Item 1. BUSINESS.
The disclosures set forth in this Annual Report on Form 10-K are qualified by the sections captioned “Risk Factors” in Item 1A
Item 1A. RISK FACTORS.
In addition to the other information in this Annual Report on Form 10-K, the following factors should be considered in evaluating us and our business. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties that we do not presently know or that we currently deem immaterial, may also impair our business, results of operations and financial condition.
RISKS RELATED TO THE MERGER
IF OUR PROPOSED MERGER WITH JDA SOFTWARE GROUP, INC. IS NOT CONSUMMATED, OUR STOCK PRICE, BUSINESS AND OPERATIONS COULD BE HARMED.
On April 24, 2006, we entered into a definitive Agreement and Plan of Merger with JDA and the Merger Sub. Under the Merger Agreement, the Merger Sub will be merged with and into the Company, with the Company continuing after the Merger as a wholly-owned subsidiary of JDA. At the effective time of the Merger, each issued and outstanding share of Company Common Stock will be converted into the right to receive $2.50 in cash.
The obligations of the Company and JDA to effect the Merger are subject to a number of conditions, including approval of the Merger by our stockholders, and the Merger may not occur. If the Merger is not consummated for any reason, we will be subject to a number of material risks, including the following:
· we may not realize any of the potential benefits of the Merger, including any potential synergies that could result from combining the resources of our Company and JDA;
· we may be required to pay JDA a termination fee of up to $9.75 million under certain circumstances;
· the price of our common stock may decline to the extent that the current market price of our common stock reflects an assumption that the merger will be completed; and
· we must pay our accrued costs related to the merger, such as legal, accounting and certain financial advisory fees, even if the merger is not completed.
In addition, our customers may, in response to the announcement of the merger, delay or defer purchasing decisions. Any delay or deferral in purchasing decisions by our customers would have a material adverse effect on our business, regardless of whether the Merger is ultimately completed.
Similarly, our current and prospective employees may experience uncertainty about their future role with JDA until JDA’s strategies with regard to us are announced or executed. This uncertainty may adversely affect our ability to attract and retain key management, marketing, technical, manufacturing, administrative, sales and other personnel. In addition, the attention of our management and our employees may be diverted from day-to-day operations.
PROVISIONS OF THE MERGER AGREEMENT MAY DETER ALTERNATIVE BUSINESS COMBINATIONS.
Restrictions in the Merger Agreement on solicitation generally prohibit us from soliciting any acquisition proposal or offer for a merger or business combination with any other party, including a proposal or offer that might be more advantageous to our stockholders when compared to the terms and conditions of the proposed Merger. If the Merger is not completed, we may not be able to conclude another merger, sale or combination on as favorable terms, in a timely manner, or at all. If the Merger Agreement is terminated, we may be required, in certain circumstances, to pay a termination fee of $9.75 million to JDA.
THE RESTRICTIVE COVENANTS IN THE MERGER AGREEMENT IMPOSE SIGNIFICANT RESTRICTIONS ON OUR BUSINESS OPERATIONS UNTIL THE COMPLETION OF THE MERGER.
Pursuant to the Merger Agreement, until the completion of the Merger, we are required to operate our business in the ordinary course consistent with our past practice and cannot do any of the following, among other things, without the prior written consent of JDA:
· issue or sell any shares of our capital stock or any options, warrants or other rights to acquire any shares of our capital stock, other than the issuance of shares of our common stock upon exercise of those options or warrants outstanding as of April 24, 2006; or
· sell, license or otherwise dispose of any of our properties or assets or incur any capital expenditures above certain threshold amounts, except in the ordinary course of business consistent with our past practice.
RISKS RELATED TO OUR INDEBTEDNESS AND FINANCIAL CONDITION
OUR INDEBTEDNESS COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR FINANCIAL CONDITION.
In November 2000, we completed an offering of $250.0 million of 5% Convertible Subordinated Notes (the “Notes”) that are due November 2007. During fiscal 2004, the balance of the Notes was reduced to $175.5 million as a result of $74.5 million of Notes being exchanged for shares of our common stock. Pursuant to the Merger Agreement, we will conduct a cash tender offer for all of the outstanding Notes. Closing of that tender offer will be conditioned on the closing of the Merger. While the Notes remain outstanding, our indebtedness could have important consequences for investors. For example, it could:
· increase our vulnerability to general adverse economic and industry conditions;
· place us at a competitive disadvantage relative to our competitors;
· limit our ability to obtain additional financing;
· require the dedication of a substantial portion of our cash flows from operations to the payment of principal of, and interest on, our indebtedness, thereby reducing the availability of capital to fund our operations, working capital, capital expenditures, acquisitions and other general corporate purposes;
· limit our flexibility in planning for, or reacting to, changes in our business and the industry; and
· influence our customers and potential customers in doing business with the Company.
We may incur additional debt in the future. While the terms of our credit facility impose certain limits on our ability to incur additional debt, we are permitted to incur additional debt subject to compliance with the terms and conditions set forth in the credit facility. The terms of the Notes set forth no limits on our ability to incur additional debt. If a significant amount of new debt is added to our current levels, the related risks described above could intensify.
WE MAY HAVE INSUFFICIENT CASH FLOW TO MEET OUR DEBT SERVICE OBLIGATIONS, WHICH COULD NEGATIVELY AFFECT OUR ABILITY TO ATTRACT AND RETAIN CUSTOMERS.
We will be required to generate sufficient cash to pay all amounts due on the Notes and to conduct our business operations. The Notes require interest payments of $8.8 million annually with $175.5 million of principal due in November 2007. As of February 28, 2006, the remaining principal and interest payments due under the Notes were $193.8 million. Our cash, cash equivalents and marketable securities totaled $140.7 million as of February 28, 2006. Assuming our cash, cash equivalents and marketable securities remain constant from our February 28, 2006 levels, and we do not consummate the Merger and related tender offer, we will have to generate a minimum of $53.1 million of net cash flow through any combination of normal operations of our Company, raising of debt and equity capital or asset sales by November 2007 to meet our remaining principal and interest payments under the Notes. We have incurred net losses in the past, and we may not be able to cover our anticipated debt service obligations. This may materially hinder our ability to make principal and interest payments on the Notes. Concerns about our ability to meet our debt service obligations could negatively affect our ability to attract and retain customers. Our ability to meet our future debt service obligations will be dependent upon our future performance, which will be subject to financial, business and other factors affecting our operations, many of which are beyond our control.
IF THE MERGER IS NOT CONSUMMATED, WE MAY CHOOSE TO EXCHANGE THE NOTES FOR SHARES OF OUR COMMON STOCK IN THE OPEN MARKET OR PURCHASE A PORTION OF THE NOTES FOR CASH, WHICH COULD MATERIALLY DILUTE EXISTING STOCKHOLDERS OR COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR FINANCIAL CONDITION.
During fiscal 2004, we issued 9,725,750 shares of our common stock in exchange for the Notes in privately negotiated transactions under Section 3(a)(9) of the Securities Act of 1933 as amended (the “Securities Act”). If the Merger is not consummated, we may choose to exchange the Notes for shares of our common stock in the open market or purchase a portion of the Notes for cash, which could materially dilute existing stockholders or could have a material adverse affect on our financial condition. If we choose to enter into privately negotiated transactions to exchange some of our outstanding Notes for shares of our common stock, it could materially dilute the ownership percentage of our existing shareholders and result in non-cash charges to earnings. In addition, to the extent we are able to do so on terms favorable to us, we may choose to purchase a portion of the Notes outstanding from time to time in the open market with cash or, alternatively, refinance the Notes. While the terms of our credit facility impose certain limits on our ability to repurchase our debt securities with cash, we are permitted to do so subject to compliance with the terms and conditions set forth in the credit facility. If purchases of the Notes in the open market were funded from available cash and cash equivalents, it could have a material adverse effect on our liquidity and financial condition.
WE MAY VIOLATE FINANCIAL COVENANTS UNDER OUR CREDIT FACILITY, WHICH COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR LIQUIDITY AND FINANCIAL CONDITION.
We have an unsecured credit facility with Silicon Valley Bank (“SVB”) with borrowing capacity of $15.0 million. As of February 28, 2006, approximately $10.0 million of letters of credit were outstanding with SVB. The terms of the credit facility require us to comply with the following financial covenants: (i) minimum tangible net worth (defined as stockholders’ equity plus convertible debt less goodwill, capitalized software costs and other intangible assets) must be at least $90.0 million plus 50% of consolidated net income generated cumulatively commencing with the first quarter of fiscal 2006 and (ii) our ratio of (a) unrestricted cash, cash equivalents, marketable securities and long-term investments deposited with SVB and its affiliates plus net accounts receivable to (b) current liabilities plus long-term indebtedness to SVB and outstanding letters of credit minus deferred revenue, must be at least 2.0 to 1.0. The credit facility requires us to maintain $50.0 million in funds with SVB Asset Management and its affiliates. Pursuant to the Merger Agreement, we will cooperate with JDA to replace, at the closing of the Merger, the letters of credit that are outstanding with SVB with newly issued letters of credit. If the Merger is not consummated, the letters of credit with SVB will remain outstanding and we will remain obligated to comply with the financial covenants contained in those letters of credit. If our future financial performance results in a violation of these financial covenants under our credit facility, or with our previous equipment financing credit line, we could be required to provide cash collateral for letters of credit or repay outstanding borrowings, which would have a material adverse effect on our liquidity and financial condition.
RISKS RELATED TO OUR BUSINESS
ADVERSE ECONOMIC AND POLITICAL CONDITIONS CONTRIBUTED TO THE DETERIORATION OF DEMAND IN THE MARKETS FOR OUR PRODUCTS AND SERVICES AND HAVE ADVERSELY AFFECTED AND COULD FURTHER ADVERSELY AFFECT OUR OPERATING PERFORMANCE AND FINANCIAL CONDITION.
Our revenue and operating results depend on the overall demand for our enterprise application software and related services. Regional and global adverse changes in the economy and political upheaval and unrest contributed to a deterioration of the markets for our products and services in recent years.
Recent improvements in economic conditions have not yet resulted in improvements in the markets for supply chain management software. These factors resulted in reductions, delays and postponements of customer purchases, which materially and adversely affected our financial performance during the last four fiscal years. Demand for our solutions designed to optimize pricing and revenue management, a component of our demand management solutions, was more severely affected than our other solutions for which there are more mature markets. If these adverse conditions continue or worsen, we would likely experience further reductions, delays, and postponements of customer purchases further adversely affecting our operating performance and financial condition.
National and global responses to future hostilities and terrorist attacks may materially and adversely affect demand for our software and services because of the economic and political effects on our markets and by interrupting the ability of our customers to do business in the ordinary course, as a result of a variety of factors, including, among others, changes or disruptions in movement and sourcing of materials, goods and components or possible interruptions in the flows of information or monies.
WE BELIEVE OUR RECENT PERFORMANCE WAS ADVERSELY AFFECTED BY CAUTIOUS CAPITAL SPENDING, CONCERNS ABOUT OUR FINANCIAL VIABILITY AND A HIGHLY COMPETITIVE ENVIRONMENT. IF WE CANNOT OVERCOME THESE DIFFICULTIES OUR OPERATING PERFORMANCE AND FINANCIAL CONDITION COULD BE MATERIALLY AND ADVERSELY AFFECTED.
We incurred significant losses during the past four fiscal years. Although we have been able to reduce operating costs, we believe our recent financial performance was adversely affected by cautious capital spending, concerns about our financial viability and a highly competitive environment.
Over the past two fiscal years, we have made substantial changes in our Company, including reorganizing and downsizing our executive management team and our sales organization, narrowing our market focus, narrowing our product focus, our ongoing move of product development to India, increasing our focus on transportation and pricing optimization markets and increasing our focus on the Asia-Pacific region. Although we believe that these changes have enabled us to improve our financial performance and cash flows from operations in our most recent quarters, we have continued to report significant losses in our annual financial statements and experience declines in both software license revenue and total revenue. If we do not successfully align our cost structure with our revenue without hindering our ability to grow revenue, or if we do not successfully overcome the factors that have hindered our performance, our operating performance and financial condition could be harmed, and we could continue to incur significant losses.
IF OUR STOCK PRICE DECREASES TO LEVELS SUCH THAT THE IMPLIED FAIR VALUE OF OUR COMPANY IS SIGNIFICANTLY LESS THAN STOCKHOLDERS’ EQUITY FOR A SUSTAINED PERIOD OF TIME, WE MAY BE REQUIRED TO RECORD ADDITIONAL SIGNIFICANT NON-CASH CHARGES ASSOCIATED WITH GOODWILL IMPAIRMENT.
On March 1, 2002, we adopted Statement of Financial Accounting Standards No.142 “Goodwill and Other Intangible Assets” (“SFAS 142”), which changed the accounting for goodwill from an amortization method to an impairment-only method. As required by SFAS 142, we test goodwill for impairment on an annual basis coinciding with our fiscal year-end, or on an interim basis if circumstances change that would more likely than not reduce our implied fair value below our carrying value. We have recorded a non-cash goodwill impairment charge in the past as a result of adverse changes in our stock price. We performed our annual fiscal 2006 and fiscal 2005 goodwill impairment review on February 28, 2006 and 2005, respectively, and interim testing at August 31, 2004, May 31, 2005 and November 30, 2005, respectively, due to volatility in our stock price and the departure of our Chief Financial Officer and determined our implied fair value (which includes factors such as, but not limited to, our market capitalization, a control premium and our
recent stock price volatility) exceeded our carrying value. Accordingly, no goodwill impairment charge was recorded.
We will continue to test for impairment on an annual basis, coinciding with our fiscal year-end, or on an interim basis if circumstances change that would more likely than not reduce the fair value of our reporting unit below its carrying value. If our stock price is significantly lower than recent levels such that the implied fair value of our Company is significantly less than stockholders’ equity for a sustained period of time, among other factors, we may be required to record additional impairment losses related to goodwill.
OUR FUTURE RESULTS COULD BE ADVERSELY AFFECTED BY VARIOUS SIGNIFICANT NON-CASH CHARGES, WHICH COULD IMPAIR OUR ABILITY TO ACHIEVE OR MAINTAIN PROFITABILITY IN THE FUTURE.
We have recorded significant non-cash charges in the past and will incur significant non-cash charges in the future related to the amortization of acquired technology and intangible assets from past acquisitions. We may also incur non-cash charges in future periods related to impairments of long-lived assets and future exchanges of Notes for shares of our common stock, if any. To achieve profitability, we must grow our revenue sufficiently to cover these charges. Our failure to achieve profitability could cause our stock price to decline.
IF OUR EXIT AND DISPOSAL PLANS AND OUR COST CONTAINMENT AND COST REDUCTION MEASURES FAIL TO ACHIEVE THE DESIRED RESULTS OR RESULT IN UNANTICIPATED NEGATIVE CONSEQUENCES, WE MAY SUFFER MATERIAL HARM TO OUR OPERATING PERFORMANCE AND FINANCIAL CONDITION.
Since fiscal 2002, we have implemented a number of exit and disposal plans and cost containment and cost reduction measures and we continue to implement cost containment and cost reduction measures to align our cost structure with our revenue. These actions have included, among other things, reductions in workforce and consolidations of our operational facilities. During the past two fiscal years, we abandoned additional idle space in our Rockville, Maryland; Tokyo, Japan; San Carlos and Calabasas, California; and Bracknell, United Kingdom facilities and closed four offices in Europe and one in the Philippines. Our exit and disposal activities are set forth in greater detail in Note 14 in the Notes to Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.
As part of the consolidation of our facilities, we negotiate lease termination agreements and lease modifications, or both and subleases for certain of our facilities. We cannot predict when or if we will be successful in negotiating lease termination agreements or subleases on terms acceptable to us. Should we be unsuccessful in such negotiations or if the negotiated terms are less favorable than currently anticipated, we may be required to materially increase our exit and disposal related expenses in future periods. Further, if we consolidate additional facilities in the future, we may incur additional exit and disposal related expenses, which could have a material adverse effect on our business, financial condition or results of operations.
There can be no assurance that we will not reduce or otherwise adjust our workforce again in the future or that related transition issues associated with such a reduction will not occur again. If we fail to achieve the desired results of our exit and disposal plans and our cost containment and cost reduction measures, we may suffer material harm to our operating performance and financial condition.
IF WE FAIL TO ATTRACT AND RETAIN A QUALIFIED WORKFORCE, OUR OPERATING PERFORMANCE AND FINANCIAL CONDITION COULD BE MATERIALLY ADVERSELY AFFECTED. FURTHER, OUR COST CONTAINMENT AND COST REDUCTION INITIATIVES MAY HINDER OR IMPAIR OUR ABILITY TO TAKE ADVANTAGE OF IMPROVEMENTS IN MARKET CONDITIONS.
We believe that our success depends on our ability to motivate, hire and retain highly skilled technical, managerial, sales, marketing and services personnel. Competition for skilled personnel can be intense, and there is no assurance that we will be successful in attracting, motivating and retaining the personnel we need to improve our financial performance and grow. As part of our cost containment and cost reduction initiatives, we have recently reduced our workforce and experienced voluntary attrition. However, headcount increased to 761 at February 28, 2006 compared to 695 employees at February 28, 2005, primarily as a result of continued staffing at our product development center in Hyderabad, India.
Continuity of personnel is a very important factor in our success. We consider stock options, restricted stock and retention programs to be critically important in attracting and retaining employees. In addition, in light of the Merger, we have implemented cash bonuses in an effort to retain certain of our employees. The decline in our stock trading price over the past year has decreased the value of stock options and restricted stock granted previously to our employees under our stock option plans. In addition, under the terms of the Merger Agreement, we are prohibited from issuing equity grants and cash bonuses to current and prospective employees as incentives. Our current and prospective employees may experience uncertainty about their future role with the Company or, if the Merger is consummated, with JDA. This uncertainty may adversely affect our ability to attract and retain key management, marketing, technical, manufacturing, administrative, sales and other personnel.
Despite our efforts to retain our employees, our existing employees may seek employment elsewhere. Failure to attract, motivate and retain highly skilled personnel could materially and adversely affect our business. Further, our cost containment and cost reduction initiatives may yield further unintended consequences, such as reduced employee morale, decreased productivity, difficulty attracting qualified personnel due to a perceived risk of future workforce reductions, and our inability to take advantage of improvements in market conditions.
WE HAVE EXPERIENCED SIGNIFICANT CHANGES IN SENIOR MANAGEMENT IN THE LAST FEW YEARS. THE SUCCESS AND GROWTH OF OUR BUSINESS MAY SUFFER IF WE EXPERIENCE TOO MANY CHANGES IN KEY PERSONNEL IN TOO SHORT A PERIOD OF TIME.
We have undergone significant changes in our senior management during the past few years. In July 2004, Gregory J. Owens resigned as our Chief Executive Officer and was replaced by Joseph L. Cowan. In August of 2004, our President, Jeremy P. Coote resigned and the position of President was eliminated. In September 2004, Jeffrey L. Kissling was hired as our Chief Technology Officer, and two other senior management personnel were promoted to new positions. In April 2005, Mr. Owens resigned as Chairman of the Board. In addition, two other senior management personnel left the Company during our third quarter of fiscal 2005 and one, whose position was eliminated, left the Company at the end of our fourth quarter of fiscal 2005. Most recently, in October 2005, Raghavan Rajaji, our Executive Vice President and Chief Financial Officer, resigned to accept a position with another company. During fiscal year 2005, we reorganized our sales and marketing organization, which resulted in further management changes within the organizational structure.
Our success depends significantly on the continued service of our executive officers and their ability to work together effectively as a management team. We do not have fixed-term employment agreements with any executive officers, other than with Joseph L. Cowan, who has a two-year employment agreement with our Company that commenced in July 2004, and we do not maintain key person life insurance on our executive officers. The loss of services of any of our senior management for any reason or their inability to
manage our Company effectively could have a material adverse effect on our operating performance and financial condition.
WE HAVE RESTRUCTURED, AND MAY IN THE FUTURE RESTRUCTURE, OUR SALES FORCE, WHICH CAN BE DISRUPTIVE. WE HAVE ALSO REDUCED OUR SALES FORCE AND CONSOLIDATED OUR SALES OFFICES AS PART OF OUR COST CONTAINMENT AND COST REDUCTION INITIATIVES. OUR FAILURE TO FIELD AN EFFECTIVE SALES ORGANIZATION COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR OPERATING PERFORMANCE AND FINANCIAL CONDITION.
We continue to rely heavily on our direct sales force. In recent years, we reorganized our sales force in response to management changes and other internal considerations, most recently in August 2005. Since fiscal 2003, we have reduced our sales force as a result of the deterioration in our markets and restructuring of our operations. Decreased software license revenue has resulted in reduced compensation earned overall by members of our sales force; it also has resulted, and may continue to result, in voluntary attrition of our sales force over time. In order to stabilize and then grow our revenue, we will have to field an effective sales force. Changes in the structure of the sales force and sales force management have generally resulted in a temporary lack of focus and reduced productivity. Further, we cannot assure you that we will be able to field a more productive sales force or successfully attract and retain qualified sales people at levels sufficient to support growth. We cannot assure you that we will not continue to restructure our sales force or that the transition issues associated with restructuring the sales force will not recur. Such restructuring or associated transition issues can be disruptive and adversely impact our operating performance and financial condition.
SALES CYCLES FOR OUR PRODUCTS AND SERVICES CAN BE LONG AND UNPREDICTABLE. VARIATIONS IN THE TIME IT TAKES US TO LICENSE OUR SOFTWARE MAY CAUSE FLUCTUATIONS IN OUR QUARTERLY OPERATING RESULTS.
Each client’s decision to license and implement our products and services is discretionary, involves a significant commitment of resources and is subject to the client’s budget cycles. The time it takes to license our software to prospective clients varies substantially, but historically has ranged between three and twelve months. Prior sales and implementation cycles should not be relied upon as any indication of future cycles. As a result of current economic conditions, recent changes in our organization and sales force and increased competition, our sales cycle has recently become longer than historical sales cycles.
Variations in the length of our sales cycles will cause our revenue to fluctuate widely from period to period. We base our operating expenses on anticipated revenue trends. Because a high percentage of our expenses are relatively fixed in the short-term and we typically recognize a substantial portion of our software license revenue in the last month of a quarter, any delay in the licensing of our products could cause significant variations in our revenue from quarter to quarter. These delays have occurred on a number of occasions in the past and have materially and adversely affected our financial performance.
The length of our sales cycle depends on a number of factors, many of which are beyond our control, including the following:
· the complexities of client challenges our solutions address;
· the breadth of the solution required by the client, including the technical, organizational and geographic scope of the license;
· the size, timing and complexity of contractual terms of licenses and sales of our products and services;
· wide variations in contractual terms, which may defer recognition of revenue;
· customer financial constraints and credit-worthiness;
· the evaluation and approval processes employed by the clients and prospects, which has become more complex and lengthy and now includes an assessment of our financial viability;
· economic, political and market conditions; and
· any other delays arising from factors beyond our control.
As a result of these and other factors, revenue for any quarter is subject to significant variation. You should not rely on period to period comparisons as indications of future performance. Our future quarterly operating results from time to time may not meet the expectations of market analysts or investors, which would likely have an adverse effect on the price of our common stock.
AN INCREASE IN SALES OF SOFTWARE PRODUCTS THAT REQUIRE CUSTOMIZATION WOULD RESULT IN REVENUE BEING RECOGNIZED OVER THE TERM OF THE CONTRACT FOR THOSE PRODUCTS AND COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR OPERATING RESULTS AND FINANCIAL CONDITION.
Historically, we have been able to recognize software license revenue upon delivery of our solutions and contract execution. Recently, more of our clients and prospects have been asking for unique capabilities in addition to our core capabilities to give them a competitive edge in the market place. These instances could cause us to recognize more of our software license revenue on a contract accounting basis over the course of the delivery of the solution rather than upon delivery and contract execution. The period between initial contact and the completion of the implementation of our products can be lengthy and is subject to a number of factors (over many of which we have little or no control) that may cause significant delays. These factors include the size and complexity of the overall project. As a result, a shift toward a higher proportion of software license contracts requiring contract accounting could have a material adverse effect on our operating results and financial condition and cause our operating results to vary significantly from quarter to quarter.
FAILURE TO MAINTAIN OUR MARGINS AND SERVICE RATES FOR IMPLEMENTATION SERVICES COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR OPERATING PERFORMANCE AND FINANCIAL CONDITION.
A significant portion of our revenue is derived from implementation services. If we fail to scope our implementation projects correctly, our service margins may suffer. Implementation services are predominately billed on an hourly or daily basis (time and materials) and sometimes under fixed price contracts. Implementation services billed on an hourly or daily basis are generally recognized as work is performed. If we are not able to maintain the current service rates for our time and materials implementation services, without corresponding cost reductions, or if the percentage of fixed price contracts increases and we underestimate the costs of our fixed price contracts, our operating performance may suffer. The rates we charge for our implementation services depend on a number of factors, including the following:
· perceptions of our ability to add value through our implementation services;
· complexity of services performed;
· competition;
· pricing policies of our competitors and systems integrators;
· the use of globally sourced, lower-cost service delivery capabilities within our industry; and
· economic, political and market conditions.
CHANGES IN THE SIZE OR NUMBER OF OUR SOFTWARE TRANSACTIONS MAY CAUSE MATERIAL FLUCTUATIONS IN OUR QUARTERLY OPERATING RESULTS.
The size and number of our software license transactions fluctuate. Fluctuations in the size and number of our software transactions have occurred, and may in the future occur, as a result of changes in demand for our software and services. Losses of, or delays in concluding, larger software transactions (which typically are more complex, take longer to negotiate and are subject to more delays) have had, and could continue to have, a proportionately greater effect on our revenue and financial performance for a particular period. We have experienced declines in the number of software transactions of $1.0 million or greater since fiscal 2002. Specifically, we recognized 38 such software transactions in fiscal 2002, 19 such software transactions in fiscal 2003, 18 such software transactions in fiscal 2004, 7 such software transactions in fiscal 2005, and 5 such software transactions in fiscal 2006. During the three months ended May 31, 2005, one transaction accounted for more than 10% of our consolidated revenue on a quarterly basis. As a result of these changes in the size and number of our software transactions, our quarterly revenue and financial performance have fluctuated significantly and may fluctuate significantly in the future.
OUR ANNUAL SOFTWARE LICENSE REVENUE HAS DECLINED SINCE FISCAL 2003. LOWER SOFTWARE LICENSE REVENUE HAS RESULTED AND MAY CONTINUE TO RESULT IN REDUCED SERVICES AND SUPPORT REVENUE.
Our ability to maintain or increase services and support revenue depends on our ability to maintain or increase the amount of software we license to customers. Since fiscal 2003, we experienced declines in services revenue primarily as a result of declining software license revenue in prior periods. Additional decreases of software license revenue or slowdowns in licensing may have a material adverse effect on our services and support revenue in future periods.
FURTHER DECLINES IN SOFTWARE LICENSE REVENUE, A REDUCTION IN THE RENEWAL RATE OF ANNUAL SUPPORT CONTRACTS, OR BOTH, COULD RESULT IN A MATERIAL ADVERSE EFFECT ON OUR OPERATING PERFORMANCE AND FINANCIAL CONDITION.
In multiple quarters during fiscal years 2003 through 2006, we experienced sequential quarterly declines in support revenue resulting from both the decline in software license revenue and clients not renewing or partially renewing existing support contracts. Our support revenue includes post-contract support and the rights to unspecified software upgrades and enhancements. Support contracts are generally renewable annually at the option of our customers. Although we have historically experienced high rates of renewed annual support contracts from our customers, if our software license revenue does not grow and if our customers fail to renew or to fully renew their support contracts at historical rates, our support revenue could materially decline.
OUR MARKETS ARE VERY COMPETITIVE, AND WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY.
The markets for our solutions are very competitive. The intensity of competition in our markets has significantly increased in part as a result of the deterioration in our markets. We expect this intensity of competition to increase in the future.
In addition, many leading companies in the business of providing enterprise application software have been the subject of mergers and acquisitions during the last several years. This industry consolidation may result in stronger competitors that are better able to compete as sole-source vendors for customers. The pace of consolidation has significantly increased over the last year and may continue. If there is significant consolidation among enterprise application software companies, we may be at a competitive disadvantage as an independent best-of-breed enterprise application software vendor.
Some competitors are offering software that competes with ours at little or no charge as components of bundled products or on a stand-alone basis. To counter this increased competition, we may need to make further adjustments to our business, including reorganizing or reducing our workforce, altering our pricing and narrowing our market focus and our product focus. Smaller niche software companies have developed, and will likely continue to develop, unique offerings that compete effectively with some of our solutions. Further, our current or prospective clients and partners may become competitors in the future.
INCREASED COMPETITION HAS RESULTED IN, AND IN THE FUTURE COULD RESULT IN, PRICE REDUCTIONS, LOWER GROSS MARGINS, LONGER SALES CYCLES AND THE LOSS OF MARKET SHARE. EACH OF THESE DEVELOPMENTS COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR OPERATING PERFORMANCE AND FINANCIAL CONDITION. MANY OF OUR CURRENT AND POTENTIAL COMPETITORS HAVE SIGNIFICANTLY GREATER RESOURCES THAN WE DO, AND THEREFORE, WE MAY BE AT A DISADVANTAGE IN COMPETING WITH THEM.
We directly compete with other enterprise application software vendors including: Aspen Technology, DemandTec, Global Logistics Technologies (acquired by Oracle), i2 Technologies, JDA Software (recently agreed to acquire us), Logility, Manhattan Associates, ProfitLogic (acquired by Oracle), PROS Revenue Management, Rapt, Retek (acquired by Oracle), Sabre, SAP and Teradata (a division of NCR). Certain ERP vendors, in addition to SAP, all of which are substantially larger than us, have acquired or developed demand-driven and supply chain management software companies, products, or functionality or have announced intentions to develop and sell demand and supply chain management solutions. Such vendors include Oracle, SAP (which recently acquired Khimetrics) and SSA Global Technologies. Some of our current and potential competitors, particularly the ERP vendors, have significantly greater financial, marketing, technical and other resources than we do, as well as greater name recognition and larger installed bases of clients. Five of our competitors, Oracle, PeopleSoft, ProfitLogic, Global Logistics Technologies and Retek, have combined and other of our current and potential competitors may combine and may subsequently utilize enhanced financial and human resources to develop and sell more competitive demand-driven supply chain products. These larger enterprise application software vendors have increasingly raised concerns about our financial viability with our clients and prospects, which has contributed to delays in successfully closing software transactions. In addition, many of our competitors have well-established relationships with our current and potential clients and have extensive knowledge of our industry. As a result, they may be able to adapt more quickly to new or emerging technologies and changes in client requirements or to devote greater resources to the development, promotion and sale of their products than we can. Any of these factors could materially impair our ability to compete and have a material adverse effect on our operating performance and financial condition.
IF THE DEVELOPMENT OF OUR PRODUCTS AND SERVICES FAILS TO KEEP PACE WITH OUR INDUSTRY’S RAPIDLY EVOLVING TECHNOLOGY, OUR ABILITY TO COMPETE IN OUR MARKETS AND OUR FUTURE RESULTS MAY BE MATERIALLY AND ADVERSELY AFFECTED.
