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TIBCO Software 10-Q 2006

Documents found in this filing:

  1. 10-Q
  2. Ex-10.1
  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

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 


(Mark One)

 

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

For the quarterly period ended March 5, 2006

OR

 

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

For the transition period from                          to                         

Commission File Number: 000-26579

TIBCO SOFTWARE INC.

(Exact name of registrant as specified in its charter)

 


 

Delaware   77-0449727

(State or other jurisdiction

of incorporation or organization)

 

(I.R.S. Employer

Identification No.)

3303 Hillview Avenue

Palo Alto, California 94304-1213

(Address of principal executive offices) (Zip code)

Registrant’s telephone number, including area code: (650) 846-1000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes x    No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer x             Accelerated filer ¨             Non-accelerated filer ¨

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

The number of shares outstanding of the registrant’s Common Stock, $0.001 par value, as of April 10, 2006 was 210,512,518 shares.

 



Table of Contents

TIBCO SOFTWARE INC.

INDEX

 

Item

        Page No.

PART I—FINANCIAL INFORMATION

  

Item 1

   Financial Statements (Unaudited):   
   Condensed Consolidated Balance Sheets as of February 28, 2006 and November 30, 2005    3
   Condensed Consolidated Statements of Operations for the three months ended February 28, 2006 and February 28, 2005    4
   Condensed Consolidated Statements of Cash Flows for the three months ended February 28, 2006 and February 28, 2005    5
   Notes to Condensed Consolidated Financial Statements    6

Item 2

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    30

Item 3

   Quantitative and Qualitative Disclosures about Market Risk    44

Item 4

   Controls and Procedures    45

PART II—OTHER INFORMATION

  

Item 1A

   Risk Factors    46

Item 2

   Unregistered Sales of Equity Securities and Use of Proceeds    55

Item 6

   Exhibits    55
   Signatures    56

 

2


Table of Contents

TIBCO SOFTWARE INC.

PART I—FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(in thousands, except par value per share)

 

     As of
February 28,
2006
    As of
November 30,
2005
 

ASSETS

    

Current assets:

    

Cash and cash equivalents

   $ 110,829     $ 208,756  

Short-term investments

     388,305       268,882  

Accounts receivable, net of allowances; $4,158 and $4,521, respectively

     97,155       121,159  

Accounts receivable from related parties

     —         1,243  

Other current assets

     18,794       18,111  
                

Total current assets

     615,083       618,151  

Property and equipment, net

     115,647       116,457  

Goodwill

     262,924       261,075  

Acquired intangible assets, net

     61,786       64,742  

Long-term deferred income tax assets

     27,440       27,440  

Other assets

     36,278       34,559  
                

Total assets

   $ 1,119,158     $ 1,122,424  
                

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Current liabilities:

    

Accounts payable

   $ 10,164     $ 9,656  

Accrued liabilities

     47,836       59,872  

Accrued restructuring and excess facilities costs

     5,574       5,840  

Deferred revenue

     81,269       82,300  

Current portion of long-term debt

     1,821       1,798  
                

Total current liabilities

     146,664       159,466  

Accrued excess facilities costs, less current portion

     22,920       24,149  

Long-term deferred income tax liabilities

     13,875       13,875  

Long-term debt

     47,881       48,345  

Other long-term liabilities

     2,855       2,970  
                

Total long-term liabilities

     87,531       89,339  

Total liabilities

     234,195       248,805  

Stockholders’ equity:

    

Common stock, $0.001 par value; 1,200,000 shares authorized; 210,372 and 210,548 shares issued and outstanding, respectively

     210       211  

Additional paid-in capital

     931,469       928,830  

Unearned stock-based compensation

     —         (123 )

Accumulated other comprehensive loss

     (11,364 )     (14,346 )

Accumulated deficit

     (35,352 )     (40,953 )
                

Total stockholders’ equity

     884,963       873,619  
                

Total liabilities and stockholders’ equity

   $ 1,119,158     $ 1,122,424  
                

See accompanying notes to condensed consolidated financial statements.

 

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TIBCO SOFTWARE INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands, except per share data)

 

     Three Months Ended  
     February 28,
2006
    February 28,
2005
 

Revenue:

    

License revenue:

    

Non-related parties

   $ 48,149     $ 36,650  

Related parties

     —         14,370  
                

Total license revenue

     48,149       51,020  
                

Service and maintenance revenue:

    

Non-related parties

     64,630       49,138  

Related parties

     —         2,780  

Billed expenses

     1,801       1,208  
                

Total service and maintenance revenue

     66,431       53,126  
                

Total revenue

     114,580       104,146  
                

Cost of revenue:

    

Cost of license

     3,909       2,932  

Cost of service and maintenance

     28,766       24,639  
                

Total cost of revenue

     32,675       27,571  
                

Gross profit

     81,905       76,575  
                

Operating expenses:

    

Research and development

     21,977       16,190  

Sales and marketing

     38,648       34,206  

General and administrative

     10,386       9,800  

Amortization of acquired intangible assets

     2,364       1,883  
                

Total operating expenses

     73,375       62,079  
                

Income from operations

     8,530       14,496  

Interest income

     4,386       2,784  

Interest expense

     (654 )     (682 )

Other income, net

     47       353  
                

Income before income taxes

     12,309       16,951  

Provision for income taxes

     6,708       6,563  
                

Net income

   $ 5,601     $ 10,388  
                

Net income per share – Basic

   $ 0.03     $ 0.05  
                

Shares used to compute net income per share – Basic

     210,577       214,751  
                

Net income per share – Diluted

   $ 0.03     $ 0.04  
                

Shares used to compute net income per share – Diluted

     220,170       233,675  
                

See accompanying notes to condensed consolidated financial statements.

 

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TIBCO SOFTWARE INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)

 

     Three Months Ended  
     February 28,
2006
    February 28,
2005
 

Cash flows from operating activities:

    

Net income

   $ 5,601     $ 10,388  

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation of property and equipment

     3,762       3,554  

Amortization of acquired intangible assets

     3,694       3,516  

Stock-based compensation

     4,587       93  

Other non-cash adjustments, net

     13       20  

Changes in assets and liabilities:

    

Accounts receivable

     24,028       26,481  

Due from related parties, net

     1,243       (11,819 )

Other assets

     (1,136 )     630  

Accounts payable

     468       1,064  

Accrued liabilities, restructuring and excess facilities costs

     (10,417 )     (19,781 )

Deferred revenue

     (1,049 )     10,016  
                

Net cash provided by operating activities

     30,794       24,162  
                

Cash flows from investing activities:

    

Purchases of short-term investments

     (164,912 )     (103,896 )

Sales and maturities of short-term investments

     45,523       26,857  

Purchases of property and equipment

     (2,832 )     (2,769 )

Purchases of private equity investments

     (17 )     —    

Restricted cash pledged as security

     (1,116 )     —    
                

Net cash used for investing activities

     (123,354 )     (79,808 )
                

Cash flows from financing activities:

    

Proceeds from exercise of stock options

     6,551       8,187  

Proceeds from employee stock purchase program

     1,061       2,969  

Repurchase of the Company’s common stock

     (13,221 )     (1,769 )

Principal payments on long term debt

     (441 )     (417 )
                

Net cash provided by (used for) financing activities

     (6,050 )     8,970  
                

Effect of exchange rate changes on cash

     683       (49 )
                

Net change in cash and cash equivalents

     (97,927 )     (46,725 )

Cash and cash equivalents—beginning of the period

     208,756       180,849  
                

Cash and cash equivalents—end of the period

   $ 110,829     $ 134,124  
                

Supplemental cash flow information:

    

Cash paid for taxes

   $ 3,458     $ 920  

Cash paid for interest

     654       656  

See accompanying notes to condensed consolidated financial statements.

 

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TIBCO SOFTWARE INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared by TIBCO Software Inc. (the “Company” or “TIBCO”) in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States of America have been condensed or omitted in accordance with such rules and regulations. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary to state fairly the financial position of the Company, and its results of operations and cash flows. These condensed consolidated financial statements should be read in conjunction with the annual audited consolidated financial statements and notes thereto as of and for the year ended November 30, 2005 included in the Company’s Annual Report on Form 10-K filed with the SEC on February 10, 2006.

The condensed consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

Certain reclassifications have been made to prior year balances in order to conform to the current period presentation. These reclassifications had no impact on previously reported net income or cash flows.

Our fiscal year ends on November 30th of each year. For purposes of presentation, we have indicated the first quarter of fiscal years 2006 and 2005 as ended on February 28, 2006 and 2005, respectively; whereas in fact, the first quarter of fiscal years 2006 and 2005 actually ended on March 5, 2006 and February 27, 2005, respectively.

The results of operations for the three months ended February 28, 2006 are not necessarily indicative of the results that may be expected for the year ending November 30, 2006 or any other future period, and we make no representations related thereto.

Use of Estimates

The preparation of the consolidated financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

 

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Revenue Recognition

License revenue consists principally of revenue earned under software license agreements. License revenue is generally recognized when a signed contract or other persuasive evidence of an arrangement exists, the software has been shipped or electronically delivered, the license fee is fixed or determinable, and collection of the resulting receivable is reasonably assured. When contracts contain multiple elements wherein vendor specific objective evidence exists for all undelivered elements, we account for the delivered elements in accordance with the “Residual Method” prescribed by SOP 98-9. Revenue from subscription license agreements, which include software, rights to unspecified future products and maintenance, is recognized ratably over the term of the subscription period. Revenue on shipments to resellers, which is generally subject to certain rights of return and

 

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TIBCO SOFTWARE INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

price protection, is recognized when the products are sold by the resellers to an end-user customer and recorded net of related costs to the resellers. Providing all other revenue criteria are met, non-refundable, prepaid fees from OEM customers are generally recognized upon delivery and on-going royalty fees are generally recognized upon reported units shipped.

Professional services revenue consists primarily of revenue received for assisting with the implementation of our software, on-site support, training and other consulting services. Many customers who license our software also enter into separate professional services arrangements with the Company. In determining whether professional services revenue should be accounted for separately from license revenue, we evaluate, among other factors, the nature of our software products; whether they are ready for use by the customer upon receipt; the nature of our implementation services, which typically do not involve significant customization to or development of the underlying software code; the availability of services from other vendors; whether the timing of payments for license revenue is coincident with performance of services and whether milestones or acceptance criteria exist that affect the realizability of the software license fee. Substantially all of our professional services arrangements are billed on a time and materials basis and, accordingly, are recognized as the services are performed. Contracts with fixed or not-to-exceed fees are recognized on a proportional performance basis. If there is significant uncertainty about the project completion or receipt of payment for professional services, revenue is deferred until the uncertainty is sufficiently resolved. Training revenue is recognized as training services are delivered.

For arrangements that do not qualify for separate accounting for the license and professional services revenues, including arrangements that involve significant modification or customization of the software, that include milestones or customer specific acceptance criteria that may affect collection of the software license fees, or where payment for the software license is tied to the performance of professional services, software license revenue is generally recognized together with the professional services revenue using either the percentage-of-completion or completed-contract method. Under the percentage-of-completion method, revenue recognized is equal to the ratio of costs expended to date to the anticipated total contract costs, based on current estimates of costs to complete the project. If the total estimated costs to complete a project exceed the total contract amount, indicating a loss, the entire anticipated loss would be recognized currently.

Maintenance revenue consists of fees for providing software updates on a when and if available basis and technical support for software products (“post-contract support” or “PCS”). Maintenance revenue is recognized ratably over the term of the agreement.

Payments received in advance of services performed are deferred. Allowances for estimated future returns and discounts are provided for upon recognition of revenue.

Stock-Based Compensation – Employee Stock-Based Awards

On December 1, 2005, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) which requires the measurement and recognition of compensation expense for all stock-based awards made to employees and directors including employee stock options and employee stock purchases under the Employee Stock Purchase Plan (“ESPP”) based on estimated fair values. SFAS 123(R) supersedes previous accounting under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) for periods beginning in fiscal year 2006. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”) providing supplemental implementation guidance for SFAS 123(R). We have applied the provisions of SAB 107 in our adoption of SFAS 123(R).

 

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TIBCO SOFTWARE INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

SFAS 123(R) requires companies to estimate the fair value of stock-based awards on the date of grant using an option pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our Consolidated Statements of Operations. We adopted SFAS 123(R) using the modified prospective transition method which requires the application of the accounting standard starting from December 1, 2005, the first day of our fiscal year 2006. Our Consolidated Financial Statements, as of and for the three months ended February 28, 2006, reflect the impact of SFAS 123(R). Stock-based compensation expense for the three months ended February 28, 2006, was $4.6 million, which consisted primarily of stock-based compensation expense related to employee stock options recognized under SFAS 123(R). Our ESPP as modified in 2005, is deemed to be non-compensatory, and therefore, no stock-based compensation expense was recognized related to our ESPP.

Prior to the adoption of SFAS 123(R), we accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB 25 as allowed under Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). Under the intrinsic value method, no stock-based compensation expense for employee stock options had been recognized in our Consolidated Statements of Operations, because the exercise price of our stock options granted to employees and directors equaled the fair market value of the underlying stock at the date of grant. In accordance with the modified prospective transition method we used in adopting SFAS 123(R), our results of operations prior to fiscal year 2006 have not been restated to reflect, and do not include, the possible impact of SFAS 123(R).

