UNWIRED PLANET, INC. 10-K 2007
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
AMENDMENT NO. 1
For the fiscal year ended June 30, 2006
For the transition period from to
Commission file number: 001-16073
OPENWAVE SYSTEMS INC.
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act:
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ¨ No x
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.
Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act): Yes ¨ No x
The aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $1,599,714,798 as of December 31, 2005 based upon the closing sale price on the NASDAQ Global Select Market reported for such date. Shares of Common Stock held by each officer and director have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.
There were 94,612,874 shares of the registrants Common Stock issued and outstanding as of November 27, 2006.
TABLE OF CONTENTS
Explanatory Note to this Amendment No. 1
In this Form 10-K/A, we are restating the consolidated balance sheets as of June 30, 2006 and 2005, and the related consolidated statements of cash flows for each of the years in the three-year period ended June 30, 2006. Our decision to restate was based on our review of the impact of the error associated with classifying accrued interest receivable on our investments in Cash and equivalents on the consolidated balance sheet as opposed to Prepaid and other assets. This misclassification in turn caused Cash from operations to be incorrect on our consolidated statements of cash flows. In addition, we are restating the consolidated statement of stockholders equity and comprehensive income for the fiscal year ended June 30, 2006 to properly reflect $1.2 million in currency translation adjustments for intangible assets related to our French subsidiary that uses the Euro as its functional currency. None of the above adjustments impacted net income or loss in any fiscal period.
Except for matters related to the aforementioned restatements above, this Amendment No. 1 does not modify or update other disclosures in the originally filed Form 10-K, including the nature and character of such disclosure to reflect events occurring after the filing date of the originally filed Form 10-K. While we are amending only certain portions of our Form 10-K, for convenience and ease of reference, we are filing the entire Form 10-K, except for certain exhibits. Accordingly, this Form 10-K/A should be read in conjunction with our filings made with the Securities and Exchange Commission.
This Form 10-K/A also reflects the restatement of (i) Selected Consolidated Financial Data for the fiscal years ended June 30, 2006, 2005, 2004 and 2003 in Item 6 and (ii) Managements Discussion and Analysis of Financial Condition and Results of Operations in Item 7 for the years ended June 30, 2006 and 2005.
In addition to historical information, this Annual Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are based upon current expectations and beliefs of our management and are subject to certain risks and uncertainties, including economic and market variables. Words such as anticipates, expects, intends, plans, believes, seeks, estimates and similar expressions identify such forward-looking statements. Forward-looking statements include, among other things, statements regarding our ability to attract and retain customers, obtain and expand market acceptance for our products and services, the information and expectations concerning our future financial performance and potential or expected competition and growth in our markets and markets in which we expect to compete, business strategy, projected plans and objectives, anticipated cost savings from restructurings, our estimates with respect to future operating results, the impact of recognizing material amounts of stock-based compensation expense which were not previously accounted for in previously issued financial statements, including, without limitation, earnings, cash flow and revenue and any statements of assumptions underlying the foregoing. These forward-looking statements are merely predictions, not historical facts and are subject to risks and uncertainties that could cause actual results to differ materially from those indicated in the forward-looking statements. These risks and uncertainties include the limited number of potential customers, highly competitive market for our products and services, technological changes and developments, potential delays in software development and technical difficulties that may be encountered in the development or use of our software, patent litigation, our ability to retain management and key personnel, and the other risks discussed below under the subheading Risk Factors under Item 1A and elsewhere in this report. The occurrence of the events described under the subheading Risk Factors could harm our business, results of operations and financial condition. These forward-
looking statements are made as of the date of our Annual Report on Form 10-K filed on December 1, 2006 and we undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. Readers should carefully review the risk factors described in this section below and any subsequently filed reports.
Explanatory Note to Originally Filed Form 10-K
In our fiscal year 2006 Form 10-K, we restated the consolidated balance sheet as of June 30, 2005 and the related consolidated statements of operations, stockholders equity and comprehensive loss, and cash flows for each of the years in the two-year period ended June 30, 2005, and each of the quarters in the fiscal year 2005. Our decision to restate was based on the results of an independent review into our stock option accounting that was conducted under the direction of a special committee of the board of directors (the Special Committee).
As part of the restatement, we have also made changes to the balance sheet as of June 30, 2005 to adjust certain income tax assets and liabilities to correct errors identified in the fourth quarter of fiscal 2006, as well as certain deferred revenues and accrued liabilities to correct errors identified in fiscal year 2005 which were not material to the statement of operations for any prior fiscal year. These changes are described in more detail below. We are also restating the pro forma disclosures for stock-based compensation expense required under Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, (FAS 123) included in Note 2 to the consolidated financial statements.
Our fiscal year 2006 Form 10-K also reflects the restatement of (i) Selected Consolidated Financial Data for the fiscal years ended June 30, 2005, 2004, 2003, and 2002 in Item 6 and (ii) Managements Discussion and Analysis of Financial Condition and Results of Operations in Item 7 for the years ended June 30, 2005 and 2004.
Stock Option Review
On October 4, 2006, we announced that the Special Committee was in the process of completing its independent review of our stock option grants and practices. The Special Committee reviewed all grants of options or restricted stock made by the Company from our predecessor company Phone.coms IPO in June 1999 to September 2006. The Special Committee conducted its review with the assistance of independent legal counsel and forensic accountants. Over 56 million shares granted were reviewed, of which approximately 33% were remeasured based upon the review. The review included an extensive examination of our accounting policies, accounting records, supporting documentation, and e-mail communications, as well as interviews with numerous current and former employees and current and former members of our board of directors. In summary, the Special Committee did not find evidence that lead it to conclude there was fraud in the granting of options. The Special Committee did not find evidence that lead it to conclude that the preparation of stock option documentation was done in a manner calculated to disguise the true nature of the option granting actions or to manipulate the exercise price of the option grants. However, the Special Committees review identified circumstances where the grant date used by us as the measurement date for accounting purposes (the Record Date) preceded the appropriate measurement date, as defined in the accounting literature.
As of October 16, 2006, instances where the Special Committee found that the Record Date preceded the appropriate measurement date principally fell into three categories:
As a result of the findings of the Special Committee, we remeasured certain stock option grants which resulted in additional stock-based compensation and associated payroll tax expense for fiscal years 2000 through 2005. This expense is the result of options granted with an intrinsic value totaling $197.4 million. Intrinsic value is the quoted market price of the stock at the measurement date less the strike price the recipient would need to pay to exercise the option. The impact of amortizing the intrinsic value over the related service periods, after accounting for forfeitures, and the associated payroll tax expense is as follows:
The impact to fiscal year 2001 reflects the large number of options remeasured with a substantial positive intrinsic value due to the increase in the stock price during that timeframe. Additionally, many options granted in fiscal year 2001 were cancelled during the same fiscal year with an agreement to reissue options six to seven months later with an exercise price equal to the stock price on the replacement grant date. The cancellation resulted in previously deferred compensation being recognized in an accelerated manner in fiscal 2001 as the cancellation was not as a result of failure of the employee to meet the service obligation.
The impact of the remeasured grants to previously disclosed pro forma expense under FAS 123 is as follows:
The following describes our methodology for selecting the appropriate measurement date:
The above methodology was followed for remeasuring grants with the exception of two grants made is fiscal 2000. These grants were made prior to the hiring of the Companys first dedicated stock administrator in January 2000, and there was an unreasonable delay between the grant date and the date of entry into the options database.
The first of these two grants was a grant of approximately 99,000 shares granted on August 9, 1999 to five employees and entered into the options database on January 19, 2000 for two employees, and January 21, 2000 for the other three employees. The stock price on the Record Date was the lowest compared to the five trading days following the grant, but was not lower than the closing price on August 2 through August 4, 1999. Had the date of entry into the options database been used as the revised measurement date, approximately $32.8 million in intrinsic value would result.
The second of these two grants was a grant of approximately 184,000 shares granted on October 27, 1999 to employees who joined the Company as a result of two acquisitions. The date of this grant coincides with the acquisitions made on October 26 and 27, 1999. The stock price on the Record Date was the lowest compared to the
five trading days prior to the grant, but was not lower than the closing price on October 29, 1999. Had the date of entry into the options database been used as the revised measurement date, approximately $11.3 million in intrinsic value would result.
Given the (i) presumed inappropriateness of the dates of entry into the options database as a measurement date in these situations, (ii) lack of evidence that the Record Dates of these two grants were incorrect, and (iii) lack of additional evidence to suggest another measurement date should be used, we concluded that the best measurement date is the original Record Date for these grants, resulting in no incremental compensation expense.
In addition, for all grants, we considered an alternate methodology (View B) assuming the original Record Dates were appropriate unless specific evidence suggested an inappropriate Record Date was used. In other words, under View B, we would not revise the measurement date of grants solely because the grant was made by the SOC outside of a routine, pre-selected date and/or where there was no affirmative evidence to suggest a grant made by UWC had a delay in approval. View B resulted in approximately 9% less intrinsic value than our methodology explained above (View A).
We also considered an alternate methodology (View C) of revising the measurement date for grants made by the SOC to eight days after the Record Date, instead of the entry date into the options database. Eight days represents our calculation of the average number of days where a known delay in communication of the grant to Stock Administration existed from review of the objective evidence. View C yielded a result of approximately 2% more intrinsic value than View A.
We consider View A as the most appropriate methodology since it acknowledges the deficiencies in the UWC and SOC granting practices, regardless of the availability of evidentiary documentation. In addition, we believe the entry date into the options database is more meaningful to individual grants than the average delay under View C. Given the relative consistency in results under Views A, B and C, we believe that View A yields a reasonable estimate.
Income Tax Assets and Liabilities
For years prior to fiscal 2006, income tax assets were netted against income tax liabilities on a worldwide basis for purposes of presentation on the consolidated balance sheet. In our Form 10-K we restated the tax assets and liabilities as of June 30, 2005 to net against one another only when the asset and liability relate to the same tax jurisdiction.
Deferred Revenue and Accrued Liabilities
For years prior to fiscal 2005, we recognized a full month of maintenance and support revenues in the month the associated contract with the customer was executed. As of the beginning of fiscal year 2005, we began recognizing maintenance and support revenues based upon the actual days in the period. The previous method created an understatement of deferred revenue and accumulated deficit as of June 30, 2001 of $3.6 million. This error was partially offset by an unrelated under-recognition of revenues accumulating to $1.2 million during the same timeframe which relates to cash receipts from customers relating to billings not recorded as revenue. Previously, the $1.2 million was included in accrued liabilities. The net impact of these two errors to fiscal years 2002 through 2004 was immaterial.
Item 1. Business.
Openwave is the leading independent provider of software solutions for the communications and media industries. We provide our customers with software and services designed to enable them to launch new revenue generating content and communications services such as messaging, location, browsing and music and entertainment content delivery rapidly.
We have three categories of products:
In addition, our experienced and knowledgeable professional services staff provides a range of services, including support and training, to deliver advanced solutions to our customers that are designed to improve the consumer experience, increase adoption of data services and create differentiation for our customers.
Our global customer base includes over 70 of the worlds leading operators, over 50 mobile handset manufacturers and numerous broadband service providers and Internet Service Providers (ISPs).
We were incorporated in 1994 as a Delaware corporation and completed our initial public offering in June 1999. Our principal executive offices are located at 2100 Seaport Boulevard, Redwood City, CA 94063. Our telephone number is (650) 480-8000. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to the Securities Exchange Act of 1934, as amended, are available free of charge through either our website at www.openwave.com or the SEC website at www.sec.gov, as soon as reasonably practicable after we file or furnish such material with the SEC. Information contained on our website is not incorporated by reference to this report.
Operating Environment and Trends
The market for open standards software products and services for the telecommunications industry is growing due to technological advances and increased end-user demand for additional services and functionality in the mobile telephone market. However, in the fourth quarter of 2006 we experienced a decline in total revenues from $113.0 million in the third quarter of fiscal 2006 to $91.1 million in the fourth quarter of 2006. Our total revenues for the first quarter of fiscal 2007 were $91.2 million and we expect revenues for the second quarter of fiscal 2007 to decrease slightly from the preceding quarter. We believe our revenues and gross margin throughout fiscal 2007 will be impacted by the following trends:
In the broader market, we are benefiting from these key trends in our core markets:
In the mobile market, 3G networks such as Wideband Code-Division Multiple Access (WCDMA) and CDMA2000 Evolution Data Only (EVDO) are being rolled out globally. Using this infrastructure, mobile operators are launching new services around music and video.
Strategy Analytics predicts that spending on mobile data services and products will grow by an average of 26% in 2006 driven by a broader penetration of 3G network access and growing consumer awareness of services. The global end user spend on mobile data services is expected to grow from $92.2 billion in 2005 to $114.4 billion in 2006. Person-to-person text messaging via SMS should remain the dominant application globally, accounting for 56% of end user spend on mobile data services.
In the server software market, we have witnessed the early adoption of integrated voice and video services, bringing rich video and animated avatars to subscribers voicemail boxes. In the area of converged services, our messaging line of business continues to pave the way for our broadband, wire line, and wireless customers who are looking to simplify and streamline the communications experience. As more consumers are using their mobile phones to access mobile content and services, we are working with carriers to help them increase overall access as well as to provide a more compelling user experience. This year, we announced that we had delivered over a trillion mobile data transactions to consumers. The mobile data market continues to experience dramatic growth with the increasing consumer uptake of services such as email, web look-ups and MMS; and Openwave software manages over three billion transactions daily for operators worldwide, including Sprint Nextel, Vodafone and Telefónica.
We benefited from the following events and developments relating to our server software business during fiscal 2006:
Client software market
In the client software area, we are experiencing demand for a broader range of technologies and a more comprehensive and integrated offering. We are seeing growing demand for complete platforms from a new set of start-up handset manufacturers and from chipset vendors planning to deliver 3G mobile phones in 2006 and 2007. In addition, In-Stat predicts that the market for wireless handsets will grow 23%, to exceed $136 billion in 2006. Strategy Analytics forecasts 1.00 billion units for the full-year 2006, up 22% from 817 million units in 2005 (source: Strategy Analytics, May 2006).
We benefited from the following trends in the client software market during fiscal 2006:
In January 2006, we acquired all of the outstanding issued share capital of Musiwave, a leading provider of mobile music entertainment services to operators and media companies primarily in Europe.
We are benefiting from the following events and developments relating to our content business during fiscal 2006:
Products and Services
Our products are modular and based on open standards, providing our customers with the ability to mix and match the right products and technologies to create differentiated mobile services. Our technology and products are designed to work on diverse mobile phones and technologies regardless of the brand of mobile phone or the type of service that operators select to offer to their subscribers. Our product portfolio includes offerings in the areas of client software for mass-market mobile phones; server software which includes mobile infrastructure and adaptive messaging; location application products for the communications industry and content services via mobile music provider Musiwave, an Openwave company. Our professional services group works with our customers around the world at all stages of development and implementation of wireless services. For financial information about our operating segment and geographic areas, see Note 6 to our Consolidated Financial Statements.