The markets for our solutions are subject to rapid technological change, changing client needs, frequent new product introductions and evolving industry standards. If we fail to keep pace with these changes, our products and services may be rendered less competitive or obsolete. Our product development and testing efforts have required, and are expected to continue to require, substantial investments. We may not possess sufficient resources in the future to continue to make further necessary investments in technology. If we are unable, for technological or other reasons, to develop and introduce new and enhanced software in a timely manner, we may lose existing clients and fail to attract new clients, which may have a material adverse effect on our operating performance and financial condition.
OUR BUSINESS IS SUBJECT TO CHANGING REGULATION OF CORPORATE GOVERNANCE AND PUBLIC DISCLOSURE THAT HAS INCREASED BOTH OUR COSTS AND THE RISK OF NONCOMPLIANCE.
Because our common stock is publicly traded, we are subject to certain rules and regulations of federal, state and financial market exchange entities charged with the protection of investors and the oversight of companies whose securities are publicly traded. These entities, including the Public Company Accounting Oversight Board, the Securities and Exchange Commission and The Nasdaq Stock Market, continue to develop and issue regulations and requirements in response to market concerns and laws enacted by Congress, most notably the Sarbanes-Oxley Act of 2002. Our efforts to comply with these regulations have resulted in, and are likely to continue to result in, increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities.
In particular, our efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations regarding our required assessment of our internal controls over financial reporting and our external auditor’s audit of that assessment have required, and continue to require, the commitment of significant financial and managerial resources. Moreover, because these laws, regulations and standards are subject to varying interpretations, their application in practice may evolve over time as new guidance becomes available. This evolution may result in continuing uncertainty regarding compliance matters and additional costs necessitated by ongoing revisions to our disclosure and governance practices.
IF WE FAIL TO MAINTAIN AN EFFECTIVE SYSTEM OF INTERNAL CONTROL OVER FINANCIAL REPORTING AND DISCLOSURE CONTROLS, WE MAY NOT BE ABLE TO REPORT OUR FINANCIAL RESULTS ACCURATELY OR PREVENT FRAUD. AS A RESULT, OUR BUSINESS, RESULTS OF OPERATIONS AND FINANCIAL CONDITION COULD BE HARMED AND INVESTORS COULD LOSE CONFIDENCE IN OUR FINANCIAL REPORTING, WHICH COULD CAUSE OUR STOCK PRICE TO DECLINE.
Effective internal controls are necessary to provide reliable financial reports and effectively prevent fraud. We have in the past discovered, and may in the future discover, areas of our system of internal control over financial reporting and disclosure controls that need improvement. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, and not absolute, assurances that the objectives of the system are met. Any failure of our system of internal control over financial reporting or disclosure controls could have a material adverse effect on our business, results of operations and financial condition. Inadequate internal controls over financial reporting or disclosure controls could also cause investors to lose confidence in our reported financial information, which could cause our stock price to decline.
OUR CONTINUED SHIFT OF OUR PRODUCT DEVELOPMENT OPERATIONS TO INDIA POSES SIGNIFICANT RISKS.
Just over one year ago, we opened our own product development facility in Hyderabad, India. We continue to move a substantial portion of our product development to India. In addition, we maintain relationships with third parties in India to which we outsource a portion of our product development effort. We are increasing the proportion of our product development work being performed at our facility in India in order to increase product development resources and to take advantage of cost efficiencies associated with India’s lower wage scale. We may not achieve the cost savings and other benefits we anticipate from this program. We may not be able to find sufficient numbers of developers with the necessary skill sets in India to meet our needs. Further, we have a heightened risk exposure to changes in the economic, security and political conditions of India as we invest greater resources in our India facility. Economic and political instability, military actions and other unforeseen occurrences in India could impair
our ability to develop and introduce new software applications and functionality in a timely manner, which could put our products at a competitive disadvantage whereby we lose existing customers and fail to attract new customers.
DEFECTS IN OUR SOFTWARE, THE IMPROPER SCOPING OF A PROJECT, OR PROBLEMS IN THE IMPLEMENTATION OF OUR SOFTWARE COULD LEAD TO CLAIMS FOR DAMAGES BY OUR CLIENTS, LOSS OF REVENUE OR DELAYS IN THE MARKET ACCEPTANCE OF OUR SOLUTIONS.
Our software is complex and must be implemented to perform within the often sophisticated and complex business processes of our clients, which can make it difficult to scope the initial project or detect errors in our software prior to implementation. We may not discover the existence of these problems until our customers install and use a given product or until the volume of services that a product provides increases. In addition, when our software is installed, the technical environment into which it is installed is frequently complex and typically contains a wide variety of systems and third-party software, with which our software must be integrated. This can make the process of implementation itself difficult and lengthy. As a result of these factors, some customers may have difficulty implementing our products successfully within anticipated timeframes or otherwise achieving the expected benefits. These problems may result in claims for damages suffered by our clients, a loss of, or delays in, the market acceptance of our solutions, client dissatisfaction and lost revenue and collection difficulties during the period required to correct these errors.
WE UTILIZE THIRD-PARTY SOFTWARE THAT WE INCORPORATE INTO AND INCLUDE WITH OUR PRODUCTS AND SOLUTIONS. IMPAIRED RELATIONS WITH THESE THIRD PARTIES, DEFECTS IN THIRD-PARTY SOFTWARE OR THEIR INABILITY OR FAILURE TO ENHANCE THEIR SOFTWARE OVER TIME COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR OPERATING PERFORMANCE AND FINANCIAL CONDITION.
We incorporate and include third-party software into and with our products and solutions. If our relations with any of these third parties are impaired, and if we are unable to obtain or develop a replacement for the software, our business could be harmed. The operation of our products would be impaired if errors occur in the third-party software that we utilize. It may be more difficult for us to correct any defects in third-party software because the software is not within our control. Accordingly, our business could be adversely affected in the event of any errors in this software. There can be no assurance that these third parties will continue to invest the appropriate levels of resources in their products and services to maintain and enhance the capabilities of their software.
WE UTILIZE THIRD PARTIES TO INTEGRATE OUR SOFTWARE WITH OTHER SOFTWARE PRODUCTS AND PLATFORMS. IF ANY OF THESE THIRD PARTIES SHOULD CEASE TO PROVIDE INTEGRATION SERVICES TO US, OUR OPERATING PERFORMANCE AND FINANCIAL CONDITION COULD BE MATERIALLY ADVERSELY AFFECTED.
We depend on companies such as Business Objects, Inovus, Tibco Software, Vignette, and webMethods to integrate our software with software and platforms developed by third parties. If relations with any of these third parties are impaired, and if we are unable to secure a replacement on a timely basis, our operating performance and financial condition could be harmed. If these companies are unable to develop or maintain software that effectively integrates with our software and is free from defects, our ability to license our products and provide solutions could be impaired and our operating performance and financial condition could be harmed. There can be no assurance that these third parties will continue to invest the appropriate levels of resources in their products and services to maintain and enhance their software’s capabilities. If we are unable to continue to license certain of this software on commercially reasonable terms, including the reporting software from Cognos and the application platform suite from
BEA Systems, we may face delays in releases of certain of our software solutions until equivalent technology can be identified, licensed or developed, and integrated into our current product. These delays, if they occur, may seriously harm our business.
OUR INABILITY TO DEVELOP AND SUSTAIN RELATIONSHIPS WITH VENDORS SUCH AS SOFTWARE COMPANIES, CONSULTING FIRMS, RESELLERS AND OTHERS TO MARKET AND IMPLEMENT OUR SOFTWARE PRODUCTS COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR OPERATING PERFORMANCE AND FINANCIAL CONDITION.
We are developing, maintaining and enhancing significant working relationships with complementary vendors, such as software companies, consulting firms, resellers and others that we believe can play important roles in marketing our products and solutions. We are currently investing, and intend to continue to invest, significant resources to develop and enhance these relationships, which could adversely affect our operating margins. We may be unable to develop relationships with organizations that will be able to market our products effectively. Our arrangements with these organizations are not exclusive and, in many cases, may be terminated by either party without cause. Many of the organizations with which we are developing or maintaining marketing relationships have commercial relationships with our competitors. There can be no assurance that any organization will continue its involvement with us and our products. The loss of relationships with such organizations could materially and adversely affect our operating performance and financial condition.
GOVERNMENT CONTRACTS ARE SUBJECT TO COST AND OTHER AUDITS BY THE GOVERNMENT AND TERMINATIONS FOR THE CONVENIENCE OF THE GOVERNMENT. GOVERNMENT PROCUREMENT IS HIGHLY REGULATED, AND CONTRACTORS ARE SUBJECT TO THE RISKS OF PROTESTS, CLAIMS, PENALTIES, FINES, DEFAULT TERMINATION, AND RESCISSION, AMONG OTHER ACTIONS. THE ADVERSE RESULT OF A GOVERNMENT AUDIT OR ACTION AGAINST ANY OF OUR CONTRACTS WITH THE GOVERNMENT COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR OPERATING PERFORMANCE AND FINANCIAL CONDITION.
Government contracts face special risks due to potential audits by government agencies.
A significant percentage of our revenue is from time to time derived from contracts with the Federal Government. Government contractors are commonly subject to various audits and investigations by Government agencies. One agency that oversees or enforces contract performance is the Defense Contract Audit Agency (“DCAA”). The DCAA generally performs a review of a contractor’s performance on its contracts, its pricing practices, costs and compliance with applicable laws, regulations and standards and to verify that costs have been properly charged to the Government. Although the DCAA completed an initial review of our accounting practices and procedures allowing us to invoice the Government, it has yet to exercise its option to perform an audit of our actual invoicing of Government contracts. These audits may occur several years after completion of the contract. If an audit were to identify significant unallowable costs, we could have a material charge to our earnings or reduction to our cash position as a result of the audit and this could have a material adverse effect on our operating performance and financial condition.
If a government audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines, and suspension or debarment from doing business with U.S. federal government agencies. In addition, we could suffer serious harm to our reputation if allegations of impropriety were made against us, whether or not true.
Government contracts are subject to unique risks of early termination.
In addition, Government contracts may be subject to termination by the Government for its convenience, as well as termination, reduction or modification in the event of budgetary constraints or any change in the Government’s requirements. If any of our time-and-materials or fixed-priced contracts were to be terminated for the Government’s convenience, we would probably receive only the purchase price for items delivered prior to termination, reimbursement for allowable costs for work-in-progress and an allowance for profit on the contract, or an adjustment for loss if completion of performance would have resulted in a loss. Government contracts are also conditioned upon the continuing availability of Congressional appropriations. Congress usually appropriates funds on a fiscal-year basis, even though the contract performance may extend over many years. Consequently, at the outset of a program, the contract is usually only partially funded, and Congress must annually determine if additional funds will be appropriated to the program. As a result, long-term contracts are subject to cancellation if appropriations for future periods become unavailable. We have not historically experienced any significant material adverse effects as a result of the Government’s failure to fund programs awarded to us. If the Government were to terminate some or all of our contracts or reduce appropriations for a program under which we have a contract, cancel appropriations, or both, our operating performance and financial condition could be materially and adversely affected.
Competitive bidding, a cornerstone to government contracting, imposes risks and costs.
From time to time we derive significant revenue from federal contracts awarded through a competitive bidding process, which can impose substantial costs upon us. We will lose revenue if we or our contracting partners (typically, prime contractors with whom we subcontract) fail to compete effectively. Competitive bidding imposes substantial costs and presents a number of risks, including: the need to bid before design is complete, bid and proposal costs, risks in estimation of prospective needs, and bid protests that may delay or derail awards.
Our work with other contractors poses risks, including risks to our reputation.
As a prime contractor, we may rely upon other companies as subcontractors to perform work we are obligated to deliver to our government clients. A failure by one or more of our subcontractors to perform the agreed-upon services on a timely and satisfactory basis may compromise our ability to perform our obligations as a prime contractor. In some cases, we have limited involvement in the work performed by the subcontractor and may have exposure as a result of problems caused by the subcontractor. In extreme cases, performance deficiencies on the part of our subcontractors could result in a government client terminating our contract for default. A default termination could expose us to liability for the agency’s costs of re-procurement, damage our reputation, and hurt our ability to compete for future contracts. Additionally, we may have disputes with our subcontractors that could impair our ability to execute our contracts as required.
Despite careful precautions that we take, we are exposed to risk due to potential employee misconduct in the highly regulated government marketplace.
We are exposed to the risk that employee fraud or other misconduct could occur. Misconduct by employees could include intentional failures to comply with federal government procurement regulations, engaging in unauthorized activities, or falsifying time records. Employee misconduct could also involve the improper use of our clients’ sensitive or classified information, which could result in regulatory sanctions against us and serious harm to our reputation. It is not always possible to deter employee misconduct, and the precautions we take to prevent and detect this activity may be ineffective in controlling unknown or unmanaged risks or losses, which could harm our business.
The government marketplace has a unique risk: that appropriations to fund contracts will not be made, or will be diverted or delayed.
A decline in overall U.S. government expenditures could cause a decrease in our revenue and adversely affect our operating performance. Defense spending levels may not continue at present levels, and future levels of expenditures and authorizations for existing programs may decline, remain constant, or shift to agencies or programs in areas where we do not currently have contracts. A significant decline in defense expenditures, or a shift in expenditures away from agencies or programs that we support, could cause a material decline in our government-related revenue.
Federal contracts are subject to unique terms and risks, not commonly found in the commercial marketplace.
Federal government contracts contain provisions and are subject to laws and regulations that provide government clients with rights and remedies not typically found in commercial contracts. These rights and remedies allow government clients, among other things, to:
· terminate existing contracts for convenience, as well as default;
· reduce or modify contracts or subcontracts, often unilaterally;
· terminate security clearances and thereby prevent classified contracting;
· cancel multi-year contracts and related orders if funds for contract performance for any subsequent years become unavailable;
· decline to exercise options to renew multi-year contracts;
· claim rights in certain products, systems, and technology produced by us;
· prohibit future awards based on a finding of an organizational conflict of interest; subject contract awards to protest; and
· suspend or debar contractors.
Our federal contracts pose unique pricing risks.
Much of our federal contracting is done through a type of special contract, sponsored by the U.S. General Services Administration (GSA), known as the “Multiple Award Schedules” (or simply “Schedules”) contract. Our GSA Schedules contract, like all others, includes a clause known as the “Price Reductions” clause; the terms of that clause are analogous to a “most favored customer” clause in commercial contracts. Under that clause, we have agreed that the prices to the government under the GSA Schedules contract will maintain a constant relationship to the prices charged to certain commercial customers, i.e., when prices to those benchmark customers drop, so too must our prices on our GSA Schedules contract. Although we have undertaken extensive efforts to comply with the Price Reductions clause, it is possible that we, through, for example, an unreported discount offered to a “benchmark” customer, might fail to honor the obligations of the Price Reductions clause. If that occurred, we could, under certain circumstances, be subject to an audit, an action in fraud, or other adverse government actions or penalties.
THE LIMITED ABILITY OF LEGAL PROTECTIONS TO SAFEGUARD OUR INTELLECTUAL PROPERTY RIGHTS COULD IMPAIR OUR ABILITY TO COMPETE EFFECTIVELY.
Our success and ability to compete are substantially dependent on our internally developed technologies and trademarks, which we protect through a combination of confidentiality procedures and agreements, contractual provisions, patent, copyright, trademark and trade secret laws. Despite our efforts to protect our proprietary rights, unauthorized parties may copy aspects of our products or obtain and use
information that we regard as proprietary. The shift of an increasing amount of our product development work to India may increase this risk. Policing unauthorized use of our products is difficult, particularly in certain foreign countries, including, among others, India and The People’s Republic of China. We are unable to determine the extent to which piracy of our software products exists. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as the laws of the U.S. In addition, our competitors may independently develop technology similar to ours.
OUR PRODUCTS MAY INFRINGE UPON THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS, WHICH MAY CAUSE US TO INCUR UNEXPECTED COSTS OR PREVENT US FROM SELLING OUR PRODUCTS.
The number of intellectual property claims in our industry may increase as the number of competing products grows and the functionality of products in different industry segments overlaps. In recent years, there has been a tendency by software companies to file substantially increasing numbers of patent applications, including those for business methods and processes. We have no way of knowing what patent applications third parties have filed until the application is published or until a patent is issued. Patent applications are often published within 18 months of filing, but it can take as long as three years or more for a patent to be granted after an application has been filed. In addition, we license our software to our customers under software license agreements, which generally provide the customer with limited indemnifications against damages, judgments, and reasonable costs and expenses incurred by the customer for any claim or suit based on infringement of a trademark or copyright as a result of the customer’s use of the software.
Although we are not aware that any of our products infringe upon the proprietary rights of any third parties, there can be no assurance that third parties will not claim infringement by us with respect to current or future products. Any intellectual property claims, with or without merit, could be time-consuming to address, result in costly litigation, cause product shipment delays or may require us to enter into royalty or license agreements which may not be available on terms acceptable to us or at all. Accordingly, any claims of this nature may have a material adverse effect on the Company’s business, operating performance, financial condition or cash flows.
OUR INTERNATIONAL OPERATIONS POSE RISKS FOR OUR BUSINESS AND FINANCIAL CONDITION.
We currently conduct international operations primarily in Europe and the Asia-Pacific region. We also have operations in Brazil, Canada and Mexico. More recently, we opened a product development center in India, where we also have relationships with third parties to outsource a portion of our implementation services effort. We intend to expand our international operations and to increase the proportion of our revenue from outside the U.S. These operations require significant management attention and financial resources and additionally subject us to risks inherent in doing business internationally, such as:
· failure to properly comply with foreign laws and regulations applicable to our foreign activities;
· failure to properly comply with U.S. laws and regulations relating to the export of our products and services;
· difficulties in managing foreign operations and appropriate levels of staffing;
· foreign currency exposure;
· longer collection cycles;
· tariffs and other trade barriers;
· seasonal reductions in business activities, particularly throughout Europe;
· proper compliance with local tax laws which can be complex and may result in unintended adverse tax consequences;
· anti-American sentiment due to the war with Iraq and other American policies that may be unpopular in certain countries; and
· increasing political instability, adverse economic conditions and the potential for war or other hostilities in many of these countries.
Our failure to properly comply with or address any of the above factors could adversely affect the success of our international operations and could have a material adverse effect on our operating performance and financial condition.
CHANGES IN THE VALUE OF THE U.S. DOLLAR, IN RELATION TO THE CURRENCIES OF FOREIGN COUNTRIES WHERE WE TRANSACT BUSINESS, COULD HARM OUR OPERATING PERFORMANCE AND FINANCIAL CONDITION.
For the fiscal years ended February 28th or 29th, 2006, 2005 and 2004, approximately 35.5%, 33.8% and 34.0% of our total revenue was derived from outside the U.S, respectively. Our international revenue and expenses are denominated in foreign currencies, typically the local currency of the selling business unit. Therefore, changes in the value of the U.S. Dollar as compared to these other currencies may adversely affect our operating results. We generally do not implement hedging programs to mitigate our exposure to currency fluctuations affecting international accounts receivable, cash balances and intercompany accounts, and we do not hedge our exposure to currency fluctuations affecting future international revenue and expenses and other commitments. For the foregoing reasons, currency exchange rate fluctuations have caused, and likely will continue to cause, variability in our foreign currency denominated revenue streams and costs and our cost to settle foreign currency denominated liabilities, which could have a material adverse effect on our operating performance and financial condition.
WE MAY BE SUBJECT TO FUTURE LIABILITY CLAIMS, AND THE REPUTATIONS OF OUR COMPANY AND PRODUCTS MAY SUFFER.
Many of our implementations involve projects that are critical to the business operations of our clients and provide benefits to the client which may be difficult to quantify. Any failure in a client’s system could result in a claim for substantial damages against us, regardless of our responsibility for the failure. We have entered into and plan to continue to enter into agreements with software vendors, consulting firms, resellers and others whereby they market and implement our solutions. If these vendors fail to meet their clients’ expectations or cause failures in their clients’ systems, our reputation and that of our products could be materially and adversely affected even if our software products perform in accordance with their functional specifications.
WE MAY CHOOSE TO CHANGE OUR BUSINESS PRACTICES OR OUR EARNINGS MAY BE AFFECTED AS A RESULT OF CHANGES IN THE REQUIREMENTS RELATING TO THE ACCOUNTING TREATMENT OF EMPLOYEE STOCK OPTIONS.
Generally accepted accounting principles in the U.S. are subject to interpretation by the Financial Accounting Standards Board, or FASB, the American Institute of Certified Public Accountants, the Public Company Accounting Oversight Board, the Securities and Exchange Commission, and various bodies formed to promulgate and interpret appropriate accounting principles. A change in these principles or interpretations could have a significant effect on our reported financial results, and could affect the reporting of transactions completed before the implementation of a new accounting principle.
We currently account for stock options in accordance with Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees” (“APB 25”) and, accordingly, we only record compensation expense related to stock options if the current market price of the underlying stock exceeds the exercise price of the stock option on the date of grant. On December 16, 2004, the FASB published FASB Statement No. 123 (R) “Share-Based Payment” (“SFAS 123(R)”), which was to be effective for public companies in periods beginning after June 15, 2005. On April 14, 2005, The Securities and Exchange Commission announced the adoption of a new rule that amends the compliance dates for SFAS 123(R). The new rule allows companies to implement SFAS 123(R) at the beginning of their next fiscal year instead of their next reporting period beginning after June 15, 2005. We will be required to implement SFAS 123(R) beginning in the first quarter of fiscal 2007. Our earnings in fiscal 2007 could be significantly reduced as a result of changing our accounting policy in accordance with SFAS 123(R). As a result, we could decide to reduce the number of stock options granted to employees or to grant options to fewer employees. This could affect our ability to retain existing employees or attract qualified candidates, and increase the need to extend additional cash compensation we pay to employees. Such a change could have a material effect on our operating performance.
In 2003, our Board of Directors and shareholders approved an amendment to our 1998 stock option plan to allow for the issuance of restricted shares of our common stock to its employees. The Company recorded $1.7 million, $1.2 million and $0.3 million in net compensation expense related to restricted shares outstanding during fiscal 2006, 2005 and 2004, respectively.
IT MAY BECOME INCREASINGLY EXPENSIVE TO OBTAIN AND MAINTAIN INSURANCE.
We obtain insurance to cover a variety of potential risks and liabilities. In the current market, insurance coverage has become more restrictive, and when insurance coverage is offered, the deductible for which we are responsible is larger and premiums have increased substantially. As a result, it may become more difficult to maintain insurance coverage at historical levels, or if such coverage is available, the cost to obtain or maintain it may increase substantially. This may result in our being forced to bear the burden of an increased portion of risks for which we have traditionally been covered by insurance, which could have a material effect on our operating performance and financial condition.
RISKS RELATED TO OUR COMMON STOCK
OUR STOCK PRICE HAS BEEN AND IS LIKELY TO CONTINUE TO BE VOLATILE. SIGNIFICANT DECLINES IN OUR STOCK PRICE MAY RESULT FOR VARIOUS REASONS, INCLUDING POOR FINANCIAL PERFORMANCE.
The trading price of our common stock has been and is likely to be volatile. Our stock price has been and could continue to be subject to wide fluctuations in response to a variety of factors, including the following:
· actual or anticipated variations in quarterly revenue and operating results and continuing losses;
· corporate and consumer confidence in the economy, evidenced in part, by stock market levels;
· changes in the size or number of our software transactions;
· announcements of technological innovations;
· new products or services offered by us or our competitors;
· changes in financial estimates and ratings by securities analysts;
· changes in the performance, market valuations, or both, of our current and potential competitors and the software industry in general;
· our announcement or a competitor’s announcement of significant acquisitions, strategic partnerships, joint ventures or capital commitments;
· adoption of industry standards and the inclusion of our technology in, or compatibility of our technology with, such standards;
· adverse or unfavorable publicity about us, or our products, services or implementations;
· adverse or unfavorable publicity regarding our competitors, including their products and implementations;
· additions or departures of key personnel;
· sales or anticipated sales of additional debt or equity securities; and
· other events or factors that may be beyond our control.
In addition, the stock markets in general, The Nasdaq National Market and the equity markets for software companies in particular, have experienced extraordinary price and volume volatility in recent years. Such volatility has adversely affected the stock prices for many companies irrespective of, or disproportionately to, the operating performance of these companies. These broad market and industry factors may materially and adversely further affect the market price of our common stock, regardless of our actual operating performance.
On April 24, 2006, we entered into a definitive Agreement and Plan of Merger with JDA and the Merger Sub. Under the Merger Agreement, the Merger Sub will be merged with and into the Company, with the Company continuing after the Merger as a wholly-owned subsidiary of JDA. From April 24, 2006 through May 8, 2006, the per share closing prices for our common stock as reported by Nasdaq were between $2.36 and $2.45. If the Merger is not consummated, our stock price may decline to the extent that the current market price reflects an assumption that the merger will be completed.
OUR CHARTER, BYLAWS AND SHAREHOLDER RIGHTS PLAN, DELAWARE LAW AND THE INDENTURE FOR THE NOTES CONTAIN PROVISIONS THAT COULD DISCOURAGE A TAKEOVER EVEN IF BENEFICIAL TO SHAREHOLDERS. IN ADDITION, CERTAIN OF OUR CURRENT OFFICERS, DIRECTORS, AND AN ENTITY AFFILIATED WITH A DIRECTOR TOGETHER MAY BE ABLE TO EXERCISE SUBSTANTIAL INFLUENCE OVER MATTERS REQUIRING SHAREHOLDER APPROVAL.
Our charter and our bylaws, in conjunction with Delaware law, contain provisions that could make it more difficult for a third party to obtain control of our Company even if doing so would be beneficial to shareholders. For example, our bylaws provide for a classified board of directors and allow our board of directors to expand its size and fill any vacancies without shareholder approval. Furthermore, our board has the authority to issue preferred stock and to designate the voting rights, dividend rate and privileges of the preferred stock, all of which may be greater than the rights of common shareholders. Additionally, upon a change of control of our Company, the holders of the Notes would have the right to require us or our successor to repurchase the Notes at a purchase price equal to 100% of the principal amount, plus accrued and unpaid interest to the date of repurchase in cash. This could make it more difficult for a third party to obtain control of us even if doing so would be beneficial to shareholders.
On October 28, 2004, we adopted a shareholder rights plan that entitles our shareholders to rights to acquire shares of our Series A Junior Participating Preferred Stock generally when a third party acquires twenty percent or more of the outstanding shares of our common stock or commences a tender offer or exchange offer for twenty percent or more of the outstanding shares of our common stock. The shareholder rights plan could delay, deter or prevent an investor from acquiring us in a transaction that shareholders may consider favorable, including transactions in which shareholders might otherwise receive
a premium over their shares. In connection with the Merger Agreement, on April 24, 2006, the Company entered into an amendment to the Rights Agreement between the Company and Computershare Trust Company, N.A. (formerly Equiserve Trust Company N.A.) As a result of the amendment, the preferred stock purchase rights issued under the Rights Agreement will be inapplicable to the Merger, the Merger Agreement, the Voting Agreements and the transactions contemplated by the Merger Agreement and the Voting Agreements. The execution, delivery, consummation or performance of the Merger Agreement, the Voting Agreements and the transactions contemplated thereby will not cause the rights to separate from shares of Company Common Stock or permit the Company’s stockholders to exercise the rights. In addition, the rights will expire immediately upon the effective time of the Merger.
In addition, our current officers, directors, and Warburg Pincus Private Equity VIII, L.P. (“WP VIII”) an entity affiliated with William H. Janeway, one of our directors, together beneficially owned approximately 23.8% of the outstanding shares of our common stock at February 28, 2006. While these shareholders do not hold a majority of our outstanding common stock, if they were to vote together, they may be able to exercise significant influence over matters requiring shareholder approval, including the election of directors and the approval of mergers, consolidations and sales of our assets. This factor may prevent or discourage tender offers for our common stock.
In order to facilitate the consummation of the transactions contemplated by the Merger Agreement, JDA entered into the Voting Agreements, pursuant to which certain of our stockholders will vote (or cause to be voted) in person or by proxy all shares of our common stock held by them (i) in favor of the adoption of the Merger Agreement and approval of the transactions contemplated thereby, (ii) against any proposal made in opposition to or competition with the consummation of the Merger and the Merger Agreement, (iii) against any proposal that would reasonably lead to or result in the conditions of JDA’s or Merger Sub’s obligations under the Merger Agreement not being fulfilled, (iv) against any takeover proposal from any party other than JDA or an affiliate of JDA, and (v) against the election of a group of individuals to replace a majority or more of the individuals presently on the Company’s Board. The stockholders that signed the Voting Agreements beneficially own approximately 24% of our outstanding shares of common stock as of April 24, 2006 and include certain of our officers and directors and entities affiliated with them. If the Merger Agreement is terminated for any reason, the Voting Agreements will also terminate. The foregoing description of the Voting Agreements is not complete and is qualified in its entirety by reference to the form of Voting Agreement, which is filed as Exhibit 99.3 to the Company’s Current Report on Form 8-K dated April 25, 2006 and is incorporated herein by reference.
FUTURE SALES OF SUBSTANTIAL AMOUNTS OF OUR COMMON STOCK COULD CAUSE OUR STOCK PRICE TO DECLINE.
Sales of substantial amounts of our common stock in the public market, or the perception that such sales may occur, could cause the market price of our common stock to decline. Our current officers, directors, and WP VIII, together beneficially owned approximately 23.8% of the outstanding shares of our common stock at February 28, 2006. Pursuant to the Voting Agreements, our current officers, directors and WP VIII agreed not to directly or indirectly sell, assign, transfer, pledge, encumber or otherwise dispose of their shares of our common stock or enter into any arrangement or understanding with respect to such a sale, assignment, transfer, pledge, encumbrance or disposition. These restrictions in the Voting Agreements terminate if the Merger Agreement is terminated.
Item 1B.
Item 1B. UNRESOLVED STAFF COMMENTS.
None.
Item 2.
Item 2. PROPERTIES.
Our principal sales, marketing, product development, support and administrative facilities are located in Rockville, MD, where we lease approximately 280,000 square feet of office space under a lease agreement which expires on June 30, 2012. Approximately 38% of this office space has been abandoned through our exit and disposal plans (See Note 14 to the Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K). Approximately 26% of our corporate headquarters space is subleased.
In addition, we lease office space for our 16 sales, service and product development offices located in North America, South America, Europe and Asia-Pacific, pursuant to leases that expire between calendar 2006 and calendar 2018. We believe that our current facilities are adequate for our current needs and suitable additional or substitute space will be available as needed to accommodate any future expansion of our operations. We continue to market office space that has been abandoned in conjunction with exit and disposal plans implemented by the Company. Please refer to Note 8 and Note 14 in the Notes to Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K for information regarding our lease obligations and exit and disposal plans.
Item 3.
Item 3. LEGAL PROCEEDINGS.
We are involved from time to time in disputes and other litigation in the ordinary course of business. We have established accruals related to such matters that are probable and reasonably estimable. We do not believe that the outcome of any pending disputes or litigation will have a material adverse effect on our business, operating results, financial condition and cash flows. However, the ultimate outcome of these matters, as with dispute resolution and litigation generally, is inherently uncertain, and it is possible that some of these matters may be resolved adversely to us. The adverse resolution of any one or more of these matters could have a material adverse effect on our business, operating results, financial condition and cash flows.
Item 4.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
Item 5.
Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Our common stock, $.002 par value per share, trades on The NASDAQ National Market under the symbol “MANU”. The following table sets forth the high and low sales prices in dollars per share for the respective quarterly periods over the last two fiscal years, as reported in published financial sources. These prices reflect inter-dealer prices, without retail markup, markdown or commission and may not necessarily represent actual transactions.
