statements of Operations for the three and six months ended September 30, 2005 and 2004, and the three months ended June 30, 2005 and 2004
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
Unaudited Condensed Consolidated Statements of Cash Flows for the six months ended September 30, 2005 and 2004, and the three months ended June 30, 2005 and 2004
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
3. Significant Accounting Policies
Principles of Consolidation
These consolidated financial statements include our accounts and those of our wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, income taxes and the valuation of goodwill, intangibles and other long-lived assets. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual future results could differ from those estimates.
Cash and Cash Equivalents
We consider all highly liquid investments with a maturity at purchase of three months or less to be cash equivalents. We invest our cash with financial institutions in money market funds, U.S. Treasury securities and other investment grade securities such as prime-rated commercial paper.
Marketable Securities
Our marketable securities consist of debt securities with maturities at purchase of greater than three months and include U.S. Treasury securities, obligations of U.S. government agencies, corporate bonds and auction rate municipal bonds. We account for our investments in marketable securities in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. Accordingly, our marketable securities have been classified as available-for-sale and are recorded at their estimated fair value. Changes in fair value are recorded as unrealized gains or losses which are included in accumulated other comprehensive income (loss) in stockholders’ equity. The cost of marketable securities sold is determined based on the specific identification method.
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
We review the fair value of our marketable securities at least quarterly to determine if declines in the fair value of individual securities are other-than-temporary in nature. If we believe the decline in the fair value of an individual security is other-than-temporary, we write-down the carrying value of the security to its estimated fair value, generally determined using quoted market prices. To determine if a decline in the fair value of an investment is other-than-temporary, we consider several factors including, among others, the period of time and extent to which the estimated fair value has been less than cost, overall market conditions, the historical and projected future financial condition of the issuer of the security and our ability and intent to hold the security for a period of time sufficient to allow for a recovery of the market value.
Marketable securities, including marketable securities classified as restricted cash (see Note 9), consist of the following:
Included in marketable securities in the accompanying consolidated balance sheets is accrued interest receivable on marketable securities of $0.3 million and $0.5 million as of March 31, 2006 and 2005, respectively.
The contractual maturities of our marketable securities at March 31, 2006 are as follows (in thousands):
Auction rate municipal bonds have been included in the above contractual maturities table based on the stated maturity date of the bond.
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
The following table summarizes the gross unrealized losses and fair value of our marketable securities with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities that have been in a continuous unrealized loss position, at March 31, 2006:
The unrealized losses on these securities were primarily caused by recent increases in market interest rates, and not the credit quality of the issuer, and we have the ability and intent to hold these securities until a recovery of fair value, which may be at maturity. As a result, we do not believe these securities to be other-than-temporarily impaired as of March 31, 2006.
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments on accounts receivable. This estimate is based on a specific customer analysis and an analysis of our historical write-offs as a percent of outstanding accounts receivable balances. If the financial condition of a customer were to deteriorate, resulting in an impairment of its ability to make payments against outstanding balances owed to us, an additional allowance may be required.
Fair Value of Financial Instruments
We carry our cash and cash equivalents, marketable securities and restricted cash at market value. The carrying amount of accounts receivable, accounts payable and accrued liabilities are considered to be representative of their respective fair values due to their short-term nature.
Property and Equipment
Property and equipment, stated at cost, consists of the following:
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
Depreciation is provided on the straight-line method over the estimated useful lives of the related assets. Assets under capital leases, if any, are amortized over the shorter of their estimated useful life or the applicable lease period. Leasehold improvements are amortized over the shorter of their estimated useful lives or the remaining lease term. Repair and maintenance costs are charged to expense as incurred.
Software Development Costs
We account for costs incurred to develop our software products in accordance with SFAS No. 86, Accounting for the Cost of Computer Software to be Sold, Leased or Otherwise Marketed. Accordingly, costs incurred in the research and development of new software products and significant enhancements to existing software products are expensed as incurred, until the technological feasibility of the product has been established. Technological feasibility occurs shortly before our software products are available for general release, and we have determined that costs eligible for capitalization are not material. Accordingly, there were no capitalized software development costs as of March 31, 2006 and 2005.
Goodwill and Acquired Intangible Assets
Changes in the carrying amount of goodwill are as follows (in thousands):
Intangible assets consist of the following:
Intangible assets are amortized using the straight-line method over their estimated useful lives. During the years ended March 31, 2006 and 2005 and December 31, 2003, and the three months ended
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
March 31, 2004 and 2003 (unaudited), intangible asset amortization expense totaled $1.7 million, $1.1 million, $2.8 million, $0 and $1.3 million, respectively.
Future estimated amortization expense for intangible assets as of March 31, 2006 for each of the succeeding five years is as follows (in thousands):
In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, we review our goodwill and indefinite-lived intangible asset for impairment at least annually in our fiscal fourth quarter and more frequently if events or changes in circumstances occur that indicate a potential reduction in the fair value of our reporting unit and/or our indefinite-lived intangible asset below their respective carrying values. Examples of such events or circumstances include: a significant adverse change in legal factors or in the business climate, a significant decline in our stock price, a significant decline in our projected revenue or cash flows, an adverse action or assessment by a regulator, unanticipated competition, a loss of key personnel, or the presence of other indicators that would indicate a reduction in the fair value of a reporting unit.
Our goodwill is considered to be impaired if we determine that the carrying value of the reporting unit to which the goodwill has been assigned exceeds management’s estimate of its fair value. Based on the guidance provided by SFAS No. 142 and SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, management has determined that our company consists of only one reporting unit given the similarities of economic characteristics between the operations and the common nature of the products, services and customers. Because we have only one reporting unit, and we are publicly traded, we determine the fair value of the reporting unit based on our market capitalization as we believe this represents the best evidence of fair value. In the fourth quarter of fiscal year 2006, we completed our annual goodwill impairment test for fiscal year 2006 in accordance with SFAS No. 142 and concluded that our goodwill was not impaired. Our conclusion that goodwill was not impaired was based on a comparison of our net assets as of March 31, 2006 to our market capitalization.
Our indefinite-lived intangible asset is considered to be impaired if we determine that the carrying value of the asset exceeds its estimated fair value. In the fourth quarter of fiscal year 2006, we completed our annual indefinite-lived intangible asset impairment test and concluded that our indefinite-lived intangible asset was not impaired. We estimated the fair value of our indefinite-lived intangible asset utilizing a discounted cash flow analysis which considers the potential royalties that would otherwise be paid to an independent third party for use of the trade name. Key assumptions included in the discounted cash flow analysis include projections of future revenue growth, market royalty rates for similar assets and the after-tax rate of return on the asset.
Impairment of Long-Lived Assets
In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, we review long-lived assets to be held and used, including acquired intangible assets subject to amortization
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
and property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable. Conditions that would necessitate an impairment assessment include a significant decline in the market price of an asset or asset group, a significant adverse change in the extent or manner in which an asset or asset group is being used, the loss of legal ownership or title to the asset, significant negative industry or economic trends or the presence of other indicators that would indicate that the carrying amount of an asset or asset group is not recoverable. An asset is considered to be impaired if management’s estimate of the undiscounted future cash flows anticipated to result from the use of the asset and its eventual disposition are not sufficient to recover the carrying value of the asset. During fiscal years 2006 and 2005, we did not identify any conditions that would necessitate an impairment assessment of our long-lived assets.
Revenue Recognition
We recognize revenues in accordance with the American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) 97-2, Software Revenue Recognition, as amended, SEC Staff Accounting Bulletin (“SAB”) No. 104, Revenue Recognition, and Emerging Issues Task Force (“EITF”) Issue No. 00-21, Revenue Arrangements with Multiple Deliverables.
We generate revenue from the following primary sources:
· software licenses,
· provision of support and maintenance services on licensed software, referred to as PCS, and
· training, installation and implementation services.