Server Software Products
Our server software products contain the foundational software required to enable Internet connectivity to mobile phones and allow service providers to build compelling services for their subscribers. These products include:
Client Software Products
We offer a line of software building blocks that enable service deployment on a broad selection of todays phones. Available as standalone components, or integrated within Openwave Phone Suite Version 7, our client software includes:
Musiwave transforms music, making it more intuitive, personal, enjoyable, interactive and user-friendly for mobile phone owners. Our content products provide turnkey mobile music entertainment services for mobile operators and media companies. These products include:
Services and Maintenance and Support Services
Our products and our customers networks are complex, requiring experienced and knowledgeable professional services, support, and training to provide advanced solutions to our customers. Our support organization provides
both 24-hour maintenance and support services to our customers. In addition, our professional services organization provides training and consulting services to our customers, often to perform integration services relating to commercial launches of our technology, as well as to provide value-added services that are designed to improve the end-to-end consumer experience, increase user adoption of wireless services and create differentiation for operators. As of June 30, 2006, we had 490 employees in our professional services and maintenance and support organizations.
Research and Product Development
Our ability to meet our customers expectations for innovation and enhancement depends on a number of factors, including our ability to identify and respond to emerging technological trends in our target markets, develop and maintain competitive products, enhance our existing products by adding features and functionality that differentiate them from those of our competitors and bring products to market on a timely basis and at competitive prices. Consequently, we continue to enhance the features and performance of our existing products and have made, and intend to continue to make, significant investments in research and product development. Our research and development expenses were $88.1 million, $95.9 million and $94.5 million for the fiscal years ended June 30, 2006, 2005 and 2004, respectively. As of June 30, 2006, we had 379 employees engaged in research and product development activities.
Our success is dependent upon continued technological development and innovation. Our messaging products have substantial innovation and technology dedicated to the specific and stringent needs of the service provider marketplace. Our products are based on open standards, and we contribute to the development of such standards in the areas of mobile Internet protocols, messaging, mobile Internet technology and enabling technologies for 2.5G and 3G networks.
Our technology is designed for deployment on very large-scale networks. Our customers require highly scalable systems, tools for monitoring and managing systems and other features specific to the size, scale and performance characteristics of their networks and service offerings.
We believe the growth and development of standards is key to our success and the success of our industry. Therefore, we take an active role in a number of industry standards organizations including the Open Mobile Alliance (OMA), the World Wide Web Consortium (W3C), CDMA Developer Group, 3G Americas, and Mobile Entertainment Forum among others. In addition, the Third Generation Partnership Projects (3GPP and 3GPP2), which are the 3G standards organizations for the GSM and CDMA, respectively, represent strategic standards for our products.
Sales, Marketing and Customer Support
We sell our products through both a direct sales force and third-party resellers. As of June 30, 2006, we had 472 employees in sales, marketing and customer support worldwide. Our sales and marketing groups focus on selling products by establishing and managing relationships with customers and resellers. Our customer support group focuses on performing maintenance and support. Our third-party resellers are strategic alliance partners including HP, IBM, CTC and Siemens.
International sales of products and services accounted for 57%, 55% and 59% of our total revenues for our fiscal years ended June 30, 2006, 2005 and 2004, respectively. Our international sales strategy is to sell directly to large operators
and to partner with leading distributors and systems integrators who have strong industry backgrounds and market presence in their respective markets and geographic regions. For further information regarding our segment revenue, geographic areas and significant customers, please refer to Note 6 of our Notes to Consolidated Financial Statements.
We believe that customer service and ongoing technical support are an essential part of the sales process in the telecommunications industry. Senior management and assigned account managers play an important role in ongoing account management and relationships. We believe maintaining focus on these customer relationships will enable us to improve customer satisfaction and develop products to meet specific customer needs.
We collaborate with companies including HP, IBM, Lucent, McAfee, Qualcomm and others that expand our reach and capabilities and maintain our company-wide focus on increasing customer satisfaction and improving the end user experience.
The market for open standards software products and services for the telecommunications industry continues to be intensely competitive and fragmented. In addition, the widespread and increasing adoption of open industry standards may make it easier for new market entrants and existing competitors to introduce new products that compete with our software products.
We expect that we will continue to compete primarily on the basis of quality, technical capability, breadth of product and service offerings, functionality, price and time to market.
In the client products market, our competitors include Access, Nokia, and Teleca Systems. In the server software products market, our competitors include Comverse, Ericsson, LogicaCMG, Siemens, 724 Solutions, Sun Microsystems and Critical Path. In addition, we have competitors within the antispam and antivirus market, such as Ironport.
Intellectual Property Rights
Our performance depends significantly on our ability to protect our intellectual property and proprietary rights to the technologies used in our products. If we are not adequately protected, our competitors could use the technologies that we have developed to enhance their products and services, which could harm our business.
As a member of several groups involved in setting standards for the industry, such as the OMA, we have agreed to license our intellectual property to other members of those groups on fair and reasonable terms to the extent that the intellectual property is essential to implementing the specifications promulgated by those groups. Each of the other members of the groups has agreed to similar provisions.
Employees and Recent Executive Officer Changes
As of June 30, 2006, we had 1,452 employees. None of our employees are covered by any collective bargaining agreements, except for certain employees located in Europe.
In August 2006, we announced that Openwave had streamlined its management team with the elimination of certain management positions, including Chief Operating Officer and Chief Administrative Officer.
Biographical and other information about our current Board of Directors and Executive Officer team is included in Part III Item 10, below.
Item 1A. Risk Factors.
You should carefully consider the following risks, as well as the other information contained in this annual report, before investing in our securities. If any of the following risks actually occurs, our business could be harmed. You should refer to the other information set forth or referred to in our annual report, including our consolidated financial statements and the related notes incorporated by reference herein.
We have a history of losses and we may not be able to achieve or maintain consistent profitability.
Our prospects must be considered in light of the risks, expenses, delays and difficulties frequently encountered by companies engaged in rapidly evolving technology markets like ours. Except for the fiscal year ended June 30, 2006, we incurred annual net losses on a GAAP basis since our inception. As of June 30, 2006, we had an accumulated deficit of approximately $2.8 billion, which includes approximately $2.0 billion of goodwill amortization and impairment. We expect to continue to spend significant amounts to develop, enhance or acquire products, services and technologies and to enhance sales and operational capabilities. We may not achieve or be able to maintain consistent profitability.
Our business faces a number of challenges including:
As a result of the foregoing risks and others, our business strategy may not be successful, and we may not adequately address these challenges to achieve or maintain consistent profitability.
Our 1996 Stock Option Plan expired in September 2006 and the failure to approve a new equity plan could adversely affect the recruitment and retention of key management and employees.
One of the key aspects of our employee retention and recruitment is equity award grants. Our 1996 Stock Option Plan which had a ten year term expired in September 2006. We plan to seek shareholder approval of a new equity incentive plan at our next annual shareholder meeting, but until we are able to obtain shareholder approval of the new plan we will not have a shareholder approved equity plan and we will be unable to issue incentive stock options. Our performance depends on attracting and retaining key management and other employees. In particular, our future
success depends in part on the continued services of many of our current employees including key executives and key engineers and other technical employees. Competition for qualified personnel in the telecommunications, Internet software and Internet messaging industries is significant. If we do not have an equity incentive plan, our recruitment and retention efforts may be materially adversely affected.
We are in a product transition phase and we may not be able to adequately develop or market products.
The market for our products and services is highly competitive, and the pace of technical innovation is high. We are currently in a product transition phase where we are developing our next generation products and other new products and features. There can be no assurance that we are able to develop, market, or sell our new products and features in a timely manner. Our new products or services may be delayed, and new products may not be accepted by the market, or may be accepted for a shorter period than anticipated. New product offerings may not properly integrate into existing platforms, and the failure of these offerings to be accepted by the market could have a material adverse effect on our business, operations, financial condition, or reputation. Our sales and operating results may be adversely affected if we are unable to bring new products to market, if customers delay purchases or if acceptance of the new products is slower than expected, if at all.
We rely upon a small number of customers for a significant portion of our revenues, and the failure to retain and expand our relationships with these customers could adversely affect our business.
Our customer base consists of a limited number of large communications service providers and mobile handset manufacturers, which makes us significantly dependent on their plans and the success of their products. Our success, in turn, depends in large part on our continued ability to introduce reliable and robust products that meet the demanding needs of these customers and their willingness to launch, maintain and market commercial services utilizing our products. Moreover, consolidation among these service providers further limits the existing and potential pool of customers for us. In this regard, revenue recognized from arrangements with Sprint-Nextel accounted for approximately 20% of our total revenues during the year ended June 30, 2006. By virtue of their size and the significant portion of our revenue that we derive from a select group of customers, these customers are able to exert significant influence in the negotiation of our commercial arrangements and the conduct of our business with them. If we are unable to retain and expand our business with key customers on favorable terms, our business and operating results will be adversely affected.
Our operating results are subject to significant fluctuations, and this may cause our stock price to decline in future periods.
Our operating results have fluctuated in the past and may do so in the future. Our revenue, particularly our licensing revenue, is difficult to forecast and is likely to fluctuate from quarter to quarter. Factors that may lead to significant fluctuation in our operating results include, but are not limited to:
In particular, our customers often defer execution of our agreements until the last week of the quarter if they elect to purchase our products. Approximately 30%-40% of our quarterly revenue typically occurs in the last month of a quarter and the pattern for revenue generation during that month is normally not linear. Accordingly, we may not recognize revenue as anticipated during a given quarter when customers defer orders or ultimately elect not to purchase our products. Therefore we could be in a position where we do not achieve our financial targets for a quarter and not determine this until very late in the quarter or after the quarter is over. As a result, our visibility into our revenue recognition for future periods is limited.
Our operating results could also be affected by general industry factors, including a slowdown in capital spending or growth in the telecommunications industry, either temporary or otherwise, disputes or litigation with other parties, and general political and economic factors, including an economic slowdown or recession, acts of terrorism or war, and health crises or disease outbreaks.
In addition, our operating results could be impacted by the amount and timing of operating costs and capital expenditures relating to our business and our ability to accurately estimate and control costs. Most of our expenses, such as compensation for current employees and lease payments for facilities and equipment, are largely fixed. In addition, our expense levels are based, in part, on our expectations regarding future revenues. As a result, any shortfall in revenues relative to our expectations could cause significant changes in our operating results from period to period. In this regard, our bookings may not be indicative of trends in our business generally or revenue that will be recognized in current or subsequent periods. Due to the foregoing factors, we believe period-to-period comparisons of our historical operating results may be of limited use. In any event, we may be unable to meet our internal projections or the projections of securities analysts and investors. If we are unable to do so, we expect that, as in the past, the trading price of our stock may fall dramatically.
Our market is highly competitive and our inability to compete successfully could adversely affect our operating results.
The market for our products and services is highly competitive. Many of our existing and potential competitors have substantially greater financial, technical, marketing and distribution resources than we have. Their resources have enabled them to aggressively price, finance and bundle their product offerings to attempt to gain market adoption or to increase market share. If our competitors offer deep discounts on certain products in an effort to gain market share or to sell other products or services, we may then need to lower prices of our products and services, change our pricing models, or offer other favorable terms in order to compete successfully, which would likely reduce our margins and adversely affect operating results.
We expect that we will continue to compete primarily on the basis of quality, breadth of product and service offerings, functionality, price, strength of customer relationships and time to market. Our current and potential competitors include the following:
Nokia also competes directly with us by offering WAP servers, client software and messaging (offering end-to-end solutions based on its proprietary smart messaging protocol and on MMS) to communication service providers. Nokia markets its WAP servers to corporate customers and content providers, which if successful, could undermine the need of communication service providers to maintain their own WAP gateways (since these WAP servers access applications and services directly rather than through WAP gateways).
Qualcomms end-to-end proprietary system called BREW does not use our technology and offers wireless handset manufacturers an alternative method for installing applications. Qualcomms strong market position in CDMA with its chipsets technology provides them with a position to build the BREW system with CDMA operators. If Qualcomms BREW system is widely adopted it could undermine the need for wireless device manufacturers to install our client software and reduce our ability to sell gateways and wireless applications to communications service providers.
Furthermore, the proliferation and evolution of operating system software in smart phones, a market segment backed by companies with resources greater than ours, such as Microsoft and Nokia, may threaten the market position of our client software offerings, as such software becomes more competitive in price.
In addition, Internet search and content providers, such as Google and Yahoo!, recently have launched data services offerings directed at wireless end users. These services may compete directly with services offered by our traditional customer base. As well, in the future Internet search and content providers could directly compete with us by launching wireless data services.
Our sales cycles are long, subjecting us to the loss or deferral of anticipated orders and related revenue.
Our sales cycle is long, often between six months and twelve months or longer, and unpredictable due to the lengthy evaluation and customer approval process for our products, including internal reviews and capital expenditure approvals. Moreover, the evolving nature of the market for data services via mobile phones may lead prospective customers to postpone their purchasing decisions pending resolution of standards or adoption of technology by others. Additionally, consolidation among our customer base has led to extended approval reviews and delayed decisions. Accordingly, we may not close sales as anticipated during a given quarter which may lead to a shortfall in revenue or bookings.
Because we depend substantially on international sales, any decrease in international sales would adversely affect our operating results.
International sales accounted for approximately 57% and 55% of our total revenues for the years ended June 30, 2006 and 2005. Risks inherent in conducting business internationally include:
While we attempt to hedge our currency risk, we may be unable to do so effectively. In addition, international sales could decline due to unexpected changes in regulatory requirements applicable to the Internet or our business, or differences in foreign laws and regulations, including foreign tax, intellectual property, labor and contract law. Any of these factors could harm our international operations and, consequently, our operating results.
We may be unable to integrate acquisitions of other businesses and technologies successfully or to achieve the expected benefits of such acquisitions.
We have acquired a number of businesses and technologies in the past and expect to continue to evaluate and consider potential strategic transactions, including acquisitions and dispositions of businesses, technologies, services, products and other assets. These transactions entail risks that may be material to our business and results of operations. For example, the limited historical revenue and operating history of Musiwave, which we acquired in January 2006, and Solomio, which we acquired in October 2006, subjects us to significant risk that we will be unable to integrate these businesses and to realize the anticipated benefits in a timely basis or at all.
In any event, the process of integrating any acquired business may create difficulties, including:
Foreign acquisitions involve special risks, including those related to integration of operations across different cultures, languages, and legal systems, currency risks, and the particular economic, political, and regulatory risks associated with specific countries. In addition, we may incur significant transaction fees and expenses, including expenses for transactions that may not be consummated. In any event, as a result of future acquisitions, we might need to issue additional equity securities, spend our cash, or incur debt or assume significant liabilities, any of which could adversely affect our business and results of operations.
Our customer contracts lack uniformity and often are particularly complex, which subjects us to business and other risks.