As of April 30, 2006, there were approximately 399 stockholders of record of our common stock, according to information provided by our transfer agent.
We have never declared or paid any cash dividends on our common stock and do not intend to do so in the foreseeable future. It is our present intention to retain any future earnings to provide funds for the operation, and expansion of our business and to retire debt. In addition, we have a two-year unsecured revolving credit facility with SVB that is scheduled to expire on March 29, 2007. If the Merger is not consummated prior to the expiration date of this credit facility, we intend to renew this credit facility before it expires. During the term of the credit facility, we are subject to a covenant not to declare or pay cash dividends to holders of our common stock under certain conditions. Future payment of cash dividends, if any, will be at the discretion of the Board and will depend upon our financial condition, results of operations, capital requirements and such other factors as the Board may deem relevant and will be subject to the covenants contained in any outstanding credit facility. The Merger Agreement also prohibits us from declaring or paying any cash dividends without JDA’s consent. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources” and Note 7 in the Notes to Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.
The following table provides information regarding our current equity compensation plans as of February 28, 2006. Share amounts are in thousands.
Equity Compensation Plan Information
Additional information regarding our equity compensation plans can be found in Note 9 in the Notes to Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.
In fiscal 2004, the Company issued 9,725,750 shares of its common stock in exchange for $74.5 million of Notes in privately negotiated transactions with note holders in reliance on the exemption from registration set forth in Section 3(a)(9) of the Securities Act.
Item 6.
Item 6. SELECTED FINANCIAL DATA.
Our selected consolidated financial data for each of the five fiscal years in the period ended February 28, 2006 and each of our last eight fiscal quarters is set forth below. This data should be read in conjunction with our Consolidated Financial Statements and related notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Annual Report on Form 10-K. The selected financial data for each of the years in the three-year period ended February 28, 2006, and as of February 28, 2006 and February 28, 2005, are derived from the Consolidated Financial Statements that have been included in this Annual Report on Form 10-K. The selected financial data as of February 28 or 29, 2004, 2003 and 2002, the years ended February 28, 2003 and 2002, and in each of our last eight fiscal quarters are derived from the Consolidated Financial Statements that have not been included in this Annual Report on Form 10-K.
(1) Exit and disposal activities and acquisition-related expenses includes amortization of intangibles and acquired technology, non-cash stock-option compensation expense and exit and disposal activities.
Item 7.
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Forward-Looking Statements
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and the related notes and other financial information included elsewhere in this Annual Report on Form 10-K. The discussion and analysis contains forward-looking statements which are made in reliance upon safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Our actual results may differ materially from those anticipated in these forward-looking statements and other forward-looking statements made elsewhere in this Annual Report on Form 10-K as a result of specified factors, including those set forth in Item 1A - Risk Factors.
Executive Summary
Our Consolidated Financial Statements are included in Item 15 of this Annual Report on Form 10-K. The following discussion is provided to allow the reader to have a better understanding of our operating results for the year ended February 28, 2006, including (i) a brief discussion of our business and products, (ii) a summary of the merger agreement signed with JDA software (iii) the business environment and factors that affected our financial performance, (iv) our focus on future improvements in our financial performance and (v) a summary of our fiscal 2006 operating results and financial metrics. This executive summary should be read in conjunction with the more detailed discussion and analysis of our financial condition and results of operations included in this Item 7, with Risk Factors in Item 1A of this Annual Report on Form 10-K and our Consolidated Financial Statements, which are included in Item 15 of this Annual Report on Form 10-K.
Overview-Business and Products
We are a leading global provider of supply chain management and demand and revenue management software products and services. We combine these products and services to deliver solutions that address specific business needs of our clients. We focus primarily on the Consumer Goods, Retail, and Government, Aerospace & Defense markets. We provide revenue management solutions for the Travel, Transportation & Hospitality markets.
Our solutions enable our clients to reduce operating costs, improve customer service and increase their top-line revenue by allowing them to plan, optimize and synchronize their demand and supply chain and to improve their revenue management practices. These benefits create efficiencies in how goods and services are brought to market, how they are priced and sold and how they are serviced and maintained. Our software solutions enable clients to optimize cost and revenue simultaneously on an enterprise-wide basis by integrating pricing, forecasting and operational planning and execution to enhance margins across the client’s enterprise and extended trading networks. In addition, our software solutions help our clients derive more benefits from their existing IT investments with other software vendors, such as legacy ERP and other transaction-based systems, and help ensure the security and integrity of their global supply chains.
Our approach to client delivery is to advise our clients on how best to use our solutions and other technologies across their demand and supply chain to integrate pricing, forecasting, operational planning and execution in a manner that will allow them to enhance margins across their enterprise and extended trading networks and to improve their revenue management practices. We deliver our solutions using commercially available products and will provide additional functionality addressed through product extensions for industry-specific capabilities. Certain of our clients and prospects ask for unique capabilities in addition to our core capabilities to give them a competitive edge in the marketplace, which we may provide on a case-by-case basis. We expect this will lead to an increase in software license revenue being
recognized on a contract accounting basis over the course of the delivery of the solution rather than upon initial delivery of the software and contract execution.
Summary of Merger Agreement Signed with JDA Software Group, Inc.
On April 24, 2006, we entered into a definitive Agreement and Plan of Merger (the “Merger Agreement”) with JDA Software Group, Inc., a Delaware corporation (“JDA”), and Stanley Acquisition Corp., a Delaware corporation and a wholly-owned subsidiary of JDA (the “Merger Sub”). Under the Merger Agreement, the Merger Sub will be merged with and into the Company (the “Merger”), with the Company continuing after the Merger as a wholly-owned subsidiary of JDA. At the effective time of the Merger, each issued and outstanding share of the Company’s Common Stock, par value $0.002 per share (the “Company Common Stock”), will be converted into the right to receive $2.50 in cash.
The Merger Agreement has been approved by the Board of Directors (the “Board”) of the Company. The Board has received an opinion from Lehman Brothers, Inc. that the consideration to be offered to the Company’s stockholders in the Merger is fair from a financial point of view to such stockholders. The transactions contemplated by the Merger Agreement are subject to approval by the holders of a majority of the issued and outstanding shares of Company Common Stock. The transactions contemplated by the Merger Agreement also are subject to the expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and certain other closing conditions. The Merger Agreement provides for a termination fee of up to $9.75 million, which is payable by the Company under certain circumstances.
Business Environment and Factors That Affected our Fiscal Year Ended February 28, 2006 Results
Our operating results for the year ended February 28, 2006 were affected by several broad-based factors including cautious capital spending by corporations for enterprise application software. We believe changing conditions over the last three fiscal years caused changes in the behavior patterns in our markets as our clients and prospects intensified their efforts to reduce costs. Many shifted their focus from larger longer-term strategic initiatives to smaller short-term tactical initiatives with more rapid paybacks. We also believe that many of our clients and prospects are focused on realizing benefits from earlier investments in information technology rather than committing to new initiatives. These changes in our markets have led to fewer opportunities for us to win business. We believe that these changes in the markets for enterprise application software will continue.
We continue to see a growing number of our clients and prospects wanting to structure deals to reduce their overall perceived risks. These deal structures include, but are not limited to, phased projects, delayed payments for software, and tying payments for software to performance. Certain of our clients and prospects want us to structure deals where we can earn additional revenue based on performance. During the year ended February 28, 2006, we closed one such transaction.
We believe that the size of enterprise application software license transactions has declined in general. We experienced declines in the numbers and size of our software transactions, including the number of software transactions of $1 million or greater, in the year ended February 28, 2006, which has also resulted in a decrease in our average selling price (“ASP”).
We believe our financial results in the fiscal year ended February 28, 2006 were also adversely affected by the ongoing consolidation in our industry, the pace of which has significantly increased over the past year and may continue. This consolidation has increased uncertainty about the abilities of smaller enterprise application software vendors to remain independent and thrive, which has negatively affected and may continue to negatively affect our ability to grow our revenue and improve our performance. In addition, some of our larger competitors increasingly have raised concerns about our financial viability with our clients and prospects, which have affected our ability to close software transactions successfully.
Over the past two fiscal years, we have made substantial changes in our Company, including reorganizing and downsizing our executive management team and our sales organization, moving a portion of our product development function to India , narrowing our market focus, narrowing our product focus, increasing our emphasis on transportation and retail markets and pricing optimization capabilities and increasing our emphasis on the Asia-Pacific region. Although we believe these changes were necessary and the correct actions to take, we have not yet been able to increase our revenue, particularly our software license revenue. However, these changes have enabled us to reduce our ongoing operating expense and to improve our financial performance in our most recent quarters.
Focus on Future Improvements in Our Financial Performance
For the year ended February 28, 2006, we continued to develop a more focused product and market strategy, and we continued the strategic restructuring of the organization in an effort to reduce our operating expenses to a level that would better position us to become profitable. During fiscal 2005, we organized our sales and marketing efforts to address the Consumer Goods, Retail, Government, Aerospace & Defense and Revenue Management markets. In Europe where we currently do not have a critical mass of resources, we eliminated certain offices, which are now being serviced from other locations in the region. We intend to provide more focused sales and marketing efforts to small and medium-sized businesses in Europe and the Asia-Pacific region through third-party reseller and agency agreements.
We intend to increase our focus and investments for the future in our Asia-Pacific region, in our Transportation and Retail industries and in our Pricing area. As part of this focus, we hired a President of our Asia-Pacific region in October 2005 and more recently hired a President of our Japan office. We are implementing specific Retail marketing programs and recruiting for sales employees with Retail experience. We intend to make strategic investments to round out the solutions and add sales and marketing people for our Pricing and Transportation solutions. In addition, we intend to start a services organization in India to reduce the number of contractors we currently use in an effort to improve the margins in our services business.
As of February 28, 2006, we had achieved quarterly cost savings of approximately $7.5 million, compared to the three months ended November 30, 2004, as a result of our exit and disposal plans enacted in fiscal 2005 (the “FY05 Q2 Plans”). These exit and disposal plans included the abandonment of certain office space and related asset write-offs and the involuntary termination of employees. We have completed most of the planned initiatives approved in our FY05 Q2 Plans and expect to complete the remainder of the initiatives in fiscal 2007.
During the fourth quarter of fiscal 2005, we commenced operations at our product development center in Hyderabad, India. We continue to move a substantial portion of our product development capabilities to our new facility while keeping our core product development capabilities at our headquarters in Rockville, Maryland. We believe this will allow us to both increase our product development resources and to lower our product development costs. As of February 28, 2006, we had approximately 178 employees at our Hyderabad, India development center and expect that number to increase through the first quarter of fiscal 2007. For the year ended February 28, 2006, amortization of previously capitalized software exceeded capitalization of software development costs by approximately $6.1 million. We expect amortization of previously capitalized software to continue to exceed capitalization of software development costs as we continue to shift development operations to Hyderabad, India. Once we have completed transitioning the development process to India, we believe that we will no longer capitalize software development costs due to the change in the developmental life cycle of our products that is due to the expected shortening of time between reaching technological feasibility and introduction of our products into the market.
If market conditions for our products and services do not improve, we may need to make further adjustments to our cost structure to further improve performance.
Summary of Fiscal 2006 Operating Results and Financial Metrics
As we entered fiscal 2006, difficult market conditions continued. Certain industries have been more or less likely to invest in enterprise application software depending on the condition of their business and industry. Our customers generally licensed fewer software modules in fiscal 2006 than in past years. We have not lost any of our largest support customers in recent quarters that had a negative material impact on revenue.
Our cost containment and cost reduction measures enacted in fiscal 2005 and fiscal 2006 have lessened the adverse impact on our financial performance of our declining revenue. During fiscal 2006, our total operating expenses decreased by 22.5%, while total revenue declined 8.8% compared to the same period.
Key Financial Metrics-Fiscal 2006
Our fiscal 2006 results and key financial metrics were negatively affected by decreased revenue; however, we have made progress in decreasing our operating costs, particularly in the second half of fiscal 2006. The following is a summary of our performance relative to certain key financial metrics during fiscal 2006 compared to fiscal 2005, as well as a summary of our quarterly performance in fiscal 2006.
(1) Includes exit and disposal activities plus acquisition related expenses such as amortization of acquired technology and intangibles, intangible asset impairment charge and non-cash stock option compensation expense.
(2) Includes cost of software license, cost of support and services, cost of reimbursed expenses, sales and marketing, product development and general and administrative costs.
The following is a brief discussion of the above financial metrics and analysis of the reasons for the changes between fiscal 2005 and fiscal 2006 and recent trends.
Software license revenue
Our software license revenue decreased during fiscal 2006 by 24.1% to $27.5 million. The following table highlights some of the significant trends impacting our software revenue:
(1) Significant software license transactions are those with a value of $100,000 or greater (excluding those recognized on a percentage-of-completion or ratable basis) recognized within the fiscal year or fiscal quarter.
Software license revenue by industry for fiscal 2006, fiscal 2005 and fiscal 2004 is as follows (in thousands):
The previous tables indicate the following trends affecting our software license revenue over the past two fiscal years:
· We reported fewer significant software license transactions, including those with a value of $1.0 million or greater, during fiscal 2006 compared to fiscal 2005.
· The average selling price of software has fluctuated the past eight quarters, ranging from $264,000 to $976,000. The ASP for the quarter ended May 31, 2005 included one software license transaction which accounted for more than 10% of total revenue for that quarter. The ASP for the quarter ended May 31, 2004 included software license revenue from installments under a large multi-year government contract.
· Software license revenue declined for all industries with the exception of the Revenue Management and Consumer Goods industry during fiscal 2006 compared to fiscal 2005. We believe the increase in revenue in the Revenue Management industry (other than airlines) reflects a recovery in travel,
transportation and hospitality, following a few years of decreased spending in these areas following the September 11, 2001 terrorist attack.
· Software license revenue in the Government, Aerospace & Defense industry decreased in fiscal 2006 and 2005 compared to fiscal 2005 and 2004, respectively. We believe the decline in our Government, Aerospace & Defense software revenue resulted from the Federal Government shifting monies (especially within the Department of Defense) to the war on terror.
· Software license revenue in the Consumer Goods industry decreased in fiscal 2005 compared to the fiscal 2004. We believe that the decrease in consumer goods spending was due to lack of capital spending by these customers who were largely focused on realizing benefits from earlier investments in information technology rather than investing in new capabilities. In addition, we believe that some consumer goods prospects had delayed purchasing decisions due to budget constraints and challenges in complying with the requirements of the Sarbanes-Oxley Act of 2002 and other regulatory requirements.
Support revenue
Our support revenue was $86.5 million in fiscal 2006 compared to $84.1 million in fiscal 2005. Our percentage of annual support renewals by our clients remains over 90%.
Services and reimbursed expense revenue
Our services and reimbursed expense revenue decreased 14.6% in fiscal 2006 to $62.2 million. Services revenue tends to track software revenue in prior periods. We primarily attribute the decrease in services and reimbursed expense revenue to the decrease in the number and size of completed software license transactions in fiscal 2006 compared to fiscal 2005 and due to the deferral of services revenue related to a transaction for which the criteria for revenue recognition has not yet been met. Additionally, we experienced competitive rate pressures on consulting engagements and lower demand for our consulting services in fiscal 2006.
Total revenue per average employee
Our total revenue per average employee decreased by 1.7% to $237 for fiscal 2006 (calculated as total revenue for the year divided by average employees for the year). This decrease was due to lower software and services revenue in fiscal 2006 partially offset by a 7.3% decrease in average employee headcount in fiscal 2006. Although average headcount was lower in fiscal 2006 compared to fiscal 2005, total headcount increased during fiscal 2006 to 761 as of February 28, 2006 as a result of the continued staffing of our product development facility in Hyderabad, India.
Total operating expenses
Our total operating expenses declined by 22.5% during fiscal 2006 to $186.3 million. Exit and disposal activities and acquisition-related expenses declined 50.5% during fiscal 2006 to $18.5 million. This decrease was the result of lower exit and disposal charges in fiscal 2006 as compared to fiscal 2005 and lower acquisition-related expenses as a result of the completed amortization of the customer relationship asset from our Talus Solutions, Inc. (“Talus”) acquisition and completed amortization of the acquired technology assets from the STG Holdings, Inc. (“STG”), Talus Solutions, Inc. and Spaceworks, Inc. acquisitions. The decrease in acquisition-related expenses was partially offset by a $3.7 million impairment charge recognized in fiscal 2006 related to acquired technology from the Partminer CSD, Inc. acquisition.
All other operating expenses declined 17.3% during fiscal 2006 to $167.9 million. This decrease was primarily related to lower professional and consulting fees, reduced office, travel and salary expenses as a result of the decrease in average employee headcount during fiscal 2006 related to our exit and disposal
plans executed during fiscal 2006 and the second half of fiscal 2005. Additionally, we recorded a $1.5 million benefit related to the reversal of a previously recorded provision for anticipated loss on a contract for which our obligation to perform services expired during fiscal 2006. We also recorded lower bad debt expense during fiscal 2006 which included the reversal of approximately $1.6 million of bad debt expense related to payment received for an outstanding receivable for which we had previously established a reserve. These decreases were partially offset by an increase in amortization of capitalized software development costs in excess of capitalized software development costs primarily as a result of changes in the product development life cycle of our products as we shift product development operations to our development center in Hyderabad, India.
Financial condition, liquidity and capital structure
During fiscal 2006, we experienced changes in our financial condition, liquidity and capital structure, including the following:
· Cash, cash equivalents, marketable securities and long-term investments increased by $4.8 million to $140.7 million primarily as a result of an increase in cash flows provided by operations of approximately $20.0 million partially offset by a higher cash usage in investing and financing activities as compared to the prior year.
Use of Estimates and Critical Accounting Policies
The accompanying discussion and analysis of our financial condition and results of operations are based upon our audited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires that we make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. 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 that are not readily apparent from other sources. Actual results could differ from the estimates made by management with respect to these and other items that require management’s estimates.
We have identified the accounting policies that are critical to understanding our historical and future performance, as these policies affect the reported amounts of revenue and the more significant areas involving management’s judgments and estimates. These critical accounting policies relate to revenue recognition and deferred revenue, allowance for doubtful accounts, capitalized software development costs, valuation of long-lived assets, including intangible assets and impairment review of goodwill, income taxes, exit and disposal related expenses and stock option-based compensation plans. These policies, and our procedures related to these policies, are described in detail below. In addition, please refer to the Consolidated Financial Statements and Notes to Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K for further discussion of our accounting policies.
Revenue Recognition and Deferred Revenue
Our revenue consists of (i) fees from licenses of our software; (ii) fees from technical support and product updates; (iii) fees from professional services, including implementation, training and hosting and (iv) reimbursed expenses. While the basis for software license revenue recognition is substantially governed by the requirements of the American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) 97-2, “Software Revenue Recognition,” as modified by SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain Transactions (“SOP 98-9”),” as well as Technical Practice Aids issued from time to time by the American Institute of Certified Public Accountants, and Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin 104, “Revenue Recognition” (“SAB 104”), we exercise judgment and use estimates in connection
with the determination of the amount of software license, support and professional services revenue to be recognized each accounting period.
Software license revenue is generally recognized using the residual method described below when:
· Persuasive evidence of an arrangement exists: We consider a non-cancelable agreement signed by us and the customer to be evidence of an arrangement.
· Delivery has occurred or services have been rendered: Delivery occurs when media containing the licensed program is provided to a common carrier, typically FOB shipping point or, in the case of electronic delivery, the customer is given access to the licensed programs.
· Fixed or determinable fee: We consider the license fee to be fixed or determinable if the fee is not subject to refund or adjustment and is payable within twelve months of the agreement date, based upon our successful collection history on such arrangements. If the arrangement fee is not fixed or determinable, we recognize the revenue as amounts become due and payable.
· Collection is probable: We perform a credit review for all significant transactions at the time the arrangement is executed to determine the credit-worthiness of the customer. Collection is deemed probable if we expect that the customer will be able to pay amounts under the arrangement as they become due. If we determine that collection is not probable, we defer recognition of the revenue until collection.
If a software license contains customer acceptance criteria or a cancellation right, recognition of the software revenue is deferred until the earlier of customer acceptance or the expiration of the acceptance period or cancellation right. Typically, payments for software licenses are due within twelve months of the agreement date. When software license agreements call for payment terms of twelve months or more from the agreement date, software revenue is recognized as payments become due and all other conditions for revenue recognition have been satisfied. Under the residual method, we defer revenue for the fair value of any undelivered elements based on vendor specific objective evidence (“VSOE”) of fair value, and the remaining portion of the arrangement fee is allocated to the delivered elements and recognized as revenue when the basic criteria in SOP 97-2 and SAB 104 have been met.
Our customer arrangements typically contain multiple elements that may include software, options for future purchases of software products not previously licensed to the customer, support, consulting, training, hosting and reimbursed expenses. Fees are allocated to the various elements of software license agreements using the residual method, based on VSOE. Each software license arrangement requires careful review to identify each individual element and to determine the proper amount of software revenue to be allocated among the various elements based on VSOE. Under the residual method, if an arrangement contains one or more undelivered elements, the VSOE of the undelivered elements are deferred and the revenue is recognized once the elements are delivered. If VSOE for one or more of the undelivered elements in an arrangement does not exist, we recognize the entire arrangement fee over the period the undelivered elements are delivered.
In addition to evaluating the VSOE of fair value of each element of an arrangement, we also consider whether such elements can be separated into separate units of accounting in accordance with SOP 97-2. When making this determination, we consider the nature of services provided when purchased with a software license (i.e., consideration of whether services are essential to the functionality of software products licensed), degree of risk, availability of services from other vendors and timing of payments, among other things. When we provide services deemed to be essential to the functionality of the software products licensed or the licensed software requires significant production, modification or customization, we recognize revenue on a percentage-of-completion basis in accordance with SOP 81-1. In these cases, software revenue is recognized based on labor hours or costs incurred to date compared to total estimated labor hours or costs for the contract.
Implementation services are separately priced and sold, are generally available from a number of suppliers and typically are not essential to the functionality of our software products. Implementation services, which include project management, systems planning, design and implementation, customer configurations and training are billed on an hourly basis (time and materials) or under fixed price contracts. Implementation services are recognized as the work is performed. On fixed price contracts, services revenue is recognized using the percentage-of-completion method of accounting by relating labor hours or costs incurred to date to total estimated labor hours or costs. In the event services are billed in advance of work being performed, the billed amount is initially recorded as deferred services revenue and recognized as services revenue when the work is performed. When total cost estimates exceed revenue, we accrue for the estimated losses immediately using cost estimates that are based upon an average fully burdened daily rate applicable to the consulting organization delivering the services. VSOE of fair value for implementation services is based upon separate sales of services at stated hourly rates.
The process of estimation inherent in the application of the percentage-of-completion method of accounting for revenue is subject to judgments and uncertainties and may affect the amounts of software and services revenue under certain contracts and related expenses reported in our consolidated financial statements. A number of internal and external factors can affect our estimates to complete client engagements, including skill level and experience of project managers, staff assigned to engagements and continuity and attrition level of implementation consulting staff. Changes in the estimated stage of completion of a particular project could create variability in our revenue and results of operations if we are required to increase or decrease previously recognized revenue related to a particular project or if we expect to incur a loss on the project.
Support revenue includes post-contract customer support and the rights to unspecified software upgrades and enhancements. Support services are separately priced and stated in our arrangements. Customer support is generally billed annually, initially recorded as deferred revenue and recognized as support revenue ratably over the support period. VSOE of fair value for support services is typically provided by renewal rates.
Allowance for Doubtful Accounts
We initially record our provision for doubtful accounts based on our historical experience and then adjust this provision at the end of each reporting period based on a detailed assessment of our accounts receivable and allowance for doubtful accounts. In estimating the allowance for doubtful accounts, management considers, among other factors, (i) the aging of the accounts receivable; (ii) trends within and ratios involving the age of the accounts receivable; (iii) the customer mix in each of the aging categories and the nature of the receivable (e.g., license, consulting, maintenance, etc.); (iv) our historical write-offs and recoveries; (v) the credit worthiness of each customer; (vi) the economic conditions of the customer’s industry; and (vii) general economic conditions. In cases where we are aware of circumstances that may impair a specific customer’s ability to meet their financial obligations to us, we record a specific allowance against amounts due from the customer.
If the assumptions we used to calculate these estimates do not properly reflect future collections, there could be an impact on future reported results of operations. Based on our total revenue reported for fiscal 2006, our provision for doubtful accounts would change by approximately $1.8 million annually for a 1% change in proportion to total revenue. The provision for doubtful accounts is included in sales and marketing expense (for software license receivables) and cost of services and support (for services and support fees receivables), in the Consolidated Statement of Operations.
Capitalized Software Development Costs
We capitalize the development cost of software, other than internal use software, in accordance with Statement of Financial Accounting Standards No. 86 (“SFAS 86”), “Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed.” Software development costs are expensed as incurred until technological feasibility has been established, at which time such costs are capitalized until the product is available for general release to clients. Software development costs are amortized using the straight-line method over the estimated economic life of the product, commencing with the date the product is first available for general release. Generally, an economic life of two years is used to amortize capitalized software development costs.
In future periods, if we determine that technological feasibility occurs at a later date, such as coincident with general product release to clients, we may not capitalize any software development costs. This would increase our reported operating expenses in the short term by the amounts we do not capitalize. The amounts of software development costs that we have capitalized have ranged between $3.5 million and $9.9 million per year during our last three fiscal years. The estimated economic life of our capitalized software development costs is subject to change in future periods based on our experience with the length of time our products or enhancements are being or are expected to be used. The amortization of software development costs have ranged between $9.0 million and $9.6 million per year during our last three fiscal years. A change in the expected economic life of our capitalized software development costs of six months would decrease our annual operating expenses by approximately $0.9 million if we increased the expected economic life by six months and would increase our annual operating expenses by approximately $1.4 million if we decreased the expected economic life by six months.
Valuation and Impairment Review of Long-Lived Assets
We account for our purchases of acquired companies in accordance with Statement of Financial Accounting Standards No. 141 “Business Combinations” (“SFAS 141”) and account for the related acquired intangible assets in accordance with Statement of Financial Accounting Standards No. 142 “Goodwill and Other Intangible Assets” (“SFAS 142”). In accordance with SFAS 141, we allocate the cost of the acquired companies to the identifiable tangible and intangible assets and liabilities acquired, with the remaining amount being classified as goodwill. Certain intangible assets, such as acquired technology, are amortized to expense over time, while in-process research and development, if any, is recorded as an expense at the acquisition date.
The majority of the entities acquired by us do not have significant tangible assets and, as a result, a significant portion of the purchase price is typically allocated to intangible assets and goodwill. As required by SFAS 142, in lieu of amortizing goodwill, we test goodwill for impairment periodically and record any necessary impairment in accordance with SFAS 142. We are amortizing our intangible assets as follows: (i) acquired technology-related intangible assets are currently being amortized over their estimated useful life using the straight-line method and (ii) customer relationship-related intangible assets are currently being amortized over their estimated useful life based on the greater of the straight-line method or the estimated customer attrition rates.
We evaluate all of our long-lived assets (primarily property and equipment and intangible assets other than goodwill) for impairment in accordance with the provisions of SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”). SFAS 144 requires that long-lived assets and intangible assets other than goodwill be evaluated for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable based on expected undiscounted cash flows attributable to that asset. In accordance with SFAS 144, when a long-lived asset or intangible asset is abandoned, the carrying value is charged to expense in the period of abandonment.
During fiscal 2006, 2005 and 2004, we recorded impairment charges of $0.2 million, $2.7 million and $4.2 million, respectively, associated with certain furniture, fixtures and leasehold improvements that we abandoned in connection with exit and disposal plans. These assets were located in facilities that we ceased to use. Based on our evaluation of these assets we determined that the assets were not marketable for resale and oftentimes could not be removed from the premises (e.g., the asset consisted of a dividing wall or other permanent fixture). Additionally during fiscal 2006, we recorded an impairment charge of approximately $3.7 million related to acquired technology from the Partminer CSD, Inc. acquisition. Although we continue to sell the products acquired in that acquisition, based on our impairment analysis, we did not believe the future operating cash flows would be sufficient to support the related asset balance.
As of February 28, 2006 and February 28, 2005, our net book value of long-lived assets, consisted of the following (in thousands):
While we do not currently believe any of our long-lived assets are impaired, and we do not anticipate an impairment in the near term, if a change in circumstances were to occur requiring an assessment of impairment, we would be required to evaluate whether the future cash flows related to the asset will be greater than its carrying value at the time of the impairment test. While our cash flow assumptions are consistent with the plans and estimates we are using to manage our operations, there is significant judgment in determining the cash flows attributable to our intangible assets over their respective estimated useful lives. If such an evaluation resulted in an impairment of any of our long-lived assets, such impairment would be recorded in the period we make the impairment determination.
We test goodwill for impairment on an annual basis, coinciding with our fiscal year end, or on an interim basis if circumstances change that would more likely than not reduce our implied fair value (which includes factors such as, but not limited to, our market capitalization, control premium and recent stock price volatility) below our carrying value. Please see Item 1A “Risk Factors”-Risks Related to Our Business. During the six months ended August 31, 2004, we experienced adverse changes in our stock price resulting from its poor financial performance. As a result, we performed a test for goodwill impairment at August 31, 2004 and determined that based upon the implied fair value (which includes factors such as, but not limited to, the Company’s market capitalization, control premium and recent stock price volatility) of the Company as of August 31, 2004 there was no impairment of goodwill.
During the three months ended November 30, 2005, our Chief Financial Officer left to take a position at another company. As a result, we performed a test for goodwill impairment as of November 30, 2005. We determined that based upon the implied fair value (which includes factors such as, but not limited to, the Company’s market capitalization, control premium and recent stock price volatility) of the Company as of November 30, 2005, there was no impairment of goodwill
We performed goodwill impairment reviews on February 28, 2006 and February 28, 2005, our annual dates for goodwill impairment review, and determined that the implied fair value of the Company exceeded the carrying value. Accordingly, no goodwill impairment charge was recorded during fiscal 2006 or fiscal 2005.
Determining the implied fair value of goodwill involves judgments as to when an impairment may exist, as well as estimates used to compute the implied fair value. If the estimates used to calculate the implied fair value of goodwill were to change such that the fair value dropped below stockholders’ equity, this could result in an impairment charge for some or all of our goodwill balance in future periods.
Income Taxes
We account for income taxes in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes.” We assess the likelihood that our deferred tax assets will be recovered from our future taxable income, and to the extent we believe that recovery is not likely, we establish a valuation allowance. We consider historical taxable income, estimates of future taxable income and ongoing prudent and feasible tax planning strategies in assessing the amount of the valuation allowance. Adjustments could be required in the future if we determine that the amount to be realized is greater or less than the valuation allowance we have recorded. Management performed an analysis, based on various factors, including our current year financial results, our cumulative losses for the three year period ended February 28, 2006, and estimates of future profitability, as of February 28, 2006 and February 28, 2005, and concluded that future taxable income will, more likely than not, be insufficient to recover our net deferred tax assets as of February 28, 2006 and February 28, 2005. Therefore, we have maintained a valuation allowance for the full amount of our net deferred tax assets. Management will continue to monitor its estimates of future profitability and the likelihood of realizing our net deferred tax assets based on evolving business conditions.
