Notes
to Unaudited Condensed Consolidated Financial Statements
(1)
Summary of Significant Accounting Policies
(a)
The Company and Nature of Operations
FalconStor
Software, Inc., a Delaware Corporation (the "Company"), develops, manufactures
and sells network storage software solutions and provides the related
maintenance, implementation and engineering services.
(b) Principles
of Consolidation
The
consolidated financial statements include the accounts of the Company and its
wholly-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.
(c)
Use of Estimates
The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting
period. The Company’s significant estimates include those related to
revenue recognition, accounts receivable allowances, share-based payment
compensation, cost-based investments, marketable securities and deferred income
taxes. Actual results could differ from those estimates.
The
financial market volatility and poor economic conditions beginning in the third
quarter of 2008 and continuing into 2009, both in the U.S. and in many other
countries where the Company operates, have impacted and may continue to impact
the Company’s business. Such conditions could have a material impact to the
Company’s significant accounting estimates discussed above, in particular those
around accounts receivable allowances, cost-based investments and marketable
securities.
(d)
Unaudited Interim Financial Information
The
accompanying unaudited interim condensed consolidated financial statements have
been prepared, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission (“SEC”). Certain information and note
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States of America
have been condensed or omitted pursuant to such rules and regulations relating
to interim financial statements.
In the
opinion of management, the accompanying unaudited interim condensed consolidated
financial statements reflect all adjustments, consisting only of normal
recurring adjustments, necessary to present fairly the financial position of the
Company at March 31, 2009, and the results of its operations for the three
months ended March 31, 2009 and 2008. The results of operations of any interim
period are not necessarily indicative of the results of operations to be
expected for the full fiscal year.
(e)
Cash Equivalents and Marketable Securities
The
Company considers all highly liquid investments with maturities of three months
or less when purchased to be cash equivalents. As of March 31, 2009 and December
31, 2008, the Company’s cash equivalents consisted of money market funds and
commercial paper, and are recorded at fair value. At March 31, 2009 and December
31, 2008, the fair value of the Company’s cash equivalents, as defined under
Financial Accounting Standards Board “FASB” Statement of Financial Accounting
Standards “SFAS” No. 157, Fair
Value Measurements, amounted to
approximately $17.1 million and $15.9 million, respectively. As of March 31,
2009 and December 31, 2008, the Company’s marketable securities consisted of
corporate bonds, certificate of deposits, auction rate securities, and
government securities, and are recorded at fair value. As of March 31, 2009 and
December 31, 2008, the fair value of the Company’s current marketable securities
as defined under SFAS No. 157 was approximately $17.9 million and $19.3 million,
respectively. In addition, at March 31, 2009 and December 31, 2008, the Company
had an additional $1.1 million and $1.2 million, respectively, of long-term
marketable securities that required a higher level of judgment to determine the
fair value, as defined under SFAS No. 157. All of the Company’s marketable
securities are classified as available-for-sale, and accordingly, unrealized
gains and losses on marketable securities, net of tax, are reflected as a
component of accumulated other comprehensive loss in stockholders’ equity. Any
other-than-temporary impairments are recorded in other income in the condensed
consolidated statement of operations. See Note (7) Fair Value Measurements for
additional information.
(f) Fair
Value of Financial Instruments
On
January 1, 2008, the Company adopted SFAS No. 157, as it relates
to financial assets and liabilities. SFAS No. 157 clarifies the definition
of fair value, prescribes methods for measuring fair value, establishes a fair
value hierarchy based on the inputs used to measure fair value, and expands
disclosures about fair value measurements. The three-tier fair value hierarchy,
which prioritizes the inputs used in the valuation methodologies, is as
follows:
Level 1—Valuations based
on quoted prices for identical assets and liabilities in active
markets.
Level 2—Valuations based
on observable inputs other than quoted prices included in Level 1, such as
quoted prices for similar assets and liabilities in active markets, quoted
prices for identical or similar assets and liabilities in markets that are not
active, or other inputs that are observable or can be corroborated by observable
market data.
Level 3—Valuations based
on unobservable inputs reflecting our own assumptions, consistent with
reasonably available assumptions made by other market participants. These
valuations require significant judgment.
As of
March 31, 2009 and December 31, 2008, the fair value of the Company’s financial
instruments, including cash and cash equivalents, accounts receivable, accounts
payable and accrued expenses, approximated book value due to the short maturity
of these instruments. See Note (7) Fair Value Measurements for
additional information.
(g)
Revenue Recognition
The
Company recognizes revenue from software licenses in accordance with Statement
of Position (“SOP”) 97-2, Software Revenue Recognition,
as amended by SOP 98-4 and SOP 98-9, and related interpretations to determine
the recognition of revenue. Accordingly, revenue for software licenses is
recognized when persuasive evidence of an arrangement exists, the fee is fixed
and determinable and the software is delivered and collection of the resulting
receivable is deemed probable. Software delivered to a customer on a trial basis
is not recognized as revenue until a permanent key code is delivered to the
customer. Reseller customers typically send the Company a purchase order only
when they have an end user identified. When a customer licenses software
together with the purchase of maintenance, the Company allocates a portion of
the fee to maintenance for its fair value. Software maintenance fees are
deferred and recognized as revenue ratably over the term of the contract. The
long-term portion of deferred revenue relates to maintenance contracts with
terms in excess of one year. The cost of providing technical support is included
in cost of maintenance, software service and other revenues. The Company
provides an allowance for software product returns as a reduction of revenue,
based upon historical experience and known or expected trends.
Revenues
associated with software implementation and software engineering services are
recognized when the services are performed. Costs of providing these services
are included in cost of maintenance, software services and other
revenues.
The
Company has entered into various distribution, licensing and joint promotion
agreements with OEMs and distributors, whereby the Company has provided to the
reseller a non-exclusive software license to install the Company’s software on
certain hardware or to resell the Company’s software in exchange for payments
based on the products distributed by the OEM or distributor. From
time to time, the Company receives nonrefundable advances and engineering fees
from an OEM which are recorded as deferred revenue and recognized as revenue
when related software engineering services, if any, are complete and the
software product master is delivered and accepted.
The
Company has transactions in which it purchases hardware and bundles this
hardware with the Company’s software and sells the bundled solution to its
customer. The Company’s software is not essential to the functionality of the
bundled hardware. The amount of revenue allocated to the software and
hardware bundle is recognized as revenue in the period delivered provided all
other revenue recognition criteria have been met. The Company further separates
the software sales revenue from the hardware revenue for purposes of
classification in the unaudited condensed consolidated statements of operations
in a systematic and rational manner based on their deemed relative fair values.
For the
three months ended March 31, 2009, the Company had two customers that together
accounted for 24% of revenues. The Company had no customers with accounts
receivable balance greater than 10% at March 31, 2009. For the three months
ended March 31, 2008, the Company had two customers that together accounted for
38% of revenues. The Company had two customers that together accounted for 24%
of the accounts receivable balance at March 31, 2008.
(h) Property
and Equipment
Property
and equipment are recorded at cost. Depreciation is recognized using the
straight-line method over the estimated useful lives of the assets (3 to 7
years). Depreciation expense was $1,120,400 and $1,032,494 for the three months
ended March 31, 2009 and 2008, respectively. Leasehold improvements are
amortized on a straight-line basis over the term of the respective leases or
over their estimated useful lives, whichever is shorter.
(i) Goodwill
and Other Intangible Assets
Goodwill
represents the excess of the purchase price over the estimated fair value of net
tangible and identifiable intangible assets acquired in business combinations.
Consistent with SFAS No. 142, Goodwill and Other Intangible
Assets, the Company has not amortized goodwill related to its
acquisitions, but instead tests the balance for impairment. The Company’s annual
impairment assessment is performed during the fourth quarter of each year, and
an assessment is made at other times if events or changes in circumstances
indicate that it is more likely than not that the asset is impaired.
Identifiable intangible assets, which include (i) assets acquired through
business combinations, which include customer contracts and intellectual
property, and (ii) patents amortized over three years using the straight-line
method. See Note (8) Acquisitions for additional
information.
Amortization
expense was $165,662 and $64,169 for the three months ended March 31, 2009 and
2008, respectively. The gross carrying amount and accumulated amortization of
other intangible assets as of March 31, 2009 and December 31, 2008 are as
follows:
|
|
|
|
|
|
|
|
|
Goodwill:
|
|
$ |
4,150,339 |
|
|
$ |
4,150,339 |
|
|
Other
intangible assets:
|
|
|
|
|
|
|
|
|
|
Gross
carrying amount
|
|
$ |
2,700,318 |
|
|
$ |
2,685,775 |
|
|
Accumulated
amortization
|
|
|
(1,475,742 |
) |
|
|
(1,310,080 |
) |
|
Net
carrying amount
|
|
$ |
1,224,576 |
|
|
$ |
1,375,695 |
|
(j)
Software Development Costs and Purchased Software Technology
In
accordance with the provisions of SFAS No. 86, Accounting for the Costs of Software
to be Sold, Leased or Otherwise Marketed, costs associated with the
development of new software products and enhancements to existing software
products are expensed as incurred until technological feasibility of the product
has been established. Based on the Company’s product development process,
technological feasibility is established upon completion of a working model.
Amortization of software development costs is recorded at the greater of
the straight line basis over the products estimated life, typically three years
or the ratio of current revenue of the related products to total current and
anticipated future revenue of these products. During the three months ended
March 31, 2009, and in accordance with SFAS No. 86, the Company capitalized
approximately $81,000 related to software development projects and did not
record any amortization as the product became available for sale on March 31,
2009.
The
purchased software technology net carrying value of $913,254 and $102,540, after
accumulated amortization of $5,414,177 and $5,274,891, is included in “other
assets” in the balance sheets as of March 31, 2009 and December 31, 2008,
respectively. Amortization expense was $139,286 and $38,869 for the three months
ended March 31, 2009 and 2008, respectively. Amortization of purchased software
technology is recorded at the greater of the straight line basis over the
products estimated remaining life or the ratio of current period revenue of the
related products to total current and anticipated future revenue of these
products.
(k)
Income Taxes
Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be realized or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date. In determining the period in which the related tax benefits are
realized for book purposes, excess share-based compensation deductions included
in net operating losses are realized after regular net operating losses are
exhausted.
The
Company accounts for uncertain tax positions in accordance with FASB
Interpretation No. 48, Accounting for Uncertainty in Income
Taxes, (“FIN 48”). FIN 48 is an interpretation of SFAS No. 109, Accounting for Income Taxes,
and addresses the determination of whether tax benefits claimed or expected to
be claimed on a tax return should be recorded in the financial
statements. Under FIN 48, the Company may recognize the tax benefit
from an uncertain tax position only if it meets the “more likely than not”
threshold that the position will be sustained on examination by the taxing
authority, based on the technical merits of the position. The tax benefits
recognized in the financial statements from such a position should be measured
based on the largest benefit that has a greater than fifty percent likelihood of
being realized upon ultimate settlement. FIN 48 also provides guidance on
de-recognition, classification, interest and penalties on income taxes,
accounting in interim periods, and also requires increased disclosures. During
2008, the Company increased its recognized benefits from uncertain tax positions
by approximately $600,000. The Company includes interest and penalties related
to its uncertain tax positions in its income tax expense within its condensed
consolidated statement of operations. See Note (6) Income Taxes for additional
information.
(l)
Long-Lived Assets
The
Company reviews its long-lived assets for impairment whenever events or changes
in circumstances indicate that the carrying amount of the asset may not be
recoverable. If the sum of the expected future cash flows, undiscounted and
without interest is less than the carrying amount of the asset, an impairment
loss is recognized as the amount by which the carrying amount of the asset
exceeds its fair value.
(m)
Share-Based Payments
The
Company accounts for stock-based awards under the provisions of SFAS No. 123(R),
Share-Based Payment,
which establishes the accounting for transactions in which an entity exchanges
its equity instruments for goods or services. Under the provisions of SFAS No.
123(R), share-based compensation expense is measured at the grant date, based on
the fair value of the award, and is recognized as an expense over the requisite
employee service period (generally the vesting period), net of estimated
forfeitures. The Company estimates the fair value of share-based payments using
the Black-Scholes option-pricing model. The estimation of stock-based awards
that will ultimately vest requires judgment, and to the extent actual results or
updated estimates differ from the Company’s current estimates, such amounts will
be recorded as a cumulative adjustment in the period estimates are revised. The
Company considers many factors when estimating expected forfeitures, including
types of awards, employee class and historical experience. Stock option
exercises and restricted stock awards are expected to be fulfilled with new
shares of common stock.
The
Company accounts for stock option grants and grants of restricted shares of
common stock to non-employees in accordance with SFAS No. 123, Accounting for Stock-Based
Compensation, and Emerging Issues Task Force (“EITF”) Issue
No. 96-18, Accounting for
Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services, which requires that the fair
value of these instruments be recognized as an expense over the period in which
the related services are rendered.