Our customers are typically large communications service providers or handset manufacturers. Their substantial purchasing power and negotiating leverage limits our ability to negotiate uniform business terms. As a result, we typically negotiate contracts on an individual customer-by-customer basis and are sometimes required to accept contract terms not favorable to us, including indemnity, refund, penalty or other terms that expose us to significant risk. In addition, we may be asked to accommodate requests that are beyond the express terms of our agreements in order to maintain our relationships with our customers. The lack of uniformity and the complexity of the terms of these contracts create difficulties with respect to ensuring timely and accurate accounting and billing under these contracts. Because of this complexity and the limitations of automated accounting software, our invoices often must be prepared manually, which sometimes leads to delays or errors that generally must be corrected before invoices can be paid by our customers and which can lead to delays in processing or collecting payments. Any delay in processing or collecting payments could adversely affect our business. Additionally, if we are unable to effectively negotiate, enforce and accurately or timely account and bill for contracts with our key customers, our business and operating results may be adversely affected.
We may not be successful in obtaining complete license usage reports from our customers on a timely basis, which could impact our reported results.
Although our customers are generally contractually obligated to provide license usage reports, at times we are unable to obtain such reports in a timely manner, if at all, or the results provided may not accurately reflect actual usage. If license usage reports are not received in a timely manner, we estimate the revenue based on historical reporting trends, if reasonably possible. Because estimates require judgments based upon late or incomplete, and therefore inherently imperfect, information, the timing or amount of revenue we recognize may vary significantly from actual or expected customer usage and could impact our reported results.
We rely on estimates to determine arrangement fee revenue recognition for a particular reporting period. If our estimates change, future expected revenues could adversely change.
We apply the percentage-of-completion method to recognize revenue for certain fixed fee solutions-based arrangements. Applying the percentage-of-completion method, we estimate progress on our professional service revenues for a particular period. If, in a particular period, our estimates to project completion change or we estimate project overruns, revenue recognition for such projects in the period may be less than expected or even negative, which could cause us to fail to realize anticipated operating results in a given period. Additionally, a portion of the payments under some of our professional services arrangements are based on customer acceptance of deliverables. If a customer fails to accept the applicable deliverable, we may not be able to recognize the related revenue or receive payment for work that we have already completed, which could adversely affect our business and operating results.
Our technology depends on the adoption of open standards, which makes us vulnerable to competition.
Our products are integrated with communication service providers systems and mobile phones through the use of open standards. If we are unable to continue to integrate our platform products with third-party technologies because they do not adopt open standards or otherwise, our business will suffer. In addition, large wireless operators sometimes create detailed service specifications and requirements, such as Vodafone Live or DoCoMo iMode, and such
operators are not required to share those specifications with us. Failure or delay in the creation of open, global specifications could have an adverse effect on the mobile data market in general and, consequently, our business and operating results. Conversely, the widespread adoption of open industry standards also may make it easier for new market entrants and existing competitors to introduce products that compete with our software products, which could adversely affect our business and operating results.
Our industry changes rapidly as a result of technological and product developments, which may quickly render our products and services less desirable or even obsolete. If we are unable or unsuccessful in supplementing our product offerings, our revenue and operating results may be materially adversely affected.
The industry in which we operate is subject to rapid technological change. The introduction of new technologies in the market, including the delay in the adoption of these technologies, as well as new alternatives for the delivery of products and services will continue to have a profound effect on competitive conditions in our market. We may not be able to develop and introduce new products, services and enhancements that respond to technological changes or evolving industry standards on a timely basis.
For example, our business depends upon the mass adoption of mobile phones for delivery of data services. Competing products, such as portable computers, PDAs, and smart phones, currently exist for mobile data delivery. If mobile phones are not widely adopted for delivery of data services or if end-users do not adopt mobile phones containing our browser or other client software, our customers may choose not to widely deploy, maintain or market offerings based on our products, which would adversely affect our business and operating results.
More generally, while in the past we have primarily provided specific component sales, in the future we intend to provide more integrated and comprehensive software solutions for our carrier customers. We also intend to develop and license new products and to enter into new product markets. We may be unable to develop and license new products in accordance with our expectations, or at all, our new products may not be adopted by the primary carriers, or we may be unable to succeed in new product markets which, in any case, would have a material adverse affect on our business and operating results.
Because of the rapid technological changes of our industry, our historic product, service, and enhancement offerings may have a shorter life than anticipated. Revenue from such products may decline faster than anticipated, and if our new products, services and enhancements are not accepted by our customers or the market as anticipated, if at all, our business and operating results may be materially and adversely affected.
Our communications service provider customers face implementation and support challenges in introducing Internet-based services, which may slow their rate of adoption or implementation of the services our products enable.
Historically, communications service providers have been relatively slow to implement new, complex services such as data services. In addition, communications service providers may encounter greater customer demands to support Internet-based services than they do for their traditional voice services. We have limited or no control over the pace at which communications service providers implement these new Internet-based services. The failure of communications service providers to introduce and support Internet-based services utilizing our products in a timely and effective manner could have a material adverse effect on our business and operating results.
Our business depends on continued investment and improvement in communication networks.
Many of our customers and other communication service providers continue to make major investments in next generation networks that are intended to support more complex applications and to provide end users with a more satisfying user experience. If communication service providers delay their deployment of networks or fail to roll such networks out successfully, there could be less demand for our products and services, which could adversely affect our business and operating results.
In addition, the communications industry has experienced significant fluctuations in capital expenditure. Although the capital spending environment may have improved recently, we have experienced significant revenue declines from historical peaks as a result of spending contraction in our industry. If capital spending and technology purchasing by communication service providers do not continue to improve or decline, our revenue would likely decline substantially.
We may not be successful in forming or maintaining strategic alliances with other companies, which could adversely affect our product offerings and sales.
Our business depends in part on forming or maintaining strategic alliances with other companies. We may not be able to form the alliances that are necessary to ensure that our products are compatible with third-party products, to enable us to license our software into potential new customers and into potential new markets, and to enable us to continue to enter into new license agreements with our existing customers. We may be unable to maintain existing relationships with other companies, to identify the best alliances for our business or enter into new alliances with other companies on acceptable terms or at all. If we cannot form and maintain significant strategic alliances with other companies as our target markets and technology evolves, our sales opportunities could deteriorate, which could have a material adverse effect on our business and operating results.
Our restructuring of operations may not achieve the results we expect and may adversely affect our business.
In October 2001, September 2002, June 2003, June 2005, August 2005, and August 2006, we initiated plans to streamline operations and reduce expenses, which included cuts in discretionary spending, reductions in capital expenditures, reductions in the work force and consolidation of certain office locations, as well as other steps to reduce expenses. In connection with the restructurings, we were required to make certain product and product development tradeoffs with limited information regarding the future demand for our various products. Following these restructurings, we may not have elected to pursue the correct product offerings to take advantage of future market opportunities. Furthermore, the implementation of our restructuring plans has placed, and may continue to place, a significant strain on our managerial, operational, financial, employee and other resources. Additionally, the restructurings may negatively affect our employee turnover as well as recruitment and retention of key employees. These employee reductions could impair our marketing, sales and customer support efforts or alter our product development plans. If we experience difficulties in carrying out the restructuring plans, our expenses could increase more quickly than expected. There can be no assurance that our restructurings will achieve the anticipated results. If we find that our planned restructurings do not achieve our objectives, it may be necessary to implement further reduction of our expenses, to perform additional reductions in our headcount, or to undertake additional restructurings of our business. In addition, our restructuring may not result in anticipated cost-savings, which could harm our business and operating results.
Our software products may contain defects or errors, which could result in rejection of our products, delays in shipment of our products, damage to our reputation, product liability and lost revenues.
The software we develop and the associated professional services we offer are complex and must meet stringent technical requirements of our customers. We must develop our products quickly to keep pace with the rapidly changing Internet software and telecommunications markets. Our software products and services may contain undetected errors or defects, especially when first introduced or when new versions are released. We have, in the past, experienced delays in releasing some versions of our products until software problems were corrected. In addition, some of our customer contracts provide for a period during which our products and services are subject to acceptance testing. Failure to achieve acceptance could result in a delay in, or inability to, receive payment. Our products may not be free from errors or defects after commercial shipments have begun, which could result in the rejection of our products and damage to our reputation, as well as lost revenues, diverted development resources and increased service and warranty costs, any of which could harm our business.
We depend on recruiting and retaining key management and technical personnel with telecommunications and Internet software experience who are integral in developing, marketing and selling our products.
Because of the technical nature of our products and the dynamic market in which we compete, our performance depends on attracting and retaining key management and other employees. In particular, our future success depends in part on the continued service of many of our current employees, including key executives and key engineers and other technical employees. Competition for qualified personnel in the telecommunications, Internet software and Internet messaging industries is significant. We believe that there are only a limited number of persons with the requisite skills to serve in many of our key positions, and it is difficult to hire and retain these persons. Furthermore, it may become more difficult to hire and retain key persons as a result of our past restructurings, any future restructurings, and our past stock performance. Competitors and others have in the past, and may in the future, attempt to recruit our employees. If we are unable to attract or retain qualified personnel, our business could be adversely affected.
Our intellectual property could be misappropriated, which could force us to become involved in expensive and time-consuming litigation.
Our ability to compete and continue to provide technological innovation is substantially dependent upon internally-developed technology. We rely on a combination of patent, copyright, and trade secret laws to protect our intellectual property or proprietary rights in such technology, although we believe that other factors such as the technological and creative skills of our personnel, new product developments, frequent product and feature enhancements and reliable product support and maintenance are more essential to maintaining a technology leadership position. We also rely on trademark law to protect the value of our corporate brand and reputation.
Despite our efforts to protect our intellectual property and proprietary rights, unauthorized parties may copy or otherwise obtain and use our products, technology or trademarks. Effectively policing our intellectual property is time consuming and costly, and the steps taken by us may not prevent infringement of our intellectual property or proprietary rights in our products, technology and trademarks, particularly in foreign countries where in many instances the local laws or legal systems do not offer the same level of protection as in the United States.
Our products may infringe the intellectual property rights of others, subjecting us to claims for infringement, payment of license royalties, or other damages.
Our products may be alleged to infringe the intellectual property rights of others, subjecting us to claims for infringement, payment of license royalties, or other remedies. As the number of our products and services increases and their features and content continue to expand, we may increasingly become subject to infringement and other intellectual property claims by third parties. From time to time, we and our customers have received and may receive in the future, offers to license or claims alleging infringement of intellectual property rights, or may become aware of certain third party patents that may relate to our products. For example, a number of parties have asserted to standards bodies such as OMA that they own intellectual property rights which may be essential for the implementation of specifications developed by those standard bodies. A number of our products are designed to conform to OMA specifications or those of other standards bodies, and have been, and may in the future be, subject to offers to license or claims of infringement on that basis by individuals, intellectual property licensing entities and other companies, including companies in the telecommunications field with greater financial resources and larger intellectual property portfolios than our own.
Additionally, our customer agreements require that we indemnify our customers for infringement of our intellectual property embedded in their products. In the past we have elected and in the future we may elect to take a license or otherwise settle claims of infringement at the request of our customers or otherwise. Any litigation regarding patents or other intellectual property could be costly and time consuming and could divert our management and key personnel from our business operations. The complexity of the technology involved, and the number of parties holding intellectual property within the wireless industry, increase the risks associated with intellectual property litigation. Moreover, patent litigation has increased due to the increased number of cases asserted by intellectual property licensing entities as well as increasing competition and overlap of product functionality in our markets. Royalty or licensing arrangements, if required, may not be available on terms acceptable to us, if at all. Any infringement claim successfully asserted against us or against a customer for which we have an obligation to defend could result in costly litigation as well as the payment of substantial damages or an injunction.
We may be unable to effectively manage future growth, if any, that we may achieve.
As a result of our efforts to control costs through restructurings and otherwise, our ability to effectively manage and control any future growth may be limited. To manage any growth, our management must continue to improve our operational, information and financial systems, procedures and controls and expand, train, retain and manage our employees. If our systems, procedures and controls are inadequate to support our operations, any expansion could decrease or stop, and investors may lose confidence in our operations or financial results. If we are unable to manage growth effectively, our business and operating results could be adversely affected, and any failure to develop and maintain adequate internal controls could cause the trading price of our shares to decline substantially.
The security provided by our products could be breached, in which case our reputation, business, financial condition and operating results could suffer.
A fundamental requirement for online communications is the secure transmission of confidential information over the Internet. Third-parties may attempt to breach the security provided by our products, or the security of our customers internal systems. If they are successful, they could obtain confidential information about our customers end users, including their passwords, financial account information, credit card numbers or other personal information. Our customers or their end users may file suits against us for any breach in security, which could result in costly litigation
or harm our reputation. The perception of security risks, whether or not valid, could inhibit market acceptance of our products. Despite our implementation of security measures, our software is vulnerable to computer viruses, electronic break-ins, intentional overloading of servers and other sabotage, and similar disruptions, which could lead to interruptions, delays, or loss of data. The occurrence or perception of security breaches could harm our business, financial condition and operating results.
Provisions of our corporate documents and Delaware law may discourage an acquisition of our business, which could affect our stock price.
Our charter and bylaws may inhibit changes of control that are not approved by our Board of Directors. In particular, our certificate of incorporation includes provisions for a classified Board of Directors, authorizes the Board of Directors to issue preferred stock without stockholder approval, prohibit cumulative voting in director elections and prohibit stockholders from taking action by written consent. Further, our bylaws include provisions that prohibit stockholders from calling special meetings and require advance notice for stockholder proposals or nomination of directors. In addition, we have adopted a stockholder rights plan such that, if a person or group acquires beneficial ownership of 15 percent or more of our common stock or commences a tender offer or exchange offer upon consummation of which such person or group would beneficially own 15 percent or more of the companys common stock, our stockholder rights plan provides for rights to be distributed as a dividend to certain of our stockholders of record. We are also subject to Section 203 of the Delaware General Corporation Law, which generally prevents a person who becomes the owner of 15% or more of the corporations outstanding voting stock from engaging in specified business combinations for three years unless specified conditions are satisfied. These provisions could have the effect of delaying or preventing changes in control or management.
Risk Related to the Restatement of Our Prior Financial Results.
The Special Committee review, the restatement of our consolidated financial statements, the SEC inquiry and related events could have a material adverse effect on us. In May 2006, we received a letter of informal inquiry from the SEC requesting documents related to our stock option grants and stock option practices. In June 2006, our Board of Directors appointed a Special Committee of three independent directors to conduct a review into past stock option grants and practices. In October 2006, the Special Committee concluded that the measurement dates for financial accounting purposes for a number of stock option grants differed from the recorded grant dates for such awards. Because the prices at the originally stated grant dates were lower than the prices on the actual measurement dates, we recognized material amounts of stock-based compensation expense which were not accounted for in our previously issued financial statements. Accordingly, management concluded that our previously issued financial statements should no longer be relied upon.
As a result of the Special Committees review, as well as managements review of our historical financial statements, we have restated our financial results for fiscal years ended June 30, 1999 through 2005, including each of the quarters in fiscal year 2005.
As a result of the events described above, we have become subject to the following significant risks, each of which could have a material adverse effect on our business, financial condition and results of operations.
We face risks related to the SEC and US Attorney inquiries regarding our historic and current stock option grants and practices, which have required significant management time and attention, caused us to incur significant accounting and legal expense and could require us to pay fines or other penalties.
