ILOG S.A. 20-F 2006
As filed with the Securities and Exchange Commission on October 13, 2006
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the fiscal year ended June 30, 2006
For the transition period from
Date of event requiring the shell company report
Commission File Number: 000-29144
(Exact name of Registrant as specified in its charter)
The Republic of France
(Jurisdiction of incorporation or organization)
9, rue de Verdun, 94253 Gentilly, France
(33)149 08 35 00
(Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
Securities registered or to be registered pursuant to Section 12(g) of the Act:
Securities for which there is a reporting obligation pursuant to Section 15 of the Act:
Indicate the number of outstanding shares of each of the issuers classes of capital or common stock as of the close of the period covered by the annual report.
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
If this report is an annual or transition report, indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
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.
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. (Check one):
Large accelerated filer Accelerated filer Non-accelerated filer
Indicate by check mark which financial statement item the Registrant has elected to follow.
Item 17 Item 18
If this is an annual report, indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
ILOG S.A. (“ILOG”) is filing this Amendment to its Annual Report on Form 20-F for its fiscal year ended June 30, 2006, in order to correct a typographical error that appears in Exhibit 13.1 in the date reference for the period covered by the Form 20-F filing, and to replace Exhibit 1 with the most current bylaws, adopted as of September 29, 2006. The entire 20-F is being revised to reference Form 20-F/A instead of Form 20-F. In addition, Exhibits 12.1, 12.2 and 15 are being revised and resubmitted to reflect the change from Form 20-F to Form 20-F/A. Exhibit 13.1 is being revised and resubmitted to correct the typographical error, i.e., to change the date from June 30, 2005 to June 30, 2006, for the applicable period covered by the certification, and to change the reference from Form 20-F to Form 20-F/A.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Many of the statements included in this Annual Report, as well as oral statements that may be made by us or by officers, directors or employees acting on behalf of us, constitute or are based on forward looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995, specifically Section 27A of the U.S. Securities Act of 1933, as amended, and Section 21E of the U.S. Securities Exchange Act of 1934, as amended. All statements other than statements of historical facts, including, among others, statements regarding the implementation of the Companys business strategy, trends in the software industry, the Companys financial outlook, liquidity and working capital, the creation of co-selling and co-marketing relationships and strategic alliances, the increased penetration of the Companys existing customers, the sale of the Companys service packages, the market risks associated with exchange rates, changes in the balance of the classes of the Companys business and other statements relating to the Companys plans, objectives, expectations, intentions, future business development and economic performance are or may be forward looking. In addition to statements that are forward-looking by reason of context, other forward-looking statements generally may be identified by the use of words such as may, will, should, expect, estimate, anticipate, intend, plan, believe, continue, outlook, judgment, predict or other similar expressions, although the absence of such words does not necessarily mean that a statement is not forward-looking.
These forward-looking statements involve a number of known and unknown risks, uncertainties and other factors that could cause the Companys actual results and outcomes to be materially different from historical results or from any future results expressed or implied by such forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in the sections entitled Item 3. Key InformationRisk Factors, Item 4. Information on the Company and Item 5. Operating and Financial Review and Prospects, including as quarterly fluctuations in our operating results and the price of our Shares or ADSs, factors adversely affecting any one of our three product lines, the need to have sufficient consultants available to staff an unpredictable demand for our consulting services, lost revenues due to consultants with specialized technical expertise occupied on competing consulting engagements, our investments in vertical products which carry high implementation costs that we discount in order to promote customer purchases, intense competition and consolidation in our industry, the extended length and variability of our sales cycle and concentration of transactions in the final weeks of a quarter, which could result in substantial fluctuations in operating results and may prevent accurate forecasting of financial results, the increasing number of higher risk fixed price consulting engagements, our dependence on certain major independent software vendors, changing market and technological requirements, our ability to provide professional services activities that satisfy customer expectations, the impact of currency fluctuations on our profitability, changes in tax laws or an adverse tax audit, errors in our software products, the loss of key personnel, logistical difficulties, cultural differences, product localization costs, import and tariff restrictions, adverse foreign tax consequences and fluctuations in currencies resulting from our global operations, the impact of intellectual property infringement disputes, our heavy dependence on our proprietary technology, risks related to acquisitions and minority investments, the impact of dilutive share issuances, or the incurrence of debt and contingent liabilities and write-offs resulting from acquisitions or minority investments, the limitations imposed by French law or our by-laws may prevent or delay an acquisition by ILOG using its Shares, changes in accounting principles that could affect our operating profits and reported results, and other matters not yet known to us or not currently considered material by us. All written and oral forward-looking statements attributable to us, or persons acting on our behalf, are qualified in their entirety by these cautionary statements.
Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect managements analysis only as of the date hereof. Unless required by law, ILOG undertakes no obligation to revise these forward-looking statements to reflect new information or events, circumstances, changes in our expectations or otherwise that arise after the date of this Annual Report on Form 20-F/A. Readers should carefully review the events and other matters described in other documents we file or submit from time to time with the United States Securities and Exchange Commission (the SEC), including reports on Form 6-K submitted by us.
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PRESENTATION OF INFORMATION
Unless the context otherwise requires, references herein to we, us, our, the Company or ILOG are to ILOG S.A. and its consolidated subsidiaries.
Our name together with our logo are registered as trademarks in France, the United States and a number of other countries. All references herein to France are to the Republic of France. All references to the United States or the U.S. are to the United States of America and all references to dollars and $ are to the currency of the United States. All references to euro or are to the common currency adopted by the twelve member states of the European Monetary Union. We publish our financial statements in U.S. dollars. Except as otherwise stated herein, all monetary amounts in this Annual Report on Form 20-F/A are presented in dollars.
The Consolidated Financial Statements for the fiscal years ended June 30, 2006, 2005 and 2004 included elsewhere in this Annual Report on Form 20-F/A are referred to herein as the Consolidated Financial Statements. References to fiscal year 2006, fiscal year 2005 and fiscal year 2004 in this Annual Report on Form 20-F/A mean the fiscal years ending on June 30, 2006, 2005 and 2004, respectively, unless the context otherwise requires.
The following trademarks are trademarks of ILOG in France, in the U.S., and other countries:
This Annual Report on Form 20-F/A may also contain tradenames or trademarks of other companies.
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AMERICAN DEPOSITARY SHARES
Pursuant to a program which we sponsor, our Ordinary Shares, or the Shares, are traded in the United States in the form of American Depositary Shares, or ADSs. Each ADS represents one Share placed on deposit with JP Morgan Chase Bank, as depositary (the Depositary), and is issued and delivered by the Depositary through its principal office in New York City at 60 Wall Street, (36th Floor), New York, New York 10260. Shares may be deposited with the Paris office of BNP Paribas, as custodian (the Custodian), or any successor or successors to such Custodian under the terms of the Deposit Agreement, dated as of February 13, 1997 and amended August 1998, between us, the Depositary and the holders of ADSs (the Deposit Agreement). The Depositary provides a variety of services to registered holders of American Depositary Receipts, as more fully set forth in the form of the Deposit Agreement which was filed as an exhibit to our Registration Statement on Form F-6 effective with the SEC on February 13, 1997 and amended August 1998 (the F-6).
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The following selected financial data should be read in conjunction with Item 5. Operating and Financial Review and Prospects, the Consolidated Financial Statements and related Notes thereto and the other financial information appearing elsewhere in this Annual Report on Form 20-F/A. The income statement data set forth below for each of the years ended June 30, 2006, 2005 and 2004 and the balance sheet data at June 30, 2006 and 2005 have been derived from our Consolidated Financial Statements included elsewhere herein, which have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) and audited by Ernst & Young Audit, independent registered public accounting firm with the Public Company Accounting Oversight Board (United States). The income statement data set forth below for each of the years ended June 30, 2003 and 2002 and the balance sheet data at June 30, 2004, 2003 and 2002 are derived from audited financial statements not included herein.
The financial statements included herein are presented in U.S. dollars and are prepared in accordance with U.S. GAAP. The Company, as a French corporation publicly listed in France, also prepares financial statements, not included herein, presented in euros and prepared in accordance with International Financial Reporting Standards (IFRS) for the fiscal years ending June 30, 2006 and 2005 and prepared in accordance with French GAAP for prior years for the purpose of its listing on Euronext and in accordance with the requirements of the Autorité des Marchés Financiers (the AMF).
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The following risk factors, together with the other information and ILOGs Consolidated Financial Statements and the related Notes thereto included elsewhere herein, should be carefully considered in evaluating ILOG and its business before making an investment decision with respect to ILOGs Shares or ADSs.
Certain risk factors that affect the software industry generally and technology companies specifically also apply to ILOG. Such factors include:
Any one or more of these circumstances could have an adverse impact on our business, operating revenues, financial results and financial condition. There can be no assurance that any of the risks described in this Annual Report on Form 20-F/A will not result in problems that materially affect the financial aspects of our business and the price of our Shares and ADSs. In addition, there may be other risks and uncertainties of which we are unaware or that we currently deem immaterial that may adversely affect our Company.
Our quarterly operating results have fluctuated significantly as has the price of our Shares and ADSs and they may continue to do so in the future.
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Revenues from license fees and/or royalties in any quarter are substantially dependent on orders booked and shipped in that quarter and on sales by the Companys independent software vendors, or ISVs (Independent Software Vendors), distributors and resellers.
Our expense levels are relatively fixed. Consequently, if revenue levels decline or are below expectations in any quarter, expense levels could be disproportionately high as a percentage of total revenues, which would have an adverse impact on our results of operations and could result in losses in that quarter. As a result, period-to-period comparisons of operating results are not necessarily meaningful and should not be unduly relied upon to predict future performance. In addition, if our operating results are below the expectations of investors and/or analysts, the price of our Shares and ADSs may fall.
We generate all our revenues from three product lines. Any factor adversely affecting any of these product families could have a material adverse effect on our business, operating results and financial condition.
ILOGs business rules, optimization and visualization product lines accounted for approximately 42%, 38% and 20% of our license and maintenance revenues in the 2006 fiscal year. We expect that revenues from each of these product lines will continue to represent a substantial portion of our total license and maintenance revenues for the foreseeable future. As a result, any factor adversely affecting one or more of these product lines could have a material adverse effect on our business, operating results and financial condition. In addition, substantially all of our consulting revenue is derived from the implementation and maintenance of software licensed to new customers and the development of applications by our customers using our software. As a result, a decline in the demand for our software would result in a decline in the demand for our consulting services.
We have attempted to increase our consulting services revenue, which required us to hire more consultants and increased our overhead that may not be offset by actual consulting service revenues, particularly during slow periods, which are unpredictable. In addition, our consulting services engagements are complex and require specific technical skills that we may or may not be able to provide due to competing engagements, which could result in lost revenues and lower than expected margins.
In the 2005 and 2006 fiscal years, we significantly increased our consulting services activity. As a result, the demand for our services temporarily exceeded our internal capacity to staff the engagements under contract, necessitating the hiring of additional third party consultants to fulfill the consulting engagements. Third party contractors are more expensive than our staff consultants, and therefore the margins for the consulting services work decreased for those engagements where we were required to use outside contractors.
The number of consulting engagements that we have at any given moment in time fluctuates and is unpredictable. As a result, we cannot be assured that we will have sufficient work to keep our consultants engaged on fee-based projects on a full time basis, thereby potentially increasing our overhead without any corresponding increase in revenues, which could adversely impact our operating results and income. In addition, our consulting services require highly technical and specific skills. We have been constrained in the past, and we may be constrained in the future, in our ability to provide consulting services when consultants with the skills required for a particular engagement are occupied on other engagements, which could result in lost revenues. In addition, due to the complex nature of our consulting services, the actual margins we earn on consulting services could be below the expectations at the outset of the engagement, which could have a negative impact on our net income and Share price.
We have invested in certain vertical markets by developing industry specific products which may or may not yield any increase in profits, particularly due to the high cost of implementation which we provide at reduced costs as an inducement to the sale of these products.
In fiscal year 2006, we continued our work to develop several new optimization products targeted to specific industries. Investments in new products and services are inherently speculative. The revenues we have received from these emerging products have not to date and may not in the future cover the associated development costs, which are still ongoing. Commercial success depends on many factors, including our ability to execute our sales strategy with respect to these products, the commercial acceptance of these products by customers and the general economic conditions in these industries, particularly
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the semiconductor chip manufacturing, transportation and process manufacturing industries. Our current strategy involves absorbing some of the implementation costs as an inducement to the sale of these products. We cannot be assured that these products will become commercially viable, or will achieve profitability.
The industry in which we operate is characterized by intense competition, consolidation and collaboration in our industry could further increase competition significantly and result in fewer customer orders, price reductions, reduced transaction size, reduced gross margins and loss of market share, any of which could have a material adverse effect on our business, operating results and financial condition.
The markets for our products and services are intensely competitive and we expect product and service offerings and pricing competition to increase. We compete with a number of private and public companies in our individual product lines, however, we do not believe we have any competitors across all three of our product lines. Our competitors include, without limitation, by product line: (i) Business Rule Management Systems: Computer Associates, Corticon Technologies, Fair Isaac, Haley, Microsoft, Pegasystems and Red Hat; (ii) Optimization: Cosytec and Dash Associates; (iii) Visualization: SL Corporation and Tom Sawyer. Some of our competitors have longer operating histories, significantly greater financial, technical and marketing resources, greater name recognition, broader product offerings and a larger installed base of customers than we do. In addition, some of our competitors have well-established relationships with our current and potential customers. As a result, they may be able to respond more quickly to new or emerging technologies and changes in customer requirements. They may also be able to devote greater resources than we can to develop, promote and sell their products and may be able to offer products cheaper than us.
We also face increased competition from companies such as Red Hat, or software developer communities who provide software with some of the functionalities provided in our Rules product on an open source or free basis. In addition, we encounter some competition from low cost companies in India and other countries, and we compete with companies that provide packaged software with respect to specific applications. In addition, virtually all of our customers have significant investments in their existing solutions and have the resources necessary to enhance existing products and to develop future products. These customers have or may develop and incorporate competing technologies into their systems, thereby replacing our current or proposed components. This would eliminate their need for our services and components and limit future opportunities. We are, therefore, required to persuade development personnel within these customer organizations to outsource the development of their software and to provide products and solutions to these customers that cost-effectively compete with their internally developed products.
Barriers to entry in our business are generally low and the software industry is currently undergoing consolidation as software companies seek to offer more extensive suites and broader arrays of software products, as well as integrated software and hardware solutions. Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address the needs of our current and prospective customers. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly gain significant market share. If one or more of our competitors were to merge or partner with another of our competitors, we could face significantly increased competition. New or enhanced products introduced by existing or future competitors could increase the competition faced by our products. Furthermore, companies larger than us could enter the market through internal expansion or by strategically aligning themselves with one of our competitors and may be able to offer cheaper products than us. Our competitors may also establish or strengthen cooperative relationships with our current or future distributors, resellers, original equipment manufacturers or other parties with whom we have relationships, thereby limiting our ability to sell through these channels and reducing promotion of our products.
The ongoing market consolidation and/or increased competition resulting from a combination of our competitors or a competitors successful collaboration with our sales partners could result in fewer customer orders, price reductions, reduced transaction size, reduced gross margins and loss of market share, any of which could have a material adverse effect on our business, operating results and financial condition. See Item 4.B. Competition.
The fact that our products require customization contributes to the extended length and variability of our sales cycle and we often experience a concentration of transactions in the final weeks of a quarter, which could result in substantial fluctuations in operating results and may prevent accurate forecasting of our financial results and cause our Share price to decline.
Because of the horizontal or generic nature of the functionality of our software components, additional development to fit the particular customer industry is required. Our vertical products also require customization to enable them to work with a
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particular customers operational parameters and requirements. For our customers that are trying to automate very complex problems, the additional development/customization process can prove difficult and expensive, and therefore purchasing decisions are sometimes difficult to predict and capture accurately in our forecasts.
Our sales cycle is generally three to six months or more and varies substantially from customer to customer and a large number of our software license agreements are consummated in the weeks immediately preceding a quarter end. Our customers are often cautious in making decisions to acquire our products because purchasing our products may involve shifts by the customer to a new software platform or a change in the customers operational procedures. Delays in completing sales and changes in the amount of expected customer orders can arise while customers complete their internal procedures to approve purchase expenditures and test and accept our products. In addition, we have been constrained in the past, and we may be constrained in the future, in our ability to provide consulting services due to a lack of resources, which may cause sales cycles to be lengthened or result in the loss of software license sales. The nature and long length of the sales cycle for our products may cause license revenue and operating results to vary significantly from period to period.
We also face difficulty predicting the amount of expected sales and the quarter in which sales to expected customers will occur due to the nature and length of the sales cycle for our products. In addition, the complexity of our consulting engagements can result in delayed deliverables or milestones, resulting in delayed receipt of revenues. We rely on forecasted revenues for planning and modelling our earnings guidance before actual sales are consummated. Forecasts, however, are only estimates and actual results may vary for a particular quarter or longer periods of time. Consequently, significant potential discrepancies between actual and forecasted results could limit our ability to plan, budget or provide accurate earnings and profitability guidance, which could adversely affect our Share price. Any publicly-stated revenue or earnings projections are subject to this risk.
We have undertaken to perform more consulting services work on a contingent fixed price basis, which presents the risk that the work product may not be accepted when finally delivered and therefore we may not be paid for our time or the cost of the engagement may be more than we receive in revenues.
Customer demand for fixed price and/or turnkey consulting engagements is increasing and we are accepting more consulting work on a fixed price basis. Typically, we perform the work for fixed price consulting services at our expense, and our payment for the work performed is contingent on the customers acceptance of the work product that we deliver at certain intervals, called milestones, or at the end of the engagement. If the customer does not accept all or part of the work product that we deliver, we may not receive some or all of the anticipated revenues to offset the costs incurred in performing the engagement, which could have an adverse impact on our revenues, net profit and financial condition.
In addition, the risks associated with these engagements include the possibility that we could poorly manage the engagement and not conduct the work in the most cost effective manner. Further, because the fee that is charged for these engagements is determined at the outset, we could underestimate the amount of work that will be required and the engagement could actually result in a loss. Moreover, we could lose other more profitable opportunities because we are required to commit significant resources to fixed price consulting engagements which may turn out to be unprofitable.
We are dependent upon certain major ISVs for a significant part of our revenues.
In fiscal year 2006, 23% of our revenues were generated from ISVs which embedded our software components in their applications, which they in turn sell to their customers. In fiscal year 2006, our largest customer was SAP A.G., an ISV that provided 3% of our revenues, and our next nine largest customers, of which three were ISVs, accounted for a further 11% of our revenues. If any or all of the ISVs decided for any reason to replace our components with their own or a competitors technology, discontinued offering any of the applications embedding our components and/or experienced a business downturn, our business, operating results and financial condition would be adversely affected. See Item 5.A. Revenues by Geography and Note 15 to Consolidated Financial Statements.
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Our ability to acquire, develop and market new products and product enhancements needs to be timely and directed to changing market and technological requirements or our business, operating results and financial condition would be materially adversely affected.
We operate in a highly competitive industry characterized by rapid technological change, evolving industry standards, changes in customer requirements and frequent new product introductions and enhancements. Accordingly, our future success will depend in large part on our ability to improve our current technologies and to acquire, develop and market new products and product enhancements that address changing market and technological requirements on a timely basis. The development of software products is a complex and time-consuming process. New products and enhancements to existing products can require long development and testing periods. Furthermore, investments in new technology are inherently speculative. Commercial success depends on many factors, including innovativeness, our ability to execute our sales strategy with respect to these products, the commercial acceptance of these products by customers and general economic conditions in the different countries in which we sell our products and in our customers industries.
There can be no assurance that we will be successful in acquiring, developing and marketing new products or product enhancements, that we will not experience difficulties that delay or prevent the successful acquisition, development, introduction or marketing of such products or enhancements or that any new products or product enhancements will adequately address market and technological requirements and achieve market acceptance. As is customary in the software industry, we have in the past experienced delays in the introduction of new products and features, and we may experience such delays in the future. As a result, revenue from new product and service investments may not be achieved for a number of years, if at all. Moreover, new products and services may not be profitable and even if they are profitable, operating margins for new products and services may not be as high as the margins we have experienced historically. If we are unable, for technological or other reasons, to integrate acquired products, develop new products or enhancements to existing products in a timely manner in response to changing market conditions or customer requirements, the Companys business, operating results and financial condition would be materially adversely affected.
If our consulting services activities fall below customer expectations, we could lose customers or be required to reimburse customers for licence and service fees paid to us.
In fiscal year 2006, 22% of our revenues were directly provided by our consulting services which are designed to facilitate customer adoption of our products, and accelerate their deployment, so that further license and maintenance revenues can be generated for us. If our consulting services fail to meet or satisfy customer expectations, we could lose customers and we may be required to reimburse customers for license and service fees paid to us.