Stock-based compensation expense recognized during a period is based on the value of the portion of stock-based awards that is ultimately expected to vest during the period. Stock-based compensation expense recognized in the three months ended February 28, 2006, included compensation expense for stock-based awards granted prior to, but not yet vested as of November 30, 2005, based on the fair value on the grant date estimated in accordance with the pro forma provisions of SFAS 123, and compensation expense for the stock-based awards granted subsequent to November 30, 2005, based on the fair value on the grant date estimated in accordance with the provisions of SFAS 123(R). In conjunction with the adoption of SFAS 123(R), we changed our method of attributing the value of stock-based compensation expense from the accelerated multiple-option method to the ratable single-option method. Compensation expense for all stock-based awards granted on or prior to November 30, 2005, will continue to be recognized using the accelerated multiple-option approach, while compensation expense for all stock-based awards granted subsequent to November 30, 2005, will be recognized using the ratable single-option method. As stock-based compensation expense recognized in our results for the first quarter of fiscal year 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Prior to fiscal year 2006, we accounted for forfeitures as they occurred for the purposes of pro forma information under SFAS 123, as disclosed in our Notes to Consolidated Financial Statements for the related periods.

Upon adoption of SFAS 123(R), we selected the Black-Scholes option pricing model as the most appropriate method for determining the estimated fair value for stock-based awards. The Black-Scholes model requires the use of highly subjective and complex assumptions which determine the fair value of stock-based awards, including the option’s expected term and the price volatility of the underlying stock. We determined that a blend of implied volatility and historical volatility is more reflective of the market conditions and a better indicator of expected volatility than solely using historical volatility.

Generally, stock options granted from our 1996 Stock Option Plan (“1996 Plan”) prior to December 1, 2005 have a contractual term of ten years from the date of grant, and stock options granted from our 1996 Plan on or after December 1, 2005 have a contractual term of seven years from the date of grant.

 

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TIBCO SOFTWARE INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

On November 10, 2005, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position No. FAS 123(R)-3 “Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards” that allows for a simplified method to establish the beginning balance of the additional paid-in capital pool (“APIC Pool”) related to the tax effects of employee stock-based compensation, and to determine the subsequent impact on the APIC Pool and Consolidated Statements of Cash Flows of the tax effects of employee stock-based compensation awards that are outstanding upon adoption of SFAS 123(R). We are still in the process of calculating the APIC Pool and have not yet determined if we will elect to adopt the simplified method.

Also see Note 9 for further discussion on stock-based compensation.

Stock-Based Compensation – Non-Employee Stock Options and Stock Options Assumed from Business Combinations

We account for stock compensation expense related to stock options granted to non-employees based on the fair value estimated using the Black-Scholes option pricing model on the date of grant and remeasured at each reporting date in compliance with Emerging Issues Task Force (“EITF”) No. 96-18 “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.” Compensation expense was amortized using the multiple option approach in compliance with FASB Interpretation No. (“FIN”) 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans.”

Pursuant to FIN 44 “Accounting for Certain Transactions Involving Stock Compensation—an Interpretation of APB 25,” options assumed in a purchase business combination are valued at the date of acquisition at their fair value calculated using the Black-Scholes option pricing model. The fair value of assumed options is included as a component of the purchase price. The intrinsic value attributable to unvested options is recorded as unearned stock-based compensation and amortized over the remaining vesting period of the options.

Income Tax

We make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes.

We assess the likelihood that we will be able to recover our deferred tax assets. We consider all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance. If recovery is not likely, we increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be recoverable. If recovery becomes likely, we may release part or all of our valuation allowance against the deferred tax assets that we estimate will ultimately be recoverable.

Also see Note 11, Provision for Income Taxes.

Net Income Per Share

Basic net income per share is computed by dividing the net income available to common stockholders for the period by the weighted average number of common shares outstanding during the period less common shares subject to repurchase. Diluted net income per share is computed by dividing the net income for the period by the

 

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TIBCO SOFTWARE INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

weighted average number of common shares and potential common shares outstanding during the period if their effect is dilutive. Certain potential common shares were not included in computing net income per share because their effect was anti-dilutive.

Also see Note 12, Net Income Per Share.

Cash, Cash Equivalents, and Short-Term Investments

We consider all highly liquid investment securities with remaining maturities, at the date of purchase, of three months or less to be cash equivalents. Management determines the appropriate classification of marketable securities at the time of purchase and evaluates such designation as of each balance sheet date. To date, all marketable securities have been classified as available-for-sale and are carried at fair value with unrealized gains and losses, if any, included as a component of accumulated other comprehensive income (loss) in stockholders’ equity. These available-for-sale investments are presented as current assets as they are subject to use within one year in current operations. Interest, dividends and realized gains and losses are included in interest income and other income (expense). Realized gains and losses are recognized based on the specific identification method.

Also see Note 3, Investments in Marketable Securities.

Valuation and Impairment of Short-Term Investments

We monitor our investment portfolio for impairment on a periodic basis. In the event that the carrying value of an investment exceeds its fair value and the decline in value is determined to be other-than-temporary, an impairment charge is recorded and a new cost basis for the investment is established. In order to determine whether a decline in value is other-than-temporary, we evaluate, among other factors: the duration and extent to which the fair value has been less than the carrying value; our financial condition and business outlook, including key operational and cash flow metrics, current market conditions and future trends in the our industry; our relative competitive position within the industry; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in fair market value.

In accordance with EITF 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” the following table summarizes the fair value and gross unrealized losses related to available-for-sale securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of February 28, 2006 (in thousands):

 

     Less than 12 months     Greater than 12 months     Total  
     Fair
Value
   Gross
Unrealized
Losses
    Fair
Value
   Gross
Unrealized
Losses
    Fair
Value
   Gross
Unrealized
Losses
 

U.S. Government debt securities

   $ 60,933    $ (472 )   $ 64,405    $ (165 )   $ 125,338    $ (637 )

Corporate debt securities

     98,341      (691 )     44,816      (188 )     143,157      (879 )

Asset-backed securities

     57,962      (375 )     4,288      (12 )     62,250      (387 )

Mortgage-backed securities

     15,619      (86 )     —        —         15,619      (86 )

Obligations in foreign sovereigns

     1,020      (4 )     —        —         1,020      (4 )
                                             
   $ 233,875    $ (1,628 )   $ 113,509    $ (365 )   $ 347,384    $ (1,993 )
                                             

U.S. Government Debt Securities: The unrealized losses on our investments in U.S. Treasury obligations and direct obligations of U.S. Government agencies were caused by rising interest rates. The contractual terms of

 

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TIBCO SOFTWARE INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

these investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. Because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired as of February 28, 2006.

Corporate Debt Securities: The unrealized losses on our investments in corporate bonds were caused by rising interest rates. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. The corporate bonds that we hold are all high investment grade, and no credit events occurred which relate to any of these corporate bonds. Therefore, we do not believe it is probable that we will be unable to collect all amounts due according to the contractual terms of the investments. It is expected that the corporate bonds would not be settled at a price less than the amortized cost of the investment. Because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired as of February 28, 2006.

Asset-Backed Securities: The unrealized losses on our investments in asset-backed securities were caused by rising interest rates. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. The asset-backed securities that we hold are all high investment grade, and no credit events occurred which relate to any of these asset-backed securities. Therefore, we do not believe it is probable that we will be unable to collect all amounts due according to the contractual terms of the investments. It is expected that the asset-backed securities would not be settled at a price less than the amortized cost of the investment. Because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired as of February 28, 2006.

Mortgage-Backed Securities: The unrealized losses on our investments in mortgage-backed securities were caused by rising interest rates. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. The mortgage-backed securities that we hold are all high investment grade, and no credit events occurred which relate to any of these mortgage-backed securities. Therefore, we do not believe it is probable that we will be unable to collect all amounts due according to the contractual terms of the investments. It is expected that the mortgage-backed securities would not be settled at a price less than the amortized cost of the investment. Because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired as of February 28, 2006.

Obligations in Foreign Sovereigns: The unrealized losses on our investments in foreign sovereign obligations were caused by rising interest rates. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. Because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired as of February 28, 2006.

Other Investments

Our investments also include minority equity investments in privately held companies that are generally carried at cost basis and are included in other assets on the balance sheet. The fair value of these investments is dependent on the performance of the companies in which we invested, as well as the volatility inherent in external markets for these investments. In assessing potential impairment, we consider these factors as well as

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

each of the companies’ cash position, earnings/revenue outlook, liquidity and management/ownership. If we believe that an other-than-temporary decline exists, we write down the investment to market value and record the related write-down as a loss on investments in our consolidated statement of operations. The carrying value of our minority equity investments is $2.3 million as of February 28, 2006 and November 30, 2005. No impairment losses were incurred in the periods presented.

Goodwill and Other Intangible Assets

In accordance with SFAS 142, “Goodwill and Other Intangible Assets,” goodwill and intangible assets with indefinite useful lives are not amortized, but are tested for impairment at least annually or as circumstances indicate their value may no longer be recoverable. Goodwill impairment testing is a two-step process: first we screen for impairment, and if any possible impairment exists, we then undertake a second step of measuring such impairment. Other purchased intangible assets with definite useful lives are amortized over their useful lives.

Also see Note 4, Goodwill and Other Intangible Assets.

Impairment of Long-Lived Assets

We evaluate the recoverability of our long-lived assets in accordance with SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” When events or changes in circumstances indicate that the carrying amount of long-lived assets may not be recoverable, we recognize such impairment in the event the net book value of such assets exceeds the future undiscounted cash flows attributable to such assets. No impairment losses were incurred in the periods presented.

Restructuring and Integration Costs

Our restructuring charges are comprised primarily of costs related to properties abandoned in connection with facilities consolidation, related write-down of leasehold improvements and severance and associated employee termination costs related to headcount reductions. For restructuring actions initiated prior to December 31, 2002, we followed the guidance provided by EITF 94-3 “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity.” We recorded the liability related to these termination costs when the plan was approved; the termination benefits were determined and communicated to the employees; the number of employees to be terminated, their locations and jobs were specifically identified; and the period of time to implement the plan was set. For restructuring actions initiated after January 1, 2003, we adopted SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities” which requires that a liability for costs associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred.

Our restructuring charges included accruals for estimated losses on facility costs based on our contractual obligations net of estimated sublease income based on current comparable market rates for leases. We reassess this liability periodically based on market conditions. Revisions to our estimates of this liability could materially impact our operating results and financial position in future periods if anticipated events and key assumptions, such as the timing and amounts of sublease rental income, either change or do not materialize. Should facilities operating lease rental rates continue to decrease in these markets or should it take longer than expected to find a suitable tenant to sublease these facilities, the actual loss as of February 28, 2006, could exceed this estimate by approximately $2.4 million.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

3. INVESTMENTS IN MARKETABLE SECURITIES

Marketable securities as of February 28, 2006, and November 30, 2005, which are classified as available-for-sale, are summarized below (in thousands):

 

     Purchase/
Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Aggregate
Fair
Value
   Classified on
Balance Sheet as:
                Cash and
Cash
Equivalents
   Short-term
Investments

As of February 28, 2006:

                

U.S. Government debt securities

   $ 130,828    $ 4    $ (637 )   $ 130,195    $ 8,965    $ 121,229

Corporate debt securities

     215,402      12      (879 )     214,535      46,750      167,786

Asset-backed securities

     71,973      3      (387 )     71,589      —        71,589

Mortgage-backed securities

     26,759      12      (86 )     26,685      —        26,685

Obligations in foreign sovereigns

     1,020      —        (4 )     1,016      —        1,016

Money market funds

     5,597      —        —         5,597      5,597      —  
                                          

Total

   $ 451,579    $ 31    $ (1,993 )   $ 449,617    $ 61,312    $ 388,305
                                          

As of November 30, 2005:

                

U.S. Government debt securities

   $ 117,639    $ —      $ (950 )   $ 116,689    $ —      $ 116,689

Corporate debt securities

     270,779      10      (797 )     269,992      153,823      116,169

Asset-backed securities

     36,273      7      (264 )     36,016      —        36,016

Marketable equity securities

     6      2      —         8      —        8

Money market funds

     8,865      —        —         8,865      8,865      —  
                                          

Total

   $ 433,562    $ 19    $ (2,011 )   $ 431,570    $ 162,688    $ 268,882
                                          

Fixed income securities included in short-term investments above, are summarized by their contractual maturities as follows (in thousands):

 

     As of
February 28,
2006
   As of
November 30,
2005

Contractual maturities:

     

Less than one year

   $ 146,640    $ 152,520

One to three years

     241,665      116,354
             

Total

   $ 388,305    $ 268,874
             

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

The following table summarizes the net realized gains (losses) on short-term investments for the periods presented (in thousands):

 

     Three Months Ended  
    

February 28,

2006

   

February 28,

2005

 

Realized gains

   $ 5     $ —    

Realized losses

     (1 )     (20 )
                

Net realized gains (losses)

   $ 4     $ (20 )
                

 

4. GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill is not amortized, but is tested for impairment at least annually, or sooner, if circumstances indicate impairment may have occurred. SFAS 142 prescribes a two-step process for impairment testing of goodwill. For the first step we screen for impairment, and if a possible impairment exists, we undertake a second step of measuring such impairment. We generally perform our goodwill impairment test annually in our fourth fiscal quarter, and the last impairment test was completed for the fiscal year ended November 30, 2005. SFAS 142 requires impairment testing based on reporting units. We periodically re-evaluate our business and have determined that we continue to operate in one segment, which we consider our sole reporting unit. Therefore, goodwill was tested and will continue to be tested for impairment at the enterprise level. To date, we have determined that there has been no impairment of goodwill.