On May 19, 2006, we received a notice of informal inquiry from the Securities and Exchange Commission regarding our historic and current stock option grants and stock option practices. While we are fully cooperating with the SEC and intend to continue to do so, we are unable to predict what consequences, if any, the SEC inquiry may have on us. Nevertheless, response to the inquiry could result in substantial legal and accounting expenses, divert managements attention from other business concerns and harm our business. If the SEC were to commence legal action, we could be required to pay significant penalties and/or fines and could become subject to administrative orders. The resolution of the SEC inquiry could require the filing of additional restatements of our prior financial statements or require that we take other actions.
On July 5, 2006, we announced that we had received subpoenas from the United States Attorney for the Eastern District of New York and the Northern District of California, each requesting documents relating to stock option grants. Responsibility for this inquiry between the districts was subsequently assigned to the Northern District of California. The inquiry remains ongoing and we are fully cooperating with the US Attorney. We cannot predict when this inquiry will conclude or its eventual outcome and there is no assurance that other regulatory inquiries will not be commenced against us. The adverse resolution of any inquiry into our stock option practices could have a material adverse effect on our business, financial condition and reputation.
We have also incurred expenses relating to legal, accounting, tax and other professional services in connection with these matters and expect to continue to incur significant expenses in the future, which may adversely affect our results of operations and cash flows.
Our senior management team and our Board of Directors have devoted a significant amount of time on matters relating to the continuing SEC inquiry, the restatement, our outstanding periodic reports, remedial efforts and related litigation. If our senior management is unable to devote a significant amount of time in the future developing and attaining our strategic business initiatives and running ongoing business operations, there may be a material adverse effect on our business, financial condition and results of operations.
We face litigation risks relating to our past practices with respect to equity incentives that could have a material adverse effect on the Company.
Several shareholder derivative lawsuits have been filed against our directors, officers, certain former directors and officers, and us as a nominal defendant relating to our past stock option grants and practices. See Part I, Item 3, and Legal Proceedings for a more detailed description of these proceedings. Additionally, in the future, we may be the subject of additional private or government actions. Litigation may be time-consuming, expensive and disruptive to normal business operations, and the outcome of litigation is difficult to predict. The defense of these lawsuits will result in significant expense and the continued diversion of managements time and attention from the operation of our business, which could impede our ability to achieve our business objectives. These lawsuits are in the preliminary stages, and an unfavorable outcome could have a material adverse effect on our business, financial condition and results of operations. Additionally, any amount that we may be required to pay to satisfy a judgment or settlement of these lawsuits may not be covered by insurance. Under our charter and the indemnification agreements that we have entered into with our officers and directors, we are required to indemnify, and advance expenses to them in connection with
their participation in proceedings arising out of their service to us. There can be no assurance that any of these payments will not be material.
If we fail to deliver periodic reports to the trustee under the indenture governing our 2 3/4% convertible subordinated notes due September 2008, we could be deemed to be in default, which could result in acceleration of the notes.
On September 23, 2003, we issued $150 million of 2 3/4% convertible subordinated notes due September 2008. On November 20, 2006, we received a notice of default related to the failure to timely provide the trustee with a copy of the Form 10-Q for the period ended September 30, 2006. The notice states that failure to correct within sixty (60) days from the receipt of the notice will result in an event of default. If we are unable to file with the trustee our Form 10-Q within the cure period, the trustee or holders of at least 25% in aggregate principal amount of the outstanding notes could elect to accelerate our obligations under the notes and declare the entire principal amount and all accrued and unpaid interest thereon to be immediately due and payable. There can be no assurance that we will file the Form 10-Q with the trustee within the requisite cure period, that a challenge by the Company to acceleration would prevail or that we would not incur substantial costs in pursuing such a challenge.
The acceleration of our debt obligations, along with any fines or payments in connection with the SEC investigation, the pending stockholder litigation and the costs of becoming current with our periodic reports could adversely affect our cash and cash flow from operations. If these expenses are of such significance that we are unable to meet our cash requirement, there can be no assurance that we will be able to obtain alternative funding on commercially reasonable terms, or at all. In the absence of such financing, our ability to respond to changing business and economic conditions, to make future acquisitions, to absorb adverse results of operations or to fund capital expenditures or increased working capital requirements would be significantly reduced.
As well, the notes are convertible into shares of our common stock at the option of the holder at any time on or prior to the business day prior to maturity. The notes are currently convertible at a conversion price of $18.396 per share and each holder may require us to purchase all or a portion of such holders notes upon the occurrence of specified change in control events. We may not have enough cash or cash resources to repay the notes in cash on a change in control or at maturity. In any event, the repurchase of our notes with shares of our common stock or the conversion of the notes into shares of our common stock may result in dilution of our earnings per share.
Because of the delayed filing of our periodic reports, we face delisting from NASDAQ which would adversely affect the trading price of our common stock.
As a result of the restatement and the delayed filing of our periodic reports with the SEC, on November 17 2006, we received a NASDAQ staff determination letter indicating that we had failed to comply with the filing requirement for continued listing set forth in NASDAQ Marketplace Rule 4310(c)(14) due to our failure to timely file our Form 10-Q for the period ended September 30, 2006, and that our securities are, therefore, subject to delisting from the NASDAQ Global Select Market. We previously received and announced a Nasdaq staff determination letter with respect to our failure to timely file this Form 10-K for the fiscal year ended June 30, 2006. We requested and subsequently attended a hearing before the NASDAQ Listing Qualifications Panel on November 16, 2006 to appeal the staff determination and presented a plan to cure both filing deficiencies and regain compliance. The filing of this Annual Report on Form 10-K is part of that plan of compliance. Both Nasdaq delisting actions have been automatically stayed pending the Nasdaq Panels decision, and the Companys stock will continue to be listed on the Nasdaq Global Select Market until the Panel issues its decision and during any extension that is allowed by the Panel.
If the Nasdaq Panel does not grant our request for an extension and continued listing, the extension is not for the duration we requested, or we are unable to fulfill the plan to regain compliance or otherwise meet or maintain compliance with all of the NASDAQ listing requirements, our securities will be delisted from the NASDAQ Global Select Market. If we are delisted, we may apply for listing on another exchange, however, there is no assurance that we will meet the requirements for initial listing or maintain compliance with the continued listing requirements of such an exchange. Delisting from the NASDAQ Global Select Market would adversely affect the trading price of our common stock, significantly limit the liquidity of our common stock and impair our ability to raise additional funds.
Item 2. Properties.
Our principal office is located in Redwood City, California, where we lease approximately 192,000 square feet in adjacent buildings under sublease agreements that terminate on June 29, 2013, with a one time option to terminate one or both of the agreements on July 30, 2009. We also have other facility leases in other locations in the United States and throughout the world, including our former headquarters which comprises approximately 283,000 square feet and which is currently vacant until January 2007, under a sublease that expires in April 2013. The future lease payments, net of sublease income, for our former headquarters is included in accrued restructuring costs on our consolidated balance sheet.
Item 3. Legal Proceedings.
Shareholder derivative lawsuits.
On May 16, 2006, a report published by the Center for Financial Research and Analysis (CFRA) identified Openwave as a company at risk for having engaged in backdating of stock options granted to our officers and directors. On May 22, 2006, we announced that we had received a letter of informal inquiry from the Securities Exchange Commission requesting documents related to our stock option grants and options granting practices. Following that announcement, seven substantially similar shareholder derivative actions were filed in California state and federal court, purportedly on behalf of the Company, against various of the Companys current and former directors and officers. The plaintiffs allege that the individual defendants mismanaged corporate assets and breached their fiduciary duties between 1999 and 2005 by authorizing or failing to halt the back-dating of certain stock options. The plaintiffs also allege that certain defendants were unjustly enriched by the receipt and retention of backdated stock options and that certain of the defendants sold Openwave stock for a profit while in possession of material, non-public information. Certain of the plaintiffs also allege that the Company issued false and misleading financial disclosures and proxy statements from 1999 through 2005 and that the individual defendants engaged in a fraudulent scheme to divert money to themselves via improper option grants.
The state court actions, which are pending in the Superior Court for the County of San Mateo are captioned:
Hertz v. Black et al., Case No. CIV 455265
Smith v. Black et al., Case No. 455266
Busse v. Puckett et al., Case No. CIV 456226
On September 5, 2006, the state court consolidated the three actions pending before it and appointed a lead plaintiff and lead counsel. On August 21, 2006, the defendants filed a motion to stay the state court actions pending resolution of the
federal actions. That motion is scheduled for December 4, 2006. On September 29, 2006, the lead plaintiff filed a consolidated amended shareholder derivative complaint. The consolidated state court action is in its very early stages.
The federal court actions, which are pending in the United States District Court for the Northern District of California, are captioned:
Hacker v. Peterschmidt et al., Civ. No. 3:06-cv-03468-SI;
Bowie v. Black et al., Civ. No. 3:2006-cv-04479-WHA;
Sherupski v. Puckett et al., Civ. No. 3:06-cv-04524-WHA;
Koning v. Puckett et al., Civ. No. 3:06-cv-04509-MJJ.
On October 11, 2006, the district court entered an order consolidating the four actions pending before it and appointed lead plaintiffs and lead counsel. The consolidated federal court action is in its very early stages.
IPO securities class action.
On November 5, 2001, a purported securities fraud class action complaint was filed in the United States District Court for the Southern District of New York. In re Openwave Systems Inc. Initial Public Offering Securities Litigation, Civ. No. 01-9744 (SAS) (S.D.N.Y.), related to In re Initial Public Offering Securities Litigation, 21 MC 92 (SAS) (S.D.N.Y.). It is brought purportedly on behalf of all persons who purchased the Companys common stock from June 11, 1999 through December 6, 2000. The defendants are the Company and five of its present or former officers (the Openwave Defendants), and several investment banking firms that served as underwriters of the Companys initial public offering and secondary public offering. Three of the individual defendants were dismissed without prejudice, subject to a tolling of the statute of limitations. The complaint alleges liability under Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, on the grounds that the registration statements for the offerings did not disclose that: (1) the underwriters had agreed to allow certain customers to purchase shares in the offerings in exchange for excess commissions paid to the underwriters; and (2) the underwriters had arranged for certain customers to purchase additional shares in the aftermarket at predetermined prices. The amended complaint also alleges that false analyst reports were issued. No specific damages are claimed. Similar allegations were made in over 300 other lawsuits challenging public offerings conducted in 1999 and 2000, and the cases were consolidated for pretrial purposes.
The Company has accepted a settlement proposal presented to all issuer defendants. Plaintiffs will dismiss and release all claims against the Openwave Defendants, in exchange for a contingent payment by the insurance companies responsible for insuring the issuers, and for the assignment or surrender of control of certain claims the Company may have against the underwriters. The Openwave Defendants will not be required to make any cash payment in the settlement, unless the pro rata amount paid by the insurers in the settlement exceeds the amount of insurance coverage, a circumstance which the Company does not believe will occur. The settlement requires approval of the Court, which cannot be assured, after class members are given the opportunity to object to or opt out of the settlement. The Court held a hearing on April 24, 2006 to consider whether final approval should be granted and the Company is awaiting a ruling. We believe a loss is not probable or estimable. Therefore no amount has been accrued as of June 30, 2006.
Item 4. Submission of Matters to a Vote of Security Holders.
During the fourth quarter of the fiscal year covered by this report, no matter was submitted to a vote of security holders through the solicitation of proxies or otherwise.
Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Price Range of Common Stock
Our common stock is listed for quotation on the Nasdaq Global Select Market under the symbol OPWV. Prior to July 1, 2006, this market was called the Nasdaq National Market. As a result of the delayed filing of our periodic reports with the SEC, on November 17 2006, we received a NASDAQ staff determination letter indicating that we had failed to comply with the filing requirement for continued listing set forth in NASDAQ Marketplace Rule 4310(c)(14) due to our failure to timely file our Form 10-Q for the period ended September 30, 2006, and that our securities are, therefore, subject to delisting from the NASDAQ Global Select Market. We previously received a NASDAQ staff determination letter with respect to our failure to timely file our Form 10-K for the fiscal year ended June 30, 2006. On November 16, 2006, we appeared at a hearing before the NASDAQ Listing Qualifications Panel to appeal the staff determination and presented a plan to cure both filing deficiencies and regain compliance. Both Nasdaq delisting actions have been automatically stayed pending the Nasdaq Panels decision, and the Companys stock will continue to be listed on the Nasdaq Global Select Market until the Panel issues its decision and during any extension that is allowed by the Panel.
The following table sets forth the high and low closing sales prices for our common stock as reported for each period indicated:
As of November 7, 2006 there were 599 holders of record of our common stock. We have not paid any dividends and currently intend to retain future earnings for reinvestment in our business or the repurchase of outstanding shares of our common stock. Therefore, we do not anticipate paying cash dividends in the foreseeable future.
Item 6. Selected Financial Data.
The following selected financial data should be read in conjunction with our consolidated financial statements and related notes thereto and with Managements Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this Form 10-K/A. The information presented in the following tables has been adjusted to reflect the restatement of our financial results which is more fully described in the Explanatory Note immediately preceding Part I of this Form 10-K/A and in Note 3 Restatement and Reclassification of Consolidated Financial Statements in the Notes to the Consolidated Financial Statements.
We have not amended our previously-filed Annual Reports on Form 10-K or Quarterly Reports on Form 10-Q for the periods affected by this restatement. The financial information that has been previously filed or otherwise reported for these periods is superseded by the information in this Annual Report on Form 10-K/A, and the financial statements and related financial information contained in such previously-filed reports should no longer be relied upon.
The following table sets forth selected Consolidated Statements of Operations and Consolidated Balance Sheet data for fiscal years ended June 30, 2006, 2005, 2004, 2003 and 2002 (in thousands, except per share data):
The following table sets forth pro forma expense under the disclosure requirements of FASBs Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation for fiscal years ended June 30, 2005, 2004, 2003, 2002, 2001 and 2000 (in thousands, except per share data):
Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion should be read in conjunction with the consolidated financial statements and notes included elsewhere in this report. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those discussed below and those listed in the Risk Factor section contained above in Item 1A. The information below has been adjusted to reflect the restatement of the Companys financial results which is more fully described in the Explanatory Notes immediately preceding Part I of this Form 10-K/A and Note 3 in the Notes to the Consolidated Financial Statements.
Our total revenues increased by $28.4 million, or 7%, from $383.6 million for the fiscal year ended June 30, 2005, to $412.0 million for the fiscal year ended June 30, 2006. The increase in revenues primarily relates to an increase in content product group revenues of $15.8 million upon our acquisition of Musiwave in January 2006, as well as an increase in our client product group revenues of $10.8 million in fiscal 2006 from fiscal 2005.
Our total operating expenses decreased by $36.4 million, or 11%, from $318.2 million for the fiscal year ended June 30, 2005, to $281.7 million for the fiscal year ended June 30, 2006. The decrease in our operating expenses was primarily due to a decrease of $65.9 million in restructuring and related costs associated primarily with the relocation of our headquarters during fiscal 2005, as well as sales of technology and other assets which resulted in a gain of $11.3 million during fiscal year 2006. Partially offsetting this reduction was a $32.3 million increase in stock-based compensation recorded in operating expenses, which was impacted by the adoption of Financial Accounting Standards Boards (FASB) Statement of Financial Accounting Standards (FAS) No. 123R. Share-Based Payment (FAS 123R) as of fiscal year 2006.