Currency fluctuations could result in lower profitability for us in dollar terms and the reporting of exchange losses.
We operate on a multinational basis and a significant portion of our business is conducted in currencies other than the U.S. dollar, our financial reporting currency for the financial statements included in this annual report. As a result, fluctuations in the value of the currencies in which we conduct our business relative to the U.S. dollar have caused and will continue to cause dollar translated amounts to vary from one period to another. Approximately 34% of our sales revenues and 53% of our operating expenses in fiscal year 2006 were denominated in euros, with the remainder in U.S. dollars and, to a lesser extent, other currencies. An increase in the value of the euro relative to the U.S. dollar will result in lower profitability in U.S. dollar terms assuming no change in revenue and cost structure. See Item 5.A. Non-GAAP Financial Measures.
Also, currency exchange rate movements of foreign currency denominated receivables and payables recorded by the Company and each of its subsidiaries, including their respective inter-company accounts, result in the reporting of realized and unrealized exchange gains or losses in our income statement. Due to the number of currencies involved, the constantly changing currency exposures and the volatility of currency exchange rates, we cannot predict the effect of exchange rate fluctuations on future operating results. In order to mitigate the impact of exchange rate fluctuations, we enter into foreign exchange derivative financial instruments to protect against foreign currency rate improvements relative to the euro for anticipated cash flows from transactions between the Company and its subsidiaries. While we have a policy of hedging our short-term currency exposures associated with anticipated cash flows from transactions with subsidiaries denominated in currencies other than the euro, there can be no assurance that this policy will be successful and/or properly executed. See Note 4 to the Consolidated Financial Statements.
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Changes in tax laws or adverse outcomes resulting from examination of our income tax returns could adversely affect our results.
We are subject to income taxes in the United States, France, and in certain other foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. Our future effective tax rates could be adversely affected by changes in tax laws, by our ability to generate taxable income in foreign jurisdictions in order to utilize foreign tax losses, and by the valuation of our deferred tax assets. We regularly assess the adequacy of our provision for income taxes, but there can be no assurance that our assessments will be deemed accurate by one or more of the taxing authorities to which we are subject in the various jurisdictions in which we do business.
Errors in our software products could result in warranty or product liability claims against us.
The software products we offer are inherently complex. Software products frequently contain undetected errors or failures, especially when first introduced or when new versions or enhancements are released. Despite our preliminary testing and use by current and potential customers, errors may not be detected in our products and product upgrades which may require us to refund license and maintenance fees paid or to pay damages. Persistent or pervasive problems with undetected errors or failures could negatively affect our reputation in the industry.
Our license agreements typically contain provisions designed to limit our exposure to potential product liability and other claims due to unforeseen or undetected errors. It is possible, however, that the limitation of liability provisions contained in our license agreements, especially unsigned shrink-wrap licenses, may not be effective under the laws of certain jurisdictions. A product liability claim, whether or not successful, could be time-consuming and costly and thus could have a material adverse affect on our business, results of operations or financial position. In addition, we sometimes grant our customers longer than normal warranty periods or provide additional non-standard warranties. We currently have limited insurance against product liability risks or errors and omissions coverage, and there can be no assurance that the current levels of insurance coverage we do have are adequate or that additional insurance would be available to us in the future on commercially reasonable terms or at all.
The loss of services of any of our key personnel could have a materially adverse impact on our business.
Our future success will depend in significant part upon the continued service of our key technical, sales and senior management personnel, including, Pierre Haren, our Chairman and Chief Executive Officer, known in France as the Président Directeur Général. We are also particularly dependent upon our technical personnel with expertise in object oriented technology, math programming and artificial intelligence technology.
Our future success will depend on our ability to train, motivate and retain highly qualified technical, sales and managerial personnel, and there can be no assurance that we will be able to do so. Competition for such personnel is intense, especially for technical personnel of the quality of our software architects and scientists. If we were to lose the services of our key technical, sales or senior management personnel or were unable to attract and retain highly qualified personnel in the future our business could be adversely impacted in a material manner.
As a result of our global operations, we are exposed to numerous risks, including logistical difficulties, cultural differences, product localization costs, import and tariff restrictions, adverse foreign tax consequences and fluctuations in currencies.
Our engineering and research and development operations are located primarily in France, except for our CPLEX products which are developed in Incline Village, Nevada, and Mountain View, California. We have also recently opened an office in Shanghai, China which we expect will perform a limited amount of research and development work on our existing products. Our sales and marketing operations are located on four continents, including a new sales office in Australia. These varied locations and the inter-related activities of these groups have in the past led, and in the future could lead to, logistical and communication difficulties.
Further, our global operations may be directly affected by adverse economic, health and geopolitical conditions in the countries where we do business. Approximately 50%, 40% and 10% of our revenues in fiscal year 2006 were from North America, Europe and the Asia-Pacific region, respectively. Worldwide operations are subject to a number of risks, including:
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Intellectual property infringement disputes could cause us significant expense and divert technical and management personnel.
There can be no assurance that we will not receive communications from third parties asserting that our products infringe, or may infringe, on their proprietary rights. We cannot prevent third parties from claiming intellectual property infringement against us. We have been subject to such claims in the past. For instance, in fiscal year 2002 we successfully defended an intellectual property infringement claim by a third party relating to JRules, which defense consumed significant expense and diverted technical and management personnel. In fiscal year 2003, a third party asserted that a feature of our ILOG Solver product infringed their patent. We vigorously contested this assertion as being without merit and while we did not change our position in this regard, we reached an agreement to amicably resolve the matter in a manner that had no material financial impact for the Company.
In addition, we may initiate claims or litigation against third parties for infringement of our proprietary rights or to establish the validity of our proprietary rights. Litigation to determine the validity of any claims could result in significant expense to us and divert the efforts of our technical and management personnel from productive tasks, whether or not such litigation was determined in our favor.
As the number of software products in the industry increases outside of Europe and the functionality of these products further overlaps, we believe that software companies may become increasingly subject to infringement claims. Any such claims against us, with or without merit, as well as claims we initiate against third parties, could be time consuming and expensive to defend or prosecute and difficult to resolve, and could result in product shipment delays. In the event of an adverse ruling in any such litigation, we might be required to pay substantial damages, discontinue the use and sale of infringing products, expend significant resources to develop non-infringing technology or obtain licenses to infringing technology. There can be no assurance that licenses to such technology would be available on commercially reasonable terms or at all.
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We depend heavily on our proprietary technology. There can be no assurance that our competitors will not develop similar technologies that directly compete with our proprietary technology or that our means of protecting our proprietary rights will be adequate.
We rely primarily on a combination of copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions to protect our proprietary technology. We also license our products primarily in object code form, which does not allow our customers access to our source code. Source code is the form in which our proprietary technology is most vulnerable to theft, copying or misappropriation. See Item 4.B. Proprietary Rights.
Despite our efforts to protect our proprietary rights, other companies could seek to design around our proprietary technology and unauthorized parties may attempt to copy, use or make copies of our products or aspects thereof, or obtain or use information that we regard as proprietary. Policing unauthorized use of our products is difficult. In addition, the laws of many jurisdictions do not protect our proprietary rights to as great an extent as do the laws of France and the U.S. In particular, shrink-wrap licenses may be unenforceable under the laws of certain jurisdictions and copyright and trade secret protection for software may be unavailable in certain countries. Under current EU intellectual property laws, software does not benefit from patent protection. Consequently, we rely primarily on the copyright laws of the US and France to protect our proprietary rights. We currently have one pending patent application in Japan, jointly filed with Mitsubishi Chemical Kabushiki Kaisha, which has been assigned application number P2003-46543, one pending provisional patent application in the U.S. entitled Method and System for Identifying Conflicting Constraints in Mixed Integer Programs, which has been assigned patent number 60/810,419, and one U.S. patent entitled Interactive Generation of Graphical Visualizations of Large Data Structures, and identified as Patent No. US 6,928,436 B2. We cannot assure you that any patents will be issued with respect to our pending or any future patent applications. Furthermore, these and any other patents we obtain in the future may be circumvented, challenged, invalidated or designed around by other companies. The objective impossibility to adequately protect our intellectual property for these or other reasons could adversely affect our business and competitive position, operating results and financial condition.
Acquisitions and minority investments may result in additional liabilities or risks for the Company or the dilution of Share interests or earnings per Share.
Our business strategy includes, among other things, seeking to acquire or make minority investments in companies with complementary product lines, technologies or businesses. Such acquisitions and investments could potentially result in the incurrence of debt and contingent liabilities and write-offs related to goodwill and other intangible assets, which could materially adversely affect our profitability. Were we to pursue one or more acquisitions, there can be no assurance that we will be able to successfully consummate such transactions, achieve the expected rates of return, integrate the acquired assets and business or the acquired companies employees successfully into our working environment, and/or retain either our or the acquired companies key employees. Similarly, investments in minority interests may not achieve our expected rates of return and are subject to additional risks, including a lack of control or ability to implement our preferred strategies at such companies whose strategies and interests may differ from ours. Such acquisitions and minority investments could also create product liability issues, and could result in a significant diversion of management attention away from the day to day operations of the Company. In addition, acquisitions and minority investments can result in a dilution of the position of our existing shareholders and our earnings per Share if we used Shares to make acquisitions or investments, as well as result in unanticipated legal risks and costs, and liabilities.
Limitations imposed by French law and our by-laws may prevent or delay an acquisition by ILOG using its Shares.
As a French company listed on the Euronext Paris stock market, we are subject to certain requirements not generally applicable to corporations organized in the U.S. For example, our shareholders are subject to voting procedures that are more complicated than for U.S. companies generally. Shareholder approval at an extraordinary shareholders meeting must be obtained for any new Shares issued in connection with a business combination, even if we are the surviving entity, or for an acquisition of assets in exchange for our shares. For the coming fiscal year, at such a meeting, the presence, in person or by proxy of shareholders holding one-fourth of the voting Shares upon first notice, and one-fifth of the voting Shares upon second notice, is required for a quorum. The increasing practice of U.S. shareholders not to exercise their voting rights may prevent us from obtaining a quorum for such a meeting and thus impair our ability to obtain shareholder approval for acquisitions, mergers and/or corporate reorganizations.
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Changes in accounting principles may affect our reported earnings and operating income.
Generally accepted accounting principles and accompanying accounting pronouncements, implementation guidelines and interpretations for many aspects of our business, such as revenue recognition for software and treatment of goodwill, are highly complex and involve subjective judgments. Changes in these rules, their interpretation, or changes in our products or business could significantly change our reported earnings and operating income and could add significant volatility to those measures, without a comparable underlying change in cash flow from operations. See Note 1 to Consolidated Financial Statements.
Holders of ADSs may be subject to additional risks related to holding ADSs rather than Shares.
Because holders of ADSs do not hold their Shares directly, they are subject to the following additional risks:
Limitations imposed by French law and our statuts, or by-laws, could prevent an acquisition of us.
French law requires any person, acting alone or in concert, who acquires more than 5%, 10%, 15%, 20%, 25%, one-third, one-half, two-thirds, 90% or 95% of our outstanding shares or voting rights, or whose shares or voting rights fall below any of these percentages, to inform us within 5 days of crossing the threshold percentage. A person acquiring, alone or in concert, more than 10% or 20% of our share capital or voting rights must include in the report a statement of the persons intentions relating to future acquisitions or participation in the management of our company for the following 12-month period. Shareholders who fail to comply with these requirements may be deprived of voting rights for a period of up to five years and may, in some cases, be subject to fines. Under the regulations of the AMF, and subject to limited exemptions granted by the AMF, any person, acting alone or in concert, who comes to own more than 33 1/3% of our share capital or voting rights, must initiate a public tender offer. In addition, French labor laws generally impose an obligation on an entity acquiring a business or product line to assume the role of employer for the employees affiliated with the business or product line being acquired. This may make it difficult for a non-French entity or an international entity with no presence in France to acquire our Company or one of our product lines.
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It may not be possible for shareholders to effect service of legal process, enforce judgments of courts outside of France or bring actions based on securities laws of jurisdictions other than France against ILOG, its executive officers or directors.
ILOG and a majority of its executive officers and directors are residents of France and other countries other than the United States. In addition, many of the assets of ILOG and such persons are located in whole or in substantial part outside of the United States. As a result, it may not be possible for you to effect service of legal process within the United States upon us or most of such persons, including with respect to matters arising under U.S. federal securities laws or applicable state securities laws. Moreover, judgments of U.S. courts, including those predicated on the civil liability provisions of the U.S. federal securities laws, may not be enforceable in French courts. As a result, our shareholders who obtain a judgment against us or such persons in the United States may not be able to require us or such persons to pay the amount of the judgment.
ILOG S.A. is a société anonyme, a form of corporation incorporated under the laws of France. The Company was registered at the Greffe of the Registry of Commerce, Paris on April 7, 1987 for a duration of 99 years. The Company was founded by Mr. Pierre Haren, Mr. Marc Fourrier and Mr. Jérôme Chailloux, with the support of the Institut National de Recherche en Informatique et en Automatique, or INRIA. We are subject to French law and in particular to the French company law and regulations under Book II of the French Code du Commerce, or the Commercial Code, and to Decree No. 67-236 of March 23, 1967 on commercial companies.
We are registered with the French Register of Commerce and Companies of Créteil under number B 340 852 458. Our corporate worldwide purposes may be found in Article 3 of our statuts, or charter, and are summarized as follows:
Our registered office is located at 9 rue de Verdun, 94253 Gentilly, France, and our telephone number is +33 1 49 08 35 00. Our agents for service of process in the United States are Corporation Service Company, 6th Floor, 80 State Street, Albany, NY 12207-2543 and CT Corporation, 3 Winners Circle, 3rd Floor, Albany, NY 12205. Our website is www.ilog.com. Information contained on or linked to ILOGs website is not part of this Annual Report. We make our Annual Reports on Form 20-F and Document de Référence, and amendments to these reports, if any, are available free of charge through our website as soon as practical following their respective filing with the SEC and the AMF.
In 1987, we began shipping software components developed in the LISP programming language. In 1992, we started to transition our products to the C++ programming language. In 1993, we began shipping ILOG Views and ILOG Solver. In 1997, we acquired the business of CPLEX Optimization, Inc., or CPLEX, located in Incline Village, Nevada, which provided linear based
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optimizer products written in the C programming language. In the late 1990s, we started to introduce Java versions of our products. We introduced a C# version of some of our visualization products in fiscal year 2004 and of our BRMS products in fiscal year 2005. C# is a programming language developed by Microsoft.
Our software development efforts are mostly based in France, except for the CPLEX products, which are developed in Incline Village, Nevada, and Mountain View, California. Until 1995 our sales were concentrated in Europe, particularly in France. In 1995, we started to expand our sales efforts globally by establishing a major sales presence in the U.S. and Asia and acquiring CPLEX in 1997, which has resulted in revenue and expense growth.
Until our initial public offering in 1997 on the NASDAQ National Market, which raised $24.9 million, we were financed through a combination of retained earnings, venture capital funding and interest free loans from French government agencies and the European Union. We partially financed the 1997 CPLEX acquisition through the issuance of 1.7 million Shares and promissory notes totaling $5.0 million. In 1998, an additional financing of $10.5 million was received from SAP A.G. in exchange for 685,064 Shares. In 1998 we listed our Shares on the Nouveau Marché of Euronext Paris. The Nouveau Marché merged into the regulated market, Eurolist of Euronext, in 2005. See Item 9. The Offer and Listing.
ILOG is a worldwide provider of enterprise software and services. We develop, market, sell and support business rule management systems, or BRMS, as well as optimization-based decision tools and applications, and visualization software components that help organizations make better decisions faster and manage change and complexity.
We believe that business software applications have not historically been able to meet rapidly changing business environments easily. Significant amounts of data, embedded software application code and outdated software systems are each impediments to an organizations ability to adapt to changing business conditions. We believe that our BRMS offering gives organizations the ability to design agility into their software systems, allowing them to address the challenges of business change in a cost-effective way. BRMS also helps organizations centralize their business rules, or policies, in one or a few repositories, facilitating their maintenance and ensuring consistent deployment across the company. Another key benefit of BRMS is that it can be implemented on top of existing software.
ILOGs optimization software allows companies to optimize the allocation of their personnel and equipment resources. For example, in order to maximize their profitability, a parts supplier would seek to maintain a low inventory of parts while still having a sufficient number on hand to fill current demand. ILOGs optimization components, as well as its vertical offerings, allow companies to decide what factors are important for profitability, such as minimal inventory in the above example and to then create an application that produces the optimal configuration of resources to achieve the companys goals.
ILOGs visualization software components provide graphical user interfaces for software developers who create applications that are used in telecom network management, the airline industry and other businesses where the visual display of information is an important tool to the management and success of the business.
We currently have business locations in nine countries, but have two principal locations where our management is based. Our principal executive offices are located at 9 Rue de Verdun in Gentilly, France, a suburb of Paris. Our U.S. executive offices are located at 1080 Linda Vista Avenue in Mountain View, California, in the San Francisco Bay Area.
Our business strategy is focused on the following key areas:
Establish Business Rule Management Systems as an Enterprise Software Platform. We are seeking to promote business rule technology through our BRMS products as essential information technology infrastructure for Global 2000 companies.
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Most large companies today develop a number of custom software applications internally, and in many cases these custom applications are mission-critical. To ensure efficiency and stability, development teams typically build these custom applications using application platform suites from the biggest platform vendors, including IBM, Oracle, SAP, Microsoft, and to a certain extent BEA and Sun. We are seeking to leverage the strong presence of these software vendors in the marketplace to drive BRMS sales by designing our BRMS products to work with these software vendors platforms and by also developing connectors and interfaces for use of our BRSM products with these platforms.
Create a Broader Market for Optimization Products. We are seeking to extend the penetration of our optimization products by promoting our products to a broader audience. Our efforts in this regard include selling our products directly to customers as well as through third party channels, and by developing vertical solutions. Our development tools now include Optimization Decision Manager, or ODM, which enables developers to develop and deploy optimization software applications faster by allowing business users, through a packaged business user interface, to take part in the rapid prototyping and iterative development needed to specify key performance indicators, business rule templates, solution views and business goals. In addition, our OPL Development Studio product is a development environment which can expedite the development and deployment of software designed to optimize resource allocation because it contains an intuitive programming language that reduces coding when used with our component libraries. We have also developed new software applications focused on specific scheduling and planning opportunities in the manufacturing and transportation markets, and we are hopeful that these solutions will be well received in these markets.
Leverage Business Process Management Software Trends. We believe the push for greater process efficiency as well as the growing popularity of Service Oriented Architecture, hereafter referred to as SOA, is driving the demand for Business Process Management, referred to herein as BPM. BPM enables an organization to manage its inter-dependent processes, such as sales, shipping and invoicing, by using a single language that is universally understood by all of the software used to manage those processes, thereby eliminating the need to repeatedly enter the same data for each step in the process. A BPM will either use services in connected applications to perform business operations, such as calculating a repayment plan for a loan, or will send messages to human workers requesting they perform certain tasks which necessitate human input. We believe that a key feature of ILOGs BRMS is that the business manager can make changes to the process in real time by changing the rules directing the flow of work or automating the decisions (for example, if the debtor is more than 10 days late, then charge a 10% penalty as part of the loan repayment plan) which means that changes in the process can be moved into operation relatively quickly. In the past, such rule changes required recoding of the software application by a software developer, which was a lengthy process.
We believe the need for more flexibility and greater control over internal processes to address the requirements for more corporate tracking and accountability have created opportunities for our products. Our BRMS and optimization components deliver real-time decision making capabilities to the processes managed by BPM systems and can empower business users to manage these decision rules directly, while our visualization components provide a real-time visual display of the process as it is being executed.
Strengthen our Services Offerings. We are actively promoting and improving our consulting services offerings. These services are designed to facilitate customer adoption of our products, and accelerate their deployment, so that we can generate further license and maintenance revenues. As part of our consulting service offering improvements, we have developed service packages and a methodology for assessing, designing and implementing business rules application projects to help our customers accelerate their development work which in turn allows them to deploy applications sooner.
Grow Alliances with Strategic Systems Integrators and Software Vendors. We have established co-selling and co-marketing relationships for ILOG products with leading BPM and Enterprise Application Integration, or EAI, vendors. In an effort to extend our market reach, we have also entered into co-selling arrangements with leading systems integrators, such as Accenture, BearingPoint, CapGemini, Infosys, Wipro, and IBM Global Services, as well as regional integrators. We have also partnered in co-selling activities with BEA, IBM, Oracle, Microsoft, and BPM and workflow vendors, such as Adobe, Documentum, FileNet, Fujitsu, HandySoft, and Vitria among others.