(n)
Foreign Currency
Assets
and liabilities of foreign operations are translated at rates of exchange at the
end of the period, while results of operations are translated at average
exchange rates in effect for the period. Gains and losses from the translation
of foreign assets and liabilities from the functional currency of the Company’s
subsidiaries into the U.S. dollar are classified as accumulated other
comprehensive income (loss) in stockholders’ equity. Gains and losses
from foreign currency transactions are included in the condensed consolidated
statements of operations within interest and other income, net.
During
the three months ended March 31, 2009 and 2008, foreign currency realized and
unrealized (loss) gain totaled approximately ($607,000) and $7,000,
respectively.
(o)
Earnings Per Share (EPS)
Basic EPS
is computed based on the weighted average number of shares of common stock
outstanding. Diluted EPS is computed based on the weighted average number of
common shares outstanding increased by dilutive common stock equivalents. Due to
the net loss for the three months ended March 31, 2009, all common stock
equivalents of 12,934,555 were excluded from diluted net loss per share because
they are anti-dilutive. As of March 31, 2008, potentially dilutive vested and
unvested common stock equivalents excluded from the computation of diluted EPS
included 9,065,012 stock option awards and restricted stock awards outstanding,
because they were anti-dilutive.
The
following represents a reconciliation of the numerators and denominators of the
basic and diluted earnings per share (“EPS”) computation:
|
|
|
Three
Months Ended March 31, 2009
|
|
|
Three
Months Ended March 31, 2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
EPS
|
|
$ |
(850,961 |
) |
|
|
44,974,677 |
|
|
$ |
(0.02 |
) |
|
$ |
1,333,757 |
|
|
|
49,590,008 |
|
|
$ |
0.03 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect
of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
options and restricted stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,100,237 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
EPS
|
|
$ |
(850,961 |
) |
|
|
44,974,677 |
|
|
$ |
(0.02 |
) |
|
$ |
1,333,757 |
|
|
|
51,690,245 |
|
|
$ |
0.03 |
|
(p)
Comprehensive (Loss) Income
Comprehensive
(loss) income includes: (i) the Company’s net (loss) income, (ii) foreign
currency translation adjustments, (iii) unrealized (gains) losses on marketable
securities, net of tax, and (iv) minimum pension liability adjustments, net of
tax, pursuant to SFAS No. 158, Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements
No. 87, 88, 106, and 132(R).
The
Company’s comprehensive (loss) income is as follows:
|
|
|
Three
Months Ended March 31,
|
|
|
|
|
2009
|
|
|
2008
|
|
|
|
|
|
|
|
|
|
|
Net
(loss) income
|
|
$ |
(850,961 |
) |
|
$ |
1,333,757 |
|
|
|
|
|
|
|
|
|
|
|
|
Other
comprehensive income (loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign
currency translation (loss) gain adjustments
|
|
|
(467,990 |
) |
|
|
304,995 |
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized
loss on marketable securities, net of tax
|
|
|
(75,415 |
) |
|
|
(62,467 |
) |
|
|
|
|
|
|
|
|
|
|
|
Minimum
pension adjustments
|
|
|
67 |
|
|
|
4,077 |
|
|
|
|
|
|
|
|
|
|
|
|
Other
comprehensive (loss) income
|
|
|
(543,338 |
) |
|
|
246,605 |
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
(loss) income
|
|
$ |
(1,394,299 |
) |
|
$ |
1,580,362 |
|
(q) Investments
As of
March 31, 2009 and December 31, 2008, the Company maintained certain cost-method
investments aggregating $1,031,033 respectively, which are included in “Other
assets” in the accompanying condensed consolidated balance sheets. During the
three months ended March 31, 2009 and 2008, the Company did not recognize any
impairment charges related to any of its cost-method investments.
(r)
New Accounting Pronouncements
In
April 2009, the FASB issued FASB Staff Position (“FSP”) SFAS No. 157-4,
Determining Fair Value When
Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly (FSP No.
157-4). FSP No. 157-4 provides guidance on how to determine the fair value of
assets and liabilities when the volume and level of activity for the
asset/liability has significantly decreased. FSP No. 157-4 also provides
guidance on identifying circumstances that indicate a transaction is not
orderly. In addition, FSP No. 157-4 requires disclosure in interim and annual
periods of the inputs and valuation techniques used to measure fair value and a
discussion of changes in valuation techniques. FSP No. 157-4 is effective for
the Company for the quarter ending June 30, 2009. The Company is currently
evaluating the potential impact, if any, of the adoption of FSP No. 157-4 on its
consolidated financial statements.
In
April 2009, the FASB issued FSP SFAS No. 115-2 and FSP SFAS No. 124-2,
Recognition and Presentation
of Other-Than-Temporary Impairment (FSP No. 115-2/124-2). FSP No.
115-2/124-2 amends the requirements for the recognition and measurement of
other-than-temporary impairments for debt securities by modifying the
pre-existing “intent and ability” indicator. Under FSP No. 115-2/124-2, an
other-than-temporary impairment is triggered when there is an intent to sell the
security, it is more likely than not that the security will be required to be
sold before recovery, or the security is not expected to recover the entire
amortized cost basis of the security. Additionally, FSP No. 115-2/124-2 changes
the presentation of an other-than-temporary impairment in the income statement
for those impairments involving credit losses. The credit loss component will be
recognized in earnings and the remainder of the decline in the fair value of the
investment will be recorded in other comprehensive income. FSP No. 115-2/124-2
is effective for the Company for the quarter ending June 30, 2009. The Company
is currently evaluating the potential impact, if any, of the adoption of FSP No.
115-2/124-2 on its consolidated financial statements.
In
April 2009, the FASB issued FSP SFAS No. 107-1 and Accounting Principles
Board (“APB”) Opinion No 28-1, Interim Disclosure about Fair Value
of Financial Instruments (FSP No. 107-1/APB No. 28-1). FSP No. 107-1/APB
No. 28-1 requires interim disclosures regarding the fair values of financial
instruments that are within the scope of SFAS 107, Disclosures about the Fair Value of
Financial Instruments. Additionally, FSP No. 107-1/APB No. 28-1 requires
disclosure of the methods and significant assumptions used to estimate the fair
value of financial instruments on an interim basis as well as changes of the
methods and significant assumptions from prior periods. FSP No. 107-1/APB No.
28-1 is effective for the Company for the quarter ended June 30, 2009. The
Company will include the required disclosures in its quarterly and annual
reports beginning in the quarter ending June 30, 2009.
In April
2008, the FASB issued SFAS No. 142-3, Determination of the Useful Life of
Intangible Assets. SFAS No. 142-3 amends the factors that
should be considered in developing renewal or extension assumptions used to
determine the useful life of a recognized intangible asset under SFAS
No. 142. The intent is to improve the consistency between the useful life
of a recognized intangible asset under SFAS No. 142 and the period of expected
cash flows used to measure the fair value of the asset under SFAS
No. 141(R), and other generally accepted accounting principles (“GAAP”).
SFAS No. 142-3 will became effective for intangible assets acquired beginning
January 1, 2009. Accordingly, the impact on the Company is limited to the
extent of any acquisitions subsequent to January 1, 2009.
In
December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations. SFAS
No. 141(R) establishes principles and requirements for how an acquirer
recognizes and measures in its financial statements the identifiable assets
acquired, the liabilities assumed, any noncontrolling interest in the acquiree
and the goodwill acquired. SFAS No. 141(R) also establishes disclosure
requirements to enable the evaluation of the nature and financial effects of the
business combination. SFAS No. 141(R) is effective for fiscal years beginning
after December 15, 2008. The adoption of the provisions of SFAS
No. 141(R) will only have an effect on the Company’s consolidated financial
statements in the event it enters into any business combinations subsequent to
January 1, 2009.
(2)
Share-Based Payment Arrangements
On May 1,
2000, the Company adopted the FalconStor Software, Inc., 2000 Stock Option Plan
(the “2000 Plan”). The 2000 Plan is administered by the Board of Directors and,
as amended, provides for the grant of options to purchase up to 14,162,296
shares of Company common stock to employees, consultants and non-employee
directors. Options may be incentive (“ISO”) or non-qualified. ISOs granted must
have exercise prices at least equal to the fair value of the common stock on the
date of grant, and have terms not greater than ten years, except those to an
employee who owns stock with greater than 10% of the voting power of all classes
of stock of the Company, in which case they must have an option price at least
110% of the fair value of the stock, and expire no later than five years from
the date of grant. Non-qualified options granted must have exercise prices not
less than eighty percent of the fair value of the common stock on the date of
grant, and have terms not greater than ten years. All options granted under the
2000 Plan must be granted before May 1, 2010. As of March 31, 2009, there were
333,631 shares available for grant under the 2000 Plan.
On May
14, 2004, the Company adopted the FalconStor Software, Inc., 2004 Outside
Directors Stock Option Plan (the “2004 Plan”). The 2004 Plan is administered by
the Board of Directors and provides for the granting of options to non-employee
directors of the Company to purchase up to 300,000 shares of Company common
stock. Exercise prices of the options must be equal to the fair market value of
the common stock on the date of grant. Options granted have terms of ten years.
All options granted under the 2004 Plan must be granted within three years of
the adoption of the 2004 Plan. As of March 31, 2009, options to purchase 250,000
shares remain outstanding from the 2004 Plan and no additional options are
available for grant under the 2004 Plan.
On May
17, 2006, the Company adopted the FalconStor Software, Inc., 2006 Incentive
Stock Plan (the “2006 Plan”). The 2006 Plan was amended on May 8,
2007 and on May 8, 2008. The 2006 Plan is administered by the Board of Directors
and provides for the grant of incentive and nonqualified stock options, shares
of restricted stock, and restricted stock units to employees, officers,
consultants and advisors of the Company. The number of shares
available for grant or issuance under the 2006 Plan, as amended, is determined
as follows: If, on July 1st of any
calendar year in which the 2006 Plan is in effect, the number of shares of stock
as to which options, restricted shares and restricted stock units may be granted
under the 2006 Plan is less than five percent (5%) of the number of outstanding
shares of stock, then the number of shares of stock available for issuance under
the 2006 Plan is automatically increased so that the number equals five percent
(5%) of the shares of stock outstanding. In no event shall the number of shares
of stock subject to the 2006 Plan in the aggregate exceed twenty million shares,
subject to adjustment as provided in the 2006 Plan. On July 1, 2008, the total
number of outstanding shares of the Company’s common stock totaled 47,952,855.
Pursuant to the 2006 Plan, as amended, the total shares available for issuance
under the 2006 Plan thus increased by 2,368,287 shares to 2,397,643 shares
available for issuance as of July 1, 2008. As of March 31, 2009, there were
252,819 shares available for grant under the 2006 Plan. Exercise prices of the
options must be equal to the fair market value of the common stock on the date
of grant. Options granted have terms of not greater than ten years. All options,
shares of restricted stock, and restricted stock units granted under the 2006
Plan must be granted within ten years of the adoption of the 2006
Plan.
On May 8,
2007, the Company adopted the FalconStor Software, Inc. 2007 Outside Directors
Equity Compensation Plan (the “2007 Plan”). The 2007 Plan was amended on May 8,
2008. The 2007 Plan is administered by the Board of Directors and provides for
the issuance of up to 300,000 shares of Company common stock upon the vesting of
options or upon the grant of shares with such restrictions as determined by the
Board of Directors to the non-employee directors of the Company. Exercise prices
of the options must be equal to the fair market value of the common stock on the
date of grant. Options granted have terms of ten years. Shares of restricted
stock have the terms and conditions set by the Board of Directors and are
forfeitable until the terms of the grant have been satisfied. As of March 31,
2009, there were 185,000 shares available for grant under the 2007
Plan.
The
following table summarizes stock option activity during the three months ended
March 31, 2009:
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Remaining
|
|
|
Aggregate
|
|
|
|
|
Number
of
|
|
|
Exercise
|
|
|
Contractual
|
|
|
Intrinsic
|
|
|
|
|
Options
|
|
|
Price
|
|
|
Life (Years)
|
|
|
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options
Outstanding at December 31, 2008
|
|
|
9,675,145 |
|
|
$ |
6.41 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
2,062,500 |
|
|
$ |
2.32 |
|
|
|
|
|
|
|
|
Exercised
|
|
|
(15,543 |
) |
|
$ |
0.35 |
|
|
|
|
|
|
|
|
Canceled
|
|
|
(38,249 |
) |
|
$ |
7.27 |
|
|
|
|
|
|
|
|
Forfeited
|
|
|
(53,605 |
) |
|
$ |
7.52 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options
Outstanding at March 31, 2009
|
|
|
11,630,248 |
|
|
$ |
5.68 |
|
|
|
6.65
|
|
|
$ |
2,212,329 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options
Exercisable at March 31, 2009
|
|
|
6,486,789 |
|
|
$ |
5.90 |
|
|
|
4.54
|
|
|
$ |
1,935,639 |
|
Stock
option exercises are fulfilled with new shares of common stock. The total cash
received from stock option exercises for the three months ended March 31, 2009
was $5,383. There were no stock option exercises during the three months ended
March 31, 2008. The total intrinsic value of stock options exercised during the
three months ended March 31, 2009 was $31,144.
