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Borland Software 10-Q 2007 Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
OR
001-10824
(Commission File Number) Borland Software Corporation
(Exact Name of Registrant as Specified in its Charter)
20450 STEVENS CREEK BOULEVARD, SUITE 500
CUPERTINO, CALIFORNIA 95014 (Address of Principal Executive Offices) (Zip Code) Registrant’s Telephone Number, Including Area Code: (408) 863-2800
Not Applicable
(Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. YES þ NO o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated
filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o Accelerated filer þ Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). YES o NO þ
The number of shares of the registrant’s common stock, par value $0.01 per share, outstanding
as of July 31, 2007, the most recent practicable date prior to the filing of this report, was
72,802,182
BORLAND SOFTWARE CORPORATION FORM 10-Q
TABLE OF CONTENTS
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PART I
FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS
BORLAND SOFTWARE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value and share amounts, unaudited)
The accompanying notes are an integral part of these condensed consolidated financial statements.
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BORLAND SOFTWARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts, unaudited)
The accompanying notes are an integral part of these condensed consolidated financial statements.
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BORLAND SOFTWARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands, unaudited)
The accompanying notes are an integral part of these condensed consolidated financial statements.
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BORLAND SOFTWARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, unaudited)
The accompanying notes are an integral part of these condensed consolidated financial statements.
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BORLAND SOFTWARE CORPORATION
Notes to Condensed Consolidated Financial Statements (unaudited)
NOTE 1. BASIS OF PRESENTATION
The accompanying Borland Software Corporation (“Borland”) condensed consolidated financial
statements at June 30, 2007 and December 31, 2006, and for the three and six months ended June 30,
2007 and 2006, are unaudited and have been prepared in accordance with accounting principles
generally accepted in the United States (“GAAP”) for interim financial information and Rule 10-01
of Regulation S-X. Accordingly, they do not include all financial information and disclosures
required by GAAP for complete financial statements and certain information and footnote disclosures
normally included in financial statements prepared in accordance with GAAP have been condensed or
omitted. The unaudited interim condensed consolidated financial statements have been prepared on
the same basis as the annual consolidated financial statements and in the opinion of management,
reflect all adjustments, which include only normal recurring adjustments, necessary for a fair
statement of Borland’s financial position at June 30, 2007 and December 31, 2006, its results of
operations for the three and six months ended June 30, 2007 and 2006, and cash flows for the three
and six months ended June 30, 2007 and 2006.
The preparation of condensed consolidated financial statements in conformity with GAAP
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 reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates. The results of operations for interim periods are not
necessarily indicative of the results to be expected for any subsequent quarter or for the full
year. The condensed consolidated financial statements and related notes should be read in
conjunction with our audited financial statements included in our Annual Report on Form 10-K for
the fiscal year ended December 31, 2006, as filed with the Securities and Exchange Commission
(“SEC”) on March 15, 2007.
NOTE 2. STOCK-BASED COMPENSATION
We follow the fair value recognition provisions of SFAS No. 123 (revised 2004), “Share-Based
Payment” (“SFAS 123R”). We currently have in effect certain stock purchase plans, stock award
plans, and equity incentive plans as described in Note 11 of Notes to Consolidated Financial
Statements in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006. There
have been no material changes to such plans.
Stock-Based Compensation Expenses
The total stock-based compensation expense associated with Borland stock-based employee
compensation plans under SFAS 123R for the three and six months ended June 30, 2007 and 2006, was
as follows:
Stock Options
Option activity during the six months ended June 30, 2007, was as follows:
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The aggregate intrinsic value in the table above represents the total pre-tax intrinsic
value (the difference between Borland’s closing stock price on the last trading day of the second
quarter of fiscal 2007 and the exercise price, multiplied by the number of in-the-money options on
such date) that option holders would have received had all option holders exercised their options
on June 30, 2007. This amount has changed based on the fluctuation in the fair market value of
Borland’s stock. The total intrinsic value of options exercised for the three and six months ended
June 30, 2007 and June 30, 2006, was $0.1 million and $0.1 million, respectively.
Information regarding the stock options outstanding at June 30, 2007, is summarized below:
The weighted-average remaining contractual life for all exercisable stock options at June
30, 2007 was 4.91 years. As of June 30, 2007, the aggregate intrinsic value of the options
outstanding was $2.9 million and the aggregate intrinsic value of the options outstanding and
exercisable was $1.0 million.
As of June 30, 2007, Borland expects to recognize $11.2 million of total unrecognized
compensation cost related to stock options over a weighted-average period of 2.94 years.
Borland estimated the fair value of share-based payment awards using the Black-Scholes option
pricing model. The weighted-average assumptions and weighted-average fair values for the three and
six months ended June 30, 2007 and 2006 are as follows:
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Restricted Stock
Unvested restricted stock awards as of December 31, 2006, and changes during the six months
ended June 30, 2007, were as follows:
As of June 30, 2007, there was $1.6 million in unrecognized stock-based compensation
expense related to unvested restricted stock awards. Borland expects to recognize that cost over a
weighted-average period of 1.38 years.
Employee Stock Purchase Plan
In December 2006, we temporarily suspended our ESPP program starting with the offering period
scheduled to commence December 1, 2006, pending our completion of a Registration Statement on Form
S-8 for an increase to the share reserve under our 1999 Employee Stock Purchase Plan. Following
the approval of our stockholders for the share increase at our 2007 Annual Stockholders’ Meeting on
May 29, 2007, we filed a Registration Statement on Form S-8 and started an offering period on July
1, 2007, which will end on November 30, 2007. Thereafter, we plan to commence six month offering
periods under our ESPP on December 1 and June 1 of each year.
NOTE 3. NET INCOME (LOSS) PER SHARE
We compute net income (loss) per share in accordance with SFAS 128, “Earnings per Share.”
Under the provisions of SFAS 128, basic net income (loss) per share is computed by dividing the net
income (loss) by the weighted-average number of common shares outstanding during the period.
Diluted net income (loss) per share is computed by dividing the net income (loss) for the period by
the weighted-average number of common and potentially dilutive shares outstanding during the
period. Potentially dilutive shares, which consist of incremental shares issuable upon exercise of
stock options and unvested restricted stock, are included in diluted net income per share in
periods in which net income is reported, to the extent such shares are dilutive. Diluted net loss
per share is the same as basic net loss per share for the three and six months ended June 30, 2007
and 2006, due to our net losses in those periods.
The following table sets forth the computation of basic and diluted net loss per share (in
thousands, except per share amounts):
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The diluted net loss per share calculation for the three months ended June 30, 2007 and
2006 excludes options to purchase 12.7 million and 15.9 million shares of common stock,
respectively, and 512,000 and 360,000 unvested restricted common shares, respectively, due to our
net loss in those periods. The diluted net loss per share calculation for the six months ended June
30, 2007 and 2006, excludes options to purchase 13.4 million and 16 million shares of common stock,
respectively, and 601,000 and 369,000 unvested restricted common shares, respectively, due to our
net loss in those periods. In addition, the dilutive net loss per share calculation for the three
and six months ended June 30, 2007, excluded the dilutive impact of 31.4 million shares and 23.4
million shares, respectively, issuable upon conversion of our 2.75% Convertible Senior Notes due
February 15, 2012, calculated using the “if converted method”, due to our net loss in those
periods. See Note 4 for information on our Convertible Senior Notes.
NOTE 4. SENIOR NOTES OFFERING
General
In February 2007, we issued 2.75% Convertible Senior Notes due February 15, 2012, for an
aggregate principal amount of $200 million in a private offering for resale to qualified
institutional buyers pursuant to SEC Rule 144A under the Securities Act of 1933. The Convertible
Senior Notes bear interest at 2.75% per annum. Interest is payable semiannually in arrears on
February 15 and August 15, of each year, beginning August 15, 2007. We received proceeds of
approximately $193.9 million after we deducted fees of the initial purchaser and our offering
expenses for the aggregate amount of approximately $6.1 million. Our fees relating to the offering
are being amortized in other operating expense over the term of the Convertible Senior Notes and
interest expense related to the offering is being accrued in other income and expense over the term
of the Convertible Senior Notes. We used approximately $30 million of the net proceeds from the
sale of the Convertible Senior Notes to repurchase approximately 5.9 million shares of our common
stock.
Conversion Process and Other Terms of the Convertible Senior Notes
On or after November 11, 2011, holders of the Convertible Senior Notes will have the right to
convert their notes. Upon conversion, we will deliver a number of shares of our common stock equal
to the conversion rate for each $1,000 of principal amount of notes converted, unless prior to the
date of such conversion we have obtained stockholder approval to settle conversions of the notes in
cash and shares of our common stock. If we obtain such approval, any notes converted after such
approval will be convertible into (i) cash equal to the lesser of the aggregate principal amount of
the notes to be converted and the total conversion value and (ii) shares of our common stock for
the remainder, if any, of the total conversion value. In addition, following specified corporate
transactions, we will increase the conversion rate for holders who elect to convert notes in
connection with such corporate transactions, provided that in no event may the shares issued upon
conversion, as a result of adjustment or otherwise, result in the issuance of more than
approximately 39.2 million shares.
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Holders may convert their Convertible Senior Notes prior to maturity if: (1) the price of our
common stock reaches $8.29 during periods of time specified in the Convertible Senior Notes, (2)
specified corporate transactions occur or (3) the trading price of the notes falls below a certain
threshold.
We evaluated the embedded conversion option in accordance with SFAS No. 133, “Accounting for
Derivative Instruments and Hedging Activities” and concluded that the embedded conversion option
contained within the Convertible Senior Notes should not be accounted for separately because the
conversion option is indexed to our common stock and is classified as stockholders’ equity.
Additionally, we evaluated the terms of the Convertible Senior Notes for a beneficial conversion
feature in accordance with EITF No. 98-5, “Accounting for Convertible Securities with Beneficial
Conversion Features or Contingently Adjustable Conversion Ratios” and EITF No. 00-27, “Application
of Issue 98-5 to Certain Convertible Instruments” and concluded that there was no beneficial
conversion feature at the commitment date based on the conversion rate of the Convertible Senior
Notes relative to the commitment date stock price.
Each $1,000 of principal of the Convertible Senior Notes will initially be convertible into
156.8627 shares of Borland common stock, which is the equivalent of $6.38 per share and would
result in the issuance of an aggregate of approximately 31.4 million shares. The number of shares
issuable upon conversion is subject to adjustment under the following circumstances: (1) during any
fiscal quarter beginning after March 31, 2007, if the last reported sale price of our common stock
for at least 20 trading days during the 30 consecutive trading days ending on the last trading day
of the immediate preceding fiscal quarter is greater or equal to 130% of the applicable conversion
price on the last day of such preceding fiscal quarter; (2) during the five business day period
after any ten consecutive trading day period in which the trading price per note for each day of
that ten consecutive trading day period was less than 98% of the product of the last reported sale
price of our common stock and the conversion rate for such day; and (3) upon the occurrence of
specified corporate transactions.
Based on SFAS No. 128, “Earnings per Share” and EITF No. 04-08, “Accounting Issues Related to
Certain Features of Contingently Convertible Debt and the Effect on Diluted Earnings per Share,”
the dilutive effect of the common shares issuable upon conversion of the Convertible Senior Notes
would normally be reflected in the diluted earnings per share calculation. However, due to the net
share settlement feature, the Convertible Senior Notes do not qualify as an Instrument C under EITF
No. 90-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in,
a Company’s Own Stock.” Therefore, we use the “if-converted” method for calculating diluted
earnings per share. Using the “if-converted” method, the shares issuable upon conversion of the
Convertible Senior Notes was anti-dilutive for the three and six months ending June 30, 2007.
Accordingly, the impact has been excluded from the computation of diluted earnings per share.
Registration Rights
Under the terms of the Convertible Senior Notes, we are required to use reasonable efforts to
file a shelf registration statement regarding the Convertible Senior Notes with the SEC by December
3, 2007. The shelf registration statement must be declared effective by the SEC by March 3, 2008.
We must keep the shelf registration statement effective until February 6, 2009 or such earlier date
as all shares issued upon conversion of the Convertible Senior Notes are sold. If we fail to meet
these terms, we will be required to pay additional interest on the Convertible Senior Notes in the
amount of 0.25% for the first 90 days after the occurrence of the failure to meet a term and 0.50%
thereafter.
NOTE 5. ACQUISITIONS
Segue Software, Inc.