Customer payments received in connection with our revenue-generating activities are recorded as deferred revenue. We recognize revenue as set forth below and when all of the following criteria are met:
· a fully executed written contract and/or purchase order has been obtained from the customer (i.e., persuasive evidence of an arrangement exists),
· the contractual price of the product or services has been defined and agreed to in the contract (i.e., price is fixed or determinable),
· delivery of the product or service has occurred and no material uncertainties regarding customer acceptance of the delivered product or service exist, and
· collection of the purchase price from the customer is deemed probable.
Software Licenses
We license software either perpetually or on a term basis. Our standard perpetual software licensing arrangements include twelve months of bundled PCS, while our standard term-based software licensing arrangements typically include PCS for the full duration of the term license. Because we do not have VSOE of the fair value of these elements, we recognize as revenue the entire fee for such licenses ratably over the term of the bundled PCS. Certain of our term-based licenses also allow the customer to substitute purchased products for other products of equal value throughout the term. We account for these arrangements as in-substance subscriptions and, accordingly, we recognize as revenue the entire fee for such licenses ratably over the contractual term of the arrangement, which is typically the same as the term of the bundled PCS.
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
Renewal of PCS under Perpetual Software Licenses
Our PCS includes the right to receive unspecified upgrades or enhancements and technical support. Fees from customer renewals of PCS related to previously purchased perpetual licenses are recognized ratably over the term of the PCS.
Training, Installation and Implementation Services
We provide certain services to our customers, including product training, non-complex product installation and non-complex implementation services which are non-essential to the operation of the software. When sold separately, revenue from these services is generally recognized as the services are delivered, according to the contractual terms. Amounts billed but not yet recognized as revenue, and other payments received prior to the recognition of revenue, are recorded as deferred revenue.
Multi-Element Arrangements
For multi-element arrangements which include software licenses, PCS and non-complex training, installation and implementation services which are non-essential to the operation of the software, the entire fee for such arrangements is recognized as revenue ratably over the term of the PCS or delivery of the services, whichever is longer.
Shipping Costs
The costs of shipping products to our customers are expensed as incurred and are included in cost of revenue in our consolidated statements of operations. We incurred $0.8 million, $0.7 million, $0.9 million, $0.2 million and $0.3 million in shipping costs during the years ended March 31, 2006 and 2005 and December 31, 2003, and the three months ended March 31, 2004 and 2003 (unaudited), respectively.
Advertising Costs
The costs of advertising are expensed as incurred and are included in sales and marketing expenses in our consolidated statements of operations. We incurred $45,000, $0.1 million $0.3 million, $43,000 and $44,000 in advertising costs during the years ended March 31, 2006 and 2005 and December 31, 2003, and the three months ended March 31, 2004 and 2003 (unaudited), respectively.
Foreign Currency Translation
In accordance with SFAS No. 52, Foreign Currency Translation, we translate the financial statements of our foreign subsidiaries into U.S. dollars using period-end exchange rates for assets and liabilities and average exchange rates during each reporting period for results of operations. Gains and losses resulting from foreign currency translation are excluded from results of operations and recorded as accumulated other comprehensive income (loss) in stockholders’ equity.
In certain instances, we and our subsidiaries conduct business with customers and vendors in currencies other than the functional currency of each entity. Foreign exchange gains (losses) resulting from these transactions are included in interest and other income, net in our consolidated statements of operations and totaled $0.3 million, $(0.1) million, $0.6 million, $(0.1) million and $0.3 million for the years ended March 31, 2006 and 2005 and December 31, 2003, and the three months ended March 31, 2004 and 2003 (unaudited), respectively.
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
Concentrations of Risk
We maintain deposits in federally insured financial institutions in excess of federally insured limits. We do not believe we are exposed to significant credit risk due to the financial position of the depository institutions in which those deposits are held. Additionally, we have established guidelines regarding diversification of our investment portfolio and maturities of investments, which are designed to maintain the safety and liquidity of our deposits and investments.
Our international sales are generally denominated in foreign currencies. Conversion of foreign-denominated receivables into U.S. dollars could have a material adverse effect on our results of operations. We conduct business in Europe and in the Asia/Pacific region, primarily in Japan. Any significant decline in the economies or the value of the currencies in these regions could have a material adverse impact on us.
Income Taxes
We account for income taxes using the liability method. Under the liability method, deferred income taxes are recognized for the tax consequences of temporary differences between the financial carrying amounts and the tax basis of existing assets and liabilities by applying enacted statutory tax rates applicable to future years. The provision for income taxes is based on our estimates for taxable income of the various legal entities and jurisdictions in which we operate. As such, income tax expense may vary from the customary relationship between income tax expense and pre-tax accounting income. We establish a valuation allowance against our net deferred tax assets to reduce deferred tax assets to the amount expected to be realized.
Net Loss Per Share
We compute net loss per share pursuant to SFAS No. 128, Earnings Per Share. Accordingly, basic and diluted net loss per share is computed by dividing the net loss for the period by the weighted average number of common shares outstanding during the period, without consideration for common stock equivalents.
Potentially dilutive common stock equivalents consist of common stock options and restricted stock that has not yet fully vested and totaled approximately 3.5 million, 3.2 million, 3.5 million, 1.7 million and 7.0 million shares for the years ended March 31, 2006 and 2005 and December 31, 2003, and the three months ended March 31, 2004 and 2003 (unaudited), respectively. Potentially dilutive common stock equivalents were excluded from the diluted earnings per share calculations for all periods presented as their effect would be anti-dilutive.
Stock-Based Compensation
As permitted by SFAS No. 123, Accounting for Stock-Based Compensation, we account for employee stock-based compensation in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Accordingly, stock-based compensation expense related to employee stock options is recognized if, on the date of grant, the exercise price of employee stock option is less than the fair market value of the underlying common stock.
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
The following table illustrates the effect on net loss and net loss per share if we had applied the fair value recognition provisions of SFAS No. 123 to our employee stock awards. For purposes of the SFAS No. 123 pro forma disclosures, the estimated fair value of employee stock awards has been amortized to expense over the related vesting period of the award on a straight-line basis.
The fair value of employee stock awards was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:
Segment and Geographic Information
In accordance with SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, our operations have been aggregated into one reportable segment given the similarities of economic characteristics between the operations and the common nature of the products, services and customers.
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
Financial information by geographic region is as follows:
Comprehensive Income (Loss)
In accordance with SFAS No. 130, Reporting Comprehensive Income, we report the components of comprehensive income (loss), including net income (loss), in the financial statements in the period in which they are recognized. Comprehensive income (loss) is defined as all changes in equity during a period from non-owner sources, including foreign currency translation adjustment and unrealized gains and losses on marketable securities. We present comprehensive income (loss) in our consolidated statements of
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
stockholders’ equity. Accumulated other comprehensive income (loss) in stockholders’ equity consists of the following:
Guarantees
We account for guarantees in accordance with Financial Accounting Standards Board Interpretation (“FASB”) Interpretation (“FIN”) No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN No. 45 requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of certain guarantees and requires certain disclosures to be made by a guarantor about its obligations under certain guarantees that it has issued.