Expand Revenues from Software Vendors. Our agreements with ISVs have consistently been a key part of our business strategy, because they enable the deployment of our software. ISVs embed portions of our software into their applications in order to avoid being required to develop certain software attributes, such as a user interface, in the case of our visualization
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products, or functions, such as a rule engine for processing the rules that govern or contribute to the output of the application. This reduces development time for ISVs and allows them to introduce their application on the market sooner than if they had to develop all of the functionalities themselves. Through ISVs we are able to penetrate and indirectly derive revenue from business application markets that we would not otherwise be able to access directly. ISVs generate revenues for us when they embed one or more ILOG components into their products. As of June 30, 2006, we have entered into agreements with 465 ISV partners, of which 243 of these ISVs generated approximately 23% of our revenues in fiscal year 2006.
Increase Penetration of our Existing Customer Base. A key component of our strategy is to achieve additional revenues from existing customers by selling additional licenses or unlimited use application-specific licenses, helping our customers extend the use of our software to new projects, and by promoting unlimited use, enterprise-wide licenses.
We offer software for business rule management, optimization and visual interfaces. Our software is designed to be flexible and can be deployed on a wide range of hardware and software platforms. We have also developed several industry-specific applications for use in the semiconductor chip manufacturing, transportation and process manufacturing sectors. These products are capable of being incorporated into a customers existing business operation following a limited development/custom implementation cycle.
Our high-performance software products are sold in object code form delivered on CD-ROM or over the internet. Our software is sold to C, C++, C# or Java developers within information technology (IT or MIS) departments of end-user enterprises or to system integrators, value added resellers, referred to herein as VARs, ISVs, and original equipment manufacturers, referred to herein as OEMs. Our software facilitates rapid development and deployment of complex applications by providing pre-written portions of the software in order to reduce the time, cost and risk associated with the application development cycle. Our software can be purchased for integration into new or existing applications individually or in combination with other softwares, and runs on the most popular Windows and UNIX platforms as well as on some main frame architectures and can be used to facilitate client-side, server-side, Web or SOA-related development efforts.
Our product revenue can be analyzed as follows:
Business Rule Management Systems
Our BRMS products allow policy managers to write their business rules in a familiar business language and manage them in a central repository. Business people have control over exactly how their business rules are being executed, and the system is designed to facilitate change when business rules change. ILOGs enterprise-class BRMSs cater to developers by enabling them to develop flexible applications based on best practices in application development, and also to policy managers by empowering them to manage their policy implementations as business needs change, rather than on an information technology schedule.
We currently have the following BRMS products:
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ILOGs optimization software is widely used around the world. Over 1,000 organizations, including 49 of the largest 100 companies in the world, use ILOG optimization tools and engines to build and maintain custom software applications that help them make better decisions in planning, scheduling, investments, pricing, procurement and other core business processes. More than 100 software companies, including SAP, Oracle, i2, Manhattan Associates, Sabre and Siemens embed ILOG optimization engines in their application products. Planning and scheduling flexibility is a core requirement in manufacturing, transportation and investment management and is increasingly important in the services, utility, energy, mining, and retail sectors. ILOGs optimization products are also used in the research and teaching programs at over 500 universities worldwide.
Optimization-based decision support applications built with ILOGs Optimization Decision Management System, or ODMS, make optimization applications easier to use and allows the developer or business user to preview the results before going live. With scenario creation and comparison features, ILOG ODM-based applications help business users understand trade-offs and choices without requiring any training in advanced mathematics. The products in ILOGs ODMS product suite are:
Supply Chain Planning and Scheduling Applications
Because of the importance of planning and scheduling in manufacturing and transportation and the gaps that exist in certain detailed scheduling areas, ILOG offers three software application products:
Our data visualization software provides visually-rich graphical user interfaces. Today, we sell the following products:
ILOG JViews is a set of portable software components based on the Java technology that enable customers to quickly and easily make user interfaces for different domains and different platforms. In particular, JViews offers 2D and 3D geographical services, schematic and monitoring interfaces, visual dashboards, automatic layout of graphs, professional charts, Gantt displays and network visualization. Development teams are able to leverage the power of JViews to build many different types of applications, such as business process modelers, data analysis tools, business activity monitoring consoles, logistics and scheduling displays, network supervision tools, tactical displays for the defense industry, and many more. The resulting
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applications can be run on desktop computers or they can be deployed on the Internet as Web interfaces. Each component of this product line can be purchased separately.
ILOG Views is a development environment for the creation of portable user interfaces based on the C++ technology. It offers a very robust foundation for building a wide range of 2D interactive displays, such as command and control interfaces, mapping applications, charts and Gantt displays, modeling and graphing tools. ILOG Views also contains specialized components to connect graphical displays to various local or remote data sources of the enterprise, such as databases or XML. The resulting applications can be deployed on many different platforms, such as Windows, Unix or Linux.
ILOG Gantt for .NET is a major evolution of the Gantt chart modules, already available in the Java and C++ product lines. This product allows developers who have selected the .NET technology from Microsoft to quickly build planning, scheduling and project management front-ends. ILOG Gantt for .NET comes with standard visual representations of resources, tasks, calendars, load charts and scheduling constraints, but also offers ready-to-use algorithms to automatically optimize a schedule, according to the multiple constraints specified by the user. Applications can be deployed on Windows desktops or as Web interfaces.
On July 2, 2004, ILOG bought the intellectual property and other selected assets of the JLoox product line for 1.5 million (USD 1.8 million) from eNGENUITY Technologies Inc., a Montreal, Canada-based software provider. Its installed base has been given access to all of our software, and more particularly to our ILOG JViews product line.
ILOG software is used in a wide range of applications in the manufacturing, financial services, transportation, communications, public and defense and aerospace sectors. Below is a summary of the types of applications developed by customers using our products by industry sectors.
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Customer support is provided globally from our primary customer support centers in Gentilly (France), Mountain View (California), Japan and Singapore. All of our maintenance subscribers receive access to our online support center, a designated telephone support center, as well as to new releases and enhancements of the products they licensed.
We have four different levels of customer support offerings. Our standard maintenance offering allows customers to call us with general usage questions or to report problems during the regular office hours of the customer support center to which they have been assigned. For after hours support, we have a 24 hour, 5 days per week follow the sun offering, which allows customers to call any one of our support centers around the world during that support centers regular hours of operation. We also have a 24/7 offering, which allows subscribers to call a member of our customer support staff anytime of the day or night to report problems that are having a critical impact on the customers ability to do business. Lastly, we have a VIP option which provides a commitment from ILOG to resolve a problem or provide a workaround for critical errors before the end of the next business day following receipt of the problem. Generally, our customers subscribe to one or more of these maintenance offerings.
We provide consulting and training services to assist customers in the design, development and deployment of their applications when using our software components and products.
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Our consulting services provide expertise in the design, development and deployment of business applications based on our BRMS, optimization and visualization products. This expertise leverages our experience building vertical applications in areas, including telecommunications, supply chain management, manufacturing, financial services, commercial and residential lending, transportation, defense and government. Most of our engagements are delivered on a time and materials basis. Our fees for this type of engagement are based primarily on the seniority of the consultant(s) staffing the engagement and the duration of the engagement. We sometimes discount our fees for longer engagements, or where the customer has a series of successive engagements. We are less likely to discount our fees where the engagement is short or where the customer presents a credit risk.
Customer demand for fixed price and/or turnkey consulting engagements is increasing and we are accepting more consulting work on a fixed price basis. Typically, we perform the work for fixed price consulting services at our expense, and our payment for the work performed is contingent on the customers acceptance of the work product that we deliver at certain intervals, called milestones, or at the end of the engagement. If the customer does not accept all or part of the work product that we deliver, we may not receive some or all of the anticipated revenues to offset the costs incurred in performing the engagement, which could have an adverse impact on our revenues, net profit and financial condition.
These fixed price engagements are usually entered into with one of our System Integrator partners responsible for development of the finished application. We also sometimes act as a subcontractor for a prime contractor who is responsible for a bigger, more comprehensive development project. Since no two consulting projects are the same, there is an inherent risk associated with fixed price engagements. We have to estimate the amount of time a given project will require at the outset of the project before we have an opportunity to fully assess all of the potential pitfalls or challenges presented by the scope of work. In addition, customer requirements frequently are modified during the development cycle as choices driven by trade-offs between the perfect solution and practical realities present themselves. Accordingly, since we accept some level of unquantifiable risk with these engagements we price them conservatively in an attempt to ensure that we can deliver the services promised and still achieve our projected consulting margins. On rare occasions, we have entered into projects where part of the work is performed on a time and materials basis and another part is on fixed price terms. The determination of which part of these mixed arrangements will be performed on a time and materials or fixed price basis is made on a case by case basis. Due to the complex nature of our consulting services, the actual margins we earn on consulting services could differ from the expectations set at the outset of the engagement.
Our consulting resources are located in major countries around the world and we periodically supplement them with third-party consulting contractors as needed. Third party contractors are more expensive than our staff consultants, and therefore the margins for the consulting services work is decreased for those engagements in which we are required to use outside contractors. See Item 3.D. Risk Factors 1. Risks concerning our ability to achieve financial resultsWe have attempted to increase our consulting services revenue, which required us to hire more consultants and increased our overhead that may not be offset by actual consulting service revenues, particularly during slow periods, which are unpredictable. In addition, our consulting services engagements require specific technical skills and are unpredictable and fluctuate, which could result in lost revenues and lower than expected margins. and Item 3.D. Risk Factors 1. Risks concerning our ability to achieve financial resultsWe have undertaken to perform more consulting services work on a contingent fixed price basis, which presents the risk that the work product may not be accepted when finally delivered and therefore we may not be paid for our time, or the cost of the engagement may be more than we receive in revenues.
Customer Education and Training
We offer training programs so that our customers can gain expertise using our BRMS, optimization, and visualization products. Regular classes are held in our offices worldwide, and we also provide training at customer sites upon request.
Sales and Marketing
We market and sell our products and services worldwide through our direct sales organization and indirectly through value-added resellers, or VARs, systems integrators, ISVs, Other Equipment Manufacturers, or OEMs, and distributors. Our field sales organization is divided into geographic regions based in the Americas, Asia-Pacific and Europe. We have field account
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managers, who manage the customer relationship, and field technical engineers, who manage the technical requirements, perform demonstrations and/or develop proof-of-concept projects for our customers. We also have a telesales organization, known as ILOG Direct which sells primarily our JViews and CPLEX products, and which also handles our academic sales. ILOG Direct focuses on higher volume product sales, while the field sales team focuses on growing and fulfilling large and complex business opportunities, and consulting projects. We also have an alliance organization in charge of recruiting and managing our partner relationships.
Our sales cycle is approximately three to six months, but varies substantially from customer to customer. It can be longer if the process involves a request for proposal, or RFP, or if the customer wants to conduct an extensive evaluation of our software prior to making a purchase. See Item 3.D. Risk Factors1. Risks concerning our ability to achieve financial resultsThe extended length and variability of our sales cycle and concentration of transactions in the final weeks of a quarter could result in substantial fluctuations in operating results and may prevent accurate forecasting of our financial results and cause our share price to decline.
To support our sales efforts, we conduct marketing programs, including advertising, direct mail, public relations, web-based and in-person seminars, participate in trade show exhibitions and engage in ongoing customer communications activities and events.
Research and Product Development
Our continued success depends on our ability to continue innovating in our areas of expertise and to anticipate and incorporate new features and functions into our products that may become critical in the future. As a result, we have committed, and expect to continue to commit, substantial resources to our research and development efforts. In fiscal year 2006, we spent $28.9 million, net of government funding, on research and development, representing approximately 22% of sales, as compared with $27.2 million and $22.8 million in fiscal year 2005 and fiscal year 2004, respectively. Our developers also work closely with customers to gain insights into usability and they actively engage with the scientific and academic communities to ensure our products stay on the cutting edge of their respective disciplines. To date, we have primarily relied on in-house development for our products, performed in our research and development centers in Gentilly and Sophia Antipolis, France, Mountain View, California and Incline Village, Nevada, but all of our products contain open-source code for which we do not have to pay a licensing fee and we have licensed some technology from third parties, especially for our ILOG Fab PowerOps product.
Research and development costs prior to the establishment of technological feasibility are expensed as incurred. Because the period between achievement of technological feasibility and the general release of the Companys products has been of relatively short duration, development costs qualifying for capitalization were insignificant during the years ended June 30, 2006, 2005 and 2004, and accordingly, have been charged to research and development expenses in the accompanying statements of operations.
In fiscal year 2006, we sold our products and services to over 2,500 customers(1) in approximately 30 countries. Our customers represent software vendors, governmental and educational institutions and major corporations operating in a wide range of industries. Below is a partial list of customers, by industry segment, who have made purchases of our software and/or services over the last two years.
(1) Customers, as used here, include divisions and subsidiaries of multinational entities and congloeates.
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The markets for our products and services are intensely competitive and we expect product and service offerings and pricing competition to increase. We compete with a number of private and public companies in our individual product lines, however, we do not believe we have any competitors across all three of our product lines. Our competitors include, without limitation, by product line: (i) Business Rule Management Systems: Computer Associates, Corticon Technologies, Fair Isaac, Haley, Microsoft, Pegasystems and Red Hat; (ii) Optimization: Cosytec and Dash Associates; (iii) Visualization: SL Corporation and Tom Sawyer. Some of our competitors have longer operating histories, significantly greater financial, technical and marketing resources, greater name recognition, broader product offerings and a larger installed base of customers than we do. In addition, some of our competitors have well-established relationships with our current and potential customers. As a result, they may be able to respond more quickly to new or emerging technologies and changes in customer requirements. They may also be able to devote greater resources than we can to develop, promote and sell their products and may be able to offer products cheaper than us.
We also face increased competition from companies such as Red Hat, or software developer communities who provide software with some of the functionalities provided in our Rules products on an « open source » or free basis. In addition, we encounter competition from low cost companies in India and other countries, and with companies that provide packaged software with respect to specific applications. In addition, virtually all of our customers have significant investments in their existing solutions and have the resources necessary to enhance existing products and to develop future products. These customers have or may develop and incorporate competing technologies into their systems, thereby replacing our current or proposed components. This would eliminate their need for our services and components and limit future opportunities. We are, therefore, required to persuade development personnel within these customer organizations to outsource the development of their software and to provide products and solutions to these customers that cost-effectively compete with their internally developed products.
Barriers to entry in our business are generally low and the software industry is currently undergoing consolidation as software companies seek to offer more extensive suites and broader arrays of software products, as well as integrated software and hardware solutions. Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address the needs of our current and prospective customers. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly gain significant market share. If one or more of our competitors were to merge or partner with another of our competitors, we could face significantly increased competition. New or enhanced products introduced by existing or future competitors could
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increase the competition faced by our products. Furthermore, companies larger than us could enter the market through internal expansion or by strategically aligning themselves with one of our competitors and may be able to offer cheaper products than us. Our competitors may also establish or strengthen cooperative relationships with our current or future distributors, resellers, original equipment manufacturers or other parties with whom we have relationships, thereby limiting our ability to sell through these channels and reducing promotion of our products.
The ongoing market consolidation and/or increased competition resulting from a combination of our competitors or a competitors successful collaboration with our sales partners could result in fewer customer orders, price reductions, reduced transaction size, reduced gross margins and loss of market share, any of which could have a material adverse effect on our business, operating results and financial condition. See Item 3.D. Risk Factors1. Risks concerning our ability to achieve financial results The industry in which we operate is characterized by intense competition, consolidation and collaboration in our industry could further increase competition significantly and result in fewer customer orders, price reductions, reduced transaction size, reduced gross margins and loss of market share, any of which could have a material adverse effect on our business, operating results and financial condition.
We believe we own or have licensed the proprietary rights of our software products. We have attempted to protect our proprietary rights through a number of ways:
ILOG S.A., our parent company, owns all of our intellectual property rights. Our subsidiaries license the ILOG intellectual property from our parent company which is, in turn, licensed or sub-licensed, to our customers or our resellers. For these licensing rights, the subsidiaries pay the parent company a royalty based on the subsidiaries revenues.
In the event of litigation or a dispute over ownership or independent development of our products, we may need to establish what source code we developed and when. Accordingly, ILOGs source codes have been deposited in France with the national software protection agency (the Agence pour la Protection des Programmes), with NCC Escrow International Limited in the U.K., and with NCC Group, Inc. and Digital Systems Innovations, Inc. (DSI), in the United States. See Item 3.D. Risk Factors3. Risks associated with our proprietary technology.
A significant proportion of our sales come from Europe. Similar to many countries in the software industry with significant sales outside of the United States, we generally realize lower revenues in the quarter ending September 30 than in the immediately preceding quarter due primarily to reduced economic activity in the summer months. See Item 3.D. Risk Factors1. Risks concerning our ability to achieve financial resultsOur quarterly operating results have fluctuated significantly as have the price of our Shares and ADSs and they may continue to do so in the future.
We currently have limited insurance against product liability risks and errors or omissions coverage, and there can be no assurance that the current levels of insurance coverage we do have are adequate or that additional insurance would be available to us in the future on commercially reasonable terms or at all. We have general liability and errors and omission insurance coverage up to a total of 29.5 million per year in France and $12 million per year in the U.S., which is limited to 12 million and $11 million per occurrence, respectively. We also have Directors and Officers insurance covering certain liabilities of our
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directors and officers as well as local property insurance coverage for each of our offices worldwide. See Item 3.D. Risk Factors2. Risks that could adversely affect our business operationsErrors in our software products could result in warranty or product liability claims against us.
ILOG S.A. is the holding company of the group, which is composed of the following wholly owned subsidiaries:
In fiscal year 2005, ILOG acquired 12.5% of a South Korean company called RTO. The RTO investment has been accounted for under the equity method in our 2005 and 2006 financial statements.
Our executive officers are located at the head office of our parent company in France and at our largest subsidiary, ILOG, Inc., in California.
Our corporate headquarters are located in Gentilly, France, a suburb of Paris, in premises consisting of approximately 62,000 square feet under leases expiring from 2007 to 2013. We have our U.S. headquarters in Mountain View, California, in premises consisting of approximately 36,000 square feet under a lease expiring in 2007. We maintain a research and development facility in Sophia Antipolis, in the south of France, in premises consisting of approximately 12,000 square feet under leases expiring from 2007 to 2014. We maintain a sales office and research and development facility in Incline Village, Nevada, in premises consisting of approximately 5,000 square feet under a lease expiring in 2007. In addition, we have leased sales offices in Arlington, Virginia; Farmington Hills, Michigan; and Southborough, Massachusetts, with approximately 12,000 square feet in aggregate under leases expiring from 2007 to 2011. We also maintain leased sales and customer support offices in Bracknell, near London, England; Bad Homburg, near Frankfurt, Germany; Madrid, Spain; Singapore; Shanghaï and Beijing, China; and Tokyo, Japan, with approximately 39,000 square feet in aggregate. Our minimum future commitment under these office leases as of June 30, 2006 amounted to approximately $12.4 million.
We periodically purchase and capitalize software and hardware equipment, which are used internally. In fiscal year 2006, this expenditure totaled appreciatively $1.9 million.
The following discussion and analysis should be read together with our Consolidated Financial Statements and the Notes to those statements included elsewhere in this Annual Report on Form 20-F/A. The Consolidated Financial Statements included herein and the financial information discussed below have been presented in U.S. dollars and prepared in accordance with U.S. GAAP. ILOG also publishes Consolidated Financial Statements, not included herein, prepared in accordance with IFRS for the fiscal years ending June 30, 2006 and 2005 and prepared in accordance with French GAAP for prior years, which differ in certain respects from U.S. GAAP.
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This discussion contains forward-looking statements based on our current expectations, assumptions, estimates, and projections. These forward-looking statements involve risks and uncertainties. Our actual results could differ materially from those indicated in these forward-looking statements as a result of certain factors, as more fully described below and in Cautionary Statement Regarding Forward-Looking Statement, Item 3. Key Information Risk Factors, Item 4. Information on the Company and elsewhere in this Annual Report on Form 20-F/A.
ILOG develops, markets, supports and provides consulting services for software used for business rule management, resource optimization and visual interfaces. Our component software is not industry specific and can be configured for use in a wide variety of businesses. Several recently developed optimization products are directed to the semiconductor chip manufacturing, transportation and process manufacturing industries. Our customers, or upon request from our customers, our consulting services department, use our software to develop strategic business applications or to solve complex business problems. Examples include insurance underwriting and claims handling, airline crew and equipment scheduling, government security operations, telecommunications network display, financial trading, commercial and residential lending, and order processing. Because of the horizontal or generic nature of the functionality of our software components, additional development to fit the particular customer industry is required. Our vertical products also require customization to enable them to work with a particular customers operational parameters and requirements. For our customers that are trying to automate very complex problems, the additional development/customization process can prove difficult and expensive, and therefore purchasing decisions are sometimes difficult to predict and capture accurately in our forecasts.