On April 19, 2006, we completed the acquisition of Segue Software, Inc., or Segue, pursuant to
an Agreement and Plan of Merger, dated as of February 7, 2006, or the Merger Agreement. Segue is
now a wholly-owned subsidiary of Borland. Segue was a Massachusetts-based provider of quality and
testing solutions. Under the terms of the Merger Agreement, we paid $8.67 per share in cash for all
outstanding shares of Segue. The purchase price was approximately $115.9 million and consisted of
fixed consideration of $105.4 million in cash used to purchase all of Segue’s outstanding common
shares, $8.1 million in cash paid to eligible Segue employees who held vested common stock options
on the closing date of the acquisition and $2.5 million of direct acquisition-related costs. The
purchase price of the transaction was allocated to the acquired assets and liabilities based on
their estimated fair values as of the date of the acquisition, including identifiable intangible
assets, with the remaining amount being classified as goodwill. Additionally, we expect to pay
contingent consideration through 2009 of up to a maximum of $1.3 million, of which a total of $0.6
million has been paid, including $0.2 million paid in the six months ended June 30, 2007, to
eligible former Segue employees who held unvested common stock options on the closing date of the
acquisition and were retained as Borland employees. The contingent
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consideration is based upon
continued employment with Borland and paid in accordance with the vesting schedules of the original
Segue common stock options. This contingent consideration is recognized as compensation expense in
the periods when it is earned and paid. Cash acquired in the acquisition was $13.5 million. The
results of operations for Segue have been included in our consolidated financial statements from
the date of acquisition. The acquisition was accounted for as a purchase and the total purchase
price was recorded as follows (in thousands):
Based upon the purchase price of the acquisition, the purchase price allocation is as follows (in thousands):
The developed technology is being amortized over three to six years, the customer
relationships and maintenance agreements over seven years, the trademarks over four years and the
non-compete agreements over one year, each from the date of acquisition. The amortizable intangible
assets were calculated using the income approach by estimating the expected cash flows from the
projects once commercially viable and discounting the net cash flows back to their present value.
The discount rates used in the valuation were 11% to 21%.
Of the purchase price, $4.8 million represented acquired in-process research and development,
or IPR&D, which had not yet reached technological feasibility and had no alternative future use.
Accordingly, this amount was immediately charged to operating expense upon completion of the
acquisition. Independent third-party sources assisted us in calculating the value of the intangible
assets, including the IPR&D. The value of the IPR&D was calculated using the income approach by
estimating the expected cash flows from the projects once commercially viable and discounting the
net cash flows back to their present value. The discount rates used in the valuation of IPR&D were
18% to 20% and factored in the costs expected to complete each project.
In accordance with SFAS 109, “Accounting for Income Taxes,” deferred tax liabilities of $17.8
million have been recorded for the tax effect of the amortizable intangible assets. We have
recorded an offsetting deferred tax asset of $17.8 million to reflect future deductible differences
that could be allocable to offset future taxable income. We are releasing a portion of the
valuation allowance to the extent the realization of deferred tax assets becomes assured as a
result of the additional taxable income generated by the non-deductible amortizable intangible
assets and other taxable temporary differences. Any future release of valuation allowance against
deferred tax assets of Segue will be recorded against goodwill. None of the goodwill recorded as a
result of the acquisition of Segue is deductible for tax purposes.
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Additionally, subsequent to the completion of the acquisition, options to purchase
approximately 843,000 shares of common stock pursuant to our 2003 Supplemental Stock Option Plan
were issued to Segue employees who became our employees. These options provided for vesting over a
four year period.
Pro Forma Financial Information
The unaudited financial information in the table below summarizes the combined results of
operations of Borland and Segue, on a pro forma basis, as though the companies had been combined as
of the beginning of each of the periods presented. The pro forma financial information is presented
for informational purposes only and is not indicative of the results of operations that would have
been achieved if the acquisition had taken place at the beginning of each of the periods presented.
The pro forma financial information for all periods presented includes the business combination
accounting effect on historical Segue revenues, amortization charges from acquired intangible
assets, stock-based compensation charges for the payouts made for unvested options, adjustments to
interest expense and related tax effects.
NOTE 6. GOODWILL AND INTANGIBLE ASSETS
Changes in the carrying amount of goodwill are as follows (in thousands):
The initial purchase price allocation for the Segue acquisition resulted in $65.5 million
of goodwill. In March 2007, we adjusted the goodwill for the Segue acquisition for amounts related
to purchase consideration adjustments primarily for accounts receivable, deferred revenue and
customer deposits based on post-closing reviews.
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The following tables summarize our intangible assets, net at June 30, 2007 (in thousands):
The intangible assets are all amortizable and have original estimated useful lives as
follows: acquired developed technology—3 to 6 years; maintenance agreements—7 years; trade names
and trademarks—4 years; customer relationships—7 years; other—1 to 3 years. Based on the current
amount of intangibles subject to amortization, the estimated future amortization expense related to
our intangible assets at June 30, 2007, is as follows (in thousands):
NOTE 7. RESTRUCTURING
We account for our restructuring activities in accordance with SFAS 146 “Accounting for Costs
Associated with Exit or Disposal Activities,” SFAS 112, “Employers’ Accounting for Postemployment
Benefits—an amendment of FASB Statement No. 5 and 43,” and SEC Staff Accounting Bulletin No. 100,
“Restructuring and Impairment Charges,” as applicable.
Summary of Restructuring Activity for the First and Second Quarters of 2007.
The following table summarizes our restructuring activity relating to our FY 2007 and FY 2006
restructurings for the first and second quarters of 2007 (in thousands):
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Of the $11.0 million in our restructuring accrual at June 30, 2007, $6.1 million was in
our short-term accrual and $4.9 million was in our long-term accrual. Our $4.9 million long-term
restructuring accrual is related to the lease obligation for excess capacity at our Scotts Valley,
California facility.
FY 2007 Restructuring
In the second quarter of 2007, we announced we would relocate our corporate headquarters
from Cupertino, California to Austin, Texas. The relocation involves restructuring actions with
respect to personnel and the consolidation of facilities. We expect approximately 70 employees, or
approximately six percent of our full-time staff, will be affected. In connection with the 2007
restructuring plan, we recognized costs at June 30, 2007, related to termination benefits for
employee positions eliminated as a result of the relocation.
During the three months ended June 30, 2007, we accrued $1.4 million and paid $0.2
million for severance, benefits and other costs.
FY 2006 Restructuring
In the second quarter of 2006, in connection with the acquisition of Segue and in response to
our previous efforts to seek a buyer for our CodeGear division, we initiated plans to restructure
our operations to eliminate certain duplicative activities, focus our resources on future growth
opportunities and reduce our cost structure. In connection with the 2006 restructuring plan, we
recognized costs related to termination benefits for employee positions that were eliminated and
for the closure of duplicative facilities.
During the three and six months ended June 30, 2007, we paid $1.3 million and $2.8 million,
respectively, related to restructured facility operating leases and $0.4 million and $3.1 million,
respectively, related accrued severance, benefits and other. During the three months ended June
30, 2007, we reversed $0.1 million in previously accrued severance and benefit costs.
The restructuring charges relating to operating leases have been recorded, net of assumed
sublease income and present value factors. Substantially all of these restructuring costs have or
will require the outlay of cash, although the timing of lease payments relating to leased
facilities over the next five years will be unchanged by the restructuring.
NOTE 8. INCOME TAXES
For the three months ended June 30, 2007 and 2006, we recorded income tax expense of $1.1
million and a tax benefit of $0.1 million, respectively. For the six months ended June 30, 2007 and
2006, we recorded income tax expense of $2.1 million and $1.3 million, respectively. Our non-U.S. income tax provision is based on our estimated annualized
foreign effective tax rate plus foreign income withholding taxes actually incurred. Our U.S. tax is
based on our actual results for the quarter.
The effective tax rates for the quarters ended June 30, 2007 and 2006, differ from applying
the U.S. federal statutory tax rate to our pre-tax loss principally because we do not fully benefit
from the operating losses incurred in the United States, and the tax effect of
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non-deductible
amortization due to acquisition accounting, together with the fact that we incur withholding and
income taxes in a number of foreign jurisdictions. Additionally, we recorded a benefit of $0.9
million for the closure of a foreign income tax audit in the quarter ended June 30, 2006. We also
provide U.S. taxes on the un-remitted earnings of our foreign subsidiaries.
We adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation of
FIN 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109,”
we recorded a $1.9 million increase in the liability for unrecognized tax benefits, a decrease in
cumulative translation adjustments of $0.7 million for the foreign currency impact of foreign
unrecognized tax benefits, a $1.3 million increase to deferred tax assets and a $0.1 million
increase to the beginning balance of retained earnings in our balance sheet. Upon adoption, we had
$58.3 million of unrecognized tax benefits of which $15 million, when recognized, will impact the
effective tax rate. In accordance with FIN 48, we reclassified $15 million of income tax
liabilities from current to non-current liabilities because payment of cash is not anticipated
within one year of the balance sheet date. These non-current income tax liabilities are recorded in
other long-term liabilities in our balance sheet. There have been no significant changes in these
amounts in the quarter ended June 30, 2007.
Included in the balance of unrecognized tax benefits at June 30, 2007, is between $2.5 to $2.8
million related to tax positions and interest for which it is reasonably possible that audits will
be closed or the statute of limitations will expire in various foreign jurisdictions within the
next twelve months.
We record interest and penalties related to unrecognized tax benefits in income tax expense.
At June 30, 2007, we had approximately $3.1 million accrued for estimated interest and $307,000 for
estimated penalties related to uncertain tax positions. Estimated interest totaled approximately
$251,000 for the quarter ended June 30, 2007.
We and our subsidiaries are subject to taxation in various foreign and state jurisdictions as
well as the U.S. Our U.S. federal and state income tax returns are generally not subject to
examination by the tax authorities for tax years before 2002. With a few exceptions, the tax years
2001-2006 remain open to examination by tax authorities in the major foreign jurisdictions in which
we operate. We are currently in the process of concluding an examination in Australia for transfer
pricing, covering the tax years 1994-2003 and an examination in Germany for tax years 2002-2005.
The final outcome of these examinations is not yet known; however, management does not anticipate
any adjustments which would result in material changes to our results of operations, financial
condition or liquidity.
NOTE 9. STOCK REPURCHASES
Discretionary Repurchase Program
In September 2001, our Board of Directors authorized the use of up to $30 million to
repurchase shares of our outstanding common stock under a discretionary stock repurchase program,
or the Discretionary Program. In February 2004 and May 2005, our Board of Directors authorized an
additional $30 million and $75 million, respectively, under this program bringing the total
discretionary stock repurchase authorizations to $135 million.
Repurchase Following Senior Notes Offering
In connection with our offering of our Convertible Senior Notes in February 2007, our Board of
Directors authorized the repurchase of 5,882,200 shares at an average price of $5.10 per share for
a total consideration of approximately $30 million.
There were no stock repurchases during the three months ending June 30, 2007, other than
repurchases of shares of restricted stock surrendered by Borland employees in order to meet tax
withholding obligations in connection with the vesting of installments of their restricted stock
awards.
NOTE 10. COMMITMENTS AND CONTINGENCIES
Indemnification Obligations and Guarantees
The following is a summary of our agreements we have determined are within the scope of FASB
Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others,” some of which are specifically
grandfathered in because the guarantees were in effect prior to December 31, 2002. Accordingly, we
have no liabilities recorded for these agreements as of June 30, 2007, except as noted below.
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We have agreements whereby we indemnify our officers and directors for certain events or
occurrences while the officer or director is, or was, serving in such capacity. The term of the
indemnification period is for the officers’ or directors’ lifetime. In connection with certain
previous acquisitions, we have assumed the acquired entity’s obligations to indemnify its directors
and officers prior to the closing of the respective acquisition. The maximum potential amount of
future payments we could be required to make under these indemnification agreements is unlimited;
however, we have a director and officer insurance policy that in certain circumstances enables us
to recover a portion of any future amounts paid. As a result of our insurance policy coverage, we
believe the estimated fair value of these indemnification agreements is minimal.
As part of the Starbase, TogetherSoft and Segue acquisitions, we entered into agreements
whereby we indemnify the officers and directors of the acquired companies for certain events or
occurrences while such officers or directors served in such capacity. The term of the
indemnification period in the Starbase and TogetherSoft acquisitions is for the officers’ or
directors’ lifetime, and in the Segue acquisition the term is for six years. The maximum potential
amount of future payments we could be required to make under these indemnification agreements is
unlimited; however, we have purchased directors’ and officers’ insurance policies for Starbase and
TogetherSoft, if applicable, through 2009, and for Segue through 2012, which in certain
circumstances enable us to recover a portion of any future amounts paid. As a result of our
insurance policy coverage, we believe the estimated fair value of these indemnification agreements
is minimal.
We sell software licenses and services to our customers via contractual arrangements. As part
of those contractual arrangements, we generally provide a warranty for our software products and
services to our customers. Our products are generally warranted to perform substantially as
described in the associated product documentation. Our services are generally warranted to be
performed in a professional manner. We have not incurred significant expense under our product or
services warranties. As a result, we believe the estimated fair value of these agreements is
minimal.