The
Company recognized share-based compensation expense for awards issued under the
Company’s stock option plans in the following line items in the condensed
consolidated statements of operations:
|
|
|
Three
Months Ended March 31,
|
|
|
Three
Months Ended March 31,
|
|
|
|
|
|
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
|
|
|
|
|
|
|
|
Cost
of maintenance, software services and other revenue
|
|
$ |
358,679 |
|
|
$ |
280,598 |
|
|
Software
development costs
|
|
|
672,747 |
|
|
|
849,598 |
|
|
Selling
and marketing
|
|
|
890,318 |
|
|
|
994,949 |
|
|
General
and administrative
|
|
|
233,370 |
|
|
|
214,501 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
2,155,114 |
|
|
$ |
2,339,646 |
|
The
Company began issuing restricted stock in 2006 and restricted stock units in
2008. The fair value of the restricted stock awards / restricted stock units are
expensed at either the fair value per share at date of grant (outside director,
officers and employees), or at the fair value per share as of each reporting
period (non-employee consultants.)
During
the three months ended March 31, 2009, the Company granted a total of 807,780
shares of restricted stock and 43,162 restricted stock units at various times to
certain officers, employees and/or non-employee consultants. The restricted
stock awards and restricted stock units are being expensed at their fair value
per share which ranges from $2.25 to $3.08 per share. During the three months
ended March 31, 2008, a total of 382,000 shares of restricted stock were granted
at various times to certain officers, employees and non-employee consultants.
The restricted stock award grants are being expensed at the then fair value per
share which ranged from $7.14 to $9.29 per share.
As of
March 31, 2009, an aggregate of 1,947,780 shares of restricted stock have been
issued, of which, 341,885 have vested and 390,500 have been canceled. As of
March 31, 2008, an aggregate of 980,000 shares of restricted stock had been
issued, of which, 87,950 had vested and 25,000 had been canceled.
As of
March 31, 2009, an aggregate of 88,912 restricted stock units have been issued,
of which none had vested or been forfeited. There were no restricted stock units
issued or outstanding during the three months ended March 31, 2008.
The
following table summarizes restricted stock activity during the three months
ended March 31, 2009:
|
|
Number
of Restricted
|
|
|
Stock
Awards / Units
|
|
|
|
|
Non-Vested
at December 31, 2008
|
488,840
|
|
|
|
|
Granted
|
850,942
|
|
Vested
|
(35,475)
|
|
Canceled
|
-
|
|
|
|
|
Non-Vested
at March 31, 2009
|
1,304,307
|
|
|
|
Restricted
stock and restricted stock units are fulfilled with new shares of common stock.
The total intrinsic value of restricted stock for which the restrictions lapsed
during the three months ended March 31, 2009 and 2008 was $84,948 and $119,898
respectively.
Options
granted to officers, employees and directors during fiscal 2009 and 2008 have
exercise prices equal to the fair market value of the stock on the date of
grant, a contractual term of ten years, and a vesting period generally of three
years. Based on each respective group’s historical vesting experience
and expected trends, the estimated forfeiture rate for officers, employees and
directors, as adjusted, was 11%, 24% and 9%, respectively.
Options
granted to non-employee consultants have exercise prices equal to the fair
market value of the stock on the date of grant and a contractual term of ten
years. Restricted stock awards granted to non-employee consultants have a
contractual term equal to the lapse of restriction(s) of each specific award.
The fair values of the share-based awards are being expensed at their fair value
per share, which was $2.39 and $7.61 at March 31, 2009 and 2008, respectively.
Vesting periods for share-based awards granted to non-employee consultants range
from one month to three years depending on service requirements. As of March 31,
2009 and 2008, the Company recognized expenses of $58,400 and $92,404,
respectively, related to share-based awards granted to non-employee consultants,
which are included in the Company’s total share-based compensation expense for
each respective period.
The
Company estimates expected volatility based primarily on historical daily
volatility of the Company’s stock and other factors, if applicable. The
risk-free interest rate is based on the United States treasury yield curve in
effect at the time of grant. The expected option term is the number of years
that the Company estimates that options will be outstanding prior to exercise.
The expected term of the awards issued after December 31, 2007 was determined
based upon an estimate of the expected term of “plain vanilla”
options as prescribed in SEC Staff Accounting Bulletin (“SAB”) No. 110. The
expected term of the awards issued prior to January 1, 2008, was determined
using the “simplified method” prescribed in SAB No. 107.
As of
March 31, 2009, there was approximately $13,197,238, of total unrecognized
compensation cost related to the Company’s unvested options and restricted
shares granted under the Company’s stock plans.
(3) Segment
Reporting
The
Company is organized in a single operating segment for purposes of making
operating decisions and assessing performance. Revenues from the United States
to customers in the following geographical areas for the three months ended
March 31, 2009 and 2008, and the location of long-lived assets as of March 31,
2009 and December 31, 2008, are summarized as follows:
|
|
|
Three
Months Ended March 31,
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Revenues:
|
|
|
|
|
|
|
|
United
States
|
|
$ |
10,883,552 |
|
|
$ |
14,881,742 |
|
|
Asia
|
|
|
5,059,845 |
|
|
|
2,674,447 |
|
|
Other
international
|
|
|
5,077,688 |
|
|
|
4,250,471 |
|
|
|
|
|
|
|
|
|
|
|
|
Total
revenues
|
|
$ |
21,021,085 |
|
|
$ |
21,806,660 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-lived
assets:
|
|
|
|
|
|
|
|
|
|
United
States
|
|
$ |
21,186,983 |
|
|
$ |
20,682,794 |
|
|
Asia
|
|
|
1,714,049 |
|
|
|
1,869,963 |
|
|
Other
international
|
|
|
414,413 |
|
|
|
386,981 |
|
|
|
|
|
|
|
|
|
|
|
|
Total
long-lived assets
|
|
$ |
23,315,445 |
|
|
$ |
22,939,738 |
|
(4)
Stock Repurchase Program
On October 25, 2001, the Company’s
Board of Directors authorized the repurchase of up to 2 million shares of the
Company’s outstanding common stock. On February 6, 2008, and on July 22, 2008,
the Company’s Board of Directors increased the authorization to repurchase the
Company’s outstanding common stock by 3 million shares and 3 million shares,
respectively, to an aggregate of 8 million shares. On February 4, 2009, the
Company’s Board of Directors again increased the authorization to repurchase the
Company’s outstanding common stock from 8 million shares to 14 million shares in
the aggregate. The repurchases may be made from time to time in open market
transactions in such amounts as determined at the discretion of the Company’s
management. The terms of the stock repurchases will be determined by management
based on market conditions. During the three months ended March 31, 2009, the
Company repurchased 566,885 shares of its common stock in open market purchases
for a total cost of $1,526,124. During the three months ended March 31, 2008,
the Company repurchased 1,760,000 shares of its common stock in open market
purchases for a total cost of $14,476,877. Since October 2001, the Company has
repurchased a total of 7,390,935 shares of its common stock at an aggregate
purchase price of $44,454,452. As of March 31, 2009, the Company had the ability
to repurchase an additional 6,609,065 shares of our common stock based upon our
judgment and market conditions.
(5)
Commitments and Contingencies
The Company has an operating lease
covering its corporate office facility that expires in February 2012. The
Company also has several operating leases related to offices in the United
States and foreign countries. The expiration dates for these leases range from
2009 through 2012. The following is a schedule of future minimum lease payments
for all operating leases as of March 31, 2009:
|
2009
|
|
|
1,700,264 |
|
|
2010
|
|
|
1,686,029 |
|
|
2011
|
|
|
1,302,543 |
|
|
2012
|
|
|
234,430 |
|
|
|
|
$ |
4,923,266 |
|
The
Company is subject to various legal proceedings and claims, asserted or
unasserted, which arise in the ordinary course of business. While the outcome of
any such matters cannot be predicted with certainty, such matters are not
expected to have a material adverse effect on the Company’s financial condition
or operating results.
On
December 31, 2007, the Company entered into an Employment Agreement (“Employment
Agreement”) with ReiJane Huai. Pursuant to the Employment Agreement, the Company
agreed to continue to employ Mr. Huai as President and Chief Executive Officer
of the Company effective January 1, 2008 through December 31, 2010, at annual
salaries of $310,000, $341,000 and $375,100 for calendar years 2008, 2009 and
2010, respectively. The Employment Agreement also provides for the potential
payment of annual bonuses to Mr. Huai, in the form of shares of the Company’s
restricted stock, based on the Company’s operating income (or “bonus targets” as
defined in the Employment Agreement) and for certain other contingent benefits
set forth in the Employment Agreement. Pursuant to the Employment Agreement, the
2009 annual bonus of restricted stock due to Mr. Huai shall be issued within
seventy-five (75) days of the end of fiscal 2009, assuming the bonus targets are
achieved. The restricted stock is subject to a three-year vesting period
commencing from the date of grant. During the three months ended March 31, 2009,
and in accordance SFAS No. 123(R), the Company recognized approximately $48,000
of share-based compensation expense, which was classified as a liability award,
as the service date precedes the grant date, within the Company’s condensed
consolidated balance sheets, based upon the Company’s projected bonus award due
to Mr. Huai for 2009.
(6)
Income Taxes
The
Company’s provision for income taxes consists of U.S., state and local, and
foreign taxes in amounts necessary to align the Company’s year-to-date tax
provision with the effective rate that the Company expects to achieve for the
full year. The Company’s 2009 annual effective tax rate is estimated to be
approximately 33% (which includes U.S., state and local and foreign taxes) based
upon the Company’s anticipated earnings both in the U.S. and in its foreign
subsidiaries.
For the three months ended March 31,
2009, the Company recorded an income tax benefit of $427,649, related
to its pre-tax book loss of $1,278,610. For the three months ended March 31,
2008, the Company’s provision for income taxes was $978,919, which consisted
primarily of U.S., state and local, and foreign taxes.
The Company’s total unrecognized tax
benefits as of March 31, 2009 and December 31, 2008 were each approximately $5.0
million, which, if recognized, would affect the Company’s effective tax rate. As
of March 31, 2009 and 2008, the Company had recorded an aggregate of $75,394 and
$43,793, respectively, of accrued interest and penalties.
(7)
Fair Value Measurements
The Company adopted the provisions of
SFAS No. 157 as of January 1, 2008, except as it applied to (i) the
nonfinancial assets and nonfinancial liabilities subject to the FSP
No. 157-2 Effective Date
of FASB Statement No. 157, which the Company adopted effective
January 1, 2009, and (ii) the provisions of FSP 157-3 Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active, which the
Company adopted effective October 10, 2008. SFAS No. 157, as amended,
clarifies that fair value is an exit price, representing the amount that would
be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants. As a basis for considering such
assumptions, SFAS No. 157 establishes a three-tier value hierarchy, which
prioritizes the inputs used in the valuation methodologies in measuring fair
value:
Fair Value
Hierarchy
SFAS No. 157 specifies a hierarchy
of valuation techniques based upon whether the inputs to those valuation
techniques reflect assumptions other market participants would use based upon
market data obtained from independent sources (observable inputs) or reflect the
Company’s own assumptions of market participant valuation (unobservable inputs).
In accordance with SFAS No. 157, these two types of inputs have created the
following fair value hierarchy:
|
·
|
Level 1 – Quoted prices
in active markets that are unadjusted and accessible at the measurement
date for identical, unrestricted assets or liabilities. The Level 1
category includes money market funds, which at March 31, 2009 and December
31, 2008 totaled $16.7 million and $15.1 million, respectively, which are
included within cash and cash equivalents and marketable securities in the
condensed consolidated balance
sheets.
|
|
·
|
Level 2 – Quoted prices
for identical assets and liabilities in markets that are not active,
quoted prices for similar assets and liabilities in active markets or
financial instruments for which significant inputs are observable, either
directly or indirectly. The Level 2 category at March 31, 2009 includes
government securities and corporate debt securities totaling $18.3
million. The Level 2 category at December 31, 2008 included commercial
paper totaling $0.8 million, government securities and corporate debt
securities totaling $19.3 million, which are included within cash and cash
equivalents and marketable securities in the condensed consolidated
balance sheets.
|
|
·
|
Level
3 – Prices or valuations that require inputs that are both significant to
the fair value measurement and unobservable. The Level 3 category includes
auction rate securities, which at March 31, 2009 and December 31, 2008
totaled $1.1 million and $1.2 million, respectively, which are included
within long-term marketable securities in the consolidated balance
sheets.
|
SFAS
No. 157 requires the use of observable market data if such data is
available without undue cost and effort.