Our revenues are generated from three different sources: software licenses, maintenance and professional services. In fiscal year 2006, we received 50% of our revenues from licenses, 28% from maintenance, and 22% from professional services.
Our financial outlook for fiscal year 2007 is dependent on favorable economic conditions and the willingness of businesses to commit resources to implement new technologies. We believe that our BRMS strategy addresses an existing and increasing need for businesses to incorporate the ability to change business processes quickly into their organizations technological backbones and architecture. BRMS, as well as BPM, are key components of service-oriented architecture, hereafter referred to as SOA, strategies. SOA is a new design approach being promoted by IT research firms such as Forrester and Gartner and leading software vendors, including IBM, Microsoft and SAP. Our products provide this capability across business sectors, leading us to believe that we are well positioned to take advantage of any improvement in the technology investment climate. In addition, we are hopeful that the offering of several industry-specific applications for use in the semiconductor chip manufacturing, transportation and process manufacturing sectors will be well received in these markets. These products are expected to be capable of being incorporated into a customers existing business operation following a limited development/custom implementation cycle. See Item 3.D Risk Factors 1. Risks concerning our ability to achieve financial resultsWe have invested in certain vertical markets by developing industry specific products which may or may not yield any increase in profits, particularly due to the high cost of implementation which we provide at reduced costs as an inducement to the sale of these products and Item 3.D. Risk Factors 1. Risks concerning our ability to achieve financial resultsThe extended length and variability of our sales cycle and concentration of transactions in the final weeks of a quarter could result in substantial fluctuations in operating results and may prevent accurate forecasting of our financial results and cause our share price to decline.
The Company, as with all global companies, faces an increasing volatility of business worldwide and a number of risk factors that could impact our ability to achieve our goals in fiscal year 2007. Those risks include increased competition, deferred purchases, changes in technology market conditions, the effectiveness of our sales and marketing activities, currency fluctuations as well as other factors. For a more detailed description of the specific risks which we believe to be material to our business operations, see Item 3.D Risk Factors.
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Since June 30, 2006, we entered into a new 10 year lease agreement for premises located in Sunnyvale, California that will start in May 2007 upon expiration of our current lease in Mountain View, California. We will occupy 65,000 square feet of the Sunnyvale premises for the first two years, and will expand to occupy the full 80,000 square feet of the building for the rest of the ten year period. The total lease payments under this new lease for the ten year period amounts to approximately $21 million.
We are in the process of acquiring a 35% interest in a Chinese joint venture for $1.7 million called Shanghai FirstTech Co. Ltd, partially owned by Shanghai Baosight Software Joint Stock Limited Company and First Technologies (Cayman). Shanghai FirstTech Co. Ltd. provides professional consulting services and IT solutions to empower customers business operations, particularly in the banking, insurance, semiconductor metal industries. We expect this transaction to close sometime in October.
Critical Accounting Policies
Use of Estimates
The preparation of the Consolidated Financial Statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates are used for, but not limited to, application of our revenue recognition policy, allowance for uncollectible accounts receivable, useful lives for property and equipment and intangibles, employee benefits, and deferred taxes. Actual results could differ materially from these estimates.
The Companys revenue is derived from three primary sources: software license fees, maintenance and professional services, including consulting and training services.
The Company recognizes revenue from product licensing fees, whether sold directly or through distributors, when the product is delivered, the fee is fixed or determinable, evidence of an arrangement has been received, all significant contractual obligations have been satisfied and the resulting receivable is deemed collectible by management, in accordance with Statement of Position 97-2, Software Revenue Recognition (SOP 97-2), as amended by Statement of Position 98-4, Deferral of the Effective Date of a Provision of SOP 97-2 and Statement of Position 98-9, Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions. If any of these criteria are not met, recognition of revenues is deferred until such time as all of the criteria are met.
Our software arrangements often include consulting and training services. Consulting revenues from these arrangements are generally accounted for separately from software license revenues as the services (1) are not essential to the functionality of the software license, (2) are available from other vendors, and (3) do not include significant modification or customization of the software. Revenues from time and material consulting services are recognized as the services are performed. Revenues from fixed price consulting services are recognized on a proportional performance basis.
When consulting services are considered essential to a software deliverable or the arrangement involves significant customization or modification of software, both the license and consulting service revenue under the arrangement are recognized under the percentage of completion method of contract accounting. Training revenue is recognized at the time service is performed.
Revenue from software maintenance agreements is recognized ratably over the arrangement period, which in most instances is for one year. Accordingly, deferred revenues consist principally of deferrals for invoiced maintenance services, not yet recognized as revenues.
In bundled software arrangements that include rights to multiple software products and/or services, the Company recognizes revenues using the residual method as prescribed by the Statement of Position 98-9 Modification of SOP No. 97-2 Software Revenue Recognition with Respect to Certain Transactions. Under the residual method, revenues are allocated to the undelivered elements based on vendor specific objective evidence of fair value of the undelivered elements and the residual
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amount of revenues are allocated to the delivered elements. Vendor specific objective evidence of the fair value of maintenance contracts is based on renewal rates as determined by the prices paid by the Companys customers when maintenance is sold separately. Vendor specific objective evidence of fair value of training and consulting services is based upon daily rates as determined by the prices paid by the Companys customers when these services are sold separately.
Our revenue recognition policy, as described above, is significant because revenue is a key component of our results from operations. In addition, revenue recognition determines the timing of certain expenses, such as incentive compensation. We follow very specific and detailed guidelines in measuring revenue. However, certain judgments and estimates affect the application of our revenue recognition policy. Revenue results are difficult to predict, and any shortfall in revenue or delay in recognizing revenue could cause our operating results to vary significantly from quarter to quarter and could result in operating losses.
The Company uses the liability method in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.
The Company is subject to income taxes in France, the United States, and in some other foreign jurisdictions. Estimates largely contribute to the calculation of the provisions for income taxes. Effective rates on future income taxes might be affected by changes in local tax regulations, the Companys ability to trigger taxable profit in foreign jurisdictions in order to use the operating loss carry forwards, and by the assessment of its deferred tax assets.
A valuation allowance is established if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized. During the year ended June 30, 2006, the Company recorded an income tax benefit of $0.9 million. This benefit included a $1.2 million reduction in the valuation allowance related to a portion of the Companys deferred tax assets that will more likely than not be realized. This determination was primarily based on projected taxable income. In evaluating the Companys ability to realize its deferred tax assets, the Company considers all available positive and negative evidences, including its past operating results and its forecast of future taxable income. In determining future taxable income, the Company makes assumptions to forecast U.S. federal and state, and non-U.S. operating income, the reversal of temporary differences, and the implementation of any feasible and prudent tax planning strategies. These assumptions require significant judgment regarding the forecasts of future taxable income, and are consistent with the forecasts used to manage the Companys business. The Company currently intends to maintain the remaining valuation allowance until sufficient further positive evidence exists to support further reversals of the valuation allowance. The Companys income tax expense recorded in the future will be reduced to the extent of offsetting decreases in its valuation allowance.
Allowance for Doubtful Accounts
Our allowance for doubtful accounts is recorded as part of general and administrative expenses. These allowances, which are netted against accounts receivable on the consolidated balance sheets, totaled $0.5 million as of June 30, 2006, as compared to $0.7 million as of June 30, 2005. These estimates are based on our bad debt write-off experience, analysis of credit information, specific identification of probable bad debts based on our collection efforts, aging of accounts receivable and other known factors. Our actual results could differ from these estimates.
Goodwill represents the excess of purchase price over the fair value of identifiable net assets of businesses acquired. Goodwill is not amortized but instead tested at least annually for impairment, or more frequently when events or changes in circumstances indicate that the asset might be impaired by comparing the carrying value to the fair value of the reporting unit to which it is assigned in accordance with FASB Statement No. 142, Goodwill and Other Intangible Assets.
Determining the fair value of a reporting unit is judgmental in nature and involves the use of significant estimates and assumptions. Our goodwill is the result of the acquisition of JLoox and represents the expected synergies between this activity and our unique reporting unit software components. The first step compares the fair value of the reporting unit with its carrying
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amount, including goodwill. If the fair value of the reporting unit is less than its carrying amount, a second step is performed to measure the amount of impairment loss. The second step allocates the fair value of the reporting unit to the Companys tangible and intangible assets and liabilities. This derives an implied fair value for the reporting units goodwill. If the carrying amount of the reporting units goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized equal to that excess. Our annual goodwill impairment analysis, which was performed during the fourth quarter of fiscal year 2006, did not result in an impairment charge.
For additional information regarding our significant accounting policies, see Note 1 to Consolidated Financial Statements.
Non-GAAP Financial Measures
In this Annual Report on Form 20-F/A, we disclose selected figures that are non-GAAP financial measures. Under the rules of the SEC, a non-GAAP financial measure is a numerical measure of our historical or future financial performance, financial position or cash flows that excludes amounts, or is subject to adjustments that have the effect of excluding amounts, that are included in the most directly comparable measure calculated and presented in accordance with GAAP in our consolidated income statement, consolidated balance sheet or consolidated statement of cash flows; or includes amounts, or is subject to adjustments that have the effect of including amounts, that are excluded from the most directly comparable measure so calculated and presented. In this regard, GAAP refers to U.S. GAAP.
Constant Currency Rates
In certain appropriate instances we compare revenues and expenses from one period to another period in this Annual Report on Form 20-F/A using constant currency rates. To present that information, current period results for entities reporting in currencies other than U.S. dollars are converted into U.S. dollars at the prior years exchange rates, rather than the exchange rates for fiscal year 2006. For example, if a French entity reporting in euros sold 1 million euros of products in each of fiscal year 2006 and fiscal year 2005, our financial statements would report $1.27 million of revenues in fiscal year 2006 (using 1 euro = $1.27 which was the average exchange rate in fiscal year 2006) and $1.19 million in revenues in fiscal year 2005 (using 1 euro = $1.19 which was the average exchange rate in fiscal year 2005). The constant currency presentation would translate the fiscal year 2006 results using the fiscal year 2005 exchange rates and indicate that underlying revenues were flat and not increasing by $0.08 million as would be reported in the financial statements under U.S. GAAP. We present this constant currency information in order to assess how our underlying business performed before taking into account currency exchange fluctuations. We also present our actual reported results in order to provide the most directly comparable data under U.S. GAAP.
We use figures prepared on a constant currency basis both for our internal analysis and for our external communications, as we believe they provide suitable means by which to analyze and explain variations from one period to another. However, these figures provided on a constant currency basis are unaudited and are not measurements of performance under U.S. GAAP.
The following table sets out the estimated impact of changes in exchange rates for certain income statement figures disclosed in this Annual Report on Form 20-F/A both on an actual basis and on a constant currency basis for fiscal years ended June 30, 2006 and 2005:
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The following table sets out the estimated impact of changes in exchange rates for certain income statement figures disclosed in this Annual Report on Form 20-F/A both on an actual basis and on a constant currency basis for fiscal years ended June 30, 2005 and 2004:
Our total revenues increased to $133.6 million in fiscal year 2006, up from $125.3 million in fiscal year 2005 and $102.8 million in fiscal year 2004, representing increases of 7% and 22%, respectively, year over year. Across geographies, the growth in fiscal year 2006 was particularly driven by the increase in maintenance and professional services revenues while license fee revenues decreased by 2%.
The growth in fiscal year 2005 primarily reflected good execution on both the European and North American markets, driven by continued penetration of our BRMS product line for business process applications and good activity of the visualization product line.
Revenues by geography
Our North American revenues increased to $67.0 million in fiscal year 2006, from $62.3 million in fiscal year 2005 and $53.4 million in fiscal year 2004, representing 50%, 50% and 52% of total revenues respectively. The 7% growth of our North American revenues in fiscal year 2006 over fiscal year 2005 was primarily driven by increasing demand for our optimization products, partially offset by reduced demand for our visualization products, and lower royalty flows from ISVs in the supply chain and telecommunication sectors. BRMS product license revenues declined slightly but the promotion of more services to help customers develop applications with ILOGs BRMS enabled growth of maintenance and professional services revenue.
Our European revenues increased to $53.5 million in fiscal year 2006, up from $51.0 million in fiscal year 2005 and $39.0 million in fiscal year 2004, representing 40%, 40% and 38% of total revenues, respectively. Our European revenues increased by 5% in fiscal year 2006 over fiscal year 2005. Expressed at fiscal year 2005 constant currency rates, European revenues increased by 10%. The growth in European revenues was primarily due to increasing demand for our BRMS products in the region especially in the manufacturing and insurance sectors. Our optimization revenues were down 6% year over year and demand for our visualization products decreased due to weak business activity in the telecommunication industry during the period. A significant increase in our professional services activity had a positive impact on European revenue growth, with the promotion of more services to help customers develop applications with ILOGs BRMS.
Our Asian revenues increased to $13.1 million in fiscal year 2006, up from $12.0 million in fiscal year 2005 and $10.4 million in fiscal year 2004, representing 10% of total revenues for each of the three fiscal years. The 9% increase in Asian revenues in fiscal year 2006 over fiscal year 2005 was primarily due to the continuing adoption of our BRMS products in this region. A significant increase in our professional services activity had a positive impact on Asian revenue growth led by the increasing demand for our BRMS products. In addition, our visualization revenues were up 11% year over year; however, our optimization revenues were down by 21%.
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The 17% growth of our North American revenues in fiscal year 2005 over fiscal year 2004 was primarily driven by an increasing demand for our visualization and BRMS products, partially offset by reduced demand for our optimization products with lower royalty flows from ISVs. A significant increase of our professional services activity combined with the increase in maintenance revenues from the growing installed base of ILOG licenses had a positive impact on North American revenue growth.
Our European revenues increased by 31% in fiscal year 2005 over fiscal year 2004. Expressed at fiscal year 2004 constant currency rates, European revenues increased by 23%. The increase in European revenues was primarily due to improved execution associated with an increasing number of new IT projects. A significant increase in our professional services activity combined with the increase in maintenance revenues from the growing installed base of ILOG licensees has had a positive impact on European revenue growth.
The 16% increase of Asian revenues in fiscal year 2005 over fiscal year 2004 was primarily due to the increasing adoption of our BRMS products in this region, especially in Japan. Our optimization products also contributed to the revenue growth in the manufacturing sector. Asian revenues suffered from weak business activity in the defense sector, which negatively impacted sales of our visualization products.
In fiscal years 2006, 2005 and 2004, SAP A.G., our largest customer, accounted for 3%, 4% and 4% of our total revenues, respectively. In fiscal year 2006 and 2005 the next four largest customers accounted for approximately 6% of our total revenues, and the next five largest accounted for approximately 5% of our total revenues. In fiscal year 2004, the next four largest customers accounted for approximately 7% of our total revenues and the next five largest customers accounted for approximately 6% of our total revenues. Revenues from a single customer in a particular quarter can materially affect our revenues and operating results for such period. See Item 3.D. Risk Factors1. Risks concerning our ability to achieve financial resultsOur quarterly operating results have fluctuated significantly as have the price of our Shares and ADSs and they may continue to do so in the future. and Item 3.D. Risk Factors 1. Risks concerning our ability to achieve financial resultsThe customization required by our products require customization contributes to the extended length and variability of our sales cycle and concentration of transactions in the final weeks of a quarter could result in substantial fluctuations in operating results and may prevent accurate forecasting of our financial results and cause our Share price to decline.
The following table sets forth our revenues, cost of revenues and margin by revenue type for the periods indicated:
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License Fees. Our revenues from license fees decreased to $66.4 million in fiscal year 2006, as compared to $67.7 million in fiscal year 2005 and $58.2 million in fiscal year 2004, representing a decrease of 2% and an increase of 16%, respectively. Expressed at fiscal year 2005 constant currency rates, fiscal year 2006 license fee revenues stayed level. The decrease in the fiscal year 2006 was primarily due to a 27% decrease in visualization product revenues, offset in part by a 16% increase in optimization product revenue. BRMS revenues also declined slightly during the fiscal year 2006. Due to increased adoption in most industry sectors, BRMS revenues increased by 29% in fiscal year 2005 over fiscal year 2004. Visualization revenues increased by 18% in fiscal year 2005 over fiscal year 2004 primarily due to the acquisition of the JLoox product in July 2004. Optimization revenues increased nominally by 2% in fiscal year 2005 over fiscal year 2004. The license revenue mix between our BRMS, optimization and visualization product lines was 45%, 36% and 19%, respectively, in the 2006 fiscal year, compared to 44%, 31% and 25%, respectively, in the 2005 fiscal year and 40%, 35% and 25%, respectively, in the 2004 fiscal year.
Our margin for license fees has remained at 98% since fiscal year 2004. Our cost of license fees, consisting primarily of royalties to third parties, documentation, packaging and freight expenses, was $1.0 million in fiscal year 2006 and 2005 and $1.1 million in fiscal year 2004 and represented 2% of revenues from license fees for each of the past three years. In the event we significantly increase the incorporation of third-party technology in our products, the increased payment of royalties may have the effect of lowering gross margins.
Maintenance. Maintenance services are typically available at an annual fee of 18% of the software fees paid. Payments related to maintenance contracts are generally received in advance with revenues deferred and recognized ratably over the term of the maintenance agreement, which is typically 12 months. Our revenues from maintenance increased to $38.1 million in fiscal year 2006 from $34.2 million in fiscal year 2005 and from $27.6 million in fiscal year 2004. This represented increases of 12% and 24% over the respective prior years. Our maintenance revenue growth since 2004 was the result of our growing installed base of ILOG licensees, the strengthening of the euro and our improvement of the maintenance renewal process. Maintenance revenues for the years ended June 30, 2006, 2005 and 2004 constituted 28%, 27% and 27% of total revenues, respectively. Our maintenance margin was 89% in fiscal year 2006 and 2005, compared to 87% in fiscal year 2004, reflecting the growth in maintenance revenue, while the cost of maintenance increased only slightly.
Professional Services. Our revenues from professional services consist of consulting and training. Professional services are billed on either a time and material basis or a fixed price basis. Our revenues from professional services increased to $29.1 million in fiscal year 2006, up from $23.4 million in fiscal year 2005 and from $17.0 million in fiscal year 2004. This represented increases of 24% and 38% over the respective prior years. Our professional services revenue growth in fiscal year 2006 was primarily the result of past investment across geographies in order to serve customers embedding our BRMS products within their applications, especially in Europe and the Asia-Pacific region. Our professional services revenue growth in fiscal year 2005 was the result of a significant investment in the U.S. and in Europe in order to serve customers embedding our BRMS products within their applications. Professional services revenues for the years ended June 30, 2006, 2005 and 2004 constituted 22%, 19% and 16% of total revenues, respectively. Our cost of professional services, consisting primarily of employee-related expenses, increased to $23.1 million in fiscal year 2006, up from $19.8 million in fiscal year 2005 and $14.1 million in fiscal year 2004, reflecting the increase in resources needed to support the increased professional services activity. The need for professional services by our customers to facilitate their adoption of our products and our ability to satisfy the demand for such services frequently has a direct impact on our ability to generate license fees. Our professional services margin increased to 21% in fiscal year 2006, up from 16% in fiscal year 2005 and 17% in fiscal year 2004 primarily as a result of the investments in additional staffing in prior years. Although the impact on the margin is not significant, costs of professional services include for the first time in fiscal year 2006 a non-cash expense of $0.2 million related to stock-based compensation as a result of the implementation of SFAFS 123 (revised 2004).
Marketing and Selling. Our marketing and selling expenses consist primarily of salaries and other payroll related expenses, incentive compensation, promotional marketing activities, customer pre-sales, technical support and overhead costs relating to occupancy. Beginning in fiscal year 2006, marketing and selling expenses also include a non-cash expense of $0.8 million related to stock-based compensation, as a result of the implementation of SFAS 123 (revised 2004) as of July 1, 2005. Our marketing and selling expenses increased to $56.4 million in fiscal year 2006 from $53.4 million in fiscal year 2005 and from $48.8 million in fiscal year 2004, representing 42%, 43% and 47% of total revenues, respectively. The decrease of our marketing and selling expenses as a percentage of total revenues in fiscal year 2006 over fiscal year 2005 was primarily due
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to a higher increase in total revenues than marketing and selling expenses. The decrease of our marketing and selling expenses as a percentage of total revenues in fiscal year 2005 over fiscal year 2004 benefited from the 22% total revenue increase while marketing and selling expenses only increased by 9%. At June 30, 2006, 2005 and 2004 our marketing and selling headcount were 277, 256 and 250 persons, respectively.