Critical Accounting Policies and Judgments
We believe that there are several accounting policies that are critical to understanding our business and prospects for our future performance, as these policies affect the reported amounts of revenue and other significant areas that involve Managements judgment and estimates. These significant accounting policies are:
These policies, and our procedures related to these policies, are described in detail below. In addition, please refer to the Notes to Consolidated Financial Statements for further discussion of our accounting policies.
We recognize revenue in accordance with Statement of Position (SOP) No. 97-2, Software Revenue Recognition, as amended by SOP No. 98-9, Modification of 97-2 Software Revenue Recognition, With Respect to Certain Transactions, and generally recognize revenue when all of the following criteria are met as set forth in paragraph 8 of SOP No. 97-2:
(1) persuasive evidence of an arrangement exists, (2) delivery has occurred, (3) the fee is fixed or determinable and (4) collectibility is probable.
One of the critical judgments that we make is the assessment that collectibility is probable. Our recognition of revenue is based on our assessment of the probability of collecting the related accounts receivable balance on a customer-by-customer basis. As a result, the timing or amount of revenue recognition may have been different if different assessments of the probability of collection had been made at the time the transactions were recorded in revenue. As of the quarter ended December 31, 2005, we revised our policy regarding the determination factor for recognition of previously deferred revenue for arrangements initially deemed not probable for collection. Prior to the quarter ended December 31, 2005, we continued to defer revenue recognition on arrangements originally deemed not probable for collection until the receipt of cash from that arrangement. As of the quarter ended December 31, 2005, we revised our policy such that revenue on arrangements previously deemed not probable for collection which are subsequently deemed probable for collection is recognized in the period of the change in the assessment of collectibility, rather than upon receipt of cash, provided all other revenue recognition criteria have been satisfied. This change in policy did not have a material impact for the fiscal year ended June 30, 2006.
Another critical judgment that we make involves the fixed or determinable criterion. We consider payment terms where arrangement fees are due within 12 months from delivery to be normal contractual terms. Payment terms beyond 12 months from delivery are considered extended and not fixed or determinable. For arrangements with extended payment terms, arrangement fee revenues are recognized when fees become due, assuming all other revenue recognition criteria have been met. In arrangements where fees are due within one year or less from delivery, we consider the entire arrangement fee as fixed or determinable.
For contracts accounted for under SOP No. 81-1, we believe we are able to reasonably estimate, track, and project the status of completion of a project, and therefore use the percentage of completion method as our primary method for recognizing revenue. We also consider customer acceptance our criteria for substantial completion. Use of estimates requires management to make judgments to estimate the progress to completion (see Risk Factors). Certain contracts contain refundability and penalty provisions. In assessing the amount or likelihood of these provisions being triggered, management makes judgments about the status of the related project and considers the customers assessment, if communicated.
In certain arrangements that require SOP 81-1 contract accounting, we sell maintenance and support for which there is no Vendor Specific Objective Evidence (VSOE) of fair value. In such arrangements, we apply the completed contract method, recognizing all arrangement fee revenue ratably over the maintenance and support period commencing when maintenance and support is the only remaining undelivered revenue element.
Certain arrangements permit the customer to pay us maintenance and support fees based only on the number of active subscribers using our software product, rather than the total number of subscribers committed to by the customer under the license agreement. Such arrangements cause an implied maintenance and support obligation for us relating to unactivated subscribers. In these cases, we defer revenue equal to the VSOE of fair value of maintenance and support of the total commitment for the estimated life of the software. This additional deferral of maintenance and support revenue results in a smaller amount of residual license revenues to be recognized upon delivery.
In multiple element arrangements where we do not have VSOE of fair value for either professional services or maintenance and support, or both, we classify revenue in our consolidated statement of operations based on derived fair value. This classification methodology does not affect the timing of revenue recognition on an aggregated
arrangement fee basis and revenue derived is recognized ratably in the respective revenue classifications. Specifically, we classify revenue first to either professional services or maintenance and support based on these respective elements derived fair value and then the residual arrangement fee is classified as license revenue. Derived fair value for professional services or maintenance and support is considered to be the respective median rate determined in our analysis of separately sold professional services and maintenance and support in the applicable geographical region. This derived fair value for professional services or maintenance and support is then multiplied by the unit measure in the arrangement and the revenue is classified accordingly. The derived professional services revenue and maintenance and support revenue and any residual license revenue is recognized ratably over the longer of the maintenance and support period or professional support delivery period commencing when there is only one remaining undelivered element without VSOE of fair value.
In certain arrangements we recognize revenue based on information contained in license usage reports provided by our customers. If such reports are not received in a timely manner, we estimate the revenue based on historical reporting trends, if reasonably possible. For all other arrangements that are not estimable, we recognize revenue related to usage fees on a consistent quarterly lag basis.
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts for estimated losses resulting from the anticipated non-payment of contractual obligations to us.
The total allowance for doubtful accounts is comprised of a specific reserve and a general reserve. We regularly review the adequacy of our allowance for doubtful accounts after considering the size and aging of the accounts receivable portfolio, the age of each invoice, each customers expected ability to pay and our collection history with each customer. We review all customer receivables to determine if a specific reserve is needed, based on our knowledge of the customers ability to pay. If the financial condition of a customer were to deteriorate, resulting in an impairment of their ability to make payments, a specific allowance would be made. When a customer is specifically identified as uncollectible, the customer receivable is reduced by the customers deferred revenue balance resulting in the net specific reserve, and we discontinue recognition of revenue from that customer until and to the extent cash is received from the customer. In addition, we maintain a general reserve for all other receivables not included in the specific reserve by applying specific percentages of projected uncollectible receivables to the various aging categories. In determining these percentages, we analyze our historical collection experience and current economic trends.
If the historical data we use to calculate the allowance provided for doubtful accounts does not reflect our ability to collect outstanding receivables, additional provisions for doubtful accounts may be needed and the future results of operations could be materially affected. As of June 30, 2006, the accounts receivable balance was $152.5 million, net of the allowance for doubtful accounts of $6.4 million. Our allowance for doubtful accounts as a percentage of gross accounts receivable was 4%, 5% and 7% in fiscal years 2006, 2005 and 2004, respectively. Based on our results for fiscal year 2006, a one-percentage point deviation in our allowance for doubtful accounts as a percentage of total gross accounts receivable would have resulted in an increase or decrease in expense of $1.6 million.
(a) Goodwill and intangible assets
In accordance with Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets (FAS 142), we review the carrying amount of goodwill for impairment on an annual basis. Additionally, we
perform an impairment assessment of goodwill and other intangible assets whenever events or changes in circumstances indicate that the carrying value of goodwill and other intangible assets may not be recoverable. Significant changes in circumstances can be both internal to our strategic and financial direction, as well as changes to the competitive and economic landscape. Past changes in circumstances that were considered important for asset impairment include, but are not limited to, a decrease in our market capitalization, contraction of the telecommunications industry, reduction or elimination of geographic economic growth, reductions in our forecasted growth and significant changes to operating costs.
We record goodwill when consideration paid in a purchase acquisition exceeds the fair value of the net tangible assets and the identified intangible assets acquired. On July 1, 2002, the Company adopted FAS 142. Prior to the adoption of FAS 142, goodwill and the identified intangible assets were amortized on a straight-line basis over three to five years. FAS 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually. We have no intangible assets with indefinite useful lives. Goodwill is tested for impairment in the Companys fiscal third quarter. FAS 142 also requires that we amortize other intangible assets over their respective finite lives up to their estimated residual values.
With the adoption of FAS 142, we determined that there was a single reporting unit for the purpose of goodwill impairment tests under FAS 142. While goodwill is tested for impairment in our fiscal third quarter, interim impairment tests may be necessary if indicators suggest the carrying value of the goodwill may not be recoverable. For purposes of assessing the impairment of our goodwill, we estimate the value of the reporting unit using our market capitalization as the best evidence of fair value. This fair value is then compared to the carrying value of the reporting unit. During the fiscal years ended June 30, 2006, 2005 and 2004 there were no impairments to goodwill.
(b) Strategic investments
We perform an impairment assessment of our strategic equity investments on a quarterly basis. In performing the impairment assessment, we consider the following factors, among others, in connection with the businesses in which investments have been made: the implicit valuation of the business indicated by recently completed financing or similar transactions, the business current solvency, and its access to future capital. In the fiscal year ended June 30, 2006, we recorded an impairment charge when a privately held company in which we have a minority interest, entered into a definitive agreement for sale in November 2006. This impairment charge is recorded within impairment of non-marketable equity securities in our consolidated statements of operations. During the fiscal years ended June 30, 2005 and 2004 there were no impairments to our strategic investments. As of June 30, 2006, the remaining book value of our investments in non-marketable equity securities was approximately $1.4 million and was recorded within deposits and other assets in our consolidated balance sheets.
Effective July 1, 2005, we adopted FAS 123R using the modified prospective method, in which compensation cost was recognized based on the requirements of FAS 123R for (a) all share-based payments granted or modified after the effective date and (b) for all awards granted to employees prior to the effective date of FAS 123R that remain unvested on the effective date. FAS 123R requires the use of judgment and estimates in performing multiple calculations. We have estimated the expected volatility as an input into the Black-Scholes-Merton valuation formula when assessing the fair value of options granted. Our estimate of volatility was based upon the historical volatility experienced in our stock price. To the extent volatility of our stock price increases in the future, our estimates of the fair value of options granted in the future could increase, thereby increasing stock-based compensation expense in future periods. For
instance, an estimate of volatility ten percentage points higher would have resulted in a $3.3 million increase in the fair value of options granted during the fiscal year ended June 30, 2006. In addition, we apply an expected forfeiture rate when amortizing stock-based compensation expense. Our estimate of the forfeiture rate was based primarily upon historical experience of employee turnover. To the extent we revise this estimate in the future, our stock-based compensation expense could be materially impacted in the quarter of revision, as well as in following quarters. An estimated forfeiture rate of one percentage point lower since adoption of FAS 123R would have resulted in a change of $0.3 million in stock-based compensation expense for the fiscal year ended June 30, 2006. Our estimate of expected term of options granted was derived from the average midpoint between vesting and the contractual term, as described in the SEC Staff Accounting Bulletin No. 107, Share-Based Payment. In the future, as information regarding post vesting termination becomes more accessible, we may change our method of deriving the expected term. This change could impact the fair value of our options granted in the future.
In connection with our restatement of stock-based compensation for periods prior to fiscal 2006, we applied significant judgment in choosing whether to revise measurement dates for prior option grants, and in choosing the methodology for applying these revised measurement dates. See the Explanatory Note to originally filed Form 10-K immediately preceding Item 1 of this Form 10-K/A for further information.
Our critical accounting policy and judgment as it relates to restructuring-related assessments includes our estimate of facility costs and severance-related costs. To determine the facility costs, which consist of the loss after our cost recovery efforts from subleasing a building, certain estimates were made related to: (1) the time period over which the relevant building would remain vacant, (2) sublease terms and (3) sublease rates, including common area charges. The facility cost is an estimate that may be adjusted in the future upon triggering events (such as changes in estimates of time and rates to sublease, based upon current market conditions, or changes in actual sublease rates). Upon the actual execution of a sublease associated with a building in our fiscal year 2003 Q1 and fiscal year 2005 restructurings during the fourth quarter of fiscal year 2006, it was determined that the actual sublease income was higher than estimated by $3.7 million. To determine the severance and employment-related charges, we made certain estimates as they relate to severance benefits including the remaining time employees will be retained and the estimated severance period. The actual severance and employment-related charges incurred during fiscal year 2004 for all restructuring plans were higher than our initial estimates by $0.3 million.
Summary of Operating Results for Fiscal Years ended June 30, 2006, 2005 and 2004
We generate five different types of revenues. License revenues are primarily associated with the licensing of our software products to communication service providers and wireless device manufacturers; maintenance and support revenues are derived from providing support services to communication service providers and wireless device manufacturers; services revenues are primarily a result of providing deployment and integration consulting services to communication service providers; project/systems revenues are derived from a porting services project in fiscal year 2004 and systems revenues which are comprised of packaged solution elements which may include our software licenses, professional services, third party software and hardware; and content revenues which are derived from downloaded music and entertainment content.
Our total revenues increased by $28.4 million, or 7%, from $383.6 million for the fiscal year ended June 30, 2005, to $412.0 million for the fiscal year ended June 30, 2006. The increase in revenues primarily relates to an increase in our
content product group revenues of $15.8 million from our acquisition of Musiwave in January 2006, as well as an increase in our client product group revenues of $10.8 million in fiscal 2006 from fiscal 2005.
The majority of our revenues have been to a limited number of customers and our sales are concentrated in a single industry segment. Significant customers during the years ended June 30, 2006, 2005 and 2004 include Sprint Nextel. No other customers accounted for 10% or more of total revenues for the fiscal years ended June 30, 2006, 2005 and 2004.
Sprint and Nextel completed their merger in August 2005, creating Sprint Nextel. As such, Sprint Nextel contributed approximately 20% of our revenues in fiscal year 2006, creating a concentration of risk. Any change in our business relationship with Sprint Nextel could have an adverse impact on our financial results and stock price.
The following table presents the key revenue information for the fiscal years ended June 30, 2006, 2005 and 2004, respectively (in thousands):
License revenues increased by $19.0 million, or 11%, during fiscal year 2006 as compared to fiscal year 2005. The overall increase in fiscal year 2006 as compared to fiscal year 2005 was primarily attributed to two large deals signed during the third quarter of fiscal year 2006, which contained site licenses for our client products and generated recognized license fees totaling $25.6 million during the third quarter. License revenues for site licenses are recognized in the quarter the license is signed and no future license revenue will result from additional shipments or use of the product under site license.
License revenues increased by $29.9 million, or 21%, during fiscal year 2005 as compared to fiscal year 2004. The overall increase in fiscal year 2005 as compared to fiscal year 2004 was primarily attributed to increased demand in the client device software and the mobile infrastructure markets resulting in several new offerings by us during fiscal 2005 as a result of technological advances in the market.
Maintenance and Support Revenues
Maintenance and support revenues remained relatively flat during fiscal year 2006, increasing by $0.5 million, or 1%.
During fiscal year 2005, maintenance and support revenues increased $9.1 million, or 11%, compared to the prior fiscal year due to the growth of our customers subscriber base and our ability to maintain contractual renewal rates of existing customer agreements.
Services revenue increased $18.4 million, or 24%, during fiscal year 2006 as compared to fiscal year 2005. The increase was primarily attributable to a shift in the nature of service engagements, from projects/systems deals in fiscal year 2005 to services in fiscal year 2006. See the corresponding decrease in project/systems revenues discussed below.
Services revenue increased $28.4 million, or 60%, for fiscal year 2005 as compared to fiscal year 2004. This increase was a result of the increase in services requested due to our expansion of client-based product offerings, and an increase in requests to build unique offerings based on our products. In addition, we experienced an increase in services provided for product upgrades of our existing technology, primarily MAG 6.0 and Email Mx 6.0, and other value-added services to our customers.