Also, as part of the process of preparing our consolidated financial statements, we are required to estimate our full-year income on a quarterly basis and the related income tax expense, including the impact, if any, of additional taxes resulting from tax examinations, in each jurisdiction in which we operate. Additionally, we make judgments regarding the recoverability of deferred tax assets for each jurisdiction. Tax liabilities can involve complex issues and may require an extended period to resolve. Changes in the geographical mix or estimated level of annual pretax income can impact our overall income tax expense. This process involves estimating our current tax liabilities in each jurisdiction in which we operate.
Exit and Disposal Activities
During fiscal 2004, 2005 and 2006 we initiated and completed a series of exit and disposal plans (the “Exit Plans”). We have accounted for the Exit Plans in accordance with SEC Staff Accounting Bulletin No. 100 “Restructuring and Impairment Charges” and other applicable accounting standards as discussed below.
In June 2002, the Financial Accounting Standards Board (the “FASB”) issued SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS 146”). SFAS 146 superseded Emerging Issues Task Force Issue No. 94-3 “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Associated with a Restructuring)” (“EITF 94-3”) and EITF Issue No. 88-10 “Costs Associated with Lease Modification or Termination” (“EITF 88-10”). We adopted SFAS 146 effective January 1, 2003; therefore, exit and disposal charges subsequent to December 31, 2002 were accounted for in accordance with SFAS 146. The adoption of SFAS 146 did not impact our exit and disposal obligations recognized prior to January 1, 2003, as these obligations must continue to be accounted for in accordance with EITF 94-3 and EITF 88-10 and other applicable pre-existing guidance.
The expenses incurred in connection with the Exit Plans are composed primarily of (i) severance and associated employee termination costs related to the reduction of our workforce, (ii) lease termination costs and/or costs associated with ceasing to use certain facilities and (iii) impairment costs related to certain long-lived assets abandoned.
SFAS 146 requires that a liability for costs associated with an exit or disposal activity be recognized when the liability is incurred, as opposed to when management commits to an exit plan. SFAS 146 also requires that (i) liabilities associated with exit and disposal activities be measured at fair value; (ii) one-time termination benefits be expensed at the date the entity notifies the employee, unless the employee must provide future service, in which case the benefits are expensed ratably over the future service period; (iii) liabilities related to an operating lease or contract be measured at fair value and recorded when the contract does not have any future economic benefit to the entity (i.e., the entity ceases to utilize the rights conveyed by the contract); and (iv) all other costs related to an exit or disposal activity be expensed as incurred. For those employees with pre-existing employment contracts which specified benefits upon termination, we accounted for severance and related benefits in accordance with SFAS No. 88, “Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits” (“SFAS 88”) as the amounts were both probable and estimable.
We accounted for costs related to the assets abandoned in connection with the Exit Plans in accordance with SFAS 144 and, accordingly, charged to expense the net carrying value of the long-lived assets when we abandoned the assets, primarily leasehold improvements and furniture and fixtures. Please refer to “Valuation and Impairment Review of Long-Lived Assets” described above for a further discussion of our accounting policy and related accounting estimates involved related to assessing whether an asset is impaired.
Inherent in the estimation of the costs related to the Exit Plans are assessments related to the most likely expected outcome of the significant actions to accomplish the exit activities. In determining the charges related to the Exit Plans, we were required to make significant estimates related to the expenses associated with our excess facilities. For example, in determining the charge for excess facilities, we were required to estimate future sublease income (including both timing and amount of the potential sublease income), future net operating expenses of the facilities (e.g., maintenance, utilities, property management fees, etc.), and potential brokerage commissions, among other expenses. We based our estimates of sublease income, operating costs and brokerage commissions, in part, on the opinions of third-party real estate advisors, current market conditions and rental rates, the status of negotiations with potential subtenants, and the location of the respective facility, among other factors. These estimates, along with other estimates made by management in connection with the Exit Plans may vary significantly depending, in part, upon factors that may be beyond our control. Specifically, these estimates will depend on our success in negotiating with lessors, the time periods required to locate and contract suitable subleases and the market rates at the time of such subleases. Changing business and real estate market conditions may affect the assumptions related to the timing and extent of our ability to sublease vacated space. We periodically review the status of exit and disposal liabilities and, if appropriate, we record changes to our exit and disposal liabilities based on management’s most current estimates.
Stock Option-Based Compensation Plans
We account for our stock option-based compensation plans in accordance with APB 25 and related interpretations using the intrinsic value based method of accounting. If we accounted for our stock option-based compensation plan using the fair value based method of accounting in accordance with the provisions as required by Statement of Financial Accounting Standards No. 123 (“SFAS 123”), “Accounting for Stock-Based Compensation,” as amended by Statement of Financial Accounting Standards No. 148 (“SFAS 148”), “Accounting for Stock-Based Compensation-Transition and Disclosure,” our net loss and loss per basic and diluted share amounts would have been as follows, in thousands except per share amounts:
Consistent with our accounting for deferred tax assets resulting from the exercise of employee stock options in the accompanying audited consolidated financial statements, we have not provided a tax benefit or expense on the pro forma expense in the above table.
Stock options granted had weighted average fair values of $0.62, $1.62 and $3.28 per share for fiscal 2006, 2005 and 2004, respectively, as calculated using the Black-Scholes option valuation model. The weighted average estimated fair value of the common stock purchase rights granted under our employee stock purchase plan was $0.37, $0.52 and $2.23 per share for fiscal 2006, 2005 and 2004, respectively.
We determined the assumptions used in computing the fair value of stock options and stock purchase plan shares by estimating the expected useful lives, giving consideration to the vesting and purchase periods, contractual lives, actual employee forfeitures, and the relationship between the exercise price and the fair market value of our common stock, among other factors. The risk-free interest rate is the U.S. Treasury bill rate for the relevant expected life. The fair value of stock options and stock purchase plan shares was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
Results of Operations
The following table includes the consolidated statements of operations data for each of the years in the three-year period ended February 28, 2006 expressed as a percentage of revenue:
The percentages shown above for cost of services and support, sales and marketing, product development and general and administrative expenses have been calculated excluding non-cash stock-option compensation expense as follows (in thousands):
See Operating Expenses: “Non-Cash Stock-Option Compensation Expense” for further detail.
Revenue
Software License Revenue. Software license revenue decreased 24.1%, or $8.7 million, in fiscal 2006 and decreased 50.9%, or $37.6 million, in fiscal 2005. We believe the decrease in software license revenue in fiscal 2006 and fiscal 2005 was due to cautious capital spending for supply chain software purchases, effects resulting from changes in our workforce, including our executive management and sales organization, difficulties in sales execution and a highly competitive environment. Additionally, we believe the decrease in software license revenue during fiscal 2006 was also due in part to concerns about consolidation in our industry and about our financial viability. We experienced lengthening sales cycles and reductions in the size of customer orders during both fiscal 2006 and 2005. These factors resulted in a decrease in the number of significant software license transactions with a value of $100,000 or greater, the number of transactions greater than $1.0 million and our ASP.
We attribute much of the caution of our clients and prospects to their concerns regarding the sustainability of the current economic recovery and the current geopolitical environment in which we operate. We saw no driving force to overcome the negative market factors that are holding back companies from supply chain initiatives. Further, we believe the effort by companies to comply with the Sarbanes-Oxley Act of 2002 and other regulatory requirements consumed the internal resources of our clients and prospects in fiscal 2005 and slowed the decision making process for other software purchases.
The following table summarizes significant software license transactions consummated during fiscal 2006, 2005 and 2004:
(1) Significant software license transactions are those with a value of $100,000 or greater (excluding those recognized on a percentage-of-completion or ratable basis) recognized within the fiscal year.
Support Revenue. Support revenue increased 2.9%, or $2.4 million, in fiscal 2006 and decreased 2.9%, or $2.5 million, in fiscal 2005. The increase in support revenue during fiscal 2006 was due to new software sales and collections from certain customers for outstanding support for which the related revenue did not previously meet the criteria for recognition. During fiscal 2005, decreases in support revenue from non-renewals were not fully offset by increases in support revenue from new software sales. Our percentage of annual support renewals by our clients remains over 90% and we have not lost any of our largest support customers in the past year that had a material negative effect on revenue. There can be no assurance that our historical renewal rate will continue.
Services Revenue. Services revenue decreased 13.6%, or $8.8 million, in fiscal 2006 and decreased 11.4%, or $8.3 million, in fiscal 2005. The decrease in services revenue in fiscal 2006 and fiscal 2005 was the result of the decrease in the number and size of completed software license transactions in fiscal 2006, fiscal 2005 and fiscal 2004, respectively, lower demand for implementation services and competitive rate pressures on consulting engagements. Additionally, the decrease in services revenue in fiscal 2006 was also due in part to the deferral of services revenue related to a closed transaction for which the criteria for revenue recognition has not yet been met. We have experienced a decrease in the number of services employees from both voluntary and involuntary terminations. Services revenue tends to track software license revenue in prior periods. There can be no assurance that the rates we charge for consulting and implementation services will improve, or even remain at current levels. The market for information
technology consulting services is highly competitive and we are affected by these market conditions. Accordingly, services revenue may continue to decline unless and until we experience a sustained increase in our software license sales and maintain adequate resource capacity and capabilities. We also expect that services revenue will continue to fluctuate on a quarter-to-quarter basis, as revenue from the implementation of software is not generally recognized in the same period as the related license revenue.
Reimbursed Expenses. Reimbursed expenses decreased 23.0%, or $1.8 million, in fiscal 2006 and decreased 16.0%, or $1.5 million, in fiscal 2005. The decrease in reimbursed expenses is consistent with decreases in services revenue in these periods.
International Revenue. We market and sell our software and services internationally, primarily in Europe, Asia, Canada, Central America and South America. Revenue outside of the U.S. decreased $2.6 million, or 4.0%, to $62.6 million, in fiscal 2006 and decreased $17.4 million, or 21.1%, to $65.2 million in fiscal 2005. Revenue by geographic area is determined on the basis of the geographic area in which transactions are consummated. Revenue outside of the U.S. as a percentage of total revenue was 35.5%, 33.8% and 34.0% in fiscal 2006, 2005 and 2004, respectively. The increase in the percentage of international revenue to total revenue in fiscal 2006 compared to fiscal 2005 is due to a software license transaction in Europe in our first quarter of fiscal 2006 which accounted for more than 10% of the total revenue for that quarter.
Customer Concentration. No individual customer accounted for more than 10% of annual revenue during fiscal 2006, fiscal 2005 or fiscal 2004.
Operating Expenses
Cost of Software License. Cost of software license consists primarily of amortization of capitalized software development costs and royalty fees associated with third-party software either embedded in our software or resold by us. The following table sets forth amortization of capitalized software development costs and other costs of software for the three fiscal years ended February 28 or 29, 2006, 2005 and 2004 (in thousands):
The increase in the total cost of software in fiscal 2006 as compared to fiscal 2005 was a result of increased amortization of capitalized software in fiscal 2006 and increased amortization of prepaid royalty fees paid to certain alliance partners over the remaining period of benefit. The decrease in the total cost of software in fiscal 2005 as compared to fiscal 2004 was a result of decreased royalties paid to third parties as a result of a decrease in software revenue, partially offset by an increase in amortization of capitalized software due to the product release of version 7.2 in February 2004 and the write-off of one of our capitalized products for which the anticipated future gross revenue was less than the estimated future costs of completing and disposing of the product. Amortization of capitalized software development costs does not vary with software revenue while royalty fees do.
Amortization of Acquired Technology. In connection with acquisitions in fiscal 2003, 2002 and 2001, we acquired developed technology that we offer as part of our integrated solutions. Acquired technology is amortized over periods ranging from four to six years. We expect annual amortization of acquired technology to be approximately $3.7 million in fiscal 2007.
Cost of Services and Support. Cost of services and support primarily includes personnel and third-party contractor costs. Cost of services and support, excluding the cost of reimbursed expenses and non-cash stock-option compensation expense, decreased $12.8 million, or 17.4%, to $60.8 million in fiscal 2006 compared to fiscal 2005 and decreased $6.6 million, or 8.2%, to $73.7 million in fiscal 2005 compared to fiscal 2004. Cost of services and support, excluding the cost of reimbursed expenses and non-cash stock-option compensation expense, as a percentage of related revenue was 42.7%, 49.5% and 50.2% in fiscal 2006, 2005 and 2004, respectively. The decrease in cost of services and support in fiscal 2006 and 2005 was attributable to an overall decrease in the average number of services and support employees to 279, 304 and 366 in fiscal 2006, 2005 and 2004, respectively. This was a result of the implementation of our cost containment and cost reduction initiatives during fiscal 2006, fiscal 2005 and fiscal 2004, as well as from voluntary attrition. The decrease in cost of services and support as a percentage of related revenue in fiscal 2006 as compared to fiscal 2005 was primarily the result of lower outside contractor costs and a $1.5 million benefit recorded in fiscal 2006 related to the reversal of a recorded provision for anticipated loss on a contract for which our obligation to provide services expired during fiscal 2006. The decrease in cost of services and support as a percentage of related revenue in fiscal 2005 as compared to fiscal 2004 reflected a slight increase in the proportion of the revenue derived from support services during fiscal 2005, which historically have higher margins than implementation services.
Sales and Marketing. Sales and marketing expense consists primarily of personnel costs, sales commissions, promotional events such as user conferences, trade shows and technical conferences, advertising and public relations programs. Sales and marketing expense decreased $14.1 million, or 26.8%, to $38.6 million in fiscal 2006 as compared to fiscal 2005 and decreased $13.4 million, or 20.3%, to $52.7 million in fiscal 2005 as compared to fiscal 2004. The decrease in fiscal 2006 and fiscal 2005 was due to:
· an overall decrease in the average number of sales, marketing and business development employees to 120 for fiscal 2006 compared to 170 for fiscal 2005 and 216 for fiscal 2004, which was primarily a result of the implementation of our exit and disposal plans in fiscal 2006, fiscal 2005 and fiscal 2004;
· a decrease in travel, advertising and public relations spending resulting from cost containment and cost reduction measures implemented in fiscal 2006 and fiscal 2005; and
· a decrease in sales commissions due to lower software revenue in fiscal 2005 as compared to fiscal 2004.
Offset by:
· an increase in sales commissions and incentives in fiscal 2006 as compared to fiscal 2005; and
· an increase in bad debt expense in fiscal 2005 as compared to fiscal 2004.
Product Development. Product development costs include expenses associated with the development of new software products, enhancements of existing products and quality assurance activities and are reported net of capitalized software development costs. Such costs are primarily from employees and third-party contractors. The following table sets forth product development costs for the three fiscal years ended February 28 or 29, 2006, 2005 and 2004 (in thousands):
Gross product development costs decreased $11.0 million, or 26.1%, in fiscal 2006 as compared to fiscal 2005 and decreased $4.1 million, or 9.0%, in fiscal 2005 as compared to fiscal 2004. The decrease in fiscal 2006 and 2005 was due to:
· a decrease in the average number of product development contractors in the U.S. in fiscal 2006 and fiscal 2005;
· a decrease in personnel costs as we continue to migrate more of our product development efforts to our product development center in Hyderabad, India and take advantage of the lower wage resources located in that region;
· an overall decrease in the average number of product development employees to 218 in fiscal 2005, compared to 275 in fiscal 2004. This was primarily a result of the implementation of our exit and disposal plans in fiscal 2005; and
· further consolidation of our U.S. product development function to our corporate headquarters in Rockville, Maryland in fiscal 2005.
General and Administrative. General and administrative expenses include personnel and other costs of our legal, finance, accounting, human resources, facilities and information systems functions. General and administrative expenses decreased $2.2 million, or 10.1%, to $19.9 million in fiscal 2006 as compared to fiscal 2005 and decreased $2.9 million, or 11.8%, to $22.1 million in fiscal 2005 as compared to fiscal 2004. The decrease in fiscal 2006 as compared to fiscal 2005 was the result of a decrease in the average number of general and administrative employees and facility expenses resulting from the implementation of our exit and disposal plans during fiscal 2006 and fiscal 2005 and decreased outside professional fees incurred in fiscal 2006. The decrease in fiscal 2005 as compared to fiscal 2004 was the result of a decrease in the average number of general and administrative employees resulting from the implementation of our exit and disposal plans during fiscal 2005 and fiscal 2004, in addition to a decrease in property tax expense related to a settlement with the State of Maryland. The decrease was partially offset by an increase in accounting professional fees primarily related to compliance with the Sarbanes-Oxley Act of 2002.
Amortization of Intangibles. Our past acquisitions were accounted for under the purchase method of accounting. As a result, we recorded goodwill and other intangible assets that represent the excess of the purchase price paid over the fair value of the net tangible assets and identifiable intangible assets acquired. Other intangible assets are amortized over periods ranging from four to seven years. Amortization of intangibles decreased $0.9 million, or 13.5%, to $5.8 million in fiscal 2006 compared to fiscal 2005 and increased $2.0 million, or 42.2%, to $6.6 million in fiscal 2005 compared to fiscal 2004. The decrease in amortization of intangibles in fiscal 2006 was due to the completed amortization in fiscal 2006 of the
customer relationship asset related to the Talus acquisition, an acquired technology asset related to the Spaceworks acquisition and the completed amortization in fiscal 2005 of acquired technology related to the STG and Talus acquisitions. Additionally, the decrease in fiscal 2006 was due in part to the absence of amortization for a full year of acquisition-related intangible assets related to the Partminer CSD, Inc. asset acquisition due to the impairment charge recorded for the remaining net book value of those assets during fiscal 2006 (See Note 6 in the Notes to Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K). The increase in amortization of intangibles in fiscal 2005 was due to a change in the Talus customer relationships amortization from seven years to five years in late fiscal 2004, partially offset by the completion of amortization in fiscal 2005 of acquired technology related to the STG and Talus acquisitions.
Goodwill Impairment. We test goodwill for impairment on an annual basis, coinciding with our fiscal year end, or on an interim basis if circumstances change that would more likely than not reduce our implied fair value (which includes factors such as, but not limited to, the Company’s market capitalization, control premium and recent stock price volatility) below our carrying value. Please see Item 1A - “Risk Factors-Risks Related to Our Business.” During the three months ended May 31, 2005 and the six months ended August 31, 2004, we experienced adverse changes in our stock price resulting from our poor financial performance. As a result, we performed a test for goodwill impairment at May 31, 2005 and August 31, 2004 and determined that based upon our implied fair value (which includes factors such as, but not limited to, our market capitalization, control premium and recent stock price volatility) as of May 31, 2005 and August 31, 2004, there was no impairment of goodwill. During the three months ended November 30, 2005, our Chief Financial Officer left to take a position at another company. As a result, we performed a test for goodwill impairment as of November 30, 2005. We determined that based upon the implied fair value (which includes factors such as, but not limited to, our market capitalization, control premium and recent stock price volatility) as of November 30, 2005, there was no impairment of goodwill.
We performed our annual goodwill impairment reviews on February 28, 2006 and February 28, 2005 and determined that our implied fair value exceeded our carrying value. Accordingly, no goodwill impairment charge was recorded during fiscal 2006 or fiscal 2005. Details of our amortization of intangibles and goodwill impairment are included in Note 6 in the Notes to Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.
Exit and Disposal Activities. In order to adjust our cost structure and resource allocation to increase efficiencies and reduce excess office space, we adopted exit and disposal plans in the second quarter of fiscal 2005, the first and fourth quarters of fiscal 2004 and in the second, third and fourth quarters of fiscal 2003. In connection with our decision to implement these plans, we incurred related exit and disposal charges of $3.3 million, $17.3 million and $18.6 million in fiscal 2006, fiscal 2005 and fiscal 2004, respectively.
The following table sets forth a summary of exit and disposal activity charges, net of adjustments, for fiscal 2006, fiscal 2005 and fiscal 2004 (in thousands):
The impact to reported basic and diluted loss per share as a result of the exit and disposal charges was $(0.04), $(0.21) and $(0.26) for fiscal 2006, fiscal 2005 and fiscal 2004, respectively.
In response to the difficulties we faced in our ability to stabilize revenue and operating performance, we enacted a number of cost containment and cost reduction measures over the past three fiscal years to better align our cost structure with expected revenue. Specifically, we took the following actions:
1. We reduced our workforce by 173 and 79 employees through involuntary terminations with the fiscal 2005 and 2004 exit and disposal plans, respectively.
2. We further consolidated our product development function in the U.S. to the corporate headquarters in Rockville, Maryland as part of the exit and disposal plans in fiscal 2005 and fiscal 2004. This included the relocation of certain employees from Wayne, Pennsylvania; San Carlos, California; Atlanta, Georgia; Denver, Colorado and Ottawa, Canada to Rockville, Maryland.
3. As a result of the workforce reductions, product development consolidation and employee attrition, certain of our facilities were under-utilized. Accordingly, we consolidated our remaining workforce in the under-utilized facilities and abandoned the then-vacated office space. The facilities permanently removed from our operations during fiscal 2006, 2005, 2004 and 2003 were located in Brussels, Belgium, Wayne, Pennsylvania; Irving, Texas; Detroit, Michigan; Denver, Colorado; Ottawa, Canada; Itasca, Illinois; Milan, Italy; Munich and Ratingen, Germany, Stockholm, Sweden and the Philippines. A portion of the office space was permanently vacated in certain facilities located in Rockville, Maryland; Atlanta, Georgia; Calabasas and San Carlos, California; Bracknell, United Kingdom and Tokyo, Japan.
4. As part of the consolidation of our facilities, certain leasehold improvements and furniture and fixtures were abandoned. As a result, we recorded non-cash charges equal to the net book value of these abandoned assets in exit and disposal activity charges.
As a result of our exit and disposal activities and cost containment initiatives during the past four fiscal years, we have reduced “all other operating expenses” (as shown in the table under “Key Financial Metrics-Fiscal 2006”) to $167.8 million in fiscal 2006 and $203.0 million in fiscal 2005. Details of our exit and disposal charges are included in Note 14 in the Notes to Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.
Substantially all of the cost savings from our exit and disposal activities and cost containment initiatives implemented in fiscal 2004 were reflected in our operating results by the first quarter of fiscal 2005. As of February 28, 2006, we had achieved quarterly cost savings of approximately $7.5 million, compared to the third quarter of fiscal 2005 as a result of implementing our exit and disposal plans during fiscal 2006 and 2005. We have completed most of the planned initiatives approved in our second quarter fiscal 2005 exit and disposal plans and will complete the remainder of the initiatives in fiscal 2007. The total exit and disposal charges reflected in the financial statements are based on management’s current estimates, which may change materially if actual lease-related expenditures or sublease income differ from current estimates.
Non-Cash Stock-Option Compensation Expense. We recognized non-cash stock-option compensation expense of $0.0 million, $0.2 million and $1.8 million in fiscal 2006, fiscal 2005 and fiscal 2004, respectively, related to unvested stock options assumed in the acquisition of Talus. As part of the Talus acquisition, we assumed all outstanding Talus stock options, which were converted into our stock options. Options to purchase approximately 631,000 shares of our common stock were unvested at the acquisition date. FASB Interpretation No. 44 (“FIN 44”) “Accounting for Certain Transactions Involving Stock Compensation” requires the acquiring company to measure the intrinsic value of unvested stock options assumed at the acquisition date in a purchase business combination and record a compensation charge over the remaining vesting period of those options to the extent those options remain outstanding. The unamortized value of these stock awards is included as a separate component of stockholders’ equity. All of these outstanding options are fully vested and all compensation expense has been recognized as of February 28, 2006.
Repriced Options. In January 1999, the Company repriced certain employee stock options, other than those held by executive officers or directors. This resulted in approximately 3.0 million options being repriced and the four-year vesting period starting over. Under FIN 44, repriced options are subject to variable plan accounting, which requires compensation cost or benefit to be recorded each period based on changes in our stock price until the repriced options are exercised, forfeited or expire. The initial fair value used to measure the ongoing stock option compensation charge or benefit was $22.19 based on the closing price of our common stock on June 30, 2000. Since our stock price at the beginning and end of fiscal 2006, 2005 and 2004 was below $22.19, no charge or benefit was recorded during fiscal 2006, 2005 and 2004. As of February 28, 2006, approximately 283,550 repriced options were still outstanding, all of which are fully vested. In future periods, we will record additional charges or benefits related to the repriced stock options still outstanding based on the change in our common stock price compared to the last reporting period. If our stock price at the beginning and end of any reporting period is less than $22.19, no charge or benefit will be recorded.
Other Expense, Net
Other Expense, Net, includes interest income from cash and cash equivalents, marketable securities and long-term investments, interest expense from borrowings and payments on our capital lease obligations, foreign currency exchange gains or losses and other gains or losses. Other expense, net, decreased $1.5 million, or 20.9%, to $5.8 million in fiscal 2006 as compared to fiscal 2005 and decreased $6.1 million, or 45.6%, to $7.3 million in fiscal 2005 as compared to fiscal 2004. The decrease in Other Expense, Net in fiscal 2006 as compared to fiscal 2005 relates primarily to an increase in interest income of $1.6 million due to increased interest rates on our cash and investments. The decrease in Other Expense, Net in fiscal 2005 compared to fiscal 2004 relates to a decrease in interest expense of approximately $3.6 million primarily related to a reduction in interest expense on our outstanding convertible notes due to the conversion of $74.5 million of our Notes during fiscal 2004 (See Note 7 in the Notes to Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K), an increase in interest income of $0.7 million in fiscal 2005 and a decrease of other expense of $0.1 million and a foreign currency exchange gain of $0.3 million in fiscal 2005 compared to a $1.6 million foreign currency exchange loss in fiscal 2004.
Debt Conversion Expense
During fiscal 2004, the Company exchanged $74.5 million of its Notes for 9,725,750 shares of its common stock in privately negotiated transactions with note holders. The offer and issuance of the common stock underlying these transactions were exempt from registration under Section 3(a) (9) of the Securities Act of 1933 and were freely traded upon issuance.
At the conversion price of $44.06 per share, the $74.5 million of Notes exchanged would have been convertible into 1,690,780 shares of common stock. For accounting purposes, the additional 8,034,970 shares of common stock that the Company issued in these transactions are considered an inducement for the holders to convert their Notes, which required the Company to record a non-operating expense equal to the fair value of the additional shares issued to the holders. Accordingly, the Company recorded a non-cash debt conversion expense of approximately $59.8 million during the year ended February 29, 2004. These transactions resulted in a $74.5 million reduction of the Notes outstanding and increased stockholders’ equity by $74.5 million. The 9,725,750 shares of common stock issued in these transactions represented approximately 11.9% of the shares outstanding as of February 28, 2004.
(Benefit from) Provision for Income Taxes
We recorded an income tax (benefit) provision of $(3.6) million, $0.7 million and $1.3 million in fiscal 2006, fiscal 2005 and fiscal 2004, respectively. In fiscal 2006, fiscal 2005 and fiscal 2004, $(3.7) million, $0.6 million and $1.0 million of the income tax (benefit) provision relates to foreign taxes, respectively.
Management performed an analysis, based on various factors, including our current year financial results, our cumulative losses for the three year period ended February 28, 2006, and estimates of future profitability, as of February 28, 2006 and February 28, 2005, and concluded that future taxable income will, more likely than not, be insufficient to recover our net deferred tax assets as of February 28, 2006 and February 28, 2005. Therefore, we have maintained a valuation allowance for the full amount of our net deferred tax assets. Management will continue to monitor its estimates of future profitability and the likelihood of realizing our net deferred tax assets based on evolving business conditions.
Loss Per Common Share
Loss per common share is computed in accordance with SFAS No. 128, “Earnings Per Share,” which requires dual presentation of basic and diluted earnings per common share for entities with complex capital structures. Basic loss per common share is based on net loss divided by the weighted-average number of common shares outstanding during the period. Diluted earnings or loss per common share includes, when dilutive, (i) the effect of stock options, warrants and restricted stock granted using the treasury stock method, (ii) the effect of contingently issuable shares earned during the period, and (iii) shares issuable under the conversion feature of our Notes using the if-converted method. Future weighted-average shares outstanding calculations will be impacted by the following factors:
· the ongoing issuance of common stock associated with stock option and warrant exercises;
· the issuance of common shares associated with our employee stock purchase plan and restricted stock grants;
· any fluctuations in our stock price, which could cause changes in the number of common stock equivalents included in the diluted earnings per common share calculations (to the extent that we have positive net income);
· the issuance of common stock to raise capital or effect business combinations should we enter into such transactions; and
· assumed or actual conversions of our convertible debt into common stock.
Liquidity and Capital Resources
Historically, we have financed our operations and met our capital expenditure requirements through cash flows provided from operations, long-term borrowings (including the sale of convertible notes) and sales of equity securities. The significant components of our working capital are liquid assets such as cash and cash equivalents, marketable securities and trade accounts receivable, reduced by accounts payable, accrued expenses, short-term restructuring obligations and deferred revenue. In fiscal 2006, working capital increased $15.2 million, to $120.7 million primarily as a result of cash flows provided by operating activities.
Cash, cash equivalents and marketable securities increased $4.8 million during fiscal 2006 to $140.7 million, as of February 28, 2006. The increase is due to changes in working capital items, including $9.7 million in payments for exit and disposal obligations, as well as:
· $0.5 million in cash proceeds from employee stock purchase plan purchases.
Offset by:
· $6.7 million in expenditures on property, equipment and software, including $3.6 million of capitalized software; and
· $2.9 million in principal payments on long-term debt and capital leases.
We believe that the combination of cash, cash equivalents and marketable securities and anticipated cash flows from operations will be sufficient to fund expected capital expenditures, capital lease obligations and working capital needs for the next twelve months.
On April 24, 2006, we entered into a definitive Agreement and Plan of Merger with JDA and the Merger Sub. Under the Merger Agreement, the Merger Sub will be merged with and into the Company, with the Company continuing after the Merger as a wholly-owned subsidiary of JDA. At the effective time of the Merger, each issued and outstanding share of Company Common Stock will be converted into the right to receive $2.50 in cash. There can be no assurance the Merger will be consummated as planned. In the event the transaction does not close, we will evaluate alternatives to address our outstanding Notes (See Note 7), which become due in November 2007, including, but not limited to, seeking additional debt or equity financing, exchanging existing Notes outstanding for equity, selling existing company assets and other potential solutions.
Commitments
As of February 28, 2006, our future fixed commitments and the effect these commitments are expected to have on our liquidity and cash flows in future periods are as follows (in thousands):
(1) Includes principal and interest payments
Lease Commitments
The lease commitments in the above table designated as “Operating lease obligations in exit and disposal activities” include only the non-cancelable portion of lease commitments included in past initiatives and, accordingly, have not been reduced by estimated sublease income. However, as required by EITF 88-10 and SFAS 146, we have reduced these lease commitments by estimated sublease income in determining the total exit and disposal obligations of $15.0 million recorded in the accompanying balance sheet as of February 28, 2006. Please refer to Note 8 and Note 14 in the Notes to Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.