Research and Development. Our research and development expenses consist principally of personnel costs, overhead costs relating to occupancy, equipment depreciation and travel, less amounts received from French government agencies and the European Union in the form of grants which reduce our cost of certain specific research and development projects. This financial support is recorded as a reduction of research and development expenses in the periods the projects are undertaken, the related expenses are incurred and the funding has been committed by the public institutions. Beginning in fiscal year 2006, research and development expenses include a non-cash expense of $0.5 million related to stock-based compensation, as a result of the implementation of SFAS 123 (revised 2004). In addition, research and development expenses were reduced for fiscal year 2006 by a research tax credit earned in France in an amount equal to $1,710. This tax credit relates to certain research costs incurred in France that give rise to a tax relief. Such credits can be applied against current income tax liabilities due in France for a period of three years, or are refunded by the tax authority three years after being filed in a tax declaration if the Company is in a tax loss situation.
The following table sets forth our research and development expenses and the amounts of government funding for fiscal year 2006, 2005 and 2004:
Our research and development expenses, net of government funding and research tax credit, increased to $28.9 million in fiscal year 2006, from $27.2 million in fiscal year 2005 and from $22.8 million in fiscal year 2004, representing 22% of total revenues over each of the past three years. The 6% increase in our research and development expenses in fiscal year 2006 over fiscal year 2005 was primarily attributable to the impact of stock based compensation as a result of the implementation of SFAS 123, additional headcount hired and annual salary increases, partly offset by the strengthening of the U.S. dollar against the euro in the 2006 fiscal year and a $1.7 million tax credit in France for research costs incurred in calendar 2005. The 19% increase in our research and development expenses in fiscal year 2005 over fiscal year 2004 was primarily attributable to the strengthening of the euro against the U.S. dollar and some additional headcount hired in the 2005 fiscal year. From June 30, 2004 to June 30, 2006 our research and development headcount increased from 164 to 200 employees. We have not capitalized any software development costs. From time to time we purchase certain products, which are licensed from third parties and are embedded in our products. In fiscal year 2006 and fiscal year 2005 software licensed from third parties was not material. Research and development costs are generally expensed as incurred. See C. Research and Development.
General and Administrative. Our general and administrative expenses consist primarily of personnel and related overhead costs for finance, legal and general management. Beginning in fiscal year 2006, general and administrative expenses also include a non-cash expense of $1 million related to stock-based compensation as a result of the implementation of SFAS 123 (revised 2004). General and administrative expenses increased to $15.3 million in fiscal year 2006 from $13.6 million in fiscal year 2005 and from $10.7 million in fiscal year 2004, representing 11% of total revenues for fiscal years 2006 and 2005 and 10% of total revenues for fiscal year 2004. The 13% increase in general and administrative expenses in fiscal year 2006 over fiscal year 2005 was primarily due to the expensing of warrants granted to ILOG directors in accordance with SFAS 123 R, additional audit fees required by new regulations in the U.S. and in France, additional headcount hired and annual salary increases, partly offset by the strengthening of the U.S. dollar against the euro in the 2006 fiscal year. The 26% increase in general and administrative expenses in fiscal year 2005 over fiscal year 2004 was primarily due to the strengthening of the euro against the U.S. dollar and additional expenses required to strengthen the administrative departments of the Company. From June 30, 2004 to June 30, 2006, the number of our employees engaged in general and administrative functions increased from 86 to 95 employees.
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Net Interest Income and Other
Net interest income and other includes foreign exchange gains and losses, net interest income and other impairment charges. Net interest income and other totaled $1.1 million, $0.9 million and $0.9 million in fiscal year 2006, fiscal year 2005 and fiscal year 2004, respectively. Other charges recorded include the impairment charge in fiscal year 2005 of our investment in Temposoft for an amount of $0.2 million.
We account for income taxes in accordance with Statement of Financial Accounting Standards No. 109 (SFAS 109), Accounting for Income Taxes.
Our income tax benefit in fiscal year 2006 was $0.9 million, as compared to an income tax expense in fiscal year 2005 and 2004 of $0.7 million and $1.1 million, respectively. Fiscal year 2006 income tax benefit includes a deferred tax benefit of $1.2 million representing part of the tax net operating losses carried forward in the US and France that the Company believes it is more likely than not to be used in the coming year, and is the result of the first release of our valuation allowance against our deferred tax assets. Our assessment was based on our history of profitability in the related tax jurisdictions and projections for taxable income in the coming year. The realization of these deferred tax assets is subject to the risk that these projected taxable incomes will not materialize due, for example, to adverse business conditions. Fiscal year 2005 and 2004 income tax expenses reflect tax charges in certain European and Asian sales subsidiaries that were profitable in those years.
At June 30, 2006, we had net operating loss carryforwards from various tax jurisdictions of approximately $80.7 million, of which $28 million and $3.9 million were in France and the U.K., respectively, with no expiration date and $48.8 million were in the U.S. (Federal and State of California) expiring between 2006 and 2025 if not utilized. Pursuant to the U.S. Internal Revenue Code, use of the U.S. net operating loss carryforwards may be limited if a cumulative change in ownership of more than 50% occurs within any three-year period. As of June 30, 2006, a valuation allowance of $26 million was provided against total deferred tax assets of $27.2 million, which consists primarily of the tax benefit of net operating loss carryforwards. See Note 13 to Consolidated Financial Statements.
Stock-based Compensation Plans
The Company grants stock options to its employees and officers pursuant to shareholders approved stock option plans and provides employees the right to purchase shares of the Company pursuant to shareholders approved employee stock purchase plans. These plans are described more fully in Note 10 Shareholders Equity to the consolidated financial statements and Item 6. Directors, Seniors Management and Employees. The Company also grants warrants to purchase shares of the Company to its non employee directors. On July 1, 2005, the Company adopted the provisions of FAS 123 R Share-based Payment (FAS 123 R) which requires recognition of stock-based compensation expense for all share-based payment awards based on fair value. Prior to July 1, 2005, the Company followed the Accounting Principles Board Opinion N° 25, accounting for Stock Issued to Employees (APB 25), and related interpretations for the Accounting of stock-based compensation, as permitted by FAS 123, Accounting for Stock Based Compensation (FAS 123), and provided pro forma disclosure amounts in accordance with FAS No. 148 Accounting for Stock-Based Compensation Transition and Disclosure (FAS 148), as if the fair value method defined by FAS 123 had been applied to its stock-based compensation. In March 2005, the U.S. Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 (SAB 107) relating to FAS 123 R. The Company applied the provisions of SAB 107 in its adoption of FAS 123 R.
The Company elected to use the modified prospective transition method for adopting FAS 123 R and has not restated results for prior periods. Under this transition method, stock-based compensation expense recognized in the year ended June 30, 2006 includes compensation expense for all share-based compensation granted prior to, but not yet vested as of July 1, 2005, based on the grant-date fair values estimated in accordance with the original provisions of FAS 123 and determined using the Black-Scholes valuation model and compensation expense, and for all share-based payments granted subsequent to July 1, 2005, based on the grant date fair value estimated in accordance with the original provisions of FAS 123 R and determined using the binomial-lattice valuation model. The Companys stock options are subject to graded vesting on service conditions. Through the end of June 2005, the Company recognized stock-based compensation costs, in the pro forma presentation in
Form 20-F/A 2006 ILOG | 37
the consolidated financial statements, net of an estimated forfeiture rate, on a straight-line basis over the requisite service period of the award. Subsequent to the adoption of FAS 123 R, awards granted before July 1, 2005 and not vested as of that date continue to be expensed, net of an estimated forfeiture rate, on a straight-line basis over the requisite service period and awards granted after July 1, 2005 are expensed, net of an estimated forfeiture rate, under the accelerated recognition method specified in FASB Interpretation No. 28 Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plan (FIN 28) over the requisite service period of the award.
As a result of adopting FAS 123 R on July 1, 2005, the Companys income before taxes and net income for the year ended June 30, 2006 are $2.5 million lower than if it had continued to account for share-based compensation under APB 25. Basic and diluted earnings per share for the year ended June 30, 2006 are $0.14 and $0.13 lower, respectively, than if it had continued to account for share-based compensation under APB 25.
The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation for the years ended June 30, 2005 and 2004 compared to the information reported for the year ended June 30, 2006.
Through the end of June 2005, the fair value of stock options, stock purchase awards and warrants was estimated using a Black-Scholes model. On July 1, 2005, the Company elected to use a binomial-lattice model to value its stock options and warrants granted after that date. We believe that the binomial model provides a better estimate of the fair value of the options granted than the Black-Scholes model. The use of a binomial-lattice model requires the use of employee exercise behaviorial data and the use of assumptions, including expected volatility, risk-free interest rate, turnover rates and dividends.
As of June 30, 2006, total compensation cost related to unvested awards not yet recognized was $1.6 million and was expected to be recognized over a weighted-average period of 1.8 years.
We operate on a multinational basis and a significant portion of our business is conducted in currencies other than the U.S. dollar, our financial reporting currency for the financial statements included in this annual report. As a result, fluctuations in the value of the currencies in which we conduct our business relative to the U.S. dollar have caused and will continue to cause dollar-translated amounts to vary from one period to another. Approximately 34% of our sales revenues and 53% of our operating expenses in fiscal year 2006 were denominated in euros, with the remainder in U.S. dollars and, to a lesser extent, other currencies. An increase in the value of the euro relative to the U.S. dollar will result in lower profitability in U.S. dollar terms assuming no change in revenue and cost structure.
38 | Form 20-F/A 2006 ILOG
Also, currency exchange rate movements of foreign currency denominated receivables and payables recorded by the Company and each of its subsidiaries, including their respective inter-company accounts, result in the reporting of realized and unrealized exchange gains or losses in our income statement. Due to the number of currencies involved, the constantly changing currency exposures and the volatility of currency exchange rates, we cannot predict the effect of exchange rate fluctuations on future operating results. In order to mitigate the impact of exchange rate fluctuations, we enter into foreign exchange derivative financial instruments to protect against foreign currency rate improvements relative to the euro for anticipated cash flows from transactions between the Company and its subsidiaries. While we have a policy of hedging our short-term currency exposures associated with anticipated cash flows from transactions with subsidiaries denominated in currencies other than the euro, there can be no assurance that this policy will be successful and/or properly executed.
Under our accounting policy for foreign currency translation, our results and the results of each of our subsidiaries are measured in the currency in which the entity primarily conducts its business (the functional currency). The functional currencies of ILOG and our subsidiaries are their respective local currencies in accordance with Statement of Financial Accounting Standard No. 52, Foreign Currency Translation. All assets and liabilities in the balance sheets of entities whose functional currency is not the U.S. dollar are translated into U.S. dollar equivalents at exchange rates as follows: (i) asset and liability accounts at year-end rates; and (ii) income statement accounts at the respective monthly average exchange rates. Translation gains or losses are recorded in shareholders equity, and transaction gains and losses are reflected in net income (loss). Our net foreign currency transaction exchange loss for fiscal year 2006 was $0.3 million as compared to a net loss of $0.1 million for fiscal year 2005 and a net gain of $0.5 million for fiscal year 2004. These amounts represent both realized and unrealized gains or losses from transactions or balance sheet items. See Notes 1 and 4 to the Consolidated Financial Statements. See Item 3.D. Risk Factors2. Risks that could adversely affect our business operationsCurrency fluctuations could result in lower profitability for us in dollar terms and the reporting of exchange losses.
Over the last three years, we have financed our operations and investments in property and capital equipment through cash from operations and the issuance of equity securities to employees under our stock option and stock purchase plans.
As of June 30, 2006, we had cash, cash equivalents and short-term investments of $69.2 million, including $7.8 million of short-term investments. As of June 30, 2005, we had cash and cash equivalents of $61.7 million and no short-term investments. As of June 30, 2006 and 2005, our net working capital was $59.5 million and $51.1 million, respectively.
Net cash decreased by $0.3 million in fiscal year 2006 compared to fiscal year 2005 was the result of different trends. The operating activities provided cash in the amount of $9.4 million and the exercise of stock options and warrants provided an additional $4.4 million in fiscal year 2006. This cash was used for various investments in the amount of
$10.3 million in fiscal year 2006, including the purchase of short-term investments for $7.4 million and capital lease payments, and the purchase of treasury stocks in the amount of $6.2 million in fiscal year 2006. As our cash is mainly denominated in euros, the increase of the value of the euro against the dollar had a positive impact on our dollar denominated cash position of $2.4 million in fiscal year 2006. The net cash increase of $31.7 million in fiscal year 2005 compared to fiscal year 2004 was primarily due to cash flows from the sale of our short term investments in the amount of $22.3 million and cash flows from operating activities in the amount of $13.7 million.
Our operating activities provided cash flows of $9.4 million, $13.7 million and $8.1 million in fiscal years 2006, 2005 and 2004, respectively. The decrease in fiscal year 2006 is explained by the accounts receivable aging as of June 30, 2006 that increased to 75 days sales outstanding, compared to 63 days as of June 30, 2005 as a result of a few late receivables not paid as of June 30, 2006, but which were paid subsequent to June 30, 2006. For fiscal year 2006, our working capital increased by 16% compared to fiscal year 2005 while our revenues increased by 7% during the same period.
Aside from the investment in and purchase of short term investments of $7.4 million, our investing activities have consisted primarily of expenditure on business combinations, fixed, intangible and other assets, which totaled $4.2 million, $5.5 million and $1.5 million in fiscal years 2006, 2005 and 2004, respectively. Fiscal year 2006 expenditures include the acquisition of distribution rights along with a partnership with Soft Computing in the first quarter of the fiscal year for an amount of Ä0.5 million in cash. The fiscal year 2005 expenditures include the purchase of the JLoox assets for $1.8 million in cash,
Form 20-F/A 2006 ILOG | 39
and 12.5% of the South Korean company RTO for $0.5 million in cash. As of June 30, 2006 fixed assets were located in the United States, France, other European countries and the Asia Pacific region with net book values of $1.5 million, $5.1 million, $0.4 million and $0.4 million, respectively. Our fixed assets are generally unencumbered.
Our net financing activities used cash in the amount of $2.3 million in fiscal year 2006, and provided cash in the amount of $2.0 million in fiscal year 2005, and $3.1 million in fiscal year 2004. Out of this net amount, $4.4 million, $3.3 million and $3.7 million were provided from the issuance of Shares under employee stock option and stock purchase plans, in fiscal years 2006, 2005 and 2004, respectively, and $0.5 million, $0.6 million and $0.6 million were used in fiscal years 2006, 2005 and 2004, respectively, to repay capitalized lease obligations. In fiscal years 2006 and 2005, $6.2 and $0.7 million, respectively, were used to purchase ILOG shares pursuant to a Share buyback program.
We believe we currently have sufficient working capital to meet our current requirements for the twelve months following the date of this Annual Report.
We have committed, and expect to continue to commit in the future, substantial resources to research and development. During fiscal years 2006, 2005 and 2004, our net research and development expenses were $28.9 million, $27.2 million, and $22.8 million, respectively. Our gross research and development expenses before the offset of funding provided by the European Union and agencies of the French government were $31.1 million, $27.7 million and $23.3 million in fiscal year 2006, fiscal year 2005 and fiscal year 2004, respectively. In addition, research and development expenses were reduced for fiscal year 2006 by a research tax credit earned in France in the amount of $1.7 million.
Since we were founded, we have maintained a research and development focus on the solution of complex problems using object oriented technology. This focus requires the fusion of different programming cultures, including object oriented developers, who tend to be attracted by high-level modeling, and developers working on complex algorithms, which tend to focus on math oriented code. This ILOG culture has arisen from nineteen years of day-to-day development, algorithmic optimization and object oriented design. Our engineers work with customers to try to ensure that their problems are solved efficiently. Our engineers also interact closely with the scientific and academic communities, which we believe is the best way to obtain and maintain high performance algorithms.
Our optimization product revenues have increased year over year in the U.S. in fiscal year 2006, however, our optimization product revenues in Europe and other regions decreased. Sales of our visualization products have declined year over year across all regions. Our business rules products (combined license and maintenance revenues) grew by 8% in fiscal year 2006 after a fiscal year 2005 increase of 32% and now comprise approximately 42% of our license and maintenance revenues. A benefit we believe is unique to our BRMS products is that they create flexible software architectures by allowing portions of software code, the business rules or business logic, to be maintained by business users instead of software professionals. We believe that by implementing ILOG BRMS across an enterprise, organizations can quickly address specific business process changes, and be proactive in response to changing business, regulatory and environmental conditions. We are targeting to meet the demand for business rule technology as a key enabler of agility and business process automation across the enterprise. Our customers are part of a growing trend of large organizations worldwide that are looking at BRMS, as well as BPM, as key components of SOA strategies. SOA is a new design approach being promoted by IT research firms such as Forrester and Gartner, and leading software vendors, including IBM, Oracle, Microsoft and SAP.
For fiscal year 2007 our performance will be dependent on favorable economic conditions and a favorable investment climate. With a growing installed base of customers, a proven and recognized portfolio of technologies, and a leading position in the areas of software components, optimization and business rules management, we believe that we are well positioned in the software market.
40 | Form 20-F/A 2006 ILOG
We had no off-balance sheet arrangements as of June 30, 2006.
The following table sets forth contracted payment obligations for the fiscal years indicated (in thousands):
As of June 30, 2006, the Company had not granted any guarantees, nor pledged any of its assets and did not have any significant purchase obligations or other long-term liabilities, except as listed above.
The Company provides retirement benefits under the French defined benefit plan which is not funded, see also Note 9. No significant payment is expected over the next five years.
In accordance with French law governing a société anonyme, ILOGs affairs are managed by our Board of Directors and by our Chairman and Chief Executive Officer, who has full executive authority to manage our business. The Chairman and Chief Executive Officer, under French law, has the broadest powers to act on behalf of ILOG and to represent us in dealings with third parties, subject only to those powers expressly reserved by law and our statuts or charter, to the Board of Directors or general shareholders meetings. The Chief Executive Officer is in charge of implementing the goals, strategies and budgets of ILOG, which are determined by the Board of Directors. The Board of Directors has the power to appoint and remove, at any time, the Chairman and Chief Executive Officer. French law gives to the Board of Directors the right to elect one person to assume the position of Chairman and Chief Executive Officer or to split the function between two different persons (the Chairman of the Board and another natural person bearing the title of Chief Executive Officer, or Directeur Général). We adopted a resolution to amend our statuts to provide for one person to assume the position of Chairman and Chief Executive Officer at the general shareholders meeting held on December 18, 2001 and at its meeting held on the same day, the Board of Directors opted for this option as well (Chairman and CEO, as opposed to General Manager), and appointed Mr. Pierre Haren as both Chairman and Chief Executive Officer. Our statuts provide that the Board of Directors could not change its decision to cumulate or to split these duties in the three year period following this decision. Pursuant to French law and our statuts, the Board of Directors can appoint up to five Directeurs Généraux Délégués (Deputy Chief Executive Officers), whose powers and responsibilities are determined by the Board together with the Chief Executive Officer, and who have broad powers to represent and bind us in dealings with third parties. The Directeur Général Délégué may be held individually responsible for his/her actions if they are deemed contrary to our interests. Pursuant to the French Law, if the function of Chairman and Chief Executive Officer is split between two different persons, the right to propose to the Board the appointment of one or several Deputy Chief Executive Officers belongs to the Chief Executive Officer. On January 20, 2003, the Board of Directors approved Bounthara Ing as a Directeur Général Délégué or Deputy Chief Executive Officer.
Form 20-F/A 2006 ILOG | 41
The following table sets forth the names, ages and positions of the Directors and executive officers of ILOG as of August 31, 2006:
For the purposes of this Annual Report on Form 20-F/A, executive officers means the Chief Executive Officer, the Deputy Chief Executive Officer, the Chief Product Officer, the Chief Financial Officer, the Chief Quality Officer, the Vice President Sales US and Europe, the Vice President and General Counsel and the Chief Information Officer. Where French law is applicable, the executive officers are not entitled, except for the Chief Executive Officer and the Deputy Chief Executive Officer, to represent the Company toward third party transactions. The Chief Executive Officer and the Deputy Chief Executive Officer may however delegate some of their powers to other individuals and notably to other executive officers of the Company.
Pierre Haren is one of our founders and was our Managing Director from 1987 to December 1995, when he was appointed Chairman and Chief Executive Officer of the Company. Prior to founding ILOG, Dr. Haren spent four years in charge of the SMECI Expert System Shell Project with the Institut National de Recherche en Informatique et en Automatique (INRIA) following a three-year term directing the research department of the French Ministry of the Sea. He is also a Director of MiddleNext (an association of mid-cap companies listed on Euronext Paris), Ecole Nationale des Ponts et Chaussées, Fondation de lEcole Polytechnique and he is a member of the French Académie des Technologies, a member of the Deans Council of the Kennedy School of Government at Harvard University and a member of the MIT Corporation Visiting Committee for the Department of Civil and Environmental Engineering. Dr. Haren received engineering degrees from Ecole Polytechnique in 1976 and Ecole Nationale des Ponts et Chaussées in 1978. He received his M.S. from Massachusetts Institute of Technology (MIT) in 1978 and Ph.D. from MIT in Civil Engineering in 1980. Dr. Harens term on the Board of Directors expires in 2008.