Project/systems revenues represent revenues which were comprised of managed services, software and systems solutions which may include our software licenses, our professional services, and third-party software and hardware.
Project/Systems revenue decreased by $25.4 million, or 65%, during fiscal year 2006 as compared to fiscal year 2005. This was due to a large project with Sprint Nextel (formerly Nextel) which concluded at the end of fiscal year 2005 and yielded $18.2 million in projects/systems revenue in fiscal year 2005. Additionally, a large project with Sprint Nextel (formerly Sprint) concluded in fiscal year 2006, which yielded $20.2 million in projects/systems revenue in fiscal year 2005 compared to $7.1 million in fiscal year 2006.
Project/systems revenue increased $25.4 million, or 182%, during fiscal year 2005 as compared with fiscal year 2004, primarily as a result of a project/systems deal entered into with Sprint Nextel (formerly Sprint) in the second quarter of fiscal year 2005.
Content revenues increased during the fiscal year ended June 30, 2006 due to the acquisition of Musiwave in January 2006. Musiwave provides downloadable music and other entertainment, which comprised the $15.8 million of content revenue in the fiscal year ended June 30, 2006. Content revenues are associated with the variable amounts charged to customers for downloads of Musiwave products, as well as implementation services and customer support related to content products.
Other Key Revenue and Operating Metrics
The other key revenue metrics reviewed by our CEO for purposes of making operating decisions and assessing financial performance include our disaggregated revenues by product groups. The disaggregated revenues by product group for the fiscal years ended June 30, 2006, 2005 and 2004 were as follows (in thousands):
Other key operating metrics include bookings and backlog. Bookings comprise the aggregate value of all new arrangements executed during a period. We define backlog as the aggregate value of all existing arrangements less revenue recognized to date. Bookings in the three months ended June 30, 2006 were approximately $120 million, an 8% decrease from bookings of approximately $130 million in the three months ended June 30, 2005. For the year ended June 30, 2006, bookings were approximately $466 million, up 13% or $54 million from approximately $412 million for the year ended June 30, 2005. These bookings resulted in a backlog of approximately $260 million as of June 30, 2006, up 32% from $197 million as of June 30, 2005. Bookings related to royalty or usage arrangements are recognized when reported and therefore do not impact backlog. Revenue resulting from bookings is generally recognized over the subsequent 12 months, and are subject to our revenue recognition policy as described under Critical Accounting Policies.
Cost of Revenues
The following table presents cost of revenues as a percentage of related revenue type for the fiscal years ended June 30, 2006, 2005, and 2004, respectively (in thousands):
Cost of License Revenues
Cost of license revenues consists primarily of third-party license fees and amortization of developed technology and customer contract intangible assets related to our acquisitions.
Cost of license revenues during fiscal year 2006 increased by $4.3 million, or 48%, as compared to fiscal year 2005. This increase was attributable to an increase in royalties in connection with the increase in license revenue during the same period. In addition, the percentage of royalty expenses for license revenue increased slightly due to the change in the product mix of licenses sold.
Cost of license revenues during fiscal year 2005 as compared to fiscal year 2004 increased by $1.2 million, or 15%. The increase is attributable to the $2.9 million increase in amortization of intangibles as a result of our two acquisitions in fiscal year 2005, offset by a $1.7 million decrease in royalty costs primarily due to royalty cost of $1.3 million in fiscal year 2004 associated with a sale of anti-spam and anti-virus products.
Cost of Maintenance and Support Revenues
Cost of maintenance and support revenues consists of compensation and related overhead costs for personnel engaged in support services to wireless device manufacturers and communication service providers.
Cost of maintenance and support revenues remained relatively consistent during fiscal year 2006, decreasing by $1.5 million, or 5%, as compared to fiscal year 2005. This decrease was the result of a reduction of $2.4 million in labor expense based upon a headcount reduction of 29 in this group from the prior year. This decrease was partially offset by a $1.4 million increase in stock based compensation related to the adoption of FAS 123R in fiscal year 2006 (see Note 2 to the consolidated financial statements).
The $7.3 million increase in maintenance and support costs during fiscal year 2005 as compared to fiscal year 2004 was primarily due to an increase in headcount, from 145 employees in the maintenance and support departments at June 30, 2004, to 171 at June 30, 2005. Due to the investments in additional personnel in fiscal year 2005, our gross margins in maintenance and support declined in fiscal year 2005 compared to the prior year.
Cost of Services Revenues
Cost of services revenues consists of compensation and independent consultant costs for personnel engaged in performing professional services, hardware purchase for resale and related overhead.
Services costs increased by $14.6 million, or 26%, in fiscal year 2006 as compared to the prior fiscal year. This increase is consistent with the $18.4 million increase in services revenue discussed above. Gross margin for services in fiscal year 2006 decreased by 1% to 25% from the prior fiscal year. This decrease in our services gross margin during fiscal 2006 is due to the adoption of FAS 123R and the resulting $1.5 million stock-based compensation expense recorded in costs of services related to stock option grants.
Services costs increased by $16.8 million, or 43%, in fiscal year 2005 as compared to the prior fiscal year. This increase is a result of the increased resources needed to support the 60% increase in professional services revenues discussed above. In fiscal year 2005, we experienced an improvement in the gross margins related to services, to 26% during fiscal year 2005, compared to 17% in fiscal year 2004. This change reflects realization of higher utilization rates achieved in fiscal year 2005 compared to fiscal year 2004, as we have improved our deployment processes.
Cost of Projects/Systems Revenues
Cost of projects/systems revenues decreased by $16.5 million, or 70%, during fiscal year 2006 as compared to the prior fiscal year. This decrease was a result of a large project with Sprint Nextel (formerly Nextel) which concluded at the end of fiscal year 2005 and a large project with Sprint Nextel (formerly Sprint) which concluded in fiscal year 2006, as discussed under projects/systems revenues above. Our gross margin related to project/systems revenues was 49% during fiscal year 2006, compared to 40% in fiscal year 2005 due to the lower mix of hardware in fiscal 2006 compared to the prior year.
Cost of project/systems revenues increased by $13.7 million, or 139%, during fiscal year 2005 as compared to the prior fiscal year. The increase in fiscal year 2005 was due to dedication of greater resources to project/systems arrangements in fiscal 2005 as compared to 2004, since the cost of project/systems revenues during fiscal year 2005 was attributable to three systems arrangements, whereas in fiscal year 2004, such costs were related to only two customers, including a porting service arrangement which was nearing completion during the later half of fiscal 2004.
The fiscal year 2005 gross margin increased to 40% from 29% in fiscal year 2004. The increase was primarily due to the Sprint Nextel (formerly Nextel) project in fiscal 2004 that generated $5.0 million in project/systems revenue recognized under the proportional performance method, initially assuming a zero profit margin as we could not reasonably determine the fair value of an undelivered element in the contract at June 30, 2004. During the first quarter of fiscal year 2005, we determined we had fair value of all remaining undelivered elements and thus were able to recognize the revenue in fiscal year 2005 yielding an average margin of 40%.
Cost of Content Revenues
Cost of content revenues consists primarily of royalties associated with customer downloads of Musiwave products, as well as the cost of implementation services and customer support associated with content products. Prior to the acquisition of Musiwave in January 2006 we did not incur any cost of content revenues.
Our total operating expenses decreased by $36.4 million, or 11%, from $318.2 million for the fiscal year ended June 30, 2005, to $281.7 million for the fiscal year ended June 30, 2006. The primary decrease in our operating expenses was a $65.9 million decrease in restructuring and related costs associated in large part with the relocation of our headquarters during fiscal 2005. Partially offsetting this reduction was a $32.3 million increase in stock-based compensation recorded in operating expenses, which was impacted by the adoption of FAS 123R in fiscal year 2006.
During fiscal year 2005, operating costs increased by $87.3 million, or 38%, from fiscal year 2004. The increase was primarily due to the $68.1 million increase in restructuring and related expense in 2005, as well as increases in general and administrative and other expenses as discussed below.
The following table represents operating expenses for the three fiscal years ended June 30, 2006, 2005 and 2004, respectively (in thousands):
Research and Development Expenses
Research and development expenses consist principally of salary and benefit expenses for software developers, contracted development efforts, related facilities costs, and expenses associated with computer equipment used in software development. We believe that investments in research and development, including recruiting and hiring of software developers, are critical to remain competitive in the marketplace and are directly related to continued timely development of new and enhanced products. While we continue to focus our attention on research and development, we undertook initiatives during our restructuring efforts to redistribute some of our research and development work offshore as well as to increase our use of outside consultants.
During fiscal year 2006, research and development costs decreased $7.8 million, compared to the prior year. This decrease can be primarily attributed to the implementation of the FY06 restructuring plan in the first quarter of fiscal year 2006 which consolidated certain engineering sites and reduced headcount and resulted in an overall decrease of $12.7 million in labor expense and employee and facility related allocation costs. This savings was partially offset by the adoption of FAS 123R in fiscal year 2006, which resulted in an increase in stock based compensation expense of $4.9 million compared to the same period in the prior year.
During fiscal year 2005, research and development costs increased $1.3 million, compared to the prior year. The increase was primarily attributable to an increase in labor expense for employees and contingent workers totaling $4.0 million, which included $1.9 million in bonus expense in connection with the fiscal year 2005 corporate bonus plan and due to the expansion of our overseas development centers. The increase in labor expense was partially offset by a decrease of $1.9 million in depreciation during fiscal year 2005 compared to fiscal year 2004 and $0.4 million net decrease in other expenses including allocated overhead.
Sales and Marketing Expenses
Sales and marketing expenses include salary and benefit expenses, sales commissions, travel expenses, and related facility costs for our sales and marketing personnel, and amortization of customer relationship intangibles. Sales and marketing expenses also include the costs of trade shows, public relations, promotional materials, redeployed professional service employees and other market development programs.
Sales and marketing expenses increased by $23.5 million during fiscal year 2006 as compared with fiscal year 2005. This increase was primarily attributable to the adoption of FAS 123R in fiscal year 2006, which resulted in an increase in stock based compensation expense of $17.5 million from the prior fiscal year. Additionally, employee and allocation related expenses increased by $6.2 million over the prior year as a result of headcount in this group comprising 22% of the Companys total headcount in fiscal 2006 versus 21% in fiscal 2005.
Sales and marketing expenses remained relatively constant, increasing by $1.0 million during fiscal year 2005 as compared with fiscal year 2004.
General and Administrative Expenses
General and administrative expenses consist principally of salary and benefit expenses, travel expenses, and facility costs for our finance, human resources, legal, information services and executive personnel. General and administrative expenses also include outside legal and accounting fees, provision for doubtful accounts, and expenses associated with computer equipment and software used in administration of the business.
General and administrative expenses increased by approximately $21.8 million in fiscal year 2006 as compared to fiscal year 2005. The majority of the increase related to the adoption of FAS 123R in fiscal year 2006, resulting in an increase of $9.9 million in stock based compensation expense over the prior year period. Additionally, an increase in labor expense of $9.3 million over the prior year occurred due to the increase in department headcount of approximately 18 over the prior year which was partially attributable to the Musiwave acquisition. There was also an increase of $2.9 million in consulting costs to outside firms as a result of increased Sarbanes-Oxley compliance review costs and general consulting costs. These increases were partially offset by a decrease of $0.9 million in depreciation expense as certain assets became fully depreciated during the period.
General and administrative expenses increased by approximately $14.3 million in fiscal year 2005 as compared to fiscal year 2004. The majority of the increase related to an increase in personnel-related expense of $9.7 million during fiscal year 2005 due to increased average headcount and average pay per employee in this department of 7% and 18%, respectively, resulting from the additional resources allocated to billing and analysis of higher revenues in the same period. Bad debt expense also increased during fiscal year 2005 by $3.3 million, from $(1.3) million in fiscal year 2004 to a positive $2.0 million in fiscal year 2005 as a result of an 80% increase in gross accounts receivable due to the 60% increase in bookings during the fourth quarter of fiscal year 2005 compared to the same period in the prior year. Additionally, professional fees increased by $2.5 million during fiscal year 2005 as compared to fiscal year 2004 due to increased Sarbanes-Oxley compliance costs. These increases were offset by a reduction in equipment and depreciation costs of $2.6 million during fiscal year 2005 due to our efforts to reduce costs and expenditures over the last several years, which has resulted in new capital equipment purchases not keeping pace with the rate at which existing fixed assets have become fully depreciated.
Restructuring and Other Costs
Restructuring and other costs decreased by $65.9 million in fiscal year 2006 as compared to fiscal year 2005. Restructuring expense during fiscal year 2005 included a $54.7 million charge for a restructuring that was announced during the third quarter, as well as $15.6 million in accelerated depreciation related to the revision in useful lives of leasehold improvements and furniture. Fiscal year 2006 restructuring and other costs included an $8.3 million charge related to a restructuring that was announced during the first quarter. In addition, there was a $2.1 million net reduction in restructuring expense during the second quarter of fiscal year 2006, partially offset by the $1.0 million charge associated with an immaterial error discovered during the same quarter. During the fourth quarter of fiscal year 2006, a change in estimate related to the sublease of restructured property resulted in a net reduction in the restructuring liability of approximately $3.0 million. Additionally, during fiscal year 2006 a $0.4 million charge for accelerated depreciation of fixed assets was recorded.
Restructuring and other costs increased by $68.1 million during fiscal year 2005 when compared to fiscal year 2004. The majority of this increase can be attributed to the $54.7 million restructuring plan that was announced during the third quarter of fiscal year 2005.
Amortization and Impairment of Goodwill and Intangible Assets
Amortization of intangible assets for the fiscal years ended June 30, 2006, 2005 and 2004 was (in thousands):
Identified intangible assets are amortized on a straight-line basis over two to six years.
Gain on Sale of Technology and Other
Gain on sale of technology and other totaled $11.3 million during fiscal year ended June 30, 2006. We sold certain intangible assets to a third party for $3.8 million in cash, which was received in March 2006 and was recorded in operating income under gain on sale of technology and other. We also sold rights to use a domain name to a third party for $3.25 million in cash, which was received in December 2005 and recorded under gain on sale of technology and other. During fiscal year 2006, we sold certain intellectual property relating to a non-core product, which resulted in a net gain of $4.3 million. We will continue to provide services to our customers who have purchased the product from us in the past under a reseller agreement with the buyer of the technology.
Interest income totaled $15.9 million, $5.5 million and $4.4 million for the fiscal years ended June 30, 2006, 2005 and 2004, respectively. The increase in interest income during the fiscal year ended June 30, 2006 as compared to the same period in the prior year can mainly be attributed to interest earned on the proceeds from our equity offering in December 2005, which yielded $277.8 million in net proceeds, as well as higher interest rates earned on our
investments during the period. Although our total cash and investments decreased by 16% during fiscal year 2005, compared to fiscal year 2004, our average effective interest rate earned during fiscal year 2005 increased to 2.9%, up from 1.3% in fiscal year 2004, as a result of general interest rate increases.