The change in the carrying amount of goodwill for the three months ended February 28, 2006 was as follows (in thousands):

 

     Goodwill

Balance as of November 30, 2005

   $ 261,075

Changes in the three months ended February 28, 2006

  

Currency adjustment

     1,849
      

Balance as of February 28, 2006

   $ 262,924
      

Our acquired intangible assets are subject to amortization on a straight line basis over their estimated useful lives as follows:

 

     Estimated Life   

Weighted Average Life

As of February 28,
2006

Developed technologies

   3 to 5 years    4.8 years

Customer base

   3 to 5 years    4.8 years

Patents/core technologies

   4 to 8 years    7.7 years

Trademarks

   3.5 to 5 years    4.9 years

Non-compete agreements

   2 to 3 years    2.3 years

OEM customer royalty agreements

   5 years    5.0 years

Maintenance agreements

   3.5 to 9 years    8.2 years

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

The carrying values of our amortized acquired intangible assets as of February 28, 2006 and November 30, 2005 are as follows (in thousands):

 

     As of February 28, 2006    As of November 30, 2005
    

Gross

Carrying
Amount

   Accumulated
Amortization
    Net
Carrying
Amount
  

Gross

Carrying
Amount

   Accumulated
Amortization
    Net
Carrying
Amount

Developed technologies

   $ 45,966    $ (29,164 )   $ 16,802    $ 45,721    $ (27,811 )   $ 17,910

Customer base

     21,344      (10,295 )     11,049      21,156      (9,380 )     11,776

Patents/core technology

     14,831      (3,209 )     11,622      14,671      (2,689 )     11,982

Trademarks

     4,986      (2,753 )     2,233      4,947      (2,568 )     2,379

Non-compete agreements

     680      (547 )     133      680      (530 )     150

OEM customer royalty agreements

     1,000      (767 )     233      1,000      (717 )     283

Maintenance agreements

     24,488      (4,774 )     19,714      24,280      (4,018 )     20,262
                                           

Total

   $ 113,295    $ (51,509 )   $ 61,786    $ 112,455    $ (47,713 )   $ 64,742
                                           

Amortization of developed technologies is recorded in cost of revenue, while the amortization of other acquired intangible assets is included in operating expenses. The following summarizes the amortization expense of acquired intangible assets for the periods indicated (in thousands):

 

     Three Months Ended
     February 28,
2006
   February 28,
2005

Amortization of acquired intangible assets:

     

In cost of revenue

   $ 1,330    $ 1,633

In operating expenses

     2,364      1,883
             

Total

   $ 3,694    $ 3,516
             

As of February 28, 2006, we expect the amortization of acquired intangible assets for future periods to be as follows (in thousands):

 

     Estimated
Amortization
Expense

Remainder of fiscal year 2006

   $ 11,083

Fiscal year 2007

     14,655

Fiscal year 2008

     14,329

Fiscal year 2009

     9,777

Fiscal year 2010

     4,888

Thereafter

     7,054
      

Total

   $ 61,786
      

 

5. ACCRUED RESTRUCTURING AND INTEGRATION COSTS

In fiscal year 2005, we initiated a restructuring plan designed to re-align our resources and cost structure, and accordingly recognized a restructuring charge of approximately $3.9 million for the resulting workforce reduction. The restructuring plan eliminated 49 employees, across all functions and primarily in our European

 

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(Unaudited)

 

operations. As of February 28, 2006, $3.6 million related to this plan has been paid and all 49 employees have been terminated. We expect to utilize the remaining accrual by the end of fiscal year 2006.

In connection with our acquisition of Staffware in the third quarter of fiscal year 2004, we recorded an accrual of $2.9 million for the estimated expenses due to the Staffware facilities that we expected to abandon. In addition, we recorded an accrual of $2.6 million for severance related to the termination of redundant Staffware personnel and $0.2 million related to the cancellation of certain marketing programs.

Also in the third quarter of fiscal year 2004, we recorded $2.2 million in additional restructuring charges related to properties vacated in connection with a facilities consolidation. The additional facilities charges resulted from revisions to our estimates of future sublease income due to the prolonged recovery of the applicable real estate market. The estimated excess facilities costs were based on our contractual obligations, net of estimated sublease income, based on current comparable rates for leases in their respective markets.

The following is a summary of activities in accrued restructuring and integration costs for the three months ended February 28, 2006 (in thousands):

 

     Accrued Excess Facilities     Accrued Severance and Other     Total  
     Headquarter
Facilities
    Staffware
Integration
    Subtotal     2005
Restructuring
    Staffware
Integration
    Subtotal    

Balance as of Nov 30, 2005

   $ 28,105     $ 1,137     $ 29,242     $ 747     $ 13     $ 760     $ 30,002  

Net cash utilized

     (867 )     (189 )     (1,056 )     (439 )     (13 )     (452 )     (1,508 )
                                                        

Balance as of February 28, 2006

   $ 27,238     $ 948     $ 28,186     $ 308     $ —       $ 308     $ 28,494  
                                                        

The remaining accrued excess facilities costs represent the estimated loss on abandoned facilities, net of sublease income, which is expected to be paid over the next six years. As of February 28, 2006, $22.9 million of the $28.5 million accrued restructuring and excess facilities costs were classified as long-term liabilities based on our current expectation that we will have to pay the remaining lease payments over the remaining term of the related leases.

 

6. LONG TERM DEBT AND LINE OF CREDIT

Mortgage Note Payable

In connection with the purchase of our corporate headquarters in June 2003, we recorded a $54.0 million mortgage note payable to a financial institution collateralized by the commercial real property acquired. The balance on the mortgage note payable was $49.7 million and $50.1 million as of February 28, 2006 and November 30, 2005, respectively.

The mortgage note payable carries a fixed annual interest rate of 5.09% and a 20-year amortization. The $33.9 million principal balance that will be remaining at the end of the 10-year term will be due as a final lump sum payment on July 1, 2013. Under the currently applicable terms of the mortgage note agreements, we are prohibited from acquiring another company without prior consent from the lender unless we maintain at least $300.0 million of cash or cash equivalents, and meet other non-financial terms as defined in the agreements. In addition, we are subject to certain non-financial covenants as defined in the agreements. We were in compliance with all covenants as of February 28, 2006.

 

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In 2003, we also capitalized $0.7 million in financing fees in connection with the mortgage note payable. These fees are being amortized to interest expense over the ten-year term of the loan.

Line of Credit

We have a $20.0 million revolving line of credit that matures on June 21, 2006. The revolving line of credit is available for cash borrowings and for the issuance of letters of credit up to $20.0 million. As of February 28, 2006, no borrowings were outstanding under the facility and a $13.0 million irrevocable letter of credit was outstanding, leaving $7.0 million of available credit for additional letters of credit or cash borrowings. The $13.0 million irrevocable letter of credit outstanding was issued in connection with the mortgage note payable. The letter of credit automatically renews for successive one-year periods, until the mortgage note payable has been satisfied in full. We are required to maintain a minimum of $40.0 million in unrestricted cash, cash equivalents, and short-term investments, net of total current and long-term indebtedness, as well as comply with other non-financial covenants defined in the agreement. As of February 28, 2006, we were in compliance with all covenants under the revolving line of credit.

 

7. COMMITMENTS AND CONTINGENCIES

Letters of Credit and Bank Guarantees

In connection with the mortgage note payable (see Note 6), we entered into an irrevocable letter of credit in the amount of $13.0 million. The letter of credit automatically renews for successive one-year periods, until the mortgage note payable has been satisfied in full and is collateralized by the line of credit.

In connection with a facility lease, we have an irrevocable letter of credit in the amount of $4.5 million. The letter of credit automatically renews annually for the duration of the lease term, which expires in December 2010.

We have an additional irrevocable letter of credit in the amount of $0.9 million in connection with a facility surrender agreement. The letter of credit automatically renews annually and expires in June 2006.

As of February 28, 2006, in connection with bank guarantees issued by some of our international subsidiaries, we had $2.9 million of restricted cash which is included in Other Assets on our Condensed Consolidated Balance Sheets.

Prepaid Land Lease

In June 2003, we entered into a 51-year lease of the land upon which our corporate headquarters is located. The lease was paid in advance for a total of $28.0 million, but is subject to adjustments every ten years based upon changes in fair market value. Should it become necessary, we have the option to prepay any rent increases due as a result of a change in fair market value. This prepaid land lease is being amortized using the straight-line method over the life of the lease; the portion to be amortized over the next twelve months is included in Other Current Assets and the remainder is included in Other Assets on our Condensed Consolidated Balance Sheets.

Operating Commitments

We lease office space and equipment under non-cancelable operating leases with various expiration dates through November 2014. Rental expense was approximately $2.4 million and $1.9 million for the three month periods ended February 28, 2006 and 2005, respectively.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

As of February 28, 2006, contractual commitments associated with indebtedness and lease obligations were as follows (in thousands):

 

     Total    

Remainder

of 2006

    2007     2008     2009     2010     Thereafter  

Operating commitments:

              

Debt principal

   $ 49,702     $ 1,357     $ 1,892     $ 1,990     $ 2,094     $ 2,203     $ 40,166  

Debt interest

     15,968       1,875       2,417       2,318       2,215       2,106       5,037  

Operating leases

     28,865       5,693       5,441       4,226       3,446       2,807       7,252  
                                                        

Total operating commitments

     94,535       8,925       9,750       8,534       7,755       7,116       52,455  

Restructuring-related commitments:

              

Gross lease obligations

     35,764       4,973       7,351       7,526       7,551       7,720       643  

Estimated sublease income

     (8,207 )     (2,361 )     (2,284 )     (1,294 )     (1,129 )     (1,050 )     (89 )
                                                        

Net restructuring-related commitment

     27,557       2,612       5,067       6,232       6,422       6,670       554  
                                                        

Total commitments

   $ 122,092     $ 11,537     $ 14,817     $ 14,766     $ 14,177     $ 13,786     $ 53,009  
                                                        

Future minimum lease payments under restructured non-cancelable operating leases are included in Accrued Restructuring and Excess Facilities Costs in our Condensed Consolidated Balance Sheets.

Derivative Instruments

We conduct business in North America, South America, Europe, the Pacific Rim and the Middle East. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or changes in economic conditions in foreign markets. A majority of our sales are currently made in U.S. dollars. To manage currency exposure related to net assets and liabilities denominated in foreign currencies, we enter into forward contracts for certain foreign denominated assets and liabilities. We do not enter into derivative financial instruments for trading purposes. Gains and losses on forward contracts are included in Other Income (Expense) in our Condensed Consolidated Statements of Operations. Our forward contracts generally have original maturities of thirty days. We had four outstanding forward contracts with total notional amounts of $40.5 million as of February 28, 2006, which are summarized as follows (in thousands):

 

    

Notional Value

Local Currency

  

Notional Value

USD

  

Fair Value
Gain/(Loss)

USD

 

Forward contracts (sold)

        

EURO

   27,000    $ 32,473    $ (73 )

British Pound

   2,000      3,505      (7 )

Japanese Yen

   230,000      1,975      5  

South African Rand

   16,000      2,578      28  
                  
      $ 40,531    $ (47 )
                  

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

Indemnifications

Our software license agreements typically provide for indemnification of customers for intellectual property infringement claims. To date, no such claims have been filed against us. We also warrant to customers that software products operate substantially in accordance with the software product’s specifications. Historically, we have incurred minimal costs related to product warranties, and, as such, no accruals for warranty costs have been made. In addition, we indemnify our officers and directors under the terms of indemnity agreements entered into with them, as well as pursuant to our certificate of incorporation, bylaws, and applicable Delaware law. To date, we have incurred costs for the payment of legal fees in connection with the legal proceedings detailed in Note 8, Legal Proceedings.

 

8. LEGAL PROCEEDINGS

Securities Class Action and Shareholder Derivative Suits

In May 2005, three purported shareholder class action complaints were filed against us and several of our officers in the U.S. District Court for the Northern District of California. The plaintiffs in such actions are seeking to represent a class of purchasers of our common stock from September 21, 2004, through March 1, 2005. The complaints generally allege that we made false or misleading statements concerning our operating results, our business and internal controls, and the integration of Staffware and seek unspecified monetary damages. Because the outcome of this litigation is undetermined and we cannot reasonably estimate the possible loss or range of loss which may arise from the litigation, we have not recorded an accrual for possible damages.

In September 2005, a shareholder derivative complaint was filed against certain of our officers and directors in the Superior Court of the State of California, Santa Clara County. The complaint is based on substantially similar facts and circumstances as the class actions and generally alleged that the named directors and officers breached their fiduciary duties to the Company. The complaint seeks unspecified monetary damages. Given the nature of derivative litigation, any recovery in a derivative suit would be to the benefit of the Company.

IPO Allocation Suit

We, certain of our directors and officers and certain investment bank underwriters have been named in a putative class action for violation of the federal securities laws in the U.S. District Court for the Southern District of New York, captioned “In re TIBCO Software Inc. Initial Public Offering Securities Litigation.” This is one of a number of cases challenging underwriting practices in the initial public offerings (“IPOs”) of more than 300 companies, which have been coordinated for pretrial proceedings as “In re Initial Public Offering Securities Litigation.” Plaintiffs generally allege that the underwriters engaged in undisclosed and improper underwriting activities, namely the receipt of excessive brokerage commissions and customer agreements regarding post-offering purchases of stock in exchange for allocations of IPO shares. Plaintiffs also allege that various investment bank securities analysts issued false and misleading analyst reports. The complaint against us claims that the purported improper underwriting activities were not disclosed in the registration statements for our IPO and secondary public offering and seeks unspecified damages on behalf of a purported class of persons who purchased our securities or sold put options during the time period from July 13, 1999, to December 6, 2000.

A lawsuit with similar allegations of undisclosed improper underwriting practices, and part of the same coordinated proceedings, is pending against Talarian Corporation (“Talarian”), which we acquired in 2002. That action is captioned “In re Talarian Corp. Initial Public Offering Securities Litigation.” The complaint against Talarian, certain of its underwriters, and certain of its former directors and officers claims that the purported improper underwriting activities were not disclosed in the registration statement for Talarian’s IPO and seeks

 

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(Unaudited)

 

unspecified damages on behalf of a purported class of persons who purchased Talarian securities during the time period from July 20, 2000, to December 6, 2000.