We also enter into standard indemnification agreements in our ordinary course of business with
our customers, suppliers and other third-party providers. With respect to our customer license
agreements, each contract generally includes certain provisions for indemnifying the customer
against losses, damages, expenses and liabilities incurred by the customer in the event our
software is found to infringe upon certain intellectual property rights of a third-party. In our
services agreements, we generally agree to indemnify our customers against any acts by our
employees or agents that cause property damage or personal injury. In our technology license
agreements, we also generally agree to indemnify our technology suppliers against any losses,
damages, expenses and liabilities incurred by the suppliers in connection with certain intellectual
property right infringement claims by any third-party with respect to our products. Finally, from
time to time we enter into other industry-standard indemnification agreements with third-party
providers. The maximum potential amount of future payments we could be required to make under any
of these indemnification agreements is presently unknown. To date, we have not incurred significant
expense to defend lawsuits or settle claims related to these indemnification agreements. As a
result, we believe the estimated fair value of these agreements is minimal.
We also have arrangements with certain vendors whereby we guarantee the expenses incurred by
the vendor. The term is from execution of the arrangement until cancellation and payment of any
outstanding amounts. We would be required to pay any unsettled expenses upon notification from the
vendor. The maximum potential amount of future payments we could be required to make under these
indemnification agreements is insignificant. As a result, we believe the estimated fair value of
these agreements is minimal. Additionally, from time to time we enter into agreements with certain
customers in certain foreign jurisdictions, which provide for penalties to be incurred if specific
non-performance or breach of agreement occurs on our behalf. To date we have not incurred a
significant expense in relation to these penalties and we believe the estimated fair value of these
penalties is minimal.
Leases
We lease certain of our office and operating facilities and certain furniture and equipment
under various operating leases. In December 2003, we recorded a capital lease obligation of $0.8
million for fixtures and equipment and our minimum future lease payments will be approximately $0.2
million per year through 2008. As of June 30, 2007, we had a total obligation of $0.2 million
remaining. Additionally, we acquired a capital lease in connection with our acquisition of Segue
for leasehold improvements on a facility in Austria. At June 30, 2007, the obligation amounted to
$0.1 million which is payable through 2011.
Our operating leases expire at various times through 2021. Future minimum lease and sublease
payments under non-cancelable leases and subleases and future minimum lease and sublease income
under non-cancelable leases and subleases including our Cupertino, CA, sublease executed on August
1, 2007, were as follows (in thousands):
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In Thousands
Rent expense, net, for all operating leases was $2.7 million and $5.2 million for the
three and six months ended June 30, 2007, respectively, and was $3.4 million and $6.1 million for
the three and six months ended June 30, 2006, respectively.
The restructured operating leases above represent total lease commitments that are not
associated with continuing operations and include facilities we vacated or partially exited in
California, Massachusetts, North Carolina, Australia, New Zealand and Japan.
Litigation
From time to time, we may be involved in lawsuits, claims, investigations and proceedings,
consisting of intellectual property, commercial, employment and other matters, which arise in the
ordinary course of business. In accordance with SFAS 5, “Accounting for Contingencies,” we record a
liability when it is both probable a liability has been incurred and the amount of the loss can be
reasonably estimated. These accruals are reviewed at least quarterly and adjusted to reflect the
impacts of negotiations, settlements, rulings, advice of legal counsel and other information and
events pertaining to a particular case. Litigation is inherently unpredictable; however, we believe
that we have valid defenses with respect to the legal matters pending against us, as well as
adequate accruals for any probable and estimable losses. If an unfavorable ruling were to occur in
any of these matters in a particular period, our liquidity and financial condition could be
adversely impacted, as well as our results of operations and cash flows.
From time to time, we receive notices from third-parties claiming infringement by our products
of third-party patent, trademark and other intellectual property rights, disputing royalties, or
disputing other commercial arrangements. Regardless of the merit of any such claim, responding to
these claims could be time consuming and expensive and may require us to enter into licensing or
royalty agreements which may not be offered or available on terms acceptable to us. If a successful
claim is made against us, our business could be materially and adversely affected. We expect that
our software products will increasingly be subject to such claims as the number of products and
competitors in our industry segment increases, the functionality of products overlap and industry
participants become more aggressive in using patents offensively.
Service Commitments
We have outsourced portions of our information technology operations. The committed
expenditures average $5.2 million per year from November 2004 through November 2014. We can
terminate this contract with or without cause upon payment of a termination fee, the maximum amount
of which is $1.3 million at June 30, 2007 and declines to $0.5 million in 2014, the final year of
the contract. These amounts are not included in the operating lease commitments table above.
NOTE 11. REPORTABLE SEGMENTS
Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an
Enterprise and Related Information,” establishes standards for reporting information about
operating segments in a company’s financial statements. Operating segments are defined as components of an enterprise about which separate financial information is available
that is evaluated regularly by the chief operating decision maker, or decision making group, in
deciding how to allocate resources and in assessing performance. Borland’s chief operating decision
maker, or CODM, is its Chief Executive Officer.
Description of Segments
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Effective January 1, 2007, consistent with how we manage our business, we changed from
reporting one segment to reporting two segments: Enterprise and CodeGear. A summary of the types of
products and services provided by the Enterprise and CodeGear segments is provided below.
Enterprise. Our Enterprise segment focuses on Open Application Lifecycle Management solutions,
or ALM, which includes a combination of software products as well as consulting and education
services to help our customers better manage their software development projects. Our ALM portfolio
includes products and services for project and portfolio management, requirements definition and
management, lifecycle quality management, software configuration and change management and
modeling. The Enterprise segment also includes our Deployment Product Group, or DPG, products.
CodeGear. Our CodeGear segment focuses on our Integrated Development Environment, or IDE
products. CodeGear was formerly Borland’s Developer Tools Group. It is focused on software
development tools, including JBuilder, Delphi, Delphi for Win32, Delphi for PHP, C++Builder,
C#Builder, Turbo™ and InterBase. CodeGear also offers worldwide developer support and education
services.
Segment Data
We derive the results of the business segments directly from our internal management reporting
system. The accounting policies we use to derive business segment results are substantially the
same as those the consolidated company uses. Management, under the direction of the CODM, measures
the performance of each business segment based on several metrics, including earnings from
operations. Additionally, management, under the direction of the CODM, uses these results, in part,
to evaluate the performance of, and to assign resources to, each of the business segments. We do
not allocate costs to CodeGear that are not directly attributable to CodeGear. We have no
intersegment revenue. Discrete operating financial information for the new segments has not been
prepared for periods prior to January 1, 2007, as we have concluded it is not practicable for us to
prepare such information.
Selected operating results information for each business segment was as follows (in thousands):
As of June 30, 2007, we have allocated goodwill and other long-lived assets to our
reportable segments as follows (in thousands):
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Enterprise-wide disclosures
We have various wholly-owned subsidiaries, which develop, market and/or distribute our
products in other countries. In certain international markets not covered by our international
subsidiaries, we generally sell through independent distributors. For our geographic disclosures,
inter-company transactions are recorded at either cost or applicable transfer price, as
appropriate. Inter-company transactions and balances are eliminated upon consolidation.
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NOTE 12. RECENT ACCOUNTING PRONOUNCEMENTS
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets
and Financial Liabilities—Including an amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159
expands the use of fair value accounting but does not affect existing standards which require
assets or liabilities to be carried at fair value. Under SFAS 159, a company may elect to use fair
value to measure accounts and loans receivable, available-for-sale and held-to-maturity securities,
equity method investments, accounts payable, guarantees and issued debt. Other eligible items
include firm commitments for financial instruments that otherwise would not be recognized at
inception and non-cash warranty obligations where a warrantor is permitted to pay a third party to
provide the warranty goods or services. If the use of fair value is elected, any upfront costs and
fees related to the item must be recognized in earnings and cannot be deferred, e.g., debt issue
costs. The fair value election is irrevocable and generally made on an instrument-by-instrument
basis, even if a company has similar instruments that it elects not to measure based on fair value.
At the adoption date, unrealized gains and losses on existing items for which fair value has been
elected are reported as a cumulative adjustment to beginning retained earnings. Subsequent to the
adoption of SFAS 159, changes in fair value are recognized in earnings. SFAS 159 is effective for
fiscal years beginning after November 15, 2007, and is required to be adopted by the Company in the
first quarter of fiscal 2008. We are currently in the process of
evaluating the impact of SFAS 159 on our financial position and
results of operations.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS
157 establishes a framework for measuring the fair value of assets and liabilities. This framework
is intended to provide increased consistency in how fair value determinations are made under
various existing accounting standards which permit, or in some cases require, estimates of fair
market value. SFAS 157 is effective for fiscal years beginning after November 15, 2007, and interim
periods within those fiscal years. Earlier application is encouraged, provided the reporting entity
has not yet issued financial statements for that fiscal year, including any financial statements
for an interim period within that fiscal year. We are currently in the process of evaluating the
impact of SFAS 157 on our financial position and results of operations.
In July 2006, the FASB issued FASB Interpretation 48, “Accounting for Uncertainty in Income
Taxes — an interpretation of FASB Statement No. 109” (“FIN 48”), which became effective for the
Company beginning in 2007. This interpretation clarifies the accounting for uncertainty in income
taxes recognized in an entity’s financial statements in accordance with SFAS 109, “Accounting for
Income Taxes.” It prescribes a recognition threshold and measurement attribute for financial
statement disclosure of tax benefits taken or expected to be taken on a tax return. Under FIN 48,
the Company must recognize the tax benefit from an uncertain tax position at the largest amount
that is more likely than not will be sustained on examination by the relevant tax authorities,
based solely on the technical merits of the position. An uncertain tax position will not be
recognized if it has less than a 50% likelihood of being
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sustained. If recognized, a tax benefit is
then measured based upon the largest benefit that has a greater than
50% likelihood of being realized upon ultimate resolution of the tax position. For additional information regarding the
adoption of FIN 48, see Note 8, Income Taxes.
In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial
Instruments” (“SFAS 155”), which amends SFAS No. 133, “Accounting for Derivative Instruments and
Hedging Activities” (“SFAS 133”) and SFAS 140, “Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities” (“SFAS 140”). SFAS 155 simplifies the accounting for
certain derivatives embedded in other financial instruments by allowing them to be accounted for as
a whole if the holder elects to account for the whole instrument on a fair value basis. SFAS 155
also clarifies and amends certain other provisions of SFAS 133 and SFAS 140. SFAS 155 is effective
for all financial instruments acquired, issued or subject to a remeasurement event occurring in
fiscal years beginning after September 15, 2006. The adoption of SFAS 155 did not have a material
impact on our consolidated financial position, results of operations or cash flows.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
The statements made throughout this Quarterly Report on Form 10-Q that are not historical
facts are forward-looking statements and accordingly, involve estimates, projections, goals,
forecasts, assumptions and uncertainties that could cause actual results or outcomes to differ
materially from those expressed or implied in the forward-looking statements. These forward-looking
statements may relate to, but are not limited to, revenues, composition of revenues, cash flows,
earnings, margins, costs, expenses, strategy, research and development, customer service and
relationships, demand for our products, market and technological trends in the software industry,
licenses, developments in technology, organizing CodeGear as a division, effects of and timeframe
for company restructuring actions and relocation of headquarters, effects of our offering of
Convertible Senior Notes, product quality, competition, sales, cash resources, utilization of cash
resources, personnel, interest rates, foreign currency exchange rates and various economic and
business trends. Generally, you can identify forward-looking statements by the use of words such as
“expect,” “estimate,” “project,” “budget,” “forecast,” “anticipate,” “goal,” “intend,” “plan,”
“may,” “will,” “could,” “should,” “believes,” “predicts,” “potential,” “continue” and similar
expressions or the negative or other variations thereof. These forward-looking statements involve
substantial risks and uncertainties. Examples of such risks and uncertainties are described under
“Risk Factors” and elsewhere in this report, as well as in our other filings with the SEC or in
materials incorporated by reference herein or therein. You should be aware that the occurrence of
any of these risks and uncertainties may cause our actual results to differ materially from those
anticipated in our forward-looking statements and have a material adverse effect on our business,
results of operations and financial condition. New factors may emerge from time to time, and it may
not be possible for us to predict new factors, nor can we assess the potential effect of any new
factors on us.
These forward-looking statements are found at various places throughout this Form 10-Q,
including the financial statement footnotes. We caution you not to place undue reliance on these
forward-looking statements, which, unless otherwise indicated, speak only as of the date they were
made. We do not undertake any obligation to update or release publicly any revisions to these
forward-looking statements to reflect events or circumstances after the date of this Form 10-Q,
except as required by law.
Overview
Effective January 1, 2007, consistent with how we manage our business, we changed from
reporting a single segment to reporting two segments: Enterprise and
CodeGear.
Enterprise. Our Enterprise segment focuses on our Open Application Lifecycle Management
solutions, or ALM, which represents the segment of the ALM market in which vendors’ solutions are
flexible enough to support a customer’s specific processes, tools and platforms. Open ALM is a new,
customer-centric approach to helping IT organizations transform software delivery into a managed, efficient and predictable business process. Borland is a leading vendor of Open ALM solutions.