We incurred interest expense during the fiscal years ended June 30, 2006, 2005, and 2004 of $5.1 million, $5.2 million, and $4.2 million, respectively. The majority of our interest expense relates to our convertible subordinated notes issued in September 2003. The increase in interest expense for fiscal year 2005 as compared to the prior fiscal year is due to our $150.0 million in convertible subordinated notes being outstanding for the entire year as compared to the prior fiscal year when the notes were only outstanding since September 2003.
Other Income (Expense), net
Included in other income (expense), net is foreign exchange gain (losses), which totaled $(1.7) million, $0.3 million, and $(0.2) million for the years ended June 30, 2006, 2005 and 2004, respectively. These fluctuations are the result of our exposure to movements in foreign currency rate changes. We use hedges to limit our exposure to these types of movements.
Impairment of Non-marketable Equity Securities
In fiscal year 2006 we incurred $0.5 million of impairment charges related to two investments we hold in private companies. Impairments represent the difference between our cost of the investment and the amount we estimate is realizable upon sale of the investment. The majority of this impairment relates to an investment in a private company which entered into a definitive agreement for sale in November 2006. As such, we revised our estimate of realizable value as of the fourth quarter of fiscal 2006 to equal our expected proceeds, which resulted in a $0.4 million impairment.
Income tax expense totaled $3.6 million, $8.8 million and $9.3 million for the fiscal years ended June 30, 2006, 2005 and 2004, respectively. Income taxes in all periods consisted primarily of foreign withholding and foreign income taxes. Foreign withholding taxes fluctuate from year to year based on both the geographical mix of our revenue, as well as the timing of the revenue recognized. The June 30, 2006 tax expense was lower due to the tax benefits realized for stock compensation and net operating losses from certain foreign jurisdictions.
In light of our history of operating losses, we recorded a valuation allowance for substantially all of our net deferred tax assets outside of certain foreign jurisdictions, as we are presently unable to conclude that it is more likely than not that the deferred tax assets in excess of deferred tax liabilities will be realized.
As of June 30, 2006, we had net operating loss carryforwards for federal and state income tax purposes of approximately $1.3 billion and $519.8 million, respectively.
Liquidity and Capital Resources
Operating Lease Obligations and Long-Term Debt Obligations
As of June 30, 2006, our principal commitments consisted of obligations outstanding under operating leases, as well as our convertible debt obligations.
Pursuant to the issuance of our Convertible Notes, we agreed to maintain certain covenants. These covenants include, among others, (1) the timely payment of principal, premium, if any, and interest on the Convertible Notes; (2) the filing of our periodic and other reports we are required to file with the SEC pursuant to the Exchange Act with the trustee within 15 days after we file such reports with the SEC; and (3) the delivery to the trustee of a compliance certificate within 120 days of the end of each fiscal year.
If we fail to observe or correct certain covenants for a period of 60 days after receipt of a notice of default from the trustee, such failure will constitute an event of default under the Convertible Notes. Upon an event of default, the trustee or holders of at least 25% in aggregate principal amount of the Convertible Notes may accelerate the Convertible Notes such that the entire principal amount and any accrued and unpaid interest shall become immediately due and payable. Holders of a majority in aggregate principal amount of the Convertible Notes may rescind or annul an acceleration if all events of default have been cured or waived, except nonpayment of the principal and any accrued and unpaid cash interest that have become due solely because of the acceleration.
On October 3, 2006, we received a notice of default related to the failure to timely provide the trustee with a copy of the Form 10-K for the period ended June 30, 2006. The filing of this Form 10-K with the trustee within the cure period will cure this default. On November 20, 2006, we received a notice of default related to the failure to timely provide the trustee with a copy of the Form 10-Q for the period ended September 30, 2006. This default remains outstanding.
On August 31, 2006, we announced a restructuring plan to better align our resources among operational groups and reduce the numbers of layers of management between customers and field and product organizations (the FY2007 Restructuring). We incurred approximately $10.3 million in pre-tax restructuring and related charges associated with this FY2007 Restructuring during the first quarter of fiscal year 2007 and accelerated depreciation of abandoned assets to be recognized over the four months ending December 31, 2006. Included in the first quarter restructuring and other charges are approximately $7.8 million related to employee termination benefits which are expected to be paid in fiscal year 2007.
In July 2006, we finalized a sublease agreement for properties included in the FY 2005 Restructuring and the FY 2003 Q1 Restructuring. As a result of the finalization of sublease terms, we reassessed the estimated obligation, future accretion and sublease income related to these properties, resulting in a net reduction in our restructuring liability of $3.0 million.
On February 28, 2005, we entered into two sublease agreements (the Sublease Agreements) to lease office space in adjacent buildings at 2100 Seaport Boulevard and 2000 Seaport Boulevard in Redwood City, California. Collectively, the Sublease Agreements cover approximately 192,000 square feet which serve as our corporate headquarters. We vacated our prior corporate headquarters located at 1400 Seaport Boulevard, Redwood City, California as of June 1, 2005.
The terms of the Sublease Agreements began on May 1, 2005 and end on June 29, 2013, with a one time right to terminate one or both of the Sublease Agreements on July 30, 2009. The Sublease Agreements are triple-net subleases and the Company has a right of first refusal to lease additional space at 2000 Seaport Boulevard. The average base rent
expense for the first 4 years will be $1.73 million per year. The average base rent for the remaining term of the leases will be approximately $2.13 million per year. In addition, we expect common area and maintenance pass-through charges, including real estate taxes, to be approximately $1.5 to $1.8 million per year. The rent obligations are being expensed on a straight-line basis, over the term of the lease beginning upon the date the premises became available for entry in February 2005.
Our prior headquarter facility lease was entered into in March 2000 for approximately 283,000 square feet of office space located at 1400 Seaport Boulevard, Redwood City, California. Lease terms that commenced in April 2001 require a base rent of $3.25 per square foot per month as provided by the lease agreement which will increase by 3.5% annually on the anniversary of the initial month of the commencement of the lease. The lease is for a period of 12 years from the commencement date of the lease.
We also have numerous facility operating leases at other locations in the United States and throughout the world.
Long-term debt obligations and future minimum lease payments under all non-cancelable operating leases with terms in excess of one year and future contractual sublease income were as follows at June 30, 2006 (in thousands):
Off-Balance Sheet Arrangements
As of June 30, 2006, we had no off-balance sheet arrangements.
Working Capital and Cash Flows
The following table presents selected financial information and statistics as of June 30, 2006, 2005 and 2004, respectively (in thousands):
We obtained a majority of our cash and investments through prior public offerings, totaling $802.7 million. In addition, we received approximately $145.0 million from the issuance of our $150 million convertible subordinated notes during the year-ended June 30, 2004.
We intend to use cash provided by such financing activities for general corporate purposes, including potential future acquisitions or other transactions. While we believe that our current working capital and anticipated cash flows from operations will be adequate to meet our cash needs for daily operations and capital expenditures for at least the next 12 months, we may elect to raise additional capital through the sale of additional equity or debt securities, obtain a credit facility or sell certain assets. If additional funds are raised through the issuance of additional debt securities, these securities could have rights, preferences and privileges senior to holders of common stock, and terms of any debt could impose restrictions on our operations. The sale of additional equity or convertible debt securities could result in additional dilution to our stockholders, and additional financing may not be available in amounts or on terms acceptable to us. If additional financing is necessary and we are unable to obtain the additional financing, we may be required to reduce the scope of our planned product development and marketing efforts, which could harm our business, financial condition and operating results. In the mean time, we will continue to manage our cash portfolios in a manner designed to ensure that we have adequate cash and cash equivalents to fund our operations as well as future acquisitions, if any.
Working capital increased by $208.1 million during the fiscal year ended June 30, 2006, as compared with the prior year. The increase was primarily attributable to proceeds from the issuance of common stock, including the public
offering in December 2005 which raised $277.8 million in net proceeds, and the remainder from employees exercise of stock options during fiscal year 2006. In addition, the increase in cash included net proceeds of $11.3 million received on sales of technology and domain names during the period. Offsetting the increase in working capital during the period was the acquisition of Musiwave for $113.9 million, net of cash acquired.
Cash, cash equivalents, short and long-term investments and restricted cash increased by $224.1 million as of June 30, 2006 compared to June 30, 2005, primarily as a result of the public offering of common stock discussed above.
Working capital was fairly constant as of June 30, 2005 compared to June 30, 2004 due to a similar increase in both current assets and current liabilities, consistent with the growth in the business during fiscal 2005. Accounts receivable increased by $58.6 million as of June 30, 2005 compared to June 30, 2004 primarily as a result of a $48.8 million increase in bookings in the fourth quarter of fiscal year 2005 compared to the same period in the prior year.
Cash, cash equivalents, short and long-term investments and restricted cash decreased by $55.0 million as of June 30, 2005 compared to June 30, 2004, primarily as a result of cash spent on acquisitions of $52.8 million in fiscal year 2005.
Cash Provided by (Used for) Operating Activities
Cash provided by (used for) operating activities totaled $16.0 million, $(6.5) million, and $(46.8) million for the years ended June 30, 2006, 2005 and 2004, respectively.
The $22.5 million increase in cash provided by operating activities in fiscal year 2006 is primarily due to improved cash from net income excluding non-cash items and the gain on sale of technology and other of $72.9 million, partially offset by a decline in working capital balances of $50.4 million.
The $40.3 million decrease in cash used for operating activities in fiscal year 2005 is due to a decrease in net loss excluding the non-cash restructuring expense, from $(28.0) million in fiscal 2004 to $7.8 million in fiscal 2005.
Cash Used for Investing Activities
Cash flows used for investing activities during the fiscal years ended June 30, 2006, 2005 and 2004 totaled $291.3 million, $39.0 million and $59.4 million, respectively.
The $252.3 million increase in our cash flows used for investing activities for fiscal year 2006 as compared to fiscal year 2005 relates to an increase of $120.8 million in purchases of short term investments, net of proceeds from maturities of short-term investments in the fiscal year 2006 compared to the prior fiscal year. Purchases of long-term investments, net of proceeds from maturities of long-term investments during the current fiscal year increased by $83.5 million over the prior fiscal year. Additionally, cash used for acquisitions was $61.2 million greater during the current fiscal year, related to the acquisition of Musiwave. This increase in cash used for investing activities was partially offset by the $11.3 million of proceeds from the sale of technology and other during fiscal year 2006, with no such comparable activity in the prior fiscal year.
The $20.4 million decrease in our cash flows used for investing activities for fiscal year 2005 as compared to fiscal year 2004 relates to a net transfer to cash and equivalents from investments totaling $24.4 million in fiscal year 2005 compared to a net transfer from cash and equivalents to investments totaling $47.3 million in fiscal year 2004, a
$71.7 million difference. This was offset by cash used for acquisitions in fiscal year 2005 of $52.8 million, primarily related to the acquisition of Magic4.
Cash Flows Provided by Financing Activities
Cash flow provided by financing activities increased by $303.1 million in fiscal year 2006 as compared to the prior fiscal year primarily due to proceeds from the issuance of common stock, including the public offering in December 2005 which resulted in $277.8 million of net proceeds, and the remainder from employees exercise of stock options during the fiscal year ended June 30, 2006.
Cash flow provided by financing activities decreased by $144.0 million in fiscal year 2005 as compared to the prior fiscal year primarily due to the issuance of convertible debt of $145.0 million during the fiscal year 2004.
Recent Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109, which clarifies the accounting for uncertainty in income taxes recognized in an entitys financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. The Interpretation prescribes a recognition threshold and measurement attribute for financial statement disclosure of tax positions taken or expected to be taken on a tax return. The Interpretation is effective beginning in our first quarter of fiscal 2008. We are currently analyzing the requirements of this Interpretation and have not yet determined its impact on our Consolidated Financial Statements.
In September 2006, the SEC Staff released Staff Accounting Bulletin (SAB) No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB No. 108 provides guidance on the process of quantifying materiality of financial statement misstatements. SAB No. 108 is effective for fiscal years ending after November 15, 2006, with early application for the first interim period ending after November 15, 2006. We are currently in the process of evaluating the effect of SAB No. 108 on our financial position and results of operations and therefore, are unable to estimate the effect on our Consolidated Financial Statements.
In June 2006, the FASB reached a conclusion to the consensus reached in EITF issue 05-1, Accounting for the Conversion of an Instrument That Became Convertible upon the Issuers Exercise of a Call Option. The FASB concluded that the issuance of equity securities to settle a debt instrument, pursuant to the instruments original conversion terms, that became convertible upon the issuers exercise of a call option should be accounted for as a conversion if the debt instrument contained a substantive conversion feature as of its issuance date. As such, no gain or loss should be recognized related to the equity securities issued to settle the instrument. This adoption of this issue is not expected to have a material impact on our results of operations, cash flows or financial position.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
(a) Foreign Currency Risk
We operate internationally and are exposed to potentially adverse movements in foreign currency rate changes. We have entered into foreign exchange derivative instruments to reduce our exposure to foreign currency rate changes on receivables, payables and intercompany balances denominated in a nonfunctional currency. The objective of these derivatives is to neutralize the impact of foreign currency exchange rate movements on our operating results. These derivatives may require us to exchange currencies at rates agreed upon at the inception of the contracts. These
contracts reduce the exposure to fluctuations in exchange rate movements because the gains and losses associated with foreign currency balances and transactions are generally offset with the gains and losses of the foreign exchange forward contracts. We do not enter into foreign exchange transactions for trading or speculative purposes, nor do we hedge foreign currency exposures in a manner that entirely offsets the effects of movement in exchange rates. We do not designate our foreign exchange forward contracts as accounting hedges and, accordingly, we adjust these instruments to fair value through earnings in the period of change in their fair value. Net foreign exchange transaction gains (losses) included in Other income (expense), net in the accompanying consolidated statements of operations totaled $(1.7) million, $0.3 million, and $(0.2) million for the years ended June 30, 2006, 2005 and 2004, respectively. As of June 30, 2006, we have the following forward contracts (in 000s):
(b) Interest Rate Risk
As of June 30, 2006, we had cash and cash equivalents, short-term and long-term investments, and restricted cash and investments of $510.1 million. Our exposure to market risks for changes in interest rates relates primarily to corporate debt securities, U.S. Treasury Notes and certificates of deposit. We place our investments with high credit quality issuers that have a rating by Moodys of A1 or higher and Standard & Poors of P-1 or higher, and, by policy, limit the amount of the credit exposure to any one issuer. Our general policy is to limit the risk of principal loss and ensure the safety of invested funds by limiting market and credit risk. All highly liquid investments with a maturity of less than three months at the date of purchase are considered to be cash equivalents; all investments with maturities of three months or greater are classified as available-for-sale and considered to be short-term investments; all investments with maturities of greater than one year and less than two years are classified as available-for-sale and considered to be long-term investments. We do not purchase investments with a maturity date greater than two years from the date of purchase.
The following is a table of the principal amounts of short-term investments and long-term investments by expected maturity at June 30, 2006 (in thousands):
Additionally, we had $20.1 million of restricted investments that were included within restricted cash and investments on the consolidated balance sheet as of June 30, 2006. $17.3 million of the restricted investments comprised a certificate of deposit to collateralize letters of credit for facility leases. $2.0 million of the balance comprises U.S. government securities pledged for payment of the remaining three semi-annual interest payments due under the terms of the convertible subordinated notes indenture. The remaining balance of $0.8 million comprises a restricted investment to secure a warranty bond pursuant to a customer contract. The weighted average interest rate on our restricted investments was 3.4% at June 30, 2006.