Effect of New Accounting Standards
In November 2005, the FASB issued Staff Position Nos. FAS 115-1 and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (“FSP Nos. 115-1 and 124-1”), which provide guidance on determining when investments in certain debt and equity securities are considered impaired and whether that impairment is other-than-temporary, and on the measurement of such impairment loss. FSP Nos. 115-1 and 124-1 also include accounting considerations subsequent to the recognition of other-than-temporary impairments and require certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. We will adopt FSP Nos. 115-1 and 124-1 in the first quarter of fiscal year 2007. While we are currently evaluating the impact on our consolidated financial statements of the adoption of FSP Nos. 115-1 and 124-1, we do not anticipate that they will have a significant impact on our results of operations and financial position.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and SFAS No. 3. Although SFAS No. 154 carries forward the guidance in APB No. 20 and SFAS No. 3 with respect to accounting for changes in estimates, changes in reporting entities, and the correction of errors, SFAS No. 154 establishes new standards for accounting for changes in accounting principles, whereby all such changes must be accounted for by retrospective application to the financial statements of prior periods unless it is impracticable to do so. SFAS No. 154 is effective for accounting changes and error corrections made in fiscal years beginning after December 15, 2005, with early adoption permitted for changes and corrections made in years beginning after May 2005. We will adopt SFAS No. 154 as of April 1, 2006. We are currently evaluating the impact of this new standard, but believe that it will not have a material impact on our financial position, results of operations or cash flows.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123R”). SFAS No. 123R requires that employee stock-based compensation is measured based on the grant date fair value of the related employee equity awards and is treated as an expense that is reflected in the financial statements over the related service period. SFAS No. 123R applies to all
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
employee equity awards granted after adoption and to the unvested portion of employee equity awards outstanding as of adoption. We will adopt SFAS No. 123R using the modified-prospective method effective April 1, 2006. While we are currently evaluating the impact on our consolidated financial statements of the adoption of SFAS No. 123R, we anticipate that it will have a significant adverse impact on our future reported results of operations because employee stock-based compensation expense will be charged directly against our reported results, but will not affect our financial position or cash flows.
4. Divestiture of Pharmacopeia Drug Discovery, Inc. (“PDD”)
On April 30, 2004, we completed the spin-off of PDD into an independent, separately traded, publicly held company through the distribution to our stockholders of a dividend of one share of PDD common stock for every two shares of our common stock. As part of this transaction, we contributed $42.3 million in marketable securities and $5.4 million in cash to PDD and incurred transaction costs of approximately $3.0 million.
We have reclassified PDD’s prior period results of operations, assets and liabilities, and cash flows as discontinued operations in our consolidated financial statements. Further, the notes to our consolidated financial statements exclude the results of operations, assets and liabilities of PDD.
In connection with the spin-off of PDD, we entered into a transition services agreement with PDD, under which we agreed to provide certain services to PDD through the first anniversary of the spin-off. Accordingly, during fiscal year 2005, we provided PDD with $0.5 million for purchase of a financial system and $0.7 million related to the consolidation of its facilities. As of March 31, 2006, we have no further obligations to PDD under the transition services agreement.
We also entered into a tax sharing and indemnification agreement with PDD, under which we are responsible for filing all federal, state and local income tax returns including PDD for all periods through the distribution date, and for paying all taxes related to those returns.
We also guaranteed the remaining lease obligations on certain of PDD’s facilities, as more fully described in Note 9.
5. Acquisition of SciTegic, Inc.
On September 27, 2004, we acquired all of the outstanding common shares of SciTegic, Inc., a leading provider of workflow software solutions for the scientific research market, in a transaction accounted for as a purchase. The results of SciTegic’s operations have been included in our consolidated financial statements since the acquisition date. The primary reason for the acquisition was to complement our existing product offerings.
The aggregate purchase price was $20.8 million, consisting of $13.4 million of cash paid and the issuance of 1,166,218 shares of our common stock valued at $7.4 million. The per share value of the stock issued was $6.37 determined based on the average market price of our common shares over the five-day period including two days before, the day of and two days after the terms of the acquisition were agreed to and announced. On the closing date of acquisition, 1,040,119 shares of our common stock were issued to SciTegic stockholders and the remaining 126,099 shares (the “earn-out shares”) were deposited into an escrow account. Further, we deposited $3.2 million of the cash consideration into an escrow account.
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition (in thousands):
The $450,000 of acquired in-process product development was written-off at the date of acquisition in accordance with FASB Interpretation No. 4, Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase Method. The goodwill resulting from the acquisition is not anticipated to be deductible for tax purposes.
Pursuant to the terms of the merger agreement, the cash escrow was released to the former SciTegic stockholders on January 31, 2005 and September 27, 2005. The earn-out shares held in escrow will be released in four semi-annual installments to former SciTegic stockholders subject to, among other things, the continued employment by us of two founders of SciTegic through September 27, 2006.
In addition to the earn-out shares described above, 208,225 shares of our common stock were deposited in the escrow account for the two founders of SciTegic. In fiscal year 2005, we recorded deferred stock-based compensation of $1.3 million for the value of these shares. Additionally, in fiscal year 2005, we recorded deferred stock-based compensation of $0.2 million for the value of our unvested stock options issued to SciTegic employees in the acquisition. The deferred stock-based compensation is being recognized over the respective vesting periods of the earn-out shares and stock options. As of March 31, 2006, the remaining deferred stock-based compensation balance was $0.4 million.
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
Assuming the acquisition had occurred on the first day of the following respective periods, our unaudited pro forma consolidated results of operations would be as follows:
6. Income Taxes
Income (loss) from continuing operations before taxes was as follows:
Income tax expense (benefit) consists of the following:
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
The following reconciles income taxes computed at the U.S. statutory federal tax rate to income tax expense (benefit):
Significant components of our deferred tax assets and liabilities are as follows:
We have provided a full valuation allowance for our net U.S. deferred tax assets as we do not believe that the ultimate realization of such deferred tax assets is more likely than not. At March 31, 2006 and 2005, we had $0.3 million and $0.4 million, respectively, of foreign deferred tax assets. The increase in the valuation allowance for deferred tax assets for the years ended March 31, 2006 and 2005 of $3.0 million and $7.4 million, respectively, was due primarily to the inability to utilize net operating loss carryforwards.
As of March 31, 2006, we had U.S. federal net operating loss carryforwards of approximately $138.2 million, and tax credit carryforwards of approximately $1.9 million. Our U.S. federal net operating loss and tax credit carryforwards expire beginning in 2008 through 2026, if not fully utilized. Realization is dependent on generating sufficient taxable income prior to expiration of the loss and credit carryforwards.
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
Approximately $46.7 million of the net operating loss carryforwards relate to stock option deductions which, when realized, will result in an increase to paid-in capital and a decrease in income taxes payable.
In addition to the net operating loss carryforwards in the table above, as of March 31, 2006, we had pre-acquisition net operating loss carryforwards of $57.0 million from acquisitions outside the U.S. which have been fully reserved. During the years ended March 31, 2006 and 2005 and December 31, 2003, we utilized $0 million, $0.7 million and $0.3 million, respectively, of pre-acquisition net operating loss carryforwards that resulted in a corresponding reduction to goodwill. The realization of our remaining pre-acquisition net operating loss carryforwards as of March 31, 2006 will result in additional reductions of goodwill.
As of March 31, 2006 and 2005, we had a tax reserve of $0.7 million and $0.6 million, respectively, related to a potential transfer pricing issue.
In April 2003, we established a wholly-owned subsidiary, Accelrys Software Solutions Pvt. Ltd., in Bangalore, India, that qualifies under applicable Indian law for a tax holiday through March 2009. The aggregate dollar amount of the tax holiday was $0.3 million, or $0.01 per share, as of March 31, 2006.
A portion of our U.S. federal and state net operating loss and tax credit carryforwards may be subject to annual usage limitations under Sections 382 and 383 of the Internal Revenue Code. Use of the U.K. net operating loss carryforwards may be limited upon the occurrence of certain events such as the discontinuation or change in the nature or conduct of our business.