Measurement
of Fair Value
The Company measures fair value as an
exit price using the procedures described below for all assets and liabilities
measured at fair value. When available, the Company uses unadjusted quoted
market prices to measure fair value and classifies such items within Level 1. If
quoted market prices are not available, fair value is based upon financial
models that use, where possible, current market-based or independently-sourced
market parameters such as interest rates and currency rates. Items valued
using financial generated models are classified according to the lowest level
input or value driver that is significant to the valuation. Thus, an item may be
classified in Level 3 even though there may be inputs that are readily
observable. If quoted market prices are not available, the valuation model used
generally depends on the specific asset or liability being valued. The
determination of fair value considers various factors including interest rate
yield curves and time value underlying the financial instruments.
As of March 31, 2009 and December 31,
2008, the Company held certain assets that are required to be measured at fair
value on a recurring basis. Included within the Company’s marketable securities
portfolio are investments in auction rate securities, which are classified as
available-for-sale securities and are reflected at fair value. However, due to
events in the U.S. credit markets, the auction events for these securities held
by the Company failed commencing in the first quarter of 2008, and continued to
fail throughout 2008 and into the first quarter of 2009. Therefore, the fair
values of these securities are estimated utilizing a discounted cash flow
analysis and other type of valuation model as of March 31, 2009 and December 31,
2008. These analyses consider, among other items, the collateral underlying the
security, the creditworthiness of the issuer, the timing of the expected future
cash flows, including the final maturity, and an assumption of when the next
time the security is expected to have a successful auction. These securities
were also compared, when possible, to other observable and relevant market data,
which is limited at this time.
As
of March 31, 2009 and December 31, 2008, the Company’s auction rate securities
totaled $1,500,000 (at par value) and are collateralized by student loan
portfolios, which are almost fully guaranteed by the United States Government.
Because there is no assurance that auctions for these securities will be
successful in the near term, the Company classified the fair value of the
auction rate securities as Level 3 long-term investments for the periods ending
March 31, 2009 and December 31, 2008, respectively. During the period
ended March 31, 2009, the Company recorded $40,000 in other-than-temporary
impairments on its auction rate securities ($40,000 cumulatively to date) and a
gain of $19,005 ($314,050 loss to date) in accumulated other comprehensive loss.
As of December 31, 2008, the total losses related to the Company’s auction rate
securities recorded in accumulated other comprehensive loss totaled $333,055.
During the period ended March 31, 2009, the valuation models used to determine
the fair value of these auction rate securities, as described above, indicated
that two of the three investments recovered a portion of their decline in fair
value as compared with the valuation models at December 31, 2008. However, one
of the three investments experienced a further decline in fair value as compared
with the fair value at December 31, 2008. The Company determined that the
decline in the fair value of this particular investment was primarily due to the
down grade in the credit rating of certain underlying subordinate securities
within the auction rate security. As a result, the Company determined a portion
of the overall decline in fair value of the auction rate security to be
other-than-temporary due to the creditworthiness of the underlying securities.
Any future fluctuation in the fair value related to any of the auction rate
securities that the Company deems to be temporary, including any recoveries of
previous write-downs, would be recorded to accumulated other comprehensive loss,
net of tax. Finally, with the exception of the creditworthiness of one of its
auction rate securities, the Company believes that the remaining temporary
declines in fair value are primarily due to liquidity concerns and not to the
creditworthiness of the remaining underlying assets, because the majority of the
underlying securities are almost entirely backed by the U.S. Government.
However, if at any time in the future the Company determines that a valuation
adjustment is other-than-temporary, it will record a charge to earnings in the
period of determination in accordance with FSP No. 115-2/124-2, which is
effective for the quarter ending June 30, 2009.
Items
Measured at Fair Value on a Recurring Basis
The
following table presents the Company’s assets that are measured at fair value on
a recurring basis at March 31, 2009, consistent with the fair value hierarchy
provisions of SFAS No. 157, as amended:
|
|
|
|
|
|
Fair Value Measurements at Reporting Date
Using
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quoted
Prices in
|
|
|
|
|
|
Significant
|
|
|
|
|
|
|
|
Active
Markets for
|
|
|
Significant
other
|
|
|
Unobservable
|
|
|
|
|
|
|
|
Identical
Assets
|
|
|
Inputs
|
|
|
Inputs
|
|
|
|
|
Total
|
|
|
(Level 1)
|
|
|
(Level 2)
|
|
|
(Level 3)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money
market funds
|
|
$ |
16,657,942 |
|
|
$ |
16,657,942 |
|
|
$ |
- |
|
|
$ |
- |
|
|
Government
securities
|
|
|
450,140 |
|
|
|
- |
|
|
|
450,140 |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Marketable
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
debt and government securities
|
|
|
17,885,290 |
|
|
|
- |
|
|
|
17,885,290 |
|
|
|
- |
|
|
Auction
rate securities
|
|
|
1,145,950 |
|
|
|
- |
|
|
|
- |
|
|
|
1,145,950 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
assets measured at fair value
|
|
$ |
36,139,322 |
|
|
$ |
16,657,942 |
|
|
$ |
18,335,430 |
|
|
$ |
1,145,950 |
|
The
following table presents the Company’s assets that are measured at fair value on
a recurring basis at December 31, 2008, consistent with the fair value hierarchy
provisions of SFAS No. 157, as amended:
|
|
|
|
|
|
Fair Value Measurements at Reporting Date
Using
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quoted
Prices in
|
|
|
|
|
|
Significant
|
|
|
|
|
|
|
|
Active
Markets for
|
|
|
Significant
other
|
|
|
Unobservable
|
|
|
|
|
|
|
|
Identical
Assets
|
|
|
Inputs
|
|
|
Inputs
|
|
|
|
|
Total
|
|
|
(Level 1)
|
|
|
(Level 2)
|
|
|
(Level 3)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money
market funds
|
|
$ |
15,088,465 |
|
|
$ |
15,088,465 |
|
|
$ |
- |
|
|
$ |
- |
|
|
Commercial
paper
|
|
|
799,920 |
|
|
|
- |
|
|
|
799,920 |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Marketable
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
debt and government securities
|
|
|
19,279,010 |
|
|
|
- |
|
|
|
19,279,010 |
|
|
|
- |
|
|
Auction
rate securities
|
|
|
1,166,945 |
|
|
|
- |
|
|
|
- |
|
|
|
1,166,945 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
assets measured at fair value
|
|
$ |
36,334,340 |
|
|
$ |
15,088,465 |
|
|
$ |
20,078,930 |
|
|
$ |
1,166,945 |
|
Based on
market conditions, the Company changed its valuation methodology for auction
rate securities to a discounted cash flow analysis and other type of valuation
model during the first quarter of 2008. Accordingly, these securities changed
from Level 1 to Level 3 within SFAS No. 157’s hierarchy since the
Company’s initial adoption of SFAS No. 157 on January 1, 2008. The
following table presents the Company’s assets measured at fair value on a
recurring basis using significant unobservable inputs (Level 3) as
defined in SFAS No. 157 as of March 31, 2009 and 2008:
|
|
Fair
Value Measurements Using Significant Unobservable
Inputs
|
|
|
(Level
3) |
|
|
|
Auction Rate Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
March
31, 2009
|
|
|
March
31, 2008
|
|
|
Beginning
Balance
|
|
$ |
1,166,945 |
|
|
$ |
- |
|
|
|
Transfers
to Level 3
|
|
|
- |
|
|
|
1,500,000 |
|
|
|
Total
unrealized gains (losses) in accumulated
|
|
|
|
|
|
|
|
|
|
|
other
comprehensive loss
|
|
|
19,005 |
|
|
|
(179,415 |
) |
|
|
Total
realized losses in other income
|
|
|
(40,000 |
) |
|
|
- |
|
|
|
Ending
Balance
|
|
$ |
1,145,950 |
|
|
$ |
1,320,585 |
|
|
(8)
Acquisitions
On July
1, 2008, the Company acquired certain assets of World Venture Limited (“World
Venture”), a network storage software business based in Hong Kong, at an
aggregate purchase price of $1.7 million including transaction costs. The
Company has accounted for the acquisition under the purchase method of
accounting and the assets acquired have been included in our condensed
consolidated financial statements at fair value, including acquired intangible
assets with estimated useful lives of three years. The excess of the purchase
price over the fair value of the net assets acquired was classified as
goodwill on the Company’s consolidated balance sheets.
The
following table summarizes the allocation
of the purchase price of World Venture on July 1, 2008. The Company obtained a
valuation of certain acquired tangible and intangible assets and has finalized
the allocations below to reflect such valuations. In addition, net assets
acquired have been finalized to reflect all adjustments identified during the
year of acquisition.
|
|
|
Value
at
|
|
|
|
|
July
1, 2008
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase
price, including transaction costs
|
|
$ |
1,716,000 |
|
|
Net
assets acquired
|
|
|
(23,000 |
) |
|
Intellectual
property (estimated useful life, 3 years)
|
|
|
(467,000 |
) |
|
Customer
contracts (estimated useful life, 3 years)
|
|
|
(589,000 |
) |
|
|
|
|
|
|
|
Goodwill,
including transaction costs (indefinite lived)
|
|
$ |
637,000 |
|
The
Company’s identifiable intangible assets, customer contracts and intellectual
property, have a weighted average useful life of three years. During the three
months ended March 31, 2009, the Company recorded amortization expense of
$38,933 and $49,050 related to intellectual property and customer contracts,
respectively. Total accumulated amortization expense recorded at March 31, 2009
related to intellectual property and customer contracts totaled $116,800 and
$147,150, respectively. Goodwill is not amortized for book or tax
purposes.
Item
2. Management’s Discussion and Analysis
of Financial Condition and Results of Operations
The
following Management’s Discussion and Analysis of Financial Condition and
Results of Operations contains “forward-looking statements” within the meaning
of Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. These forward-looking statements can be
identified by the use of predictive, future-tense or forward-looking
terminology, such as “believes,” “anticipates,” “expects,” “estimates,” “plans,”
“may,” “intends,” “will,” or similar terms. Investors are cautioned
that any forward-looking statements are not guarantees of future performance and
involve significant risks and uncertainties, and that actual results may differ
materially from those projected in the forward-looking statements. The following
discussion should be read together with the consolidated financial statements
and notes to those financial statements included elsewhere in this
report.
OVERVIEW
Our
revenues for the first quarter of 2009 met our expectations and declined only
slightly from the first quarter of 2008, even with the difficult economic
conditions. Net cash flows from operations remained positive and we
continued to invest in our business by increasing both human capital and the
equipment necessary for further growth.
Revenues
for the first quarter of 2009 decreased 4% to $21.0 million compared with
revenues of $21.8 million in the first quarter of 2008.
Revenues
from our resellers increased compared with the first quarter of 2008 while
revenues from our OEMs declined. For the quarter, 64% of our revenues came from
resellers. We have always expected an increase in the percentage of revenue from
our channel sales as our business grows and matures. It was intended
that our agreements with OEMs would provide us with early market exposure and
sales, followed by an increase in the licensing of FalconStor-branded software
through our resellers. We anticipate that this trend will continue and that
revenues from our resellers will continue to be the majority of our
revenues. Revenues from the channel grew compared with the same
period in 2008 in both our Asia-Pacific region and our Europe, Middle East and
Africa region. Revenues from channel sales declined compared with the same
period in 2008 in our Americas region. We believe this decline was a
result of an increase in the amount of time taken by businesses in North America
to decide whether to invest in additional technology and in which technology
investments should be made. This lengthening of the sales cycle seems
to be a result of both the difficult economic conditions, which has resulted in
a tightening of money available for new technology spending, and more products
being available for consideration. We are still seeing healthy pipelines of
deals in all three regions.
EMC
Corporation accounted for 13% of our revenues in the quarter. We anticipate that
EMC will account for 10% or more of our revenues for the full year 2009, but not
20% or more of our revenue as it has in the past. Sun Microsystems accounted for
11% of our revenues in the quarter, despite significant cuts in Sun’s sales
force and the uncertainty caused by rumors and an official announcement
concerning Sun’s future. We continue to anticipate that Sun will account for 10%
or more of our revenues for the full year 2009. However, Oracle’s recent
announcement that it will acquire Sun makes it more difficult to predict the
revenues we will receive from Sun. Oracle has indicated that it intends to
continue the Sun product lines. Nevertheless, we expect that
uncertainty regarding the future of Sun’s products, and further cuts to Sun’s
sales force, could have a short-term negative effect on the amount of revenues
we receive from Sun. Our second fiscal quarter coincides with Sun’s fourth
quarter, and is typically a time when our revenues from Sun are high. There can
be no assurance that we will see this historical seasonality repeated this
year.
We had a
loss for the quarter. Our net loss for the quarter was $0.9 million,
compared with net income of $1.3 million in the first quarter of 2008. This net
loss includes $2.2 million of share-based compensation expense related to SFAS
No. 123(R). Our net loss includes a $0.5 million loss from “Interest and Other
Income.” This loss came primarily from foreign currency
losses. Because our sales in foreign currency have increased, in the
second quarter of fiscal 2009 we have begun to hedge our currency exposure to
minimize any fluctuation in our earnings. Of course, no hedging
program can entirely remove all risk related to changes in relative values of
the U.S. Dollar and the foreign currency in which some of our revenues are
recorded.
