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Saba Software 10-Q 2005

Documents found in this filing:

  1. 10-Q
  2. Ex-2.1
  3. Ex-31.1
  4. Ex-31.2
  5. Ex-32.1
  6. Ex-32.2
  7. Ex-32.2
Form 10-Q
Table of Contents

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 


 

x QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended February 28, 2005

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from              to             

 

000-30221

(Commission File number)

 


 

SABA SOFTWARE, INC.

(Exact Name of Registrant as Specified in Its Charter)

 


 

Delaware   94-3267638

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

2400 Bridge Parkway,

Redwood Shores, CA

  94065-1166
(Address of principal executive offices)   (Zip Code)

 

(650) 696-3840

(Registrant’s telephone number, including area code)

 


 

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 Company was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

 

On April 12, 2005, 16,192,091 shares of the registrant’s Common Stock, $.001 par value, were outstanding.

 



Table of Contents

SABA SOFTWARE, INC.

FORM 10-Q

 

QUARTER ENDED February 28, 2005

INDEX

 

          Page

Part I.

   FINANCIAL INFORMATION     

Item 1.

   Financial Statements (Unaudited)    3
     Condensed Consolidated Balance Sheets as of February 28, 2005 and May 31, 2004    3
     Condensed Consolidated Statements of Operations for the three and nine months ended February 28, 2005 and February 29, 2004    4
     Condensed Consolidated Statements of Cash Flows for the nine months ended February 28, 2005 and February 29, 2004    5
     Notes to Condensed Consolidated Financial Statements    6

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    11

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk    22

Item 4.

   Controls and Procedures    23

Part II.

   OTHER INFORMATION     

Item 1.

   Legal Proceedings    23

Item 2.

   Unregistered Sales of Equity Securities and Use Of Proceeds    23

Item 3.

   Defaults Upon Senior Securities    23

Item 4.

   Submission of Matters to a Vote of Securities Holders    23

Item 5.

   Other Information    23

Item 6.

   Exhibits    23
SIGNATURES    24

 

 


Table of Contents

PART 1: FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

SABA SOFTWARE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

(unaudited)

 

     February 28,
2005


    May 31,
2004


 
ASSETS                 

Current assets:

                

Cash and cash equivalents

   $ 15,362     $ 16,628  

Short-term investments

     —         150  

Accounts receivable, net

     9,058       6,648  

Prepaid expenses and other current assets

     1,136       1,030  
    


 


Total current assets

     25,556       24,456  

Property and equipment, net

     710       1,040  

Goodwill, net

     5,288       5,288  

Purchased intangible assets, net

     —         2  

Other assets

     909       955  
    


 


Total assets

   $ 32,463     $ 31,741  
    


 


LIABILITIES AND STOCKHOLDERS’ EQUITY                 

Current liabilities:

                

Accounts payable

   $ 991     $ 1,625  

Accrued compensation and related expenses

     2,532       2,533  

Accrued expenses

     3,014       4,175  

Deferred revenue

     9,422       9,265  

Borrowings under bank line of credit

     —         3,500  

Current portion of debt and lease obligations

     780       752  
    


 


Total current liabilities

     16,739       21,850  

Deferred revenue

     83       179  

Accrued rent

     2,594       2,520  

Debt and lease obligations, less current portion

     357       671  
    


 


Total liabilities

     19,773       25,220  

Stockholders’ equity:

                

Preferred stock, issuable in series: $0.001 par value; 5,000,000 authorized shares at February 28, 2004; none issued or Outstanding

     —         —    

Common stock: $0.001 par value; 50,000,000 authorized shares and 16,282,237 issued at February 28, 2005 and 200,000,000 authorized shares and 13,328,680 issued at May 31, 2004

     56       54  

Additional paid-in capital

     200,887       191,925  

Treasury stock: 102,997 shares held at February 28, 2005 and at May 31, 2004, at cost

     (232 )     (232 )

Accumulated deficit

     (187,856 )     (185,012 )

Accumulated other comprehensive loss

     (165 )     (214 )
    


 


Total stockholders’ equity

     12,690       6,521  
    


 


Total liabilities and stockholders’ equity

   $ 32,463     $ 31,741  
    


 


 

See Accompanying Notes to Condensed Consolidated Financial Statements.

 

3


Table of Contents

SABA SOFTWARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

 

     Three months ended

    Nine months ended

 
     February 28,
2005


    February 29,
2004


    February 28,
2005


    February 29,
2004


 

Revenues:

                                

License

   $ 3,758     $ 2,320     $ 9,598     $ 6,316  

Services

     6,780       5,515       20,590       17,940  
    


 


 


 


Total revenues

     10,538       7,835       30,188       24,256  
    


 


 


 


Cost of revenues:

                                

Cost of license

     43       27       219       178  

Cost of services

     2,895       2,845       9,054       9,188  

Amortization of acquired developed technology

     —         96       2       290  
    


 


 


 


Total cost of revenues

     2,938       2,968       9,275       9,656  
    


 


 


 


Gross profit

     7,600       4,867       20,913       14,600  

Operating expenses:

                                

Research and development

     2,417       2,310       7,197       7,516  

Sales and marketing

     4,309       3,933       12,775       12,405  

General and administrative

     1,228       872       3,544       3,188  

Amortization of deferred stock compensation and other stock charges

     —         4       —         45  

Amortization of purchased intangible assets

     —         41       —         125  

Settlement of litigation

     —         —         —         1,701  
    


 


 


 


Total operating expenses

     7,954       7,160       23,516       24,980  
    


 


 


 


Loss from operations

     (354 )     (2,293 )     (2,603 )     (10,380 )

Interest income (expense) and other, net

     (73 )     47       (101 )     16  
    


 


 


 


Loss before provision for income taxes

     (427 )     (2,246 )     (2,704 )     (10,364 )

Provision for income taxes

     (58 )     (45 )     (140 )     (127 )
    


 


 


 


Net loss

   $ (485 )   $ (2,291 )   $ (2,844 )   $ (10,491 )
    


 


 


 


Basic and diluted net loss per share

   $ (0.03 )   $ (0.17 )   $ (0.18 )   $ (0.79 )
    


 


 


 


Shares used in computing basic and diluted net loss per share

     16,146       13,370       15,419       13,281  
    


 


 


 


 

See Accompanying Notes to Condensed Consolidated Financial Statements.

 

4


Table of Contents

SABA SOFTWARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

     Nine months ended

 
     February 28,
2005


    February 29,
2004


 

Operating activities:

                

Net loss

   $ (2,844 )   $ (10,491 )

Adjustments to reconcile net loss to net cash used in operating activities:

                

Depreciation and amortization

     710       1,346  

Gain on sale of fixed assets

     (1 )     —    

Amortization of purchased intangible assets

     —         125  

Amortization of acquired developed technology

     2       290  

Amortization of deferred stock compensation

     —         45  

Changes in operating assets and liabilities:

                

Accounts receivable

     (2,361 )     (476 )

Prepaid expenses and other current assets

     (106 )     168  

Other assets

     46       (11 )

Accounts payable

     (634 )     (405 )

Accrued expenses

     (1,162 )     1  

Accrued rent

     74       (126 )

Deferred revenue

     61       1,611  

Other liabilities

     —         (61 )
    


 


Net cash used in operating activities

     (6,215 )     (7,984 )

Investing activities:

                

Purchases of short-term investments

     —         —    

Proceeds from redemptions and maturities of short-term investments

     150       3,474  

Proceeds from sale of property and equipment

     1       —    

Purchases of property and equipment

     (380 )     (184 )
    


 


Net cash (used in) provided by investing activities

     (229 )     3,290  

Financing activities:

                

Proceeds from issuance of common stock under stock plans

     295       92  

Proceeds from issuance of common stock in private placement, net of issuance costs

     8,669       —    

Borrowings, net of issuance costs

     304       10,523  

Repayments on borrowings under the credit facility

     (3,500 )     (7,171 )

Repayments on equipment term loan

     (527 )     —    

Repayments on note payable

     (52 )     (53 )

Principal payments under capital lease obligations

     (11 )     (26 )
    


 


Net cash provided by financing activities

     5,178       3,365  

Increase (decrease) in cash and cash equivalents

     (1,266 )     (1,329 )

Cash and cash equivalents, beginning of period

     16,628       17,566  
    


 


Cash and cash equivalents, end of period

     15,362       16,237  

Short-term investments, end of period

     —         152  
    


 


Total cash, cash equivalents and short-term investments, end of period

   $ 15,362     $ 16,389  
    


 


Supplemental disclosure of non-cash transactions:

                

Common stock issued for settlement of litigation

   $ —       $ 576  
    


 


 

See Accompanying Notes to Condensed Consolidated Financial Statements.

 

5


Table of Contents

SABA SOFTWARE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

1. Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements include the accounts of Saba Software, Inc. and its subsidiaries (“Saba”) and, in the opinion of management, reflect all adjustments (consisting only of normal recurring adjustments) necessary to fairly state Saba’s consolidated financial position, results of operations, and cash flows as of and for the dates and periods presented.

 

These unaudited condensed consolidated financial statements should be read in conjunction with Saba’s audited consolidated financial statements included in Saba’s Amended Annual Report on Form 10-K/A filed with the Securities and Exchange Commission on October 27, 2004. The results of operations for the three and nine months ended February 28, 2005 are not necessarily indicative of results for the entire fiscal year ending May 31, 2005 or for any future period.

 

The condensed consolidated balance sheet at May 31, 2004 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.

 

2. Basic and Diluted Net Loss Per Share

 

Basic and diluted net loss per share information for all periods is presented under the requirements of Statement of Financial Accounting Standards (SFAS) No. 128, “Earnings per Share.” Basic earnings per share has been computed using the weighted-average number of shares of common stock outstanding during the period, less shares that may be repurchased, and excludes any dilutive effects of options and warrants. Potentially dilutive issuances have been excluded from the computation of diluted net loss per share as their inclusion would be anti-dilutive. The calculations of basic and diluted net loss per share are as follows:

 

     Three months ended

    Nine months ended

 
     February 28,
2005


    February 29,
2004


    February 28,
2005


    February 29,
2004


 
     (in thousands, except per share data)  

Net loss

   $ (485 )   $ (2,291 )   $ (2,844 )   $ (10,491 )
    


 


 


 


Weighted-average shares of common stock outstanding

     16,146       13,388       15,421       13,311  

Weighted-average shares of common stock subject to repurchase

     —         (18 )     (2 )     (30 )
    


 


 


 


Weighted-average shares of common stock used in computing basic and diluted net loss per share

     16,146       13,370       15,419       13,281  
    


 


 


 


Basic and diluted net loss per share

   $ (0.03 )   $ (0.17 )   $ (0.18 )   $ (0.79 )
    


 


 


 


 

3. Comprehensive Loss

 

Saba reports comprehensive loss in accordance with SFAS No. 130, “Reporting Comprehensive Income.” The following table sets forth the calculation of comprehensive loss for all periods presented:

 

     Three months ended

    Nine months ended

 
     February 28,
2005


    February 29,
2004


    February 28,
2005


    February 29,
2004


 
     (in thousands)  

Net loss

   $ (485 )   $ (2,291 )   $ (2,844 )   $ (10,491 )

Foreign currency translation (loss) gain

     13       (12 )     49       14  

Unrealized (loss) gain on investments

     —         —         —         (4 )
    


 


 


 


Comprehensive loss

   $ (472 )   $ (2,303 )   $ (2,795 )   $ (10,481 )
    


 


 


 


 

 

6


Table of Contents

4. Segment Information

 

Saba operates in a single operating segment, providing human capital software and services that enable global organizations to increase the productivity and competency of people across their extended enterprise.