A proposal to settle the claims against all of the issuers and individual defendants in the coordinated litigation was accepted by us and given preliminary approval by the U.S. District Court for the Southern District of New York. The completion of the settlement is subject to a number of conditions, including final approval by the U.S. District Court for the Southern District of New York. Under the settlement, the plaintiffs will dismiss and release all claims against participating defendants in exchange for a contingent payment guaranty by the insurance companies collectively responsible for insuring the issuers in the action, and the assignment or surrender to the plaintiffs of certain claims the issuer defendants may have against the underwriters. Under the guaranty, the insurers will be required to pay an amount equal to $1.0 billion less any amounts ultimately collected by the plaintiffs from the underwriter defendants in all the cases. Unlike most of the defendant issuers’ insurance policies, including ours, Talarian’s policy contains a specific self-insured retention in the amount of $0.5 million for IPO “laddering” claims, including those alleged in this matter. Thus, under the proposed settlement, if any payment is required under the insurers’ guaranty, our subsidiary, Talarian, would be responsible for paying its pro rata share of the shortfall, up to $0.5 million of the self-insured retention remaining under its policy. The self insured retention of $0.5 million was accrued at the time of the acquisition.

 

9. STOCK BENEFIT PLANS AND STOCK-BASED COMPENSATION

Stock Benefit Plans

1996 Stock Option Plan. In 1996, we adopted the 1996 Plan. The 1996 Plan provides for the granting of stock options to our employees and consultants. Options granted under the 1996 Plan may be either incentive stock options or nonqualified stock options. Incentive stock options may be granted only to employees (including officers and directors who are employees). Nonqualified stock options may be granted to our employees and consultants. Options granted before our IPO in 1999 are exercisable immediately upon grant and generally vest over five years and are subject to repurchase until vested. Options granted after our IPO are not generally exercisable immediately and generally vest over four years. The 1996 Plan provides for an automatic increase to the number of shares of common stock reserved for issuance (to be added on the first day of each fiscal year beginning in 2000) equal to the lesser of (i) 60 million shares, (ii) 5% of the outstanding shares of our common stock, or (iii) a lesser amount determined by the Board of Directors. As of February 28, 2006, there were 28.3 million shares reserved for grant under this plan.

Talarian Stock Option Plans. In April 2002, we assumed all of the Talarian Stock Option Plans (the “Talarian Plans”) in connection with our acquisition of Talarian. At the date of acquisition all outstanding options of Talarian common stock were converted, according to the exchange ratio, into options of our common stock with terms and conditions equivalent to those applicable at the time of conversion. We recorded an initial $0.7 million of deferred compensation related to 486,000 options assumed and converted under the Talarian Plans in fiscal year 2002. Though we have no intention of issuing additional grants, there were 0.1 million shares reserved for grant under the Talarian Plans as of February 28, 2006.

2000 Extensibility Stock Option Plan. In 2000, we adopted the 2000 Extensibility Stock Option Plan (the “Extensibility Plan”) in connection with options assumed in our acquisition of Extensibility. Extensibility employees who continued service with us were granted options with terms and conditions equivalent to those applicable at the date of acquisition. Though we have no intention of issuing additional grants, there were 22,000 shares reserved for grant under this plan as of February 28, 2006.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

1998 Director Option Plan. In February 1998, we adopted the 1998 Director Option Plan (the “Director Plan”). As amended in April 2002, the Director Plan provides for an automatic initial grant of 100,000 shares to members of the Board who are not employees of the Company or Reuters (“External Directors”). At any subsequent annual re-election, each External Director shall be granted an option to purchase 40,000 additional shares. Options are granted at an exercise price not less than the fair market value of the stock on the date of grant and become exercisable over a three-year period with a third of the shares vesting annually. Options granted prior to February 27, 2006 have a term not to exceed ten years, and options granted on or after February 27, 2006 have a term not to exceed seven years. Any External Director with over one year of consecutive service prior to the effective date of the Director Plan received an initial grant of 450,000 shares. As of February 28, 2006, there were 2.5 million shares reserved for grant under this plan.

The activities under all stock option plans are summarized as follows (in thousands, except per share data):

 

     Three Months Ended,
February 28, 2006
     Options    

Weighted Average

Exercise Price

Outstanding at beginning of period

   46,266     $ 7.01

Granted

   359       7.79

Exercised

   (1,384 )     4.73

Canceled

   (581 )     7.52
        

Outstanding at end of period

   44,660       7.08
        

Options exercisable at end of period

   31,881     $ 7.13
        

The following table summarizes information about stock options outstanding as of February 28, 2006 (in thousands, except number of years and per share data):

 

     Options Outstanding    Options Exercisable

Range of Exercise Price

  

Number of

Shares

Underlying

Options

  

Weighted

Average

Remaining

Contractual

Life

  

Weighted

Average

Exercise

Price

  

Number of

Shares

Underlying

Options

  

Weighted

Average

Exercise

Price

$0.20

   5,864    0.82    $ 0.20    5,864    $ 0.20

$0.21 to $5.54

   5,054    5.41      3.47    4,000      3.12

$5.55 to $6.29

   5,408    7.16      6.02    3,780      6.03

$6.30 to $6.63

   5,163    9.16      6.62    955      6.62

$6.64 to $7.30

   5,556    8.28      7.24    2,128      7.26

$7.31 to $8.00

   6,624    6.21      7.93    5,466      7.97

$8.01 to $11.96

   4,811    6.57      10.43    3,682      10.86

$11.97 to $13.58

   5,566    5.90      12.53    5,392      12.53

$13.59 to $71.81

   614    4.29      29.43    614      29.43
                  

Total

   44,660    6.10    $ 7.08    31,881    $ 7.13
                  

Employee Stock Purchase Program. In June 1999, we amended the 1996 Plan to include the ESPP. Employees are generally eligible to participate in the ESPP if they are customarily employed by us for more than 20 hours per week and more than 5 months in a calendar year and are not (and would not become as a result of being granted an option under the ESPP) 5% stockholders of the

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

Company. Under the ESPP, eligible employees may select a rate of payroll deduction up to 10% of their eligible compensation subject to certain maximum purchase limitations.

Our ESPP was modified in 2005, in response to the recent changes in accounting for stock-based payments, as stated in SFAS 123(R). The duration for offering periods was changed to six months and the price at which the common stock is purchased under the ESPP was set at 95% of the fair market value of our common stock on the last day of the respective purchase period. These modifications to the ESPP are effective as of the purchase period beginning February 1, 2005. Since the administrative burden and tax consequences appear to outweigh any benefit that our international employees might receive from participating in the ESPP, we have also chosen to exclude all non-U.S. employees from the ESPP, on a country-by-country basis.

We issued approximately 0.1 million shares under our ESPP, representing approximately $1.1 million in employee contributions for the three months ended February 28, 2006. As of February 28, 2006, there were 0.8 million shares reserved for grant under this program.

Stock-Based Compensation

On December 1, 2005, we adopted SFAS 123(R) using the modified prospective transition method. SFAS 123(R) requires the measurement and recognition of compensation expense for all stock-based awards made to our employees and directors including employee stock options, employee stock purchase plans, and other stock-based awards based on estimated fair values. The following table summarizes the impact of the adoption of SFAS 123(R) on stock-based compensation costs for employees on our Condensed Consolidated Statements of Operations for the three months ended February 28, 2006 and 2005 (in thousands):

 

     Three Months Ended
     February 28,
2006
   February 28,
2005

Employee stock-based compensation in:

     

Cost of license

   $ 15    $ —  

Cost of service and maintenance

     631      —  
             

Total employee stock-based compensation in cost of revenue

     646      —  

Research and development expense

     1,122      —  

Sales and marketing expense

     1,321      —  

General and administrative expense

     1,478      —  
             

Total employee stock-based compensation in operating expense

     3,921      —  
             

Total employee stock-based compensation

     4,567      —  

Total other stock-based compensation (1)

     20      93
             

Total stock-based compensation

   $ 4,587    $ 93
             

(1) Other stock-based compensation represents charges primarily related to non-employee stock options. 

Prior to the adoption of SFAS 123(R), we accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB 25 as allowed under SFAS 123. Under the intrinsic value method, no stock-based compensation expense for employee stock options had been recognized in our results of operations in the prior period, because the exercise price of the stock options granted to employees and

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

directors equaled the fair market value of the underlying stock at the date of grant. In accordance with the modified prospective transition method that we used in adopting SFAS 123(R), our Consolidated Statements of Operations prior to fiscal year 2006 have not been restated to reflect, and do not include, the possible impact of SFAS 123(R). The table below reflects net income and net income per share for the three months ended February 28, 2006, compared with the pro forma information for the three months ended February 28, 2005 (in thousands, except income per share amounts):

 

     Three Months Ended  
    

February 28,

2006

   

February 28,

2005

(pro forma)

 

Net income, before stock-based compensation for employees, prior period

     N/A     $ 10,388  

Add: Stock-based compensation expense for employees previously determined under intrinsic value method, net of tax effect

   $ —         9  

Less: Stock-based compensation expense for employees determined under fair value based method, net of tax effect

     (4,567 )     (7,651 )
          

Net income, after effect of stock-based compensation for employees

   $ 5,601     $ 2,746  
                

Net income per share:

    

Basic – as reported for prior period

     N/A     $ 0.05  
          

Basic – after effect of stock-based compensation for employees

   $ 0.03     $ 0.01  
                

Diluted – as reported for prior period

     N/A     $ 0.04  
          

Diluted – after effect of stock-based compensation for employees

   $ 0.03     $ 0.01  
                

As of February 28, 2006, total unamortized stock-based compensation cost related to non-vested stock options was $17.9 million which is expected to be recognized over the remaining vesting period of each grant, up to the next 48 months. Compensation costs for all stock-based awards granted on or prior to November 30, 2005 will continue to be recognized using the accelerated multiple-option approach, while compensation expense for all stock-based awards granted subsequent to November 30, 2005 will be recognized using the ratable single-option method.

Upon adoption of SFAS 123(R), we selected the Black-Scholes option pricing model as the most appropriate model for determining the estimated fair value for stock-based awards. The use of the Black-Scholes model requires the use of extensive actual employee exercise behavior data and the use of a number of complex assumptions including expected volatility, risk-free interest rate, and expected dividends. The weighted-average estimated value of employee stock options granted was $3.17 and $5.27 per share during the three months ended February 28, 2006 and 2005, respectively. The assumptions used to value options granted are as follows:

 

     Three Months Ended
    

February 28,

2006

 

February 28,

2005

Risk free interest rate

   4.46%   3.53%

Expected term

   4.3 years   3.0 years

Dividend yield

   0.0   0.0

Expected volatility

   43.0%   64.4%

 

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TIBCO SOFTWARE INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

Beginning December 1, 2005, we estimated the volatility of our stock using historical volatility as well as the implied volatility in market-traded options on our common stock in accordance with guidance in SFAS 123(R) and SAB 107. Management determined that a blend of implied volatility and historical volatility is more reflective of market conditions and a better indicator of expected volatility than using purely historical volatility. We will continue to monitor these and other relevant factors used to measure expected volatility for future option grants. Prior to the adoption of SFAS 123(R), we had used our historical stock price volatility in accordance with SFAS 123 for purposes of pro forma information disclosed in our Notes to Consolidated Financial Statements for prior periods.

The risk-free interest rate assumption is based upon observed interest rates appropriate for the term of our employee stock options. The dividend yield assumption is based on our history and expectation of dividend payouts.

The expected term of employee stock options represents the weighted-average period that the stock options are expected to remain outstanding. We derived the expected term assumption based on our historical settlement experience, while giving consideration to options that have life cycles less than the contractual terms and vesting schedules in accordance with guidance in SFAS 123(R) and SAB 107. Prior to the adoption of SFAS 123(R), we used our historical settlement experience to derive the expected term for the purposes of pro forma information under SFAS 123, as disclosed in our Notes to Consolidated Financial Statements for the related periods.

As stock-based compensation expense recognized in our results for the three months ended February 28, 2006, is based on awards ultimately expected to vest, the amount has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based on our historical experience. Prior to fiscal year 2006, we accounted for forfeitures as they occurred for the purposes of our pro forma information under SFAS 123, as disclosed in Notes to Consolidated Financial Statements for the related periods.

 

10. COMPREHENSIVE INCOME

Comprehensive income includes net income and other comprehensive income (loss), which consists of unrealized gains (losses) on available-for-sale securities and cumulative translation adjustments. A summary of the comprehensive income for the periods indicated is as follows (in thousands):

 

     Three Months Ended  
    

February 28,

2006

  

February 28,

2005

 

Net income

   $ 5,601    $ 10,388  

Translation gain (loss)

     2,927      (40 )

Change in unrealized gain (loss) on investments, net of taxes

     55      (856 )
               

Comprehensive income

   $ 8,583    $ 9,492  
               

 

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TIBCO SOFTWARE INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

Components of accumulated other comprehensive income (loss), disclosed as a separate component of stockholder’s equity in the accompanying Condensed Consolidated Balance Sheets, are as follows (in thousands):

 

    

Unrealized Gain

(Loss) in

Available-for-Sale

Securities

   

Foreign

Currency

Translation

   

Accumulated

Other

Comprehensive

Income (Loss)

 

Balance as of November 30, 2005

   $ (2,017 )   $ (12,329 )   $ (14,346 )

Net change during three month period

     55       2,927       2,982  
                        

Balance as of February 28, 2006

   $ (1,962 )   $ (9,402 )   $ (11,364 )
                        

 

11. PROVISION FOR INCOME TAXES

We make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes. Our effective tax rate for the three months ended February 28, 2006 was impacted by our adoption of SFAS 123(R) and additional taxes incurred attributable to repatriation of foreign earnings from our UK subsidiaries in fiscal year 2006.

As part of the process of preparing our Consolidated Financial Statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves us estimating our current tax exposure under the most recent tax laws and assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our Condensed Consolidated Balance Sheets.