Even in
the challenging economic environment, cash flows from operations in the first
quarter of 2009 continued to be positive. We continue to believe that our
ability to fund our own growth internally bodes well for our long-term
success.
Deferred
revenue at March 31, 2009 increased 10%, compared with the balance at March 31,
2008. We consider the continued growth of our deferred revenue as an important
indicator of the success of our products. We believe that support and
maintenance renewals, which comprise the majority of our deferred revenue,
indicate satisfaction with our products and our support organization from our
end users.
Operating
expenses increased by $1.8 million, or 9%, compared with the first quarter of
2008. Operating expenses include $2.2 million in share-based compensation
expense for the first quarter of 2009, and $2.3 million in share-based
compensation expense for the first quarter of 2008. We will continue to monitor
expenses carefully, but we do not manage the Company on a quarter to quarter
basis and we will continue to invest in the long-term success of the
Company.
Our gross
margins decreased to 82% for the first quarter of 2009 from 85% for the first
quarter of 2008. The major contributors to the decline in gross margins were
compensation expense and the decrease in software license revenue.
At March
31, 2009, we had 521 employees, compared with 439 employees at March 31, 2008.
While we will be prudent, we plan to continue adding research and development
and sales and support personnel, both in the United States and worldwide, as
necessary. We also plan to continue investing in infrastructure, including both
equipment and property. We believe this continued investment is
necessary to keep growing our business.
While
other companies may be cutting headcount and foregoing investments in this
economy, we continue to build for the long term, rather than merely responding
to short-term conditions. We continue to operate the business with
the goal of long-term growth. We believe that our ability to continue to refine
our existing products and features and to introduce new products and features
will be the primary driver of additional growth among existing resellers, OEMs
and end users, and will drive our strategy to attempt to engage additional
reseller and OEM partners and to expand the FalconStor product lines offered by
these partners.
RESULTS
OF OPERATIONS – FOR THE THREE MONTHS ENDED MARCH 31, 2009 COMPARED WITH THE
THREE MONTHS ENDED MARCH 31, 2008.
Revenues
for the three months ended March 31, 2009 decreased 4% to $21.0 million compared
with $21.8 million for the three months ended March 31, 2008. Our operating
expenses increased 9% from $20.1 million for the three months ended March 31,
2008 to $21.8 million for the three months ended March 31, 2009. Included in our
operating expenses for the three months ended March 31, 2009 and 2008 was $2.2
million and $2.3 million, respectively, of share-based compensation expense in
accordance with SFAS No. 123(R). Net loss for the three months ended March 31,
2009 was $0.9 million compared with net income of $1.3 million for the three
months ended March 31, 2008. Included in our net (loss) income for the three
months ended March 31, 2009 and 2008, was an income tax benefit of $0.4 million
compared with an income tax provision of $1.0 million, respectively. Our 4%
decline in revenue for the three months ended March 31, 2009, as compared with
the same period in 2008, was primarily due to the current macroeconomic
environment. Beginning in the second half of 2008, our revenue growth slowed,
particularly software license revenues, as a result of the difficult economic
conditions encountered due to disruptions in the global financial markets,
specifically in North America, which we continued to experience during the first
three months of 2009. The declines in software license revenues were offset by
modest increases in our maintenance revenues. Due to our well-established
installed customer base, our revenue from maintenance agreements were not
significantly impacted as compared with our software license revenues as a
result of the downturn in information technology spending experienced beginning
in the second half of 2008 and continuing through the first three months of
2009. Revenue contribution from our OEM partners decreased in both absolute
dollars and as a percentage of total revenues for the three months ended March
31, 2009 as compared with the same period in 2008. Revenue from resellers,
distributors and direct end-users increased in both absolute dollars and as a
percentage of total revenue for the three months ended March 31, 2009 as
compared with the same period in 2008. Expenses increased in all aspects of our
business as we continue to invest in our future by increasing headcount both
domestically and internationally. To support our anticipated future growth, we
increased our worldwide headcount to 521 employees as of March 31, 2009, as
compared with 439 employees as of March 31, 2008. Although our continued
investments in the future through additional headcounts may impact our operating
profits and margins, we believe these investments are in line with our long-term
outlook. Finally, we continue to invest in our infrastructure by increasing our
capital expenditures, particularly with purchases of equipment for support of
our existing and future product offerings.
Revenues
|
|
|
Three
months ended March 31,
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Revenues:
|
|
|
|
|
|
|
|
Software
license revenue
|
|
$ |
13,650,062 |
|
|
$ |
15,318,919 |
|
|
Maintenance
revenue
|
|
|
6,088,784 |
|
|
|
5,114,247 |
|
|
Software
services and other revenue
|
|
|
1,282,239 |
|
|
|
1,373,494 |
|
|
|
|
|
|
|
|
|
|
|
|
Total
Revenues
|
|
$ |
21,021,085 |
|
|
$ |
21,806,660 |
|
|
|
|
|
|
|
|
|
|
|
|
Year-over-year
Percentage Growth
|
|
|
|
|
|
|
|
|
|
Software
license revenue
|
|
|
-11% |
|
|
|
47% |
|
|
Maintenance
revenue
|
|
|
19% |
|
|
|
18% |
|
|
Software
services and other revenue
|
|
|
-7% |
|
|
|
-12% |
|
|
|
|
|
|
|
|
|
|
|
|
Total
percentage growth
|
|
|
-4% |
|
|
|
33% |
|
Software
license revenue
Software
license revenue is comprised of software licenses sold through our OEMs,
value-added resellers and distributors to end-users and, to a lesser extent,
directly to end-users. These revenues are recognized when, among
other requirements, we receive a customer purchase order or a royalty report
summarizing software licenses sold and the software and permanent key codes are
delivered to the customer. We sometimes receive nonrefundable royalty
advances and engineering fees from some of our OEM partners. These
arrangements are evidenced by a signed customer contract, and the revenue is
recognized when the software product master is delivered and accepted, and the
engineering services, if any, have been performed.
Software
license revenue decreased 11% from $15.3 million for the three months ended
March 31, 2008 to $13.7 million for the three months ended March 31, 2009.
Software license revenue represented 65% of our total revenues for the three
months ended March 31, 2009 and 70% of our total revenues for the same period in
2008. Over the past several years, as we have experienced a broader market
acceptance of our software applications, the number of new product offerings and
increased demand for our products were the major contributors for our increase
in both our customer base as well as the number of software solutions our
installed customer base purchased. However, beginning in the second half of
2008, our software license revenues slowed, as a result of the difficult
macroeconomic environment and downturn in information technology spending which
we continued to experience during the first three months of 2009. Overall,
during the three months ended March 31, 2009, gross software license revenue
from our OEM partners decreased 28%, while gross software license revenues from
our direct end-users and resellers decreased 10% when compared to the same
period in 2008. We expect our software license revenue to grow in future
periods.
Maintenance
revenue
Maintenance
revenue is comprised of software maintenance and technical support services.
Revenues derived from maintenance and technical support contracts are deferred
and recognized ratably over the contractual maintenance term. Maintenance
revenues increased 19% from $5.1 million for the three months ended March 31,
2008 to $6.1 million for the three months ended March 31, 2009.
The major
factor behind the increase in maintenance revenue was an increase in the number
of maintenance and technical support contracts we sold. As we are in business
longer, and as we license more software to new customers and grow our installed
customer base, we expect the amount of maintenance and technical support
contracts we have to grow as well. We expect our maintenance revenue to continue
to increase primarily because (i) the majority of our new customers purchase
maintenance and support contracts, and (ii) the majority of our growing existing
customer base renewed their maintenance and support contracts after their
initial contracts expired.
Software
services and other revenue
Software
services and other revenues are comprised of professional services primarily
related to the implementation of our software, engineering services, and sales
of computer hardware. Professional services revenue is recognized in the period
that the related services are performed. Revenue from engineering services is
primarily related to customizing software product masters for some of our OEM
partners. Revenue from engineering services is recognized in the period in which
the services are completed. We have transactions in which we purchase hardware
and bundled this hardware with our software and sell this bundled solution to
our customer base. Our software is not essential to the functionality of the
bundled hardware. The amount of revenue allocated to the software and
hardware bundle is recognized as revenue in the period delivered provided all
other revenue recognition criteria have been met. We further separate the
software sales revenue from the hardware revenue for purposes of classification
in the unaudited condensed consolidated statements of operations in a systematic
and rational manner based on their deemed relative fair values Software services
and other revenue decreased 7% from $1.4 million for the three months ended
March 31, 2008 to $1.3 million for the three months ended March 31,
2009.
The
decrease in software services and other revenue was primarily due to a decrease
in computer hardware sales, which declined from $1.0 million for the three
months ended March 31, 2008 to $0.4 million for the same period in 2009. Our
professional services revenue increased to $0.8 million for the three months
ended March 31, 2009 from $0.4 million in the same period in 2008. The
professional services revenue will vary from year to year based upon (i) the
number of software license contracts sold during the year, (ii) the number of
our software license customers who elected to purchase professional services,
and/or (iii) the number of professional services contracts that were completed
during the year. We expect professional services revenues to vary from year to
year based upon the number of customers who elect to utilize our professional
services upon purchasing our software licenses. The hardware revenue will vary
from period to period based upon the number of customers who wish to have us
bundle hardware with our software for one complete solution.
Cost
of Revenues
|
|
|
Three
months ended March 31,
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Total
Revenues:
|
|
$ |
21,021,085 |
|
|
$ |
21,806,660 |
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of maintenance, software services
|
|
|
|
|
|
|
|
|
|
and
other revenue
|
|
$ |
3,806,043 |
|
|
$ |
3,314,488 |
|
|
Gross
Profit
|
|
$ |
17,215,042 |
|
|
$ |
18,492,172 |
|
|
|
|
|
|
|
|
|
|
|
|
Gross
Margin
|
|
|
82 |
% |
|
|
85 |
% |
Cost
of maintenance, software services and other revenue
Cost of
maintenance, software services and other revenues consists primarily of
personnel and other costs associated with providing software implementations,
technical support under maintenance contracts, training, amortization of
purchased and capitalized software and share-based compensation expense
associated with SFAS No. 123(R). Cost of maintenance, software services and
other revenues also includes the cost of hardware purchased that was
resold. Cost of
maintenance, software services and other revenues for the three months ended
March 31, 2009 increased by 15% to $3.8 million compared with $3.3 million for
the same period in 2008. The increase in cost of maintenance, software services
and other revenue was primarily due to (i) the increase in personnel and related
costs, and (ii) the increase in amortization related to purchased and
capitalized software, specifically related to the acquisition of World Venture
Limited on July 1, 2008 (see Note (8) Acquisitions to our unaudited
condensed consolidated financial statements for additional information) for the
three months ended March 31, 2009 as compared with the same period in 2008. As a
result of our increased sales from maintenance and support contracts, we
continued to hire additional employees to provide technical support services.
Our cost of maintenance, software services and other revenue will continue to
grow in absolute dollars as our revenues from these services also
increase.
Gross
profit decreased $1.3 million from $18.5 million for the three months ended
March 31, 2008 to $17.2 million for the three months ended March 31, 2009. Gross
margins decreased from 85% for the three months ended March 31, 2008 to 82% for
the three months ended March 31, 2009. The decreases in both our gross profit
and gross margins for the three months ended March 31, 2009, as compared with
the same period in 2008, were primarily due to the 4% decrease in our revenues
and our continued investments in the future through increasing our headcounts
which adversely impacted our operating profits and margins. Generally, our gross
margins may fluctuate based on several factors, including (i) revenue growth
levels, (ii) changes in personnel headcount and related costs, and (iii) our
product offerings and service mix of sales. Share-based compensation expense
included in the cost of maintenance, software services and other revenue
increased in absolute dollars to $0.4 million from $0.3 million for the three
months ended March 31, 2009 and March 31, 2008, respectively. Share-based
compensation expense was equal to 2% and 1% of revenue for the three months
ended March 31, 2009 and March 31, 2008, respectively.
Software
Development Costs
Software
development costs consist primarily of personnel costs for product development
personnel, share-based compensation expense associated with SFAS No. 123(R), and
other related costs associated with the development of new products,
enhancements to existing products, quality assurance and
testing. Software development costs increased 7% to $6.3 million for
the three months ended March 31, 2009 from $5.9 million in the same period in
2008. The major contributing factors to the increase in software development
costs were higher salary and personnel related costs as a result of increased
headcount to enhance and to test our core network storage software product and
the development of new innovative products, features and options. Share-based
compensation expense included in software development costs decreased in
absolute dollars to $0.7 million from $0.8 million for the three months ended
March 31, 2009 and March 31, 2008, respectively. Share-based compensation
expense included in software development costs was equal to 3% and 4% of revenue
for the three months ended March 31, 2009 and March 31, 2008, respectively. We
intend to continue recruiting and hiring product development personnel to
support our software development process.