7. Stock Plans
On August 2, 2005, our stockholders approved the Amended and Restated 2004 Stock Incentive Plan (“2004 Plan”). The 2004 Plan authorizes the grant of equity awards to purchase the number of shares of our common stock equal to the sum of (i) 1,900,000 shares and (ii) the number of shares of common stock underlying any stock awards granted under certain prior equity plans (the 1994 Incentive Stock Plan, the 1996 Equity Incentive Plan, the 2000 Stock Option Plan and the 2004 New-Hire Equity Incentive Plan) that expire or are canceled or forfeited without having been exercised in full or that are repurchased by us. Potential types of equity awards that may be granted under the 2004 Plan to our officers, directors, employees and consultants include stock options, restricted stock awards, common stock awards, stock appreciation rights, performance awards and deferred stock units. Pursuant to the 2004 Plan, any shares of common stock that are awarded under the 2004 Plan as restricted stock awards, common stock awards, performance awards or deferred stock units (but not as stock options or stock appreciation rights) are counted against the maximum number of shares of common stock available for issuance under the 2004 Plan based on a 1.15-to-1 ratio. The terms and conditions of specific awards are set at the discretion of our board of directors although generally awards vest over not more than five years, expire no later than ten years from the date of grant and do not have exercise prices less than the fair market value of the underlying common stock. At March 31, 2006, approximately 2,045,000 shares of our common stock remain available for issuance pursuant to awards granted under the 2004 Plan.
On August 2, 2005, our stockholders also approved the 2005 Employee Stock Purchase Plan (“2005 ESPP”), under which we have reserved 1,000,000 shares of our common stock for issuance. Under the 2005 ESPP, employees may defer up to 10% of their base salary to purchase shares of our common stock. The purchase price of the common stock is equal to 85% of the lower of the fair market value per share of our common stock on the commencement date of the applicable offering period or the purchase date. To date,
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
we have not issued shares under the 2005 ESPP and 1,000,000 shares remain available for future issuance under the 2005 ESPP as of March 31, 2006.
The 2005 ESPP replaced our 1995 Employee Stock Purchase Plan (“1995 ESPP”) which expired in fiscal year 2006. During the years ended March 31, 2006 and 2005 and December 31, 2003, 75,080 shares, 95,720 shares and 112,439 shares, respectively, of our common stock were issued under the 1995 ESPP. No shares of our common stock were issued under the 1995 ESPP during the three months ended March 31, 2004 and 2003 (unaudited), respectively.
A summary of activity under our stock plans, excluding the 2005 ESPP and 1995 ESPP, is as follows (in thousands, except per share amounts):
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
A summary of stock options outstanding and exercisable as of March 31, 2006 is as follows:
8. Retirement Savings Plans
U.S. Based Employees
We have an employee savings and retirement plan (“401(K) Plan”). The 401(K) Plan is intended to be a tax-qualified plan covering substantially all U.S. based employees. Under the terms of the 401(K) Plan, employees may elect to contribute up to 20% of their compensation, or the statutory prescribed limit, if less. We may, at our discretion, match employee contributions up to a maximum of 3% of the employee’s compensation. Employer matching contributions totaled $0.4 million, $0.6 million, $0.7 million, $0.2 million and $0.2 million for the years ended March 31, 2006 and 2005 and December 31, 2003, and the three months ending March 31, 2004 and 2003 (unaudited), respectively.
For our U.S. based executives and members of our board of directors, we provide an executive deferred compensation plan (the “EDC Plan”). Eligible participants can contribute up to 90% of their base salary and 100% of all other forms of compensation into the EDC Plan. On a discretionary basis, we can make matching contributions up to $5,000 per participant into the EDC Plan, and such employer contributions, if any, vest over a three-year period. To date, we have not made any matching contributions to the EDC Plan.
In addition, the EDC Plan contains a bonus employer contribution. The bonus employer contribution is determined based on each percent that our stock outperforms the Russell 2000 Index, up to a maximum of 20% of the participant’s annual retainer or base salary, as appropriate. Bonus employer contributions totaled $0.5 million for the year ended December 31, 2003. No bonus employer contributions were made for all other periods presented.
Non-U.S. Based Employees
We provide retirement benefits for employees located outside the U.S. commensurate with other similar companies in those respective locations. Employer contributions, in the form of cash, totaled $0.7 million, $0.7 million, $0.6 million, $0.2 million and $0.1 million for the years ended March 31, 2006 and 2005 and December 31, 2003, and the three months ending March 31, 2004 and 2003 (unaudited), respectively.
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
9. Commitments and Contingencies
Operating Leases
We lease office space in several facilities under operating leases that expire through 2022. For accounting purposes, we recognize rent expense on a straight-line basis over the term of the related operating leases. Rent expense recognized in excess of rent paid is reflected as a deferred rent liability, which is included in deferred rent, lease concessions and lease guarantee in the accompanying consolidated balance sheets. Rent expense under our operating leases for the years ended March 31, 2006 and 2005 and December 31, 2003, and the three months ended March 31, 2004 and 2003 (unaudited), was approximately $4.2 million, $4.6 million, $4.3 million, $1.2 million and $1.0 million, respectively.
The terms of our lease for our corporate office in San Diego, California include a tenant improvement allowance of up to $1.8 million. We initially recorded the entire tenant improvement allowance as a receivable from the landlord and as a corresponding lease concessions liability. We are amortizing the liability ratably over the term of the related lease as a reduction to rent expense. During the year ended March 31, 2006, we determined that the remaining tenant improvement allowance receivable from the landlord of $0.4 million was uncollectible and accordingly we wrote-off the remaining receivable against the lease concessions liability.
Additionally, under the terms of the lease for our San Diego, California corporate office, we were required to place $6.6 million in a restricted cash account to ensure our performance under the lease agreement. If we are not in default under the lease, the cash restriction will decrease to $4.4 million on September 1, 2009, $3.0 million on September 1, 2011 and will expire upon termination of the lease on September 1, 2013. At March 31, 2006 and 2005, we had a restricted cash balance of $6.6 million and $6.6 million, respectively, which consisted entirely of marketable securities.
We attempt to sublease any unoccupied office space. We recognized sublease income of $0.4 million, $0.5 million, $0.3 million, $0.1 million and $5,000 for the years ended March 31, 2006 and 2005 and December 31, 2003, and for the three months ended March 31, 2004 and 2003 (unaudited), respectively.
Future minimum lease commitments and future committed sublease income as of March 31, 2006 are as follows:
Guarantee of Lease Obligation of Others
On April 30, 2004, relating to the spin-off of PDD, the landlords of our New Jersey facilities, which were used by our PDD operations, consented to the assignment of the leases to PDD. Despite the
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
assignment, the landlords required us to guarantee the remaining lease obligations, which totaled approximately $25 million as of March 31, 2006. In accordance with FIN No. 45, we recognized a liability and corresponding charge to stockholders’ equity for the probability-weighted fair market value of the guarantee. Changes to the fair market value of the liability are recognized in stockholders’ equity. At March 31, 2006 and 2005, the liability for our guarantee of the lease obligation was $0.6 million and $0.7 million, respectively.
Royalties
We are obligated to pay royalties for licenses to enhance and market certain software used in connection with our product offerings. Annual contractual minimum royalty payments as of March 31, 2006 are as follows (in thousands):
(1) For purposes of the contractual minimum royalty payments table, we have included indefinite-lived contractual minimum royalty payments due in the ten fiscal years following fiscal year 2006.
In addition to the contractual minimum royalties included in the table above, we have several royalty agreements that are long term or perpetual in nature and the royalty obligations are generally based on a percentage of revenues derived from certain software license sales including associated sales of PCS. The royalty agreements require quarterly payments and generally do not limit the maximum royalties owed. During the years ended March 31, 2006 and 2005 and December 31, 2003, and the three months ended March 31, 2004 and 2003 (unaudited), we incurred related royalty expense of $3.0 million, $2.8 million, $2.8 million, $0.4 million and $0.5 million, respectively.
Litigation
In the ordinary course of business, we may be subject to claims and, from time to time, named in various legal proceedings. We are currently not involved in any matters of material litigation.
Other Guarantees and Indemnifications
We provide indemnifications of varying scope and size to certain customers against claims of intellectual property infringement made by third parties arising from the use of our products. We have also entered into indemnification agreements with our officers and directors. Although the maximum potential amount of future payments we could be required to make under these indemnifications is unlimited, to date we have not incurred material costs to defend lawsuits or settle claims related to these indemnification provisions. Additionally, we have insurance policies that, in most cases, would limit our exposure and enable us to recover a portion of any amounts paid. Therefore, we believe the estimated fair
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
value of these agreements is minimal and likelihood of incurring an obligation is remote. Accordingly, we have not accrued any liabilities in connection with these indemnification obligations as of March 31, 2006.