Our solutions address four critical ALM processes: project & portfolio management, requirements
definition & management, lifecycle quality management and software change management. Open ALM
products include Tempo, CaliberRM, Caliber DefineIT, SilkCentral Test Manager, SilkPerformer,
SilkTest, Gauntlet, Together and StarTeam. We also offer services aimed at streamlining the path to
software process improvement, including technical support, consulting and education services.
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Our Enterprise segment also includes our Deployment Products Group, or DPG, which includes our
VisiBroker and AppServer products. Our deployment products are application middleware for
high-performance, low-latency, transaction-intensive applications.
CodeGear. Our CodeGear segment focuses on developing tools for individual developers and
currently offers a number of Integrated Developer Environment, or IDE, products for Java, .NET,
Windows and Linux development. IDE products include Delphi, Delphi for PHP, C++Builder, C#Builder
and JBuilder. CodeGear also provides worldwide developer support and education services.
Summary of key financial results
The following is a summary of our key financial results for the three and six months ended
June 30, 2007:
For a more in-depth discussion of our business, including a discussion of our critical
accounting policies and estimates, please read our Annual Report on Form 10-K for the year ended
December 31, 2006, as filed with the SEC on March 15, 2007.
Results of Operations
The following table presents our Condensed Consolidated Statements of Operations data and the
related percentage of total revenues (dollars in thousands):
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The following table presents our total revenues and the absolute dollar and percentage
change from the comparable prior year periods (dollars in thousands):
We derive revenues from the license of our software and the sale of related services. No
single customer represented more than 10% of our total revenues in the quarter ended June 30, 2007.
Revenues by Product
We have three major product categories: Application Lifecycle Management (“ALM”), which
includes our Tempo, Caliber, Together, Silk and Gauntlet products; Deployment Product Group
(“DPG”), which includes our VisiBroker and AppServer products; and Integrated Development
Environment (“IDE”), which includes our JBuilder, Delphi, Delphi for PHP, C++Builder, C# Builder,
Turbo and Interbase products.
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The following table presents our revenues by product (in thousands):
License and Other Revenues
License and other revenues represent amounts for license fees and royalties earned for
granting customers the right to use and distribute our software products. Revenue recognition for
our software licenses may be affected by numerous aspects of a contract, for the majority of our
customer contracts we recognize software license revenue upon shipment of the product. License and
other revenues decreased $11 million in the quarter ended June 30, 2007, as compared to the
year-ago quarter. ALM license revenue decreased 23% compared to the year-ago quarter, from $20
million to $15.4 million. This decrease was the result of lower sales of our Caliber, Control
Center and OptimizeIt products, partially offset by the incremental contribution of our Silk
products, which we obtained through our acquisition of Segue in April 2006. DPG license revenue
decreased 30% compared to the year-ago quarter, from $8.5 million to $5.9 million. The decrease was
primarily driven by lower sales of VisiBroker in the U.S. and Europe. License revenue in our
established IDE products decreased 29% from $12.9 million to $9.1 million, when compared to the
year-ago quarter, on lower sales of our Interbase, Delphi and JBuilder products.
License and other revenues decreased $13.2 million in the six months ended June 30, 2007, as
compared to the year-ago period. ALM license revenue decreased 3% compared to the year-ago period,
from $35.6 million to $34.5 million. This decrease was the result of lower sales of our Caliber,
Control Center and OptimizeIt products, partially offset by improved performance in solution
selling to larger enterprise-level customers and the incremental contribution of our Silk products,
which we obtained through our acquisition of Segue in April 2006. DPG license revenue decreased 3%
compared to the year-ago period, from $14.7 million to $14.2 million. License revenues in our
established IDE products decreased 38% from $30.6 million to
$18.9 million, when compared to the
year-ago period. The IDE products have been historically release driven and so far this year we
have not benefited from the typical increase in sales when new versions of products are released.
Service Revenues
Service revenues represent amounts earned for technical support, which includes call support,
maintenance and upgrades and for consulting and education services for our software products.
Service revenues decreased 7% compared to the year-ago quarter, from $35.5 million to $33 million
in the quarter ended June 30, 2007 and increased $1.1 million to $66.8 million in the six months
ended June 30, 2007, from $65.7 million in the year-ago period.
Technical support revenues decreased 1% compared to the year-ago quarter, from $26 million to
$25.7 million, and increased $4.1 million to $51.5 million in the six months ended June 30, 2007,
from $47.4 million in the year-ago period. The increase during the six month period was due to the
contribution of Silk products as a result of the Segue acquisition in April 2006 and support
revenue growth in our Caliber, StarTeam and Together products, partially offset by decreases in
both the DPG and IDE products.
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Consulting and education services revenues decreased 24% compared to the year-ago quarter,
from $9.6 million to $7.3 million and decreased $3.1 million to $15.2 million in the six months
ended June 30, 2007 from $18.3 million in the year-ago period. The decrease was primarily
attributable to completion of a large consulting engagement and a focus on more license driven
consulting projects versus pure consulting engagements.
As of June 30, 2007, open sales orders were insignificant.
International Revenues
International revenues represented 56% and 54% of total revenues in the quarters ended June
30, 2007 and 2006, respectively, and represented 55% and 56% of total revenues in the six months
ended June 30, 2007 and 2006, respectively.
The following table presents our total revenues by country and the absolute dollar and
percentage change from the comparable prior year periods (dollars in thousands):
No single country, other than the United States, accounted for revenues greater than 10% of
total revenues in the three months ended June 30, 2007 or 2006, respectively. No single country,
other than the United States and Germany, accounted for revenues greater than 10% of total revenues
in the six months ended June 30, 2007 or 2006, respectively.
Regional Revenues
The following table presents our total revenues by region and the absolute dollar and the
percentage change from the comparable prior year periods (dollars in thousands):
Our Americas operations include our activities in the United States as well as
subsidiaries and branch offices in Brazil and Canada. Our Europe, Middle East and Africa, or EMEA,
operations include activities of our subsidiaries and branch offices in Austria, Czech Republic,
Finland, France, Germany, Ireland, Italy, Netherlands, Russia, Spain, Sweden and the United
Kingdom. Our Asia Pacific, or APAC, operations include activities of our subsidiaries and branch
offices in Australia, China, Hong Kong, India, Japan, New Zealand, Singapore and Taiwan.
Americas. Revenues in our Americas region decreased 18% to $33.6 million in the three months
ended June 30, 2007, from $40.8 million in the year-ago period. Of the decrease in revenues from
our Americas region, license revenues decreased $5.2 million and service revenues decreased $2
million.
Revenues in our Americas region decreased 1% to $73.2 million in the six months ended June 30,
2007, from $74.2 million in the year-ago period. Of the decrease in revenues from our Americas
region, license revenues decreased $1.8 million and service revenues increased $0.8 million.
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EMEA. Revenues in our EMEA region decreased 23% to $20.1 million in the three months ended
June 30, 2007, from $26.1 million in the year-ago period. Of the decrease in revenues from our EMEA
region, license revenues decreased $5.5 million and service revenues decreased $0.5 million.
Revenues in our EMEA region decreased 17% to $43.6 million in the six months ended June 30,
2007, from $52.3 million in the year-ago period. Of the decrease in revenues from our EMEA region,
license revenues decreased $9.3 million and service revenues increased $0.6 million.
APAC. Revenues in our APAC region decreased 4% to $9.6 million in the three months ended June
30, 2007, from $10 million in the year-ago period. The decrease was due primarily to the decline of
IDE license revenue.
Revenues in our APAC region decreased 12% to $17.6 million in the six months ended June 30,
2007, from $19.9 million in the year-ago period. The decrease was due primarily to the decline of
IDE license revenue.
Cost of Revenues
The following table presents cost of revenues and the absolute dollar and percentage changes
from the comparable prior year periods (dollars in thousands):
Cost of License and Other Revenues
Cost of license and other revenues consists primarily of variable costs including production
costs, product packaging costs and royalties paid to third-party vendors. Cost of license and other
revenues decreased $0.3 million compared to the year-ago quarter, from $1.7 million to $1.4 million
and decreased $0.8 million to $3.1 million in the six months ended June 30, 2007, from $3.9 million
in the year-ago period. The decrease was attributable to a reduction in royalties and production
materials. Royalty, manufacturing and shipping costs tend to fluctuate with changes in the mix of
products sold. Generally, manufacturing and shipping costs are lower for ALM, as compared to IDE
and DPG, due to the greater proportion of ALM contracts that are fulfilled electronically. The
level of royalty costs in future periods will be dependent upon our ability to obtain favorable
licensing terms for our products that include third-party technology and the extent to which we
include such third-party technology in our product offerings.
Cost of Service Revenues
Cost of service revenues consists primarily of employee salaries and benefits, third-party
contractor costs and related expenses incurred in providing technical support and consulting and
education services. Cost of service revenues decreased $4.2 million compared to the year-ago
quarter, from $14.5 million to $10.3 million and decreased $6 million to $21.6 million in the six
months ended June 30, 2007, from $27.6 million in the year-ago period. The overall decrease in cost
of services as a percentage of service revenues was attributable to the replacement of non-billable
headcount by billable headcount, improved resource utilization, lower negotiated rates with
third-party contractors and effective cost management through consolidation of worldwide call
centers from nine to three.
Amortization of Acquired Intangibles and Other Charges
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Amortization of acquired intangibles and other charges consists of the amortization of
acquired developed technology, maintenance agreements and customer relationships. Amortization of
acquired intangibles decreased $0.1 million compared to the year-ago quarter, from $2.2 million to
$2.1 million and increased $1.5 million to $4.2 million in the six months ended June 30, 2007, from
$2.7 million in the year-ago period. The increase in amortization was attributable to the
acquisition of Segue.
Operating Expenses
Selling, General and Administrative Expenses
The following table presents our selling, general and administrative expenses and the absolute
dollar and percentage change from the comparable prior year periods (dollars in thousands):
Selling, general and administrative expenses primarily consists of employee salaries and
benefits, sales commissions, marketing programs, professional fees, and facilities and equipment
costs. Selling, general and administrative expenses decreased $5.8 million compared to the year-ago
quarter, from $50.4 million to $44.6 million. The decrease was primarily due to decreased employee
compensation, severance, outside services and legal expenses. These decreases were partially offset
by an increase in depreciation expense.
Selling, general and administrative expenses decreased $4.2 million to $92.4 million in the
six month ended June 30, 2007, from $96.6 million in the year-ago period. The decrease was
primarily due to decreased employee compensation, severance and facilities expenses. These
decreases were partially offset by increases in depreciation expense, bad debt expense and outside
services.
Research and Development Expenses
The following table presents our research and development expenses and the absolute dollar and
percentage change from the comparable prior year periods (dollars in thousands):
Research and development expenses primarily consist of employee salaries, benefits, and
related costs of our engineering staff, external personnel costs, and facilities and equipment
costs. Research and development expenses decreased $4.6 million compared to the year-ago quarter,
from $18.3 million to $13.7 million. The decrease is due to
personnel, severance and facilities expense reductions resulting from
the worldwide R&D restructuring and consolidation of physical
development locations in 2006.
Research and development expenses decreased $4.1 million to $29.6 million in the six months
ended June 30, 2007, from $33.7 million in the year-ago period. The decrease is due to
personnel, severance and facilities expense reductions resulting from
the worldwide R&D restructuring and consolidation of physical
development locations in 2006.
Restructuring, Amortization of Other Intangibles, Acquisition-Related Expenses and Other Charges
The following table summarizes our restructuring, amortization of other intangibles and
acquisition-related expenses and the absolute dollar and percentage change from the comparable
prior year periods (dollars in thousands):
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Restructuring.
The following table summarizes our restructuring activity relating to our FY 2006 and FY 2007
restructurings for the first and second quarters of 2007 (in thousands):
Of the $11.0 million in our restructuring accrual at June 30, 2007, $6.1 million was in
our short-term accrual and $4.9 million was in our long-term accrual. Our $4.9 million long-term
restructuring accrual is related to the lease obligation for excess capacity at our Scotts Valley,
California facility.
Amortization of other intangibles. In the three months and six months ended June 30, 2007, we
incurred $0.1 million and $0.3 million, respectively, of amortization expense related to intangible
non-compete agreements and trade names as a result of our acquisitions, compared to $0.1 million
and $0.2 million in the comparable year-ago periods. Amortization of other intangibles decreased
due to the completion of amortization of trade names in December 2006, related to the acquisition
of TogetherSoft.
Acquisition-related expenses. In the three and six months ended June 30, 2007, we recorded
$0.8 million and $1.5 million, respectively, in acquisition-related expenses, which primarily
consisted of contingent consideration payable under the terms of the Legadero acquisition
agreement. Acquisition-related expenses in the three and six months ended June 30, 2006, consisted
of $1.0 million and $2 million, respectively, of contingent consideration payable under the terms
of the TeraQuest and Legadero acquisitions.