Bounthara Ing, ILOGs Deputy Chief Executive Officer since January 2003, was appointed Executive Vice President Asia Pacific in July 2006. Previously he served as our Chief Operating Officer from April 2002 to July 2006. He was our Vice President and General Manager, Industry Solutions Division from July 1999 to April 2002, and has been President of ILOG Ltd. (Japan) since September 1997, and Managing Director of ILOG (Pte.) Ltd. (Singapore) since January 1994. He joined us in 1988 as a software developer and in 1992, became the Director of Graphic Development. Previously, Mr. Ing was a software engineer at Compagnie Générale dInformatique in Paris, France, and at European Computer Research Center in Munich, Germany. Mr. Ing received an Engineering degree from Ecole Centrale de Paris in 1986.
Jean-François Abramatic has served as our Chief Product Officer since February 2003. Since July 2006 he has also been in charge of all marketing activities. He is responsible for product vision and strategy; product design and development; product marketing and management; strategic and field marketing; and marketing communications. From July 2000 to February 2003 he was our Senior Vice President, Research and Development. He was a Director of ILOG S.A. from December 1994 to July 2000. From September 1996 to December 2001, Dr. Abramatic was the Chairman of the International World Wide Web
42 | Form 20-F/A 2006 ILOG
Consortium and from September 1996 to September 1997 he was an Associate Director of the MIT Laboratory of Computer Science. Dr. Abramatic has been appointed as a member of the Advisory Board of the World Wide Web Consortium since July 1, 2004 and was re-elected in July 2006. From September 1997 to July 2000, Dr. Abramatic was INRIAs Director of Development and Industrial Relations and from 1992 to September 1997 its Director of Development. Dr. Abramatic received an Engineering degree from Ecole des Mines, Nancy, France in 1971 and a Ph.D. from the University of Paris VI in 1980.
Jérôme Arnaud has served as ILOGs Chief Financial Officer since January 2004. He was previously ILOGs Group Controller since 2000. He served as Audit Manager, then Senior Manager at Price Waterhouse in Lyon, Paris and New York, NY from 1990 to 1999. He then served as Director of the Financial Reporting at Ansaldo Signal NV until joining ILOG. Mr. Arnaud graduated from Ecole Supérieure de Commerce de Lille in 1990.
Eric Brisson has served as ILOGs Vice President Sales with overall responsibility for sales in the U.S. and Europe since July 2006. Previously, Mr. Brisson was Vice President of European Sales from August 2003 to June 2006. Prior to that, he led ILOGs Strategic Business Development Division, with responsibility for ILOGs award-winning partnership program from August 2002 to August 2003. An 11-year ILOG veteran, Mr. Brisson has also served as general manager of ILOGs Communications Business Division from August 2000 to August 2002. Mr. Brisson also helped develop ILOGs professional services organization. He joined ILOG as a senior software developer in 1995. From 1991 to 1995, Mr. Brisson was a research engineer for CSTB, the French government research center. Mr. Brisson earned a bachelors degree in computer science at the University of Nice in 1988, and a masters degree in computer science at the University of Paris in 1990.
Christian Deutsch has served as ILOGs Chief Quality Officer since December 2003. Mr. Deutsch was previously Vice President and General Manager of European sales, General Manager of the former Value Chain Management business division, Vice President of Operations, Director of strategic partnerships and Program Director for ILOG Professional Services. Prior to joining ILOG in 1998, Mr. Deutsch served as co-Chief Executive Officer of OPEFORM, an IT solutions company in the transportation industry. Mr. Deutsch also held the position of Chief Technology Officer at ERAAM, an IT services provider, which was later acquired by Lockheed Martin. From 1973 to 1983, Mr. Deutsch held the positions of researcher and professor of mathematics at Paris University. He was also a member of several professional societies, including IALA, UNIDO and IMO. Mr. Deutsch earned doctoral and masters degrees in mathematics from the University of Paris in 1972.
Kim Funk has served as ILOGs Vice President and General Counsel since June 2000. Ms. Funk was in-house litigation counsel for American Airlines from July 1998 to May 2000. Prior to that, she was partner with Royston, Razyor, Vickery and Williams L.L.P. in Houston, Texas, where she worked as a business defense litigator for 11 years. Ms. Funk earned a Bachelors of Business Administration from the University of Texas in 1979. Ms. Funk then went into business in Houston, Texas, and worked at various jobs before earning a Doctor of Jurisprudence, graduating with honors, from the University of Houston Law Center in 1988.
Olivier Maurel has served as ILOGs Chief Information Officer since January 2006. He has 30 years of professional experience. He has worked for IBM from 1976 to 1979, for Thomson from 1979 to 1981, for Alsys from 1981 to 1982, for Alcatel from 1983 to 1986, for ADP-GSI from 1987 to 1995, for SAGA from 1995 to 1997, for Software AG from 1997 to 1999, and for SNCF (French Railways) from 1999 to 2006, as well for various start-up companies. In the logistics and transportation sector (SAGA, French Railways), Mr. Maurel was an early adopter of ILOG products. More recently, at the SNCF Freight division, Mr. Maurel was in charge of development and operations of high performance systems for demanding IT users. Mr. Maurel earned an engineering degree at ENSIMAG.
Michel Alard has served as a Director since July 2000. Mr. Alard is Chairman of the Board of Directors of Wavecom S.A., which he co-founded in 1993. Previously, from 1988 he was a project manager at Matra Communications. Mr. Alard received degrees from Ecole Polytechnique in 1976 and from the Ecole Nationale Supérieure des Télécommunications in 1978. Mr. Alards term on the Board of Directors expires at the ordinary shareholders meeting scheduled to take place on November 30, 2006 and will be submitted for renewal at that time for a further three year term.
Marie-Claude Bernal has served as a Director since December 2000. From 1979 until December 2000 she worked in Boston, MA for Wellington Management Company, where she was a senior vice president, partner and international equity portfolio manager. She is also President of the Supervisory Board of Esker S.A. and a Director of Potentia Pharmaceuticals Inc. Ms. Bernal graduated valedictorian from Frances Haut Enseignement Commercial pour les Jeunes Filles, with a major in
Form 20-F/A 2006 ILOG | 43
finance and accounting in 1967 and received an M.B.A. from the University of Chicago in finance and computer science in 1971. Ms. Bernals term on the Board of Directors expires in 2008.
Pascal Brandys has served as a Director since September 1998. Mr. Brandys is the President of Biobank, a global life sciences investment company he co-founded in 2000. Previously Mr. Brandys was the Chairman of the Board of Directors and Chief Executive Officer of Genset S.A., which he co-founded in 1989. Mr. Brandys is a Director of Ceres Inc. and two private biotechnology companies Calpass Corp. and Endocube SAS. Mr. Brandys graduated from the Ecole Polytechnique in 1980, received an M.S. in Economic Systems from Stanford University in 1982 and an M.S. in Civil Engineering from the Ecole Nationale des Ponts et Chaussées in 1983. Mr. Brandyss term on the Board of Directors expires at the ordinary shareholders meeting scheduled to take place on November 30, 2006 and will be submitted for renewal at that time for a further three year term.
Marc Fourrier has served as a Director since April 1987. Mr. Fourrier has served as President of Delphis, a holding company that specializes in the creation and development of companies, since May 1989. He is also a Director of Dexem, Highdeal and Kiala. Mr. Fourrier received engineering degrees from Ecole Polytechnique in 1976 and Ecole Nationale des Ponts et Chaussées in 1978, and an M.S. from MIT in 1978. Mr. Fourriers term on the Board of Directors expires in 2007.
Richard Liebhaber has served as a Director since December 2000. From 1995 to 2000 he served on the board of Qwest Communications and from 1985 until 1995 he served as a board member and management committee member at MCI Communications. From 1954 through 1985 Mr. Liebhaber worked at IBM, where he served in a number of positions. He is also a Director of JDS Uniphase, Cogent Communications and Avici Systems. He graduated from New York University with a BSEE in 1954. Mr. Liebhabers term on the Board of Directors expires at the ordinary shareholders meeting scheduled to take place on November 30, 2006 and will be submitted for renewal at that time for a further three year term.
Stéphane Lizeray has served as an ILOG Director representing employees since November 2005. He was re-elected by the French employees in March 2006. He is Chairman of the Supervisory Board of the French employee investment fund ILOG Actionnariat. He joined ILOG in December 2000 as a software architect in the R&D department. Mr. Lizeray earned an engineering degree from Conservatoire National des Arts et Métiers in 1999. Mr. Lizerays term on the Board of Directors expires in 2009.
Todd Lowe has served as a Director since August 1997, and served as our Executive Vice President until April 2002. From 1988 until 1997 he was President of CPLEX Optimization, Inc., a company acquired by ILOG during 1997. Mr. Lowe is a principal and managing director in two privately held companies: LTI and LL&P. He received a Chemical Engineering degree from the University of California in 1977. He is a registered professional engineer and formerly held various management positions with Shell Oil and Chemical Company. Mr. Lowes term on the Board of Directors expires at the Ordinary Shareholders Meeting scheduled to take place on November 30, 2006, and will be submitted for renewal at that time for a further three year term.
Pierre-Michel Peugnet was nominated by the Board of Directors as a Director in April 2006, replacing Thomas Weatherford who served as a Director from December 2002 until April 2006 when he resigned. Mr. Peugnet is Vice President of the Planning Business Unit for Business Objects Europe, Middle East, and Asia (EMEA) regions where he heads the European operations of the division that markets the Business Objects suite of financial applications. He was previously Group Vice President, Corporate Finance, and Corporate Controller for Business Objects, based in San Jose, California. In this role, he oversaw the worldwide consolidation and external reporting on both the NASDAQ and EURONEXT Paris stock exchanges. He also supervised worldwide planning, budgeting, reporting and worldwide treasury management. Prior to that, he was Chief Financial Officer of the EMEA regions for Business Objects for more than six years. Before joining Business Objects, Mr. Peugnet was Senior Auditor at the Calan Ramolino auditing firm, now part of the Deloitte Touche Tohmatsu financial advisory firm. He has a Masters Degree in Finance and Economics from Paris Dauphine University and is a Board member of the French American Chamber of Commerce of San Francisco. Mr. Peugnet is replacing Mr. Thomas Weatherford as the Boards financial expert. Mr. Peugnets term on the Board of Directors will be submitted for ratification at the ordinary shareholders meeting scheduled to take place on November 30, 2006.
Pursuant to French law, each of ILOGs Directors, CEO and Deputy CEO shall not concurrently hold more than five director or executive officer mandates including the mandate of ILOG in companies having their registered office in France. However, this shall not apply to mandates in companies which are controlled (as defined in by article L.233-16 of the French Commercial Code) by the company of which that individual is a Director.
44 | Form 20-F/A 2006 ILOG
Technical Advisory Board
Historically, we have had a Technical Advisory Board (TAB) since December 2000, consisting of a select group of industry and academic leaders, designed to strengthen our links with the technical and research communities as well as stimulate our corporate awareness of fundamental technology issues and developments. Key technologies represented by the TAB included: business rules and agent technologies; constraint programming; mathematical programming/optimization; visualization; and the world wide web. The TAB met twice a year for two days until January 2004, with each day devoted to a specific technology-based topic and discussion on its applicability to ILOGs long term vision and market focus. No meeting of the TAB was organized in fiscal year 2005, and the TAB was disbanded in fiscal year 2006, with the last meeting taking place on June 2, 2006. The Company believes that it currently has sufficient links with the technical and research communities due to its influence in the technological environment and its regular communications with academic and business leaders.
In fiscal year 2006, no warrants were granted to or exercised by the five non-ILOG employee TAB members who were granted warrants in the 2004 fiscal year.
The aggregate amount of all compensation paid, and benefits in kind granted, comprising of salary, commissions, bonus and benefits and gains, to all our executive officers as a group (7 persons before Eric Brissons nomination as an executive in July 2006) for services in all capacities for the year ended June 30, 2006, was approximately $1.8 million. Our Chairman of the Board of Directors and his Deputy Chief Executive Officer, Dr. Haren and Mr. Ings individual compensation was 293,000 (or $356,000) and $266,000, respectively, in the year ended June 30, 2006.
In consideration for their services on the Board, Directors are entitled to receive jetons de présence (directors fees). In accordance with French law, the total annual amount of jetons de présence is fixed by the shareholders meeting. The Board of Directors then has full and discretionary authority to decide the allocation of the Directors fees authorized by the shareholders among its members, depending on the Directors participation in the meetings of the Board of Directors and the Boards Committees, of which they are members. In addition, remuneration may be granted to Directors on a case-by-case basis for special assignments. A Director may not vote for his or her own remuneration. If he or she does vote, the decision is void. The Board may also authorize the reimbursement of travel and accommodation expenses as well as other expenses incurred by Directors in the corporate interest of the Company. The Chairman and/or Chief Executive Officer are entitled to receive remuneration in addition to the jetons de présence granted by the general shareholders meeting. The Board of Directors determines this additional remuneration and in this case, the Chairman and/or Chief Executive Officer can vote on a resolution concerning his or her remuneration. For fiscal year 2006 the shareholders authorized up to 300,000 in aggregate directors fees. Directors compensation, exclusive of capital gains for fiscal year 2006 was as follows:
Form 20-F/A 2006 ILOG | 45
Under French law, we cannot grant options to members of the Board of Directors who are not employees (which is the case for the Chairman and Chief Executive Officer). During fiscal year 2006, our Directors exercised 42,000 warrants at an average price of 8.78 ($10.69).
In addition, 10,000 stock options were granted under our 1998 Stock Option Plans in fiscal year 2006 to Olivier Maurel, one of our executive officers, at an exercise price per share of 12.45. No stock option was exercised under our Stock Option Plans by our executive officers in fiscal year 2006.
For additional information relating to options granted to employees and warrants granted to ILOGs Directors in fiscal year 2005 see B. Compensation above and E. Share Ownership below, as well as Note 10 to the Notes to our Consolidated Financial Statements included elsewhere herein.
Under French law, the Board of Directors sets the guidelines of the Companys activity and supervises their implementation. Within the limits set out by our statuts and subject to the powers expressly granted by French law to the general shareholders meetings, the Board of Directors may make any decision with respect to the business of the Company. In addition, the Board of Directors is responsible, among other things, for presenting the year-end accounts of ILOG to the shareholders and convening shareholders meetings. In addition, the Board of Directors reviews and monitors our economic, financial and technical strategies. French law and the statuts provide that the Board of Directors be composed of no fewer than three and no more than 18 members. The number of members of the Board may be increased only by decision of the shareholders by a simple majority vote. Our Board of Directors currently consists of nine members. Each Director must be an ILOG shareholder pursuant to art L. 225-25 of the French Commercial Code. Under French law, a Director may be an individual or a corporation, in which latter case, the corporation must appoint a représentant légal, but the Chief Executive Officer and the Chairman must be individuals. The Chief Executive Officer is not required to be a member of the Board of Directors if the functions of Chairman and Chief Executive Officer are separated. The Deputy Chief Executive Officer is also not required to be a member of the Board. A Director does not need to be a French national. Each Director is elected for a three year term. There is no limitation, other than applicable age limits, on the number of terms that a Director may serve. Directors are appointed by the shareholders at an ordinary shareholders meeting and serve until the expiration of their respective terms, or until their resignation, death or removal, with or without cause, by the shareholders at an ordinary shareholders meeting. The Chief Executive Officer may be removed by the Board of Directors at any time, and any Deputy Chief Executive Officer may be removed by the Board of Directors at any time upon the proposal of the Chief Executive Officer. However, under the French law of May 15, 2001, if either is removed by the Board of Directors without cause, they may obtain damages. Any vacancy in the Board of Directors may be filled by the Board of Directors, pending ratification at the next ordinary shareholders meeting. However, if the number of Directors falls below the legal minimum of three, the remaining Directors must immediately call an ordinary shareholders meeting to elect a sufficient number of Directors to reach the legal minimum.
Meetings of the Board of Directors, which are held as often as needed, are normally convened and presided over by the Chairman of the Board, who is elected by the Board of Directors. At the beginning of each fiscal year, the Chairman establishes a preliminary schedule of agenda subjects to be discussed during the year. Each Director is free to suggest the inclusion of items on the agenda. Each Director may raise at any Board meeting matters that are not on the agenda for that meeting. According to French law, if the Board of Directors has not met for more than two months, at least one-third of the members of the Board of Directors may request that the Chairman convene a meeting of the Board of Directors regarding matters listed on the agenda. The Board of Directors met seven times in fiscal year 2006 and the attendance rate averaged 60% for voting purposes (which does not include telephone participation). Including telephone participation, 83% of our directors on average were present for our seven meetings. According to the Companys statuts, Directors who take part in a meeting of the Board by means of videoconference are deemed present, for purposes of calculating the quorum and the majority. A quorum consists of one-half of the members of the Board of Directors and decisions are generally taken by a vote of the majority of the members present, deemed to be present or represented by other members of the Board of Directors. The Chairman has the ability to cast a deciding vote in the event of a tie vote. A Director may give a proxy to another Director but a Director cannot represent more than one other Director at any particular meeting. Members of the Board of Directors represented by another member at meetings do not count for purposes of determining the existence of a quorum. As required under French law, a work-committee has been formed. Two representatives from our employees are entitled to be present at meetings of the Board of Directors, but they do not have any voting rights.
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Directors are required to comply with applicable law and ILOGs statuts. Under French law, Directors are liable for violations of French legal or regulatory requirements applicable to sociétés anonymes, violation of our statuts or mismanagement. Directors may be held liable for such actions either individually or jointly and severally with the other Directors as the case may be. A Chief Executive Officer or Deputy Chief Executive Officer may be held individually responsible for his or her actions if they are deemed contrary to our interests.
French law generally prohibits ILOG from entering into indemnification agreements with its Directors and officers providing for limitations on personal liability for damages and other costs and expenses that may be incurred by Directors and officers arising out of or related to acts or omissions in such capacity. French law also prohibits our statuts from providing for the limitation of liability of a member of the Board of Directors. These prohibitions may adversely affect our ability to attract and retain Directors. Generally, under French law, Directors and officers will not be held personally liable for decisions taken diligently and in our corporate interest.
We have entered into an agreement with each of our Directors, our Chairman and Chief Executive Officer, our Deputy Chief Executive Officer, our Chief Product Officer, our Chief Financial Officer, our Chief Quality Officer, our Vice President Sales US and Europe, our Vice President and General Counsel, our Chief Information Officer and our management team to contract for and maintain liability insurance against liabilities which may be incurred by such persons in their respective capacities, including liabilities which may be incurred under the U.S. federal and state securities laws, subject to certain limitations. We believe that entering into such agreements and maintaining appropriate liability insurance for our Directors and officers will assist us in attracting and retaining qualified individuals to serve as Directors and officers. There are no service contracts with Directors providing for benefits upon termination of employment.
Under the Commercial Code and our statuts, any transactions we enter into, either directly or indirectly through an intermediary in which a member of our Board of Directors, or our Chief Executive Officer or our Deputy Chief Executive Officer, or one of our shareholders holding more than 10% of the voting rights (or, if it is a company, the company controlling it) has a direct or indirect interest and that is not in the ordinary course of business and/or is not at arms-length is subject to the prior consent of our Board of Directors. The same applies for transactions between the company and another company, whenever one of our directors or our Chief Executive Officer is the owner, a partner with unlimited liability, a manager, director, Chief Executive Officer or Deputy Chief Executive Officer, member of the management board (directoire) or supervisory board (conseil de surveillance) of such a company. Furthermore, the types and the purposes of these transactions must be communicated by the chairman to the Board of Directors and to the statutory auditors. The interested director is not taken into account for the quorum calculation and his or her vote is not taken into consideration for the calculation of whether the transaction has been approved by the Board of Directors. Any such transactions concluded without the prior consent of our Board of Directors can be deemed to be null and void if it causes prejudice to the Company. In addition, the related director, or Chief Executive Officer, can be held liable on this basis. Our statutory auditor must be informed of any such transaction within one month following its conclusion and must prepare a special report to be submitted to our shareholders for approval at their next annual meeting. In the event the transaction is not ratified by our shareholders at a shareholders meeting, it will remain enforceable by third parties against us, but we may in turn hold the interested director or Chief Executive Officer, as the case may be, and, in some circumstances, the other members of the Board of Directors, liable for any damages we may suffer as a result. In addition, the transaction may be cancelled if it is fraudulent. Moreover, certain transactions between a corporation and a member of its Board of Directors who is a natural person and/or its managing directors, Chief Executive Officer or Deputy Chief Executive Officer, if any, are prohibited under French commercial law. Such prohibition also applies to natural persons representing a company acting as a Board member.