10. Severance and Lease Abandonment
The following summarizes the changes in our severance and lease abandonment liability:
During fiscal year 2002, we implemented various actions designed to improve our operations and overall financial performance through workforce reductions and the abandonment of two leased facilities. As a result of the implementation of these actions, we recognized a charge of $4.3 million, consisting of $2.3 million in severance benefits from the termination of 71 employees and $2.0 million related to the abandonment of the two leased facilities. The severance benefits were paid in full in fiscal year 2003. During fiscal year 2003, we negotiated the termination of the operating lease for one of the abandoned leased facilities and finalized certain remaining severance obligations which resulted in a $0.4 million reduction to the original $2.0 million liability. Additionally, during fiscal year 2005, we subleased the other abandoned leased facility which resulted in a $0.2 million reduction to the original $2.0 million liability. Our lease obligation for this facility terminates in fiscal year 2008.
During the three months ended March 31, 2004, we implemented a workforce reduction of 73 employees designed to improve the efficiency of our product development activities and reduce general and administrative costs. As a result of the implementation of this workforce reduction, we incurred a charge of $2.8 million for severance benefits for the terminated employees. The severance benefits were paid in full in fiscal year 2005.
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
During fiscal year 2005, as a result of the relocation of our corporate headquarters, we recorded a lease abandonment charge of $3.6 million representing the future lease obligations, net of estimated future sublease income. Our lease obligation for this facility terminates in fiscal year 2007.
Additionally, during fiscal year 2005, we implemented various actions designed to improve the efficiency of our sales department and eliminate duplicative general and administrative personnel through workforce reductions and the abandonment of a leased facility in Germany. As a result of the implementation of these actions, we recognized a charge of $1.7 million, consisting of $1.4 million in severance benefits from the termination of 42 employees and $0.3 million related to the abandonment of the leased facility. The severance benefits were paid in full in fiscal year 2006. Our lease obligation for the abandoned facility terminates in fiscal year 2010.
In March 2006, we implemented various actions designed to realign our resources with our portfolio of products and services, eliminate redundancies in our workforce and streamline our operations through workforce reductions and abandoning a portion of a leased facility in the United Kingdom. As a result of the implementation of these actions, we recognized a charge of $3.2 million, consisting of $1.8 million in severance benefits from the termination of approximately 50 employees and $1.4 million for our future lease obligations related to the abandoned facility, net of estimated future sublease income. We anticipate completing the workforce reductions and payment of severance benefits in the first quarter of fiscal year 2007. The lease obligation for the abandoned facility terminates in fiscal year 2016.
11. Variable Interest Entity
In March 2000, we established a rabbi trust for the benefit of our directors and officers under the EDC Plan. In accordance with FIN No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51, we have included the assets of the rabbi trust in our consolidated balance sheets since the trust’s inception. As of March 31, 2006 and 2005, the asset and liabilities of the trust were $0.4 million and $0.8 million, respectively. Changes in the values of the assets held by the rabbi trust accrue to the directors and officers and not to us.
12. Related Party Transactions
A former member of our board of directors is a partner in the former principal outside law firm that provided legal services to us through April 30, 2004. For the years ended March 31, 2005 and December 31, 2003, and the three months ended March 31, 2004, we incurred a total of $0.2 million, $0.5 million and $0.4 million, respectively, in fees related to services provided by the legal firm.
Our former chairman, president and chief executive officer is also the chairman of the board of directors of a customer. For the years ended March 31, 2006 and 2005 and December 31, 2003, and the three months ended March 31, 2004, we received $4,000, $0.1 million, $0.7 million and $2,000, respectively, in payment for products and services provided to the customer.
Accelrys, Inc.
Notes to Consolidated Financial Statements (Continued)
13. Selected Quarterly Financial Information (unaudited)
The following quarterly financial data, in the opinion of management, reflects all adjustments, consisting of normal recurring adjustments and the restatement adjustments more fully described in Note 2, necessary for a fair presentation of results for the periods presented:
(1) The increase in total operating costs and expenses in the third quarter of fiscal year 2005 as compared to the second quarter of fiscal year 2005 is partially due to costs from our SciTegic subsidiary, which was acquired on September 27, 2004, as more fully described in Note 5. The results of SciTegic’s operations have been included in our consolidated financial statements since the acquisition date.
(2) As more fully described in Note 4, on April 30, 2004, we completed the spin-off of PDD into an independent, separately traded, publicly held company. Accordingly, we have reclassified PDD’s prior period results of operations, assets and liabilities, and cash flows as discontinued operations in our consolidated financial statements.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
Item 9A.
Item 9A. Controls and Procedures
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
We maintain disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that are designed to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required financial disclosures. Because of inherent limitations, our disclosure controls and procedures, no matter how well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of such disclosure controls and procedures are met.
As of the end of the period covered by this Report, we conducted an evaluation, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rules 13a-15(b) and 15d-15(b). Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were not effective as of March 31, 2006. In particular, in connection with the restatement of our previously issued financial statements, management identified certain control deficiencies that represent material weaknesses in our internal control over financial reporting, as more fully described below. As a result of the restatement of our previously issued financial statements and notwithstanding the material weaknesses described below, management believes that the consolidated financial statements included in this Report fairly present, in all material respects, our financial position, results of operations and cash flows for the periods presented.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the financial statements for external purposes in accordance with generally accepted accounting principles. 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 internal controls may become inadequate because of changes in conditions, or that the degree of compliance with policies and procedures may deteriorate.
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework set forth in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework set forth in Internal Control-Integrated Framework, our management identified certain control deficiencies that represent material weaknesses in our internal control over financial reporting as of March 31, 2006. A material weakness is defined as a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented or detected. The material weaknesses identified by management are as follows:
Timing of Revenue Recognition. We did not maintain effective controls over the application of software revenue recognition principles to our term-based and perpetual software license arrangements. In connection with a review of our Annual Report on Form 10-K for the year ended March 31, 2005 by the Corporate Finance Division of the SEC, we determined that we had failed to properly recognize revenue from software arrangements which include multiple elements (typically software licenses and PCS) in the correct reporting periods, although the total revenue recognized over the term of the arrangements was appropriate. Therefore, we have restated our previously issued consolidated financial statements to correct revenue and deferred revenue. Our failure to properly apply software revenue recognition principles to our term-based and perpetual software license arrangements resulted from a lack of a sufficient number of employees with appropriate levels of knowledge, expertise and training in the application of generally accepted accounting principles relevant to software revenue recognition.
Accounting for Software Development Costs. We did not maintain effective controls over the application of SFAS No. 86, Accounting for the Cost of Computer Software to be Sold, Leased or Otherwise Marketed, to our software development projects. As a result of an internal review of our historical accounting for software development costs, we determined that we did not have contemporaneous evidence of the achievement of technological feasibility of our software development projects as required for capitalization under SFAS No. 86. As a result, we historically capitalized software development costs prior to the achievement of technological feasibility. Based on this review, we have determined that technological feasibility occurs shortly before our software products are available for general release. Using this revised methodology, we have determined that costs eligible for capitalization under SFAS No. 86 would not be material. Therefore, we have restated our previously issued consolidated financial statements to remove all historical capitalization of product development costs and related assets and amortization. Our failure to properly apply SFAS No. 86 resulted from a lack of a sufficient number of employees with appropriate levels of knowledge, expertise and training in the application of generally accepted accounting principles relevant to software development costs.
Because of the material weaknesses described above, which resulted in material misstatements of our previously issued consolidated financial statements, our management concluded that we did not maintain effective internal control over financial reporting as of March 31, 2006 based on the criteria in Internal Control-Integrated Framework. Our management’s assessment of the effectiveness of our internal control over financial reporting as of March 31, 2006 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report which is included herein.