We assess the likelihood that we will be able to recover our deferred tax assets. We consider all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance. If recovery is not likely, we increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be recoverable. If recovery becomes likely, we may release part or all of our valuation allowance against the deferred tax assets that we estimate will ultimately be recoverable. The available positive evidence at February 28, 2006, included three years of historical operating profits and a projection of future income limited to three years which coincides with the period over which we recorded historical operating profits, due to our lack of visibility into earnings further into the future. As a result of our analysis of all available evidence, both positive and negative, we have concluded that no additional valuation allowance should be released in the first quarter of fiscal year 2006. We continue to closely monitor available evidence, both positive and negative, and may release additional valuation allowance in future periods.

As of February 28, 2006, we believed that the amount of the deferred tax assets recorded on our balance sheet as a result of the partial release of valuation allowance during fiscal year 2005 would ultimately be recovered. However, should there be a change in our ability to recover our deferred tax assets, our tax provision would increase in the period in which we determine that the recovery is not probable. If we have to re-establish the full valuation allowance, it may result in a charge of $30.2 million to the tax provision.

 

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TIBCO SOFTWARE INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

With the exception of our subsidiaries in the United Kingdom, net undistributed earnings of our foreign subsidiaries are generally considered to be indefinitely reinvested, and accordingly, no provision for U.S. income taxes has been provided thereon. Upon distribution of these earnings in the form of dividends or otherwise, we will be subject to U.S. income taxes net of available net operating loss carryovers and foreign tax credits associated with these earnings.

 

12. NET INCOME PER SHARE

Basic net income per share is computed by dividing the net income available to common stockholders for the period by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing the net income for the period by the weighted average number of common shares and potential common share equivalents outstanding during the period if their effect is dilutive.

The following table sets forth the computation of basic and diluted net income per share for the periods indicated (in thousands, except per share data):

 

     Three Months Ended
     February 28,
2006
   February 28,
2005

Net income

   $ 5,601    $ 10,388
             

Weighted-average common stock shares used to compute basic net income per share

     210,577      214,751

Effect of dilutive common stock equivalents:

     

Options to purchase common stock

     9,593      18,924
             

Weighted-average common stock shares used to compute diluted net income per share

     220,170      233,675
             

Net income per share – Basic

   $ 0.03    $ 0.05
             

Net income per share – Diluted

   $ 0.03    $ 0.04
             

The following potential common share equivalents are not included in the diluted net income per share calculation above, because their effect was anti-dilutive for the periods indicated (in thousands):

 

     Three Months Ended
     February 28,
2006
   February 28,
2005

Options to purchase common stock

   28,066    6,581
         

 

13. RELATED PARTY TRANSACTIONS

Reuters

We have commercial arrangements with affiliates of Reuters Group PLC (“Reuters”), one of our stockholders. During fiscal year 2005, Reuters reduced its holdings such that as of November 30, 2005, Reuters owned less than 1% of our outstanding shares of common stock. Beginning December 1, 2005, Reuters was no longer considered a related party. Transactions with Reuters subsequent to November 30, 2005, are presented

 

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TIBCO SOFTWARE INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

along with other non-related party transactions and are no longer separately disclosed as related party transactions.

Revenue from Reuters consists primarily of product license and maintenance fees on its sales of TIBCO products under the terms of our license, maintenance and distribution agreement with Reuters (the “Reuters Agreement”). Revenue from Reuters, while it was considered a related party during the three months ended February 28, 2005, is summarized as follow (in thousands):

 

     Three Months Ended  
     February 28,
2005
 

License fees

   $ 14,370  

Service and maintenance revenue:

  

Maintenance

     2,729  

Service

     51  
        

Total service and maintenance

     2,780  
        

Total revenue from Reuters as a related party

   $ 17,150  
        

Percent of total revenue

     16 %
        

License revenue from Reuters for the three months ended February 28, 2005, was primarily related to a $9.9 million non-refundable prepaid royalty we received from Reuters pursuant to the terms of an amendment to the Reuters Agreement we entered into in February 2005. We did not have transactions with Reuters of a similar amount in the three months ended February 28, 2006, and we do not expect to have any transaction of a similar amount with Reuters in the near future.

Accounts receivable due from Reuters was $1.2 million as of November 30, 2005. We incurred an immaterial amount in royalty and commission expense payable to Reuters in the three month period ended February 28, 2005.

 

14. SEGMENT INFORMATION

We operate our business in one reportable segment: the development and marketing of a suite of software products that enables businesses to link internal operations, business partners and customer channels through the real-time distribution of information. Operating segments are defined as components of an enterprise for which separate financial information is available and evaluated regularly by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance. Our chief operating decision maker is our Chief Executive Officer.

 

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TIBCO SOFTWARE INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

Our revenue by geographic region, based on the location at which each sale originates, is summarized as follows (in thousands):

 

     Three months Ended
     February 28,
2006
   February 28,
2005

Americas:

     

United States of America

   $ 58,407    $ 54,863

Other Americas

     1,945      976

Europe, Middle East and Africa:

     

United Kingdom

     10,149      25,621

Other Europe

     32,829      15,598

Pacific Rim

     11,250      7,088
             

Total Revenue

   $ 114,580    $ 104,146
             

No customer accounted for more than 10% of total revenue for the three months ended February 28, 2006. Revenue from Reuters accounted for 16% of total revenue for the three months ended February 28, 2005. No customer had a balance in excess of 10% of our net accounts receivable at February 28, 2006, or November 30, 2005.

Our long-lived assets, which are tangible assets such as property and equipment, by major country are summarized as follows (in thousands):

 

     February 28,
2006
   November 30,
2005

United States of America

   $ 108,351    $ 110,063

United Kingdom

     3,565      3,615

Other countries

     3,731      2,779
             

Total long-lived assets

   $ 115,647    $ 116,457
             

 

15. BUSINESS COMBINATIONS

Acquisitions in Fiscal Year 2005

Velosel Corporation. On August 1, 2005, we acquired certain assets of Velosel Corporation (“Velosel”), a Delaware corporation providing customer and product information management. The total purchase price was approximately $3.4 million paid in cash. Substantially all of the purchase price was related to amortizable intangible assets, including developed technologies. The acquired intangible assets are amortizable over their estimated useful lives of three to six years. No goodwill has been recorded for this acquisition as the fair value of acquired assets exceeded the purchase price.

The results of operations of Velosel have been included in our Condensed Consolidated Statements of Operations from August 1, 2005. As the effect of this acquisition would not have been material to our results of operations, pro forma results as if we had acquired Velosel at the beginning of fiscal year 2005 are not presented in this report.

ObjectStar International Limited. On March 7, 2005, we acquired substantially all of the assets and certain liabilities of ObjectStar International Limited (“ObjectStar”), a privately held native mainframe integration

 

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TIBCO SOFTWARE INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

solutions provider. The total purchase price was approximately $21.4 million. We recorded intangible assets of $13.9 million and goodwill of $7.4 million for the transaction. Amounts allocated to developed technology, patents/core technology, and customer base are amortized over their estimated useful lives of five years. Maintenance agreements are amortized over their estimated useful lives of nine years and non-competition agreements are amortized over their estimated useful lives of three years. Goodwill is not being amortized and will be tested for impairment annually, or sooner, if circumstances indicate that impairment may have occurred.

The results of operations of ObjectStar have been included in our Condensed Consolidated Statements of Operations from March 7, 2005. As the effect of this acquisition would not have been material to our results of operations, pro forma results as if we had acquired ObjectStar at the beginning of fiscal year 2005 are not presented in this report.

 

16. STOCK REPURCHASE PROGRAMS

In September 2004, our Board of Directors approved a two-year stock repurchase program pursuant to which we repurchased $50.0 million of our outstanding common stock. The program was completed by the end of the first quarter of fiscal year 2006.

In December 2005, our Board of Directors approved a new eighteen-month stock repurchase program pursuant to which we may repurchase up to $100.0 million of our outstanding common stock. The timing and amount of any repurchases is dependent upon market conditions and other corporate considerations.

During the first quarter of fiscal year 2006, we repurchased 1.7 million shares of our common stock, for a total of $13.2 million. Since the inception of the stock repurchase programs through the end of the first quarter of fiscal year 2006, we had repurchased a total of 8.3 million shares of our common stock, for a total of $62.2 million. The repurchased shares of common stock have been retired. As of the end of the first quarter of fiscal year 2006, $87.8 million remained for future repurchases under the stock repurchase program approved in December 2005.

 

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

The following contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements relate to expectations concerning matters that are not historical facts. Words such as “projects,” “believes,” “anticipates,” “plans,” “expects,” “intends,” and similar words and expressions are intended to identify forward-looking statements. These forward-looking statements include, but are not limited to, statements related to our expected business; results of operations; future financial position; our ability to increase our revenues; the mix of our revenues between license, service and maintenance revenues; the effect of stock-based compensation on our financial results; our financing plans and capital requirements; our costs of revenue; our expenses; our potential tax benefit or liabilities; the effect of recent accounting pronouncements; our investments, debt service and principal repayment obligations; cash flows and our ability to finance operations from cash flows; and similar matters and include statements based on current expectations, estimates, forecasts and projections about the economies and markets in which we operate and our beliefs and assumptions regarding these economies and markets.

These forward-looking statements are based on current expectations and involve known and unknown risks and uncertainties that may cause our actual results, operating performance or achievements to be materially different from those expressed or implied by the forward-looking statements. We believe that the expectations reflected in the forward-looking statements are reasonable, but we cannot assure you that those expectations will prove to be correct. Factors that could cause or contribute to such differences include, but are not limited to, our ability to address new markets and complex technologies by delivering successful, new products on a timely basis; the impact of competitive products and pricing; the success of our strategic relationships; charges for restructuring and option expenses; and other costs and other risk factors detailed in this Quarterly Report on Form 10-Q for the first fiscal quarter of 2006 and other periodic filings with the SEC. All forward-looking statements are expressly qualified in their entirety by these factors and all related cautionary statements. We do not undertake any obligation to update any forward-looking statements.

EXECUTIVE OVERVIEW

Our suite of business integration and process management software solutions makes us a leading enabler of real-time business. We use the term “real-time business” to mean doing business in such a way that organizations can use current information to execute their critical business processes and make smarter decisions. We are the successor to a portion of the business of Teknekron Software Systems, Inc. Teknekron developed software, known as the TIB technology, for the integration and delivery of market data, such as stock quotes, news and other financial information, in trading rooms of large banks and financial services institutions. In 1992, Teknekron expanded its development efforts to include solutions designed to enable complex and disparate manufacturing equipment and software applications, primarily in the semiconductor fabrication market, to communicate within the factory environment. Teknekron was acquired by Reuters, the global information company, in 1994. Following the acquisition, continued development of the TIB technology was undertaken to expand its use in the financial services markets.

In January 1997, our company, TIBCO Software Inc., was established as an entity separate from Teknekron. We were formed to create and market software solutions for use in the integration of business information, processes and applications. In connection with our establishment as a separate entity, Reuters transferred to us certain assets and liabilities related to our business and granted to us a royalty-free license to the intellectual property from which some of our messaging software products originated.

In June 2004, we acquired Staffware plc, a provider of BPM solutions that enable businesses to automate, refine and manage their processes. The addition of Staffware’s BPM solutions enabled us to offer our combined customer base an expanded real-time business integration solution, by making it easier for our customers to

 

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utilize their existing systems through real-time information exchange and automation and management of enterprise business processes regardless of where such processes reside. BPM enables companies to save time and money by driving costs and time out of business processes (for example, reducing error rates or manual steps), while at the same time ensuring that business processes are compliant with internal procedures and external regulations. Our acquisition of Staffware also increased our distribution capabilities through the cross-selling of products into new geographic regions, as well as an expanded customer and partner base.

Our products are currently licensed by companies worldwide in diverse industries such as financial services, telecommunications, retail, healthcare, manufacturing, energy, transportation, logistics, government and insurance. We sell our products through a direct sales force and through alliances with leading software vendors and systems integrators.

Our revenue consists of license, maintenance fees and consulting services from our end user customers and partners who resell our products or embed our software in their hardware and networking systems.

First-year maintenance typically is sold with the related software license and renewed on an annual basis thereafter. Maintenance revenue is determined based on vendor-specific objective evidence (“VSOE”) of fair value and amortized over the term of the maintenance contract, typically twelve months. Consulting and training revenues are typically recognized as the services are performed, which services are usually performed on a time and materials basis. Such services primarily consist of implementation services related to the installation of our products and generally do not include significant customization to or development of the underlying software code.

Our revenue is generally derived from a diverse customer base. No single customer represented greater than 10% of total revenue for the three months ended February 28, 2006. Revenue from Reuters accounted for 16% of total revenue for the three months ended February 28, 2005. As of February 28, 2006, no single customer had a balance in excess of 10% of our net accounts receivable. We establish allowances for doubtful accounts based on our evaluation of collectibility and an allowance for returns and discounts based on specifically identified credits and historical experience.

Relationship with Reuters

Reuters is currently an embedding partner to customers in the financial services segment. The Reuters Agreement restricts our ability to sell risk management and market data distribution products to customers in the financial services market. The limitations on our ability to sell risk management and market data distribution products and on reselling through the specified resellers will expire in May 2008. During fiscal year 2005, Reuters reduced its holdings such that as of November 30, 2005 Reuters owned less than 1% of our outstanding common stock. Transactions with Reuters subsequent to November 30, 2005 are presented along with other non-related party transactions and are no longer separately disclosed as related party transactions.

CRITICAL ACCOUNTING POLICIES

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.