 

Geographic Information

 

The following tables present revenue and long-lived assets information by geographic area:

 

     Total Revenue

   Total Revenue

     Three months ended

   Nine months ended

     February 28,
2005


   February 29,
2004


   February 28,
2005


   February 29,
2004


     (in thousands)

United States

   $ 6,713    $ 4,624    $ 16,429    $ 14,869

United Kingdom

     1,254      907      4,507      3,503

Rest of World

     2,571      2,304      9,252      5,884
    

  

  

  

Total

   $ 10,538    $ 7,835    $ 30,188    $ 24,256
    

  

  

  

 

     Long-Lived Assets

     As of
February 28,
2005


   As of
May 31,
2004


     (in thousands)

United States

   $ 5,810    $ 6,159

International

     188      171
    

  

Total

   $ 5,998    $ 6,330
    

  

 

Major Customers

 

For each of the three and nine months ended February 28, 2005 and February 29, 2004, no customer accounted for greater than 10% of revenues.

 

5. Credit Facility

 

In August 2004, Saba amended its credit facility to provide for a $5.0 million non-formula based revolving line of credit and an equipment term loan of up to $400,000. Under the revolving line of credit and equipment term loan, Saba may make draws through August 2005. Interest on borrowings under the revolving line of credit must be repaid monthly and outstanding principal must be repaid in August 2005. Borrowings under the equipment term loan must be repaid in 36 equal monthly installments of principal plus interest. Outstanding principal under the revolving line of credit bears interest at a rate equal to the bank’s prime rate plus 1.50% and outstanding principal under equipment term loan bears interest at either a fluctuating rate equal to the bank’s prime rate plus 1.75% or a fixed rate equal to the 36-month U.S. Treasury note plus 4.00%. Other terms of the credit facility remain unchanged. This amended credit facility requires us to satisfy certain covenants including a financial covenant to maintain a minimum balance of unrestricted cash and cash equivalents, net of borrowings, of $7.5 million on deposit with the bank at all times. The credit facility also restricts Saba’s ability to pay cash dividends. As of February 28, 2005, Saba had not borrowed any amounts under the revolving line of credit and was in compliance with the covenants applicable to this facility.

 

7


Table of Contents

6. Restructuring

 

During each of fiscal 2004, fiscal 2003 and fiscal 2002, Saba implemented restructuring programs to reduce expenses to align its operations and cost structure with market conditions. The restructurings programs during fiscal 2004 were implemented under the provisions of SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” while the restructuring programs during fiscal 2003 and fiscal 2002 were implemented under EITF No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” The restructuring programs included worldwide workforce reductions across all functions and consolidation of excess facilities. Workforce reduction charges consist primarily of severance and fringe benefits. A summary of the movements on the restructuring accrual during the nine months ended February 28, 2005 is outlined as follows:

 

     Workforce
Reduction
Charges


    Facilities
Related
Charges


    Total

 
     (in thousands)  

Accrual as of May 31, 2004

   $ 72     $ 677     $ 749  

Charges

     2       12       14  

Deductions – cash payments

     (51 )     (312 )     (363 )
    


 


 


Accrual as of February 28, 2005

   $ 23     $ 377     $ 400  
    


 


 


Estimated remaining cash expenditures

   $ 23     $ 377     $ 400  
    


 


 


 

During the first quarter of fiscal 2004, Saba recorded net restructuring charges of $432,000. These charges were comprised of $80,000 for an excess facility that arose after default by a subtenant and $393,000 from the consolidation of an excess facility. These charges were partially offset by a $41,000 decrease to a workforce reduction accrual made in a prior period that resulted from severance payments that were less than previous estimates. The excess facilities charges were based on the present value of the sum of non-cancelable lease costs, less estimates for future sublease income, which will be paid over the estimated vacancy periods through fiscal 2006. As a result of this restructuring, Saba estimates that it will not recognize net lease expenses of approximately $218,000 in fiscal 2005 and $98,000 in fiscal 2006. There will not be any future cash savings from this restructuring.

 

During the second quarter of fiscal 2003, Saba recorded net restructuring charges of $922,000. These charges were comprised of $770,000 for employee severance payments and $152,000 from the consolidation of an excess facility. This restructuring included a worldwide workforce reduction of 24 employees across all business functions and geographies. As of February 28, 2005 all amounts relating this restructuring had been paid.

 

During the third quarter of fiscal 2003, Saba recorded net restructuring charges of $940,000. These charges were comprised of $416,000 for employee severance payments and $524,000 from the consolidation of excess facilities. This restructuring included a worldwide workforce reduction of 16 employees across all business functions and geographies. It is expected that the remaining workforce reduction payments will be made by the end of fiscal 2005. Amounts related to the excess facility charge will be paid over the remaining lease periods through the end of fiscal 2006.

 

7. Stock Options and Equity Instruments Exchanged for Services

 

Saba accounts for employee stock options using the intrinsic value method in accordance with APB Opinion No. 25, “Accounting for Stock Issued to Employees” while adhering to the disclosure requirements of SFAS No. 123, “Accounting for Stock-Based Compensation” and SFAS No. 148 “Accounting for Stock-Based Compensation—Transition and Disclosure.” The fair value of options, warrants and restricted stock issued for services rendered by non-employees or assets acquired is determined using the Black-Scholes option-pricing model. To calculate the expense or asset value, Saba uses either the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measured. The following table illustrates the effect on net loss and net loss per share had compensation cost for Saba’s stock compensation plans been determined using the fair value method required by SFAS No. 123:

 

The value of stock-based awards on the date of grant using the Black-Scholes option pricing model was calculated using the assumptions in the following table:

 

     Three months ended

    Nine months ended

 
     February 28,
2005


    February 29,
2004


    February 28,
2005


    February 29,
2004


 
     (in thousands, except per share amounts)  

Net loss as reported

   $ (485 )   $ (2,291 )   $ (2,844 )   $ (10,491 )

Add: Total stock-based employee compensation expense included in net loss

     —         4       —         46  

Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects

     (1,724 )     (2,840 )     (6,390 )     (9,319 )
    


 


 


 


Adjusted net loss

   $ (2,209 )   $ (5,127 )   $ (9,234 )   $ (19,764 )
    


 


 


 


Net loss per share as reported

   $ (0.03 )   $ (0.17 )   $ (0.16 )   $ (0.79 )

Adjusted net loss per share

   $ (0.14 )   $ (0.38 )   $ (0.60 )   $ (1.48 )

 

 

8


Table of Contents
     Three months ended

    Nine months ended

 

Employee Options


   February 28,
2005


    February 29,
2004


   

February 28,

2005


   

February 29,

2004


 

Dividend Yield

   0.0 %   0.0 %   0.0%     0.0%  

Volatility

   1.31     0.76     1.31 to 1.34     0.76 to 0.92  

Risk Free rate of interest

   3.9 1%   2.13 %   2.88% to 3.91%     2.13% to 2.56%  

Expected lives of options

   2.24 years     3.0 years     2.24 to 2.35 years     3.0 years  
     Three months ended

    Six months ended

 

Employee Stock Purchase Plan


   February 28,
2004


    February 29,
2004


   

February 29,

2005


   

February 29,

2004


 

Dividend Yield

   0.0 %   0.0 %   0.0 %   0.0 %

Volatility

   0.76     0.76     0.76     0.76  

Risk Free rate of interest

   2.13 %   2.13 %   2.13 %   2.13 %

Expected lives of purchase option

   0.5 years     0.5 years     0.5 years     0.5 years  

 

8. Guarantees

 

Saba enters into license agreements that generally provide indemnification for its customers against intellectual property claims. To date, Saba has not incurred any costs as a result of such indemnifications and has not accrued any liabilities related to such obligations in its consolidated financial statements.

 

Saba’s license agreements also generally include a warranty that its software products will substantially operate as described in the applicable program documentation for a period of generally 90 days after delivery. To date, Saba has not incurred or accrued any material costs associated with these warranties.

 

9. Equity Funding

 

In August 2004, Saba entered into a common stock purchase agreement with Pequot Private Equity Fund III, L.P. and Pequot Offshore Private Equity Partners III, L.P. providing for the issuance of 2,674,500 shares of Saba’s common stock at a price of $3.2841 per share. Total proceeds, net of issuance costs of $115,000, from the private placement were $8.7 million. Under the terms of the funding agreement, Saba filed a Registration Statement with the Securities and Exchange Commission for the common stock issued.

 

10. Legal Matters

 

In November 2001, a complaint was filed in the United States District Court for the Southern District of New York against Saba, certain of its officers and directors, and certain underwriters of Saba’s initial public offering. The complaint was purportedly filed on behalf of a class of certain persons who purchased Saba common stock between April 6, 2000 and December 6, 2000. The complaint alleges violations by Saba and its officers and directors of the Securities Act of 1933 in connection with certain alleged compensation arrangements entered into by the underwriters in connection with the offering. An amended complaint was filed in April 2002. Similar complaints have been filed against hundreds of other issuers that have had initial public offerings since 1998. The complaints were later consolidated into a single action. On July 16, 2003, a committee of Saba’s board of directors conditionally approved a proposed partial settlement with the plaintiffs in this matter. The settlement would provide, among other things, a release of Saba and of the individual defendants for the conduct alleged in the action to be wrongful in the amended complaint. Saba would agree to undertake other responsibilities under the partial settlement, including agreeing to assign away, not assert, or release certain potential claims Saba may have against its underwriters. Any direct financial impact of the proposed settlement is expected to be borne by Saba’s insurers. The committee agreed to approve the settlement subject to a number of conditions, including the participation of a substantial number of other issuer defendants in the proposed settlement, the consent of Saba’s insurers to the settlement, and the completion of acceptable final settlement documentation. In June 2004, an agreement of settlement was submitted to the Court for preliminary approval. The court requested that any objections to preliminary approval of the settlement be submitted by July 14, 2004, and the underwriter defendants formally objected to the settlement. The plaintiffs and issuer defendants separately filed replies to the underwriter defendants’ objections to the settlement on August 4, 2004. The court granted preliminary approval motion on February 15, 2005, subject to certain modifications. If the parties are able to agree upon the required modifications, and such modifications are acceptable to the court, notice will be given to all class members of the settlement, a “fairness” hearing will be held and if the court determines that the settlement is fair to the class members, the settlement will be approved. There can be no assurance that this proposed settlement would be approved and implemented in its current form, or at all. If the settlement is not finalized, Saba intends to dispute these claims and defend the lawsuit vigorously. However, due to the inherent uncertainties of litigation, Saba cannot accurately predict the ultimate outcome of the litigation. An unfavorable outcome in litigation could materially and adversely affect Saba’s business, financial condition and results of operations.