Changes in Internal Control Over Financial Reporting
There have been no changes in our internal control over financial reporting that occurred in our last fiscal quarter that have or are reasonably likely to materially affect our internal control over financial reporting identified in connection with the previously mentioned evaluation other than those described below.
With oversight from our Audit Committee, we have formulated a remediation plan intended to address the control deficiencies identified above and we are committed to effectively implementing the plan as expeditiously as possible. Notwithstanding the remediation initiatives described below, the control deficiencies will not be considered remediated until new controls are implemented, in operation for a sufficient period of time, are tested and our management concludes that the new controls are operating effectively. Specifically, the following actions have been taken as part of the remediation activities:
(1) We hired three senior-level accounting employees in March and April 2006 who have significant expertise in financial controls and the application of generally accepted accounting principles relevant to our business, including software revenue recognition.
(2) We initiated a program of additional training regarding our revenue recognition policies designed to ensure all relevant personnel involved in software revenue recognition transactions understand and apply applicable generally accepted accounting principles, and have set an annual minimum training requirement.
(3) We implemented an enhanced quarterly and annual financial statement close, review and reporting process to include additional levels of analysis and review.
We continue to take remedial steps to strengthen our internal controls and enhance our financial reporting processes. Our ongoing review of our internal controls and financial reporting processes may result in further remediation efforts in addition to those listed above.
Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting
The Board of Directors and Stockholders
Accelrys, Inc.
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Accelrys, Inc. did not maintain effective internal control over financial reporting as of March 31, 2006, because of the effect of the material weaknesses identified in the Company’s system of internal control related to the analysis and recording of revenue and software development costs that resulted in the restatement of prior year’s financial statements, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Accelrys Inc.’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. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’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, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, 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.
A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weaknesses have been identified and included in management’s assessment:
· Failure to properly apply software revenue recognition principles to term-based and perpetual software license arrangements resulted from the Company’s historical lack of a sufficient number of employees with appropriate levels of knowledge, expertise and training in the application of generally accepted accounting principles relevant to software revenue recognition.
· Failure to properly apply applicable accounting literature to the Company’s software development projects resulted from the Company’s lack of a sufficient number of employees with appropriate levels of knowledge, expertise and training in the application of generally accepted accounting principles relevant to software development costs.
These material weaknesses resulted in the Company restating certain of its previously issued financial statements as of March 31, 2005 and for the years ended March 31, 2005 and December 31, 2003 and the three-month period ended March 31, 2004 to reflect the appropriate accounting for revenue, cost of revenues, operating expenses, long-lived assets and deferred revenue. The Company was required to record revenue based on the term of the license rather than recognizing a portion of the fee up-front and a portion over the post contract support term, which changed the timing of revenue recognition. In addition, the Company was required to expense previously capitalized costs associated with software development in the period originally incurred, which has the effect of increasing research and development expense and decreasing cost of revenues for the related amortization. These material weaknesses were considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2006 financial statements, and this report does not affect our report dated May 5, 2006 on those financial statements.
In our opinion, management’s assessment that Accelrys, Inc. did not maintain effective internal control over financial reporting as of March 31, 2006, is fairly stated, in all material respects, based on the COSO control criteria. Also, in our opinion, because of the effect of the material weaknesses described above on the achievement of objectives of the control criteria, Accelrys, Inc. has not maintained effective internal control over financial reporting as of March 31, 2006, based on the COSO control criteria.
/s/ Ernst & Young LLP
San Diego, California
May 5, 2006
Item 9B.
Item 9B. Other Information
Employment Agreement with Mark J. Emkjer
On May 22, 2006, we entered into an employment agreement (the “Emkjer Employment Agreement”) with Mark J. Emkjer, our current president and chief executive officer. Pursuant to the terms of the employment agreement, Mr. Emkjer is entitled to receive an annual base salary in the amount of $400,000, which amount is subject to annual review by the Human Resources Committee of the Board of Directors (the “HR Committee”). Mr. Emkjer is also entitled to participate in our management incentive plan, which allows him to receive, subject to the criteria set forth in the management incentive plan, an incentive bonus in an amount equal to up to 85% of his annual base salary for each year he remains employed with us.
We may terminate the agreement upon two years notice. Such notice may be given commencing twelve months after execution of the agreement. However, even during the term of the agreement, Mr. Emkjer’s employment with us will be at-will, meaning that either we or Mr. Emkjer may terminate the employment relationship at any time. If Mr. Emkjer’s employment with us is terminated by us during the term without “cause” or by Mr. Emkjer for “good reason” (each as defined in the Emkjer Employment Agreement), Mr. Emkjer will be entitled to receive, subject to his continued compliance with certain non-competition, non-solictation and non-disparagement provisions contained in the Emkjer Employment Agreement, severance payments and benefits consisting of: (1) an amount equal to twice the amount of his then-current base salary, payable in equal monthly installments over a period of two years following the date of termination; (2) a pro-rated amount equal to the incentive bonus that he would otherwise have been entitled to receive under the management incentive plan for the then-current fiscal year, payable as a lump sum; (3) an amount equal to twice the amount of his then-current target bonus amount under the management incentive plan, payable in equal monthly installments over a period of two years following the date of termination; and (4) reimbursements for COBRA payments made under our medical and dental insurance plans for a period of up to two years following the date of termination.
In addition, if Mr. Emkjer’s employment with us is terminated within the period commencing two months prior to, and extending eighteen months following, the occurrence of a “change of control” (as defined in the Emkjer Employment Agreement) which takes place during the term of the Emkjer Employment Agreement, Mr. Emkjer will be entitled to receive, subject to his continued compliance with certain non-competition, non-solictation and non-disparagement provisions contained in the Emkjer Employment Agreement, severance payments and benefits consisting of: (1) an amount equal to twice the amount of his then-current base salary, payable in equal monthly installments over a period of one year following the date of termination; (2) a pro-rated amount equal to the incentive bonus that he would otherwise have been entitled to receive under the management incentive plan for the then-current fiscal year, payable as a lump sum; (3) an amount equal to twice the amount of his then-current target bonus amount under the management incentive plan, payable in equal monthly installments over a period of one year following the date of termination; and (4) reimbursements for COBRA payments made under our medical and dental insurance plans for a period of up to two years following the date of termination. In addition, all stock awards issued to Mr. Emkjer pursuant to our stock incentive plans will automatically accelerate and become vested in full as of the date of termination.
The timing of payments to Mr. Emkjer of his severance payments and benefits under the Emkjer Employment Agreement may be deferred to avoid incurring additional taxes and penalties pursuant to Section 409A of the Internal Revenue Code of 1986 (the “Code”). All payments are subject certain gross-up provisions in the event that they are characterized as “excess parachute payments” within the meaning of Section 280G of the Code.
Annual Management Bonuses
On May 18, 2006, the HR Committee authorized the payment of a bonus to our management level employees. Under the terms of our fiscal year 2006 Management Incentive Plan, the HR Committee had discretion to award bonuses ranging from zero to up to six times the actual amounts paid. The amounts paid are set forth below:
In addition, Richard Murphy, our Senior Vice President, Worldwide Sales and Services, received a bonus payment of $57,188 in accordance with the terms of Mr. Murphy’s employment letter, dated September 29, 2005, and Matthew Hahn, Ph.D., our Chief Science and Technology Officer, received a bonus payment of $48,020 in accordance with the terms of Dr. Hahn’s employment letter, dated August 12, 2005.