Interest and Other Income, Net
The following table presents our interest and other income, net and the absolute dollar and
percentage change from the comparable prior year periods (dollars in thousands):
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Interest and other income, net consists primarily of interest earned on cash and cash
equivalents and interest expense, but also includes foreign exchange transaction gains and losses.
The increase in interest and other income, net in the three months ended June 30, 2007, was
primarily attributable to interest income and offsetting interest expense generated from our
Convertible Senior Notes offering that occurred in the first quarter of 2007. The decrease in
interest and other income, net in the six months ended June 30, 2007, when comparing the year-ago
period, was primarily attributable to interest incurred on our Convertible Senior Notes offering
that occurred in the first quarter of 2007. The amount of foreign currency and other gains or
losses we realize primarily represents fluctuations in the U.S. dollar versus the foreign
currencies in which we conduct business with respect to short-term inter-company balances with our
international subsidiaries, offset by gains and losses recognized on foreign currency forward
exchange contracts entered into as hedges of these inter-company foreign currency exposures.
Income Taxes
The following table presents our income taxes and the absolute dollar and percentage change
from the comparable prior year periods (dollars in thousands):
On a consolidated basis, we generated pre-tax losses of $10.1 million and $18.3 million
in the three and six months ended June 30, 2007, respectively, and in the three and six months
ended June 30, 2006, we reported pre-tax losses of $19.1 million and $26.6 million, respectively. Our income tax provision, as a percentage of pre-tax loss, was 11% and
nil for the three months ended June 30, 2007 and 2006, respectively. Our income tax provision, as a
percentage of pre-tax loss, was 12% and 5% for the six months ended June 30, 2007 and 2006,
respectively. The increase in our income tax provision in absolute dollars and as a percentage of
pre-tax loss in the three and six months ended June 30, 2007, as compared to the year-ago periods,
was largely due to a benefit of $0.9 million for the closure of a foreign income tax audit in the
quarter ended June 30, 2006. In the three and six months ended June 30, 2007 and 2006,
respectively, substantially all of our tax provision related to non-U.S. taxes.
Our effective tax rate is primarily dependent on the location of taxable profits, if any, and
the utilization of our net operating loss carryforwards in certain jurisdictions. Our tax rate is
also affected by the tax impact of nondeductible amortization due to acquisition accounting and the
imposition of withholding taxes on revenues regardless of our profitability.
Liquidity and Capital Resources
Cash, cash equivalents and short-term investments. Cash, cash equivalents and short-term
investments were $204.6 million at June 30, 2007, an increase of $149.3 million from a balance of
$55.3 million at December 31, 2006. Working capital increased $167.6 million to $157 million at
June 30, 2007, from a negative $10.6 million at December 31, 2006.
In February 2007, we completed a debt offering. We issued 2.75% Convertible Senior Notes due
2012 in the aggregate principal amount of $200 million to qualified institutional buyers in
accordance with Rule 144A under the Securities Act of 1933, as amended. We used approximately $30
million of the net proceeds from the sale of the notes to repurchase approximately 5.9 million
shares of our common stock.
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Net cash used in operating activities. Net cash used in operating activities, in the six
months ended June 30, 2007, was $13.9 million, which includes $4.8 million used in restructuring
activities.
Net cash used in investing activities. Net cash used in investing activities, during the six
months ended June 30, 2007, was $2.7 million, primarily driven by the purchase of property and
equipment.
Net cash provided by financing activities. Net cash provided by financing activities during
the six months ended June 30, 2007, was $165.3 million, resulting primarily from net proceeds of
$194.2 million from the 2.75% Convertible Senior Notes offering issued in February 2007 and $1
million received from the exercise of stock options. These proceeds were partially offset by our
$29.9 million repurchase of shares of our common stock in the open market.
Currency. Although we utilize foreign currency forward exchange contracts to reduce our
foreign currency exchange rate risk, the strengthening of the United States dollar against the
Euro, the United Kingdom Pound Sterling, the Australian and Singapore dollars and the Japanese Yen
could harm our financial condition. We cannot predict currency exchange rate fluctuations and there
can be no assurance that foreign currency exchange rates will not have a material adverse impact on
our future cash flows and operating results. Refer to Item 3 “Quantitative and Qualitative
Disclosures About Market Risk” for additional discussion of foreign currency risk.
Contractual Obligations and Off-Balance Sheet Arrangements
Leases. We lease certain of our office and operating facilities and certain furniture and
equipment under various operating leases. In December 2003, we recorded a capital lease obligation
of $0.8 million for fixtures and equipment and our minimum future lease payments will be
approximately $0.2 million per year through 2008. As of June 30, 2007, we had a total obligation of
$0.2 million remaining. Additionally, we acquired a capital lease in connection with our
acquisition of Segue for leasehold improvements on a facility in Austria. At June 30, 2007, the
obligation amounted to $0.1 million which is payable through 2011.
Our operating leases expire at various times through 2021. Future minimum lease and sublease
payments under non-cancelable leases and subleases and future minimum lease and sublease income
under non-cancelable leases and subleases including our Cupertino, CA, sublease executed on August
1, 2007, were as follows (in thousands):
In Thousands
The restructured operating leases above represent total lease commitments that are not
associated with continuing operations and include facilities we vacated or partially exited in
California, Massachusetts, North Carolina, Australia, New Zealand and Japan.
Additionally, we have a commitment regarding an outsourcing arrangement for portions of our
information technology operations. The committed expenditures average $5.2 million per year from
November 2004 through November 2014. We can terminate this contract with or without cause upon
payment of a termination fee, the maximum amount of which is $1.3 million at June 30, 2007,
declining to $0.5 million in 2014, the final year of the contract. These amounts are not included
in the operating lease commitments table above.
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Indemnification Obligations and Guarantees. For information regarding our indemnification
obligations and guarantees, refer to Note 10 of Notes to Condensed Consolidated Financial
Statements in Item 1.
Off-Balance Sheet Arrangements. As part of our ongoing business, we do not participate in
material transactions that generate relationships with unconsolidated entities or financial
partnerships, such as entities often referred to as structured finance, variable interest or
special purpose entities, which would have been established for the purpose of facilitating
off-balance sheet arrangements or other contractually narrow or limited purposes. As of June 30,
2007, we are not involved in any material unconsolidated transactions.
Critical Accounting Estimates and Policies
Goodwill and Purchased Intangible Assets
Goodwill and identifiable intangibles are accounted for in accordance with SFAS No. 141
“Business Combinations” and SFAS No. 142 “Goodwill and Other Intangible Assets.” We recorded
goodwill and identifiable intangibles related to our acquisitions and we evaluate these items for
impairment on an annual basis, or more often if events or changes in circumstances indicate that
the carrying values may not be recoverable. Impairment testing of goodwill is performed in two
steps. First, the carrying value of the reporting unit is compared to the fair value of the
reporting unit including the goodwill. If the carrying amount of the reporting unit is greater than
the fair value of the reporting unit, we perform the second step. The second step of the impairment
test, used to measure the amount of impairment loss, compares the implied fair value of the
reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of the
reporting unit goodwill exceeds the implied fair value of the goodwill, the impairment loss shall
be recognized as an operating expense in an amount equal to that excess. We performed our goodwill
impairment testing in the third quarter of 2006 based on a single reporting unit and concluded
there was no impairment as of September 30, 2006. The market capitalization method was the primary
method used to determine the fair values for SFAS 142 impairment purposes. We did not record
impairment to goodwill during 2005, however, we recorded a $0.5 million impairment to acquired
developed technology in the second quarter of 2006 as a result of the departure of certain key
employees. Refer to Note 6 of Notes to Condensed Consolidated Financial Statements in Part 1—Item 1
for further discussion of the valuation of goodwill and intangible assets and the impairment charge
to acquired developed technology. Due to our new reporting of two segments, we will no longer
utilize the market capitalization method. As of January 1, 2007, we began utilizing a discounted
fair value method and goodwill will be allocated to each of the reporting units. For more
information on the accounting related to the reportable segments, please see the narrative below
under the heading “Reportable Segments” in this note.
Reportable Segments
Under SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” we
operate in two reportable segments. Effective January 1, 2007, consistent with how we manage our
business, we changed from reporting one segment to reporting two segments: Enterprise and CodeGear.
We market our products in the United States and in foreign countries through our sales personnel
and our subsidiaries. The Chief Executive Officer is our Chief Operating Decision Maker, or CODM,
as defined by SFAS No. 131. Refer to Note 11 of Notes to Condensed Consolidated Financial
Statements in Item 1 for a discussion of our reportable segments.
For a more in-depth discussion of our other critical accounting policies and estimates, please
read our Annual Report on Form 10-K for the year ended December 31, 2006, as filed with the SEC on
March 15, 2007.
Effect of New Accounting Pronouncements
For information regarding the effect of new accounting pronouncements, refer to Note 13 of
Notes to Condensed Consolidated Financial Statements in Item 1.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risks relating to our operations result primarily from changes in interest rates and
foreign currency exchange rates, as well as credit risk concentrations. To address the foreign
currency exchange rate risk we enter into various foreign currency forward exchange contracts as
described below. We do not use financial instruments for trading purposes.
Foreign Currency Risk
A portion of our business is conducted in currencies other than the U.S. dollar. The
functional currency for all of our foreign
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operations is the local currency of the country in which
we have established business operations. Both revenues and operating expenses in each of these
countries are largely denominated in local currencies, which mitigate a portion of the exposure
related to fluctuations in local currencies against the U.S. dollar. However, our financial results
could still be adversely affected by factors such as changes in foreign currency exchange rates or
weak economic conditions in foreign markets. In addition, we have established a program to minimize
our foreign currency exposure utilizing forward exchange contracts to manage foreign currency
exposures related to short-term inter-company balances denominated in foreign currencies. The goal
of this program is to offset the translation effect of foreign currency-denominated short-term
inter-company balances by entering into contracts to buy or sell foreign currency at the time a
foreign currency receivable or payable is generated. At month-end, foreign currency-denominated
balances and the forward exchange contracts are marked-to-market and unrealized gains and losses
are included in interest and other income, net.
During the three and six months ended June 30, 2007, we recorded net realized foreign exchange
losses of $0.4 million and $0.6 million, respectively, included as part of interest and other
income, net, in our Condensed Consolidated Statements of Operations. The foreign exchange losses
were generated primarily from fluctuations in the Brazilian Real, the Canadian dollar, the Euro,
the United Kingdom Pound Sterling, and the Japanese Yen versus the U.S. dollar. It is uncertain
whether these currency trends will continue. In the future we may experience foreign exchange
losses on our inter-company receivables and payables to the extent that we have not mitigated our
exposure utilizing foreign currency forward exchange contracts. Foreign exchange losses could have
a material adverse effect on our operating results and cash flows.
During the three and six months ended June 30, 2007, we had an increase of $0.1 million and a
decrease of $0.5 million, respectively, in unrealized foreign currency gains in cumulative other
comprehensive income on our Condensed Consolidated Balance Sheets, in part, due to foreign currency
movements on our long-term inter-company balances. As of June 30, 2007, we had $19.4 million, $11.7
million, $5.5 million, $1.5 million and $0.4 million in long-term inter-company receivable balances
that will be settled in Australian dollars, Singapore dollars, Indian Rupees, Brazilian Real, and
Japanese Yen, respectively and $14.7 million in long-term inter-company payable balances that will
be settled in Euros.
The table below provides information about our derivative financial instruments, comprised of
foreign currency forward exchange contracts as of June 30, 2007. The information is provided in
U.S. dollar equivalent amounts, as presented in our financial statements. For foreign currency
forward exchange contracts, the table below presents the notional amounts (at the contract exchange
rates), the weighted-average contractual foreign currency exchange rates and the net fair value for
our foreign currency forward exchange contracts as of June 30, 2007. All foreign currency forward
exchange contracts in the table below represent contracts to buy or sell the currencies listed. All
instruments mature within one month (dollar amounts in thousands):
Interest Rate Risk
Our exposure to market risk for changes in interest rates relates primarily to our investment
portfolio. We do not use derivative financial instruments in our investment portfolio. We place our
cash equivalents primarily with money market funds or banking institutions.
Cash and cash equivalents include investments which have an original maturity of 90 days or
less and short-term investments include investments which have an original maturity of 91 days up
to one year. As of June 30, 2007 and December 31, 2006, we held no investments classified as
long-term. For three months ended June 30, 2007, the weighted-average interest rate we earned on
our average cash and cash equivalent balances was 4.8%. For the year ended December 31, 2006, the
weighted-average interest rate we earned on our average cash and cash equivalent balances was 3.2%.
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Credit Risks
Our financial instruments that are exposed to concentrations of credit risk consist primarily
of cash, cash equivalents, short-term investments and trade receivables. Our cash, cash equivalents
and short-term investments are in high-quality securities placed with major banks and financial
institutions and commercial paper. Concentrations of credit risk with respect to receivables are
limited due to the large number of customers and their dispersion across geographic areas. We
perform periodic credit evaluations of our customers’ financial condition and generally do not
require collateral. No single customer represented greater than 10% of total accounts receivable,
net of allowances, as of June 30, 2007.