 

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On March 12, 2004, Docent, Inc. filed a compliant against Saba and two employees in the Circuit Court of Cook County, Illinois. The complaint alleges, among other things, that Saba and the two employees gained an unfair competitive advantage by using Docent confidential employee information to solicit and hire certain Docent employees. In addition, the complaint alleges that Saba and the two employees used certain Docent proprietary information to interfere with Docent’s client and prospective client relationships. On October 26, 2004 we entered into a settlement agreement with Docent. Under the terms of the settlement agreement, the litigation was dismissed. The settlement will have no material impact on our financial condition or operations.

 

Saba is also party to various legal disputes and proceedings arising from the ordinary course of general business activities. While, in the opinion of management, resolution of these matters is not expected to have a material adverse effect on Saba’s consolidated financial position, results of operations or cash flows, the ultimate outcome of any litigation is uncertain. Were an unfavorable outcome to occur, the impact could be material to Saba.

 

11. Recent Accounting Pronouncements

 

On December 16, 2004 the Financial Accounting Standards Board or “FASB” issued Statement of Financial Accounting Standard (revised) “Share Based Payment” or “SFAS123R.” SFAS123R, which is effective for the first annual or interim period beginning after June 15, 2005 will require that any share based payment, including stock option, made to an employee be recognized in the financial statements based on their fair value. Under the terms of SFAS 123R the fair value of any equity award will be estimated at the grant date and this fair value will be recognized as compensation cost over the service period for all awards that are subject to a vesting period. SFAS123R requires that fair value be estimated using an option pricing model that takes into account at least the following items – the exercise price, the expected term of the option, the current price of the underlying share, the expected volatility of the price of the underlying share, the expected dividends on the underlying share and the risk free rate of interest.

 

SFAS123R will be effective for the second quarter of fiscal 2006. The effects of the adoption of SFAS 123R on our results of operations and financial are dependent upon a number of factors, including the number of employee options which may be granted in the future, the future market value and volatility of our stock price, movements in the risk free rate of interest, stock option exercise and forfeiture patterns and the stock option valuation model used to estimate the fair value of each option. As a result of these variables it is not possible to estimate the effect of the adoption of SFAS123R on our results of operations and financial condition, however note 7 provides an indication of the effects of using the Black Scholes option pricing model using the assumptions detailed therein to estimate the fair value of employee stock options and employee stock purchase plan options upon the results of operations for the three and nine months ended February 28, 2005.

 

12. Subsequent Events

 

On March 24, 2005, Saba, entered into an Agreement and Plan of Merger (the “Merger Agreement”) providing for the acquisition of THINQ Learning Solutions, Inc., a privately held Delaware corporation (the “Merger”). The Boards of Directors of Saba and THINQ have unanimously approved the Merger and the Merger Agreement.

 

If the Merger is completed, THINQ will become a wholly-owned indirect subsidiary of Saba. The Merger will be a combined stock-for-stock and cash transaction and the aggregate consideration payable by Saba is up to 1,700,000 shares of Parent common stock and $500,000, subject to a post-closing balance sheet adjustment. In addition, up to an additional 100,000 shares of Saba common stock may be issued over a three-year period pursuant to an earn-out provision. As security for the Stockholders’ indemnification obligations set forth in the Merger Agreement, approximately 20% of the total merger consideration will be held in escrow until the date that Saba’s Annual Report on Form 10-K for the fiscal year ended May 31, 2006 is required to be filed with the Securities and Exchange Commission.

 

The Merger is subject to customary conditions to closing, including (i) obtaining all required third party consents and approvals of governmental entities, (ii) the accuracy of representations and warranties and the absence of any material adverse change in THINQ (in each case, subject to certain exceptions), and (iii) the delivery of customary opinions from counsel to THINQ. Closing is expected to occur within 60 days of the date of the Merger Agreement.

 

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ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and related notes contained herein and the information included in our annual report on Form 10-K for our fiscal year ended May 31, 2004 and in our other filings with the Securities and Exchange Commission. This discussion includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 (the “Securities Act”) and Section 21E of the Securities and Exchange Act of 1934 (the “Exchange Act”). All statements in this Quarterly Report on Form 10-Q other than statements of historical fact are forward-looking statements for purposes of these provisions, including any statements of the plans and objectives for future operations and any statement of assumptions underlying any of the foregoing. Statements that include the use of terminology such as “may,” “will,” “expects,” “believes,” “plans,” “estimates,” “potential,” or “continue,” or the negative thereof or other comparable terminology are forward-looking statements. Forward-looking statements include (i) in Part I, Item 1, statements regarding estimates of recognition of net lease expenses and the absence of future cash savings from restructuring, expectations regarding workforce reduction payments and payments related to the excess facility charge, statements regarding the resolution and effect of pending litigation, statements regarding the adequacy of our tax provision and statements regarding the acquisition of THINQ, (ii) in Part I, Item 2, statements regarding the design of our products to increase organizational performance and help large enterprises, that the timing of a few large software license transactions can substantially affect quarterly revenue, our belief that support revenue will continue to grow, continued investment in areas that we believe accelerate growth, that business conditions may require us to adopt additional restructuring programs, that many of our customers have not resumed previous levels of expenditures on information technologies, our anticipation that the negative impact of seasonality on our first quarter will continue, our expectation that research and development expenses will remain relatively flat for the foreseeable future, our anticipation that we will continue to experience long sales cycles, the sufficiency of cash resources, credit facilities and cash flows to meet working capital, capital expense and business expansion requirements for at least the next 12 months, our expectation to derive substantially all of our revenues for the foreseeable future from the licensing of Saba Enterprise Learning and providing related services, our expectation to derive revenues from new products over the long term, our expectation to continue to incur non-cash expenses relating to the amortization of purchased intangible assets, along with any potential goodwill impairment, that our operating results will fluctuate significantly in the future, our expectation to increase our operating expenses, the impact of SFAS No. 123R and Statement of Position 97-2, our intention to expand our international presence in the future, our expectation to regularly release new products and new versions of existing products, our expectation of continued operating losses and negative cash flow from operations, our expectation to continue to acquire complementary businesses or technologies, that the acquisition of THINQ and any future acquisitions would result in the use of significant amounts of cash, potentially dilutive issuance of equity securities, and/or the incurrence of debt, (iii) in Part I, Item 3, that more of our contracts may be denominated in foreign currencies, and (iv) in Part II, Item 1, statements regarding the resolution and effect of pending litigation. These forward-looking statements involve known and unknown risks and uncertainties. Our actual results may differ materially from those projected or assumed in such forward-looking statements. Among the factors that could cause actual results to differ materially are incorrect estimates or assumptions, unanticipated adverse results for pending litigation, contraction of the economy and world markets, lack of demand for information technologies from our customers, requirements for increased spending in research and development, unanticipated need for capital for operations, lack of demand for our products, inability to introduce new products and the factors detailed under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Factors That May Impact Future Operating Results.” All forward-looking statements and risk factors included in this document are made as of the date of this report, based on information available to us as of such date. We assume no obligation to update any forward-looking statement or risk factor.

 

OVERVIEW

 

Business, Principal Products, Revenue Models and Locations

 

We are a leading provider of human capital management solutions, which are designed to enable global organizations to increase the productivity and competency of people across their extended enterprise. Our solutions can help large enterprises to efficiently manage regulatory compliance, increase sales and channel readiness, accelerate time-to-competency of people across the extended enterprise, increase speed of customer acquisition, shorten time-to-market of new products and increase visibility into organizational performance. Our leadership position is supported by publicly available reports published by independent, third-party analysts that research vendors in our industry and rank them based on a number of factors, including product offerings, technology and customer base.

 

We commenced operations in April 1997 and, through March 1998, focused substantially all of our efforts on research activities, developing our products and building our business infrastructure. We shipped our first Saba Enterprise Learning products and began to generate revenues from software license fees, implementation and consulting services fees and support fees in April 1998. In August 2003, we shipped our generally available version of Saba Enterprise Performance.

 

Substantially all of our revenues are derived from perpetual licenses of our software products and related product-support and professional services. Specifically, we license our software solutions in multi-element arrangements that include a combination of our software, product support and/or professional services. To date, a substantial majority of our software license revenue has been derived from Saba Enterprise Learning. Our license revenue is affected by the strength of general economic and business conditions, as well as customers’ budgetary cycles and the competitive position of our software products. In addition, the sales cycle for our products is long, typically 6 to 12 months. The timing of a few large software license transactions can substantially affect our quarterly license revenue.

 

Product support includes technical support and future updates for the applicable software product. We typically sell support for an initial period of one year concurrently with the sale of the related software license. After the initial period, support is renewable on an annual basis at the option of the customer. Accordingly, our support revenue depends upon both our sale of additional software licenses and annual renewals of existing support agreements. The growth rate of support revenue does not necessarily correlate directly to the growth rate of license revenue as the support renewal rate has a greater impact on support revenue as our installed base of customers grows. For example, if license revenues remained constant, support revenue would continue to grow as a result of the incremental support revenue associated with new license sales, assuming renewal rates stayed relatively constant. We believe that support revenue will continue to grow as we anticipate that a substantial majority of our customers will renew their annual contracts and the sale of new software licenses will increase the number of customers that purchase support.

 

Our professional services offerings include (i) implementation services, (ii) education services for our customers regarding how to use our software, and (iii) hosting services that enable customers’ that separately purchase software licenses to access and use the software on computers operated by or for us. Our implementation and education services are typically initiated and provided to customers that license software directly from us over a period of three to nine months after licensing the software. Accordingly, our implementation and education services revenue varies directly with the levels of license revenue generated from our direct sales organization in the preceding three- to nine-month period. In addition, our implementation and education services revenue varies following our commercial release of significant software updates as our customers generally engage our services to assist with the implementation and education of their software upgrade. Although we primarily provide implementation services on a time and materials basis, a significant portion of these services is provided on a fixed fee basis. Hosting services are generally provided pursuant to annual agreements and the associated revenue is recognized ratably over the hosting term.

 

 

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Our corporate headquarters are located in Redwood Shores, California. In addition, we have seven non-U.S. subsidiaries through which we conduct various operating activities related to our business. In each of the non-U.S. jurisdictions in which we have subsidiaries, India, France, Japan, Germany, the United Kingdom, Canada and Australia, we have employees or consultants engaged in sales and services activities. In the case of our India subsidiary, our employees primarily engage in software development and quality assurance testing activities.

 

Significant Trends and Developments in Our Business

 

Since we began operations in 1997 and continuing throughout fiscal 2001, our business grew rapidly. During fiscal 2002 and continuing through the first three quarters of fiscal 2004, our revenues declined as a result of a deterioration of the overall economy and information technology industry. Beginning in the later part of fiscal 2004, many key indicators began to demonstrate signs of an economic recovery. Consistent with these indicators, our business began to improve during the fourth quarter of fiscal 2004 and the first three quarters of fiscal 2005.