Our significant accounting policies are described in Note 2 to the annual consolidated financial statements as of and for the year ended November 30, 2005, included in our Annual Report on Form 10-K filed with the SEC on February 10, 2006 and notes to condensed consolidated financial statements as of and for the three

 

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month period ended February 28, 2006, included herein. Our most critical accounting policies have not changed since November 30, 2005 and include the following:

 

    Revenue Recognition;

 

    Allowances for Doubtful Accounts, Returns and Discounts;

 

    Stock-Based Compensation;

 

    Valuation and Impairment of Investments;

 

    Goodwill and Other Intangible Assets;

 

    Impairment of Long-Lived Assets;

 

    Restructuring and Integration Costs; and

 

    Accounting for Income Taxes.

Our accounting policy for stock-based compensation for employee stock-based awards was recently modified due to the adoption of SFAS 123(R) and is described below.

Stock-Based Compensation – Employee Stock-Based Awards

On December 1, 2005, we adopted SFAS 123(R) which requires the measurement and recognition of compensation expense for all stock-based awards made to employees and directors including employee stock options and employee stock purchases under the ESPP based on estimated fair values. SFAS 123(R) supersedes our previous accounting under APB 25 for periods beginning in fiscal year 2006. In March 2005, the SEC issued SAB 107 providing supplemental implementation guidance for SFAS 123(R). We have applied the provisions of SAB 107 in our adoption of SFAS 123(R).

SFAS 123(R) requires companies to estimate the fair value of stock-based awards on the date of grant using an option pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our Consolidated Statements of Operations. We adopted SFAS 123(R) using the modified prospective transition method which requires the application of the accounting standard starting from December 1, 2005, the first day of our fiscal year 2006. Our Consolidated Financial Statements, as of and for the three months ended February 28, 2006, reflect the impact of SFAS 123(R). Stock-based compensation expense for the three months ended February 28, 2006, was $4.6 million, which consisted primarily of stock-based compensation expense related to employee stock options recognized under SFAS 123(R). Our ESPP as modified in 2005, is deemed to be non-compensatory, and therefore, no stock-based compensation expense was recognized related to our ESPP.

Prior to the adoption of SFAS 123(R), we accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB 25 as allowed under SFAS 123 “Accounting for Stock-Based Compensation.” Under the intrinsic value method, no stock-based compensation expense for employee stock options had been recognized in our Consolidated Statements of Operations, because the exercise price of our stock options granted to employees and directors equaled the fair market value of the underlying stock at the date of grant. In accordance with the modified prospective transition method we used in adopting SFAS 123(R), our results of operations prior to fiscal year 2006 have not been restated to reflect, and do not include, the possible impact of SFAS 123(R).

Stock-based compensation expense recognized during a period is based on the value of the portion of stock-based awards that is ultimately expected to vest during the period. Stock-based compensation expense recognized in the three months ended February 28, 2006, included compensation expense for stock-based awards granted prior to, but not yet vested as of November 30, 2005, based on the fair value on the grant date estimated in accordance with the pro forma provisions of SFAS 123, and compensation expense for the stock-based awards

 

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granted subsequent to November 30, 2005, based on the fair value on the grant date estimated in accordance with the provisions of SFAS 123(R). In conjunction with the adoption of SFAS 123(R), we changed our method of attributing the value of stock-based compensation expense from the accelerated multiple-option method to the ratable single-option method. Compensation expense for all stock-based awards granted on or prior to November 30, 2005, will continue to be recognized using the accelerated multiple-option approach, while compensation expense for all stock-based awards granted subsequent to November 30, 2005, will be recognized using the ratable single-option method. As stock-based compensation expense recognized in our results for the first quarter of fiscal year 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Prior to fiscal year 2006, we accounted for forfeitures as they occurred for the purposes of pro forma information under SFAS 123, as disclosed in our Notes to Consolidated Financial Statements for the related periods.

Upon adoption of SFAS 123(R), we selected the Black-Scholes option pricing model as the most appropriate method for determining the estimated fair value for stock-based awards. The Black-Scholes model requires the use of highly subjective and complex assumptions which determine the fair value of stock-based awards, including the option’s expected term and the price volatility of the underlying stock.

Generally, stock options granted from our 1996 Plan prior to December 1, 2005 have a contractual term of ten years from the date of grant, and stock options granted from our 1996 Plan on or after December 1, 2005 have a contractual term of seven years from the date of grant.

On November 10, 2005, the FASB issued FASB Staff Position No. FAS 123(R)-3 “Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards” that allows for a simplified method to establish the beginning balance of the APIC Pool related to the tax effects of employee stock-based compensation, and to determine the subsequent impact on the APIC Pool and Consolidated Statements of Cash Flows of the tax effects of employee stock-based compensation awards that are outstanding upon adoption of SFAS 123(R). We are still in the process of calculating the APIC Pool and have not yet determined if we will elect to adopt the simplified method.

Also see Note 9 to the Consolidated Financial Statements on Stock-Based Compensation.

 

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RESULTS OF OPERATIONS

For purposes of presentation, we have indicated the first quarter of fiscal years 2006 and 2005 as ended on February 28, 2006 and 2005, respectively; whereas in fact, the first quarter of fiscal years 2006 and 2005 actually ended on March 5, 2006 and February 27, 2005, respectively. All amounts presented in the tables in the following sections on Results of Operations are stated in thousand of dollars, except for percentages and unless otherwise stated.

The following table sets forth the components of our results of operations as percentages of total revenue for the periods indicated:

 

     Three Months Ended  
     February 28,
2006
    February 28,
2005
 

Revenue:

    

License revenue:

    

Non-related parties

   42 %   35 %

Related parties

   —       14  
            

Total license revenue

   42     49  
            

Service and maintenance revenue:

    

Non-related parties

   56     47  

Related parties

   —       3  

Billed expenses

   2     1  
            

Total service and maintenance revenue

   58     51  
            

Total revenue

   100     100  
            

Cost of revenue:

    

Cost of license revenue

   3     3  

Cost of service and maintenance

   25     23  
            

Total cost of revenue

   28     26  
            

Gross profit

   72     74  
            

Operating expenses:

    

Research and development

   19     16  

Sales and marketing

   34     33  

General and administrative

   9     9  

Amortization of acquired intangible assets

   2     2  
            

Total operating expenses

   64     60  
            

Income from operations

   8     14  

Interest income

   4     3  

Interest expense

   (1 )   (1 )

Other expense, net

   —       —    
            

Income before income taxes

   11     16  

Provision for income taxes

   6     6  
            

Net income

   5 %   10 %
            

 

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REVENUE

Total Revenue

Our total revenue consisted primarily of license, consulting and maintenance fees from our customers and partners.

 

     Three Months Ended February 28,  
             2006                    2005                    Change          

Total revenue

   $ 114,580    $ 104,146    10 %

Total revenue for the first quarter of fiscal year 2006 compared to the same period last year increased by $10.4 million or 10%. The increase was comprised of a $13.3 million or 25% increase in service and maintenance revenue, offset by a $2.9 million or 6% decrease in license revenue.

We do not have revenue from related parties in the current quarter, as compared to $17.2 million of revenue from related parties for the first quarter of fiscal year 2005, representing 16% of our total revenue for that quarter. Reuters was considered a related party in the first quarter of fiscal year 2005, but during fiscal year 2005, Reuters reduced its holdings such that as of November 30, 2005, Reuters owned less than 1% of our outstanding common stock. Beginning December 1, 2005, Reuters was no longer considered a related party. Pursuant to the terms of the amended agreement we entered into in February 2005, Reuters had the right to distribute certain of our products in conjunction with the sale by Reuters to end users of its market data delivery solutions. The initial term of the amendment was one year, which Reuters had the option to extend for two additional one-year periods upon payment of additional license fees. Reuters did not exercise the option to extend the agreement. The initial $9.9 million non-refundable prepaid royalty was recognized as related party license revenue in the first quarter of fiscal year 2005. Another $1.1 million under the amended agreement represents maintenance fees and was recognized ratably over the one year maintenance period.

We have no other single customer that accounted for more than 10% of total revenue in the current quarter. In the same quarter last year, Reuters accounted for 16% of total revenue for that quarter.

Geographically, our total revenue for the current quarter is approximately 53% from North America; 37% from the Europe, Middle East and Africa region (“EMEA”); and 10% from the Pacific Rim. As for the first quarter of fiscal year 2005, our total revenue was approximately 54% from North America, 39% from EMEA, and 7% from the Pacific Rim. Particularly, we experienced a 59% or $4.2 million growth in revenue from the Pacific Rim region in the current quarter as compared to same quarter last year. See Note 14 to the Condensed Consolidated Financial Statements for further detail on total revenue by region.

Our total revenue may fluctuate from quarter to quarter, based in part upon seasonality in our business.

License Revenue and Cost

 

     Three Months Ended February 28,  
             2006                     2005                     Change          

License revenue

   $ 48,149     $ 51,020     (6 )%

As percent of total revenue

     42 %     49 %  

Cost of license revenue

   $ 3,909     $ 2,932     33 %

As percent of total revenue

     3 %     3 %  

As percent of license revenue

     8 %     6 %  

 

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License revenue decreased 6% for the current quarter as compared to the same quarter last year. The decrease was primarily due to a reduction of related party license revenue. In the first quarter of fiscal year 2005, we recognized $14.4 million of license revenue from a former related party, Reuters. We do not have transactions with Reuters of a similar amount in the current quarter, and we do not expect to have any transaction of a similar amount with Reuters in the near future.

There were 61 license revenue deals of over $0.1 million each in the current quarter, which increased from 55 deals in the same quarter last year. Excluding the effect of the $14.4 million of license revenue from Reuters in the first quarter of fiscal year 2005, the average deal size for transactions of over $0.1 million each was approximately $0.7 million and $0.7 million in the first quarter of fiscal years 2006 and 2005, respectively. We have 13 deals at $1.0 million or over in the current quarter, and the same number of such deals in the same quarter last year.

Cost of license revenue mainly consisted of royalty costs and amortization of developed technology acquired through corporate acquisitions. Cost of license revenue remained approximately 3% of total revenue in the current quarter and the same quarter last year. The increase in absolute dollars in cost of license revenue in the current quarter as compared to the same quarter last year resulted primarily from an increase of $1.1 million of royalty cost.

We estimate license revenues to be approximately 40% to 55% of our total revenue, and we estimate the cost of license revenue to remain approximately 5% to 10% of license revenue for the remainder of fiscal year 2006.

Service and Maintenance Revenue and Cost

 

     Three Months Ended February 28,  
             2006                     2005                     Change          

Service and maintenance revenue

   $ 66,431     $ 53,126     25 %

As percent of total revenue

     58 %     51 %  

Cost of service and maintenance

   $ 28,766     $ 24,639     17 %

As percent of total revenue

     25 %     23 %  

As percent of service and maintenance revenue

     43 %     46 %  

Service and maintenance revenue increased $13.3 million or 25% for the current quarter compared to the same quarter last year. This increase was comprised of a $5.6 million or 28% increase in consulting revenue, and a $7.6 million or 23% increase in maintenance revenue. Consulting revenue increased due to increasingly more comprehensive and larger engagements with respect to a number of accounts and an increased focus on providing more services to customers. Maintenance revenue increased primarily due to growth in our installed software base.

Cost of service and maintenance revenue consists primarily of compensation of professional services, customer support personnel and third-party contractors, and associated expenses related to providing consulting services.

The cost of service and maintenance revenue increased by $4.1 million or 17% for the current quarter as compared to the same quarter last year. The cost of service and maintenance revenue increased as a percentage of total revenue, primarily due to the relative proportion of consulting revenue increase. The increase in absolute dollars in the current quarter as compared to the same quarter last year resulted primarily from a $0.6 million increase in stock-based compensation, a $2.0 million increase related to other personnel compensation, a $0.8 million increase in third-party contractor compensation and consulting fees, and a $0.6 million increase in travel costs. Increased stock-based compensation was due to the adoption of SFAS 123(R) in the current quarter as

 

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further discussed below. Increased other personnel compensation cost was primarily due to an increase in professional services and customer support staff. Increased third-party contractor and consulting fees were directly related to increased service revenues.

We estimate service and maintenance revenue to be approximately 45% to 60% of total revenue in the remainder of fiscal year 2006. We estimate the cost of service and maintenance revenue to increase in absolute dollars and in line with increasing service and maintenance revenue in the near future.

STOCK-BASED COMPENSATION

The stock-based compensation cost was included in the Condensed Consolidated Statements of Operations corresponding to the same functional lines as cash compensation paid to the same employees, as follows:

 

     Three Months Ended February 28,  
             2006                     2005                     Change          

Stock-based compensation, included in:

      

Cost of license

   $ 15     $ —      

Cost of service and maintenance

     631       4    
                  

Total in cost of revenue

     646       4    

Research and development expense

     1,122       4    

Sales and marketing expense

     1,341       85    

General and administrative expense

     1,478       —      
                  

Total in cost of revenue

     3,941       89    

Total stock-based compensation

   $ 4,587     $ 93     4,832 %
                  

As percent of total revenue

     4 %     —   %  

On December 1, 2005, we adopted SFAS 123(R), which requires recognition of compensation expense for all stock-based awards made to employees in our Consolidated Statements of Operations. Prior to the adoption of SFAS 123(R), we accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB 25, and under this method, no stock-based compensation expense for employee stock options was recognized in the prior period in our Consolidated Statements of Operations because the exercise price of our stock options granted to employees and directors equaled the fair market value of the underlying stock at the date of grant. In accordance with the modified prospective transition method we used in adopting SFAS 123(R), our results of operations prior to fiscal year 2006 have not been restated to reflect, and do not include, the possible impact of SFAS 123(R).

Stock-based compensation cost for the first quarter of fiscal year 2005 was related to non-employee stock options and stock options we assumed from business acquisitions in prior years. Such stock-based compensation cost in fiscal year 2006 was insignificant. Also see Note 9 to the Consolidated Financial Statements on Stock-Based Compensation.

We currently estimate our total stock-based compensation cost to be $4.5 million to $6.5 million per quarter through the remainder of fiscal year 2006.