ITEM 4. CONTROLS AND PROCEDURES
Material Weakness in Prior Period
In our Annual Report on Form 10-K for the year ended December 31, 2006 and in our quarterly
report for the period ended March 31, 2007, we reported the following material weakness in our
internal control over financial reporting. A material weakness is a control deficiency, or
combination of control deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented or detected. As
of December 31, 2006, we did not maintain an effective control environment with respect to
promoting compliance with policies and procedures and the prevention and detection of the override
of our internal controls. Management determined that this control deficiency could have resulted
in a material misstatement of our annual or interim consolidated financial statements that could
not be prevented or detected. Accordingly, management determined that this control deficiency
constituted a material weakness
Remediation Measures
Management has implemented significant measures to remediate the material weakness in our
internal control over financial reporting. Starting in 2006 and continuing through the quarter
ended June 30, 2007, we have designed and implemented measures to remediate the material weakness
and increase the effectiveness of our internal control over financial reporting. These measures
have included, among others, requiring the sales and services organizations to complete quarterly
certifications, revenue recognition training for sales personnel and corporate governance training
for key members of the management team. In August 2006, we conducted corporate governance training
for senior personnel which was attended by our Chief Executive Officer and other senior members of
our management team. We also hired a Chief Financial Officer in November 2006 and a General
Counsel in October 2006, each of whom has taken an active role to significantly strengthen our
control environment by implementing the compliance training and policies mentioned above. In
addition, during the quarter ended June 30. 2007, we implemented on-going and sustainable
compliance training programs, including a company-wide ethics training program. These compliance
programs have been supplemented with enhanced written policies and compliance with these training
programs and policies is monitored. In the quarter ended June 30, 2007, management completed the
testing of the design and operating effectiveness of these controls and concluded they have been in
operation for a sustained period to maintain an effective control environment with respect to
promoting compliance with policies and procedures and the prevention or detection of the override
of our controls. As a result of these measures, management, including our Chief Executive Officer
and Chief Financial Officer, has determined that the material weakness has been remediated as of
June 30, 2007.
Evaluation of Our Disclosure Controls and Procedures
Disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e)
under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”)) are those controls
and procedures designed to ensure that information required to be disclosed in our reports filed
under the Exchange Act is recorded, processed, summarized and reported within the time periods
specified in the SEC’s rules and forms, and that such information is accumulated and communicated
to our management, including the Chief Executive Officer and Chief Financial Officer, who is our
Principal Financial Officer, to allow timely decisions regarding required disclosure.
Under the supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, we evaluated our disclosure controls and procedures
pursuant to the Exchange Act rules as of the end of the period covered by this Report. Based upon
this evaluation, our Chief Executive Officer and Principal Financial Officer concluded that, as of
June 30, 2007, our disclosure controls and procedures were effective to provide a reasonable level
of assurance that the financial
information we are required to disclose in the reports we file or submit under the Exchange
Act was recorded, processed, summarized and reported accurately within the time periods specified
in the SEC’s rules and forms.
Changes in Internal Control Over Financial Reporting
There have been changes in our internal control over financial reporting, as indicated above,
during the quarter ended June 30, 2007 which our management concluded have materially affected, or
are reasonably likely to materially affect, our internal control over financial reporting.
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PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, we may be involved in lawsuits, claims, investigations and proceedings,
consisting of intellectual property, commercial, employment and other matters, which arise in the
ordinary course of business. In accordance with SFAS 5, “Accounting for Contingencies” we record a
liability when it is both probable that a liability has been incurred and the amount of the loss
can be reasonably estimated. These accruals are reviewed at least quarterly and adjusted to reflect
the impacts of negotiations, settlements, rulings, advice of legal counsel and other information
and events pertaining to a particular case. Litigation is inherently unpredictable; however, we
believe that we have valid defenses with respect to the legal matters pending against us, as well
as adequate accruals for any probable and estimable losses. If an unfavorable ruling were to occur
in any of these matters in a particular period, our liquidity and financial condition could be
adversely impacted, as well as our results of operations and cash flows.
From time to time, we receive notices from third-parties claiming infringement by our products
of third-party patent, trademark and other intellectual property rights, disputing royalties, or
disputing other commercial arrangements. Regardless of the merit of any such claim, responding to
these claims could be time consuming and expensive, and may require us to enter into licensing or
royalty agreements which may not be offered or available on terms acceptable to us. If a successful
claim is made against us, our business could be materially and adversely affected. We expect that
our software products will increasingly be subject to such claims as the number of products and
competitors in our industry segment increases, the functionality of products overlap and industry
participants become more aggressive in using patents offensively.
ITEM 1A. RISK FACTORS
We operate in a rapidly changing environment that involves many risks, some of which are
beyond our control. The following discussion highlights some of these risks. Additional risks and
uncertainties not presently known to us or that we currently deem immaterial also may impair our
business operations or results. If any of these risks actually occur, our business operations or
results could be harmed. Risk Factors that have been added or have materially changed since the
filing of our Annual Report on Form 10-K for the year ended December 31, 2006, are identified with
an “*”.
Risks Relating to Our Business
We are re-focusing the company to primarily focus on the development and distribution of enterprise
software development solutions. If we are unable to successfully complete this change to the
business quickly and smoothly, our operating results could be harmed.
Over the past several quarters we have been transforming our business to focus on Open
Application Lifecycle Management, or ALM, solutions. Prior to the development of our ALM strategy,
our principal business related to our integrated developer environment, or IDE, products, which we
now operate as our CodeGear division. Our enterprise business focuses on the development and
distribution of enterprise software development solutions, in contrast to our CodeGear division,
which targets development tools for individual software developers. The risks of this change in
focus include, among others:
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While we believe the change in our business to focus on our ALM strategy is critical to
growing our business, we may be unable to manage this change effectively and quickly and our
business, results of operations, financial condition and prospects could be harmed. In addition,
expenses associated with our restructuring and change of strategy will likely continue to have an
adverse impact on our operating results at least through 2007.
Our failure to efficiently complete the separation of our CodeGear division from our enterprise
business and effectively operate CodeGear could harm our operating
results.*
As announced in November 2006, we are retaining our IDE assets for the foreseeable future
rather than selling them. We began operating this part of our business as our CodeGear division on
January 1, 2007, the separation of CodeGear from our enterprise business is a complicated process
which is not yet complete. The process includes a worldwide analysis and plan to identify and
separate personnel, customers and partner relationships, office space, intellectual property and
other assets. We are also working to run our international operations
more efficiently, which involves changes to the sales structure. This process requires time and effort of management and key personnel of both our
enterprise business and CodeGear division who would otherwise be dedicated to running these
respective businesses. There will continue to be other resources dedicated to facilitate the
separation, including those relating to IT, development and systems for financial reporting and
internal controls. While our goal is to separate CodeGear and operate
it in a manner that is efficient for our
CodeGear and enterprise businesses, there can be no guarantee that we will achieve these goals.
Sales may be negatively impacted by changes in the sales structure
and customers may lose confidence in the CodeGear business during
this transition period. Failure to implement this separation efficiently could have a material adverse effect on our
overall business, results of operations and financial condition.
We have experienced significant changes in our senior management team over the past two years and
if we are not able to effectively integrate new senior management members, our business could be
harmed. *
There have been a number of significant changes in our senior management team, including the
addition of our new Senior Vice President, Research and Development in August 2006, our new Senior
Vice President and General Counsel in October 2006, our new Chief Financial Officer in November
2006 and our new Senior Vice President of Worldwide Field Operations in January 2007. As a result
of these changes, we may not be able to effectively manage our business during this period of
transition, especially in light of the changes in our strategy, our restructuring actions and
related operations. In addition, after we relocate our headquarters from Cupertino, CA to
Austin, TX, our General Counsel and Chief Marketing Officer will remain in our Cupertino office
while other senior management will relocate to Austin, TX. Our ongoing operations could be
disrupted during this transition period. There is a risk that the management may not work
effectively as a team, at least in the near term. During this transition period, our customers may
defer purchasing our products or decide not to purchase them at all. We may experience employee
distraction, or we may see increased
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competitive pressure as our competitors attempt to use this period of change to their
advantage. If we are unable to effectively manage through this transition quickly and effectively,
it could adversely affect our operating results.
Our failure to implement systems to meet the requirements and manage the large service projects
necessary for our enterprise may result in delays in recognizing revenue on these projects and thus
could harm our profit and adversely affect our results of operations.
Our enterprise business focuses on large enterprise sales which may include complex
professional services agreements. Our inability to structure and manage services agreements may
result in unanticipated changes to the timing of our services revenue. In addition, if we bundle
services together with our license agreements, this may also affect the timing of recognizing our
license revenue. We may need to implement new systems or upgrade current systems to manage these
large, complex services agreements. If we fail to make appropriate changes to our existing systems
or if our services agreements lead to unanticipated changes to the timing of revenue recognition,
our results of operations could be harmed.
Our inability to forecast our revenue pipeline or convert revenue pipeline into contracts,
especially given our increasing focus on enterprise customers, could increase fluctuations in our
revenue and financial results.
We use a “pipeline” system, a common industry practice, to forecast sales and trends in our
ALM business. Our sales personnel monitor the status of all potential transactions, including the
estimated closing date and potential dollar amount of each transaction. We aggregate these
estimates periodically to generate a sales pipeline and then evaluate the pipeline to identify
trends in our business. This pipeline analysis and related estimates of revenue may differ
significantly from actual revenues in a particular reporting period. When customers delay
purchasing decisions, reduce the amount of their purchases or cancel their purchases altogether, it
will reduce the rate of conversion of the pipeline into contracts and our revenues will be harmed.
In addition, because a substantial portion of our software license contracts close in the latter
part of a quarter, we may not be able to adjust our cost structure to respond to a variation in the
conversion of the pipeline into contracts in a timely manner. Our inability to respond to a
variation in the pipeline or in the conversion of the pipeline into contracts in a timely manner,
or at all, could cause us to plan or budget inaccurately and thereby could adversely affect our
results of operations and financial condition.
We have begun to license our software directly to large enterprises and have experienced sales
cycles that are substantially more lengthy and uncertain than those associated with our traditional
business of licensing software through indirect and retail channels and more modest direct sales.
As we focus on large transactions involving multiple elements, enterprise customers generally
require us to expend substantial time, effort and money establishing a relationship and educating
them about our solutions. Also, sales to enterprise customers generally require an extensive sales
effort throughout many levels within the customer’s organization and often require final approval
by several layers of executives, including the customer’s chief information officer, chief
financial officer and/or other senior executives. These factors substantially extend the sales
cycle and increase the uncertainty of whether a sale will be made in any particular quarter, or at
all. We have experienced and expect to continue to experience delays and uncertainties in our sales
cycles as well as increased up-front expenses in connection with our enterprise sales efforts. The
timing of the execution of enterprise volume licenses could cause our results of operations to vary
significantly from quarter to quarter, especially when we anticipate certain transactions will
close in a particular quarter. Further, industry buying patterns suggest that larger transactions
are frequently deferred until later in the quarter, creating increased difficulty in quarterly
forecasting. If a sale is never completed despite months or even years of selling efforts, we will
have expended substantial time, money and resources during the pre-sales effort without generating
any revenue to offset these expenses. Finally, due to the complexity and time commitment necessary
to pursue each of these transactions, we focus on a small number of proposed sales at any time and
if we fail to complete any of these sales, our business, results of operations and financial
condition would be negatively affected.
Because competition for qualified finance, technical and management personnel is intense and
because we are in the process of moving headquarters, we may not be able to recruit or retain
qualified personnel quickly, which could harm our business.*
We believe our ability to successfully manage and grow our business and to develop new
products depends, in large part, on our ability to recruit and retain qualified employees,
particularly highly skilled finance personnel, software engineers, sales personnel and management
personnel. Competition for qualified technical and management personnel is intense. As we announced
in April 2007, we are moving our headquarters from Cupertino, CA to Austin, TX. While we believe we
will be able to retain qualified personnel in Austin, it may take longer than we expect to hire
those people and for them to be able to function effectively. Also, in the past some of our
competitors have utilized their greater resources to provide substantial signing bonuses and other
inducements to lure key personnel away from us. We employ a variety of measures to retain our key
people, including granting of stock options and restricted stock and the use of bonuses, but these
measures may not be sufficient.
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We have experienced a relatively high rate of employee turnover and could be subject to
continued risk of turnover given the changes we are experiencing. If we are unable to recruit and
retain quality personnel, our ability to provide competitive products could be harmed. As a result,
we may lose customers or may not achieve anticipated sales during a particular period. In addition,
the loss of technical talent may result in the inability to ship new products or product upgrades
at the times originally planned. If we experience delays in the shipment of new products or product
upgrades, we may be unable to achieve anticipated sales during a particular period.