 

During fiscal 2004, fiscal 2003 and fiscal 2002, in response to the global economic slowdown, we implemented restructuring programs to reduce expenses to align our operations and cost structure with market conditions. The restructuring programs included worldwide workforce reductions across all functions and consolidation of excess facilities. Although we do not have any current plans to implement additional restructuring programs, business conditions may require us to reduce or otherwise adjust our workforce or consolidate excess facilities in the future.

 

Despite these recent improvements in macro-economic trends, we believe many of our customers have not resumed previous levels of expenditures on information technologies, particularly enterprise software. We attribute this continued level of depressed spending on enterprise software to customers’ concerns regarding the sustainability of the current economic recovery and the current geopolitical environment.

 

In order to achieve profitability, we will need to generate significantly higher revenue and continue to manage our expenses. Our ability to generate higher revenues and achieve profitability depends on many factors, including the demand for our products and services, the level of product and price competition, market acceptance of our new products and general economic conditions. In this regard, we continue to invest in areas that we believe can accelerate revenue growth and to manage expenses to align our operations and cost structure with market conditions. For example, we recently expanded our worldwide field organizations, particularly our North American sales team, and reduced research and development expenses by reallocating headcount from the U.S. to our lower-cost development center in India. We currently do not have plans to shift any other operations outside of the U.S.

 

We experience seasonality during our first fiscal quarter as sales are typically lower than sales in the immediately preceding fourth fiscal quarter. Contributing to this seasonality is the timing of our first fiscal quarter that occurs during the summer months when general business activities slow down in a number of territories where we conduct our operations, particularly Europe. Our commission structure and other sales incentives also tend to result in fewer sales in the first fiscal quarter than in the fourth fiscal quarter. We anticipate that the negative impact of seasonality on our first quarter will continue.

 

CRITICAL ACCOUNTING POLICIES

 

Our discussion and analysis of financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ materially from those estimates. We base our estimates and judgments on historical experience and on various other assumptions that we believe are reasonable under the circumstances. However, future events are subject to change and the best estimates and judgments routinely require adjustment. While there are a number of accounting policies, methods and estimates affecting our financial statements, areas that are particularly significant include revenue recognition policies, the allowance for doubtful accounts, the assessment of recoverability of goodwill and purchased intangible assets and restructuring costs. We have reviewed the critical accounting policies described in the following paragraphs with our Audit Committee.

 

Revenue Recognition. We recognize revenues in accordance with the provisions of American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 97-2, “Software Revenue Recognition,” as amended by SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions.” Under SOP 97-2, as amended, we recognize revenues when all of the following conditions are met:

 

    persuasive evidence of an agreement exists;

 

    delivery of the product has occurred;

 

    the fee is fixed or determinable; and

 

    collection of these fees is probable.

 

SOP 97-2, as amended, requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on the relative fair values of the elements. We have analyzed each element in our multiple-element arrangements and determined that we have sufficient vendor-specific objective evidence (VSOE) to allocate revenues to support, consulting, hosting and education services. Accordingly, assuming all other revenue recognition criteria are met, revenues from perpetual licenses are recognized upon delivery using the residual method in accordance with SOP 98-9. We limit our assessment of VSOE for each element to either the price charged when the same element is sold separately or the price established by management, having the relevant authority to do so, for an element not yet sold separately.

 

License revenues are generally recognized on delivery if the other conditions of SOP 97-2 are satisfied. We do not grant our resellers the right of return and we do not recognize revenue from resellers until the end-user has been identified. Support revenue is recognized ratably over the support term, typically 12 months, and revenue related to implementation, consulting, education and other services is generally recognized as the services are performed. Although we primarily provide implementation and consulting services on a time and materials basis, a significant portion of these services is provided on a fixed-fee basis. For contracts that involve significant customization and implementation or consulting services that are essential to the functionality of the software, the license and services revenues are recognized over the service delivery period using the percentage-of-completion method. We use labor hours incurred as a percentage of total expected hours as the measure of progress towards completion.

 

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We recognize revenue from multiple element arrangements involving licenses and hosting services in accordance with SOP 97-2, Software Revenue Recognition, as these arrangements are with customers that have separately licensed and taken possession of our software independent of the hosting services. Revenue from our application service provider offerings is recognized under SAB 104, Revenue Recognition, as these arrangements are integrated offerings pursuant to which the customers’ ability to access our software is not separable from the services necessary to operate the software and customers are not allowed to take possession of our software. Revenue from both our hosting services and application service provider offerings are recognized as service arrangements, whereby the revenue is recognized ratably over the term of the arrangement.

 

Allowance for doubtful accounts. Accounts receivable are recorded net of allowance for doubtful accounts and totaled approximately $9.1 million as of February 28, 2005. The allowance for doubtful accounts, which totaled approximately $226,000 as of February 28, 2005, is based on our assessment of the collectibility of specific customer accounts historical experience and the aging of the accounts receivable. If there is a deterioration of a major customer’s credit worthiness or actual defaults are higher than our historical experience, we may be required to increase the allowance for doubtful accounts.

 

Recoverability of goodwill and purchased intangible assets. Effective June 1, 2002, we adopted SFAS No. 142. As such, we ceased amortization of goodwill as of May 31, 2002. In addition, we evaluated our purchased intangible assets and determined that all such assets have determinable lives. Total amortization of goodwill prior to June 1, 2002 was $2.5 million and our remaining goodwill balance at February 28, 2005 was $5.3 million. As of February 28, 2005, we had no remaining balance of purchased intangibles to be amortized.

 

On March 24, 2005 Saba announced that it had entered into an agreement and plan of merger providing for the acquisitions of THINQ Learning Solutions, Inc. (“THINQ”), a privately held Delaware Corporation, for consideration of up to 1,700,000 shares of Saba stock and $500,000. Saba may issue up to an additional 100,000 shares of common stock pursuant to an earn-out provision. We expect that, should the acquisition be completed, the allocation of the purchase price will result in the identification of purchased intangible assets, which will be amortized to expense over their useful economic lives. Until the final purchase price has been determined and fully allocated, it is not currently possible to identify the value of these assets and the expected amortization expense, which will arise in future periods. In addition, it is likely that some portion of the purchase price will be allocated to goodwill, increasing that balance which must be assessed for impairment on a regular basis.

 

SFAS No. 142 prescribes a two-phase process for impairment testing of goodwill. The first phase screens for impairment; while the second phase, if necessary, measures the impairment. We consider Saba to be a single reporting unit. Accordingly, all of our goodwill is associated with the entire company. We perform the required impairment analysis of goodwill annually, or on an interim basis if circumstances dictate. Any reduction of enterprise fair value below the recorded amount of stockholders’ equity could require us to write down the value of goodwill to its fair value and record an expense for the impairment loss.

 

Restructuring costs. The total accrued restructuring balance as of February 28, 2005 was $401,000, which was comprised of $377,000 for facilities related charges and $24,000 for workforce reduction charges. The assumptions we have made are based on the current market conditions in the various areas where we have vacant space and necessarily entail a high level of management judgment. These market conditions can fluctuate greatly due to such factors as changes in property occupancy rates and the rental prices charged for comparable properties. These changes could materially affect our accrual. If, in future periods, it is determined that we have over accrued for restructuring charges for the consolidation of facilities, the reversal of such over accrual would have a favorable impact on our results of operations in the period this was determined and would be recorded as a credit to restructuring costs. Conversely, if it is determined that our accrual is insufficient, an additional charge would have an unfavorable impact on our results of operations in the period this was determined.

 

RESULTS OF OPERATIONS

 

THREE AND NINE MONTHS ENDED FEBRUARY 28, 2005 AND FEBRUARY 29, 2004

 

Revenues

 

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    Nine months ended

 
     February 28,
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     (dollars in thousands)  

Revenues

                                                    

License

   $ 3,758    36  %   $ 2,320    30  %   $ 9,598    32  %   $ 6,316    26  %

Services

     6,780    64  %     5,515    70  %     20,590    68  %     17,940    74  %
    

  

 

  

 

  

 

  

Total revenues

   $ 10,538    100  %   $ 7,835    100  %   $ 30,188    100  %   $ 24,256    100  %
    

  

 

  

 

  

 

  

 

Total Revenues: Total revenues increased by 34% during the three months ended February 28, 2005 compared to the three months ended February 29, 2004. For the nine months ended February 28, 2005, total revenues increased by 24% compared to the nine months ended February 29, 2004. These increases were the result of increases in both license and services revenue. As a percentage of total revenues, revenues from customers outside the United States represented 36% for the three months ended February 28, 2005 and 41% for the three months ended February 29, 2004. For the nine months ended February 28, 2005 and February 29, 2004 revenues from customers outside the United States represented 39% and 27% of total revenues, respectively. During each of the three months and nine months ended February 28, 2005 and February 28, 2004, no customer represented more than 10% of our total revenues.

 

License Revenue. License revenue increased by 62% during the three months ended February 28, 2005 compared to the three months ended February 29, 2004 and 52% during the nine months ended February 28, 2005 compared to the nine months ended February 29, 2004. The increase in the dollar amount of license revenue for the three and nine months periods ended February 29, 2004 was attributable to an increase in new license sales.

 

Services Revenue. Service revenue increased by 23% during the three months ended February 28, 2005 compared to the three months ended February 29, 2004 and 15% during the nine months ended February 28, 2005 compared to the nine months ended February 29, 2004. The increase in services revenue during the three months ended February 28, 2005 is attributable to an increase in consulting revenue of approximately $663,000 and an increase in maintenance revenue of approximately $494,000. The increase in consulting revenue is attributable to an increase in the number of consulting projects resulting from an increase in the number of new license sales. The increase in maintenance revenue results from a continued high level of maintenance renewals combined with additional maintenance purchased by new customers.

 

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The increase in services revenue during the nine months ended February 28, 2005 is attributable to an increase in maintenance revenue of approximately $1.5 million and consulting revenue of approximately $1.1 million. The increase in maintenance revenue is attributable to an increase in the number of customers purchasing maintenance across an expanded base of installed customers and to approximately $325,000 of back maintenance fees received from an existing customer during the first quarter of fiscal 2005. The increase in consulting revenue is attributable to an increase in the number of consulting projects resulting from an increase in the number of new license sales.

 

International revenue as a percentage of total revenues and the mix of license and services revenue as a percentage of total revenues have varied significantly primarily due to variability in new license sales.