Selling
and Marketing
Selling
and marketing expenses consist primarily of sales and marketing personnel and
related costs, share-based compensation expense associated with SFAS No. 123(R),
travel, public relations expense, marketing literature and promotions,
commissions, trade show expenses, and the costs associated with our foreign
sales offices. Selling and marketing expenses increased 6% to $9.5 million for
the three months ended March 31, 2009 from $9.0 million for the same period in
2008. The increase in selling and marketing expenses was primarily due to (i)
higher salary and personnel related costs as a result of increased sales and
marketing headcount and (ii) higher advertising and marketing related expenses
as a result of our new product offerings/enhancements, ongoing product branding
and related advertising and marketing of such initiatives. Share-based
compensation expense included in selling and marketing decreased in absolute
dollars to $0.9 million from $1.0 million for the three months ended March 31,
2009 and March 31, 2008, respectively. Share-based compensation expense included
in selling and marketing expenses was equal to 4% and 5% of revenue for the
three months ended March 31, 2009 and March 31, 2008, respectively. In addition,
we continued to hire new sales and sales support personnel and to expand our
worldwide presence to accommodate our anticipated future revenue growth. We
anticipate that as we continue to grow sales, our sales and marketing expenses
will continue to increase in support of such sales growth.
General
and Administrative
General
and administrative expenses consist primarily of personnel costs of general and
administrative functions, share-based compensation expense associated with SFAS
No. 123(R), public company related costs, directors and officers insurance,
legal and professional fees, and other general corporate overhead
costs. General and administrative expenses increased 17% to $2.2
million for the three months ended March 31, 2009 from $1.9 million for the same
period in 2008. Increased compensation and personnel related costs as a result
of increased headcount to support our general and administrative needs was
partially offset by decreases in professional fees and various administrative
expenses during the three months ended March 31, 2009 as compared with the same
period in 2008. Share-based compensation expense included in general and
administrative remained consistent in absolute dollars at $0.2 million for the
three months ended March 31, 2009 and March 31, 2008. Share-based compensation
expense included in general and administrative expenses was equal to 1% of
revenue for the three months ended March 31, 2009 and March 31, 2008,
respectively. Additionally, as we
continue to increase our headcount as part of our investment in the Company’s
future infrastructure, our overall general corporate overhead costs have
generally increased and are likely to continue to increase.
Interest
and Other (Loss) Income
We invest
our cash primarily in money market funds, commercial paper, government
securities, and corporate bonds. As of March 31, 2009, our cash, cash
equivalents, and marketable securities totaled $41.8 million, compared with
$56.8 million as of March 31, 2008. Interest and other (loss) income decreased
$1.0 million to ($0.5) million for the three month ended March 31, 2009,
compared with $0.6 million for the same period in 2008. The decrease in interest
and other (loss) income was due to a decrease in both our interest income as
well as other (loss) income. The decrease in interest income for the three
months ended March 31, 2009 compared with the same period in 2008 was primarily
related to (i) a decrease in our cash, cash equivalents and marketable
securities balances as a result of our repurchase of 6.2 million shares of our
common stock at a total cost of $35.4 million since January 1, 2008, and (ii)
lower interest rates on average cash balances invested during the three months
ended March 31, 2009, as a result of the U.S. banking liquidity crisis and
difficult macroeconomic environment, as compared with the same period in 2008.
The decreases in other (loss) income was primarily related to other
non-operating expenses, particularly, (i) realized losses of $40,000 on auction
rate securities (see Note (7) Fair Value Measurements to
our unaudited condensed consolidated financial statements for additional
information) and (ii) foreign currency losses of $0.6 million for the three
months ended March 31, 2009 as compared with a foreign currency gain of $7,000
for the same period in 2008.
Income
Taxes
Our provision for income taxes consists
of U.S., state and local and foreign taxes in amounts necessary to align our
year-to-date tax provision with the effective rate that we expect to achieve for
the full year. For the three months ended March 31, 2009, we recorded an income
tax benefit of $427,649 as compared with an income tax provision of $978,919 for
the same period in 2008. The decline in the provision for income taxes was
primarily attributable to our pre-tax loss of $1.3 million for the three months
ended March 31, 2009 as compared with pre-tax income of $2.3 million for the
same period in 2008. In addition, our effective tax rate decreased to 33% for
the three months ended March 31, 2009 as compared with 42% in the same period in
2008.
As of January 1, 2008, we
had approximately $5.1 million of federal net operating loss carryforwards
available to offset future taxable income. These net operating loss
carryforwards related to excess compensation deductions from previous year’s
exercises of stock options and during 2008, we utilized all of our net loss
carryforwards, the benefits of which were credited to
additional-paid-in-capital. As of March 31, 2009 and December 31, 2008, our
deferred tax assets, net of a deferred tax liabilities and valuation allowance,
were $10.6 million and $10.0 million, respectively.
Critical
Accounting Policies and Estimates
Our critical accounting policies and
estimates are those related to revenue recognition, accounts receivable
allowances, deferred income taxes, accounting for share-based compensation
expense, acquisitions, goodwill and other intangible assets, and fair value
measurements.
Revenue Recognition. We
recognize revenue in accordance with the provisions of Statement of Position
97-2, Software Revenue
Recognition, as amended. Software license revenue is
recognized only when pervasive evidence of an arrangement exists and the fee is
fixed and determinable, among other criteria. An arrangement is
evidenced by a signed customer contract for nonrefundable royalty advances
received from OEMs or a customer purchase order or a royalty report summarizing
software licenses sold for each software license resold by an OEM, distributor
or solution provider to an end user. The software license fees are fixed and
determinable as our standard payment terms range from 30 to 90 days, depending
on regional billing practices, and we have not provided any of our customers
extended payment terms. When a customer licenses software together with the
purchase of maintenance, we allocate a portion of the fee to maintenance for its
fair value based on the contractual maintenance renewal rate.
Accounts Receivable. We review
accounts receivable to determine which are doubtful of collection due to product
returns and creditworthiness of customers. In making the
determination of the appropriate allowance for uncollectible accounts and
returns, we consider (i) historical return rates, (ii) specific past due
accounts, (iii) analysis of our accounts receivable aging, (iv) customer payment
terms, (v) historical collections, write-offs and returns, (vi) changes in
customer demand and relationships, and (vii) concentrations of credit risk and
customer credit worthiness. Historically, we have experienced a somewhat
consistent level of write-offs and returns as a percentage of revenue due to our
customer relationships, contract provisions and credit assessments. Changes in
the product return rates; credit worthiness of customers; general economic
conditions and other factors may impact the level of future write-offs, revenues
and our general and administrative expenses.
Deferred Income Taxes. Consistent
with the provisions of SFAS No. 109, we regularly estimate our ability to
recover deferred tax assets, and report such deferred tax assets at the amount
that is determined to be more-likely-than-not recoverable. We also have to
estimate our income taxes in each of the taxing jurisdictions in which we
operate. This process involves estimating our current tax expense together with
assessing any temporary differences resulting from the different treatment of
certain items, such as the timing for recognizing revenue and expenses for tax
and accounting purposes, as well as estimating foreign tax credits. These
differences may result in deferred tax assets and liabilities, which are
included in our consolidated balance sheet. We are required to assess the
likelihood that our deferred tax assets, which include temporary differences
that are expected to be deductible in future years, will be recoverable from
future taxable income or other tax planning strategies. If recovery is not
likely, we have to provide a valuation allowance based on our estimates of
future taxable income in the various taxing jurisdictions, and the amount of
deferred taxes that are ultimately realizable. The provision for current and
deferred taxes involves evaluations and judgments of uncertainties in the
interpretation of complex tax regulations. This evaluation considers several
factors, including an estimate of the likelihood of generating sufficient
taxable income in future periods, the effect of temporary differences, the
expected reversal of deferred tax liabilities, past and projected taxable
income, and available tax planning strategies. As of March 31, 2009 and December
31, 2008, our deferred tax assets, net of deferred tax liabilities and valuation
allowance, were $10.6 million and $10.0 million, respectively.
Accounting for Share-Based
Payments. As discussed further in Note (2) Share-Based Payment
Arrangements to our unaudited consolidated financial statements, we
account for stock-based awards under SFAS No. 123(R).
We have used and expect to continue to
use the Black-Scholes option-pricing model to compute the estimated fair value
of share-based compensation expense. The Black-Scholes option-pricing model
includes assumptions regarding dividend yields, expected volatility, expected
option term and risk-free interest rates. The assumptions used in computing the
fair value of share-based compensation expense reflect our best estimates, but
involve uncertainties relating to market and other conditions, many of which are
outside of our control. We estimate expected volatility based primarily on
historical daily price changes of our stock and other factors. The expected
option term is the number of years that we estimate that the stock options will
be outstanding prior to exercise. The estimated expected term of the stock
awards issued after December 31, 2007 was determined pursuant to SEC Staff
Accounting Bulletin (“SAB”) No. 110. The expected term of the awards issued
prior to January 1, 2008 was determined using the “simplified method” prescribed
in SAB No. 107. Additionally, we estimate forfeiture rates based primarily
upon historical experiences, adjusted when appropriate for known events or
expected trends. We may adjust share-based compensation expense on a quarterly
basis for changes to our estimate of expected equity award forfeitures based on
our review of these events and trends, and recognize the effect of adjusting the
forfeiture rate for all expense amortization after January 1, 2006, in the
period in which we revised the forfeiture estimate. If other assumptions or
estimates had been used, the share-based compensation expense that was recorded
for the three months ended March 31, 2009 and 2008 could have been materially
different. Furthermore, if different assumptions or estimates are used in future
periods, share-based compensation expense could be materially impacted in the
future.
Acquisitions. We account for
acquisitions using the purchase method of accounting as required by SFAS No.
141(R), Business
Combinations. Under SFAS No. 141(R), the acquiring company allocates the
purchase price of the assets acquired and liabilities assumed based on their
estimated fair values at the date of acquisition, including intangible assets
that can be identified. The purchase price in excess of the fair value of the
net assets and liabilities is recorded as goodwill. Among other sources of
relevant information, we use independent appraisals or other valuations to
assist in determining the estimated and final recorded fair value of assets and
liabilities acquired. As discussed further in Note (8) Acquisitions, in our
unaudited condensed consolidated financial statements, during the third quarter
of 2008, we purchased certain assets of World Venture Limited for an aggregate
purchase price of $1.7 million including transaction and closing costs, and
recorded approximately $0.6 million of goodwill as a result of the related fair
value appraisals performed.
Goodwill and Other Intangible
Assets. As discussed further in Note (1) Summary of Significant Accounting
Policies to our unaudited condensed consolidated financial statements, we
account for goodwill and other intangible assets as required by SFAS No. 142,
Goodwill and Other Intangible
Assets and SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS No. 142 requires an
impairment-only approach to accounting for goodwill and other intangibles with
an indefinite life. Absent any prior indicators of impairment, we perform an
annual impairment analysis during the fourth quarter of our fiscal
year.
As of each March 31, 2009 and December
31, 2008, we had $4.2 million of goodwill and $1.2 million and $1.4 million (net
of amortization) respectively, of other identifiable intangible assets. We do
not amortize goodwill, but we assess for impairment at least annually and more
often if a trigger event occurs. We amortize identifiable intangible assets over
their estimated useful lives, which typically is three-years. We evaluate the
recoverability of goodwill using a two-step process based on an evaluation of
the reporting unit. The first step involves a comparison of a reporting unit’s
fair value to its carrying value. In the second step, if the reporting unit’s
carrying value exceeds its fair value, we compare the goodwill’s implied fair
value and its carrying value. If the goodwill’s carrying value exceeds its
implied fair value, we recognize an impairment loss in an amount equal to such
excess. We evaluate the recoverability of other identifiable intangible assets
whenever events or changes in circumstances indicate that its carrying value may
not be recoverable. Such events include significant adverse changes in business
climate, several periods of operating or cash flow losses, forecasted continuing
losses or a current expectation that an asset or asset a group will be disposed
of before the end of its useful life. As of March 31, 2009 and December 31,
2008, we did not record any impairment charges on either our goodwill or other
identifiable intangible assets.
Fair Value Measurement. As
discussed further in Note (7) Fair Value Measurements, to
our unaudited condensed consolidated financial statements, we determine fair
value measurements of both financial and nonfinancial assets and liabilities in
accordance with SFAS No. 157, as amended.
In the
current market environment, the assessment of the fair value of our marketable
securities, specifically our debt instruments, can be difficult and subjective.
The volume of trading activity of certain debt instruments has declined, and the
rapid changes occurring in the current financial markets can lead to changes in
the fair value of financial instruments in relatively short periods of time.
SFAS No. 157, as emended, establishes three levels of inputs that may be
used to measure fair value. Each level of input has different levels of
subjectivity and difficulty involved in determining fair value.