We have historically used stock options and other forms of equity compensation as key
components of our employee compensation program in order to align employees’ interest with the
interests of our stockholders while encouraging employee retention. The decline of our stock price
over the last few years has made stock options a less attractive portion of our employee
compensation program. As a result, we may find it increasingly difficult to attract, retain and
motivate employees.
Our success is dependent upon our ability to enhance the quality and scalability of our various
products, improve the integration and overall functionality of these products, and evolve our
solutions toward our ALM strategy.
We produce and sell a broad portfolio of products to manage the software development process.
The market for these products is characterized by continuous technological advancement, evolving
industry standards and changing customer requirements. A significant portion of our research and
development focus is on integrating our many existing and recently acquired products into a
cohesive ALM solution. Managing our development activities as we execute our change in strategy is
complex and involves a number of risks, especially with respect to maintaining competitiveness
across our individual products while at the same time bolstering the integration and functionality
of our products. We may not be successful in designing and marketing new products, integrating
acquired products, providing the necessary product enhancements or features to address increasingly
sophisticated and varied needs of our customers or in enhancing the integration and functionality
of our ALM platform. To be successful in this market, we will also need to be able to compete with
several large and well-established companies with more experience in these markets.
Our customers use a wide variety of constantly changing hardware, software and operating
platforms, adding to our development challenges. We will continue to invest significant resources
to develop products for new or emerging software and hardware platforms in the server, desktop,
mobile and other environments that may develop from time to time. However, there is a risk that a
new hardware or software platform for which we do not provide products could rapidly grow in
popularity. In particular, we believe that this risk is substantial for particular proprietary
platforms and languages for which we may not be given economically feasible access or access at
all. As a result, we may not be in a position to develop products for such platforms or may be late
in doing so. If we fail to introduce new products that address the needs of emerging market
segments or if our new products do not achieve market acceptance as a result of delays in
development or other factors, our future growth and revenue opportunity could suffer.
If we are unable to maintain revenue levels for our deployment products, our financial results may
be harmed.
We currently have a portion of our revenue attributable to our deployment products. These
products are mature products and we primarily rely on new sales to existing customers, maintenance
agreements with existing customers, compliance purchases through customer audits and sales through
existing independent software vendors and original equipment manufacturers’ partners to generate
revenue. We have experienced weakness and fluctuations in revenue from these products in the past
and believe they will continue to be subject to commoditization. Our deployment products are
generally based on older standards and technologies, which are used in a decreasing number of
industries, networks and applications. We devote little marketing to these products and primarily
rely on the effectiveness of the sales force and compliance teams to work with customers and
partners to generate sales. There have been many changes in the sales force over the past several
quarters, especially in Europe where we have historically generated a significant amount of revenue
from our deployment products. If we are unable to maintain effective sales programs for our
deployment products, or if existing customers migrate away from our deployment products, our
business, results of operations and financial condition could suffer.
We may not be able to compete successfully against current and potential competitors.
Our markets are intensely competitive. In the market for comprehensive software development
solutions, we face competition from some of the largest software providers in the world. For
example, IBM, Microsoft, Sun Microsystems, Hewlett-Packard, Computer Associates and others provide
or have stated they intend to provide comprehensive enterprise software development and integration
solutions. Traditionally, we have partnered with some of these competitors to offer a broader
solution to their or our customer base; however, as our partners and business strategy change, a
larger market overlap may develop and some or all of these partnering arrangements could be
adversely affected or terminated. Most of these competitors have substantially greater financial,
management, marketing and technical resources than we have. In addition, many of our competitors
have well established relationships with our current and potential customers, extensive knowledge
of the market, substantial experience in selling enterprise solutions, strong professional services
and technical support offerings and extensive product development, sales and marketing
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resources. As a result of their greater resources and established relationships, these
competitors may be more successful than we are at developing and marketing products and solutions
in our markets.
In addition, the markets for our CodeGear products are characterized by rapid change, new and
emerging technologies, and aggressive competition. Some of our competitors include IBM, Microsoft
and Sun Microsystems. We attempt to differentiate our products from those of our competitors based
on interoperability, total cost of ownership, product quality, performance, level of integration
and reliability. We may be unable to successfully differentiate our products from those of our
competitors, or we may be unable to compete with the substantially greater resources many of our
competitors have. If so, our business, results of operations and financial condition may suffer.
The complexity of accounting regulations and related interpretations and policies, particularly
those related to revenue recognition, could materially affect our financial results for a given
period.
Although we use standardized agreements designed to meet current revenue recognition criteria
under generally accepted accounting principles, we must often negotiate and revise terms and
conditions of these standardized agreements, particularly in multi-product license and services
transactions. As our transactions have increased in complexity, particularly with the sale of
larger, multi-product licenses, negotiation of mutually acceptable terms and conditions may require
us to defer recognition of revenue on such licenses. We believe that we are in compliance with
Statement of Position 97-2, “Software Revenue Recognition,” as amended; however, more complex,
multi-product license transactions require additional accounting analysis to account for them
accurately. Errors in such analysis in any period could lead to unanticipated changes in our
revenue accounting practices and may affect the timing of revenue recognition, which could
adversely affect our financial results for any given period. If we discover that we have
interpreted and applied revenue recognition rules differently than prescribed by generally accepted
accounting principles in the U.S, we could be required to devote significant management resources,
and incur the expense associated with an audit, restatement or other examination of our financial
statements.
We previously had material weaknesses in our internal control over financial reporting. While our
management has determined that we do not currently have any material weaknesses in our internal
control over financial reporting, there can be no assurance that we will maintain an effective
framework for internal control over financial reporting in the future, which would harm our
business and the trading price of our stock.*
Under Section 404 of the Sarbanes-Oxley Act of 2002, we are required to evaluate and determine
the effectiveness of our internal control over financial reporting. We dedicated a significant
amount of time and resources to ensure compliance with this legislation for the year ended December
31, 2006, and the quarters ended March 31, 2007 and June 30, 2007, and will continue to do so for
future fiscal periods. We may encounter problems or delays in completing the review and evaluation,
the implementation of improvements and the receipt of a positive attestation, or any attestation at
all, by our independent registered public accounting firm. Additionally, management’s assessment of
our internal control over financial reporting may identify deficiencies that need to be addressed
in our internal control over financial reporting or other matters that may raise concerns for
investors.
A material weakness is a control deficiency, or combination of control deficiencies, that
results in more than a remote likelihood that a material misstatement of the annual or interim
financial statements will not be prevented or detected. In our Form 10-K for the fiscal year ended
December 31, 2005, we reported management’s conclusion that we had two material weaknesses in our
internal control over financial reporting. One of the material weaknesses was our lack of
effective controls in our services organization to ensure that invoices from third party
contractors were completely and accurately recorded. This material weakness was remediated as of
the quarter ended September 30, 2006. The second material weakness was our lack of an effective
control environment based on the criteria established in the COSO framework with respect to
promoting compliance with policies and procedures and the prevention or detection of the override
of our controls. As a result of this control deficiency, a senior officer was able to override
controls which resulted in: (1) an amendment to a sales contract creating an obligation to deliver
an additional software feature without authorization of the finance and legal organization, and (2)
a post-contract offer to refund the customer payment in the same transaction without authorization
of the finance and legal organization. This material weakness was remediated as of the quarter
ended June 30, 2007.
Because of their inherent limitations, internal control over financial reporting may not
prevent or detect misstatements or fraud. A control system, no matter how well conceived and
operated, can provide only reasonable, not absolute, assurance that the objectives of the control
system are met. Also, projections of an evaluation of effectiveness to future periods are subject
to the risk that controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate. Should we or our independent
registered public accounting firm, determine in future fiscal periods that we have a material
weaknesses
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in our internal control over financial reporting, the reliability of our financial reports may
be impacted, and our results of operations or financial condition may be harmed and the price of
our common stock may decline.
We have been unable to timely file our annual and quarterly reports as required by the Securities
Exchange Act of 1934, and our continued inability to file these reports on time could result in
your not having access to important information about us and the delisting of our common stock from
the Nasdaq Global Market.
We were late in filing our Annual Report on Form 10-K for the fiscal year ended December 31,
2005, and our Quarterly Reports on Forms 10-Q for the fiscal quarters ended March 31, 2006, June
30, 2006, and September 30, 2006. As a result, during the periods in which these reports were late,
we were not in compliance with the continued listing requirements of the Nasdaq Global Market and,
in some cases, with the SEC’s rules and regulations under the Securities Exchange Act of 1934. We
are required to comply with these rules as a condition of the continued listing of our stock on the
Nasdaq Global Market.
Although we are not currently late with respect to any annual or quarterly report, there can
be no assurance that we will be able to file all such reports in the future in a timely manner. If
we are unable to timely file these reports in the future, it may impede your access to important
information about us and, in the case of a prolonged delay in filing, result in our common stock
being delisted from the Nasdaq Global Market. Delisting could result in our common stock no longer
being traded on any securities exchange or over-the-counter market and could impact its liquidity
and price. In addition, if we were delisted, we would be in default under the Convertible Senior
Notes we issued in February 2007, which would cause the notes to become immediately due and
payable.
We are in the midst of significant changes to our financial reporting and accounting team and
systems, which may impact our ability to comply with our financial reporting and accounting
obligations. *
Our financial reporting and accounting team has undergone several personnel changes, including
the departure of our Chief Financial Officer in the second quarter of 2006, and the hiring of our
new Chief Financial Officer in November 2006. We are currently moving our corporate headquarters
from Cupertino, CA to Austin, TX and in the process of transitioning a significant portion of our
finance team. While we believe we have retained qualified individuals on an interim basis and have
hired new permanent employees in Austin and have put measures in place to retain employees based
in Cupertino long enough to facilitate an orderly transition, our hiring activities and
headquarters move may impair the ability of our finance organization to function effectively.
During this transition period, we may have a difficult time attracting, recruiting and retaining
qualified finance personnel. In addition, we are in the process of
changing our financial reporting systems. While we have taken measures
aimed at protecting data and keeping accurate records, there can be
no assurance the transition will be done without causing errors,
delays or inefficiencies. If we fail to staff our accounting and finance function adequately or
maintain adequate internal control over financial reporting, we may be unable to report our
financial results accurately or in a timely manner and our business, results of operations and
financial condition may suffer.
We are in the process of moving our headquarters and implementing plans for reducing expenses and
if we fail to achieve the results we expect, there will be a negative effect on our financial
condition.*
As a part of our restructuring plans, we are in the process of moving our headquarters from
Cupertino, CA to Austin, TX and implementing other plans to reduce expenses, which have included
the consolidation of certain office locations worldwide, reductions in capital expenditures,
reduction in discretionary spending and reduction in our work force. These restructuring actions
may distract management and other key personnel from focusing on our business. In addition, if we
experience difficulties in implementing these measures, it may be necessary to implement additional
cost cutting measures. Our plans to reduce expenses may not be completed in a timely manner or
result in anticipated cost savings, which would impair our goal to achieve profitability and
positive cash flow. In addition, we are currently operating at a net loss and there can be no
assurance as to when we will return to profitability, if at all. In order to fund our ongoing
operations in future periods it will be necessary for us to achieve profitability.
Consolidation in our industry or fluctuation in our stock price may impede our ability to compete
effectively.
Consolidation continues to occur among companies that compete in our markets. Additionally,
some of the largest software and hardware providers in the world have sought to expand their
software and services offerings through acquisitions in the software development, deployment and
integration space. For instance, in November 2006, Hewlett Packard acquired one of our competitors,
Mercury Interactive. If these large providers, who have significantly greater financial,
management, marketing and technical resources than we have, are successful in increasing their
offerings in the software development market, our business will be subject to significant pressure
and our ability to compete effectively harmed. Additionally, changes resulting from these and other
consolidations may harm our competitive position, particularly as certain products, when offered as
part of a bundled suite, are offered for free or are given away to sell more hardware,
infrastructure components or information technology services.
As the trend toward consolidation continues, we may encounter increased competition for
attractive acquisition targets and may
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have to pay higher prices for those businesses or technologies we seek to acquire. In
addition, we have seen a recent decline in our stock price, which will in turn make it more
difficult for us to use stock as a currency for the acquisition of strategic businesses or
technologies. This will put pressure on our ability to seek out potential acquisition targets which
may impede our growth and our ability to compete effectively.
We depend on technologies licensed to us by third parties, such as Sun Microsystems and Microsoft,
and the loss of or inability to maintain these licenses could prevent or delay sales or shipments
of certain of our products.
We depend on licenses from third-party suppliers for some elements of our products such as
various file libraries. In particular, we depend on technology licenses from Sun Microsystems for
certain of our Java products, and we depend on licenses from Microsoft for our Delphi, C++,
C#Builder and Borland Developer Studio products. If any of these licenses or other third-party
licenses were terminated or were not renewed, or if these third-parties failed to notify us in a
timely manner of any new or updated technology, we might not be able to ship such products as
planned or provide support for such products, including upgrades. We would then have to seek an
alternative to the third-party’s technology and, in some cases, an alternative may not exist. This
could result in delays in releasing and/or shipping our products, increased costs by having to
secure unfavorable royalty arrangements or reduced functionality of our products, which in turn
could adversely affect our business, results of operations and financial condition.