Exemptions from certain NASDAQ corporate governance rules
At the time ILOG listed its ADRs with the NASDAQ National Market, it received an exemption from certain corporate governance requirements. This exemption was received on February 12, 1997. NASDAQ rules permit NASDAQ to provide exemptions from the NASDAQ corporate governance standards to a foreign issuer when those standards are contrary to a law, rule or regulation of any public authority exercising jurisdiction over such issuer or contrary to generally accepted business practices in the issuers country of domicile. ILOG has received from NASDAQ an exemption from compliance with certain corporate governance standards that are contrary to the laws, rules, regulations or generally accepted business practices of France. The exemptions, and the practices followed by the company, are described below:
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The Company is exempt from NASDAQs quorum requirements applicable to meetings of shareholders. In keeping with French law and generally accepted business practices in France, the presence in person or by proxy of shareholders having not less than 20% (in the case of an ordinary shareholders meeting or an extraordinary shareholders meeting, deciding upon any capital increase by capitalization of reserves), or 25% (in the case of any other extraordinary shareholders meeting) or a third (in the case of a special meeting of the shareholders) of the Shares is necessary for a quorum. If a quorum is not present at any meeting, the meeting is adjourned. Upon recommencement of an adjourned meeting, there is no quorum requirement in the case of an ordinary shareholders meeting or an extraordinary shareholders meeting deciding upon any capital increase by capitalization of reserves. There is a 20% quorum requirement in the case of any other extraordinary general meeting, or special meeting. The Company has petitioned for this exemption because it would not be legally permissible for a French public company to adopt in its articles of association quorum requirements that would be more stringent than those prescribed by French law.
The Company is exempt from NASDAQs requirements that director nominees must be selected, or recommended for the Board of Directors, either by a majority of the independent directors or a nominations committee comprised solely of independent directors within the meaning of NASDAQs rules. Under French law, there is no independence requirement for the Board members who perform the function of finding and nominating new Directors. The Company considers that one of the three members of ILOGs Board of Directors Nominating and Corporate Governance Committees, Todd Lowe, is not independent because his spouse is an employee of the Company. The Company has provided to the NASDAQ a written statement from independent counsel in the Companys home country certifying that the Companys practices are not prohibited by the home countrys laws.
Boards Charter and Corporate Governance Guidelines
We have adopted NASDAQ standards for independence, and we consider all of our Directors to be independent other than Todd Lowe, Pierre Haren and Stéphane Lizeray.
A substantial portion of the analysis and work of the Board of Directors is done by standing Board Committees. Each Committee develops proposals, recommendations and opinions, as the case may be, within its respective field of competence, as prescribed in each Committees Charter. The Board currently has three committees: the Audit Committee composed of Marie-Claude Bernal, as Chairperson, Marc Fourrier and Pierre-Michel Peugnet; a Compensation Committee, composed of Michel Alard and Richard Liebhaber, as Chairperson; and a Nominating and Corporate Governance Committee, composed of Marie-Claude Bernal, Richard Liebhaber and Todd Lowe, as Chairperson. Committee members are appointed by the full Board upon recommendation of the Nominating and Corporate Governance Committee, which considers the views of individual Directors.
Each Board Committee has its own Charter. The Charters set forth the purposes, goals and responsibilities of the Committees as well as the qualifications for Committee membership, procedures for Committee member appointment and removal, Committee structure and operations and Committee reporting to the Board. The members of each Board Committee are required to meet the other membership criteria specified in their respective Committees Charters.
The primary responsibility of the Audit Committee is to oversee our financial reporting process on behalf of the Board of Directors and to report the results of its activities to the Board of Directors. In accordance with its Charter, the Audit Committee primarily reviews with management and our independent registered public accounting firm, our internal accounting procedures and quarterly and annual financial statements and consults with and reviews the services provided by our independent registered public accounting firm. The Committee reviews the interim financial statements and our financial disclosures, as well as earnings press releases. The Audit Committee must be composed of at least three Directors. Each member of the Audit Committee is required to be an independent member of the Board of Directors. Members of the Board of Directors shall be considered independent as long as they do not, other than in their capacity as members of the Board of Directors, the Audit Committee or any other Committee of the Company, accept any consulting, advisory, or other compensatory fee from the Company and are not an affiliated person of the Company or any of its subsidiaries, and otherwise meet the independence requirements of applicable French and U.S. stock exchange listing standards and other applicable laws and regulations. The Audit Committee provides assistance to the Board of Directors in fulfilling their oversight responsibility to the shareholders, potential shareholders, the investment community and others, relating to: the integrity of ILOGs financial statements; the financial reporting process;
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the systems of internal accounting and financial controls; the independent registered public accounting firms qualifications and independence; our compliance with ethics policies and legal and regulatory requirements; the accuracy of our insider trading policy and the quality of our policy for investors communications. The Audit Committee is empowered to investigate any matters brought to its attention with full access to all books, records, facilities, and personnel of ILOG and the authority to recommend the engagement and/or dismissal of external auditors, independent counsel and other advisers as it determines necessary to carry out its duties. In fiscal year 2006, the Audit Committee met five times and the attendance rate, including telephone participation, was 100%.
The Compensation Committee is charged, pursuant to its Charter, with reviewing and recommending to the full Board of Directors the level of compensation, including salary, fees, retirement benefits, executive incentive plans and fringe benefits, of the Chairman and Chief Executive Officer and Deputy Chief Executive Officer, as well as members of the Board; reviewing and approving annually the general compensation policies applicable to the Companys executive officers, including the relationship of the Companys performance to executive compensation; reviewing and advising the Board of Directors concerning, and if deemed appropriate, retaining independent consultants regarding, national, regional and industry-wide compensation practices and trends in order to assess the adequacy and competitiveness within the high technology and software industries of the Companys executive compensation programs; overseeing and recommending from time to time for adoption by the Board of Directors share option plans, share appreciation rights plans, pension and profit sharing plans, bonus plans, deferred compensation plans, warrant award plans for independent Directors, independent Director compensation plans and other similar programs; overseeing and recommending to the Board of Directors the Companys stock incentive and purchase plans as in effect and as adopted from time to time for adoption by the Companys shareholders; performing such other functions and having such other powers as may be necessary or convenient for the efficient discharge of the foregoing; and reporting to the Board of Directors regarding the foregoing from time to time. In fiscal year 2006, the variable component of executive officers and all other employees remuneration included a bonus. This bonus calculation was based on a formula weighing the achievement of two fixed objectives for the year, namely operating profit greater than $11.5 million and revenue growth greater than 20%. For fiscal year 2006, one of the objectives was not reached, with actual revenue growth was 6.58% and operating profit was $4.6 million. Therefore, because actual growth is lower than one third of targeted growth (20%), there is no performance bonus was granted. In fiscal year 2006, the Compensation Committee met three times and the attendance rate, including telephone participation, was 100%.
The Nominating and Corporate Governance Committee was established in October 2002 with the primary objectives, pursuant to its Charter, of identifying individuals qualified to become Board members and recommending that the Board select a group of director nominees for each next annual meeting of our shareholders; ensuring that the Audit, Compensation, Corporate Governance and Nominating, and any other future Committees of the Board shall have the benefit of an appropriate number of qualified and experienced independent directors; developing and recommending to the Board a set of effective corporate governance policies and procedures applicable to us; monitoring significant developments in the law and practice of corporate governance; and leading the Board and each committee thereof in its annual performance evaluation, including establishing criteria to be used in connection with such evaluation. Key decisions and actions of the Nominating and Corporate Governance Committee in fiscal year 2006 included the selection and nomination of two new directors, one of which was also designated as the financial expert for the Audit Committee, as well as updating the succession plan and ongoing monitoring of the applicable French and US regulatory requirements. In fiscal year 2006, the Nominating and Corporate Governance Committee met three times and the attendance rate, including telephone participation, was 100%.
Our Board of Directors has determined that Mr. Pierre-Michel Peugnet who replaced Mr. Thomas Weatherford in April 2006, is an Audit Committee financial expert within the meaning of Item 16A. (b) and (c) of the requirements of Form 20-F of the SEC. The SEC has determined that the audit committee financial expert designation does not impose on the person with that designation, any duties, obligations or liability that are greater than the duties, obligations or liabilities imposed on such person as a member of the audit committee of the Board of Directors in the absence of such designation.
Internal Control Procedures
Under the French Financial Security Law, issuers of publicly traded securities are subject to new disclosure requirements for corporate governance and internal control. The Chairman is required to report to shareholders annually, in a document appended to the Management Report issued by the Board of Directors, on the way in which the Board prepares and organizes
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its work, as well as on the internal control procedures implemented by the Company. For corporations with a Board of Directors, the report must also specify whether the powers of the Chief Executive Officer have been restricted in any way.
One of the objectives of the internal control procedures is to prevent and control risks arising from the Companys businesses and risks of error or fraud, particularly in the areas of accounting and finance. As with every control system, it cannot provide an absolute guarantee that these risks are totally eliminated. See also Item 15 of this Form 20-F/A.
Ethical Values and Principles of Conduct for the Group
The ethical values and principles of conduct for the Company are defined in two of the Companys principal documents:
(1) ILOG Code of Business Conducts and Ethics
(2) Supplementary Code of Ethics and Business Conduct for Designated Executives
The following chart indicates our total number of employees and the distribution of employees by function, as of June 30, 2006, 2005, and 2004:
The following chart indicates the geographic distribution of our employees, as of June 30, 2006, 2005 and 2004:
Employee turnover was approximately 11% and 13% in fiscal year 2006 and fiscal year 2005 respectively.
We have never experienced a strike and believe that our relationships with our employees are good. Our employees in France are generally employed on a permanent basis. We do employ a few temporary workers during periods of transition, and we subcontract a small portion of our work to third parties. See Item 3.D. Risk Factors.
Our employees in France are represented by an independent union, and management is required under the French Labor Code to hold monthly meetings with a delegation of elected employee representatives to discuss, in particular, employment matters and the economic condition of the Company and to provide appropriate information and documents relating thereto. Monthly reports are published on the ILOG intranet. As required under the French Labor Code, two representatives of the employees are entitled to attend meetings of the Board of Directors, but do not have any voting rights. Furthermore, the November 29, 2005 annual meeting of the Shareholders approved a resolution modifying ILOG S.A. by-laws in order to allow the appointment of a representative of the employees to the Board. Mr. Stéphane Lizeray was elected a Director by the French personnel of the Company on March 17, 2006.
A profit sharing plan (accord dintéressement) was developed and approved by the Board in December 2004 for implementation for French employees in fiscal years 2005, 2006 and 2007. Payments under the plan are determined as a
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percentage of the yearly paid remuneration and with the same method as the one used for all other employees located in our subsidiaries, i.e., based on yearly targeted growth and operating profit. No performance bonus will be paid in fiscal year 2006 as these targets were not achieved.
The table below sets forth certain information with respect to the beneficial ownership of Shares, including Shares represented by ADSs, options and/or warrants outstanding as of August 31, 2006 by our Directors and executive officers, where such beneficial ownership represents more than one percent:
We have various employee stock option and employee stock purchase plans currently in effect. Under French law, we cannot grant options to members of the Board of Directors (other than the Chairman and Chief Executive Officer or Deputy Chief Executive Officers) who are not employees. See Note 10 of the Notes to our Consolidated Financial Statements included elsewhere herein for information related to option grants.
Warrants for Non-Executive Directors and TAB Members. Pursuant to resolutions adopted on September 21, 1999, October 18, 2000, December 18, 2000, December 18, 2001, December 17, 2002, December 16, 2003, November 30, 2004, and November 29, 2005, the shareholders have authorized the Board to issue warrants to the non-executive Directors and TAB members for the purchase of ILOG Shares, up to a total of 456,000 Shares. On September 22, 1999, November 22, 2000, December 18, 2000, December 18, 2001, February 26, 2003, June 18, 2003, December 16, 2003, November 30, 2004, and November 29, 2005, warrants to purchase 20,000, 32,000, 80,000, 60,000, 20,000, 56,000, 76,000, 56,000, and 56,000 Shares, respectively, were granted to 11 non-executive Directors and five TAB members. Warrants representing
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242,000 shares were outstanding as of August 31, 2006, as two directors did not accept their grants. The warrants may be exercised at prices between 4.48 and 13.10 per Share at any time until the fifth anniversary of the date of grant, when they lapse. When granted, the exercise price of the warrant is the highest of (i) the average trading closing price as quoted on Eurolist during the ten days preceding the Shareholders meeting or (ii) the closing price for a share on Eurolist on the trading day preceding the Shareholders meeting. The warrants are issued at a price representing 5% of the exercise price, and must be subscribed within three months from the date of the grants.
The following is a summary description of each of the Companys stock plans.
The 1996 Stock Option Plan. In 1994, ILOGs shareholders, at an extraordinary meeting, authorized the Board of Directors to grant, until November 23, 1999, options on up to 500,000 shares at a price to be determined by the Board of Directors on the date of grant based on ILOGs net assets, a reasonable estimate of its future profitability and its future development prospects (the 1994 Plan). In order to comply with the U.S. Internal Revenue Code of 1986, as amended (the Code), for the granting of incentive stock options, we decided to adopt a new plan (the 1996 Plan), incorporating Shares authorized under the 1994 Plan. The 1996 Plan was approved by the shareholders at an extraordinary meeting on May 30, 1996, and on that date 600,000 Shares were granted; on October 17, 1996, 200,000 Shares; on August 20, 1997, 1,600,000 Shares; on December 17, 1997, 500,000 Shares; and on August 31, 1998, 1,000,000 Shares, were added to the 1996 Plan with respect to which options could also be granted by the Board of Directors until November 23, 1999. Following the approval by shareholders at an extraordinary meeting of the 1998 Plan (see below), 1,000,000 shares authorized for the 1996 Plan were transferred to the 1998 Plan. Under the 1996 Plan, optionees are entitled to exercise options for ten years (or seven years less one day for U.K. employees). Under the 1996 Plan, generally and unless otherwise specified, one-fourth of the Shares subject to option vest 12 months after the date of grant of options and 1/48 of the Shares vest each month thereafter provided the optionee continues to render services to ILOG. As of August 31, 2006, options with respect to an aggregate of 979,636 Shares were outstanding at exercise prices ranging from 3.81 to 13.54.
The 1998 Stock Option Plan. On November 4, 1998, ILOGs shareholders, at an extraordinary meeting, approved the 1998 Stock Option Plan, to succeed the 1996 Stock Option Plan, and at that time options representing 1,000,000 Shares previously authorized for the 1996 Plan were transferred to the 1998 Plan. In addition, on September 21, 1999, 900,000 Shares and on October 18, 2000, 1,250,000 Shares, were authorized with respect to which options may be granted by the Board of Directors. The 1998 Stock Option Plan is identical to the 1996 Stock Option Plan except that it expired in October 2005. As of August 31, 2006, options with respect to an aggregate of 2,624,237 Shares were outstanding at exercise prices ranging from 2.92 to 51.50.
The 2001 Stock Option Plan. On September 25, 2001, ILOGs shareholders, at an extraordinary meeting, authorized the Board of Directors to grant options, which give the right to subscribe for or purchase up to 1,100,000 Shares, to employees under the 2001 Stock Option Plan (the 2001 Plan). On December 18, 2001, the shareholders ratified and amended the 2001 Plan. Pursuant to the 2001 Plan, the issue price of the Shares will be equal to the closing price of a Share on the Eurolist by Euronext on the last trading day preceding the date of the grant of the options, provided that the issue price is not less than (i) 80% of the average of the closing prices quoted for a Share on the Eurolist by Euronext during the twenty trading days preceding such date of grant and (ii) 80% of the average repurchase price of any Shares held by the Company. Under the 2001 Plan, generally and unless otherwise specified, one-fourth of the Shares subject to option vest 12 months after the date of grant and 1/48 of the Shares vest each month thereafter provided the optionee continues to render services to ILOG. The 2001 Plan expired in November 2005. As of August 31, 2006, options with respect to an aggregate 935,990 Shares were outstanding at exercise prices ranging from 8.66 to 10.78.
The 2004 Stock Option Plan. On November 30, 2004, ILOGs shareholders, at an extraordinary meeting, authorized the Board of Directors to grant options, which give the right to subscribe for or purchase up to 800,000 Shares to employees. Under the 2004 Stock Option Plan (the 2004 Plan), the issue price of the Shares will be equal to the closing price of a Share on the Eurolist by Euronext on the last trading day preceding the date of the grant of the options, provided that the issue price is not less than (i) 80% of the average of the closing prices quoted for a Share on the Eurolist by Euronext during the twenty trading days preceding such date of grant and (ii) 80% of the average repurchase price of any Shares held by the Company. Under the 2004 Plan, generally and unless otherwise specified, one-fourth of the Shares subject to option vest 12 months after
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the date of grant and 1/48 of the Shares vest each month thereafter provided the optionee continues to render services to ILOG. As of August 31, 2006, options with respect to an aggregate 10,000 Shares had been issued under the 2004 Plan and were outstanding at an exercise price of 12.45, and options to purchase or subscribe for 790,000 Shares remained available for grant under the 2004 Plan.
All options granted under the 1996, 1998, 2001 and 2004 Plans have a term of ten years, other than options granted to employees in the United Kingdom which have a term of seven years less one day. Generally, and unless otherwise specified, if an optionee terminates his or her employment with ILOG, the optionee may exercise only those options vested as of the date of termination and must effect such exercise within three months, except for optionees who are French tax residents at the date of grant of the options who may exercise their options until the termination of the term of their options. Since the ILOG insider trading policy has been extended to all employees worldwide, this three-month period is extended by the number of weeks during which the terminated employee cannot exercise due to blackout periods. In general, if an optionee dies during his or her employment, or within three months after termination of employment, such persons options may be exercised up to six months after his or her death to the extent vested at the time of his or her death or termination. No option may be transferred by the optionee other than by will or the laws of intestacy.
In December 1996, the French parliament adopted a law that requires French companies and optionees to pay French social contributions and certain salary-based taxes, which may represent, for ILOG, up to 45% of the taxable amount, on the difference between the exercise price of a stock option and the fair market value of the underlying shares on the exercise date, if the beneficiary is a French resident subject to French social security at the date of grant of the stock options and disposes of the shares, or converts the shares into bearer form, before the fifth anniversary of the date of option grant. In addition, such difference is treated as salary income for personal income tax purposes if the shares are sold or otherwise disposed of within five years of the grant date. This applies to all options exercised after January 1, 1997 and granted to French residents subject to French social security. Thus, in order to avoid paying these social contributions, the option Plans provide that the shares to be obtained by exercise of the options granted as of and after January 1, 1997 to French residents subject to French social security can not be disposed of or converted into bearer form except with express written authorization from Company, until the end of the five-year holding period from the date of grant of the options. In addition, pursuant to the French Law of July 2, 1998, both the beneficiary and ILOG are exempt from social contributions if the options were granted before January 1, 1997 and are exercised after April 1, 1998 due to the fact that ILOG has not been registered for more than 15 years at the date of grant of such options. Under the French Law of May 15, 2001, the five-year holding period is reduced to four years with respect to stock options granted on or after April 27, 2000.
We have not recorded a liability for social contributions and certain salary-based taxes that may be assessed for options granted up to June 30, 2006, as the liability, being dependent on future values of our Shares and the timing of employees decisions to exercise options and sell the related Shares, cannot be estimated. We also do not consider that the liability is probable because the Company has control over whether to make an exception to the option plans, and of the significant income tax disincentives to employees exercising options and selling the Shares prior to the end of the minimum holding period.
International Employee Stock Purchase Plan. In October 1996, ILOGs shareholders had approved our International Employee Stock Purchase Plan (the Purchase Plan) and renewed such approval in December 2003, which reserved a total of 400,000 Shares for issuance to the ILOG S.A. Employee Benefits Trust for a period of two years. The Purchase Plan permitted eligible employees to acquire Shares in the form of ADSs through payroll deductions. The Purchase Plan was intended to qualify as an employee stock purchase plan under Section 423 of the Code. The Board of Directors decided to use the Plan until January 2005 when the last offering period was closed. The December 2003 shareholders approval expired in November 2005 and was not renewed.
French Employee Savings Plan. ILOGs shareholders in December 2003 reserved a total of 600,000 Shares for issuance to ILOG employees participating in the French Employee Savings Plan the (Savings Plan) for a period of two years. The Savings Plan permitted eligible employees to make contributions for purposes of purchasing units in investment funds managed for ILOG on behalf of the employees, or to acquire ILOG Shares at a preferential price. The Savings Plan is an Employee Savings Plan under Article L.443-1 et. seq. of the French Labor Code. The Board of Directors decided to use the Plan until September 2004 when the last offering period was closed. The December 2003 shareholders approval expired in November 2005 and was renewed for a period of two years and for a total of 100,000 shares. As of August 31, 2006, the Board of Directors had not used the Plan under this authority.