Convertible Subordinated Notes
The Company had $175.5 million in Notes outstanding as of February 28, 2006. The Notes bear interest at 5.0% per annum which is payable semi-annually. The fair market value of the Notes in the hands of the holders was $164.5 million on February 28, 2006, based on market quotes. The Notes mature in November 2007 and are convertible into approximately 4.0 million shares of the Company’s common stock at a conversion price of $44.06, subject to adjustment under certain conditions. The conversion price of the Notes will be adjusted in the event that we issue our common stock as a dividend or distribution with respect to our common stock, we subdivide, combine or reclassify our common stock, we issue rights to our common stockholders to purchase our common stock at less than market price, we make certain distributions of securities, cash or other property to our common stockholders (other than ordinary cash
dividends), or we make certain repurchases of our common stock. Upon a change of control of the Company, the holders of the Notes would have the right to require us or our successor to repurchase the Notes at a purchase price equal to 100% of the principal amount, plus accrued and unpaid interest to the date of repurchase in cash. The Notes do not have any financial covenants. Since November 7, 2003, we have had the right to redeem, from time to time, the Notes in whole or in part, at our option. Redemption can be made on at least 30 days’ notice if the trading price of our common stock for 20 trading days in a period of 30 consecutive trading days ending on the day prior to the mailing of notice of redemption exceeds 120% of the conversion price of the Notes. The redemption price, expressed as a percentage of the principal amount, is:
Pursuant to the Merger Agreement, we will conduct a cash tender offer for all of the outstanding Notes. Closing of that tender offer will be conditioned on the closing of the Merger. If the Merger is not consummated, we may choose to purchase a portion of the Notes in the open market from time to time with cash or enter into alternative transactions to reduce the balance of the Notes, such as exchanging Notes for shares of our common stock, if we are able to do so on terms favorable to us. Purchases of the Notes with cash would reduce our debt outstanding and may result in a decrease to our liquidity and working capital.
Credit Facility
We had a one-year unsecured revolving credit facility with Silicon Valley Bank (“SVB”) for $15.0 million which expired on March 30, 2005. On April 8, 2005, we renewed the credit facility with SVB for $15.0 million and a two-year term, effective March 29, 2005 (the “Credit Facility”). Under the terms of the Credit Facility, we may request cash advances, letters of credit, or both. Borrowings under the Credit Facility accrue interest at the prime rate plus 0.5%. The Credit Facility requires us to comply with the following financial covenants: (i) minimum tangible net worth (defined as stockholders’ equity plus convertible debt less goodwill, capitalized software costs and other intangible assets) must be at least $90.0 million plus 50% of consolidated net income generated cumulatively commencing with the first quarter of fiscal 2006 and (ii) our ratio of (a) unrestricted cash, cash equivalents, marketable securities and long-term investments deposited with SVB and its affiliates plus net accounts receivable to (b) current liabilities plus long-term indebtedness to SVB and outstanding letters of credit minus deferred revenue, must be at least 2.0 to 1.0. We were in compliance with all financial covenants as of February 28, 2006 and there were no cash draws outstanding. As of February 28, 2006, we had $10.0 million in letters of credit outstanding under the Credit Facility, of which $8.9 million is related to securing our lease obligations for certain office space and $1.1 million is related to securing an additional line of credit in China, which was never executed. The $1.1 million letter of credit expires in May 2007 and cannot be drawn upon by the beneficiary because the line of credit for which it was issued to secure was never executed. Pursuant to the Merger Agreement, we will cooperate with JDA to replace, at the closing of the Merger, the letters of credit that are outstanding with SVB with newly issued letters of credit.
The Credit Facility requires us to maintain $50.0 million in funds with SVB Asset Management and its affiliates. The Credit Facility also restricts the amount of additional debt we can incur and restricts the amount of cash that we can use for acquisitions and for the repurchase of convertible debt. Under the terms of the Credit Facility, we retain the right to terminate the facility at any time upon repayment of any advances and the posting of cash collateral for any outstanding letters of credit. Under the Credit Facility, SVB has the right to obtain a lien on all of our assets, other than intellectual property, upon an occurrence
of default, unless we terminate the facility as provided above. The Credit Facility also provides that, upon an event of default, we are prohibited from paying a cash dividend to our shareholders.
The Credit Facility includes a provision for supplemental equipment advances, under which we may borrow up to an additional $5.0 million for the purchase of equipment, office furniture and other capital expenditures. Amounts could be borrowed for such capital expenditures through December 31, 2005 and accrued interest at a fixed interest rate equal to 7.75% annually. Equipment advances would have been repaid monthly over a 36-month-period, beginning in the month following the advance. Our right to request supplemental equipment advances expired on December 31, 2005 and we made no draw downs. The financial covenants for the supplemental equipment advances were the same as The Credit Facility and we were in compliance with all financial covenants.
We had an additional credit agreement (the “Equipment Line”) with SVB, as amended, which expired March 31, 2003, under which we were permitted to borrow up to $5.0 million for the purchase of equipment. Amounts borrowed under the Equipment Line accrue interest at a rate equal to the greater of the three-year Treasury note rate plus 5%, or 8.25%, and are repaid monthly over a 36-month period. During fiscal 2003, we borrowed $2.9 million under the Equipment Line. As of February 28, 2006, we have repaid all amounts borrowed and have no amounts outstanding. The financial covenants for the Equipment Line are the same as the financial covenants for the Credit Facility. We were in compliance with all financial covenants as of February 28, 2006.
Cash Flows
Cash provided by (used in) operations was $14.5 million, $(5.5) million and $6.8 million in fiscal 2006, 2005 and 2004, respectively. The improvement in operating cash flows of $20.0 million in fiscal 2006 compared to fiscal 2005 resulted from a lower net loss in fiscal 2006, decreased payments made to vendors related to the timing of receiving vendor invoices, decreased payments made related to our exit and disposal activities, decreased employee compensation payments related to the timing of our payroll, partially offset by a lower contribution of accounts receivable and an increase in deferred revenue related to the timing and seasonality of our support renewals. The decline in operating cash flows of $12.3 million in fiscal 2005 compared to fiscal 2004 resulted from a decrease in contribution of accounts receivable due to lower revenue, increased payments related to exit and disposal activities, increased payments made to vendors related to the timing of receiving vendor invoices, partially offset by a decrease in the payment of interest on our convertible debt as a result of the decrease in our outstanding debt balance and a lower net loss in fiscal 2005 compared to fiscal 2004.
Cash used in investing activities was $11.8 million, $10.8 million and $34.0 million in fiscal 2006, 2005 and 2004, respectively. Investing activities consist of the sales and purchases of marketable securities and long-term investments, changes in restricted cash, purchases and sales of property and equipment, purchases and capitalization of software, and acquisitions of businesses. Total purchases of property and equipment were $3.1 million in fiscal 2006, $4.1 million in fiscal 2005 and $2.2 million in fiscal 2004. In fiscal 2004, approximately $13.0 million was provided by the elimination of cash restrictions upon the transfer of our letters of credit from Bank of America to SVB. Approximately $3.3 million of this $13.0 million was recorded as a deposit to secure an international lease. Acquisitions of businesses, net of cash acquired of $2.0 million during fiscal 2004 relates to proceeds received that were held in escrow from prior acquisitions. Sales of marketable securities, net of (purchases), were $(5.1) million in fiscal 2006, $20.1 million in fiscal 2005 and $(26.3) million in fiscal 2004. Sales of long-term investments, net of (purchases), were $(18.9) million in fiscal 2005 and $(9.0) million in fiscal 2004.
Cash (used in) provided by financing activities was $(2.4) million, $(1.7) million and $5.5 million in fiscal 2006, 2005 and 2004, respectively. Cash (used in) provided by financing activities consisted of cash proceeds from the exercise of stock options and employee stock plan purchases, cash proceeds from
borrowings on our line of credit and cash payments for principal amounts on our SVB equipment line of credit and capital lease obligations.
Our cash position may decline in the future, primarily due to cash outflows associated with our exit and disposal activities, our operations and our debt service obligations. We are obligated to pay approximately $8.8 million of interest annually on our $175.5 million of Notes. Additionally, the Notes will mature and become due and payable in November 2007.
Although we expect that existing cash, cash equivalents and short-term investment balances will satisfy our working capital and capital expenditure requirements for the next twelve months, there can be no assurance that in the longer term we will be successful in obtaining or maintaining an adequate level of cash resources. We may be forced to act more aggressively in the future in the area of expense reduction in order to conserve cash as we look for alternative liquidity solutions.
Off-Balance Sheet Arrangements
We do not use off-balance sheet arrangements with unconsolidated entities or related parties, nor do we use other forms of off-balance sheet arrangements such as research and development arrangements. Accordingly, our liquidity and capital resources are not subject to off-balance sheet risks from unconsolidated entities.
Lease Arrangements.
We have entered into operating leases with unrelated third parties for our U.S. and international sales and support offices and certain equipment in the normal course of business. These arrangements are sometimes referred to as a form of off-balance sheet financing. Future minimum lease payments under our operating leases as February 28, 2006 are detailed previously in “Liquidity and Capital Resources.” Under the terms of our Credit Facility, we may request cash advances, letters of credit, or both. As of February 28, 2006, $10.0 million in letters of credit was outstanding under the Credit Facility, of which $8.9 million is related to securing our lease obligations for certain office space.
Recently Issued Accounting Pronouncements
In May 2005, the FASB issued SFAS 154, “Accounting Changes and Error Corrections-A replacement of APB Opinion No. 20 and FASB Statement No. 3” (“SFAS 154”). The FASB issued SFAS 154 to provide guidance on the accounting for and reporting of error corrections. Unless otherwise impracticable, it establishes retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. SFAS 154 also provides guidance for determining whether retrospective application is impracticable and for reporting an accounting change when retrospective application is impracticable. Furthermore, this statement addresses the reporting of a correction of an error in previously issued financial statements by restating previously issued financial statements. This Statement is effective for financial statements for fiscal years beginning after December 15, 2005. The adoption of this statement is not expected to have a material impact on our consolidated financial statements.
SFAS No. 123 (Revision 2004), “Share-Based Payment” (“SFAS 123 (R)”) was issued in December 2004 and was to be effective for reporting periods beginning after June 15, 2005. The new statement requires all share-based payments to employees to be recognized in the financial statements based on their fair values. We currently account for our share-based payments to employees under the intrinsic value method of accounting set forth in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issues to Employees.” Additionally, we comply with the stock-based employer compensation disclosure requirements of SFAS 148. On March 29, 2005, the SEC issued Staff Accounting Bulletin Topic 14, “Share-Based Payment” (“SAB 107”). SAB 107, which becomes effective for public companies upon their
adoption of SFAS No. 123(R), describes the SEC Staff’s views in determining the assumptions that underlie the fair value estimates and interaction of SFAS No. 123(R) with certain existing SEC guidance. On April 14, 2005, The Securities and Exchange Commission announced the adoption of a new rule that amends the compliance dates for SFAS 123 (R). The new rule allows companies to implement SFAS 123 (R) at the beginning of their next fiscal year, instead of their next reporting period beginning after June 15, 2005. We plan to adopt the new statement beginning in the first quarter of fiscal 2007. We believe the adoption of SFAS 123 (R ) will have a material impact on our financial position and results of operations.
Item 7A.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS.
Foreign Currency Risk. We are subject to risk from changes in foreign exchange rates for our subsidiaries that use a foreign currency as their functional currency and are translated into U.S. dollars. Such changes could result in cumulative translation gains or losses that are included in shareholders’ equity. Revenue outside of the U.S. as a percentage of total revenue was 35.5%, 33.8% and 34.0% for fiscal 2006, 2005 and 2004, respectively. Revenue outside the U.S. is derived from operations in Australia, Belgium, Brazil, Canada, The People’s Republic of China, France, Hong Kong, Japan, Malaysia, Mexico, Singapore, Taiwan and the United Kingdom. Exchange rate fluctuations between the U.S. dollar and the currencies of these countries result in positive or negative fluctuations in the amounts relating to foreign operations reported in our condensed consolidated financial statements. None of the components of our Statement of Operations were materially affected by exchange rate fluctuations during fiscal 2006, 2005 and 2004. We generally do not use foreign currency options and forward contracts to hedge against the earnings effects of such fluctuations. While we do not expect to incur material losses as a result of this currency risk, there can be no assurance that losses will not result.
Interest Rate Risk. Our marketable securities and certain cash equivalents are subject to interest rate risk. Fixed income instruments are subject to interest rate risk and, accordingly, if market interest rates increase, these investments will decline in value. We manage this risk by maintaining an overall investment portfolio of available-for-sale instruments with high credit quality and relatively short average maturities. Instruments in our entire portfolio include, but are not limited to, commercial paper, money-market instruments, bank time deposits and variable rate and fixed rate obligations of corporations and national, state and local governments and agencies, in accordance with an investment policy approved by our Board of Directors. These instruments are denominated in U.S. dollars. As of February 28, 2006 and February 28, 2005, the fair market value of our long-term investments and marketable securities held was $61.2 million and $55.5 million, respectively. We also hold cash balances in accounts with commercial banks in the U.S. and foreign countries. These cash balances represent operating balances only and are invested in short-term deposits of the local bank.
The U.S. Federal Reserve Board influences the general market rates of interest. During fiscal 2006, the Federal Reserve Board increased the discount rate by 300 basis points from 2.5% to 5.5%. The Federal Reserve Board subsequently raised the discount rate by 0.25 basis points. As of May 10, 2006, the discount rate was 5.75%.
The weighted average yield on interest-bearing investments held as of February 28, 2006 and February 28, 2005 was approximately 3.61% and 1.7%, respectively. Based on our investment holdings at February 28, 2006, a 100 basis point decline in the average yield would reduce our annual interest income by $0.9 million.
Credit Risk. Financial instruments that potentially subject us to concentrations of credit risk consist primarily of cash and cash equivalents, investments in marketable securities, long-term investments and trade accounts receivable. We have policies that limit investments in investment grade securities and the amount of credit exposure to any one issuer. We perform ongoing credit evaluations of our customers and
maintain an allowance for potential credit losses. We do not require collateral or other security to support client receivables since most of our customers are large, well-established companies. Our credit risk is also mitigated because our customer base is diversified both by geography and industry, and no single customer has accounted for more than 10% of our consolidated revenue on an annual basis, although we have had customers which accounted for more than 10% of our consolidated revenue on a quarterly basis. We generally do not use foreign exchange contracts to hedge the risk in receivables denominated in foreign currencies. We do not hold or issue derivative financial instruments for trading or speculative purposes.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Our Consolidated Financial Statements and supplementary data, together with the reports of our independent registered public accounting firm, are included in Part IV of this Annual Report on Form 10-K.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
Item 9A.
Item 9A. CONTROLS AND PROCEDURES.
Our management, with the participation of our Chief Executive Officer and acting Principal Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Annual Report on Form 10-K. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), means controls and other procedures of a company that are designed to ensure that information required to be disclosed by the company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Securities Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives. Based on the evaluation of our disclosure controls and procedures as of the end of the period covered by this Annual Report on Form 10-K, our Chief Executive Officer and acting Principal Financial Officer concluded the Company’s disclosure controls and procedures were effective at a reasonable assurance level.
MANAGEMENT’S REPORT ON INTERNAL CONTROLS OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in the Exchange Act Rules 13a-15(f) and 15d-15(f). Those rules define internal control over financial reporting as 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 and includes those policies and procedures that:
· pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;
· 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
· 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. 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.
As part of our compliance efforts relative to Section 404 of the Sarbanes-Oxley Act of 2002, our management assessed the effectiveness of our internal controls over financial reporting as of February 28, 2006. In making this assessment, management used the criteria set forth in the Internal Control-Integrated Framework by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on our evaluation under COSO, our management concluded that our internal control over financial reporting was effective as of February 28, 2006.
The Company’s independent auditors have issued an audit report on our assessment of the Company’s internal control over financial reporting. This report appears below.
Changes in Internal Control over Financial Reporting
Based on the evaluation conducted by management, including the Chief Executive Officer and the acting Principal Financial Officer, there were no changes in our internal controls during the fourth quarter ended February 28, 2006 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Manugistics Group, Inc.
Rockville, Maryland
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Manugistics Group, Inc. and subsidiaries (the “Company”) maintained effective internal control over financial reporting as of February 28, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’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 opinions.
A company’s internal control over financial reporting is a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel 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 the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of February 28, 2006, is fairly stated, in all material respects, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of February 28, 2006, based on the criteria
established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended February 28, 2006, of the Company and our report dated May 14, 2006 expressed an unqualified opinion on those financial statements.
/s/ DELOITTE & TOUCHE LLP
McLean, Virginia
May 14, 2006
Item 9B.
Item 9B. Other information.
Special Recognition Cash Bonus Pool
During the first quarter of fiscal year 2007, the Board and the Compensation Committee of the Board (the “Compensation Committee”) considered on several occasions the appropriate level of special recognition bonuses for certain employees of the Company in light of the Merger, and approved an aggregate of up to $1.25 million of cash bonuses (the “Special Recognition Bonus Pool”) to be allocated among the applicable employees of the Company, separate from and in addition to any other compensation owed them and contingent upon the closing of the Merger. The Board and the Compensation Committee (i) approved the allocation of $350,000 of the Special Recognition Bonus Pool to Joseph L. Cowan, Chief Executive Officer of the Company, and (ii) authorized Mr. Cowan to determine the allocation of the remaining $900,000 of the Special Recognition Bonus Pool to executive officers and key employees of the Company. An aggregate of $627,500 of the Special Recognition Bonus Pool will be awarded to the Company’s remaining executive officers (with the balance of the pool allocated to other employees) including $104,500 to Edward R. Daihl, Senior Vice President, Revenue Management, $73,000 to Kelly Davis-Stoudt, Vice President, Controller and Chief Accounting Officer, $195,000 to Jeffrey L. Kissling, Senior Vice President and Chief Technology Officer, $55,000 to Ronald P. Kubera, Senior Vice President of Consumer Goods and European Operations, $45,000 to Lori Mitchell-Keller, Senior Vice President of Global Marketing & Solution Management and $155,000 to Timothy T. Smith, Senior Vice President & General Counsel. These bonuses will be paid within thirty (30) days after closing of the Merger, subject to the continued employment of each individual with the Company up to and through the closing of the Merger.
PART III
Item 10.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
In light of the pending Merger, the Company has not scheduled an annual meeting of stockholders for 2006 and does not plan to file a definitive proxy statement involving the election of directors unless the Company’s stockholders do not approve the Merger at the special meeting of stockholders.
Directors and Executive Officers
The Third Amended and Restated By-Laws of the Company (the “By-Laws”) provide that the Company’s business shall be managed by a Board of Directors of not fewer than six and not more than nine directors, with the number of directors to be fixed by the Board of Directors from time to time. The number of directors is presently fixed at nine. The By-Laws also provide that the Company’s Board of Directors is divided into three classes: Class I, Class II and Class III, each class being as nearly equal in number as possible. The directors in each class serve terms of three years and until their respective successors have been elected and qualified. The term of office of one class of directors expires each year in rotation so that one class is elected at each annual meeting of stockholders for a three-year term.
There are presently three directors in Class I, two directors in Class II and three directors in Class III. There is presently one vacancy on the Board. Based upon the recommendations to be made by the Corporate Governance Committee, the Board of Directors will consider suitable candidates to fill the vacancy.
Executive officers of the Company are elected by the Board of Directors on an annual basis and serve at the discretion of the Board.
Set forth below is certain information concerning our directors as well as the executive officers of the Company and Manugistics, Inc., our principal operating subsidiary. There are no family relationships among any of our executive officers or directors.
Mr. Cowan has served as Chief Executive Officer of the Company since July 2004, and as a director of the Company since August 2004. From November 2002 to December 2003, Mr. Cowan served as President and Chief Executive Officer of EXE Technologies, Inc., a provider of supply chain management and work management software and services. From April 2001 to November 2002, he served as President and Chief Executive Officer of Invensys Automation & Information Systems, a business unit of Invensys plc and provider of enterprise resource planning and supply chain management software. From July 2000 to April 2001, Mr. Cowan served as President and Chief Executive Officer, and from April 1998 to July 2000, as Senior Vice President, Sales and Marketing, of Wonderware, a business unit of Invensys plc and provider of industrial automation software.
Mr. Fritz has served as a director of the Company since 1995. Mr. Fritz has been Director General of the Fritz Institute, a disaster relief management firm, since January 2001. From August 2000 to the present, Mr. Fritz has served as Chairman of the Board and Chief Executive Officer of LynnCo Supply Chain Solutions, Inc., a provider of solutions that optimize and analyze logistics networks. From 1988 through May 2001, Mr. Fritz served as Chairman of the Board and Chief Executive Officer of Fritz Companies, Inc., a global freight forwarding and custom house brokerage company.
Mr. Gibson rejoined the Board as a director of the Company in 2005. From its formation in 1986 to 2001, Mr. Gibson served as Chairman of the Board of the Company. From 1986 until June 2000,
Mr. Gibson also served as Chief Executive Officer and President of the Company. Mr. Gibson has been Managing Partner of The Albermarle Group, a private investment company, since February 2001. Mr. Gibson is also a member of the Board of Directors of Venture Philanthropy Partners and the Board of Regents of Villanova University.
Mr. Jacovini has served as a director of the Company since 1986. He is a partner at Dilworth Paxson LLP, based in Philadelphia, Pennsylvania, where he has practiced law since 1965. He has served as Chairman of that firm since January 1998, and as Co-Chairman from 1992 through December 1997. Mr. Jacovini has served as Chairman of the Board of Trustees of Drexel University since May 2003 and as a Trustee of Drexel University since 1990.
Mr. Janeway has served as a director of the Company since October 2002. Mr. Janeway joined Warburg Pincus LLC, a private investment firm, in 1988 as a Managing Director and has served as Vice Chairman of the firm since January 2001. Mr. Janeway serves on the Board of Directors of BEA Systems, Inc., an application platform software provider; and Nuance Communications, Inc., a provider of speech and imaging solutions.
Mr. Melia has served as Chairman of the Board of the Company since April 2005 and as a director of the Company since July 2003. Mr. Melia served as Chairman of the Board and Chief Executive Officer of Manufacturer’s Service Ltd., a large electronic equipment production outsourcing company, from June 1994 to January 2002 and as Chairman of Manufacturer’s Service Ltd. from January 2002 to January 2003. Mr. Melia serves as Chairman of the Board of Iona Technologies, plc, a provider of software products and services for communications providers, and Lightbridge, Inc., a provider of software products and services for communications providers. He also serves as a director of Eircom Group, plc, a telecommunications company and Radisys Corp., a provider of integration software.
Mr. Nelson has served as a director of the Company since 1986. Since 1990, Mr. Nelson has served as Chairman of the Board of HarrisData Services of Wisconsin, Inc., a provider of business application software to mid-size organizations. Mr. Nelson was Chief Executive Officer of HarrisData Services from 1990 to June 2002. Since June 1999, Mr. Nelson has served as Chairman of the Board of Repository Technologies, Inc., a provider of customer relationship management systems for the software industry. From July 1996 until October 2000, Mr. Nelson served as the Chairman of the Board, and, from September 1996 until April 1999, he served as Chief Executive Officer and President, of Geac Computer Corporation Limited, a Canadian provider of enterprise software and systems. From 1986 until its sale in March 2006, Mr. Nelson served on the Board of Directors of Geac Computer Corporation Limited (Canada). Mr. Nelson serves on the Board of Directors of HealthGate Data Corp., a provider of healthcare information and, from May 2002 until 2005, served on the Board of Directors of Catalyst International, Inc., a provider of warehouse management software.
Mr. Skelton has served as a director of the Company since April 1992. Since November 1999, Mr. Skelton has been the principal of Skelton & Associates, LLC, through which he serves as an investor in and advisor to computer software and services companies. He served as President of Cambar Software, Inc. from August 1997 to November 1999. Mr. Skelton also serves on the Board of Directors of Calian Technology Ltd. (Canada), a technology services provider.
Ms. Mitchell-Keller has served as Senior Vice President of Global Marketing & Solution Management since September 2004. From February 2003 to September 2004, Ms. Mitchell-Keller served as Senior Vice President of Product Development & Strategy. From March 2001 to February 2003, Ms. Mitchell-Keller served as Senior Vice President of Market and Technology Strategy. From March 2000 to March 2001, she served as Vice President of Technology Strategy, from October 1999 to March 2000, as Vice President of Product & Solution Marketing and from March 1999 to September 1999, as Vice President of Product Marketing.
Mr. Kissling has served as Senior Vice President and Chief Technology Officer since September 2004. From March 2002 to September 2004, Mr. Kissling was an independent consultant. From June 2001 to March 2002, Mr. Kissling served as Chief Technology Officer of Baan Company, a provider of enterprise resource planning systems and a provider of software and consulting services (“Baan Company”). From June 1999 to June 2001, he served as the Chief Technology Officer of Invensys Manufacturing and Process Systems, a business unit of Invensys plc and provider of enterprise industrial automation systems.
Mr. Kubera has served as Senior Vice President of Consumer Goods since March 2005. From October 2003 to February 2005, Mr. Kubera served as Senior Vice President of Northern European Operations, from March 2001 to October 2003, as Senior Vice President of Global Services, and from March 1999 to February 2001, as Vice President.
Mr. Smith has served as Senior Vice President, General Counsel and Secretary from January 2000 through February 2002 and since July 2002. From June 1998 to December 1999, he served as Vice President and General Counsel for Land Rover North America, Inc., an automobile importer and distributor.
Mr. Daihl has served as Senior Vice President of Revenue Management since November 2005. From September 2004 to October 2005, Mr. Daihl served as Group Vice President of Revenue Management. From August 2003 to September 2004, Mr. Daihl served as President of Dexec Consulting, a provider of management advisory services to the high tech industry. From July 2000 to August 2003, he served as President of CAPS Logistics, a wholly-owned subsidiary of Baan Company, and from July 1999 to July 2000 as the Vice President, Consulting, of Baan Company.
Ms. Davis-Stoudt has served as the Company’s Vice President, Controller and Chief Accounting Officer since May 2004. From April 1999 to May 2004, Ms. Davis-Stoudt served as Assistant Controller.
On October 24, 2002, William H. Janeway, a partner of Warburg Pincus & Co. and a Vice-Chairman and member of Warburg Pincus LLC, a private equity investment firm, was nominated and appointed as a Class III director pursuant to the request for representation on the Board from Warburg Pincus Private Equity VIII, L.P. (“WP VIII”) as a result of WP VIII’s significant ownership interest in the Company in 2002. In connection with Mr. Janeway’s appointment to the Board, the Company entered into a standstill agreement with WP VIII. Under the standstill agreement, the Company consented to the acquisition by WP VIII and certain of its affiliates of up to 19.9% of the Common Stock and agreed that, for as long as WP VIII and its affiliates beneficially own at least ten percent (10%) of the outstanding shares of Common Stock, the Company would nominate and use its best efforts to have elected to the Board one person designated by WP VIII and reasonably acceptable to the Company. If WP VIII beneficially owns less than ten percent (10%) of the outstanding shares of Common Stock as a result of the sale, transfer or disposition of shares of Common Stock by WP VIII, then upon the request of the Company, WP VIII’s designated member of the Board would be required to resign from the Board. Mr. Janeway is indemnified by WP VIII in connection with his service on the Company’s Board of Directors. The standstill agreement expired in October 2005.
Audit Committee and Audit Committee Financial Expert
The Audit Committee presently consists of William G. Nelson (Chairman), Kevin C. Melia and Thomas A. Skelton. The Board of Directors has determined that all members of the Audit Committee are “independent” as that term is defined in the applicable Nasdaq listing standards and regulations of the Securities and Exchange Commission. In addition, the Board of Directors has determined that Mr. Nelson, Mr. Melia and Mr. Skelton have the financial experience required by the applicable Nasdaq listing standards and each of Mr. Nelson and Mr. Melia is an “audit committee financial expert” as defined by applicable regulations of the Securities and Exchange Commission.
The information contained in this Annual Report on Form 10-K with respect to the independence of the members of the Audit Committee shall not be deemed to be “filed” with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any prior or subsequent filing under the Securities Act or the Exchange Act, except to the extent that the Company specifically incorporates it by reference in such filing.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires the Company’s executive officers, directors and persons who own more than ten percent (10%) of the Common Stock (collectively, “Reporting Persons”) to file initial reports of ownership and reports of changes of ownership of the Common Stock with the Securities and Exchange Commission (“SEC”) and the Nasdaq Stock Market. Reporting Persons are required to furnish the Company with copies of all forms that they file under Section 16(a). Based solely upon a review of the copies of such forms received by the Company or written representations from Reporting Persons, the Company believes that, with respect to fiscal year 2005, all Reporting Persons complied with all applicable filing requirements under Section 16(a) with the exception of Thomas Skelton who failed to timely file three Form 4 Statements of Changes in Beneficial Ownership each reporting one transaction with respect to certain transfers of shares among himself, his wife and a joint account held for the benefit of himself and his wife and one Form 5 Annual Statement of Changes in Beneficial Ownership of Securities to report four transactions with respect to gifts of shares from Mr. Skelton and his wife to their daughters.
Code of Ethics:
We have adopted a code of business conduct and ethics for all employees of our Finance department and those with financial oversight responsibility, including our Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer, known as the Code of Ethics pursuant to Section 406 of the Sarbanes-Oxley Act of 2002. The Code of Ethics is available on our website at www.manugistics.com.
We intend to disclose any amendment to, and any waiver from, a provision of the Code of Ethics that applies to the Chief Executive Officer, Chief Financial Officer, Chief Accounting Officer or any other executive officer and that relates to any element of the Code of Ethics definition enumerated in Item 406(b) of Regulation S-K, on Form 8-K, within five business days following the date of such amendment or waiver.
Code of Conduct:
We have adopted a code of business conduct and ethics for all directors, officers and employees, known as the Code of Conduct pursuant to applicable NASDAQ listing standards. The Code of Conduct is available on our website at www.manugistics.com.
We intend to disclose any amendment to the Code of Conduct that relates to any element of the Code of Ethics definition enumerated in Item 406(b) of Regulation S-K, and any waiver from a provision of the Code of Conduct granted to any director or executive officer, on Form 8-K, within five business days following the date of such amendment or waiver.
Item 11.
Item 11. EXECUTIVE COMPENSATION.
Summary Compensation Table
The following table sets forth summary information regarding compensation paid or accrued by the Company for services during fiscal years 2006, 2005 and 2004 to each person serving as the Company’s Chief Executive Officer and each of the four most highly compensated executive officers other than the
persons serving as Chief Executive Officer whose individual total salary and bonus on an annual basis exceeded $100,000 for fiscal 2006 (the “Named Executives”). Mr. Cowan and Mr. Kissling joined the Company during fiscal 2005; accordingly, the annual compensation reported for them in fiscal 2005 is for a partial year. Mr. Kubera was not an executive officer at any time during fiscal 2004. Mr. Daihl became an executive officer in fiscal 2006. Mr Rajaji resigned as Executive Vice President and Chief Financial Officer on October 18, 2005, effective November 4, 2005.
Summary Compensation Table
(1) No bonuses were paid during fiscal 2006. Each of Messrs. Cowan, Kissling, Kubera and Daihl and Ms. Mitchell-Keller received cash awards for achieving corporate performance or managerial targets and goals in the fourth quarter of fiscal 2006 in the amounts of $100,000, $33,750, $56,250, $30,000 and $35,550, respectively, which cash awards were paid in the first quarter of fiscal 2007.
(2) Represents a car allowance of $16,200 and $2,198 in transportation and living expenses.
(3) Represents $40,417 in housing expenses, $4,132 for additional life insurance premiums, and a $1,333 employer contribution to the Company’s 401(k) Plan.
(4) Represents a car allowance of $9,885 and $7,982 in transportation and living expenses.
(5) In connection with his employment with the Company, Mr. Cowan was awarded a total of 333,000 restricted shares, 200,000 of which vested upon grant and the remainder of which vested on January 1, 2006 as a result of his employment through that date.
(6) Represents $21,436 in housing expenses, $1,033 for additional life insurance premiums and $5,525 for legal services.