Approval of 2007 Management Incentive Plan
On May 18, 2006, the HR Committee approved our management incentive plan for fiscal year 2007 (the “2007 Bonus Plan”), pursuant to which our management-level employees will be eligible to receive cash bonuses based on our achievement of certain corporate goals specified in the 2007 Bonus Plan, including achieving certain earnings before interest and taxes, revenue levels and product orders. These bonuses are designed to attract, motivate, retain and reward our management-level employees. Under the 2007 Bonus Plan, the Chief Executive Officer has an annual bonus target equal to 85% of base salary, the Senior Vice President of Worldwide Sales and Support has an annual bonus target of 60% of base salary, and Vice Presidents have an annual bonus target equal to 40% of base salary. Payouts under the 2007 Bonus Plan will vary dependant upon the level of achievement of the specified corporate goals, and will range from zero to two times the targeted bonus amount in the event that the 2007 Bonus Plan’s goals are significantly exceeded. The HR Committee will make all final determinations regarding the achievement of goals and the payment of bonuses pursuant to the 2007 Bonus Plan. The HR Committee has the ability to modify, suspend or terminate the 2007 Bonus plan at any time.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
The information required by this item concerning our directors and executive officers is incorporated by reference from the Proxy Statement.
Item 11.
Item 11. Executive Compensation
The information required by this item is incorporated by reference from the section entitled “Additional Information” in the Proxy Statement.
Item 12.
Item 12. Security Ownership of Certain Benefical Owners and Management and Related Stockholders Matters
The information required by this item is incorporated by reference from the section entitled “Additional Information” in the Proxy Statement.
Item 13.
Item 13. Cetain Relationships and Related Transactions
The information required by this item is incorporated by reference from the section entitled “Additional Information” in the Proxy Statement.
Item 14.
Item 14. Principal Accountant Fees and Services
The information required by this item is incorporated by reference from the sections entitled “Proposal No. 2-Ratification of the Selection of Independent Registered Public Accounting Firm” and “Additional Information” in the Proxy Statement.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a)(1) Financial Statements
The following Consolidated Financial Statements are included:
Report of Ernst & Young LLP, Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of March 31, 2006 and 2005
Consolidated Statements of Operations for the years ended March 31, 2006 and 2005 and December 31, 2003, and the three months ended March 31, 2004
Consolidated Statements of Stockholders’ Equity for the years ended March 31, 2006 and 2005 and December 31, 2003, and the three months ended March 31, 2004
Consolidated Statements of Cash Flows for the years ended March 31, 2006 and 2005 and December 31, 2003, and the three months ended March 31, 2004
Notes to Consolidated Financial Statements
(a)(2) Financial Statement Schedules
Schedule II-Valuation and Qualifying Accounts
(1) Represents write-offs, net of recoveries.
All other schedules are omitted because they are not applicable, or not required, or because the required information is included in the financial statements or notes thereto.
(a)(3) Exhibits:
4.1
Rights Agreement, dated as of September 6, 2002, between Pharmacopeia, Inc. and American Stock Transfer & Trust Company, as Rights Agent, which includes as Exhibit A thereto the Certificate of Designation, Preferences and Rights of Series A Junior Participating Preferred Stock and Exhibit B thereto the Form of Right Certificate (incorporated by reference to Exhibit 4.1 to Accelrys, Inc.’s Report on Form 8-K dated September 4, 2002).
10.1#
Amended 1994 Incentive Stock Plan (incorporated by reference to Exhibit 10.5 to Accelrys, Inc.’s Report on Form 10-K for the year ended December 31, 1995).
10.1(a)#
Amendment No. 1 to the 1994 Incentive Stock Plan (incorporated by reference to Exhibit 10.1(a) to Accelrys, Inc.’s Report on Form 10-K for the year ended December 31, 2000).
10.1(b)#
Amendment No. 2 to the 1994 Incentive Stock Plan (incorporated by reference to Exhibit 10.1(b) to Accelrys, Inc.’s Report on Form 10-K for the year ended December 31, 2000).
10.1(c)#
Amendment No. 3 to the 1994 Incentive Stock Plan (incorporated by reference to Exhibit 10.5(a) to Accelrys, Inc.’s Report on Form 10-Q for the quarter ended June 30, 1997).
10.1(d)#
Amendment No. 4 to the 1994 Incentive Stock Plan (incorporated by reference to Exhibit 10.1(d) to Accelrys, Inc.’s Report on Form 10-K for the year ended December 31, 2000).
10.1(e)#
Amendment No. 5 to the 1994 Incentive Stock Plan (incorporated by reference to Exhibit 10.1(e) to Accelrys, Inc.’s Report on Form 10-K for the year ended December 31, 2000).
10.1(f)#
Amendment No. 6 to the 1994 Incentive Stock Plan (incorporated by reference to Exhibit 10.1(f) to Accelrys, Inc.’s Report on Form 10-K for the year ended December 31, 2000).
10.1(g)#
Amendment No. 7 to the 1994 Incentive Stock Plan (incorporated by reference to Exhibit 10.1(g) to Accelrys, Inc.’s Report on Form 10-K for the year ended December 31, 2000).
10.1(h)#
Amendment No. 8 to the 1994 Incentive Stock Plan (incorporated by reference to Exhibit 10.54 to Accelrys, Inc.’s Report on Form 10-Q for the quarter ended June 30, 2000).
10.1(i)#
Amendment No. 9 to the 1994 Incentive Stock Plan (incorporated by reference to Exhibit 10.1(i) to Accelrys, Inc.’s Report on Form 10-Q for the quarter ended March 31, 2002).
10.2#
1995 Employee Stock Purchase Plan (incorporated by reference to Exhibit 10.6 to Accelrys, Inc.’s Registration Statement on Form S-1 (Reg. No. 33-98246)).
10.2(a)#
Amendment No. 1 to the Employee Stock Purchase Plan (incorporated by reference to Exhibit 10.2(a) to Accelrys, Inc.’s Report on Form 10-Q for the quarter ended March 31, 2001).
10.3#
1995 Director Option Plan (incorporated by reference to Exhibit 10.7 to Accelrys, Inc.’s Registration Statement on Form S-1 (Reg. No. 33-98246)).
10.3(a)#
Amendment No. 1 to 1995 Director Option Plan (incorporated by reference to Exhibit 10.3(a) to Accelrys, Inc.’s report on form 10-K for the year ended December 31, 2000).
10.3(b)#
Amendment No. 2 to the 1995 Director Option Plan (incorporated by reference to Exhibit 10.3(b) to Accelrys, Inc.’s report on Form 10-Q for the quarter ended March 31, 2001).
10.3 (c)
Accelrys, Inc. 2004 New Hire Equity Incentive Plan (incorporated by reference to Exhibit 10.3(c) to Accelrys, Inc.’s Report on Form 10-K for the year ended March 31, 2005).
10.4
Lease Agreement between Accelrys, Inc. and Eastpark at 8A (incorporated by Reference to Exhibit 10.13 to Accelrys, Inc.’s Registration Statement on Form S-1 (Reg. No. 33-98246)).
10.4(a)
Amendment dated as of January 22, 1996 to Lease Agreement between Accelrys, Inc. and Eastpark at 8A (incorporated by reference to Exhibit 10.13(a) to Accelrys, Inc.’s Report on Form 10-K for the year ended December 31, 1995).
10.4(b)
Third Amendment to Lease Agreement dated March 31, 1996 between Pharmacopeia, Inc. and Eastpark at 8A (incorporated by reference to Exhibit 10.13(b) to Accelrys, Inc.’s Report on Form 10-Q for the quarter ended June 30, 1996).
10.5#
Employment Agreement dated as of February 26, 2001 between the Company and Joseph A. Mollica, Ph.D. (incorporated by reference to Exhibit 10.9 to Accelrys, Inc.’s Report on form 10-K for the year ended December 31, 2000).
10.5(a)#
Amendment to employment agreement, effective as of May 1, 2003, between the Company and Joseph A. Mollica, Ph.D. (incorporated by reference to exhibit 10.9(a) to Accelrys, Inc.’s report on Form 10-Q for the quarter ended March 31, 2003.)
10.6
Lease dated November 12, 1998 between Molecular Simulations Inc. and San Diego Tech Center, LLC (incorporated by reference to Exhibit 10.47 to Accelrys, Inc.’s Report on Form 10-K for the year ended December 31, 1998).