Level 2 - instruments include
observable inputs other than Level 1 prices, such as quoted prices for identical
instruments in markets with insufficient volume or infrequent transactions (less
active markets), issuer credit ratings, non-binding market consensus prices that
can be corroborated with observable market data, model-derived valuations in
which all significant inputs are observable or can be derived principally from
or corroborated with observable market data for substantially the full term of
the assets or liabilities, or quoted prices for similar assets or liabilities.
These Level 2 instruments require more management judgment and subjectivity
compared to Level 1 instruments.
Level 3 - instruments include
unobservable inputs to the valuation methodology that are significant to the
measurement of fair value of assets or liabilities. The determination of fair
value for Level 3 instruments requires the most management judgment and
subjectivity. Most of our marketable debt instruments classified as Level 3 are
valued using a undiscounted cash flow analysis, non-binding market consensus
price and/or a non-binding broker quote, all of which we corroborate with
unobservable data. Non-binding market consensus prices are based on the
proprietary valuation models of
pricing providers or brokers. These valuation models incorporate a number of
inputs, including non-binding and binding broker quotes; observable market
prices for identical and/or similar securities; and the internal assumptions of
pricing providers or brokers that use observable market inputs, and to a lesser
degree non-observable market inputs. Adjustments to the fair value of
instruments priced using non-binding market consensus prices and non-binding
broker quotes, and classified as Level 3, were not significant for the three
months ended March 31, 2009 or for the year-ended December 31,
2008.
Other-Than-Temporary
Impairment
After
determining the fair value of our available-for-sale debt instruments, gains or
losses on these investments are recorded to other comprehensive income, until
either the investment is sold or we determine that the decline in value is
other-than-temporary. Determining whether the decline in fair value is
other-than-temporary requires management judgment based on the specific facts
and circumstances of each investment. For investments in debt instruments, these
judgments primarily consider the financial condition and liquidity of the
issuer, the issuer’s credit rating, and any specific events that may cause us to
believe that the debt instrument will not mature and be paid in full; and our
ability and intent to hold the investment to maturity. Given the current market
conditions, these judgments could prove to be wrong, and companies with
relatively high credit ratings and solid financial conditions may not be able to
fulfill their obligations.
As of
March 31, 2009, our investments in marketable securities included $1.5
million (at par value) of available-for-sale auction rate securities. During the
three months ended March 31, 2009, we recognized $40,000 in other-than-temporary
impairments on our available-for-sale auction rate securities ($40,000
cumulatively). As of March 31, 2009, our cumulative unrealized losses
related to our auction rate securities classified as available-for-sale was
$314,050 ($333,055 as of December 31, 2008).
Impact
of Recently Issued Accounting Pronouncements
See Item
1 of Part 1, Condensed Consolidated Financial Statements – Note (1) Summary of Significant Accounting
Policies – New Accounting Pronouncements.
LIQUIDITY
AND CAPITAL RESOURCES
|
|
|
Three
months ended March 31,
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Cash
provided by (used in):
|
|
|
|
|
|
|
|
Operating
activities
|
|
$ |
3,275,785 |
|
|
$ |
8,502,710 |
|
|
Investing
activities
|
|
|
(862,240 |
) |
|
|
4,933,523 |
|
|
Financing
activities
|
|
|
(1,520,741 |
) |
|
|
(13,521,017 |
) |
|
Effect
of exchange rate changes
|
|
|
(488,268 |
) |
|
|
268,310 |
|
|
|
|
|
|
|
|
|
|
|
|
Net
increase in cash and cash equivalents
|
|
$ |
404,536 |
|
|
$ |
183,526 |
|
Our
principal sources of liquidity are cash flows generated from operations and our
cash, cash equivalents, and marketable securities balances. Our cash and cash
equivalents and marketable securities balances as of March 31, 2009 totaled
$41.8 million, compared with $42.8 million as of December 31, 2008. Cash and
cash equivalents totaled $22.8 million and marketable securities totaled $19.0
million at March 31, 2009. As of December 31, 2008, we had $22.4 million in cash
and cash equivalents and $20.4 million in marketable securities.
During
the three months ended March 31, 2009, we continued making investments in our
infrastructure to support our current and long-term growth. We increased our
total number of employees as well as our investments in property and equipment
to support our long-term growth. As we prepare for the future, we will continue
to make investments in property and equipment and we will continue to increase
our headcount. In the past, we have also used cash to purchase software licenses
and to make acquisitions. We will continue to evaluate potential software
license purchases and acquisitions and if the right opportunity presents itself,
we may continue to use our cash for these purposes. However, as of the date of
this filing, we have no agreements, commitments or understandings with respect
to any such acquisitions.
We
currently do not have any debt and our only significant commitments are related
to our office leases.
In
October 2001, our Board of Directors authorized the repurchase of up to 2
million shares of our outstanding common stock. On February 6, 2008
and July 22, 2008, our Board of Directors increased the authorization to
repurchase our outstanding common stock by 3 million shares and 3 million
shares, respectively, to 8 million shares in the aggregate. On February 4, 2009,
our Board of Directors again increased the authorization to repurchase our
outstanding common stock from 8 million shares to 14 million shares in the
aggregate. During the three months ended March 31, 2009, we repurchased 566,885
shares at an aggregate purchase price of $1.5 million. During the three months
ended March 31, 2008, we repurchased 1,760,000 shares at an aggregate purchase
price of $14.5 million. Since October 2001, we have repurchased a total of
7,390,935 shares at an aggregate purchase price of $44.5 million. As of March
31, 2009, we had the authorization to purchase an additional 6,609,065 shares of
our common stock based upon our judgment and market conditions.
Net cash provided by operating
activities totaled $3.3 million for the three months ended March 31, 2009,
compared with net cash provided by operating activities of $8.5 million for the
same period in 2008. The decrease in net cash provided by operating
activities during the three months ended March 31, 2009, as compared with the
same period in 2008, was primarily the result of recording a net loss of $0.9
million as compared with a net income of $1.3 million, respectively, adjusted
for: (i) the impact of non-cash charges, particularly relating to the provision
for doubtful accounts and deferred income taxes; and (ii) adjustments for net
changes in operating assets and liabilities, particularly changes in our
accounts receivable, deferred revenues, and accrued expenses. These amounts were
primarily offset by the adjustment for the impact from the tax benefits
recognized as a result of excess stock-based compensation deductions and
exercises of stock options. SFAS No. 123(R) requires tax benefits relating to
excess stock-based compensation deductions to be presented as cash outflows from
operating activities. We recognized tax benefits related to stock-based
compensation deductions of $1.0 million for the three months ended March 31,
2008. There were no adjustments for the impact of non-cash income tax benefits
for the three months ended March 31, 2009.
Net cash
used in investing activities was $0.9 million for the three months ended March
31, 2009, compared with net cash provided by investing activities of $4.9
million for the same period in 2008. Included in investing activities for both
the three months ended March 31, 2009 and March 31, 2008 are the sales and
purchases of our marketable securities. These represent the sales, maturities
and reinvestment of our marketable securities. The net cash provided by
investing activities from the net sales (purchases) of securities was $1.3
million for the three months ended March 31, 2009, and $6.2 million for the same
period in 2008. These amounts will fluctuate from period to period depending on
the maturity dates of our marketable securities. The cash used to purchase
property and equipment was $1.1 million and $1.2 million for the three months
ended March 31, 2009 and 2008, respectively. The cash used to purchase software
licenses was $1.0 million for the three months ended March 31, 2009. We did not
purchase any software licenses during the three months ended March 31, 2008. We
continually evaluate potential software licenses and we may continue to make
similar investments if we find opportunities that would benefit our business. We
anticipate continued capital expenditures as we continue to invest in our
infrastructure to support our ongoing future growth and expansion both
domestically and internationally.
Net cash
used in financing activities was $1.5 million and $13.5 million for the three
months ended March 31, 2009 and March 31, 2008, respectively. Cash outflows from
financing activities result from the repurchase of our outstanding common stock.
During the three months ended March 31, 2009, we repurchased 566,885 shares of
our common at an aggregate purchase price of $1.5 million. During the three
months ended March 31, 2008, we repurchased 1,760,000 shares of our common at an
aggregate purchase price of $14.5 million. Cash inflows from financing
activities primarily result from the proceeds received from the exercise of
stock options. We did not have any material cash inflows from the proceeds of
exercise of stock options for three months ended March 31, 2009. There were no
stock options exercised during the three months ended March 31, 2008. During the
three months ended March 31, 2008, cash inflows from financing activities was
also impacted by the tax benefits recognized as a result of excess stock-based
compensation deductions and exercises of stock options. SFAS No. 123(R) requires
that tax benefits relating to excess stock-based compensation deductions be
presented as cash inflows from financing activities. We recognized tax benefits
related to stock-based compensation deductions of $1.0 million for the three
months ended March 31, 2008. There were no tax benefits related to stock-based
compensation deductions recognized during the three months ended March 31,
2009.
As
discussed in Note (7) Fair Value Measurements, to
our unaudited condensed consolidated financial statements, we adopted the
provisions of SFAS No. 157, as amended, effective January 1, 2008. We
utilize unobservable (Level 3) inputs in determining the fair value of
auction rate securities we hold totaling $1.5 million as of March 31, 2009
and December 31, 2008.
As of
March 31, 2009 and December 31, 2008, $1.5 million (at par value) of our
investments were comprised of auction rate securities. Liquidity for these
auction rate securities is typically provided by an auction process, which
allows holders to sell their notes, and resets the applicable interest rate at
pre-determined intervals. During the first quarter of 2008, we began
experiencing failed auctions on auction rate securities. An auction failure
means that the parties wishing to sell their securities could not be matched
with an adequate volume of buyers. In the event that there is a failed auction,
the indenture governing the security requires the issuer to pay interest at a
contractually defined rate that is generally above market rates for other types
of similar short-term instruments. The securities for which auctions have failed
will continue to accrue interest at the contractual rate and continue to reset
the next auction date every 28 or 35 days until the auction succeeds, the
issuer calls the securities, or they mature. Because there is no assurance that
auctions for these securities will be successful in the near term, and due to
our ability and intent to hold these securities to maturity, the auction rate
securities were classified as long-term investments in our unaudited condensed
consolidated balance sheet at March 31, 2009 and December 31, 2008,
respectively.
Our
auction rate securities are classified as available-for-sale securities and are
reflected at fair value. In prior periods during the auction process, which took
place every 28-35 days for most securities, quoted market prices were
readily available, which would qualify the securities as Level 1 under SFAS
No. 157. However, due to events in the credit markets beginning in the second
half of 2008, and continuing into 2009, the auction events for most of these
instruments failed and, therefore, we have determined the estimated fair values
of these securities utilizing a discounted cash flow analysis or other type of
valuation model as of March 31, 2009 and December 31, 2008. These analyses
consider, among other items, the collateral underlying the security, the
creditworthiness of the issuer, the timing of the expected future cash flows,
including the final maturity, associated with the securities, and an assumption
of when the next time the security is expected to have a successful auction.
These securities were also compared, when possible, to other observable and
relevant market data, which is limited at this time. Due to these events, we
reclassified these instruments as Level 3 commencing in 2008 and continue
to do so in 2009.
During
the period ending March 31, 2009, we recorded $40,000 in other-than-temporary
impairments on our auction rate securities and a cumulative temporary decline in
fair value of approximately $314,050 in accumulated other comprehensive loss. As
of December 31, 2008, the total losses related to our auction rate securities
recorded in accumulated other comprehensive loss totaled $333,055. During the
period ending March 31, 2009, the valuation models used to determine the fair
value of these auction rate securities, as described above, indicated that two
of three of our investments recovered a portion of their decline in fair value
as compared with the valuation models at December 31, 2008. However, one of the
three investments experienced a further decline in fair value as compared with
December 31, 2008. We determined the decline in the fair value of this
particular investment was primarily due to a downgrade in the credit rating of
certain underlying subordinate securities within the auction rate security. As a
result, we determined a portion of the overall decline in fair value of the
auction rate security to be other-than-temporary due to the creditworthiness of
the underlying securities. Any future fluctuation in the fair value related to
any of the auction rate securities that we deem to be temporary, including any
recoveries of previous write-downs, would be recorded to accumulated other
comprehensive loss, net of tax. Finally, with the exception of the
creditworthiness of one of our auction rate securities, we believe that the
remaining temporary declines in fair value are primarily due to liquidity
concerns and not to the creditworthiness of the remaining underlying assets,
because the majority of the underlying securities are almost entirely backed by
the U.S. Government. However, if at any time in the future that we
determine that a valuation adjustment is other-than-temporary, we will record a
charge to earnings in the period of determination.
Finally,
our holdings of auction rate securities represented approximately 4% of our cash
equivalents, and marketable securities balance at both March 31, 2009 and
December 31, 2008, respectively, which we believe allows us sufficient time for
the securities to return to full value or to be refinanced by the issuer.