(7) Represents a $2,063 employer contribution to the Company’s 401(k) Plan.
(8) Represents $271 in housing expenses.
(9) Includes $129,675 for tax equalization payments.
(10) Represents a $3,191 employer contribution to the Company’s 401(k) Plan and $650 for additional life insurance premiums.
(11) Includes $24,646 for tax equalization payments.
(12) Represents $94,272 for housing and relocation expenses, $22,195 for cost of living expenses, $650 for additional life insurance premiums and a $2,987 employer contribution to the Company’s 401(k) Plan.
(13) Represents a $3,187 employer contribution to the Company’s 401(k) Plan and $225 for additional life insurance premiums.
(14) Represents a $200 good health subsidy.
(15) Represents a $2,967 employer contribution to the Company’s 401(k) Plan and $225 for additional life insurance premiums.
(16) Represents $225 for additional life insurance premiums.
(17) Represents a $1,500 employer contribution to the Company’s 401(k) Plan.
(18) Represents $757 in unpaid vacation pay.
(19) Represents a $2,278 employer contribution to the Company’s 401(k) Plan, $3,341 for additional life insurance premiums and $4,059 for professional tax services.
(20) Represents $3,304 for additional life insurance premiums, $1,733 for professional tax services and a $2,838 employer contribution to the Company’s 401(k) Plan.
(21) Includes 245,429 options granted in connection with the Company’s option exchange program commenced February 10, 2003 (“2003 OEP”).
(22) Represents $6,609 for additional life insurance premiums, $1,567 for professional tax services and a $3,263 employer contribution to the Company’s 401(k) Plan.
(23) The number and value of the aggregate restricted stock holdings of Messrs. Kissling and Kubera, Ms. Mitchell-Keller and Messrs. Daihl and Rajaji at the end of fiscal 2006 were 30,000 shares valued at $55,800, 55,000 shares valued at $46,500, 65,000 shares valued at $120,900, 25,000 shares valued at $46,500, and 60,000 shares valued at $111,600, respectively. Mr. Cowan had no restricted shares at the end of fiscal 2006. If the Merger is consummated, any restricted stock will be cashed out in the Merger at a price per share of $2.50, less any required tax withholdings.
(24) If the Merger is consummated, any options that are not exercised in advance of the closing will be cashed out in connection with the Merger for the positive difference (if any) between $2.50 and the exercise price of the options, without regard to whether the options were already vested, and with the result reduced by applicable tax withholdings.
Stock Options
The following table sets forth certain information concerning the grant of options to the persons serving as Chief Executive Officer and other Named Executives in fiscal 2006. The Company has not granted any stock appreciation rights (“SARs”).
Option Grants in Last Fiscal Year
* All options have an exercise price equal to the fair market value of the Common Stock on the date of grant.
(1) Vests on the earliest to occur of: (i) the executive officer’s involuntary termination without cause or resignation for good reason; (ii) a change of control of the Company; or (iii) 11/01/2006. If the Merger is consummated, any options that are not exercised in advance of the closing will be cashed out in connection with the Merger for the positive difference (if any) between $2.50 and the exercise price of the options, without regard to whether the options were already vested, and with the result reduced by applicable tax withholdings.
(2) Mr Rajaji resigned as Executive Vice President and Chief Financial Officer on October 18, 2005, effective November 4, 2005.
Neither the Chief Executive Officer nor any of the other Named Executive Officers exercised outstanding options during fiscal 2006.
The following table summarizes the value realized upon exercise of outstanding stock options during fiscal 2006 and the value of the outstanding options held by the Chief Executive Officer and the other Named Executive Officers.
Aggregated Option Exercises in Fiscal 2006 and
Fiscal Year-End Option Values
(1) Computed by multiplying the number of shares of Common Stock acquired upon exercise of options by the difference between (i) the per-share fair market value of the Common Stock on the date of exercise and (ii) the exercise price per share.
(2) Computed by multiplying the number of options by the difference between (i) the per-share market value of the Common Stock on February 28, 2006 of $1.86 and (ii) the exercise price per share.
Compensation of Directors
The Company pays all non-employee directors an annual retainer of $15,000, except for the Chairman of the Board, who receives an annual retainer of $80,000. Additionally, the Chairman of the Audit Committee receives an annual retainer of $10,000, and each of the Chairmen of the Company’s other committees receives an annual retainer of $5,000. Non-employee directors also receive $1,000 for each Board and committee meeting attended. Directors who are employees of the Company do not receive any compensation for their service on the Board. Directors are reimbursed for their reasonable out-of-pocket expenses incurred in connection with attendance at meetings of the Board of Directors and its committees.
In addition, under the Company’s Amended and Restated 1998 Stock Option Plan (the “1998 SOP”), each non-employee director, including the Chairman of the Board, receives annually, commencing with the first annual meeting of shareholders following the date of appointment or election to the Board, an option to purchase 10,000 shares of Common Stock. Any non-employee director who is appointed or elected to the Board after March 1, 2003 receives an option to purchase 35,000 shares on the date of appointment or election, prorated based on the number of fiscal quarters ending from the date of the appointment or election until the next annual meeting. All of these options vest quarterly over a five-year period. The 1998 SOP further provides that discretionary grants of options may also be made to non-employee directors. In April 2005, Mr. Melia received a discretionary grant of an option to purchase 100,000 shares of Common Stock in connection with his appointment as Chairman of the Board, which vests quarterly over five years. All stock option grants have been granted with a per share exercise price equal to the market price of a share of Common Stock on the date of grant, as determined under the 1998 SOP. If the Merger is consummated, any options that are not exercised in advance of the closing will be cashed out in connection with the Merger for the positive difference (if any) between $2.50 and the exercise price of the options, without regard to whether the options were already vested, and with the result reduced by applicable tax withholdings.
On October 10, 2005, the Board of Directors established a Special Committee, initially composed of Kevin Melia (Chairman of the Special Committee), Joseph Jacovini and William Janeway to provide an efficient process for the evaluation of various strategic alternatives for the assets or businesses of the Company. On November 1, 2005, Mr. Janeway resigned from the Special Committee and was replaced by Thomas Skelton. On April 23, 2006, the Corporate Governance Committee approved meeting fees for the Special Committee. The fees for meetings actually attended are $750 per meeting for the Chairman of the Special Committee and $500 per meeting for the other members of the Special Committee.
Employment Agreements
The Company entered into a two-year employment agreement with Mr. Cowan in fiscal 2005 in connection with the commencement of his employment with the Company under which he receives a minimum annual base salary. Under his agreement, Mr. Cowan is eligible for bonuses of up to 100% of his annual base salary. The Company entered into offer letters with each of Mr. Kubera in 1993, Messrs. Kissling and Daihl in 2004, and Ms. Mitchell-Keller in 1997, in connection with the commencement of their employment with the Company under which they receive a minimum annual base salary. Assuming the fiscal 2006 bonus arrangements continue without modification in fiscal 2007, Messrs. Kissling, Kubera and Daihl and Ms. Mitchell-Keller would be eligible for bonuses of up to 60%, 100%, 60% and 63.2%, respectively, of their respective annual base salaries. The Company also provides to each of Messrs. Cowan, Kubera, Daihl and Kissling and Ms. Mitchell-Keller certain benefits, including medical, life and disability insurance, participation in the Company’s employee stock purchase plan, and fringe benefits. In addition, Mr. Cowan receives a monthly car allowance of $1,350, receives a housing allowance (with the benefit extended in April 2006 to run through the earliest of July 21, 2006, the date he obtains a residence within commuting distance from the Company, and 30 days after the date his employment with the Company ends) and is entitled to a health club membership subject to an annual cap of $3,000 and reimbursement up to $25,000 for financial or tax advice in the event of a change in control of the Company. Mr. Cowan’s agreement also includes a provision providing a gross-up to make him whole for the imposition of certain parachute excise taxes in the event of a change in control that provides him compensation benefits above a certain threshold.
During fiscal 2006, the Company entered into letter agreements amending the terms of employment of each of Messrs. Cowan, Kissling, Kubera, Daihl, and Ms. Mitchell-Keller with respect to a change in control of the Company. Under the terms of these letter agreements, if, within one year of a change in control of the Company, the Company terminates the executive’s employment other than for cause or the executive officer terminates his or her employment for good reason, the Company will make severance payments to the executive in the amount of his/her base salary and benefits during the twelve-month period, in the case of Messrs. Kissling, Kubera, and Daihl and Ms. Mitchell-Keller, and during a twenty-four-month period, in the case of Mr. Cowan, commencing on the termination date. The severance payments to the executive will continue even if he or she obtains alternative employment during the severance period. In addition, under the terms of their letter agreements, all options and shares of restricted stock granted to each of Messrs. Cowan, Kissling, Kubera, Daihl and Ms. Mitchell-Keller shall continue to vest or be exercisable during the period severance payments are made, except as noted in the preceding paragraph regarding options and any restricted stock then held will be cashed out in the Merger at a price per share of $2.50, less any required tax withholdings.
Pursuant to the terms of the Merger Agreement, the parties thereto agreed that for all benefit plans (including all severance agreements, employment related agreements, stock option plans, restricted stock plans and any and all award or other agreements associated with any benefit plan), the Merger would be deemed a change in control, would vest fully any outstanding stock option and restricted stock awards, and would establish for specified individuals, including Joseph L. Cowan, Ed Daihl, Timothy Smith and Kelly Davis-Stoudt among the executive officers, and excluding any individuals who waive such treatment in
writing before the Closing, the existence of a termination without cause or a resignation with or for good reason, with the consequences, including, but not limited to, the right of each such person to continue, at no cost to the person, any medical insurance coverage that was in effect, for the person and his or her dependents (if any), immediately before the Closing Date until the earlier of the expiration of such person’s continuation coverage under the Consolidated Omnibus Budget Reconciliation Act of 1985, as amended, and the date on which the replacement coverage begins with another employer.
Compensation Committee Interlocks and Insider Participation
The current members of the Compensation Committee are Thomas A. Skelton (Chairman), William G. Nelson and William H. Janeway. No executive officer of the Company has served as a director or member of the compensation committee (or other committee serving an equivalent function) of any other entity, whose executive officers served as a director or member of the Compensation Committee of the Company during fiscal 2006.
The information set forth in the following Report of the Compensation Committee of the Board of Directors and in the Performance Graph shall not be deemed incorporated by reference into any existing or future filings under the Securities Act or the Exchange Act, except to the extent that the Company specifically incorporates such information by reference.
Report of the Compensation Committee of the Board of Directors on Executive Compensation
During fiscal 2006, Joseph L. Cowan served as Chief Executive Officer of the Company. The Compensation Committee of the Board of Directors was directly responsible for the approval and administration of the compensation program for Mr. Cowan. For fiscal 2006, the Board of Directors approved the salary and cash incentive components of the compensation program of Mr. Cowan. The award targets and goals underlying the cash incentive component of Mr. Cowan’s Compensation Program were approved by the Compensation Committee and ratified by the Board of Directors.
During fiscal 2006, the Chief Executive Officer implemented the Company’s compensation program for the other executive officers of the Company, including those named in the Summary Compensation Table. Based in part on the recommendations made by Mr. Cowan, the salary and cash incentive components of the fiscal 2006 compensation program for other executive officers were approved by the Compensation Committee and were reviewed by the Board of Directors.
The Compensation Committee was responsible for the administration of the Company’s equity compensation plans. The Compensation Committee also approved the grant of options and restricted stock to executive officers other than the Chief Executive Officer under the Company’s various stock option plans, although it delegated limited authority to the Chief Executive Officer with respect to the grant of stock options to employees who are not executive officers. The Compensation Committee’s approval was based, in part, on grant recommendations made by Mr. Cowan.
The Compensation Committee consisted of three non-employee directors of the Company: Thomas A. Skelton, Chairman of the Committee, William H. Janeway and William G. Nelson.
Objectives and Policies
The objectives of the Company’s executive compensation programs are to:
· Attract and retain highly qualified executives to lead and manage the Company by providing competitive total compensation packages;
· Reward executives based on the business performance of the Company and upon individual performance;
· Provide executives with incentives designed to maximize the long-term performance of the Company and to align further their interests with those of the shareholders of the Company; and
· Assure that consistent objectives for corporate and individual performance are established and measured.
Compensation of Executive Officers other than the Chief Executive Officer
In fiscal 2006, the Company’s compensation program for executive officers other than Mr. Cowan consisted of cash compensation and the award of stock options and restricted stock. Cash compensation consisted of base salary and cash bonuses awarded based upon the attainment of certain corporate, managerial and personal award targets and goals.
Base Salary. Base salaries for executive officers of the Company (including the Chief Executive Officer) have historically been determined by evaluating the responsibilities associated with their respective positions, the experience of the officers, individual performance and by reference to salary surveys and other publicly available compensation data for executive officers with comparable ability and experience at similarly-sized companies in the technology industry. Individual salary increases are reviewed annually and, in fiscal year 2006, the review was based primarily on competitive market forces affecting compensation for executive officers and the period of time since the executive officer’s last increase in base salary. At the close of fiscal 2006, there were seven executive officers, including the Chief Executive Officer.
In fiscal 2006, annual base salaries for the executive officers, other than the Chief Executive Officer, were approved by the Compensation Committee based, in part, on the recommendation of the Chief Executive Officer. Base salaries, including Mr. Cowan’s base salary, were not increased in fiscal 2006.
Cash Bonuses. During fiscal 2006, each of the executive officers, other than the Chief Executive Officer, was eligible to receive an annual incentive cash bonus in an amount ranging up to 100% of the executive officer’s base salary, payable quarterly, based on corporate performance, managerial and personal award targets or goals. The corporate performance award targets consisted of specific revenue and operational goals to be reached by the Company during the course of the fiscal year. Managerial awards were based on a subjective evaluation by the Chief Executive Officer of the overall performance of the executive officer for the quarter, and were subject to the achievement of a specific operational goal of the Company. Personal award targets consisted of specific operational goals and revenue targets to be achieved by the executive officer or the Company during the course of the fiscal year. The award targets and goals were recommended by Mr. Cowan and approved by the Compensation Committee. In formulating the award targets and goals, the Chief Executive Officer considered, among other factors, corporate and individual performance, growth in the economy as projected by various economists and industry growth expectations as published by AMR Research and others.
The Company did not achieve its corporate performance award targets or the operational goal upon which the managerial award was based for fiscal 2006 for the overall fiscal year; however the seven executive officers received cash compensation for achieving corporate performance or managerial targets and goals for the fourth quarter of fiscal 2006.
Stock-Option/Restricted Stock Awards. Each executive officer other than the Chief Executive Officer is also eligible to receive performance awards in the form of stock-option grants and restricted stock awards which are recommended by the Chief Executive Officer to the Compensation Committee for approval. In fiscal 2006, Mr. Cowan based his recommendations primarily on his evaluation of the performance of such executive officer, competitive market forces affecting executive compensation, the size of previous option grants to such executive officer, together with the number of options held by such executive officer at the beginning of fiscal 2006. These stock option grants and restricted stock awards were
also intended to serve as a strong long-term retention incentive. The Compensation Committee approved and the Board of Directors ratified the stock-option grants and restricted stock awards as recommended by Mr. Cowan. In making its decision, the Compensation Committee considered a report commissioned by the Company from an independent compensation specialist presenting prevailing market practices for retention programs, certain constraints imposed by the terms of the Company’s equity plans, the number of outstanding equity awards, the likely potential for mandatory option expensing in the near future and coordination of an equity retention program with the Company’s annual equity grant program.
In November 2005, the Company established a supplemental retention program (the “Supplemental Retention Program”) for certain executive officers and employees. The Supplemental Retention Program provides for the payment of a total of $130,000 in cash to certain executive officers, and grants of a total of 300,000 shares of restricted stock pursuant to the Amended and Restated 1998 Stock Option Plan of the Company (the “1998 Plan”) and 915,000 stock options to certain executive officers and employees pursuant to the 1998 Plan. During the fourth quarter of fiscal 2006, the Company entered into restricted stock bonus agreements and stock option grant agreements with certain employees and executive officers pursuant to the Supplemental Retention Program. The cash payments and grants of restricted stock and stock options to the executive officers under the Supplemental Retention Plan were as follows:
Compensation of the Chief Executive Officer
Joseph L. Cowan
Mr. Cowan has served as the Company’s Chief Executive Officer since July 22, 2004. He has a two-year Employment Agreement with the Company. When determining the overall compensation program for Mr. Cowan, the Board of Directors and the Compensation Committee considered competitive market conditions for chief executive officers of similar companies with volatile stock prices.
Base Salary. Mr. Cowan’s annualized base salary for fiscal 2006 was $400,000. In setting Mr. Cowan’s base salary, the Compensation Committee considered the responsibilities associated with the position, Mr. Cowan’s experience, reference to salary surveys and other publicly available compensation data for chief executive officers with comparable ability and experience at similarly-sized companies in the technology industry.
Cash Bonuses. In fiscal 2006, Mr. Cowan was eligible to receive an annual incentive cash bonus of up to $400,000, an amount equal to 100% of his annual base salary during fiscal 2006, based on the corporate performance award targets referred to above and certain managerial and personal performance targets and goals approved by the Compensation Committee and ratified by the Board of Directors. The Company did not achieve its corporate performance award targets or the operational goal upon which the managerial award was based for fiscal 2006 for the overall fiscal year; however, Mr. Cowan did receive an annual incentive cash bonus for achieving corporate performance or managerial targets and goals for the fourth quarter of fiscal 2006.
Stock-Option/Restricted Stock Awards. Mr. Cowan did not receive any equity grants in fiscal 2006.
Changes in Compensation After Fiscal 2006
Enhanced Bonus for Kelly Davis-Stoudt. In April 2006, the Compensation Committee approved an additional discretionary bonus for Kelly Davis-Stoudt, the Company’s Vice President, Chief Accounting Officer and Controller, with respect to her services in the fourth quarter of fiscal 2006 (by treating her as though her bonus percentage for that quarter had been 60% of base salary rather than 40% of base salary) and changed her target bonus percentage for the current fiscal year and forward from 40% of base salary to 60% of base salary.
Special Recognition Cash Bonus Pool. In April 2006, JDA Software Group, Inc. (“JDA”) and the Company announced that they had entered into a definitive merger agreement (the “Merger Agreement”) for JDA to acquire all of the issued and outstanding shares of the Company (the “Merger”), subject to the approval of the Company’s stockholders and certain regulatory and customary conditions. In light of the Merger, the Board and the Compensation Committee considered on several occasions the appropriate level of special recognition bonuses for certain employees of the Company, and in the first quarter of fiscal 2007, approved an aggregate of up to $1.25 million of cash bonuses (the “Special Recognition Bonus Pool”) to be allocated among the applicable employees of the Company, separate from and in addition to any other compensation owed them and contingent upon the consummation of the Merger. The Board and the Compensation Committee (i) approved the allocation of $350,0000 of the Special Recognition Bonus Pool to Mr. Cowan, and (ii) authorized Mr. Cowan to determine the allocation of the remaining $900,000 of the Special Recognition Bonus Pool. These bonuses will be paid upon closing of the Merger, subject to the continued employment of each individual up to and through the closing of the Merger.
Section 162(m)
Section 162(m) of the Internal Revenue Code of 1986, as amended, generally disallows a tax deduction to public companies for certain compensation in excess of $1 million paid to the Company’s Chief Executive Officer and the four other most highly compensated executive officers. Certain compensation, including qualified performance-based compensation, will not be subject to the deduction limit if certain requirements are met. The Compensation Committee reviews the potential effect of Section 162(m) periodically and uses its judgment to authorize compensation payments that may be subject to the limit when the Compensation Committee believes such payments are appropriate and in the best interests of the Company and its stockholders, after taking into consideration changing business conditions and the performance of its employees.
Compensation Committee
Thomas A. Skelton, Chairman
William H. Janeway
William G. Nelson
Stock Performance Graph
The following graph compares the cumulative total return to shareholders of the Common Stock with the cumulative total return of the Nasdaq Stock Market (US) Index and of the Nasdaq Computer and Data Processing Stocks Index from February 28, 2001 to the end of the Company’s last fiscal year (February 28, 2006). The graph assumes that the value of the investment in the Common Stock and each index was $100 on February 28, 2001 and that all dividends were reinvested. The Company has not paid any cash dividends on its Common Stock and does not intend to do so in the foreseeable future. The performance graph is not necessarily indicative of future performance.
COMPARE 5-YEAR CUMULATIVE TOTAL RETURN
AMONG MANUGISTICS GROUP, INC.
NASDAQ MARKET INDEX AND NASDAQ COMPUTER & DATA PROCESSING
ASSUMES $100 INVESTED ON FEB. 28, 2001
ASSUMES DIVIDEND REINVESTED
FISCAL YEAR ENDING FEB. 28, 2006
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
The following table sets forth certain information, as of April 30, 2006 unless otherwise indicated in the footnotes to the table, with respect to the beneficial ownership of shares of Common Stock by (i) each shareholder known by the Company to be the beneficial owner of more than five percent (5%) of the outstanding shares of Common Stock; (ii) each director of the Company; (iii) each executive officer named in the Summary Compensation Table appearing above in Item 11 - “Executive Compensation”; and (iv) all executive officers and directors as a group. Except as indicated in the footnotes to the table, the persons and entities named in the table have sole voting and investment power with respect to all shares of Common Stock which they respectively own beneficially. Beneficial ownership is based on 84,142,830 outstanding shares of Common Stock as of April 30, 2006. Under applicable rules promulgated under the Exchange Act, a person is deemed to be the beneficial owner of shares of Common Stock if, among other
things, he or she directly or indirectly has or shares voting power or investment power with respect to such shares. A person is also considered to beneficially own shares of Common Stock which he or she does not actually own but has the right to acquire presently or within sixty (60) days of April 30, 2006, by exercise of stock options or otherwise. Mr. Rajaji resigned as the Company’s Executive Vice President, Treasurer and Chief Financial Officer on November 4, 2005. Pursuant to the terms of a change in status agreement, Mr. Rajaji served as a part-time employee of the Company from November 4, 2005 to March 5, 2006.
The address of each person who is an officer or director of the Company is 9715 Key West Avenue, Rockville, MD 20850.
* Less than 1% of the outstanding Common Stock.
* Shares subject to Voting Agreement, the terms of which are described under the heading “Merger Agreement and Voting Agreement” under Item 13
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
William M. Gibson
Two family members of William M. Gibson, who owns more than five percent (5%) of the outstanding shares of Common Stock and is a director of the Company and who was formerly an executive officer of the Company, are employees of the Company. Mr. Gibson’s brother, Sean Gibson, has been employed as a member of the Company’s sales force since 1985 and received $188,187 in compensation from the Company for the last fiscal year. Mr. Gibson’s brother, Patrick Gibson, has been an employee in the Company’s solutions support group since 1985 and received $89,476 in compensation from the Company for the last fiscal year. In addition, since 2001 Mr. Gibson has served as a director of LynnCo Supply Chain Solutions, Inc., a company for which Lynn C. Fritz, a director of the Company, serves as Chairman and Chief Executive Officer.
Joseph H. Jacovini
Joseph H. Jacovini, a director of the Company, is a partner and Chairman of Dilworth Paxson LLP, which provides legal services to the Company.
William H. Janeway
William H. Janeway, a director of the Company since October 2002, is a director of BEA Systems, Inc. Since 1998, the Company has licensed certain software from BEA Systems which the Company resells as part of its software solutions. Consistent with prior years, total revenues paid by the Company to BEA Systems in fiscal 2006 were significantly less than 5% of the consolidated gross revenues of each company for its last full fiscal year.
Kevin C. Melia
Kevin C. Melia, Chairman of the Board of the Company since April 2005 and a director of the Company since July 2003, is Chairman of the Board of IONA Technologies plc. Since 1995, the Company has licensed certain software from IONA Technologies which it uses in the production of Manugistics software. Consistent with prior years, total revenues paid by the Company to IONA Technologies in fiscal 2006 were significantly less than 5% of the consolidated gross revenues of each company for its last full fiscal year.
Ronald P. Kubera
Sherri Rogers-Kubera, the sister-in-law of Ronald P. Kubera, Senior Vice President of Consumer Goods of the Company, is employed by the Company in its Manugistics Consulting Services group. Ms. Rogers-Kubera received $55,322 in compensation from the Company for the last fiscal year.
Merger Agreement and Voting Agreements
As disclosed under the heading “Merger Agreement and Voting Agreements” in Item 1 - “Business” and elsewhere in this Annual Report on Form 10-K, on April 24, 2006, the Company entered into the Merger Agreement pursuant to which the Merger Sub will be merged with and into the Company, with the Company continuing after the Merger as a wholly-owned subsidiary of JDA. At the effective time of the Merger, each issued and outstanding share of Company Common Stock will be converted into the right to receive $2.50 in cash. The Merger Agreement has been approved by the Board. The Board has received an opinion from Lehman Brothers, Inc. that the consideration to be offered to the Company’s stockholders in the Merger is fair from a financial point of view to such stockholders. The transactions contemplated by the Merger Agreement are subject to approval by the holders of a majority of the issued and outstanding shares of Company Common Stock. The transactions contemplated by the Merger Agreement also are
subject to the expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and certain other closing conditions. The Merger Agreement provides for a termination fee of $9.75 million, which is payable by the Company under certain circumstances. The foregoing description of the Merger Agreement is not complete and is qualified in its entirety by reference to the Merger Agreement, which is filed as Exhibit 2.1 to the Company’s Current Report on Form 8-K dated April 25, 2006 and is incorporated herein by reference.
In connection with the execution of the Merger Agreement, certain stockholders, officers and directors of the Company entered into Voting Agreements, whereby such stockholders will vote (or cause to be voted) in person or by proxy all shares of our common stock held by them (i) in favor of the adoption of the Merger Agreement and approval of the transactions contemplated thereby, (ii) against any proposal made in opposition to or competition with the consummation of the Merger and the Merger Agreement, (iii) against any proposal that would reasonably lead to or result in the conditions of JDA’s or Merger Sub’s obligations under the Merger Agreement not being fulfilled, (iv) against any takeover proposal from any party other than JDA or an affiliate of JDA, and (v) against the election of a group of individuals to replace a majority or more of the individuals presently on the Company’s Board. The stockholders that signed the Voting Agreements beneficially own approximately 24% of our outstanding shares of common stock as of April 24, 2006 and include certain of our officers and directors and entities affiliated with them. If the Merger Agreement is terminated for any reason, the Voting Agreements will also terminate. The foregoing description of the Voting Agreements is not complete and is qualified in its entirety by reference to the form of Voting Agreement, which is filed as Exhibit 99.3 to the Company’s Current Report on Form 8-K dated April 25, 2006 and is incorporated herein by reference.
Item 14.
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
The following table presents fees for professional services rendered by Deloitte & Touche LLP, the member firms of Deloitte Touche Tohmatsu, and their respective affiliates (collectively, “Deloitte & Touche”), which includes Deloitte Consulting, for the audit of the Company’s annual financial statements and review of interim financial statements for fiscal years 2005 and 2006, and fees for other services rendered by Deloitte & Touche for fiscal years 2005 and 2006.
(a) Audit Fees for the fiscal years 2005 and 2006 were for all services performed in connection with the audits of the Company’s annual consolidated financial statements, quarterly reviews and statutory audits.
(b) Audit-Related Fees for the fiscal years 2005 and 2006 were for employee benefit plan audits and other audit related services.
(c) Tax Fees for the fiscal years 2005 and 2006 were for tax compliance, tax planning and tax advice provided to the Company and its foreign subsidiaries.
In fiscal 2004, the Audit Committee established its current policy regarding pre-approval of all audit and permissible non-audit services provided by the Company’s independent auditor. This policy requires (i) the general pre-approval of specified audit, audit-related and tax services on a twelve-month basis up to a specified amount, (ii) specific pre-approval of services not covered by the general pre-approval, including
pre-approved services which exceed the pre-approved amount, and prohibits the Company’s independent auditor from providing non-audit services prohibited pursuant to Section 201 of the Sarbanes-Oxley Act of 2002, which includes services such as bookkeeping services, financial systems consulting services and internal audit services.
Since the May 6, 2003 effective date of the Exchange Act rules stating that an auditor is not independent of an audit client if the services it provides to the client are not appropriately approved, all services performed by the Company’s independent auditor under engagement were approved by the Audit Committee pursuant to its pre-approval policy, and none was approved pursuant to the de minimis exception to the rules and regulations of the Securities and Exchange Commission on pre-approval.
PART IV
Item 15.
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) Documents filed as a part of this Annual Report on Form 10-K:
(1) Financial Statements
The financial statements listed above are filed as part of this Annual Report on Form 10-K.
(2) Financial Statement Schedules are omitted because they are not required, are not applicable or the required information is shown in the Consolidated Financial Statements or notes thereto contained in this Annual Report on Form 10-K.
(3) Exhibits
The exhibits required by Item 601 of Regulation S-K are listed below and are filed or incorporated by reference as part of this Annual Report on Form 10-K. Exhibits 10.2, 10.11, 10.13(b), 10.14, 10.32 and 10.62 through 10.79 are management contracts or compensatory plans or arrangements.
(A) Incorporated by reference from the exhibits to the Company’s registration statement on Form S-1 (REG No. 33-65312).
(B) Incorporated by reference to 4.1(A) to the Company’s registration statement on Form S-3 (REG. No. 333-31949).
(C) Incorporated by reference to exhibit 4.1(b) to the Company’s registration statement on Form S-3 (REG. No. 333-31949).
(D) Incorporated by reference from Exhibit 10.1 to the Company’s quarterly registration statement on Form S-8 filed August 5, 2004 (REG No. 333-117955).
(E) Incorporated by reference from the exhibits to the Company’s quarterly report on Form 10-Q for the quarter ended August 31, 1995.
(F) Incorporated by reference from the exhibits to the Company’s registration statement on Form S-8 filed August 2, 1996 (REG No. 333-09481).
(G) Incorporated by reference from the exhibits to the Company’s annual report on Form 10-K for fiscal year ended February 28, 1999.
(H) Incorporated by reference from the exhibits to the Company’s quarterly report on Form 10-Q for the quarter ended August 31, 1999.
(I) Incorporated by reference from the exhibits to the Company’s quarterly report on Form 10-Q for the quarter ended November 30, 1999.
(J) Incorporated by reference from the exhibits to the Company’s quarterly report on Form 10-Q for the quarter ended August 31, 1998.
(L) Incorporated by reference from the exhibits to the Company’s quarterly report on Form 10-Q for the quarter ended May 31, 2000.
(M) Incorporated by reference from the exhibits to the Company’s current report on Form 8-K/A dated October 11, 2000.
(N) Incorporated by reference from the exhibits to the Company’s current report on Form 10-Q for the quarter ended November 30, 2000.
(O) Incorporated by reference from the exhibits to the Company’s registration statement on Form S-3/A (No. 333-53918).
(P) Incorporated by reference from the exhibits to the Company’s quarterly report on Form 10-Q for the quarter ended May 31, 2001.
(Q) Incorporated by reference from the exhibits to the Company’s annual report on Form 10-K for the fiscal year ended February 28, 2002.
(R) Incorporated by reference from the exhibits to the Company’s quarterly report on Form 10-Q for the quarter ended May 31, 2002.
(S) Incorporated by reference from the exhibits to the Company’s quarterly report on Form 10-Q for the quarter ended November 30, 2002.
(U) Incorporated by reference from the exhibits to the Company’s quarterly report on Form 10-Q for the quarter ended August 31, 2002.