10.7#
Form of Indemnity Agreement for Directors and Executive Officers (incorporated by reference to Exhibit 10.48 to Accelrys, Inc.’s Report on Form 10-K for the year ended December 31, 1998).
10.8
Lease Agreement, dated May 1, 1999, between Accelrys, Inc. and South Brunswick Rental I, LTD (incorporated by reference to Exhibit 10.49 to Accelrys, Inc.’s Report on Form 10-Q for the quarter ended June 30, 1999).
10.9#
Accelrys, Inc. 2000 Stock Option Plan (incorporated by reference to Exhibit 10.23 to Accelrys, Inc.’s Report on form 10-K for the year ended December 31, 2000).
10.10#
Accelrys, Inc. Executive Non-Qualified Deferred Compensation Plan (incorporated by reference to Exhibit 10.52 to Accelrys, Inc.’s Report on Form 10-Q for the quarter ended March 31, 2000).
10.11
Form of Stock Purchase Agreement, dated as of March 8, 2000, among the company and the investors set forth therein (incorporated by reference to Exhibit 10.53 to Accelrys, Inc.’s Report on Form 10-Q for the quarter ended March 31, 2000)
10.12
Employment Agreement dated May 1, 2001 between the Company and Michael R. Stapleton. (incorporated by reference to Exhibit 10.28 to Accelrys, Inc.’s Report on form 10-Q for the quarter ended September 30, 2001).
10.12(a)#
Separation Agreement and Release of Claims dated September 30, 2002, by and between Accelrys, Inc. and Michael R. Stapleton (incorporated by reference to Exhibit 10.25/a to Accelrys, Inc.’s Report on Form 10-K for the year ended December 31, 2002).
10.13
Lease Agreement dated July 29, 2001 among the Master, Fellows and Scholars of Trinity College, Cambridge, Accelrys Limited, and Accelrys Inc. and Trinity College (CSP) Limited (incorporated by reference to Exhibit 10.30 to Accelrys, Inc.’s Report on form 10-Q for the quarter ended September 30, 2001).
10.14#
Employment Agreement dated December 3, 2002 by and between Accelrys, Inc. and Mark J. Emkjer (incorporated by reference to Exhibit 10.28 to Accelrys, Inc.’s Report on Form 10-K for the year ended December 31, 2002).
10.15
Lease, dated August 20, 2003, between Accelrys, Inc. and Eastpark at 8A (Building 1000) (incorporated by reference to Exhibit 10.35 to Accelrys, Inc.’s Report on Form 10-Q for the quarter ended September 30, 2003).
10.16
Lease, dated August 20, 2003, between Accelrys, Inc. and Eastpark at 8A (Building 3000) (incorporated by reference to Exhibit 10.36 to Accelrys, Inc.’s Report on Form 10-Q for the quarter ended September 30, 2003).
10.17
Sublease, dated May 18, 2004, between Accelrys, Inc. and Pfizer Inc. (incorporated by reference to Exhibit 10.18 to Accelrys, Inc.’s Report on Form 10-Q for the quarter ended December 31, 2004).
10.18
Lease, dated May 18, 2004, between Accelrys, Inc. and AGRRI Seaview, L.LC. (incorporated by reference to Exhibit 10.19 to Accelrys, Inc.’s Report on Form 10-Q for the quarter ended December 31, 2004).
10.19
Sublease, dated January 27, 2005, between Accelrys, Inc. and QUALCOMM Incorporated (incorporated by reference to Exhibit 10.20 to Accelrys, Inc.’s Report on Form 10-Q for the quarter ended December 31, 2004).
10.20#
David M. Sankaran employment letter (incorporated by reference to Exhibit 10.21 to Accelrys, Inc.’s Report on Form 10-Q for the quarter ended December 31, 2004).
10.21#
Mahesh Krishnamurthy employment letter (incorporated by reference to Exhibit 10.22 to Accelrys, Inc.’s Report on Form 10-Q for the quarter ended December 31, 2004).
10.22#
R. William Taylor employment letter (incorporated by reference to Exhibit 10.23 to Accelrys, Inc.’s Report on Form 10-Q for the quarter ended December 31, 2004).
10.23#
Separation Agreement and Release for John J. Hanlon (incorporated by reference to Exhibit 10.24 to Accelrys, Inc.’s Report on Form 10-Q for the quarter ended December 31, 2004).
10.24#
Separation Agreement and Mutual Release, dated October 4, 2005, between Accelrys, Inc. and Mahesh Krishnamurthy (incorporated by reference to Exhibit 1.011 to Accelrys, Inc.’s Form 8-K dated October 11, 2005).
10.25#
Letter of Employment, dated September 29, 2005, between Accelrys, Inc. and Richard Murphy (incorporated by reference to Exhibit 99.1 to Accelrys, Inc.’s Form 8-K dated October 19, 2005).
10.26#
FY2006 Management Incentive Plan Form (incorporated by reference to Exhibit 10.26 to Accelrys, Inc.’s Report on Form 10-Q for the quarter ended June 30, 2005).
10.27#
Accelrys, Inc. Amended and Restated 2004 Stock Incentive Plan (incorporated by reference to Exhibit 4.2 to Accelrys, Inc.’s Report on Form S-8 filed on August 26, 2005).
10.28#
Form of Stock Option Award Agreement pursuant to Amended and Restated 2004 Stock Incentive Plan (incorporated by reference to Exhibit 4.3 to Accelrys, Inc.’s Report on Form S-8 filed on August 26, 2005).
10.29#
Form of SAR Award Agreement pursuant to Amended and Restated 2004 Stock Incentive Plan (incorporated by reference to Exhibit 4.4 to Accelrys, Inc.’s Report on Form S-8 filed on August 26, 2005).
10.30#
Form of Restricted Stock Award Agreement pursuant to Amended and Restated 2004 Stock Incentive Plan (incorporated by reference to Exhibit 4.5 to Accelrys, Inc.’s Report on Form S-8 filed on August 26, 2005).
10.31#
Form of Restricted Stock Unit Award Agreement pursuant to Amended and Restated 2004 Stock Incentive Plan (incorporated by reference to Exhibit 4.6 to Accelrys, Inc.’s Report on Form S-8 filed on August 26, 2005).
10.32#
Terms of continuing employment of Matthew Hahn, dated as of August 12, 2005 (incorporated by reference to Exhibit 10.3 to Accelrys, Inc.’s Report on Form 10-Q for the quarter ended September 30, 2005).
10.33*
Sublease, dated May 10, 2006, between Accelrys, Inc., Accelrys, Ltd., QUALCOMM Inc., and QUALCOMM UK Ltd.
10.34*#
Employment Agreement dated May 21, 2006 by and between Accelrys, Inc. and Mark J. Emkjer.
10.35*#
Fiscal year 2007 Management Incentive Plan.
14.1
Code of Ethics (incorporated by reference to Exhibit 14.1 to Accelrys, Inc.’s Report on Form 8-K filed on February 5, 2005.)
21.1*
Subsidiaries of registrant
23.1*
Consent of Independent Registered Public Accounting Firm
31.1*
Section 302 Certification of the Principal Executive Officer
31.2*
Section 302 Certification of the Principal Financial Officer
32.1*
Section 906 Certification of the Chief Executive Officer and Chief Financial Officer
+ Confidential treatment granted.
++ Confidential treatment requested.
# Represents a management contract or compensatory plan or arrangement.
* Filed herewith
(b) Exhibits
See Item 15(a)(3) above.
(c) Financial Statement Schedules
See Item 15(a)(2) above.
SIGNATURE
Pursuant to the requirements of section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Mark J. Emkjer and David M. Sankaran, jointly and severally, as his or her attorney-in-fact, each with full power of substitution, for him or her, in any and all capacities, to sign each amendment to this report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact or his or her substitute or substitutes may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:
[Rest of Page intentionally left blank]