Because we believe that the decline in fair value deemed to be temporary is
primarily due to liquidity issues in the credit markets, any difference between
our estimate and an estimate that would be arrived at by another party would
have no impact on our earnings, since such difference would also be recorded to
accumulated other comprehensive loss. We will continue to re-evaluate each of
these factors as market conditions change in subsequent periods.
We
currently do not have any debt and our only material cash commitments are
related to our office leases. We have an operating lease covering our corporate
office facility that expires in February 2012. We also have several operating
leases related to offices in the United States and foreign countries. The
expiration dates for these leases range from 2009 through 2012. Refer to Note
(5) Commitments and
Contingencies to our unaudited condensed consolidated financial
statements.
We
believe that our current balance of cash, cash equivalents and marketable
securities, and expected cash flows from operations, will be sufficient to meet
our cash requirements for at least the next twelve months.
Off-Balance
Sheet Arrangements
As of
March 31, 2009 and December 31, 2008, we had no off-balance sheet
arrangements.
Item 3. Qualitative and
Quantitative Disclosures About Market Risk
Interest Rate Risks. Our
cash, cash equivalents and marketable securities aggregated $41.8 million as of
March 31, 2009. Our exposure to market risk for changes in interest rates
relates primarily to our investment portfolio. All of our cash equivalent and
marketable securities are designated as available-for-sale and, accordingly, are
presented at fair value on our consolidated balance sheets. We regularly assess
these risks and have established policies and business practices to manage the
market risk of our marketable securities. We generally invest our
excess cash in investment grade short- to intermediate-term fixed income
securities and AAA-rated money market funds. Fixed rate securities may have
their fair market value adversely affected due to a rise in interest rates, and
we may suffer losses in principal if forced to sell securities that have
declined in market value due to changes in interest rates. Due to the short-term
nature of the majority of our investments and the fact that approximately 50% of
our investments are in money market funds, we do not believe we are subject to
any material interest rate risks on our investment balances levels at March 31,
2009.
Foreign Currency Risk. We
have several offices outside the United States. Accordingly, we are subject to
exposure from adverse movements in foreign currency exchange rates. For the
three months ended March 31, 2009 and full year ended December 31, 2008,
approximately 48% and 40%, respectively, of our sales were from outside the
United States. Not all of these transactions were made in foreign currencies.
Our primary exposure is to fluctuations in exchange rates for the U.S. dollar
versus the Euro, Japanese yen, the New Taiwanese Dollar, Korean won, and to a
lesser extent the Canadian dollar and the Australian dollar. Changes in exchange
rates in the functional currency for each geographic area’s revenues are
primarily offset by the related expenses associated with such revenues. However,
changes in exchange rates of a particular currency could impact the
remeasurement of such balances on our balance sheets.
If
foreign currency exchange rates were to change adversely by 10% from the levels
at March 31, 2009, the effect on our results before taxes from foreign currency
fluctuations on our balance sheet would be approximately $0.9 million. During
the second quarter of 2009, we entered into foreign currency hedges to minimize
our exposure to changes in certain foreign currency exchange rates on the
balance sheet. The above analysis disregards the possibility that rate for
different foreign currencies can move in opposite directions and that losses
from one currency may be offset by gains from another currency.
Item 4. Controls and
Procedures
Under the supervision and with the
participation of our management, including our principal executive officer and
principal financial officer, we have evaluated the effectiveness of the design
and operation of our disclosure controls and procedures as of the end of the
period covered by this report, and, based on their evaluation, our principal
executive officer and principal financial officer have concluded that these
controls and procedures are effective. No changes in the Company's internal
controls over financial reporting occurred during the quarter ended March
31, 2009, that have materially affected, or are reasonably likely to
materially affect, the Company’s internal controls over financial
reporting.
Disclosure controls and procedures are
procedures that are designed to ensure that information required to be disclosed
by us in the reports that we file or submit under the Securities Exchange Act of
1934, as amended, is recorded, processed, summarized and reported, within the
time periods specified in the Securities and Exchange Commission's rules and
forms. Disclosure controls and procedures include, without limitation, controls
and procedures designed to ensure that information required to be disclosed by
us in the reports that we file under the Exchange Act is accumulated and
communicated to our management, including our principal executive officer and
principal financial officer, as appropriate to allow timely decisions regarding
required disclosure.
PART
II. OTHER
INFORMATION
Item 1. Legal
Proceedings
We are
subject to various legal proceedings and claims, asserted or unasserted, which
arise in the ordinary course of business. While the outcome of any such matters
cannot be predicted with certainty, we believe that such matters will not have a
material adverse effect on our financial condition or operating
results.
We are
affected by risks specific to us as well as factors that affect all businesses
operating in a global market. The significant factors known to us that could
materially adversely affect our business, financial condition, or operating
results are set forth in Item 1A to our Annual Report on Form 10-K for the year
ended December 31, 2008 (the “2008 10-K”). The information below sets
forth additional risk factors or risk factors that have had material changes
since the 2008 10-K, and should be read in conjunction with Item 1A of the 2008
10-K.
We
are dependent on certain key customers and a significant portion of our
receivables is concentrated with three customers.
We tend
to have one or more customers account for 10% or more of our revenues during
each fiscal quarter. For the quarter ended March 31, 2009, two
customers together accounted for 24% of our revenues. Both of these customers,
EMC Corporation and Sun Microsystems, are OEM customers. While we believe that
we will continue to receive revenues from these customers, our agreements do not
have any minimum sales requirements and we cannot guarantee continued revenue.
If our contracts with these customers terminate, or if the volume of sales from
these customers significantly declines, it would have a material adverse effect
on our operating results.
In
addition, as of March 31, 2009, three customers together accounted for a total
of 20% of our outstanding receivables. While we currently have no reason to
doubt the collectibility of these receivables, a business failure or
reorganization by any of these customers could harm our ability to collect these
receivables and if we were unable to collect these receivables, it would have a
material adverse effect on our cash flow.
The
change in control of Sun Microsystems could hurt our short-term and/or long-term
results.
In April, 2009, Oracle Corporation and
Sun Microsystems announced that they had entered into an agreement for Oracle to
purchase Sun. Oracle and Sun have stated that they expect the transaction to
close by July 31, 2009. Oracle has publicly stated that it intends to retain
Sun’s existing hardware lines, which would include the Sun products that
incorporate our software and for which we receive license fees from
Sun. However, there can be no assurance that Oracle will continue to
sell the Sun products for which we receive royalties or that Oracle will promote
these products to the same degree as Sun has promoted them. In addition, it is
expected that Oracle will make cuts in the combined Oracle-Sun workforce. Oracle
could cut the marketing and sales personnel most familiar with the Sun products
for which we receive royalties. Last, uncertainty concerning the future of the
Sun products could depress sales of those products in the short term, even if
the products are ultimately offered for the long term. In all of
these cases, our revenues could suffer which could negatively impact our
short-term and/or long-term results.
Foreign
currency fluctuations may impact our revenues.
Our licenses and services in Japan are
sold in Yen. Our licenses and services in the Republic of Korea are sold in Won.
Our licenses and services in Taiwan are sold in the New Taiwanese Dollar. Many
of the sales of our licenses and services in Europe, the Middle East and Africa,
are made in European Monetary Units (“Euros”).
Changes in economic or political
conditions globally and in any of the countries in which we operate could result
in exchange rate movements, new currency or exchange controls or other
restrictions being imposed on our operations.
Fluctuations
in the value of the U.S. dollar may adversely affect our results of operations.
Because our consolidated financial results are reported in U.S. dollars,
translation of sales or earnings generated in other currencies into U.S. dollars
can result in a significant increase or decrease in the reported amount of those
sales or earnings. Significant changes in the value of these foreign
currencies relative to the U.S. dollar could have a material adverse effect on
our financial condition or results of operations.
Fluctuations
in currencies relative to currencies in which our earnings are generated make it
more difficult to perform period-to-period comparisons of our reported results
of operations. For purposes of accounting, the assets and liabilities of our
foreign operations, where the local currency is the functional currency, are
translated using period-end exchange rates, and the revenues, expenses and cash
flows of our foreign operations are translated using average exchange rates
during each period.
In
addition to currency translation risks, we incur currency transaction risk
whenever we enter into either a purchase or a sales transaction using a currency
other than the local currency of the transacting entity. Given the volatility of
exchange rates, we cannot be assured we will be able to effectively manage our
currency transaction and/or translation risks. Volatility in currency exchange
rates may have a material effect on our financial condition or results of
operations. For the first quarter of 2009, we had a $0.6 million loss due to
currency rate fluctuations. While we have begun to hedge our currency risks, we
may continue to experience an impact on earnings as a result of foreign
currency exchange rate fluctuations.
In April, 2009, we began a program to
hedge some of our foreign currency risks. The hedging program will not remove
all downside risk and limits the gains we might otherwise receive from currency
fluctuations. There can be no assurance that we will be able to enter into
future currency hedges on terms acceptable to us.
We
have a significant number of outstanding options, the exercise of which would
dilute the then-existing stockholders’ percentage ownership of our common stock,
and a smaller number of restricted shares of stock, the vesting of which will
also dilute the then-existing stockholders’ percentage ownership of our common
stock.
As of
March 31, 2009, we had options to purchase 11,630,248 shares of our common stock
outstanding, and we had an aggregate of 1,304,307 outstanding restricted shares
and restricted stock units. If all of these outstanding options were exercised,
and all of the outstanding restricted stock and restricted stock units vested,
the proceeds to the Company would average $5.11 per share. We also had 771,450
shares of our common stock reserved for issuance under our stock plans with
respect to options (or restricted stock or restricted stock units) that have not
been granted. In addition, if, on July 1st of any calendar year in which our
2006 Incentive Stock Plan, as amended (the “2006 Plan”), is in effect, the
number of shares of stock to which options, restricted shares and restricted
stock units may be granted is less than five percent (5%) of the number of
outstanding shares of stock, then the number of shares of stock available for
issuance under the 2006 Plan shall be increased so that the number equals five
percent (5%) of the shares of stock outstanding. In no event shall the number of
shares of stock subject to the 2006 Plan in the aggregate exceed twenty million
shares, subject to adjustment as provided in the 2006 Plan. See Note (2) Share-Based Payment
Arrangements to our unaudited condensed consolidated financial
statements.
The
exercise of all of the outstanding options and/or the vesting of all outstanding
restricted shares and restricted stock units and/or the grant and exercise of
additional options and/or the grant and vesting of restricted stock and
restricted stock units would dilute the then-existing stockholders’ percentage
ownership of common stock, and any sales in the public market of the common
stock issuable upon such exercise could adversely affect prevailing market
prices for the common stock. Moreover, the terms upon which we would
be able to obtain additional equity capital could be adversely affected because
the holders of such securities can be expected to exercise or convert them at a
time when we would, in all likelihood, be able to obtain any needed capital on
terms more favorable than those provided by such securities.
Our
marketable securities portfolio could experience a decline in market value which
could materially and adversely affect our financial results.
As of March 31, 2009, we held
short-term and long-term marketable securities aggregating $19.0 million.
We invest in a mixture of corporate bonds, government securities and marketable
debt securities, the majority of which are high investment grade, and we limit
the amount of credit exposure through diversification and investment in highly
rated securities. However, investing in highly rated securities does not
entirely mitigate the risk of potential declines in market value. A further
deterioration in the economy, including further tightening of credit markets or
significant volatility in interest rates, could cause our marketable securities
to decline in value or could impact the liquidity of the portfolio. If market
conditions deteriorate significantly, our results of operations or financial
condition could be materially and adversely affected.
Unknown
Factors
Additional
risks and uncertainties of which we are unaware or which currently we deem
immaterial also may become important factors that affect us.
Item 2. Unregistered Sales of
Equity Securities and Use of Proceeds
Shares of
common stock repurchased during the quarter ended March 31, 2009:
|
|
|
|
|
|
Total
Number of
|
|
Maximum
Number
|
|
|
|
|
|
|
Shares
Purchased
|
|
of
Shares that May
|
|
|
Total
Number of
|
|
Average
Price
|
|
as
Part of Publicly
|
|
Yet
Be Purchased Under
|
|
|
Shares
Purchased
|
|
Paid
per Share
|
|
Announced
Plan
|
|
the
Plan at Month End
|
|
|
|
|
|
|
|
|
|
|
February
2009
|
250,000
|
|
$3.04
|
|
250,000
|
|
6,925,950
|
|
March
2009
|
316,885
|
|
$2.42
|
|
316,885
|
|
6,609,065
|
|
|
|
|
|
|
|
|
|
|
Total
|
566,885
|
|
$2.69
|
|
566,885
|
|
6,609,065
|
On
February 4, 2009, the Company’s Board of Directors increased its authorization
to repurchase the Company’s outstanding common stock from eight million shares
to fourteen million shares in the aggregate. As of March 31, 2009, the Company
had repurchased 7,390,935 shares since October 2001. The program has no
expiration date. See Note (4) Sock Repurchase Program to
our unaudited condensed consolidated financial statements for further
information.