(V) Incorporated by reference from the exhibits to the Company’s current report on Form 8-K dated January 16, 2003.
(X) Incorporated by reference from the exhibits to the Company’s quarterly report on Form 10-Q for the quarter ended May 31, 2003.
(Y) Incorporated by reference from the exhibits to the Company’s quarterly report on Form 10-Q for the quarter ended August 31, 2003.
(Z) Incorporated by reference from the exhibits to the Company’s quarterly report on Form 10-Q for the quarter ended November 30, 2003.
(AA) Incorporated by reference to the Company’s Post-effective Amendment No. 1 to Form S-8 filed by the Company on September 15, 2003 (No. 333-108811).
(BB) Incorporated by reference from exhibits to the Company’s annual report on Form 10-K for the fiscal year ended February 29, 2004.
(CC) Incorporated by reference from exhibits to the Company’s quarterly report on Form 10-Q for the quarter ended August 31, 2004.
(DD) Incorporated by reference from exhibits to the Company’s current report on Form 8-K dated September 23, 2004.
(EE) Incorporated by reference from exhibits to the Company’s current report on Form 8-K dated October 29, 2004.
(GG) Incorporated by reference from exhibits to the Company’s annual report on Form 10-K for the fiscal year ended February 29, 2004.
(HH) Incorporated by reference from exhibits to the Company’s quarterly report on Form 10-Q for the quarter ended August 31, 2005.
(II) Incorporated by reference from exhibits to the Company’s current report on Form 8-K dated November 7, 2005.
(JJ) Incorporated by reference from exhibits to the Company’s quarterly report on Form 10-Q for the quarter ended November 30, 2005.
(KK) Incorporated by reference from exhibits to the Company’s current report on Form 8-K dated April 25, 2006.
(b) Exhibits
See the response to Item 15(a)(2) above.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this annual report to be signed on its behalf by the undersigned, thereunto duly authorized, on May 15, 2006.
MANUGISTICS GROUP, INC.
(Registrant)
/s/ Joseph L. Cowan
Joseph L. Cowan
Director and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this annual report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on May 15, 2006.
/s/ Joseph L. Cowan
Joseph L. Cowan
Director and Chief Executive Officer
(Principal Executive Officer)
/s/ Kelly Davis-Stoudt
Kelly Davis-Stoudt
Vice President, Controller and
Chief Accounting Officer
(Principal Accounting Officer and
Acting Principal Financial Officer)
/s/ Kevin C. Melia
/s/ Thomas A. Skelton
Kevin C. Melia
Thomas A. Skelton
Chairman of the Board
Director
/s/ William H. Janeway
/s/ Lynn C. Fritz
William H. Janeway
Lynn C. Fritz
Director
Director
/s/ Joseph H. Jacovini
/s/ William G. Nelson
Joseph H. Jacovini
William G. Nelson
Director
Director
/s/ William M. Gibson
William M. Gibson
Director
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Manugistics Group, Inc.
Rockville, Maryland
We have audited the accompanying consolidated balance sheets of Manugistics Group, Inc. and subsidiaries (the “Company”) as of February 28, 2006 and 2005, and the related consolidated statements of operations and comprehensive loss, stockholders’ equity, and cash flows for each of the three years in the period ended February 28, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Manugistics Group, Inc. and subsidiaries as of February 28, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended February 28, 2006, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of February 28, 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 14, 2006 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
/s/ DELOITTE & TOUCHE LLP
McLean, Virginia
May 14, 2006
MANUGISTICS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
See accompanying Notes to Consolidated Financial Statements.
MANUGISTICS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(in thousands, except per share data)
See accompanying Notes to Consolidated Financial Statements.
MANUGISTICS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands)
See accompanying Notes to Consolidated Financial Statements
MANUGISTICS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
See accompanying Notes to Consolidated Financial Statements.
MANUGISTICS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES
The Company
Manugistics Group, Inc. (the “Company”) is a leading global provider of demand-driven supply chain management software products and services. The Company combines its products and services to deliver solutions that address the specific demand-driven supply chain business needs of its clients. The Company’s approach to client delivery is to advise clients on how to best use its software and other technologies across their entire demand-driven supply chain. The Company’s solutions enable companies to reduce their operating costs, improve customer service and increase their top-line revenue by allowing them to plan, optimize and synchronize their entire demand-driven supply chain.
Basis of Presentation
The Consolidated Financial Statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany transactions and balances have been eliminated. Certain prior year amounts have been reclassified to conform to the current year financial statement presentation.
Use of Estimates
The preparation of consolidated financial statements, in conformity with accounting principles generally accepted in the U.S. of America (“GAAP”), requires management to make estimates, judgments and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results may differ from these estimates. Significant items subject to such estimates and assumptions include revenue recognition, carrying amount and useful lives of long-lived assets, valuation allowances for accounts receivable and deferred tax assets, sublease income associated with exit and disposal plans, capitalized software development costs and loss contingencies, such as litigation, claims and assessments.
Cash and Cash Equivalents
Cash and cash equivalents are comprised of amounts in operating accounts, money market investments and other short-term, highly liquid investments with original maturities of three months or less. In fiscal 2005, the Company reclassified prior year auction rate securities to available-for-sale securities (marketable securities) in accordance with Financial Accounting Standards No. 115 “Investments in Debt and Equity Securities” (“SFAS 115”). In prior years, auction rate securities were classified as cash equivalents due to the short period of time between auctions.
Marketable Securities
The Company’s short-term marketable securities are classified as available-for-sale. These securities are recorded at fair value with unrealized gains and losses reported as a component of stockholders’ equity and comprehensive loss. Realized gains and losses on available-for-sale securities are computed using the specific identification method. As of February 28, 2006 and February 28, 2005, marketable securities consisted of investments in corporate debt, municipal bonds and other short-term investments which mature in one year or less. Marketable securities also consisted of investments in auction-rate securities, with auctions held monthly and maturity dates ranging from 2028 to 2043. Purchases of auction rate
securities were $7.1 million and $29.1 million and sales of auction rate securities were $6.8 million and $60.5 million in fiscal 2006 and fiscal 2005, respectively, and are included in purchases and sales of marketable securities in the Consolidated Statement of Cash Flows.
Long-Term Investments
The Company’s long-term investments are classified as available-for-sale. These investments are reported at fair value with unrealized gains and losses reported as a component of stockholders’ equity. Realized gains and losses on available-for-sale securities are computed using the specific identification method. As of February 28, 2005, long-term investments consisted of corporate debt securities and U.S. agency securities with original maturities in excess of one year. There were no long-term investments as of February 28, 2006.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents, investments in marketable securities, long-term investments and trade accounts receivable. The Company has policies that limit investments to investment grade securities, limit the amount of credit exposure to any one issuer and maximum investment maturities, both individually and in aggregate. The Company performs ongoing credit evaluations of its customers and maintains an allowance for potential credit losses. The Company does not require collateral or other security to support customers’ receivables since most of its customers are large, well-established companies. The Company’s credit risk is also mitigated because its customer base is diversified both by geography and industry and no single customer accounts for more than 10% of consolidated annual revenue for any period presented. The Company initially records a provision for doubtful accounts based on historical experience of write-offs and adjusts the allowance for doubtful accounts at the end of each reporting period based on a detailed assessment of accounts receivable. In estimating the allowance for doubtful accounts, management considers the age of the accounts receivable, the Company’s historical write-offs, the credit-worthiness of the customer, the economic conditions of the customer’s industry and general economic conditions, among other factors. Should any of these factors change, the estimates made by management will also change, which could affect the level of the Company’s future provision for doubtful accounts.
Property and Equipment
Property and equipment is stated at cost. Office, furniture and equipment are depreciated on a straight-line basis over three to ten years. Information technology equipment and purchased software are depreciated on a straight-line basis over two to three years. Leasehold improvements are amortized over the shorter of the lease term or the useful life of the improvements. Repairs and maintenance costs are expensed as incurred. When assets are sold or retired, the related asset and accumulated depreciation amounts are removed from their respective accounts and any gain or loss is recognized in the Consolidated Statements of Operations and Comprehensive Loss.
Software Development Costs
The Company capitalizes the development costs of software, other than internal use software, in accordance with Statement of Financial Accounting Standards No. 86 (“SFAS 86”), “Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed.” Software development costs are expensed as incurred until technological feasibility has been established, at which time such costs are capitalized until the product is available for general release to clients. Software development costs are amortized at the greater of the amount computed using either:
(a) the straight-line method over the estimated economic life of the product, commencing with the date the product is first available for general release; or
(b) the ratio that current gross revenue bears to the total current and anticipated future gross revenue.
Intangible Assets and Goodwill
Intangible assets include goodwill, acquired technology, customer relationships and software developed for internal use. Goodwill, which is equal to the excess of cost over the fair value of acquired net assets and identifiable intangible assets, has been recorded in conjunction with several of the Company’s business combinations. Goodwill recorded in business combinations prior to June 30, 2001 was amortized on a straight-line basis through February 28, 2002 over five years (see Notes 6 and 14). Assembled workforce acquired in conjunction with certain of the Company’s purchase business combinations was amortized using the straight-line method through February 28, 2002 over two years. Acquired technology is amortized on a straight-line basis over four to six years. Customer relationships acquired in conjunction with certain of the Company’s business combinations are amortized using the straight-line method over five to seven years. In accordance with Statement of Financial Accounting Standards No. 142 “Goodwill and Other Intangible Assets” (“SFAS 142”), the Company ceased amortizing goodwill and assembled workforce, effective March 1, 2002.
Software Developed for Internal Use
The Company capitalizes certain costs to develop internal use software in accordance with American Institute of Certified Public Accountants (“AICPA”) Statement of Position No. 98-1 (“SOP 98-1”), “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.” These capitalized costs are amortized on a straight-line basis over a period of two to five years after completion or acquisition of the software. Software developed for internal use is included in other intangibles and non-current assets in the Consolidated Balance Sheets.
Impairment of Long-Lived Assets
The Company assesses the impairment of long-lived assets, including property and equipment, identifiable intangible assets and software developed for internal use, whenever events or changes in circumstances indicate that the carrying value may not be fully recoverable. When the Company determines that the carrying value of such assets may not be recoverable, it measures recoverability based on the undiscounted cash flows expected to be generated by the related asset or asset group. If the Company determines that a long-lived asset or asset group is not recoverable, it records an impairment loss equal to the difference between the carrying amount of the asset or asset group and fair value of the asset or asset group. The Company generally measures fair value of an asset or asset group in accordance with Statement of Financial Accounting Standards No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”). In addition, at each reporting date, the Company compares the net realizable value of capitalized software development costs to the unamortized capitalized costs. To the extent the unamortized capitalized costs exceed the net realizable value, the excess amount is written off and the loss is recognized in the Consolidated Statement of Operations.
Purchased Research and Development
Technology or business acquisitions may include the purchase of technology that had not yet been determined to be technologically feasible and had no alternative future use at its then-current stage of development. In accordance with Statement of Financial Accounting Standards No. 141 “Business Combinations” (“SFAS 141”), the portion of the purchase price allocated to in-process research and development is expensed immediately upon the consummation of the acquisition. In making the purchase
price allocation, the Company considers present value calculations of projected income, an analysis of project accomplishments and remaining outstanding items, an assessment of overall contributions, as well as project risks. The value assigned to purchased, in-process technology is determined by estimating the costs to develop the acquired technology into commercially viable projects, estimating the resulting cash flows from the projects, and discounting the net cash flows to their present value. The revenue projection used to value the in-process research and development is based on estimates of relevant market sizes and growth factors, expected trends in technology, and the nature and expected timing of new product introduction by competitors and the Company as of the acquisition date. The resulting net cash flows from such projects are based on estimates of cost of sales and operating expenses from such projects.
Other Non-Current Assets
Other non-current assets include deferred financing fees and a long-term deposit related to our office facility located in Bracknell, United Kingdom. No individual amounts exceed five percent of total assets.
Other Current Liabilities
Other current liabilities consist primarily of accrued interest, accrued royalty fees, deferred rent, accrued professional fees and income taxes payable. No individual amounts exceed five percent of total current liabilities.
Advertising Costs
Advertising and promotional costs are expensed as incurred. Advertising and promotional costs are included in sales and marketing expense and amounted to $6.5 million, $5.0 million and $6.4 million in fiscal 2006, 2005 and 2004, respectively.
Contingent Liabilities
The Company has a number of unresolved regulatory, legal and tax matters, as discussed further in Note 8. The Company provides for contingent liabilities in accordance with Statement of Financial Accounting Standards No. 5 “Accounting for Contingencies” (“SFAS 5”). In accordance with SFAS 5, a loss contingency is charged to income when (i) it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements and (ii) the amount of the loss can be reasonably estimated. Disclosure in the notes to the financial statements is required for loss contingencies that do not meet both those conditions if there is a reasonable possibility that a loss may have been incurred. Gain contingencies are not recorded until realized. The Company expenses all legal costs incurred to resolve regulatory, legal and tax matters as incurred.
Periodically, the Company reviews the status of each significant matter to assess the potential financial exposure. Significant judgment is required to determine the probability that a liability has been incurred and whether such liability can be reasonably estimated. Because of uncertainties related to these matters, accruals are based on the best information available at the time. Further, estimates of this nature are highly subjective, and the final outcome of these matters could vary significantly from the amounts that have been included in the accompanying consolidated financial statements. As additional information becomes available, the Company reassesses the potential liability related to its pending claims and litigation and may revise its estimates accordingly. Such revisions in the estimates of potential liabilities could have a material impact on the Company’s results of operations and financial position.
Accounting for and Disclosure of Guarantees
The Company accounts for guarantees in accordance with Financial Accounting Standards Board (“FASB”) issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“Interpretation No. 45”). Interpretation 45 elaborates on the disclosures required in financial statements concerning obligations under certain guarantees. It also clarifies the requirements related to the recognition of liabilities by a guarantor at the inception of certain guarantees. The provisions related to recognizing a liability at inception of the guarantee do not apply to product warranties or indemnification provisions in the Company’s software license agreements.
Fair Value of Financial Instruments
The carrying values of cash and cash equivalents, marketable securities, accounts receivable and accounts payable approximate fair value due to the short maturities of such instruments. The fair value of convertible debt was $164.5 million on February 28, 2006 and $161.2 million on February 28, 2005 based on market quotes.
Foreign Currency Translation and Operations
Assets and liabilities of the Company’s foreign subsidiaries are translated at the exchange rate in effect on the balance sheet date. The related revenue and expenses are translated using the average exchange rate in effect during the reporting period. Foreign currency translation adjustments are disclosed as a separate component of stockholders’ equity and comprehensive loss.
The Company generates revenue from sales outside the U.S. which are denominated in foreign currencies, typically the local currency of the international subsidiary. There are certain economic, political, technological and regulatory risks associated with operating in foreign countries. Foreign sales and operations may be adversely affected by the imposition of governmental controls, foreign currency exchange rate fluctuations and economic and political instability.
Revenue Recognition and Deferred Revenue
Revenue consists of (i) fees from licenses of our software; (ii) fees from technical support and product updates; (iii) fees from professional services, including implementation, training and hosting and (iv) reimbursed expenses. While the basis for software license revenue recognition is substantially governed by the requirements of the American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) 97-2, “Software Revenue Recognition,” as modified by SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain Transactions” (“SOP 98-9”), as well as Technical Practice Aids issued from time to time by the American Institute of Certified Public Accountants, and Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin 104, “Revenue Recognition” (“SAB 104”), the Company exercises judgment and uses estimates in connection with the determination of the amount of software license, support and professional services revenue to be recognized each accounting period.
Software license revenue is generally recognized using the residual method when:
· Persuasive evidence of an arrangement exists: The Company considers a non-cancelable agreement signed by the Company and the customer to be evidence of an arrangement.
· Delivery has occurred or services have been rendered: Delivery occurs when media containing the licensed program is provided to a common carrier, typically FOB shipping point or, in the case of electronic delivery, the customer is given access to the licensed programs.
· Fixed or determinable fee: The Company considers the license fee to be fixed or determinable if the fee is not subject to refund or adjustment and is payable within twelve months of the agreement date, based upon the Company’s successful collection history on such arrangements. If the
arrangement fee is not fixed or determinable, revenue is recognized as amounts become due and payable.
· Collection is probable: The Company performs a credit review for all significant transactions at the time the arrangement is executed to determine the credit-worthiness of the customer. Collection is deemed probable if the Company expects that the customer will be able to pay amounts under the arrangement as they become due. If the Company determines that collection is not probable, revenue recognition is deferred until collection.
If a software license contains customer acceptance criteria or a cancellation right, recognition of the software revenue is deferred until the earlier of customer acceptance or the expiration of the acceptance period or cancellation right. Typically, payments for software licenses are due within twelve months of the agreement date. When software license agreements call for payment terms of twelve months or more from the agreement date, software revenue is recognized as payments become due and all other conditions for revenue recognition have been satisfied. Under the residual method, the Company defers revenue for the fair value of any undelivered elements based on vendor specific objective evidence (“VSOE”) of fair value, and the remaining portion of the arrangement fee is allocated to the delivered elements and recognized as revenue when the basic criteria in SOP 97-2 and SAB 104 have been met.
The Company’s customer arrangements typically contain multiple elements that may include software, options for future purchases of software products not previously licensed to the customer, support, consulting, training, hosting and reimbursed expenses. Fees are allocated to the various elements of software license agreements using the residual method based on VSOE. Each software license arrangement requires careful review to identify each individual element and to determine the proper amount of software revenue to be allocated among the various elements based on VSOE. Under the residual method, if an arrangement contains one or more undelivered elements, the VSOE of the undelivered elements are deferred and the revenue is recognized once the elements are delivered. If VSOE for one or more of the undelivered elements in an arrangement does not exist, the entire arrangement fee is recognized over the period the undelivered elements are delivered.
In addition to evaluating the VSOE of fair value of each element of an arrangement, the Company also considers whether such elements can be separated into separate units of accounting in accordance with SOP 97-2. When making this determination, the Company considers the nature of services provided, when purchased with a software license (i.e., consideration of whether services are essential to the functionality of software products licensed), degree of risk, availability of services from other vendors and timing of payments, among other things. When the Company provides services deemed to be essential to the functionality of the software products licensed or the licensed software requires significant production, modification or customization, revenue is recognized on a percentage-of-completion basis in accordance with SOP 81-1, “Accounting for Performance of Construction Type and Certain Production Type Contracts.” In these cases, software revenue is recognized based on labor hours or costs incurred to date compared to total estimated labor hours or costs for the contract.
Implementation services are separately priced and sold, are generally available from a number of suppliers and typically are not essential to the functionality of the Company’s software products. Implementation services, which include project management, systems planning, design and implementation, customer configurations and training are billed on an hourly basis (time and materials) or under fixed price contracts. Implementation services are recognized as the work is performed. On fixed price contracts, services revenue is recognized using the percentage-of-completion method of accounting by relating labor hours incurred to date to total estimated labor hours. In the event services are billed in advance of work being performed, the billed amount is initially recorded as deferred services revenue and recognized as services revenue when the work is performed. When total cost estimates exceed revenue, the Company accrues for the estimated losses immediately using cost estimates that are based upon an average fully burdened daily rate applicable to the consulting organization delivering the services. VSOE of fair value for implementation services is based upon separate sales of services at stated hourly rates.
The process of estimation inherent in the application of the percentage-of-completion method of accounting for revenue is subject to judgments and uncertainties and may affect the amounts of software and services revenue under certain contracts and related expenses reported in the consolidated financial statements. A number of internal and external factors can affect the Company’s estimates to complete client engagements, including skill level and experience of project managers, staff assigned to engagements and continuity and attrition level of implementation consulting staff. Changes in the estimated stage of completion of a particular project could create variability in revenue and results of operations if the Company is required to increase or decrease previously recognized revenue related to a particular project or if the Company expects to incur a loss on the project.
Support revenue includes post-contract customer support and the rights to unspecified software upgrades and enhancements. Support services are separately priced and stated in the Company’s arrangements. Customer support is generally billed annually, initially recorded as deferred revenue and recognized as support revenue ratably over the support period. VSOE of fair value for support services is typically provided by renewal rates.
Provision for Income Taxes
The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes.” The Company assesses the likelihood that the deferred tax assets will be recovered from future taxable income, and to the extent that recovery is not likely, a valuation allowance is established. The Company considers historical taxable income, estimates of future taxable income and ongoing prudent and feasible tax planning strategies in assessing the amount of the valuation allowance. Adjustments could be required in the future if it is determined that the amount to be realized is greater or less than the valuation allowance the Company has recorded. The Company performed an analysis, based on various factors, including current year financial results, cumulative losses for the three year period ended February 28, 2006 and estimates of future profitability, as of February 28, 2006 and February 28, 2005, and concluded that future taxable income will, more likely than not, be insufficient to recover the Company’s net deferred tax assets as of February 28, 2006 and February 28, 2005. Therefore, the Company has maintained a valuation allowance for the full amount of the net deferred tax assets. The Company will continue to monitor its estimates of future profitability and the likelihood of realizing our net deferred tax assets based on evolving business conditions.
Also, as part of the process of preparing consolidated financial statements, the Company is required to estimate full-year income and the related income tax expense on a quarterly basis, including the impact, if any, of additional taxes resulting from tax examinations, in each jurisdiction in which the Company operates. Additionally, the Company makes judgments regarding the recoverability of deferred tax assets for each jurisdiction. Tax liabilities can involve complex issues and may require an extended period to resolve. Changes in the geographical mix or estimated level of annual pretax income can impact the Company’s overall income tax expense. This process involves estimating current tax liabilities in each jurisdiction in which the Company operates.
Net Loss Per Share
Basic net loss per share is computed using the weighted average number of shares of common stock outstanding. Diluted net loss per share is computed using the weighted average number of shares of common stock and, when dilutive, potential common shares from options, restricted stock and warrants to purchase common stock using the treasury stock method and the effect of the assumed conversion of the Company’s convertible subordinated debt. The dilutive effect of options, restricted stock and warrants to acquire 0.2 million, 1.1 million and 1.1 million shares was excluded from the calculation of diluted net loss per share in fiscal 2006, 2005 and 2004, respectively, because including these shares would be anti-dilutive due to the Company’s reported net loss. The assumed conversion of the Company’s convertible debt was
excluded from the computation of diluted net loss per share for fiscal 2006, 2005 and 2004 because including these shares would be anti-dilutive due to the Company’s reported net loss.
Stock Option-Based Compensation Plans
The Company accounts for its stock option-based compensation plans in accordance with Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations using the intrinsic value based method of accounting. If the Company accounted for its stock option-based compensation plan using the fair value based method of accounting in accordance with the provisions as required by Statement of Financial Accounting Standards No. 123 (“SFAS 123”), “Accounting for Stock-Based Compensation,” as amended by Statement of Financial Accounting Standards No. 148 (“SFAS 148”), “Accounting for Stock-Based Compensation-Transition and Disclosure,” the Company’s net loss and loss per basic and diluted share amounts would have been as follows, in thousands except per share amounts:
The Company adopted FASB Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation” (“FIN 44”) effective July 1, 2000. In accordance with FIN 44, repriced stock options are accounted for as compensatory options using variable accounting treatment (see Note 9). In addition, deferred compensation is recorded for the intrinsic value of unvested stock options exchanged in a purchase business combination (see Note 9) and amortized over the vesting period.
New Accounting Pronouncements
In May 2005, the FASB issued SFAS 154, “Accounting Changes and Error Corrections-A replacement of APB Opinion No. 20 and FASB Statement No. 3” (“SFAS 154”). The FASB issued SFAS 154 to provide guidance on the accounting for and reporting of error corrections. Unless otherwise impracticable, it establishes retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. SFAS 154 also provides guidance for determining whether retrospective application is impracticable and for reporting an accounting change when retrospective application is impracticable. Furthermore, this statement addresses the reporting of a correction of an error in previously issued financial statements by restating previously issued financial statements. This Statement is effective for financial statements for fiscal years beginning after December 15, 2005. The adoption of this statement is not expected to have a material impact on the Company’s consolidated financial statements.
SFAS No. 123 (Revision 2004), “Share-Based Payment” (“SFAS 123 (R)”) was issued in December 2004 and was to be effective for reporting periods beginning after June 15, 2005. The new statement requires all share-based payments to employees to be recognized in the financial statements based on their fair values. The Company currently accounts for its share-based payments to employees under the intrinsic value method of accounting set forth in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issues to Employees.” Additionally, the Company complies with the stock-based employer compensation disclosure requirements of SFAS 148. On March 29, 2005, the SEC issued Staff
Accounting Bulletin Topic 14, “Share-Based Payment” (“SAB 107”). SAB 107, which becomes effective for public companies upon their adoption of SFAS No. 123(R), describes the SEC Staff’s views in determining the assumptions that underlie the fair value estimates and interaction of SFAS No. 123(R) with certain existing SEC guidance. On April 14, 2005, The Securities and Exchange Commission announced the adoption of a new rule that amends the compliance dates for SFAS 123(R). The new rule allows companies to implement SFAS 123 (R) at the beginning of their next fiscal year, instead of their next reporting period beginning after June 15, 2005. The Company plans to adopt the new statement beginning in the first quarter of fiscal 2007. The Company believes the adoption of SFAS 123(R) will have a material impact on its financial position and results of operations.
2. CASH, CASH EQUIVALENTS, MARKETABLE SECURITIES AND LONG-TERM INVESTMENTS
The following is a summary of cash, cash equivalents and marketable securities as of February 28, 2006 and February 28, 2005 (in thousands):
See “Cash and Cash Equivalents” in Note 1 regarding certain reclassifications of auction rate securities made in fiscal 2005.
Long-term investments are comprised of U.S. treasury and agency debt securities with original maturities in excess of one year. The following is a summary of long-term investments as of February 28, 2005 (in thousands):
3. ALLOWANCE FOR DOUBTFUL ACCOUNTS
Activity in the allowance for doubtful accounts for the fiscal years ended February 28 or 29, 2006, 2005 and 2004 was as follows (in thousands):
4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
Depreciation expense for fiscal 2006, 2005 and 2004 was approximately $5.8 million, $7.3 million and $6.5 million, respectively.
5. CAPITALIZED SOFTWARE DEVELOPMENT COSTS AND SOFTWARE DEVELOPED FOR INTERNAL USE
CAPITALIZED SOFTWARE DEVELOPMENT COSTS
The Company capitalizes costs incurred in the development of its software products for commercial availability. Software development costs include certain internal development costs. Costs incurred prior to establishing technological feasibility are charged to product development expense as incurred. Capitalized software development costs are amortized at the greater of the amount computed using either:
(a) the straight-line method over the estimated economic life of the product, commencing with the date the product is first available for general release; or
(b) the ratio that current gross revenue bears to the total current and anticipated future gross revenue.
Generally, an economic life of two years is assigned to Capitalized Software Development Costs.
The Company capitalized software development costs of $3.5 million, $9.6 million and $9.9 million and recorded related amortization expense of $9.6 million, $9.4 million and $9.0 million for fiscal 2006, 2005 and 2004, respectively, in accordance with SFAS 86.
The total amortization expense for the Company’s capitalized software development costs for fiscal 2006, 2005 and 2004 include write-offs totaling approximately $0 million, $0.3 million and $0.2 million, respectively, of previously capitalized software development costs. These capitalized costs were deemed to exceed their future net realizable value.
SOFTWARE DEVELOPED FOR INTERNAL USE
The Company capitalized internally developed software costs (excluding amounts acquired) of $0.1 million, $0.3 million and $1.6 million and recorded related amortization expense of $1.0 million, $1.2 million and $1.1 million for fiscal 2006, 2005 and 2004, respectively.
6. INTANGIBLE ASSETS AND GOODWILL
Acquisition-related intangible assets subject to amortization as of February 28, 2006 and February 28, 2005 are as follows (in thousands):
During the three months ended August 31, 2005, the Company performed an impairment test of its long-lived assets and concluded that although it continues to sell the products acquired in the PartMiner CSD, Inc. asset acquisition, the Company did not believe that future operating cash flows would be sufficient to support the related asset balance. Therefore, the Company wrote-off the remaining book value of those intangible assets of $3.7 million.
The changes in the carrying amount of goodwill for the years ended February 28, 2006 and 2005 are as follows (amounts in thousands):
Amortization expense related to other intangible assets was $11.4 million, $19.9 million and $18.9 million during fiscal 2006, 2005 and 2004, respectively. Estimated aggregate future amortization expense for acquisition-related intangible assets in future fiscal years are as follows (amounts in thousands):
GOODWILL IMPAIRMENT
The Company tests goodwill for impairment on an annual basis, coinciding with the Company’s fiscal year end, or on an interim basis if circumstances change that would more likely than not reduce the Company’s implied fair value (which includes factors such as, but not limited to, the Company’s market capitalization, control premium and recent stock price volatility) below its carrying value.
During the six months ended August 31, 2004 and the three months ended May 31, 2005, the Company experienced adverse changes in its stock price resulting from its poor financial performance. As a result, the Company performed a test for goodwill impairment at August 31, 2004 and May 31, 2005 and determined that based upon the implied fair value (which includes factors such as, but not limited to, the Company’s market capitalization, control premium and recent stock price volatility) of the Company as of August 31, 2004 and May 31, 2005, there was no impairment of goodwill.
During the three months ended November 30, 2005, the Company’s Chief Financial Officer left the Company to take a position at another company. As a result, the Company performed a test for goodwill impairment as of November 30, 2005. The Company determined that based upon the implied fair value (which includes factors such as, but not limited to, the Company’s market capitalization, control premium and recent stock price volatility) of the Company as of November 30, 2005, there was no impairment of goodwill.
The Company performed a test for goodwill impairment at February 28, 2006 and February 28, 2005, the Company’s annual date for goodwill impairment review, and determined that based upon the implied fair value (which includes factors such as, but not limited to, the Company’s market capitalization, control premium and recent stock price volatility) of the Company as of February 28, 2006 and February 28, 2005, there was no impairment of goodwill. The Company will continue to test for impairment on an annual basis, coinciding with its fiscal year end, or on an interim basis, if circumstances change that would more likely than not reduce the implied fair value of the Company below its carrying value.
7. LONG-TERM DEBT AND DEBT CONVERSION EXPENSE
5% Convertible Subordinated Notes. The Company completed a private placement of $250.0 million of Notes in October and November 2000. The Notes bear interest at 5.0% per annum which is payable semi-annually. The Company had $175.5 million outstanding as of February 28, 2006 and February 28, 2005, respectively. The fair market value of the Notes was $164.5 million and $161.2 million on February 28, 2006 and February 28, 2005, respectively, based on market quotes. The Notes mature in November 2007 and are convertible into approximately 4.0 million shares of the Company’s common stock at a conversion price of $44.06, subject to adjustment under certain conditions. The conversion price of the Notes will be adjusted in the event that the Company issues common stock as a dividend or distribution with respect to its common stock, subdivides, combines or reclassifies its common stock, issues rights to its common stockholders to purchase common stock at less than market price, makes certain distributions of securities, cash or other property to its common stockholders (other than ordinary cash dividends), or makes certain repurchases of common stock. Upon a change of control of the Company, the holders of the Notes would have the right to require the Company or its successor to repurchase the Notes at a purchase price equal to 100% of the principal amount, plus accrued and unpaid interest to the date of repurchase in cash. The Notes do not have any financial covenants.