 

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OPERATING EXPENSES

Research and Development Expenses

Research and development expenses consist primarily of personnel, third party contractors and related costs associated with the development and enhancement of our suite of products.

 

     Three Months Ended February 28,
             2006                     2005                     Change        

Research and development expenses:

      

Research and development expenses, excluding stock-based compensation

   $ 20,855     $ 16,186     29%

Stock-based compensation expenses

     1,122       4     N/A
                  

Total research and development expenses

   $ 21,977     $ 16,190     36%
                  

As percent of total revenue

     19 %     16 %  

Research and development expenses increased by $5.8 million or 36% in the current quarter as compared to the same quarter last year, resulting primarily from a $1.1 million increase in stock-based compensation, a $3.0 million increase in other personnel compensation due to increased headcount, and a $0.5 million increase in third-party contractor compensation and consulting fees.

We believe that continued investment in research and development is critical to attaining our strategic objectives. Accordingly, we estimate that spending on research and development will increase slightly in absolute dollars and will continue to account for approximately 16% to 20% of total revenue for the remainder of fiscal year 2006.

Sales and Marketing Expenses

Sales and marketing expenses consist primarily of personnel and related costs of our direct sales force and marketing staff and the cost of marketing programs, including customer conferences, promotional materials, trade shows and advertising, and related travel expenses.

 

     Three Months Ended February 28,
             2006                     2005                     Change        

Sales and marketing expenses:

      

Sales and marketing expenses, excluding stock-based compensation

   $ 37,307     $ 34,121     9%

Stock-based compensation expenses

     1,341       85     N/A
                  

Total sales and marketing expenses

   $ 38,648     $ 34,206     13%
                  

As percent of total revenue

     34 %     33 %  

The $4.4 million or 13% increase in sales and marketing expense for the current quarter as compared to the same quarter last year was primarily due to a $1.3 million increase in stock-based compensation, a $1.1 million increase in other personnel compensation, a $1.2 million increase in travel expense, a $0.8 million increase in facilities expenses, and a $0.8 million increase in sales referral fees. The increase in personnel compensation was mainly related to increased commission and incentives to employees due to higher commissionable revenue. The increase in facilities costs was mainly due to additional costs to support expanded sales operations.

We intend to selectively increase staff in our direct sales organization and to increase our marketing efforts during the remainder of fiscal year 2006. Accordingly, we estimate that sales and marketing expenses will increase in absolute dollars, and will continue to account for approximately 30% to 35% of total revenue through the remainder of fiscal year 2006.

 

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General and Administrative Expenses

General and administrative expenses consist primarily of personnel and related costs for general corporate functions, including executive, legal, finance, accounting, and human resources.

 

     Three Months Ended February 28,  
             2006                     2005                     Change          

General and administrative expenses:

      

General and administrative expenses, excluding stock-based compensation

   $ 8,908     $ 9,800     (9 )%

Stock-based compensation expenses

     1,478       —       N/A  
                  

Total general and administrative expenses

   $ 10,386     $ 9,800     6 %
                  

As percent of total revenue

     9 %     9 %  

General and administrative expenses increased by $0.6 million or 6% in the current quarter as compared to the same quarter last year, primarily due to a $1.5 million increase in stock-based compensation, offset by a $1.1 million decrease in professional fees, primarily legal, accounting and tax consulting fees.

We will continue to invest in improving our corporate infrastructure to enhance effective management of internal controls, and we therefore estimate that general and administrative spending will increase in absolute dollars and will account for approximately 8% to 10% of total revenue through the remainder of fiscal year 2006.

Amortization of Acquired Intangible Assets

Intangible assets acquired through corporate acquisitions are comprised of the expected value of developed technologies, patents, trademarks, established customer bases, non-compete agreements, as well as maintenance and OEM customer royalty agreements. Amortization of developed technologies is recorded as a cost of revenue, and amortization of other acquired intangible assets is included in operating expenses.

 

     Three Months Ended February 28,  
             2006                     2005                     Change          

Amortization of acquired intangible assets, included in:

      

Cost of revenue

   $ 1,330     $ 1,633     (19 )%

Operating expenses

     2,364       1,883     26 %
                  

Total amortization of acquired intangible assets:

   $ 3,694     $ 3,516     5 %
                  

As percent of total revenue

     3 %     3 %  

The decrease in amortization of developed technologies, as included in cost of revenue, in the current quarter as compared to the same quarter last year was primarily due to certain intangible assets acquired in earlier years which are now fully amortized. The increase in amortization of other acquired intangible assets, as included in operating expenses, in the current quarter as compared to the same quarter last year was primarily due to the addition of acquired intangible assets recorded from the Objectstar and Velosel acquisitions in fiscal year 2005. See Note 4 to Condensed Consolidated Financial Statements for further detail on acquired intangible assets.

We expect the amortization of acquired intangible assets to be approximately $3.7 million per quarter for fiscal year 2006, provided that there are no new acquisitions.

 

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Interest Income

 

     Three Months Ended February 28,  
             2006                     2005                     Change          

Interest income

   $ 4,386     $ 2,784     58 %

As percent of total revenue

     4 %     3 %  

The increase in interest income in the current quarter as compared to the same quarter last year was primarily due to a higher investment balance and increased interest rates on our investments.

Interest Expense

 

     Three Months Ended February 28,  
             2006                     2005                     Change          

Interest expense

   $ 654     $ 682     (4 )%

As percent of total revenue

     1 %     1 %  

Interest expense is related to a $54.0 million mortgage note issued in connection with the purchase of our corporate headquarters. The mortgage note is payable to a financial institution collateralized by the commercial real property acquired, and carries a fixed annual interest rate of 5.09% and a 20-year amortization. The slight decrease of interest expense for the current quarter as compared to the same quarter last year is due to principal amortization of the mortgage note. See Note 6 to Condensed Consolidated Financial Statements for further detail on the mortgage note payable.

Other Income (Expense), Net

Other income (expense), net, is comprised of realized gains and losses on investments and other miscellaneous income and expense items. Realized gain (loss) on investments represents gains or losses realized when such investments are sold and when other-than-temporary impairment on individual securities is recorded.

 

     Three Months Ended February 28,  
         2006                     2005                     Change          

Other income (expense), net:

      

Foreign exchange gain, net

   $ 125     $ 288     (57 )%

Realized gain (loss) on short-term investments, net

     4       (20 )   (120 )%

Miscellaneous income (expense), net

     (82 )     85     (196 )%
                  

Total other income, net

   $ 47     $ 353     (87 )%
                  

As percent of total revenue

     —   %     —   %  

The decrease in other income, net, in absolute dollars for the current quarter as compared to the same quarter last year was due to lower foreign exchange gains and increased other miscellaneous expenses.

Provision for Income Taxes

 

     Three Months Ended February 28,  
             2006                     2005                     Change          

Provision for income taxes

   $ 6,708     $ 6,563     2 %

Effective tax rate

     54.5 %     39.0 %  

 

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During the three months ended February 28, 2006, the effective tax rate was 54.5% and differs from our projected annual effective tax rate of 53.5% for fiscal year 2006 due to the expensing of certain foreign taxes which were treated as a discrete event allocable to the first quarter. Our effective tax rate of 54.5% for the three months ended February 28, 2006 differs from the effective tax rate of 39% used to record the provision for income taxes for the comparable period in fiscal year 2005 primarily due to the tax impact of the stock compensation charge under SFAS 123(R) and additional taxes incurred attributable to repatriation of foreign earnings from our UK subsidiaries in fiscal year 2006.

We make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes.

As part of the process of preparing our Consolidated Financial Statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves us estimating our current tax exposure under the most recent tax laws and assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our Condensed Consolidated Balance Sheets.

We assess the likelihood that we will be able to recover our deferred tax assets. We consider all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance. If recovery is not likely, we increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be recoverable. If recovery becomes likely, we may release part or all of our valuation allowance against the deferred tax assets that we estimate will ultimately be recoverable. The available positive evidence as of February 28, 2006, included three years of historical operating profits and a projection of future income limited to three years which coincides with the period over which we recorded historical operating profits, due to our lack of visibility into earnings further into the future. As a result of our analysis of all available evidence, both positive and negative, we have concluded that no additional valuation allowance should be released in the first quarter of fiscal year 2006. We continue to closely monitor available evidence, both positive and negative, and may release additional valuation allowance in future periods.

As of February 28, 2006, we believed that the amount of the deferred tax assets recorded on our balance sheet as a result of the partial release of valuation allowance during fiscal year 2005 would ultimately be recovered. However, should there be a change in our ability to recover our deferred tax assets; our tax provision would increase in the period in which we determine that the recovery is not probable. If we have to re-establish the full valuation allowance, it may result in a charge of $30.2 million to the tax provision.

LIQUIDITY AND CAPITAL RESOURCES

Current Cash Flows

As of February 28, 2006, we had cash, cash equivalents and short-term investments totaling $499.1 million, an increase of $21.5 million as compared to November 30, 2005. Our short-term available-for-sale investments, which primarily consist of high grade corporate debt, U.S. government debt securities and asset-based securities, totaled $388.3 million as of February 28, 2005 and $268.9 million as of November 30, 2005.

Net cash provided by operating activities in the current quarter was $30.8 million, resulting from net income of $5.6 million, adjusted for non-cash charges including $7.5 million of depreciation and amortization, $4.6 million in stock-based compensation, net cash collections of accounts receivable of $24.0 million, offset by a $10.4 million decrease in accrued liabilities mainly due to payments during the quarter.

 

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To the extent that non-cash items increase or decrease our future operating results, there will be no corresponding impact on our cash flows. After excluding the effects of these non-cash charges, the primary changes in cash flows relating to operating activities result from changes in working capital. Our primary source of operating cash flows is the collection of accounts receivable from our customers, including maintenance which is typically billed annually in advance. Our operating cash flows are also impacted by the timing of payments to our vendors for accounts payable. We generally pay our vendors and service providers in accordance with the invoice terms and conditions. The timing of cash payments in future periods will be impacted by the terms of accounts payable arrangements and the timing of our cash inflows.

Net cash used for investing activities was $123.4 million in the first quarter of fiscal year 2006, which resulted primarily from the net purchases of short-term investments of $119.4 million, $2.8 million for capital expenditures and $1.1 million in restricted cash pledged as security.

Net cash used for financing activities was $6.1 million in the first quarter of fiscal year 2006, which resulted primarily from $13.2 million used to repurchase our shares of common stock on the open market, offset by $7.6 million cash received from the exercise of stock options and the sale of common stock under our ESPP. In December 2005, our Board of Directors approved an eighteen-month stock repurchase program pursuant to which we may repurchase up to $100.0 million of our outstanding common stock, of which $87.8 million remained available for future repurchases as of the end of the first quarter of fiscal year 2006. The timing and amount of any repurchases is dependent upon market conditions and other corporate considerations.

Starting in fiscal year 2006, in accordance with SFAS 123(R), a part of the tax benefit related to stock-based awards will be classified as cash flows from financing activities, instead of cash flows from operating activities. Even though we do not have this item in the first quarter of fiscal year 2006, our cash flows from operating activities may decrease by this tax benefit in the future quarters and be offset by an increase in cash flows from financing activities.

We anticipate our operating expenses will grow in absolute dollars and in line with total revenue for the foreseeable future, and we intend to fund our operating expenses through cash flows from operations. Our capital expenditures are estimated to be approximately $10.0 million to $15.0 million for fiscal year 2006. We expect to use primarily our current cash resources to fund capital expenditures, acquisitions or investments in complementary businesses, technologies or product lines, and repurchases of our common stock. We believe that our current cash, cash equivalents and short-term investments together with expected cash flows from operations will be sufficient to meet our anticipated cash requirements for working capital, capital expenditures, and currently approved stock repurchases for at least the next twelve months.

Commitments with Banks

In June 2003, we purchased our corporate headquarters with a $54.0 million mortgage note to lower our operating costs. The principal balance of $33.9 million that will be remaining at the end of the 10-year term will be due as a final lump sum payment on July 1, 2013. Under the currently applicable terms of the mortgage note agreements, we are prohibited from acquiring another company without prior consent from the lender unless we maintain at least $300.0 million of cash or cash equivalents, and meet other non-financial terms as defined in the agreements. In addition, we are subject to certain non-financial covenants as defined in the agreements. We were in compliance with all covenants as of February 28, 2006.

In conjunction with the purchase of our corporate headquarters, we entered into a 51-year lease of the land upon which the property is located. The lease was paid in advance for a total of $28.0 million, but is subject to adjustments every ten years based upon changes in fair market value of the land. Should it become necessary, we have the option to prepay any rent increases due as a result of a change in fair market value.

We have a $20.0 million revolving line of credit that matures on June 21, 2006. The revolving line of credit is available for cash borrowings and for the issuance of letters of credit up to $20.0 million. As of February 28,

 

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2006, no borrowings were outstanding under the facility and a $13.0 million irrevocable letter of credit was outstanding, leaving $7.0 million of available credit for additional letters of credit or cash borrowings. The $13.0 million irrevocable letter of credit outstanding was issued in connection with the mortgage note payable. The letter of credit automatically renews for successive one-year periods, until the mortgage note payable has been satisfied in full. We are required to maintain a minimum of $40.0 million in unrestricted cash, cash equivalents, and short-term investments, net of total current and long-term indebtedness, as well as comply with other non-financial covenants defined in the agreement. As of February 28, 2006, we were in compliance with all covenants under the revolving line of credit.

As of February 28, 2006, we had $2.9 million in restricted cash in connection with bank guarantees issued by some of our international subsidiaries. The cash collateral is presented as restricted cash and included in Other Assets on the Condensed Consolidated Balance Sheets.

Operating Commitments

At various locations worldwide, we lease office space and equipment under non-cancelable operating leases with various expiration dates through November 2014. Rental expenses were approximately $2.4 million and $1.9 million for the three months ended February 28, 2006 and 2005, respectively.