 

Cost of Revenues

 

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Cost of revenues

                                                    

Cost of license

   $ 43    %   $ 27    %   $ 219    %   $ 178    %

Cost of services

     2,895    27  %     2,845    36  %     9,054    30  %     9,188    38  %

Amortization of acquired developed technology

     —      —         96    %     2    —    %     290    %
    

  

 

  

 

  

 

  

Total cost of revenues

   $ 2,938    28  %   $ 2.968    37  %   $ 9,275    31  %   $ 9,656    40  %
    

  

 

  

 

  

 

  

 

Cost of License Revenue. Our cost of license revenue includes the cost of manuals and product documentation, production media, shipping costs and royalties to third parties. As a percentage of license revenue, cost of license revenue was approximately 1% for each of the three months ended February 28, 2005 and February 29, 2004. As a percentage of license revenue, cost of license revenue was approximately 2% for the nine months ended February 28,2005 and 3% for the nine months ended February 29, 2004. The increase on an absolute basis for both periods is primarily due to an increase in the amount of third party royalties.

 

Cost of Services Revenue. Our cost of services revenue includes salaries and related expenses for our professional services and support organizations, as well as third-party subcontractors, hosting costs and billed expenses. For the three months ended February 28, 2005 cost of services revenue increased 2% compared to the three months ended February 29, 2004. The increase in the cost of services revenue was primarily attributable to an increase in employee related salary and benefits expense of $227,000 and increase in the use of third party consultants of approximately $85,000, partially offset by a decrease of $219,000 related to the allocation of facilities costs. As a percentage of services revenue, cost of services was 43% for the three months ended February 28, 2005 and 52% for the three months ended February 29, 2004. The decline in cost of services revenue as a percentage of service revenue during the three months ended February 28, 2005 is due to an increase in maintenance revenue, which is generally higher margin, as well as improvements in the overall utilization levels of our consulting services personnel.

 

For the nine months ended February 28, 2005 cost of services decreased 1% compared to the nine months ended February 29, 2004. The decrease is primarily attributable to a decrease of approximately $686,000 as a result of lower headcount and the restructuring of certain of our United States facilities and $42,000 as a result of a lower depreciable base of fixed assets. These decreases were partially offset by an increase of $693,000 associated with an increased use of third party consultants. As a percentage of services revenue, cost of services was 44% for the nine months ended February 28, 2005 and 51% for the nine months ended February 29, 2004. The decrease in the cost of services revenue as a percentage of services revenue during the nine months ended February 28, 2005 was attributable to higher margin support revenue as a percent of total services revenue, savings as a result of our restructuring and improvements in the overall utilization levels of our consulting services personnel.

 

Amortization of Acquired Developed Technology. The cost of revenues includes amortization of acquired developed technology of $96,000 for the three months ended February 29, 2004. This amortization resulted from our March 2001 acquisition of Human Performance Technologies, Inc. and June 2001 acquisition of Ultris Inc. These intangible assets were fully amortized as of August 31, 2004.

 

We expect that, should the acquisition of THINQ be completed, the allocation of the purchase price will result in the identification of purchased intangible assets, some of which will may need to be amortized to total cost of revenues over their useful economic lives. Until the final purchase price has been determined and fully allocated it is not currently possible to identify the value of these assets and the expected amortization expense, which may arise in future periods.

 

Because our cost of services revenue is greater than our cost of license revenue, cost of total revenues, as a percentage of total revenues, will fluctuate based on the mix of licenses and services sold.

 

 

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Operating Expenses

 

We classify all operating expenses, except amortization of purchased intangible assets, to the research and development, sales and marketing and general and administrative expense categories based on the nature of the expenses. Each of these three categories includes commonly recurring expenses such as salaries, employee benefits, stock compensation, other stock charges, travel and entertainment costs, and allocated communication, rent and depreciation costs. We allocate these expenses to each of the functional areas that derive a benefit from such expenses based upon their respective headcounts. The sales and marketing category of operating expenses also includes sales commissions and expenses related to public relations and advertising, trade shows and marketing collateral materials. The general and administrative category of operating expenses also includes allowance for doubtful accounts and administrative and professional services fees.

 

     Three months ended

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Operating expenses:

                                                    

Research and development

   $ 2,417    23  %   $ 2,310    29  %   $ 7,197    24  %   $ 7,516    31  %

Sales and marketing

     4,309    41  %     3,933    50  %     12,775    42  %     12,405    51  %

General and administrative

     1,228    11  %     872    11  %     3,544    12  %     3,188    13  %

Amortization of deferred stock compensation and other stock charges

     —      —         4    —    %     —      —         45    —    %

Amortization of purchased intangible assets

     —      —         41    %     —      —         125    1 %

Settlement of litigation

     —      —         —      —         —      —         1,701    7 %
    

  

 

  

 

  

 

  

Total operating expenses

   $ 7,954    75  %   $ 7,160    91  %   $ 23,516    78  %   $ 24,980    103  %
    

  

 

  

 

  

 

  

 

Research and development. Research and development expenses increased 5% for the three months ended February 28, 2005 compared to the three months ended February 29, 2004. The increase for the three months ended February 28, 2005 was a result of an increase in employee related salary and benefits expenses as we expanded our headcount in India with the opening of a second Research and Development facility in Pune. For the nine months ended February 28, 2005, research and development expenses decreased 4% compared to the nine months ended February 29, 2004. The decrease was primarily attributable to a decrease in research and development personnel in the U.S., offset by increased staffing in our lower-cost development center in India. We expect research and development expenses to remain relatively flat for the foreseeable future.

 

Sales and marketing. Sales and marketing expenses increased 10% for the three months ended February 28, 2005 compared to the three months ended February 29, 2004. Sales and marketing expenses for the nine months ended February 28, 2005 increased 3% compared to the nine months ended February 29, 2004. These increases were primarily attributable to an increase in employee related expenses as a result of an increase in sales personnel and an increase in commission expense due to an increase in revenues.

 

General and administrative. General and administrative expenses increased 41% for the three months ended February 28, 2005 compared to the three months ended February 29, 2004. The increase is primarily due to an increase in outside service provider fees associated with our annual audit and our Sarbanes Oxley documentation project together with the fact that we recognized a reversal of bad debt provision of $141,000 during the three months ended February 29, 2004. For the nine months ended February 28, 2005, general and administrative expenses increased 11% compared to the nine months ended February 29, 2004.

 

Amortization of deferred stock compensation and other stock charges. During the three months and nine months ended February 28, 2005, we did not issue any options to non-employees and as a result did not incur any fair value stock-based compensation charges. On December 16, 2004 the Financial Accounting Standards Board issued SFAS123R. SFAS123R requires that, for annual or interim period beginning after June 15, 2005 any share-based payment, including grants of employee stock options, be recognized at fair value in the financial statements. – See also “Recent Accounting Pronouncements”.

 

Amortization of purchased intangible assets. Amortization of purchased intangible assets for the three and nine months ended February 29, 2004 is attributable to the non-competition agreements entered into as a result of our March 2001 acquisition of Human Performance Technologies, Inc. This balance was fully amortized in the fourth quarter of fiscal year 2004.

 

We expect that, should the acquisition of THINQ be completed, the allocation of the purchase price will result in the identification of purchased intangible assets, which will be amortized to operating expenses over their useful economic lives. Until the final purchase price has been determined and fully allocated it is not currently possible to identify the value of these assets and the expected amortization expense, which will arise in future periods.

 

Settlement of litigation. In September 2003, we reached an agreement regarding the settlement of pending patent litigation and recorded a charge of $1.7 million. Under the terms of the settlement agreement, we were required to pay $1.1 million over nine months. As of February 28, 2005, all amounts due under this settlement had been paid.

 

Interest income (expense) and other, net

 

Interest income (expense) and other, net consists of interest income, interest expense and other non-operating expenses. Interest income (expense) and other, was an expense of $73,000 for the three months ended February 28, 2005, and income of $47,000 for the three months ended February 29, 2004. Interest income (expense) and other, was an expense of $101,000 for the nine months ended February 28, 2005 and income of $16,000 for the nine months ended February 29, 2004. The decrease was primarily attributable to foreign exchange losses resulting from unfavorable fluctuations in foreign currency denominated payables.

 

 

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Provision for income taxes

 

From inception through February 28, 2005, we incurred net losses for federal and state tax purposes. Income tax expense was $58,000 during the three months ended February 28, 2005 and $45,000 during the three months ended February 29, 2004. Income tax expense was $140,000 for the nine months ended February 28, 2005 and $127,000 for nine months ended February 29, 2004. The income tax expense consists entirely of foreign tax expense incurred as a result of local country profits.

 

We are subject to income tax audits in all of the jurisdictions in which we operate. Currently, our California Sales Tax returns and French income tax returns for 2001 through 2003 are the subject of audits being conducted by the relevant tax authority. As a result, we must assess exposures to any potential issues arising from these current or any future audits of current and prior years tax returns. Accordingly, we must assess such potential exposure and, where necessary, provide a reserve to cover any expected loss. While we believe that we have made adequate provision for our expected tax exposures, in the event that our current or previously filed returns are subject to audit, additional assessments may be made by the relevant taxing authority. In the event we are unsuccessful in reducing the amount of such assessments, our estimates related to our total costs and expenses could be adversely affected.

 

FLUCTUATIONS OF QUARTERLY RESULTS

 

Our results of operations could vary significantly from quarter to quarter. If revenues fall below our expectations, we will not be able to reduce our spending rapidly in response to the shortfall and operating losses will increase. We anticipate that we will continue to experience long sales cycles. Therefore, the timing of future customer contracts could be difficult to predict, making it difficult to predict revenues between quarters.

 

Other factors that could affect our quarterly operating results include those described below and under the caption “Factors That May Affect Future Operating Results:”

 

    dependence of our revenues on a small number of large orders and the average order value;

 

    our ability to attract new customers;

 

    any changes in revenue recognition rules and interpretations of these rules;

 

    our ability to license additional products to current customers;

 

    the announcement or introduction of new products or services by us or our competitors;

 

    changes in the pricing of our products and services or those of our competitors;

 

    variability in the mix of our products and services revenues in any quarter;

 

    the amount and timing of operating costs and capital expenditures relating to expansion or contraction of our business; and

 

    foreign currency fluctuations.

 

LIQUIDITY AND CAPITAL RESOURCES

 

     Nine months ended

 
     February 28,
2005


    February 29,
2004


 
     (in thousands)  

Cash used in operating activities

   $ (6,215 )   $ (7,984 )

Cash (used in) provided by investing activities

     (229 )     3,290  

Cash provided by financing activities

     5,178       3,365  

 

As of February 28, 2005, our principal source of liquidity included cash and cash equivalents of $15.4 million. We also have the ability, until the facility expires in August 2005, to borrow up to an additional $5.0 million through our existing credit facility, which is subject to our compliance with the financial covenants of that facility.

 

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Cash Used In Operating Activities

 

Cash used in operating activities was $6.2 million during the nine months ended February 28, 2005 compared to $8.0 million during the nine months ended February 29, 2004. Cash used in operating activities during the nine months ended February 28, 2005 was primarily attributable to a net loss of $2.8 million and an increase in receivables of $2.4 million as a result of increased invoicing in the quarter ended February 29, 2004 versus the same quarter of the prior year. Cash used in operating activities during the nine months ended February 29, 2004 was primarily attributable to a net loss of $10.5 million, which was partially offset by an increase in deferred revenue of $1.6 million as we recorded a large license transaction in the quarter ended February 29, 2004.