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As of June 30, 2005, we had issued 177,720 and 28,534 Shares under the International Employee Purchase Plan and the French Employee Savings Plan, respectively, since ILOGs shareholders approval in December 2003. In fiscal year 2006, no shares were issued under these plans.
Free shares. On November 29, 2005, ILOGs shareholders, at an extraordinary meeting, authorized the Board of Directors to allow grants of new shares and/or existing shares representing up to 4% of the Companys share capital, for free to certain employees and executives of the Company or its affiliates, excluding any executives or employees who own more than 10% of the Companys share capital. The grant of free shares to the beneficiaries of this program would be definitive at the end of the vesting period, which would occur each month between the 24th month and the 84th month following the date of grant, with respect to 1/60th of the shares granted to each beneficiary. There would be a lock-up period of two years following the definitive grant of each share, with respect to such share. The Board has not awarded any grants as of October 6, 2006.
The table below sets forth certain information with respect to the beneficial ownership of ILOG Shares as of August 31, 2006 by any person known to us to be the owner of five percent or more of the outstanding Shares and employees:
On March 23, 2005 a French company Financière de lEchiquier purchased 912,717 shares representing, 5.0% of the Companys shares at August 31, 2005. Since this date, Financière de lEchiquier has not published any further notifications. Fidelity Investments, through various funds under its management had, during 2003 and in prior years, control of between approximately 5% and 10% of the Companys outstanding shares. Fidelity Investments reduced its share in ILOG below 5% on August 8, 2003. Robert Bixbys beneficial ownership was 5.1% in fiscal year 2003 but had decreased below 5% in fiscal year 2004. To our knowledge, over the last three years there have been no other significant changes in the percentage ownership held by any other of the Companys major shareholders.
To our knowledge, except as disclosed above, the Company is not directly or indirectly controlled by any other corporation, foreign government or any other natural or legal person severally or jointly and the Company is not aware of any arrangements, the operation of which may at a subsequent date result in a change of control of the Company.
None of the holders of Shares listed in this table have voting rights different from other holders of shares. We are not aware of any shareholders agreement with respect to our shares.
54 | Form 20-F/A 2006 ILOG
As of August 31, 2006, ADRs evidencing approximately 2,247,584 ADSs were held of record by approximately 37 registered holders. The 2,247,584 Shares represented by those ADRs (approximately 12% of the Companys issued and outstanding Shares) were registered in the name of BNP-Paribas. Because the shares are dematerialized, we are not able to identify the number of record shareholders without unreasonable expense. Since certain of the Companys ADSs and Ordinary Shares are held by brokers and other nominees, the number of ADSs and Ordinary Shares held of record and the number of record holders may not be representative of the location of where the beneficial holders are resident.
Janet Lowe is the wife of director Todd Lowe, and is an employee of the Company. ILOG has no other related party transactions.
See Item 18. Financial Statements for a list of the financial statements filed with this Annual Report on Form 20-F/A.
ILOG is involved in a lawsuit entitled Jensen Denmark A/S and Naicom Technologies vs. ILOG S.A. This suit was brought by Jensen Denmark and Naicom Technologies against ILOG for breach of contract, bad faith, and failure to meet the standard of care owed by a professional consultant. ILOG has filed a counterclaim in which it alleges that ILOG is entitled to recover from the plaintiffs fees which we incurred but which were not paid, as well as additional damages. The case was tried before a judge in France and the court found in ILOGs favor and against Naicom Jensen. The court dismissed ILOGs counterclaim. Naicom Jensen has appealed this ruling and the case is currently pending on appeal in the Court of Appeals of Paris, France. The amount of damages claimed by Jensen Naicom is below the limits of our applicable insurance coverage, and the insurance company has accepted the defense of this matter.
We are a party to various other legal proceedings from time to time in the ordinary course of business. There is currently no such proceeding which we believe is likely to have, or recently has had, a material adverse effect on our financial position or profitability. Any litigation, however, involves potential risk and potentially significant litigation costs, and therefore there can be no assurance that any litigation which may arise in the future will not have a material adverse effect on our financial position or profitability.
To the knowledge of the Company, there are no other significant commitments or contingencies as of June 30, 2006.
We have not paid any cash dividends on our share capital to date. We currently anticipate that we will retain any future earnings for use in our business and, therefore, do not anticipate paying any cash dividends in the foreseeable future. Any dividend would be declared and paid in euros and under French law and our statuts, may only be paid from ILOG S.A.s pre-consolidated statutory retained earnings. As of June 30, 2006, ILOG S.A.s pre-consolidated accumulated profit was approximately $6 million. Any dividends paid to holders of ADSs would be converted from euros to U.S. dollars, subject to a charge by the Depositary for any expenses incurred by the Depositary in such conversion. Fluctuations in the exchange rate between euros and dollars and expenses of the Depositary would affect the dollar amounts actually received by holders of ADSs upon conversion by the Depositary of such cash dividends. See Item 3.D.Risk Factors5. Other risks of owning ILOG
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Shares and ADSsHolders of ADSs may be subject to additional risks related to holding ADSs rather than Shares. See Item 10.E.Taxation for a description of the principal French and U.S. federal income tax consequences regarding the taxation of dividends for holders of ADSs and Ordinary Shares.
Except as disclosed elsewhere in this Annual Report, there have been no significant changes in the Companys business since June 30, 2006, the date of the annual financial statements included in this Annual Report.
Closing Sale Prices of ILOG ADSs and Shares
The following table sets forth the range of low and high reported closing sale prices of our ADSs (each ADS representing one Share) on the NASDAQ National Market for the last five fiscal years and periods indicated.
On August 31, 2006, the last sale price for the ADSs as reported on the NASDAQ National Market was $11.78 per ADS.
The Depositary for the ADSs is JPMorgan Chase Bank. Each ADS registered on the books of the Depositary represents to one Share. As of August 31, 2006, there were 37 record holders of American Depositary Receipts evidencing 2,247,584 ADSs.
From December 1998 to February 2005, the Shares were listed on the Nouveau Marché of Euronext Paris, and are since then listed on Eurolist by Euronext. The following table sets forth the range of high and low reported closing sale prices of the Shares on the Eurolist by Euronext (and, prior to February 21, 2005, on the Nouveau Marché) for the last five fiscal years and periods indicated.
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On August 31, 2006, the last sale price for the Shares as reported on the Eurolist by Euronext was 8.61 per Share.
The ADSs are quoted on the NASDAQ National Market under the symbol ILOG. The Shares are also listed on the Eurolist by Euronext. The Nouveau Marché of Euronext Paris, on which our shares were previously traded, merged into a new market called Eurolist by Euronext on February 21, 2005 and the Shares are accordingly traded on the Eurolist by Euronext since that date.
The Paris Market
The Financial Security Law provided for the creation of a single regulatory body, the Autorité des Marchés Financiers (the AMF), to control and supervise French financial markets. Accordingly, the AMF, an independent administrative authority, resulted from the merger of three former independent market watchdogs, namely the Commission des Opérations de Bourse (the COB), the Conseil des Marchés Financiers (the CMF) and the Conseil de Discipline de la Gestion Financière. The AMF is responsible for the protection of investors, the dissemination of information to the public by traded companies and the proper running of the securities markets. References in this Annual Report on Form 20-F/A to the AMF include its predecessors, the COB and the CMF.
Effective September 22, 2000, Euronext was formed from the merger of Paris Bourse SBF S.A. (which changed its name to Euronext Paris), the Amsterdam Stock Exchange and the Brussels Exchange, and the Portugal Exchange was included in Euronext in January 2002. Euronext operates four subsidiary holding companies in each of the four member countries. Each subsidiary continues to hold an exchange license for its local capital market. Listed companies remain listed on their original
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exchange but all shares are traded on a single integrated trading platform and listing requirements have been harmonized. Trading is regulated with a single rulebook and the take-over rules continue to be imposed domestically. Euronext provides integrated trading, clearing and settlement on all four markets, and a central counter party, netting and clearing house for all executed trades via Clearnet.
Official trading of listed securities on Euronext Paris is transacted through providers of investment services known as prestataires de services dinvestissements (investment companies and other financial institutions). The trading of ILOG Shares takes place continuously on each business day from 9:00 a.m. through 5:25 p.m. (Paris time), with a pre-closing session from 5:25 p.m. to 5:30 p.m. during which time transactions are recorded but not executed, with a closing auction at 5:30 p.m. During a pre-opening session from 7:15 a.m. through 9:00 a.m. transactions are recorded but not executed. Any trade effected after the close of a stock-exchange session is recorded on the next Euronext Paris trading day, at the closing price for the relevant security at the end of the previous days session.
Euronext Paris is a market enterprise (entreprise de marché) to which is entrusted the operation of regulated markets, including the admission of financial instruments. Euronext Paris publishes a daily Official Price List that includes price information on each listed security. Euronext Paris provides continuous trading by computer during trading hours for all listed securities.
Reform of the Regulated Market of Euronext
On February 21, 2005, Euronext replaced its three regulated markets (Premier Marché, Second Marché and Nouveau Marché) by a single list called Eurolist by Euronext. Companies on this regulated market are classified by alphabetical order and by market capitalization.
Previously, the securities of most large public companies were listed on the Premier Marché of Euronext Paris. The Second Marché was available for small and medium-sized companies. The Nouveau Marché, on which the ILOG shares were listed was for companies seeking development capital, and the EDR market for European Depositary Receipts. Shares of certain other companies are traded on the marché libre-OTC, an unregulated over-the-counter type of market. In addition, shares listed on Eurolist by Euronext are placed in one of three categories depending on the volume of transactions. The Shares are listed in the category known as Continu, or continuous trading, which includes the most actively traded shares.
Trading in the listed securities of an issuer may be reserved or suspended by Euronext Paris if changes in quoted prices exceed certain price limits defined by its regulations. In particular, if the quoted price of a security varies by more than 10% from the reference price, Euronext Paris may restrict trading in that security for up to four minutes (réservation à la hausse ou à la baisse). The reference price is usually the opening price, or, with respect to the first quoted price of a given trading day, the last traded price of the previous trading day, as adjusted if necessary by Euronext Paris to take into account available information. Further suspensions for up to four minutes are also possible if the price again varies by more than 10% from a new reference price equal to the price that caused the first trading suspension. Euronext Paris may also reserve trading for a four-minute period if the quoted price of a security varies by more than 2% from the last traded price. However, subject to trading conditions and appropriate and timely information, Euronext Paris may modify the reservation period and may accept broader fluctuation ranges than mentioned above. Euronext Paris may also suspend trading of a listed security in certain other limited circumstances, including, for example, the occurrence of unusual trading activity in such security. In addition, in exceptional cases, the AMF may ask Euronext to suspend trading.
Trades of securities listed on Eurolist by Euronext are cleared and settled through Euroclear France S.A.. A fee or commission is payable to the broker-dealer or other agent involved in the transaction.
The Company currently has no plans to list its securities for trading on any other markets.
The NextEconomy segment
ILOG joined the NextEconomy segment of Euronext N.V., when it was created on January 2, 2002. This segment contains companies from sectors related to the new economy. Companies included in this segment undertake to comply with specific
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commitments for financial transparency, in addition to existing local obligations. Shares included in the NextEconomy segment are traded on a continuous basis, with or without the involvement of one or more liquidity providers.
For any financial year beginning on or after January 1, 2005, ILOG is required to prepare and publish annual Consolidated Financial Statements and interim reports, reviewed and approved by the Audit Committee and an independent registered public accounting firm (Commissaires aux Comptes), for each financial year with a one year comparison in accordance with the International Financial Reporting Standards (IFRS) (in line with European Regulation n°1606/2002). Comparative figures shall be provided and restated on the same basis as for the 2005 year. Euronext regards as best practice that companies included in the NextEconomy segment publish first and third quarterly reports with a content that shall be the same as the content of the half-yearly report.
ILOG complies with all Euronext requirements with respect to the NextEconomy segment. With regards to best practice as set forth by Euronext, ILOG has filed a document de référence with the AMF on an annual basis since its admission to listing on the Nouveau Marché (which became Eurolist by Euronext) and publishes quarterly financial information.
The Shares have been included in the following indices managed by Euronext : Index SBF 250, IT CAC, Next 150 and NextEconomy.
The Company is a société anonyme, a form of corporation, incorporated under the laws of France. In this section, we summarize material information concerning our share capital, together with material provisions of applicable French law and our statuts. An unofficial English translation of the Companys statuts is included as an exhibit to this Annual Report on Form 20-F/A. You may obtain copies of our statuts in French from the Clerk of the Registry of Commerce and Companies of Créteil, France.
For a complete discussion of directors powers under French law and the Companys bylaws, please see Item 6A-Directors and Senior Management.
For the Companys registration number and corporate purpose, please see Item 4. Information on the CompanyHistory and Development of ILOG.
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For information related to the rights of ADS holders, see the Form F-6, which is hereby incorporated by reference herein.
Each Director must own at least one share during his term of office. If, at the time of his or her appointment, a Director does not own the required number of shares or if, during his or her term of office, he or she ceases to be the owner thereof, he or she shall have a period of three months to purchase such number of shares, in default of which he or she shall be automatically deemed to have resigned.
The number of Directors who are more than seventy-five (75) years old may not exceed one third of the Directors in office. Should such quota be reached during an ongoing term of office, the appointment of the oldest Director would be automatically terminated at the close of the following ordinary shareholders meeting.
Since the statuts do not contain any provisions relating to the Directors compensation, French law described under Item 6 A. and Item 6 C. applies without restriction.
The entering into of arrangements or contracts in which a Director is interested is subject to the prior consent of our Board of Directors and must be approved by our shareholders meeting. Our bylaws refer to the applicable French laws described under Item 6 C. Please see Item 6 C Board Parties. Directors, other than legal entities, are forbidden to contract loans from the Company in any form whatsoever, to secure an overdraft from it, as a current account or otherwise, or to have the Company guarantee or secure their commitments toward third parties. The same prohibition applies to the CEO (directeur général), the deputy CEO (directeur général délégué) and the permanent representatives of legal entities that are Directors. It also applies to spouses, ascendants and descendants of the persons of the foregoing, as well as to all intermediaries.
In accordance with French law, there are two types of shareholders meetings, ordinary and extraordinary.
Ordinary shareholders meetings are required for matters such as:
Following the adoption of French ordinance dated June 24, 2004, the issuance of debt securities by French commercial companies may now be decided by the Board of Directors, and an authorization by the shareholders at the ordinary shareholders meeting is no longer necessary.
Extraordinary shareholders meetings are required for approval of matters such as amendments to the Companys statuts and rights of holders of any category of shares, including any amendment required in connection with extraordinary corporate actions. Extraordinary corporate actions include:
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Annual Ordinary Meetings
French law requires the Companys Board of Directors to convene an annual ordinary shareholders meeting for approval of the annual financial statements. This meeting must be held within six months of the end of each fiscal year. This period may, however, be extended by an order of the President of the Tribunal de Commerce (Commercial Court). The Board of Directors may also convene an ordinary or extraordinary meeting of shareholders upon proper notice at any time during the year. If the Board of Directors fails to convene a shareholders meeting, the Companys independent registered public accounting firm may call the meeting. The Companys liquidator in bankruptcy or a court-appointed agent may also call a shareholders meeting in some instances. A court agent may be appointed at the request of:
Notice of Shareholders Meetings
The Company must announce shareholders meetings at least 30 days in advance by means of a preliminary notice, which is published in the Bulletin des Annonces Légales Obligatoires, or BALO, and must be sent to the AMF prior to publication. This preliminary notice must contain, among other things, the time, date and place of the meeting, the agenda, a draft of the resolutions to be submitted to the shareholders, a description of the procedures that holders of bearer shares must follow to attend the meeting and the procedure for voting by mail.
At least 15 days prior to the date set for the meetings and at least six days if the required Quorum is not met, the Company must publish a final notice (avis de convocation) containing among other things, the final agenda, time and place of the meeting and other related information. This final notice must be sent by mail to all registered shareholders who have held shares for at least one month prior to the date of publication of the final notice, and must also be published in a newspaper authorized to publish legal announcements in the local administrative area (département) in which the Company is registered, as well as in the BALO, with prior notice having been given to the AMF.
In general, shareholders can only take action at shareholders meetings on matters listed on the agenda for the meeting. As an exception, shareholders may take action with respect to the dismissal of Directors even though this action has not been included on the agenda.
Additional resolutions to be submitted for approval by the shareholders at the meeting may be proposed to the Board of Directors within 10 days of the publication of the preliminary notice in the BALO by:
The Board of Directors must submit these resolutions to a vote of the shareholders.
In addition, during the two weeks preceding a meeting of shareholders, any shareholder may submit written questions to the Board of Directors relating to the agenda for the meeting. The Board of Directors is then obliged to respond to these questions, so long as they relate to the agenda.
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Attendance and Voting at Shareholders Meetings
Each Share confers on a shareholder the right to one vote. Shareholders may attend ordinary shareholders meetings and extraordinary shareholders meetings and exercise their voting rights, subject to the conditions specified in French law and the Companys statuts. There is no requirement that a shareholder have a minimum number of shares in order to attend or to be represented at an ordinary or extraordinary shareholders meeting or to vote by mail or, upon decision of the Board, by videoconference or by other means of telecommunication which allow shareholders to be identified.
According to the Companys statuts, in order to participate in any shareholders meeting, a holder of shares held in registered form must have its shares registered in its name in a shareholder account maintained by the Company or on the Companys behalf by an agent appointed by the Company at least one day prior to the date of the meeting.
A holder of bearer shares must obtain a certificate from the accredited intermediary with whom the holder has deposited its shares. This certificate must indicate the number of bearer shares the holder owns and must state that these shares are not transferable until the time fixed for the meeting. The holder must deposit this certificate at the place specified in the notice of the meeting at least one day before the meeting. For a description of certain voting procedures for ADS holders, see Item 3. D. Holders of ADSs may be subject to additional risks related to holding ADSs rather than Shares.
The Companys statuts provide that shareholders may, if the Board of Directors so approve when the meeting is convened, participate in a shareholders meeting by videoconference or by other means of telecommunication provided shareholder identification is possible in accordance with applicable laws and regulations.
Proxies and Votes by Mail
In general, all shareholders who have properly registered their Shares or duly presented a certificate from their accredited financial intermediary may participate in shareholders meetings. Shareholders may participate and vote in shareholders meetings either in person, by proxy, by mail, or upon decision of the Board, by videoconference or by any other means of telecommunication which allows shareholders to be identified.
Proxies will be sent to any shareholder on request with, among other things, the text of the resolutions to be passed at the relevant meeting. In order to be counted, such proxies must be received at the Companys registered office, or at any other address indicated on the notice convening the meeting, prior to the date of the meeting. A shareholder may grant proxies to his or her spouse or to another shareholder. If the shareholder is not a French resident, the grant of proxies should be made through an intermediary declaring his position as an intermediary holding shares on behalf of beneficial owners as set forth by French law. A shareholder that is a corporation may grant proxies to a legal representative. Alternatively, the shareholder may send the Company a blank proxy without nominating any representative. In this case, the chairman of the meeting will vote the blank proxies in favor of all resolutions proposed or agreed by the Board of Directors and against all others.
In addition, shareholders may vote by mail or email. The Company must send shareholders a voting form. The completed form voting must be returned by the shareholder to the Company at least three days prior to the date of the shareholders meeting.
French law requires that shareholders having at least 20% of the shares entitled to voting rights must be present in person or voting by mail, by proxy or by videoconference or by any other means of telecommunication that allows shareholders to be identified to satisfy the quorum requirement for:
The quorum requirement is 25% of the shares entitled to voting rights, on the same basis, for any other extraordinary shareholders meetings resolution.
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If a quorum is not present at a meeting, the meeting is adjourned. When an adjourned ordinary meeting is resumed, there is no quorum requirement. Therefore, no quorum is required when an adjourned extraordinary meeting is resumed only to approve an increase in the Companys share capital through incorporation of reserves, profits or share premiums. In the case of any other resumed meeting, shareholders having at least 20% of outstanding voting rights must be present in person or voting by mail or by proxy and by videoconference or by any means of telecommunication allowing them to be identified for a quorum. If a quorum is not present, the reconvened meeting may be adjourned for a maximum of two months. No deliberation by the shareholders may take place without a quorum. However, only questions which were on the agenda of the adjourned meeting may be discussed and voted upon.
A simple majority of shareholders may pass a resolution at either an ordinary shareholders meeting or an extraordinary shareholders meeting