At any time on or after November 7, 2003, the Company may redeem, from time to time, the Notes in whole, or in part, at the Company’s option. Redemption can be made on at least 30 days notice if the trading price of the Company’s common stock for 20 trading days in a period of 30 consecutive trading days ending on the day prior to the mailing of notice of redemption exceeds 120% of the conversion price of the Notes. The redemption price, expressed as a percentage of the principal amount, is:
Debt Conversion Expense. During fiscal 2004, the Company exchanged $74.5 million of the Notes for 9,725,750 shares of its common stock in privately negotiated transactions with note holders. The offer and issuance of the common stock underlying these transactions are exempt from registration under Section 3(a)(9) of the Securities Act of 1933 and may be freely traded upon issuance.
At the conversion price of $44.06 per share, the $74.5 million of Notes exchanged would have been convertible into 1,690,780 shares of common stock. For accounting purposes, the additional 8,034,970 shares of common stock that the Company issued in these transactions are considered an inducement for the holders to convert their Notes, which required the Company to record a non-operating expense equal to the fair value of the additional shares issued to the holders. Accordingly, the Company recorded a non-cash debt conversion expense of approximately $59.8 million during the twelve months ended February 29, 2004. These transactions resulted in a $74.5 million reduction of the Notes outstanding and increased stockholders’ equity by $74.5 million. The 9,725,750 shares of common stock issued in these transactions represented approximately 11.9% of the shares outstanding as of February 29, 2004.
Line of Credit. The Company had a one-year unsecured revolving credit facility with Silicon Valley Bank (“SVB”) for $15.0 million which expired on March 30, 2005. On April 8, 2005, the Company renewed the credit facility with SVB for $15.0 million and a two-year term, effective March 29, 2005 (the “Credit Facility”). Under the terms of the Credit Facility, the Company may request cash advances, letters of credit, or both. Borrowings under the Credit Facility accrue interest at the prime rate plus 0.5%. The Credit Facility requires the Company to comply with the following financial covenants: (i) minimum tangible net worth (defined as stockholders’ equity plus convertible debt less goodwill, capitalized software costs and other intangible assets) must be at least $90.0 million plus 50% of consolidated net income generated cumulatively commencing with the first quarter of fiscal 2006 and (ii) the Company’s ratio of (a) unrestricted cash, cash equivalents, marketable securities and long-term investments deposited with SVB and its affiliates plus net accounts receivable to (b) current liabilities plus long-term indebtedness to SVB and outstanding letters of credit minus deferred revenue, must be at least 2.0 to 1.0. The Company was in compliance with all financial covenants as of February 28, 2006 and there were no cash draws outstanding. As of February 28, 2006, the Company had $10.0 million in letters of credit outstanding under the Credit Facility, of which $8.9 million is related to securing our lease obligations for certain office space and $1.1 million is related to securing an additional line of credit in China, which was never executed. The $1.1 million letter of credit expires in May 2007 and cannot be drawn upon by the beneficiary because the line of credit for which it was issued to secure was never executed.
The Credit Facility requires the Company to maintain $50.0 million in funds with SVB Asset Management and its affiliates. The Credit Facility also restricts the amount of additional debt the Company can incur and restricts the amount of cash that the Company can use for acquisitions and for the repurchase of convertible debt. Under the terms of the Credit Facility, the Company retains the right to terminate the facility at any time upon repayment of any advances and the posting of cash collateral for any outstanding letters of credit. Under the Credit Facility, SVB has the right to obtain a lien on all of the Company’s assets, other than intellectual property, upon an occurrence of default, unless the Company
terminates the facility as provided above. The Credit Facility also provides that, upon an event of default, the Company is prohibited from paying a cash dividend to its shareholders.
The Credit Facility includes a provision for supplemental equipment advances, under which the Company could borrow up to an additional $5.0 million for the purchase of equipment, office furniture and other capital expenditures. Amounts could be borrowed for such capital expenditures through December 31, 2005 and accrued interest at a fixed interest rate equal to 7.75% annually. Equipment advances would have been repaid monthly over a 36-month-period, beginning in the month following the advance. The Company’s right to request supplemental equipment advances expired on December 31, 2005 and the Company made no draw downs. The financial covenants for the supplemental equipment advances were the same as The Credit Facility and the Company was in compliance with all financial covenants.
The Company had an additional credit agreement (the “Equipment Line”) with SVB, as amended, which expired March 31, 2003, under which the Company was permitted to borrow up to $5.0 million for the purchase of equipment. Amounts borrowed under the Equipment Line accrue interest at a rate equal to the greater of the three-year Treasury note rate plus 5%, or 8.25%, and are repaid monthly over a 36-month period. During fiscal 2003, the Company borrowed $2.9 million under the Equipment Line. As of February 28, 2006, all amounts borrowed had been repaid and there was no outstanding balance. The financial covenants for the Equipment Line are the same as the financial covenants for the Credit Facility. The Company was in compliance with all financial covenants as of February 28, 2006.
8. COMMITMENTS AND CONTINGENCIES
Commitments. The Company leases office space, office equipment and automobiles under operating leases and various computers and other equipment under capital leases. Aggregate property acquired through capital leases amounted to $8.1 million and $7.9 million at February 28, 2006 and February 28, 2005, respectively, and has been included in purchased software and office furniture and equipment (see Note 4). Total accumulated amortization relating to these leases was $4.5 million and $3.7 million as of February 28, 2006 and February 28, 2005, respectively.
Rent expense for fiscal 2006, 2005 and 2004, was approximately $10.0 million, $13.6 million and $19.7 million, respectively. The future minimum lease payments under these capital and operating leases for each of the succeeding five fiscal years beginning March 1, 2006 are as follows (in thousands):
(1) Approximately $1.7 million and $0.9 million is included in other current liabilities and long-term debt and capital leases, respectively, in the consolidated balance sheet as of February 28, 2006.
Contingencies. The Company is involved from time to time in disputes and other litigation in the ordinary course of business. The Company has established accruals related to such matters that are probable and reasonably estimable. The Company does not believe that the outcome of any pending disputes or litigation will have a material adverse effect on the Company’s business, operating results, financial condition and cash flows. However, the ultimate outcome of these matters, as with dispute resolution and litigation generally, is inherently uncertain, and it is possible that some of these matters may be resolved adversely to the Company. The adverse resolution of any one or more of these matters could have a material adverse effect on the Company’s business, operating results, financial condition and cash flows.
Indemnification. The Company licenses software to its customers under contracts which the Company refers to as Software License Agreements (“SLA”). Each SLA contains the relevant terms of the contractual arrangement with the customer, and generally includes certain provisions for indemnifying the customer against losses, expenses, and liabilities from damages that may be awarded against the customer in the event the Company’s software is found to infringe upon a patent, copyright, trademark or other proprietary right of a third party. The SLA generally limits the scope and remedies for such indemnification obligations in a variety of industry-standard respects, including but not limited to certain time and geography-based scope limitations and a right to replace an infringing product or modify the product so that it is no longer infringing. If the Company cannot address the infringement by replacing the products or services, or modifying the products or services, the Company is allowed to cancel the software license and return the fees paid by customer. The Company requires its employees to sign a proprietary information and inventions assignment agreement, which assigns the rights in its employees’ development work to the Company.
To date, the Company has not had to reimburse any of its customers for any losses related to these indemnifications provisions and no material claims are outstanding as of February 28, 2006. For several reasons, including the lack of prior indemnification claims and the lack of a monetary liability limit for certain infringement cases under the SLAs, the Company cannot determine the maximum amount of potential future payments, if any, related to such indemnification provisions. There can be no assurance that potential future payment will not have a material adverse effect on the Company’s operating performance or financial condition.
Product Warranty. The Company generally warrants its software products. The Company provides for the estimated cost of product warranties based on specific warranty claims, provided that it is probable that a liability exists and provided the amount can be reasonably estimated. To date, the Company has not had any material costs associated with these warranties. There was no liability for warranty claims as of February 28, 2006 and 2005, respectively.
9. STOCKHOLDERS’ EQUITY
Preferred Stock
The Company has authorized 4,620,253 shares of $.01 par value preferred stock. As of February 28, 2006 and 2005, no preferred shares were outstanding.
Common Stock
The Company has authorized 300,000,000 shares of $.002 par value common stock. No cash dividends on common stock have been declared or paid in any of the fiscal years presented.
Warrants and Customer Stock Issuances
In connection with the acquisition of Talus Solutions, Inc. (“Talus”) in fiscal 2001, the Company assumed warrants issued to purchase up to 65,000 shares of the Company’s common stock for certain past services rendered by outside consultants and the issuance of certain notes payable. On February 28, 2001, warrants to purchase 49,096 shares were exercised. As of February 28, 2006, there were no warrants outstanding as all unexercised warrants expired during fiscal 2006.
In March 2004, the Company entered into an amendment to an existing alliance agreement with International Business Machines Corporation (“IBM”) under which the companies will develop, market, sell and deliver demand and supply chain solutions globally. In connection with entering into the amendment to the alliance agreement, the Company issued a warrant (the “Warrant”) to IBM to acquire 250,000 shares of the Company’s common stock at a per share purchase price of $8.51, in reliance upon an exception provided under Section 4(2) of the Securities Act of 1933, as amended, for transactions not involving a public offering. The Warrant is immediately exercisable, expires March 12, 2009, and provides for customary registration and indemnification rights and certain limited transfer rights. The fair value of the Warrant of $1.1 million is being recognized as operating expense over the three-year service period of the alliance agreement. The fair value of the Warrant was calculated using the Black-Scholes option pricing model with the following assumptions: risk-free interest rate of 2.79%; dividend yield of zero; volatility of 99%; and a Warrant life of five years. The Company recorded $0.4 million in amortization expense in each of the fiscal years ended February 28, 2006 and 2005 associated with the Warrant.
Employee Stock Purchase Plan
In October 1994, the Company adopted an employee stock purchase plan (“ESPP”) that authorizes the Company to sell up to 2,000,000 shares of common stock to employees through voluntary payroll withholdings. The stock price to be paid by employees is equal to 85% or 95% of the lower of the average market price as reported on the National Association of Securities Dealers Automated Quotation System for either the first or last day of each six-month withholding period. Payroll deductions may not exceed the lesser of 10% of a participant’s compensation or $25,000 per year. The employee stock purchase plan was suspended as of June 30, 2003. At the 2004 Annual Meeting of Shareholders, the shareholders of the Company approved the 2004 Employee Stock Purchase Plan of Manugistics Group, Inc. that authorizes the Company to sell up to 3,000,000 shares of common stock to employees through voluntary payroll withholdings. Participation commenced on September 1, 2004. The number of shares purchased under these plans by employees totaled 286,612 shares, 163,015 shares and 211,589 shares in fiscal 2006, 2005 and 2004, respectively. The weighted average estimated fair value of shares purchased in fiscal 2006, 2005 and 2004 was $0.37, $0.52 and $2.23, respectively.
Stock Options
Effective September 13, 2000, the Company adopted the 2000 Non-Qualified Stock Option Plan (“2000 Plan”) under which non-qualified stock options may be granted to officers, directors and employees to purchase a total of up to 8.0 million new shares of common stock at prices not less than fair market value at the time of grant. Effective July 24, 1998, the Company adopted the 1998 Plan under which incentive and non-qualified stock options may be granted to officers, directors and employees to purchase a total of up to 10.5 million new shares of common stock at prices not less than the fair market value at the time of grant. In April 2001, the Board of Directors of the Company adopted a proposed amendment to the 1998 Stock Option Plan (“1998 Plan”) to increase the number of shares of Common Stock reserved for issuance to 20,475,800. In addition, the Board of Directors approved the termination of the 2000 Plan. The terms of the 2000 Plan remain in effect for options outstanding at the termination date. Prior to the adoption of the 1998 Plan, the Company had additional plans under which it granted stock options including the 1994 Employee Stock Option Plan (“1994 Plan”), the 1994 Outside Directors Non-qualified
Stock Option Plan (“1994 Director Plan”) and the 1994 Executive Incentive Stock Option Plan (“1994 Executive Plan”). No new options will be granted under these additional stock option plans, which will remain in effect with respect to options outstanding under such plans until such options are exercised, terminated or expire. Options under the employee option exchange program were granted under the 1998 Plan and the 2000 Plan. As of February 28, 2006, the Company has cumulatively granted options of 4.4 million shares under the 2000 Plan, 15.7 million shares under the 1998 Plan, 12.3 million shares under the 1994 Plan, 0.8 million shares under the 1994 Director Plan and 0.4 million shares under the 1994 Executive Plan.
Under the 2000 Plan and the 1998 Plan, the vesting period for new options issued is in accordance with the Incentive and Non-Qualified Stock Option Policy approved by the Compensation Committee of the Board of Directors. Options outstanding under the plans vest over various terms, ranging from immediate vesting to annual vesting over a five-year period from the date of grant. The right to exercise the vested options expires upon the earlier of either ten years (or for options granted prior to 1994, eleven years) from the date of grant or, generally, within thirty days of termination of employment.
During fiscal 2004 the Company granted non-qualified stock options in the amount of 0.4 million to several of the Company’s executive officers and employees. These stock option grants were approved by the Company’s Board of Directors and were not granted under any of the above-mentioned stock option plans. These shares vest and become exercisable over periods ranging from immediate vesting to one hundred percent vesting upon the earlier of achievement of certain pre-defined performance targets or seven years from the date of grant. As of February 28, 2006, none of these options were outstanding. No options of this nature were granted in fiscal 2006 and fiscal 2005.
Under FASB Interpretation No. 44 “Accounting for Certain Transactions Involving Stock Compensation,” (“FIN 44”), which is retroactive to option repricings effected after December 15, 1998, companies are required to treat repriced options as compensatory options accounted for using variable accounting treatment. As a result, the Company will record non-cash stock compensation (benefit) expense, over the term of the option, based upon changes in the market price of its common stock over the market price at June 30, 2000 ($23.38 per share). As of February 28, 2006, the Company had approximately 283,550 repriced options outstanding. Since the stock price at the beginning and end of each of the fiscal 2006 quarters was below $23.38, no charge or benefit was recorded during fiscal 2006.
As part of the Talus acquisition, the Company assumed all outstanding stock options, which were converted into Manugistics’ stock options. Options to purchase approximately 631,000 shares of Manugistics’ common stock were unvested at the acquisition date. FIN 44 requires the acquiring company to measure the intrinsic value of unvested stock options assumed at the acquisition date in a purchase business combination and record a compensation charge over the remaining vesting period of those options to the extent those options remain outstanding. This resulted in a charge of $0.2 million and $1.8 million in fiscal 2005 and 2004, respectively. All of the outstanding options related to the Talus acquisition are fully vested and all compensation expense has been recognized by the end of fiscal 2005.
A summary of the status of the Company’s stock option plans and changes during the fiscal years is presented below with share amounts in thousands:
Restricted Stock Program
In June 2003, the Company’s Board of Directors approved an amendment to the Company’s 1998 stock option plan to issue restricted shares of Manugistics’ common stock to its employees. This amendment was approved by stockholders at the Company’s 2003 Annual Meeting of Shareholders on July 29, 2003. During fiscal 2006, the Company issued 0.4 million shares of restricted stock to certain key employees. The restricted stock awards granted to key employees have a vesting schedule pursuant to which the stock awards may vest immediately, upon change in control or up to five years from the date of grant. The total value of the fiscal 2006 restricted stock awards granted of approximately $0.5 million was computed using the closing stock price on the date of grant and was recorded as a component of deferred compensation. The Company has recorded the deferred compensation using an estimated forfeiture rate, which has ranged from 0% to 22%. The related compensation expense will be recognized over the vesting period.
In fiscal 2005, the Company issued 1.6 million shares of restricted stock to certain key employees. The total value of the fiscal 2005 restricted stock awards granted of approximately $3.5 million was computed using the closing stock price on the date of grant and was recorded as a component of deferred compensation. The Company has recorded the deferred compensation using an estimated forfeiture rate, which has ranged from 0% to 36%. The related compensation expense will be recognized over the vesting period.
In fiscal 2004, the Company issued 0.2 million shares of restricted stock to certain key employees. The total value of the fiscal 2004 restricted stock awards granted of approximately $1.3 million was computed using the closing stock price on the date of grant and was recorded as a component of deferred compensation. The related compensation expense will be recognized and amortized over the vesting period.
The Company recorded $1.7 million, $1.2 million and $0.3 million in net compensation expense related to restricted shares outstanding during the fiscal years ended February 28, 2006, February 28, 2005 and February 29, 2004, respectively.
Stock Option-Based Compensation
As permitted under SFAS No. 123, as amended by SFAS 148, the Company continues to account for stock option-based compensation to employees in accordance with APB Opinion No. 25, under which no compensation expense is recognized, since the exercise price of options granted is equal to or greater than the fair market value of the underlying security on the grant date. Pro forma information regarding net loss and loss per share as if the fair value method had been applied in accordance with SFAS 123 is required by
SFAS No. 148. The fair value of the Company’s stock option-based awards to employees was estimated as of the date of grant using the Black-Scholes option pricing model. Limitations on the effectiveness of the Black-Scholes option pricing model include that it was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable and that the model requires the use of highly subjective assumptions including expected stock price volatility. Because the Company’s stock option-based awards to employees have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock option-based awards.
Had compensation cost for these plans been recorded, the Company’s net loss and loss per basic and diluted share amounts would have been as follows, in thousands except per share amounts:
Fiscal 2006, 2005 and 2004 pro forma amounts include $117 thousand, $37 thousand and $170 thousand, respectively, related to the purchases under the employee stock purchase plan.
The weighted average fair value of options granted in fiscal 2006, 2005 and 2004 was $0.65, $1.62 and $3.28 per share, respectively. The fair value of options granted was estimated assuming no dividends and using the following weighted-average assumptions for each of the fiscal years presented:
A summary of the weighted average remaining contractual life and the weighted average exercise price of options outstanding as of February 28, 2006 is presented below with share amounts in thousands:
Employee Stock Option Exchange Program
On February 10, 2003, the Company announced a voluntary stock option exchange program for its employees. Under the program, the Company offered to exchange options to purchase approximately an aggregate of 6.1 million shares of Manugistics common stock held by eligible employees, vested or unvested, that had exercise prices equal to or greater than $7.0001 per share. All employees had the opportunity to exchange existing eligible options for a promise to grant new options at exchange ratios dependent on the exercise price of the exchanged options. Members of our Board of Directors, including the Company’s Chairman and CEO, did not participate in this program.
On March 10, 2003, the Company announced that it had accepted for cancellation and exchange options to purchase approximately 4.8 million shares of its common stock in exchange for approximately 1.5 million new options of its common stock, to be granted on September 16, 2003. The Company granted approximately 1.2 million new options on September 16, 2003 as a result of the option exchange program. The number of new options granted to employees declined from the original expected amount as a result of voluntary and involuntary terminations. The replacement options have terms and conditions that are substantially the same as those of the cancelled options. The exercise price of the replacement options is $5.55 per share, which was the market value of a share of the Company’s common stock on the date of grant as determined under the Company’s option plans.
Options cancelled in the exchange program and the new options have been treated as fixed option awards for accounting purposes as the new options were granted six months and five days after the cancellation date and any options granted after August 9, 2002 (the “look back period”) were required to be exchanged in order to participate in the program. Therefore, no compensation expense was recorded as a result of the program.
10. STOCKHOLDER RIGHTS AGREEMENT
On October 28, 2004, the Board of Directors declared a dividend of one right (a “Right”) for each outstanding share of the Company’s common stock to stockholders of record at the close of business on November 8, 2004. Each Right entitles the registered holder to purchase from the Company one one-thousandth of a share of series A junior participating preferred stock, $.01 par value per share, at a purchase price of $19.00 in cash, subject to adjustment. Initially, the Rights are not exercisable and will be attached to all certificates representing outstanding shares of common stock, and no separate Rights certificates will be distributed. The Rights will become exercisable and separate from the common stock, and the distribution date will occur, upon the earlier of (i) 10 business days following the later of (a) the first date of a public announcement that a person or group of affiliated or associated persons (an “Acquiring Person”) has acquired, or obtained the right to acquire, beneficial ownership of 20% or more of the outstanding shares of common stock or (b) the first date on which an executive officer of the Company has actual knowledge that an Acquiring Person has become such or (ii) 10 business days following the commencement of a tender offer or exchange offer that would result in a person or group beneficially owning 20% or more of the outstanding shares of common stock. The distribution date may be deferred in circumstances determined by the Board of Directors. In addition, certain inadvertent acquisitions will not trigger the occurrence of the distribution date. The Rights expire upon the close of business on October 27, 2014, unless earlier redeemed or exchanged (See Note 18).
11. RETIREMENT PLANS
The Company has two defined contribution retirement savings plans (one in the U.S. and another in the U.K.) under the terms of which the Company matches a percentage of the employees’ qualified contributions. New employees are eligible to participate in the plans upon completing one month of service. The Company’s contribution to the plans totaled $1.2 million, $1.4 million and $1.8 million for fiscal 2006, 2005 and 2004, respectively.
12. INCOME TAXES
The components of the income tax provision are as follows (in thousands):
The components of the Company’s deferred tax assets and liabilities are as follows (in thousands):
Deferred tax assets of approximately $47.5 million pertain to certain net operating loss carryforwards resulting from the exercise of employee stock options. The Company has provided a valuation allowance on these deferred tax assets. The valuation allowance on these deferred tax assets will be reduced in the period in which the Company realizes a benefit on its tax return from a reduction of income tax payable stemming from the utilization of these losses. When realized, the tax benefits of these credits and losses
will be accounted for as a credit to stockholders equity rather than as a reduction of the income tax provision.
Changes in the valuation allowance during fiscal 2006 are as follows (in thousands):
At February 28, 2006, the Company had a total of approximately $329.8 million of U.S. federal and $86.1 million of foreign net operating losses available to offset future taxable income in those respective taxing jurisdictions. The federal net operating losses expire during the fiscal years 2012 to 2026. In addition to maintaining a full valuation allowance against the net deferred tax assets, the net operating losses may also be subject to further limitations under Internal Revenue Code 382 should there be a change in ownership pertaining to a single holder of 5% of the Company’s common stock. Approximately $3.6 million of the foreign net operating losses expire during the calendar years 2007 to 2011, while the remaining foreign net operating losses are available in perpetuity. The Company considers the earnings of foreign subsidiaries to be permanently reinvested outside of the U.S. Accordingly, no U.S. income tax on these earnings has been provided.
The Company also has $6.3 million of research and development tax credit carryforwards, which expire between calendar years 2011 and 2014, and $0.6 million of foreign tax credit carryforwards that expire in calendar year 2010.
Profit (loss) before income taxes includes income (losses) from foreign operations of approximately $7.4 million, $(10.9) million and $(0.5) million in fiscal 2006, fiscal 2005 and fiscal 2004, respectively. Additionally, the Company had foreign tax refunds and credits totaling $4.1 million in fiscal 2006. Of this amount, $1.1 million relates to the reversal of a previously recorded tax accrual for which the statute of limitations has expired. The Company received a $1.9 million tax refund and reversed a previously recorded liability in the amount of $0.7 million due to the favorable outcome of a three-year audit performed by the Canadian tax authorities.
Statutory Rate Reconciliation. The difference between the reported amount of income tax expense and the amount of income tax expense that would result from applying statutory U.S. federal tax rate of 35% is summarized as follows (in thousands):
13. OTHER EXPENSE
Other expense consists of the following (in thousands):
14. EXIT AND DISPOSAL ACTIVITIES
Summary: The Company has adjusted its cost structure and resource allocation several times in recent years to respond to business and market conditions. Each exit and disposal plan has included involuntary terminations across most functional areas throughout the Company and the reduction of excess office space.
The following table sets forth a summary of total exit and disposal charges, payments made against those charges and the remaining liabilities as of February 28, 2006 (amounts in thousands):
(1) Certain accrued lease obligations extend through fiscal year 2019.
(2) Includes $478 thousand of accretion expense in adjustments to charges in the twelve months ended February 28, 2006.
The Company has outstanding lease obligations for facilities that have been entirely vacated which are located in Brussels, Belgium; Wayne, Pennsylvania; Detroit, Michigan and Munich, Germany. The Company has outstanding lease obligations for facilities for which a portion of the office space was vacated in certain facilities that are located in Rockville, Maryland; Atlanta, Georgia; San Carlos, California; and Bracknell, United Kingdom.
Exit and disposal activities: In order to further adjust the Company’s cost structure and resource allocation to increase efficiencies and reduce excess office space in response to current business conditions, the Company announced and began implementing two exit and disposal plans, (the “FY05 Q2 Plans”) in the second quarter of fiscal 2005. Actions taken included the involuntary termination of employees across most business functions and the abandonment of excess office space. The Company has completed most of the planned initiatives approved in the FY05 Q2 Plans and expects to complete the remainder of the initiatives in fiscal 2007.
The following table summarizes the Company’s exit and disposal activities since fiscal year 2003 (amounts in millions, except number of involuntarily terminated employees)
a) 141 US, 11 United Kingdom, 16 Other Europe, 4 Asia, 1 Canada.
b) Partially vacated-Rockville, Maryland; San Carlos and Calabasas, California; Bracknell, United Kingdom and Tokyo, Japan. Completely vacated-Brussels, Belgium, Munich and Ratingen, Germany; Stockholm, Sweden and the Philippines and includes adjustments to estimated sublease income based upon actual signed subleases in San Carlos, California, Atlanta, Georgia, Wayne, Pennsylvania and Detroit, Michigan.
c) 73 US, 3 Mexico, 2 Canada, 1 Asia.
d) Partially vacated Atlanta, Georgia, Bracknell, United Kingdom, Calabasas and San Carlos, California, Detroit, Michigan, Itasca, Illinois, Irving, Texas, Rockville, Maryland. Completely vacated Wayne, Pennsylvania.
Exit and disposal accounting policies and practices: The Company records exit and disposal costs in accordance with SFAS 146.
SFAS 146 (excess office space): The Company records charges for excess office space once vacated based on the present value of the sum of expected remaining lease commitments offset by management’s best estimate of expected sublease income and costs associated with subleasing the vacated space. The estimated sublease income amounts require judgment and include assumptions regarding the period of sublease and the price per square foot to be paid by sublessors. The Company reviews these estimates periodically and records appropriate adjustments, as necessary, to reflect management’s best estimates. In certain cases, only a portion of the total office space within a property is vacated when such excess office space allows appropriate physical separation.
SFAS 146 (severance costs): All terminated employees are notified within the requisite time period as prescribed by SFAS 146 and are typically not required to render service beyond the earlier of their termination date or a minimum retention period of 60 days, as defined by SFAS 146. When employees are required to render service beyond the earlier of their termination date or minimum retention period of 60 days, the severance cost for such employees is recognized and accrued over the required service period in accordance with SFAS 146. There were seven employees involuntarily terminated during fiscal year 2006 and 23 during fiscal year 2005 who were required to render service beyond 60 days.
SFAS 88: Certain terminated employees had employment contracts that defined the amount of severance and related benefits received upon termination. The severance and related benefits for such employees are accounted for in accordance with SFAS 88 when amounts are both probable and estimable. During fiscal year 2005, three employees with employment contracts that defined the amount of severance and related benefits were involuntarily terminated.
SFAS 144: In connection with permanently vacating excess office space, the Company records an impairment charge of certain property, plant and equipment and leasehold improvements in accordance with SFAS 144.
15. SEGMENT INFORMATION
The Company considers itself to be in a single reportable segment. The Company and its subsidiaries are principally engaged in the design, development, marketing, licensing and support and implementation of demand and supply chain management software. Substantially all revenue results from the licensing of the Company’s software products and related consulting and support services. The Company’s chief operating decision maker reviews financial information, presented on a consolidated basis, accompanied by disaggregated information about revenue by geographic region for purposes of making operating decisions and assessing financial performance.
Revenue is attributable to geographic regions based on the location of the Company’s customers. The following table presents total revenue and total long-lived assets by geographic region for fiscal 2006, 2005 and 2004:
No single customer accounted for 10% or more of the Company’s annual revenue in fiscal 2006, 2005 or 2004.
16. RELATED PARTY TRANSACTIONS
Relationship with Warburg Pincus
In October, 2002, the Company appointed William H. Janeway, a Vice-Chairman of Warburg Pincus LLC, a private equity investment firm, as a Class III director of its Board of Directors, with a term expiring in 2004. In connection with Dr. Janeway’s appointment to the Board, the Company entered into an agreement with Warburg Pincus Private Equity VIII, L.P. in which the Company consented to the acquisition by Warburg Pincus and certain of its affiliates of up to 19.9% of Manugistics common stock and agreed that for as long as Warburg Pincus and its affiliates beneficially own at least ten percent (10%) of Manugistics common stock, the Company would nominate and use its best efforts to have elected to its Board one person designated by Warburg Pincus and reasonably acceptable to the Company. In addition, Warburg Pincus agreed that, for the duration of the standstill period, neither it nor its affiliates would acquire more than 19.9% of Manugistics common stock.
The standstill period is the earlier of:
· three years;
· the date on which another person acquires more than 15% of Manugistics common stock with the Company’s consent and on terms more favorable than those obtained by Warburg Pincus; or
· the date on which the Company fails to perform its agreement with respect to the acquisition of additional shares by Warburg Pincus and the election of a director designated by Warburg Pincus.
At the time the agreement was entered into, Warburg Pincus and certain of its affiliates held approximately 10.9% of Manugistics common stock. As of February 28, 2006 and February 28, 2005, Warburg Pincus and certain of its affiliates held approximately 9.1% of Manugistics common stock.
17. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized quarterly consolidated financial information for fiscal 2006 and 2005 follows:
Included in the first, second, third and fourth quarters of fiscal 2006 and fiscal 2005 are charges and adjustments to charges related to exit and disposal activities (See Note 14).
18. SUBSEQUENT EVENTS
Merger agreement. On April 24, 2006, the Company entered into a definitive Agreement and Plan of Merger (the “Merger Agreement”) with JDA Software Group, Inc., a Delaware corporation (“JDA”), and Stanley Acquisition Corp., a Delaware corporation and a wholly-owned subsidiary of JDA (the “Merger Sub”). Under the Merger Agreement, the Merger Sub will be merged with and into the Company (the “Merger”), with the Company continuing after the Merger as a wholly-owned subsidiary of JDA. At the effective time of the Merger, each issued and outstanding share of the Company’s Common Stock, par value $0.002 per share (the “Company Common Stock”), will be converted into the right to receive $2.50 in cash.
The Merger Agreement has been approved by the Board of Directors (the “Board”) of the Company. The transactions contemplated by the Merger Agreement are subject to approval by the holders of a majority of the issued and outstanding shares of Company Common Stock. The transactions contemplated by the Merger Agreement also are subject to the expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and certain other closing conditions. The Merger Agreement provides for a termination fee of up to $9.75 million in connection with the transactions contemplated by the Merger Agreement, which is payable by the Company under certain circumstances.
Stockholder Rights amendment. In connection with the Merger Agreement, on April 24, 2006, the Company entered into an amendment to the Rights Agreement between the Company and Computershare Trust Company, N.A. As a result of the amendment, the preferred stock purchase rights issued under the Rights Agreement will be inapplicable to the Merger, the Merger Agreement, the Voting Agreements and the transactions contemplated by the Merger Agreement and the Voting Agreements.
The execution, delivery, consummation or performance of the Merger Agreement, the Voting Agreements and the transactions contemplated thereby will not cause the rights to separate from shares of Company Common Stock or permit the Company’s stockholders to exercise the rights. In addition, the rights will expire immediately upon the effective time of the Merger. (See Note 10 “Stockholder Rights Agreement.”)