 

Cash Provided By Investing Activities

 

Cash used in investing activities during the nine months ended February 28, 2005 of approximately $229,000 compared to cash provided by investing activities during the nine months ended February 29, 2004 of $3.3 million. The decrease was primarily attributable to lower net redemptions and maturities of short-term investments as we held all of our cash balance in short term deposits.

 

Cash Provided By Financing Activities

 

Cash provided by financing activities of $5.2 million during the nine months ended February 28, 2005 was primarily attributable to net proceeds of approximately $8.7 million from our private placement in August 2004 offset by the repayment of $3.5 million from borrowings under our credit facility. Cash provided by financing activities of $3.3 million during the nine months ended February 29, 2004 was primarily attributable to $10.5 million of borrowings under our credit facility, which was partially offset by repayments of $7.2 million.

 

Contractual Obligations

 

At February 28, 2005, we did not have any material commitments for capital expenses. Our principal commitments consisted of obligations under capital and operating leases and a note payable.

 

The following table summarizes our contractual obligations at February 28, 2005 and the effect these obligations are expected to have on our liquidity and cash flows in future periods. Of the $24.3 million in operating leases, net of sublease income, $377,000 has been included in accrued restructuring charges as of February 28, 2005. Sublease income included in the table below amounted to $73,000 for the remainder of fiscal 2005, $241,000 for fiscal 2006 and $31,000 for fiscal 2007.

 

     Total

   Operating
Leases


   Debt
Obligations


     (in thousands)
Fiscal Year Ending May 31,                     

2005

   $ 1,000    $ 787    $ 213

2006

     3,503      2,834      666

2007

     2,585      2,380      205

2008

     2,424      2,371      53

2009

     2,439      2,439      —  

Thereafter

     13,499      13,499      —  
    

  

  

     $ 25,450    $ 24,310    $ 1,137
    

  

  

 

As of February 28, 2005 we had no significant commitments related to purchase obligations for goods or services.

 

On March 24, 2005 we entered into an agreement and plan of merger providing for the acquisition of THINQ for consideration that includes a cash payment of $500,000, subject to adjustment based on the post closing balance sheet of THINQ.

 

We currently anticipate that our available cash resources and credit facilities, combined with cash flows generated from revenues, will be sufficient to meet our presently anticipated working capital, capital expense and business expansion requirements, including any cash payment which may be required upon closure of the THINQ acquisition, for at least the next 12 months. However, we may be required, or could choose, to raise additional funds at any time. Our future liquidity and capital requirements will depend on numerous factors, including our future revenues, the timing and extent of spending to support product development efforts and expansion of sales and marketing and general and administrative activities, the success of our existing and new product and service offerings and competing technological and market developments. There can be no assurance that additional funding, if needed, will be available on terms acceptable to us, if at all.

 

Off-Balance Sheet Arrangements

 

As of February 28, 2005, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.

 

RECENT ACCOUNTING PRONOUNCEMENTS

 

On December 16, 2004 the Financial Accounting Standards Board or “FASB” issued SFAS123. SFAS123R, which is effective for the first annual or interim period beginning after June 15, 2005 will require that any share based payment, including stock options, made to an employee be recognized in the financial statements based on their fair value. Under the terms of SFAS 123R the fair value of any equity award will be estimated at the grant date and this fair value will be recognized as compensation cost over the service period for all awards that are subject to a vesting period. SFAS123R requires that fair value be estimated using an option pricing model that takes into account at least the following items – the exercise price, the expected term of the option, the current price of the underlying share, the expected volatility of the price of the underlying share, the expected dividends on the underlying share and the risk free rate of interest.

 

SFAS123R will be effective for the second quarter of fiscal 2006. The effects of the adoption of SFAS 123R on our results of operations and financial condition are dependent upon a number of factors, including the number of employee options which may be granted in the future, the future market value and volatility of our stock price, movements in the risk free rate of interest, stock option exercise and forfeiture patterns and the stock option valuation model used to estimate the fair value of each option. As a result of these variables it is not possible to estimate the effect of the adoption of SFAS123R on our results of operations and financial condition, however note 7 to the Notes to Condensed Consolidated Financial Statements provides an indication of the effects of using the Black Scholes option pricing model using the assumptions detailed therein to estimate the fair value of employee stock options and employee stock purchase plan options upon the results of operations for the three and nine months ended February 28, 2005.

 

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FACTORS THAT MAY IMPACT FUTURE OPERATING RESULTS

 

We have a history of losses, expect future losses and cannot assure you that we will achieve profitability

 

We have incurred significant losses and negative cash flows from operations since our inception. We have not achieved profitability and cannot be certain that we will realize sufficient revenues to achieve or sustain profitability. We expect to derive substantially all of our revenues for the foreseeable future from the licensing of Saba Enterprise Learning and providing related services. Over the longer term, we expect to derive revenues from new products such as Saba Enterprise Performance and related services. In the future, we expect to continue to incur non-cash expenses relating to the amortization of purchased intangible assets that will contribute to our net losses, along with any potential goodwill impairment. As of February 28, 2005 we had no purchased intangible assets to be amortized and our remaining goodwill balance was $5.3 million. As a result of all of the foregoing, we expect to incur losses for the foreseeable future and will need to generate significantly higher revenues in order to achieve profitability. If we achieve profitability, we may not be able to sustain it.

 

Fluctuations of our results could cause our stock price to experience significant fluctuations or declines

 

Our operating results have varied significantly in the past and will likely fluctuate significantly in the future. For instance, in the last two fiscal years our quarterly revenues have fluctuated between approximately $14.7 million and $7.8 million and our quarterly net loss has fluctuated between approximately $1.9 million and $7.9 million. Our quarterly operating results are likely to be particularly affected by the number of customers licensing our products during any quarter and the size of such licensing transactions. We have limited visibility into our future revenue, especially license revenue, which often has been heavily concentrated in the third month of each quarter. Since we forecast our expenses based in part on future revenue projections, our operating results would be adversely affected if we cannot meet those revenue projections.

 

Other factors that could affect our quarterly operating results include:

 

    the demand for our products and professional services and our efficiency in rendering our professional services;

 

    the variability in the mix of our license and services revenue in any quarter;

 

    the variability in the mix of the type of services delivered in any quarter and the extent to which third party contractors are used to provide such services;

 

    the size and complexity of our license transactions and potential delays in recognizing revenue from license transactions;

 

    the amount and timing of our operating expenses and capital expenditures;

 

    the performance of our international business, which accounts for a substantial part of our consolidated revenues; and

 

    fluctuations in foreign currency exchange rates.

 

Due to these and other factors, we believe that quarter-to-quarter comparisons of our revenues and operating results are not necessarily meaningful and should not be relied on as indicators of future performance. It is possible that in some future quarter our operating results may be below the expectations of public market analysts or investors, which could cause the market price of our common stock to fall.

 

Our operating expenses are based on our expectations of future revenues and are relatively fixed in the short-term. During fiscal 2004 and fiscal 2003 we took actions to reduce our operating expenses and, while we may from time to time reduce operating expenses in response to variability in our revenues, including variability caused by downturns in the United States and/or international economies, over the long term we generally expect to increase our operating expenses to expand our sales and marketing operations, fund greater levels of research and development, develop new alliances, increase our services and support capabilities and improve our operational and financial systems. If our revenues do not increase along with these expenses, our business would be seriously harmed and net losses in a given quarter would be even larger than expected.

 

Our products have a long sales cycle, which increases the cost of completing sales and renders completion of sales less predictable

 

The period between our initial contact with a potential customer and the purchase of our products and services is often long. A customer’s decision to purchase our products and services requires the commitment to increase performance through human capital management, involves a significant allocation of resources, and is influenced by a customer’s budgetary cycles. To successfully sell our products and services, we generally must educate our potential customers regarding the use and benefits of our products and services, which can require significant time and resources. Many of our potential customers are large enterprises that generally take longer to make significant business decisions. Our typical sales cycle has been approximately 6 to 12 months, making it difficult to predict the quarter in which we may recognize revenue. The delay or failure to complete sales in a particular quarter could reduce our revenues in that quarter. If our sales cycle unexpectedly lengthens in general or for one or more large orders, it would adversely affect the timing of our revenues. If we were to experience a delay on a large order, it could harm our ability to meet our forecasts for a given quarter.

 

A decline in the price of, or demand for, our main product, Saba Enterprise Learning or our related services offerings would seriously harm our revenues and operating margins

 

To date, Saba Enterprise Learning and related services have accounted for a substantial majority of our revenues. We anticipate that revenues from Saba Enterprise Learning and related services will continue to constitute a substantial majority of our revenues for the foreseeable future. Consequently, a decline in the price of, or demand for, Saba Enterprise Learning or failure to achieve broad market acceptance would seriously harm our business.

 

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We experience seasonality in our sales, which could cause our operating results to fluctuate from quarter to quarter

 

We experience quarterly seasonality in the licensing of our products and delivery of our services. For example, revenue has through most of our history been lower in our first fiscal quarter than in the immediately preceding fourth fiscal quarter. Contributing to this seasonality is the timing of our first fiscal quarter that occurs during the summer months when general business activities slow down in a number of territories where we conduct our operations, particularly Europe. Our commission structure and other sales incentives also tend to result in fewer sales in the first fiscal quarter than in the fourth fiscal quarter. These seasonal variations in our revenue are likely to lead to fluctuations in our quarterly operating results.

 

Our performance depends on a new market: human capital management

 

The market for software solutions that automate human capital management is relatively new and rapidly evolving. Substantially all of our revenues are attributable to the suite of products and services in this market. If this market fails to develop or develops more slowly than we expect, or if we fail to identify the challenges and risks in this new market or successfully address these risks, our business would be harmed.

 

Changes in accounting regulations and related interpretations and policies, particularly those related to revenue recognition, could cause us to defer recognition of revenue or recognize lower revenue

 

While we believe that we are in compliance with Statement of Position 97-2, Software Revenue Recognition, as amended, the American Institute of Certified Public Accountants continues to issue implementation guidelines for these standards and the accounting profession continues to discuss a wide range of potential interpretations. Additional implementation guidelines, and changes in interpretations of such guidelines, could lead to unanticipated changes in our current revenue accounting practices that could cause us to defer the recognition of revenue to future periods or to recognize lower revenue.

 

In addition, there has been an ongoing public debate whether employee stock option and employee stock purchase plan shares should be measured at their fair value and treated as a compensation expense and, if so, how to properly value such charges. Effective from the second quarter of Fiscal 2006 we will be required to record an expense for our stock-based compensation plans using the fair value method, which could result in significant compensation charges. For example, for fiscal 2004, fiscal 2003, and fiscal 2002, had we accounted for stock-based compensation plans under Financial Accounting Standards Board (“FASB”) Statement No. 123, as amended by FASB Statement No. 148, diluted loss per share would have been increased by $0.89, $1.02, and $1.38 per share, respectively. Although we are currently not required to record any compensation expense using the fair value method in connection with option grants that have an exercise price at or above fair market value and for shares issued under our employee stock purchase plan, it is possible that future laws or regulations will require us to treat all stock-based compensation as a compensation expense using the fair value method. See Note 2 of the Notes to Consolidated Financial Statements.