Failure to effectively manage our international operations could harm our results.
A substantial portion of our revenues are generated from international sales. In addition, a
significant portion of our operations consist of activities outside the United States. We now have
research and development facilities in several domestic and international locations, and we
currently have a direct sales force in approximately twenty countries around the world. We have a
complicated corporate structure, and historically have had geographically dispersed operational
controls. In particular, we rely on personnel in our international locations to properly account
for and manage our international operations, which introduce inherent difficulties in management
and control. Given this, we have and may continue to experience difficulty in efficiently and
effectively managing our dispersed and complicated organization. As a result, our results of
operations may suffer. In addition, we are subject to other risks inherent in doing business
internationally, including:
One or more of these risks could harm our future research operations and international sales.
If we are unable to manage these risks of doing business internationally, our business, results of
operations and financial condition could suffer.
Bundling arrangements or product give-aways by our competitors, including available, cost-free
development technologies, may diminish demand for our products or pressure us to reduce our prices.
Some of our competitors, particularly those that are primarily hardware vendors or platform
providers, generate a substantially
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greater proportion of their sales in markets in which we do not directly compete. We believe a
number of these competitors view sales of software application lifecycle technologies as important
to enhancing the functionality and demand for their core products. As a result, these companies
often bundle software products that compete with our offerings, with products such as application
servers, work stations, personal computers, operating systems databases and information technology
services. When competitors do so, the effective price for their software products that compete with
our software development platform/solutions are often heavily discounted or offered at no charge.
This has required us to reduce the price of our products and related services in certain
circumstances, sometimes to no avail. Similarly, industry alliances and arrangements exist or may
be formed in the future under which our competitors ally with companies in markets in which we do
not compete to bundle products. These arrangements may also result in lower effective prices for
our competitors’ products than for our products, putting pressure on our business and diminishing
our competitive position.
Our future success depends upon enhancing existing relationships and establishing new technology
alliances.
The market for enterprise software application development and deployment solutions is broad,
and our products and solutions must integrate with a wide variety of technologies. To be
successful, we must continue to establish and enhance strategic alliances with a wide variety of
companies in the software development ecosystem. Many of these companies have competitive products
or have stated a desire to move broadly into the software development lifecycle space. In addition,
many of these companies are competitive with one another and approach partnering with us
cautiously. This has made it difficult in some cases to establish or enhance desired relationships
or achieve intended objectives. We currently have a number of important strategic alliances and
technology relationships with industry leaders. Where we have established working relationships,
our allies may choose to terminate their arrangements with us where no binding contractual
arrangements exist. The failure to develop or maintain our strategic alliances and technology
relationships or our allies’ decision to opt out of their arrangements with us may impede our
ability to introduce new products or enter new markets, and consequently harm our business, results
of operations and financial condition.
Our products may contain unknown defects that could result in a loss of revenues, decreased market
acceptance, injury to our reputation and product liability claims.
Software products occasionally contain errors or defects, especially when they are first
introduced or when new versions are released. We cannot be certain that our products are currently
or will be completely free of defects and errors. We could lose revenue as a result of product
defects or errors, including defects contained in third-party products that enable our products to
work. In addition, the discovery of a defect or error in a new version or product may result in the
following consequences, among others:
As we transition from selling individual IDE products towards selling enterprise-wide
solutions, we also expect our products to become more critical to our customers. Thus, a defect or
error in our products could result in a significant disruption to our customers’ businesses. In
addition, as we transition to selling larger, more complex solutions, there is also the risk that
our current products will not prove scalable without substantial effort. In addition, there could
be a market perception that our products are too complex. If we are unable to develop products that
are free of defects or errors or if our products are not able to scale across an enterprise or are
perceived to be too complex to scale across an enterprise, our business, results of operations and
financial condition could be harmed.
Third-party claims of intellectual property infringement may subject us to costly litigation or
settlement terms or limit the sales of our products.
From time to time, we receive notices claiming that we have infringed a third-party’s patent
or other intellectual property right. We expect that software products in general will increasingly
be subject to these claims as the number of products and competitors
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increase, the functionality of products overlap and as the patenting of software functionality
becomes more widespread. Further, the receipt of a notice alleging infringement may require in some
situations a costly opinion of counsel be obtained to prevent an allegation of intentional
infringement. Regardless of its merits, responding to any claim can be time consuming and costly
and divert the efforts of our technical and management personnel. In the event of a successful
claim against us, we may be required to pay significant monetary damages, including treble damages
if we are held to have willfully infringed, discontinue the use and sale of the infringing
products, expend significant resources to develop non-infringing technology and/or enter into
royalty and licensing agreements that might not be offered or be available on acceptable terms. If
a successful claim was made against us and we failed to commercially develop or license a
substitute technology, our business, results of operations and financial condition could be harmed.
In addition, we may not have insurance coverage for these types of claims or our insurance coverage
for these types of claims may not be adequate.
If we are unable to protect our intellectual property, we may lose valuable assets.
As a software company, our intellectual property rights are among our most valuable assets. We
rely on a combination of patent, copyright, trademark, trade secrets, confidentiality agreements
and other contractual arrangements and other methods to protect our intellectual property rights,
but these measures may provide only limited protection. The protective steps we have taken may be
inadequate to deter misappropriations of our intellectual property rights. In addition, it may be
possible for an unauthorized third-party to reverse-engineer or decompile our software products. We
may be unable to detect the unauthorized use of, or take appropriate steps to enforce, our
intellectual property rights, particularly in certain international markets, making
misappropriation of our intellectual property more likely. Litigation may be necessary to protect
our intellectual property rights, and such litigation can be time consuming and expensive.
Our debt obligations expose us to risks that could adversely affect our business, operating results
and financial condition.
In February 2007, we issued an aggregate principal amount of $200,000,000 in 2.75% Convertible
Senior Notes due in 2012. The level of our indebtedness, among other things, could:
If we experience a decline in revenue due to any of the factors described in this section
entitled “Risk Factors,” or otherwise, we could have difficulty paying amounts due on our
indebtedness. Although the Convertible Senior Notes mature in 2012, the holders of the convertible
senior notes may require us to repurchase their notes prior to maturity under certain
circumstances, including specified fundamental changes such as the sale of a majority of the voting
power of the company. If we are unable to generate sufficient cash flow or otherwise obtain funds
necessary to make required payments, or if we fail to comply with the various requirements of the
convertible senior notes, we would be in default, which would permit the holders of our
indebtedness to accelerate the maturity of the indebtedness and could cause defaults under any
other indebtedness that we may have outstanding at such time. Any default under our indebtedness
could have a material adverse effect on our business, operating results and financial condition.
Conversion of the Convertible Senior Notes will dilute the ownership interests of existing
stockholders.
The terms of the Convertible Senior Notes permit the holders to convert the notes into shares
of our common stock. The Convertible Senior Notes are convertible into our common stock initially
at a conversion price of $6.38 per share, which would result in an aggregate of approximately 31.4
million shares of our common stock being issued upon conversion, subject to adjustment upon the
occurrence of specified events, provided that the total number of shares of common stock issuable
upon conversion, as may be
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adjusted for fundamental changes or otherwise, may not exceed approximately 39.2 million
shares. The conversion of some or all of the Convertible Senior Notes will dilute the ownership
interest of our existing stockholders. Any sales in the public market of the common stock issuable
upon conversion could adversely affect prevailing market prices of our common stock.
Each $1,000 of principal of the Convertible Senior Notes is initially convertible into
156.8627 shares of our common stock, subject to adjustment upon the occurrence of specified events.
However we may seek to obtain stockholder approval to settle conversions of the notes in cash and
shares of common stock, which approval would require the vote of a majority of shares of our common
stock at a stockholder meeting duly called and convened in accordance with our organizational
documents, applicable law and the rules of the Nasdaq Global Market.
In addition, holders may convert their Convertible Senior Notes prior to maturity if: (1) the
price of our common stock reaches $8.29 during specific periods of time, (2) specified corporate
transactions occur or (3) the trading price of the notes falls below a certain threshold. As a
result, although the convertible senior notes mature in 2012, the holders may require us to convert
the notes prior to maturity. As of the date this Quarterly Report on Form 10-Q was filed with the
Securities and Exchange Commission, none of the conditions allowing holders of the notes to convert
had occurred.
Under the terms of the 2.75% Convertible Senior Notes due 2012, events that we do not control may
trigger conversion rights that, if exercised, may have an adverse effect on our liquidity.
Holders of our convertible senior notes due 2012 will have the right to require us to
repurchase the notes upon the occurrence of a fundamental change of Borland, including some types
of change of control transactions. We may not have sufficient funds to repurchase the notes in cash
or to make the required repayment at such time or have the ability to arrange necessary financing
on acceptable terms. In addition, upon conversion of the notes, if we have received approval from
our stockholders to settle conversions of the notes in cash and shares of our common stock, we will
be required to make cash payments to the holders of the notes equal to the lesser of the principal
amount of the notes being converted and the conversion value of those notes. Such payments could be
significant, and we may not have sufficient funds to make them at such time. Our failure to
repurchase the notes or pay cash in respect of conversions when required would result in an event
of default.
Our rights plan and our ability to issue additional preferred stock could harm the rights of our
common stockholders.
In October 2001, we adopted our stockholder rights plan and currently each share of our
outstanding common stock is associated with one right. Each right entitles the registered
stockholder to purchase 1/1,000 of a share of our Series D Junior Participating Preferred Stock at
an exercise price of $80.00.
The rights only become exercisable in certain limited circumstances following the tenth day
after a person or group announces acquisition of or tender offers for 15% or more of our common
stock. For a limited period of time following the announcement of any such acquisition or offer,
the rights are redeemable by us at a price of $0.01 per right. If the rights are not redeemed, each
right will then entitle the holder to purchase common stock having the value of twice the
then-current exercise price. For a limited period of time after the exercisability of the rights,
each right, at the discretion of our board of directors, may be exchanged for either 1/1,000 share
of Series D Junior Participating Preferred Stock or one share of common stock. The rights expire on
December 19, 2011.
Pursuant to our restated certificate of incorporation, our board of directors has the
authority to issue up to 850,000 shares of undesignated preferred stock and to determine the
powers, preferences and rights and the qualifications, limitations or restrictions granted to or
imposed upon any wholly unissued shares of undesignated preferred stock and to fix the number of
shares constituting any series and the designation of such series, without the consent of our
stockholders. The preferred stock could be issued with voting, liquidation, dividend and other
rights superior to those of the holders of common stock.
The issuance of Series D Junior Participating Preferred Stock or any preferred stock
subsequently issued by our board of directors, under some circumstances, could have the effect of
delaying, deferring or preventing a change in control. For example, an issuance of shares of our
preferred stock could:
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Specifically, some provisions may deter tender offers for shares of common stock, which may be
attractive to stockholders, or deter purchases of large blocks of common stock, thereby limiting
the opportunity for stockholders to receive a premium for their shares of common stock over the
then-prevailing market prices.
Provisions of our certificate of incorporation and bylaws might discourage, delay or prevent a
change of control of our company or changes in our management and, therefore, depress the trading
price of our common stock.
Our certificate of incorporation and bylaws contain provisions that could discourage, delay or
prevent a change in control of our company or changes in our management that our stockholders may
deem advantageous. These provisions:
In addition, certain of our named executive officers and certain other executives have entered
into change of control severance agreements, which were approved by our compensation committee.
These agreements would likely increase the costs that an acquiror would face in purchasing us and
may thereby act to discourage such a purchase.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
SALES OF UNREGISTERED SECURITES
The shares shown as repurchased in the table below were surrendered by Borland employees in
order to meet minimum tax withholding obligations in connection with the vesting of an installment
of their restricted stock awards. Below is a summary of these transactions for the three months
ended June 30, 2007:
ISSUER PURCHASES OF EQUITY SECURITIES
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ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We held our Annual Meeting of Stockholders on May 29, 2007 at 10889 North DeAnza Boulevard,
Cupertino, California. At the Annual Meeting, the following matters were submitted to, and
approved by, our stockholders, as indicated by the voting results set forth below.
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There were no broker non-votes as to this proposal.
There were no broker non-votes as to this proposal.
There were no broker non-votes as to this proposal.
ITEM 5. OTHER INFORMATION
None.
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ITEM 6. EXHIBITS
(a) Exhibits
Except as so indicated in Exhibits 32.1 and 32.2, the following exhibits are filed as part of, or
incorporated by reference into, this Quarterly Report.
A copy of any exhibit will be furnished (at a reasonable cost) to any stockholder of Borland
upon receipt of a written request. Such request should be sent to Borland Software Corporation,
20450 Stevens Creek Boulevard, Suite 500, Cupertino, California 95014, Attention: Investor
Relations.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized on the
9th day of August 2007.
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EXHIBIT INDEX
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