Item 8. Financial Statements and Supplementary Data.
Our Consolidated Financial Statements, together with related notes and the reports of independent registered public accounting firm KPMG LLP are set forth as indicated in Item 15.
Quarterly Results of Operations
The following tables set forth a summary of our unaudited quarterly operating results for each of the eight quarters in the period ended June 30, 2006. The information has been derived from our unaudited consolidated financial statements that, in managements opinion, have been prepared on a basis consistent with the audited consolidated financial statements contained elsewhere in this annual report and include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of this information when read in conjunction with our audited consolidated financial statements and notes thereto. The operating results for any quarter are not necessarily indicative of results to be expected for any future period.
This selected quarterly information has been restated for all quarters of fiscal year 2005 from previously reported information filed on Form 10-Q and Form 10-K, as a result of the restatement of our financial results discussed in our 2006 Annual Report on Form 10-K.
The impact of the adjustments was immaterial to all interim balance sheets of fiscal year 2005.
During the quarter ended June 30, 2006, the Company discovered an overstatement of the income tax expense recorded during previous quarters of fiscal 2006. To correct the overstatement the Company recorded a tax benefit related to stock option expenses of $1.6 million and a tax benefit related to net operating losses of $0.2 million in the fourth quarter of fiscal 2006. The tax benefit that should have been recorded in the first, second and third quarters of fiscal 2006 was $0.6 million, $0.2 million and $1.0 million respectively.
During the quarter ended December 31, 2005, the Company entered into a non-binding agreement with a potential subtenant for properties that are included in the Companys fiscal year 2005 and fiscal year 2003 Q1 restructuring plans. As such, the Company reassessed its estimated obligation and sublease income related to these properties, resulting in a net reduction of $2.1 million in restructuring expense recorded during the quarter ended December 31, 2005, which was partially offset by $0.8 million in accretion expense related to the measurement of restructuring
liabilities at net present value. During this reassessment, an error was noted with respect to the rent obligations in the fiscal year 2003 Q1 restructuring, which had resulted in a cumulative understatement of the restructuring liability for periods prior to the three months ended December 31, 2005 of approximately $1.0 million. The effect of the error was not material to any relevant prior period. To correct this error, $1.0 million was recorded as an increase in the restructuring liability on the condensed consolidated balance sheet as of December 31, 2005, and a corresponding $1.0 million restructuring expense was recorded in the condensed consolidated statement of operations for the three months ended December 31, 2005.
Item 9A. Controls and Procedures.
(a) Managements Report on Internal Control Over Financial Reporting (as Restated)
Management is responsible for establishing and maintaining adequate internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act). Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations.
Under the supervision and with the participation of management, including our chief executive officer and chief financial officer, the Company conducted an evaluation of the effectiveness of our internal control over financial reporting as of June 30, 2006. In making this assessment, management used the framework established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Management identified the following material weaknesses in our internal control over financial reporting as of June 30, 2006:
Because of the material weaknesses described above, management has concluded that the Company did not maintain effective internal control over financial reporting as of June 30, 2006, based on criteria established in Internal Control -Integrated Framework issued by COSO.
Management previously had concluded that the Company did not maintain effective internal control over financial reporting as of June 30, 2006 because of the existence of the material weakness described in (i) above. In connection with the restatement of the Companys consolidated financial statements described in Note 3 to the consolidated financial statements, management determined that the material weakness described in (ii) above also existed as of June 30, 2006. Accordingly, management has restated this report on internal control over financial reporting to include this additional material weakness.
Openwave acquired Musiwave during fiscal 2006, and management excluded from its assessment of the effectiveness of the Companys internal control over financial reporting as of June 30, 2006, Musiwaves internal control over financial reporting associated with total assets and total revenue which represent 3% and 4% of Openwaves consolidated total assets and consolidated total revenue, respectively, as of June 30, 2006 and for the year then ended.
Our independent registered public accounting firm, KPMG LLP, has issued an audit report on our assessment of our internal control over financial reporting (as restated).
(b) Changes in Internal Control Over Financial Reporting
There have not been any changes in the Companys internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the three months ended June 30, 2006 that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.
Subsequent to June 30, 2006, we have or are planning to take the following actions to address the material weaknesses described in (a) above:
(i) modify our internal control over financial reporting to require the completion of a comprehensive checklist to help ensure compliance with Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes, SFAS No. 5, Accounting for Contingencies, and other relevant literature; and
(ii) modify our internal control over financial reporting to require a review of our quarterly and annual tax accounting by a professional accounting firm.
(iii) modify the design of our policies and procedures to ensure all items are identified and properly presented in the statement of cash flows.
(c) Evaluation of Disclosure Controls and Procedures
The Companys management, with the participation of the Companys Chief Executive Officer (CEO) and Chief Financial Officer (CFO), have evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report, which is June 30, 2006 (the Evaluation Date). Based on such evaluation, our CEO and CFO have concluded that, as of the Evaluation Date, the Companys disclosure controls and procedures are not effective as a result of the material weaknesses in internal control over financial reporting discussed in (a) above.
As noted in Item 1, we are restating the consolidated balance sheet as of June 30, 2006 and 2005 and the related consolidated statements of operations, stockholders equity and comprehensive loss, and cash flows for each of the years in the three-year period ended June 30, 2006, and each of the quarters in the fiscal year 2005. In the Special Committees review of the Companys historical stock option grants and practices, deficiencies in internal control over financial reporting with respect to our stock option grants were determined to exist in certain periods through at least June 30, 2004. However, in fiscal 2005, we changed our practices related to stock option grants and remediated such control deficiencies. Because no new errors in accounting for stock compensation originated subsequent to the aforementioned remediation and based on our evaluation of disclosure controls and procedures and assessment of internal control over financial reporting as of June 30, 2006, we concluded that there is not a material weakness in disclosure controls and procedures or of internal control over financial reporting related to accounting for stock compensation as of such date.
Item 10. Directors, Executive Officers and Corporate Governance.
The Companys Board of Directors is currently comprised of six Directors. The Amended and Restated Certificate of Incorporation divides the Board of Directors into three classes; Class I, Class II and Class III, with members of each class serving staggered three-year terms. One class of Directors is elected by the stockholders at each Annual Meeting to serve a three-year term or until their successors are duly elected and qualified, or if applicable for mid-term nominees and appointees, to complete the term of that class of Director.
The names of the incumbent Directors serving on the Openwave Board of Directors, and related biographical information about them, as of November 27, 2006, is set forth below:
Each member of the Board of Directors has been engaged in the principal occupations described below during the past five years. The information below is furnished by each respective Board member. There are no family relationships among any of the Companys Directors or Executive Officers.
Kenneth D. Denman has served as a Director of the Company since April 2004. Since October 2001, Mr. Denman has served as the Chairman and Chief Executive Officer of iPass, Inc., a global provider of software-enabled trusted connections and services for the enterprise and its mobile workers. From January 2000 to March 2001, Mr. Denman was Chief Executive Officer of AuraServ Communications, a managed service provider of broadband voice and data applications. From August 1998 to May 2000, Mr. Denman was Senior Vice President, National Markets Group at MediaOne, Inc., a broadband cable and communications company, and from June 1996 to August 1998, he was Chief Operating Officer, Wireless at MediaOne International, a broadband cable and communications company. Mr. Denman received his MBA from the University of Washington and a BS in Accounting from Central Washington University.
Bo C. Hedfors has served as a Director of the Company since April 2002. Mr. Hedfors is currently President and Founder of Hedfone Consulting, which he established in April 2002. Previously, Mr. Hedfors was Executive Vice President of Motorola and President of its global wireless infrastructure business based in Chicago from 1998 to 2002. Prior to joining Motorola, he spent thirty years in different management positions at Ericsson, including President and Chief Executive Officer of Ericsson, Inc. from 1994-1998, Chief Technology Officer of LM Ericsson from 1990-1993, and President of Honeywell Ericsson Development Co. from 1984-1986. Mr. Hedfors is also a member of the Board of Directors of Kineto Wireless, Tellabs, SwitchCore AB and Virtutech, Inc. Mr. Hedfors is a
former member of the Cellular Telecommunications and Internet Association (CTIA), has served on several university boards and is currently Chairman of US Friends of Chalmers University of Technology, Inc. Mr. Hedfors has a MS degree in Electrical Engineering from Chalmers University of Technology in Gothenburg, Sweden and is a member of the Royal Swedish Academy of Engineering Sciences.
Gerald (Jerry) Held, Ph.D., has served as a Director of the Company since his appointment in April 2005. Since 1999, Dr. Held has been Chief Executive Officer of Held Consulting, LLC where he is a strategic consultant to chief executive officers and senior executives of technology firms ranging from startups to large, publicly-traded organizations. From 2000 to 2001, Dr. Held was the acting Chief Executive Officer of Cantiga Systems. In 1998, Dr. Held was Chief Executive Officer-In-Residence at the venture capital firm of Kleiner Perkins Caufield & Byers. Through 1997, Dr. Held was Senior Vice President of Oracles server product division, where he led Oracles database business as well as the development of pioneering interactive multimedia technology that included some of the earliest e-commerce application trials. Prior to Oracle, Dr. Held spent eighteen years at Tandem Computers, Inc. Dr. Held is the Chairman of the Board of Directors of Software Development Technologies, Inc. and serves on the Board of Directors of MetaMatrix, Inc. and Business Objects.
Masood Jabbar has served as a Director of the Company since August 2003. In September 2003, Mr. Jabbar retired from Sun Microsystems, Inc. after sixteen years, where he held a variety of senior positions, including Executive Vice President and Advisor to the Chief Executive Officer from July 2002 through September 2003, Executive Vice President of Global Sales Operations from July 2000 to June 2002, President of the Computer Systems Division from February 1998 to June 2002 and, prior to that, Vice President, Chief Financial Officer and Chief of Staff of Sun Microsystems Computer Corporation from May 1994 to January 1998. Prior to joining Sun Microsystems, Inc., Mr. Jabbar worked for ten years at Xerox Corporation and prior to Xerox, two years at IBM Corporation. Mr. Jabbar serves on the Board of Directors of Picsel Technologies Ltd., MSC Software Corporation and JDS Uniphase Corporation. Mr. Jabbar holds a MA in International Management from the American Graduate School of International Management, a MBA from West Texas A&M University and a BA in Economics & Statistics from the University of the Punjab, Pakistan.
David C. Peterschmidt has served as President and Chief Executive Officer and as a Director of the Company since November 2004. Prior to joining the Company, Mr. Peterschmidt served as Chief Executive Officer and Chairman of Securify, Inc., a security software company, from September 2003 to November 2004. Mr. Peterschmidt was Chief Executive Officer and Chairman of Inktomi, Inc. from July 1996 to March 2003. Mr. Peterschmidt also served as Chief Operating Officer of Sybase from 1991 to 1996, and has also held a range of executive positions at other technology software and hardware companies. Mr. Peterschmidt serves on the Board of Directors of Business Objects S.A., UGS Corp. and Cellular Telecommunications and Internet Association (CTIA). Mr. Peterschmidt earned his MA from Chapman College and BA in Political Science from University of Missouri.
Bernard Puckett has served as a Director of the Company since November 2000 and was appointed Chairman of the Board of Directors in October 2002. Mr. Puckett was a Director of Software.com from July 1997 until the merger of Phone.com and Software.com in November 2000. From January 1994 to January 1996, Mr. Puckett was President and Chief Executive Officer of Mobile Telecommunications Technologies. From 1967 to 1994, Mr. Puckett was at IBM Corp., where he held a variety of positions, including Senior Vice President, Corporate Strategy and Development and Vice President and General Manager, Applications Software. As General Manager of the Application Solutions Group, he founded the IBM Consulting Group and ISSC, IBMs outsourcing services arm. Mr. Puckett also serves on the Board of Directors of IMS Health and Direct Insite Corp. Mr. Puckett received his BS in Mathematics from the University of Mississippi.
The Company has a separately designated standing Audit Committee established in accordance with Section 3(a)(58)(A) of the Exchange Act. The Audit Committee consists of Directors Kenneth D. Denman, Masood Jabbar and Bernard Puckett, Audit Committee Chair. The Board of Directors has determined that each of the members of the Audit Committee is independent as defined under SEC rules and Nasdaq listing standards, that each audit committee member is financially literate (able to read and understand financial statements at the time of appointment), and that at least one member of the Audit Committee has past employment experience in finance or accounting, requisite professional certification in accounting, or other comparable experience or background which results in the individuals financial sophistication, including having been a Chief Executive Officer, chief financial officer or other senior officer with financial oversight responsibilities. The Board of Directors has also determined that each of Messrs. Puckett and Jabbar qualify as an audit committee financial expert in accordance with SEC rules, based upon each such members experience and understanding with respect to certain accounting and auditing matters.
The Companys executive officers and their ages as of November 27, 2006, are as follows:
For the biographical summary of David C. Peterschmidt, see Directors section above.
Harold (Hal) L. Covert has served as Chief Financial Officer of the Company since October 1, 2005. Mr. Covert previously served as an independent Director, Chairman of the Audit Committee and member of the Nominating & Corporate Governance Committee of the Company from April 2003 to September 2005. Prior to his appointment as Chief Financial Officer of the Company, Mr. Covert served as Chief Financial Officer of Fortinet, Inc., a security software company, from December 2003 to September 2005 and as Chief Financial Officer of Extreme Networks, Inc., a network infrastructure equipment provider, from July 2001 to October 2003, where he remained in a consulting capacity until March 2004. At Extreme Networks, Mr. Covert was responsible for management of its financial operations and information technology systems. Mr. Covert held the positions of President and Chief Financial Officer at Silicon Graphics, Inc. from May 2001 to July 2001 and prior to that, he served as Chief Financial Officer from July 2000. Prior to joining Silicon Graphics, Inc., Mr. Covert served as Executive Vice President and Chief Financial Officer at Adobe Systems, Inc. from 1998 to 2000. Mr. Covert holds a MBA from Cleveland State University, a BS in Business Administration from Lake Erie College and is a Certified Public Accountant.
David Whalen has served as Senior Vice President of Worldwide Sales since October 2005. Previously, Mr. Whalen had been Vice President and General Manager of the Companys business operations in the Americas since September 2003. Before joining the Company, he served as Corporate Vice President of Global Sales and Marketing at Kyocera Wireless Corp. from September 2002 to August 2003. From June 2001 to August 2002, Mr. Whalen served as Senior Vice President of Worldwide Sales and Marketing for Signalsoft Corporation, a subsidiary of the Company. Prior to this, he served as Senior Vice President of Global Sales and Services at Wireless Knowledge Inc. from November 1998 to June 2001. Mr. Whalen earned his BA in Sociology at Ithaca College, and, while serving in the U.S. Army, he completed MBA coursework at Boston Universitys campus in Munich, Germany. Mr. Whalen is a member of the