 

The loss of the services of our senior executives and key personnel would likely cause our business to suffer

 

Our success depends to a significant degree on the performance of the senior management team and other key employees. The loss of any of these individuals could harm our business. We do not have employment agreements with any of our executives or other key employees, and we do not maintain key person life insurance for any officers or key employees.

 

Intense competition in our target market could impair our ability to grow and to achieve profitability

 

The market for our products and services is intensely competitive, dynamic and subject to rapid technological change. The intensity of the competition and the pace of change are expected to increase in the future. Increased competition is likely to result in price reductions, reduced gross margins and loss of market share, any one of which could seriously harm our business. Competitors vary in size and in the scope and breadth of the products and services offered. We encounter competition with respect to different aspects of our solution from a variety of sources including:

 

    companies that market and license training, learning, performance, content, resource, talent and staffing management systems;

 

    enterprise software vendors that offer human resources information systems and employee relationship management systems with training and performance modules; and

 

    potential customers’ internal development efforts.

 

We expect competition from a variety of companies

 

Many of our competitors have longer operating histories, substantially greater financial, technical, marketing or other resources, or greater name recognition than we do. Our competitors may be able to respond more quickly than we can to new or emerging technologies and changes in customer requirements. Competition could seriously impede our ability to sell additional products and services on terms favorable to us. Our current and potential competitors may develop and market new technologies that render our existing or future products and services obsolete, unmarketable or less competitive. Our current and potential competitors may make strategic acquisitions or establish cooperative relationships among themselves or with other learning solution providers, thereby increasing the availability of their services to address the needs of our current and prospective customers. We may not be able to compete successfully against our current and future competitors, and competitive pressures that we encounter may seriously harm our business.

 

If we are unable to manage the complexity of conducting business globally, our international revenues may suffer

 

International revenues accounted for 36% of our revenues for the three months ended February 28, 2005 and 41% for the three months ended February 29, 2004. International revenues accounted for 46% of our revenues for the nine months ended February 28, 2005 and 27% of our revenues for the nine months ended February 29, 2004. Although we intend to continue to expand our international presence in the future we may not be able to successfully market, sell or distribute our products and services in foreign markets. Factors that could materially adversely affect our international operations, and, our business and future growth include:

 

    difficulties in staffing and managing foreign operations, including language barriers;

 

    seasonal fluctuations in purchasing patterns in other countries, particularly declining sales during July and August in European markets;

 

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    difficulties in collecting accounts receivable in foreign countries, particularly European countries in which collections take considerably more time than the United States and collections are more difficult to effect;

 

    currency exchange rate fluctuations, particularly in countries where we sell our products in denominations other than U.S. dollars, such as in the United Kingdom, the euro zone, and Japan, or have exposures in intercompany accounts denominated in foreign currencies;

 

    the need to develop internationalized versions of our products and marketing and sales materials;

 

    the burdens of complying with a wide variety of foreign laws and reduced protection for intellectual property rights in some countries; and

 

    tariffs, export controls and other trade barriers.

 

    potentially harmful tax consequences.

 

Delays in releasing new products or enhanced versions of our existing products could adversely affect our competitive position

 

As part of our strategy, we expect to regularly release new products and new versions of our existing products. Even if our new products or new versions of our existing products contain the features and functionality our customers want, in the event we are unable to timely introduce these new products or product releases, our competitive position may be harmed. We cannot assure you that we will be able to successfully complete the development of currently planned or future products or product releases in a timely and efficient manner. Due to the complexity of our products, internal quality assurance testing and customer testing of pre-commercial releases may reveal product performance issues or desirable feature enhancements that could lead us to postpone the release of these products. In addition, the reallocation of resources associated with any postponement would likely cause delays in the development and release of other future products or enhancements to our currently available products. Any delay in releasing future products or enhancements of our products could harm our business.

 

If we release products containing defects, we may need to halt further shipments and our business and reputation would be harmed

 

Products as complex as ours often contain unknown and undetected errors or performance problems. Many serious defects are frequently found during the period immediately following introduction and initial shipment of new products or enhancements to existing products. Although we attempt to resolve all errors that we believe would be considered serious by our customers before shipment to them, our products are not error-free. These errors or performance problems could result in lost revenues or delays in customer acceptance and would be detrimental to our business and reputation. As is typical in the software industry, with each release we have discovered errors in our products after introduction. We will not be able to detect and correct all errors before releasing our products commercially and these undetected errors could be significant. We cannot assure you that undetected errors or performance problems in our existing or future products will not be discovered in the future or that known errors considered minor by us will not be considered serious by our customers, resulting in a decrease in our revenues.

 

Our past and future acquisitions may result in disruptions to our business if we fail to adequately integrate acquired businesses

 

In March 2001, we acquired Human Performance Technologies, Inc. and, in June 2001, we acquired Ultris Inc. As part of our overall business strategy, we expect to continue to acquire complementary businesses or technologies that will provide additional products or services offerings, additional industry expertise or an expanded geographic presence. For example, on March 24, 2005 we announced that we had signed a definitive agreement to acquire THINQ Learning Solution, Inc., (“THINQ”). The acquisition of THINQ, should it be completed will and, any future acquisitions could result in the use of significant amounts of cash, potentially dilutive issuances of equity securities, and/or the incurrence of debt. In addition, any acquisition may increase the risk of future write-offs for acquired in-process research and development, write-offs for the impairment of goodwill or long-lived assets, or amortization of expenses related to intangible assets, any of which could materially adversely affect our business and our operating results. For example, as of February 28, 2005, our remaining goodwill balance was $5.3 million. The THINQ acquisition and any future acquisitions involve numerous risks, including:

 

    difficulties in the assimilation of the operations, technologies, products and personnel of the acquired company;

 

    the diversion of management’s attention from other business concerns;

 

    risks of entering markets in which we have no or limited prior experience; and

 

    the potential loss of key employees of the acquired company.

 

Claims by third parties that we infringe their intellectual property rights may result in costly litigation

 

In recent years, there has been significant litigation in the United States involving patents and other intellectual property rights, particularly in the software and Internet-related industries. We have in the past been subject to one intellectual property action. In our market, one company initiated patent infringement actions against us in 2002 as well as at least four other companies. In September 2003, we settled the action against us and recorded a charge of $1.7 million. We have paid all amounts due under this settlement. In the future, we could become subject to intellectual property infringement claims as the number of our competitors grows and our products and services overlap with competitive offerings. Any of these claims, even if not meritorious, could be expensive to defend and could divert management’s attention from operating our company. If we become liable to third parties for infringing their intellectual property rights, we could be required to pay a substantial award of damages and to develop noninfringing technology, obtain a license or cease selling the products that contain the infringing intellectual property. We may be unable to develop noninfringing technology or obtain a license on commercially reasonable terms, if at all.

 

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We may not be able to adequately protect our proprietary technology, and our competitors may be able to offer similar products and services that would harm our competitive position

 

Our success depends upon our proprietary technology. We rely primarily on copyright, trademark and trade secret laws, confidentiality procedures and contractual provisions to establish and protect our proprietary rights. As part of our confidentiality procedures, we enter into non-disclosure agreements with our employees. Despite these precautions, third parties could copy or otherwise obtain and use our technology without authorization, or develop similar technology independently. In addition, we have three patents issued in the United States and four patent applications pending in the United States. We cannot assure you that any patents will be issued for any of the pending patent applications. Even for the issued patent, or any patent issued to us in the future, there can be no assurance that such patent will protect our intellectual property, or will not be challenged by third parties. Furthermore, effective protection of intellectual property rights is unavailable or limited in certain foreign countries. We cannot assure you that the protection of our proprietary rights will be adequate or that our competitors will not independently develop similar technology, duplicate our products and services or design around any patents or other intellectual property rights we hold.

 

Our disaster recovery plan does not include redundant systems, and a disaster could severely damage our operations

 

Our disaster recovery plan does not include fully redundant systems for our services at an alternate site. A disaster could severely harm our business because our services could be interrupted for an indeterminate length of time. Our operations depend upon our ability to maintain and protect the computer systems needed for the day-to-day operation of Saba Learning ASP Edition and our hosting services. A number of these computer systems are located on or near known earthquake fault zones. Although these systems are designed to be fault tolerant, they are vulnerable to damage from fire, floods, earthquakes, power loss, telecommunications failures and other events. Additionally, we do not carry sufficient business insurance to compensate us for all potential losses that could occur.

 

We outsource the management and maintenance of our hosted and ASP solutions to third parties and will depend upon them to provide adequate management and maintenance services

 

We rely on third parties to provide key components of our networks and systems. For instance, we rely on third-party Internet service providers to our products for customers who desire to have these solutions hosted. We also rely on third-party communications service providers for the high-speed connections that link our and our Internet service providers’ Web servers and office systems to the Internet. Any Internet or communications systems failure or interruption could result in disruption of our service or loss or compromise of customer orders and data. These failures, especially if they are prolonged or repeated, would make our services less attractive to customers and tarnish our reputation.

 

We depend upon continuing our relationship with third-party integrators who support our solutions

 

Our success depends upon the acceptance and successful integration by customers of our products. We often rely on third-party systems integrators to assist with implementation of our products. We will need to continue to rely on these systems integrators even as we increase the size of our professional services group. If large systems integrators fail to continue to support our solution or commit resources to us, if any of our customers are not able to successfully integrate our solution or if we are unable to adequately train our existing systems integration partners, our business, operating results and financial condition could suffer. In addition, we have only limited control over the level and quality of service provided by our current and future third-party integrators.

 

We may not be able to secure necessary funding in the future; additional funding may result in dilution to our stockholders

 

We require substantial working capital to fund our business. We have had significant operating losses and negative cash flow from operations since inception and expect this to continue for the foreseeable future. We expect to use our available cash resources and credit facilities primarily to fund sales and marketing activities, research and development, and continued operations, and possibly make future acquisitions. We believe that our existing capital resources will be sufficient to meet our capital requirements for the next twelve months. However, if our capital requirements increase materially from those currently planned or if revenues fail to materialize, we may require additional financing sooner than anticipated. If additional funds are raised through the issuance of equity securities, the percentage ownership of our stockholders will be reduced, stockholders may experience dilution, or such equity securities may have rights, preferences or privileges senior to those of the holders of our common stock. Additional financing may not be available when needed on terms favorable to us or at all. If adequate funds are not available or are not available on acceptable terms, we may be unable to develop or enhance our products and services, take advantage of future opportunities or respond to competitive pressures.

 

Although we currently meet all testing requirements for the Nasdaq National Market, we must continue to meet those requirements to remain listed.

 

In order for our common stock to continue to be quoted on the Nasdaq National Market, we must satisfy various financial requirements established by Nasdaq. At February 28, 2005, we complied with Nasdaq’s minimum stockholders’ equity requirement. As Nasdaq does with all companies, it will continue to monitor us for ongoing compliance with the minimum stockholders’ equity requirement. Failure to demonstrate compliance with the minimum stockholders’ equity requirement or other requirements could subject us to delisting from the Nasdaq National Market. Delisting on the Nasdaq National Market, among other things, limit the liquidity and adversely affect the trading price of our stock.

 

If we are unable to reach a favorable conclusion after assessing the effectiveness of our internal control over financial reporting, or if our independent auditors are unable to provide an unqualified attestation report, our stock price could be adversely affected.

 

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 and depending on whether we meet the definition of an “accelerated filer “, beginning with our Annual Report on Form 10-K for the year ending May 31, 2006, our management will be required to report on, and our independent auditors to attest to, the effectiveness of our internal controls over financial reporting as of May 31, 2006. In the event we do not meet the accelerated filer requirements, we will be required to perform these procedures as of May 31, 2007. The rules governing the standards that must be met for management to assess our internal controls over financial reporting are new and complex, and require significant documentation, testing and possible remediation. We are currently in the process of reviewing and documenting our internal controls over financial reporting and once this is completed we will begin testing of these controls. This has and will likely continue to result in increased expenses and the devotion of significant management and other internal resources. We may encounter unforeseen problems or delays in completing the implementation of any changes necessary to make a favorable assessment of our internal controls over financial reporting and any requested improvements necessary to receive a favorable attestation. If we cannot favorably assess the effectiveness of our internal controls over financial reporting, or if our independent auditors are unable to provide an unqualified attestation report on our assessment, investor confidence and our stock price could be adversely affected.

 

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Our stock price may fluctuate substantially

 

In the last two fiscal years the market price for our common stock has fluctuated between $12.60 per share and $2.32 per share. The market price for our common stock may be affected by a number of factors, including those described above and the following:

 

    the announcement of new products and services or product and service enhancements by us or our competitors;

 

    quarterly variations in our results of operations or those of our competitors;

 

    changes in earnings estimates or recommendations by securities analysts that may follow our stock;

 

    developments in our industry; and

 

    general market conditions and other factors, including factors unrelated to our operating performance or the operating performance of our competitors.

 

In addition, the stock market in general, and the Nasdaq National Market and technology companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of particular companies. Broad market and industry trends may also materially and adversely affect the market price of our common stock, regardless of our actual operating performance. In the past, following periods of volatility in the market price of a company’s securities, securities class-action litigation has often been initiated against that company. Class-action litigation could result in substantial costs and a diversion of management’s attention and resources.

 

The anti-takeover provisions in our charter documents could adversely affect the rights of the holders of our common stock

 

Our Amended and Restated Certificate of Incorporation and Amended and Restated Bylaws contain provisions that could make it harder for a third-party to acquire us without the consent of our board of directors. For example, if a potential acquiror were to make a hostile bid for us, the acquiror would not be able to call a special meeting of stockholders to remove our board of directors or act by written consent without a meeting. In addition, our board of directors has staggered terms that make it difficult to remove all directors at once. The acquiror would also be required to provide advance notice of its proposal to remove directors at an annual meeting. The acquiror will not be able to cumulate votes at a meeting, which will require the acquiror to hold more shares to gain representation on the board of directors than if cumulative voting were permitted.

 

Our board of directors also has the ability to issue preferred stock that would significantly dilute the ownership of a hostile acquiror. In addition, Section 203 of the Delaware General Corporation Law limits business combination transactions with 15% stockholders that have not been approved by the board of directors. These provisions and other similar provisions make it more difficult for a third party to acquire us without negotiation. These provisions may apply even if the offer may be considered beneficial by some stockholders.

 

Our board of directors could choose not to negotiate with an acquiror that it did not feel was in our strategic interests. If the acquiror was discouraged from offering to acquire us or prevented from successfully completing a hostile acquisition by our anti-takeover measures, you could lose the opportunity to sell your shares at a favorable price.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Interest Rate Risk

 

Our investments are made in accordance with an investment policy approved by our Board of Directors. All investments are carried at market value, which approximates cost. At February 28, 2005, all of our investments were in the form of cash equivalents and short-term deposits. As a result, we believe that there is no material market risk exposure.

 

The revolving line of credit portion of our credit facility allows us to make draws at a variable interest rate of the bank’s prime rate plus 1.5%. As of February 28, 2005 we had not borrowed against this facility.

 

The equipment term loan portion bears interest at either a fluctuating rate equal to the bank’s prime rate plus 1.75% or a fixed rate equal to the 36-month U.S. Treasury note plus 4.00%. As of February 28, 2005, we had outstanding equipment term loans of $983,000 that carry fixed interest rates ranging from 4.9% to 7.75%. Therefore, only future borrowings on the equipment term loan portion of our credit facility would be affected by changes in market interest rates.

 

Foreign Currency Risk

 

We provide our products and services to customers in the United States, Europe and elsewhere throughout the world. Sales are primarily made in U.S. Dollars, and to a lesser but increasing extent, British Pounds and Euros. As we continue to expand our operations, more of our contracts may be denominated in Australian Dollars, Canadian Dollars and Japanese Yen. A strengthening of the U.S. Dollar could make our products less competitive in foreign markets.

 

Our exposure to foreign exchange rate fluctuations also arises in part from the translation of the financial results of foreign subsidiaries into U.S. dollars in consolidation. As exchange rates vary, these results, when translated, may vary from expectations and adversely impact overall expected profitability.

 

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ITEM 4. CONTROLS AND PROCEDURES

 

As of February 28, 2005, our management evaluated, under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in this report. There has been no change in our internal control over financial reporting that occurred during the fiscal quarter ended February 28, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

PART II OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

In November 2001, a complaint was filed in the United States District Court for the Southern District of New York against us, certain of our officers and directors, and certain underwriters of our initial public offering. The complaint was purportedly filed on behalf of a class of certain persons who purchased our common stock between April 6, 2000 and December 6, 2000. The complaint alleges violations by us and our officers and directors of the Securities Act of 1933 in connection with certain alleged compensation arrangements entered into by the underwriters in connection with the offering. An amended complaint was filed in April 2002. Similar complaints have been filed against hundreds of other issuers that have had initial public offerings since 1998. The complaints were later consolidated into a single action. On July 16, 2003, a committee of our board of directors conditionally approved a proposed partial settlement with the plaintiffs in this matter. The settlement would provide, among other things, a release of us and of the individual defendants for the conduct alleged in the action to be wrongful in the amended complaint. We would agree to undertake other responsibilities under the partial settlement, including agreeing to assign away, not assert, or release certain potential claims we may have against our underwriters. Any direct financial impact of the proposed settlement is expected to be borne by our insurers. The committee agreed to approve the settlement subject to a number of conditions, including the participation of a substantial number of other issuer defendants in the proposed settlement, the consent of our insurers to the settlement, and the completion of acceptable final settlement documentation. In June 2004, an agreement of settlement was submitted to the Court for preliminary approval. The court requested that any objections to preliminary approval of the settlement be submitted by July 14, 2004, and the underwriter defendants formally objected to the settlement. The plaintiffs and issuer defendants separately filed replies to the underwriter defendants’ objections to the settlement on August 4, 2004. The court granted the preliminary approval motion on February 15, 2005, subject to certain modifications. If the parties are able to agree on the required modifications, and such modifications are acceptable to the court, notice will be given to all class members of the settlement, a “fairness” hearing will be held and if the court determines that the settlement is fair to the class members, the settlement will be approved. There can be no assurance that this proposed settlement would be approved and implemented in its current form, or at all. If the settlement is not finalized, we intend to dispute these claims and defend the lawsuit vigorously. However, due to the inherent uncertainties of litigation, we cannot accurately predict the ultimate outcome of the litigation. An unfavorable outcome in litigation could materially and adversely affect our business, financial condition and results of operations.

 

On March 12, 2004, Docent, Inc. filed a compliant against Saba and two employees in the Circuit Court of Cook County, Illinois. The complaint alleges, among other things, that Saba and the two employees gained an unfair competitive advantage by using Docent confidential employee information to solicit and hire certain Docent employees. In addition, the complaint alleges that Saba and the two employees used certain Docent proprietary information to interfere with Docent’s client and prospective client relationships. On October 26, 2004 we entered into a settlement agreement with Docent. Under the terms of the settlement agreement, the litigation was dismissed. The settlement will have no material impact on our financial condition or operations.

 

We are also party to various legal disputes and proceedings arising from the ordinary course of general business activities. While, in the opinion of management, resolution of these matters is not expected to have a material adverse effect on our consolidated financial position, results of operations or cash flows, the ultimate outcome of any litigation is uncertain. Were an unfavorable outcome to occur, the impact could be material to us.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

Not applicable.

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

None.

 

ITEM 5. OTHER INFORMATION

 

None.

 

ITEM 6. EXHIBITS

 

a. Exhibits

 

See Exhibit Index following the signature page.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

   

SABA SOFTWARE, INC.

Dated: April 14, 2005

 

By:

 

/s/ Bobby Yazdani


        Chief Executive Officer and Chairman of the Board
        (Principal Executive Officer)
   

By:

 

/s/ Peter E. Williams III


        Chief Financial Officer (Principal Financial and Accounting Officer)

 

 

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EXHIBIT INDEX

 

Exhibit
Number


 

Document


2.1   Agreement and Plan of Merger by and among the Company, Storm Holding Corporation, a Delaware corporation that is a wholly-owned subsidiary of the Company (“Holding”), Storm Acquisition Corporation, a Delaware corporation that is a wholly-owned subsidiary of Holding (the “Subsidiary”), THINQ Learning Solutions, Inc, a Delaware corporation and an unaffiliated entity (“THINQ”), and Daniel H. Bathon, Jr. as representative of the stockholders of THINQ.
3.1(1)   Amended and Restated Certificate of Incorporation of the Company effective as of April 12, 2000.
3.2(2)   Amended and Restated Bylaws of the Company effective as of September 18, 2003.
3.3(3)   Certificate of Amendment to Amended and Restated Certificate of Incorporation of the Company effective as of May 12, 2003.
3.4(4)   Certificate of Amendment to Amended and Restated Certificate of Incorporation of the Company effective as of November 19, 2004.
4.1   Reference is made to Exhibits 3.1, 3.2, 3.3 and 3.4.
31.1   Certification of Bobby Yazdani, Chief Executive Officer and Chairman of the Board, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2   Certification of Peter E. Williams, Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1   Certification of Bobby Yazdani, Chief Executive Officer and Chairman of the Board, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2   Certification of Peter E. Williams, Chief Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(1) Incorporated by reference to Exhibit 3.3 to the Company’s Registration Statement on Form S-1 (Registration No. 333-95761) previously filed with the SEC.
(2) Incorporated by reference to the Company’s annual report on Form 10-K for the period ended May 31, 2004, previously filed with the SEC.
(3) Incorporated by reference to the Company’s quarterly report on Form 10-Q for the period ended November 30, 2003, previously filed with the SEC.
(4) Incorporated by reference to the Company’s quarterly report on Form 10-Q for the period ended November 30, 2004, previously filed with the SEC.
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