As of February 28, 2006, contractual commitments associated with indebtedness and lease obligations were as follows, (in thousands):

 

    Total    

Remainder

of 2006

    2007     2008     2009     2010     Thereafter  

Operating commitments:

             

Debt principal

  $ 49,702     $ 1,357     $ 1,892     $ 1,990     $ 2,094     $ 2,203     $ 40,166  

Debt interest

    15,968       1,875       2,417       2,318       2,215       2,106       5,037  

Operating leases

    28,865       5,693       5,441       4,226       3,446       2,807       7,252  
                                                       

Total operating commitments

    94,535       8,925       9,750       8,534       7,755       7,116       52,455  

Restructuring-related commitments:

             

Gross lease obligations

    35,764       4,973       7,351       7,526       7,551       7,720       643  

Estimated sublease income

    (8,207 )     (2,361 )     (2,284 )     (1,294 )     (1,129 )     (1,050 )     (89 )
                                                       

Net restructuring-related commitments

    27,557       2,612       5,067       6,232       6,422       6,670       554  
                                                       

Total commitments

  $ 122,092     $ 11,537     $ 14,817     $ 14,766     $ 14,177     $ 13,786     $ 53,009  
                                                       

Future minimum lease payments under restructured non-cancelable operating leases are included in Accrued Restructuring and Excess Facilities Costs in our Condensed Consolidated Balance Sheets.

Indemnification

Our software license agreements typically provide for indemnification of customers for intellectual property infringement claims. To date, no such claims have been filed against us. We also warrant to customers that software products operate substantially in accordance with the software product’s specifications. Historically, we have incurred minimal costs related to product warranties, and, as such, no accruals for warranty costs have been made. In addition, we indemnify our officers and directors under the terms of indemnity agreements entered into with them, as well as pursuant to our certificate of incorporation, bylaws, and applicable provisions of Delaware law. To date, we have not incurred any costs related to these indemnification arrangements.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to the impact of interest rate changes and foreign currency fluctuations.

INTEREST RATE RISK

Our exposure to market rate risk for changes in interest rates relates primarily to our investment portfolio. We invest excess cash in marketable debt instruments of the U.S. Government and its agencies, high-quality corporate debt securities, asset-backed and mortgage-backed debt securities and, by policy, limit the amount of credit exposure to any one issuer. We protect and preserve invested funds by limiting default, market and reinvestment risk.

Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates, or we may suffer losses in principal if forced to sell securities which have declined in market value due to changes in interest rates. As of February 28, 2006, we had an investment portfolio of fixed income securities totaling $388.3 million, excluding those classified as cash and cash equivalents. Our investments consist primarily of marketable debt instruments of the U.S. Government and its agencies, high-quality corporate debt securities, asset-backed and mortgage-backed debt securities. These securities are classified as available-for-sale and are recorded on the balance sheet at fair market value with unrealized gains or losses reported as a separate component of stockholders’ equity. Unrealized losses are charged against income when a decline in fair market value is determined to be other-than-temporary. The specific identification method is used to determine the cost of securities sold.

A hypothetical 100 basis point increase in interest rates would result in an approximate $3.0 million decrease in the fair value of our available-for-sale debt securities as of February 28, 2006.

FOREIGN CURRENCY RISK

We develop products in the United States of America and sell products in North America, South America, Europe, the Pacific Rim and the Middle East. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. A majority of sales are currently made in U.S. dollars; however, a strengthening of the dollar could make our products less competitive in foreign markets. To manage currency exposure related to net assets and liabilities denominated in foreign currencies, we enter into forward contracts for certain foreign denominated assets and liabilities. Our forward contracts generally have original maturities of approximately thirty days. Gains and losses on the forward contracts are recognized each period in our Consolidated Statements of Operations. We do not enter into derivative financial instruments for trading purposes.

As of February 28, 2006, we had four outstanding forward contracts with total notional amounts of $40.5 million, which are summarized as follows (in thousands):

 

    

Notional Value

Local Currency

  

Notional Value

USD

   Fair Value
Gain/(Loss)
USD
 

Forward contracts (sold)

        

EURO

   27,000    $ 32,473    $ (73 )

British Pound

   2,000      3,505      (7 )

Japanese Yen

   230,000      1,975      5  

South African Rand

   16,000      2,578      28  
                  
      $ 40,531    $ (47 )
                  

 

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We are also exposed to foreign exchange rate fluctuations as we convert the financial statements of our foreign subsidiaries into U.S. dollars in consolidation. If there is a change in foreign currency exchange rates, the conversion of the foreign subsidiaries’ financial statements into U.S. dollars will lead to a translation gain or loss which is recorded as a component of other comprehensive income.

 

ITEM 4. CONTROLS AND PROCEDURES

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Exchange Act, that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

Based on their evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

There was no change in our internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II—OTHER INFORMATION

 

ITEM 1A. RISK FACTORS

The following risk factors could materially and adversely affect our future operating results and could cause actual events to differ materially from those predicted in the forward-looking statements we make about our business.

Our future revenue is unpredictable, and we expect our quarterly operating results to fluctuate, which may cause our stock price to decline.

Period-to-period comparisons of our operating results may not be a good indication of our future performance. Moreover, our operating results in some quarters have not in the past, and may not in the future, meet the expectations of stock market analysts and investors. This has in the past and may in the future cause our stock price to decline. As a result of the evolving nature of the markets in which we compete and the size of our customer agreements, we have difficulty accurately forecasting our revenue in any given period. In addition to the factors discussed elsewhere in this section, a number of factors may cause our revenue to fall short of our expectations, or those of stock market analysts and investors, or cause fluctuations in our operating results, including:

 

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

 

    the relatively long sales cycles for many of our products;

 

    the tendency of some of our customers to wait until the end of a fiscal quarter or our fiscal year in the hope of obtaining more favorable terms;

 

    the timing of our new products or product enhancements or any delays in such introductions;

 

    the delay or deferral of customer implementations of our products;

 

    changes in customer budgets and decision making processes that could affect both the timing and size of any transaction;

 

    our dependence on large deals, which if such deals do not close, can greatly impact revenues for a particular quarter;

 

    the impact of our provision of services on our recognition of license revenue;

 

    any difficulty we encounter in integrating acquired businesses, products or technologies;

 

    the amount and timing of operating costs and capital expenditures relating to the expansion of our operations;

 

    the impact of employee stock-based compensation expenses on our earnings per share; and

 

    changes in local, national and international regulatory requirements.

In addition, while we may in future years record positive net income and/or increases in net income over prior periods, we may not show period-over-period earnings per share growth or earnings per share growth that meets the expectations of stock market analysts or investors, as a result of the number of our shares outstanding during such periods. In such case, our stock price may decline.

Our stock price may be volatile, which could cause investors to lose all or part of their investments in our stock or negatively impact the effectiveness of our equity incentive plans.

The stock market in general and the stock prices of technology companies in particular, have experienced volatility which has often been unrelated to the operating performance of any particular company or companies.

 

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For example, during fiscal year 2005, our stock price fluctuated between a high of $13.50 and a low of $5.60, and during the first quarter of fiscal year 2006, our stock price fluctuated between a high of $9.02 and a low of $7.05. If market or industry-based fluctuations continue, our stock price could decline in the future regardless of our actual operating performance and investors could lose all or part of their investments.

We are required to recognize expense for stock-based compensation related to stock-based awards, and the recognition of this expense could cause the trading price of our common stock to decline.

On December 1, 2005, we adopted SFAS 123(R) which requires the measurement and recognition of compensation expense for all stock-based awards made to employees and directors based on estimated fair values. As a result, starting with fiscal year 2006, our operating results contain a charge for stock-based compensation expense related to employee stock options. This charge is in addition to stock-based compensation expense we have recognized in prior periods related to non-employee stock options and business acquisitions. The application of SFAS 123(R) requires the use of an option-pricing model to determine the fair value of stock-based awards. This determination of fair value is affected by our stock price, as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, expected stock price volatility, expected term, risk-free interest rate, and expected dividends. As a result of the adoption of SFAS 123(R), beginning with the first quarter of fiscal year 2006, our earnings were lower than they would have been had we not been required to adopt SFAS 123(R). This will continue to be the case for future periods, and we cannot accurately predict the magnitude of this effect on our earnings in future periods. Further, we cannot predict what the impact will be on the trading price of our common stock as a result of the adoption of SFAS 123(R).

Increases in services revenues as a percentage of total revenues may decrease overall margins.

We have in the past realized and may continue in the future to realize a higher percentage of revenues from services and maintenance. For example, for the first quarter ended February 28, 2006, our service and maintenance revenue represented 58% of our total revenue as compared to 51% for the same quarter last year. We realize lower profit margins on our services and maintenance revenues than on our software license revenues. In addition, we may contract with certain third parties to supplement the services we provide to customers, which may yield lower margins than our internal services business. As a result, if services and maintenance revenues continue to increase as a percentage of total revenues or if we increase our use of third parties to provide services, our profit margins may decrease which could impact our stock price.

We must overcome significant competition in order to succeed.

The market for our products and services is extremely competitive and subject to rapid change. We compete with various providers of enterprise application integration solutions, including webMethods. We also compete with various providers of web services such as Microsoft, BEA, SAP and IBM. We believe that of these companies, IBM has the potential to offer the most complete competitive set of products for enterprise application integration. As a result of our acquisition of Staffware, we now also compete with various providers of BPM solutions. In addition, some of our competitors are expanding their competitive product offerings and market position through acquisitions. For example, Sun Microsystems acquired SeeBeyond in August 2005, potentially making Sun Microsystems a direct competitor of ours as well. BEA has also acquired companies that expand its offerings, such as Fuego in March 2006, which potentially makes BEA a more direct competitor in BPM solutions. We expect additional competition from other established and emerging companies. We also face competition for certain aspects of our product and service offerings from major systems integrators. Further, we may face increasing competition from open source software initiatives, in which competitors provide software and intellectual property without charging license fees. If customers choose such open source products over our proprietary software, our revenues and earnings could be adversely affected.

Many of our current and potential competitors have longer operating histories; significantly greater financial, technical, product development, and marketing resources; greater name recognition; and larger

 

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customer bases than we do. Our present or future competitors may be able to develop products comparable or superior to those we offer; adapt more quickly than we do to new technologies, evolving industry trends or customer requirements; or devote greater resources to the development, promotion and sale of their products than we do. Accordingly, we may not be able to compete effectively in our markets or competition may intensify and harm our business and operating results. If we are not successful in developing enhancements to existing products and new products in a timely manner, achieving customer acceptance or generating higher average selling prices, our gross margins may decline, and our business and operating results may suffer.

Future changes in financial accounting standards and financial reporting regulations may adversely affect our reported results of operations.

A change in accounting standards and financial reporting regulations can have a significant effect on our reported results. New accounting pronouncements and varying interpretations of accounting pronouncements have occurred and may occur in the future. These new accounting pronouncements may adversely affect our reported financial results.

For example, beginning in the first quarter of fiscal year 2006, we are required to comply with SFAS 123(R), which mandates accounting for our stock-based awards to employees based on the fair value method and recording the compensation expense in our results of operations. Due to this, our net income and net income per share have been reduced. In the first quarter of fiscal year 2006, we recorded $4.6 million in stock-based compensation expense as compared to less than $0.1 million for the same quarter last year.

Our strategy contemplates possible future acquisitions which may result in us incurring unanticipated expenses or additional debt, difficulty in integrating our operations and dilution to our stockholders and may harm our operating results.

Our success depends in part on our ability to continually enhance and broaden our product offerings in response to changing technologies, customer demands and competitive pressures. We have in the past and may in the future, acquire complementary businesses, products or technologies. In this regard, we have made strategic acquisitions, including the acquisition of certain assets of Velosel and ObjectStar in 2005, and the acquisition of Staffware plc and General Interface Corporation in 2004. We do not know if we will be able to complete any subsequent acquisition or that we will be able to successfully integrate any acquired business, operate it profitably, or retain its key employees. Integrating any newly acquired business, product or technology could be expensive and time-consuming, could disrupt our ongoing business and could distract our management. In particular, integrating sales forces and strategies for marketing and sales has in the past required and will likely require in the future, much time, effort and expense, especially from our management team. Therefore, we might not be able, either immediately post-acquisition or ever, to replicate the pre-acquisition revenues achieved by companies that we acquire or achieve the benefits of the acquisition we anticipated in valuing the businesses, products or technologies we acquire. Furthermore, the costs of integrating acquired companies in international transactions can be particularly high, due to local laws and regulations. If we are unable to integrate any newly acquired entity, products or technology effectively, our business, financial condition and operating results would suffer. In addition, any amortization or impairment of acquired intangible assets, stock-based compensation or other charges resulting from the costs of acquisitions could harm our operating results.

In addition, we may face competition for acquisition targets from larger and more established companies with greater financial resources. Also, in order to finance any acquisition, we might need to raise additional funds through public or private financings or use our cash reserves. In that event, we could be forced to obtain equity or debt financing on terms that are not favorable to us and, in the case of equity financing that may result in dilution to our stockholders. Use of our cash reserves for acquisitions could limit our financial flexibility in the future. Moreover, the terms of existing loan agreements may prohibit certain acquisitions or may place limits on our ability to incur additional indebtedness or issue additional equity securities to finance acquisitions. If we are not able to acquire strategically attractive businesses, products or technologies, we may not be able to remain competitive in our industry.

 

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The past slowdown in the market for infrastructure software and its protracted recovery have caused our revenue to decline in the past and could cause our revenue or results of operations to fall below expectations in the future.

The market for infrastructure software is relatively new and evolving. We earn a substantial portion of our revenue from licenses of our infrastructure software, including application integration software and sales of related services. We expect to earn substantially all of our revenue in the foreseeable future from sales of these products and services. Our future financial performance will depend on continued growth in the number of organizations demanding software and services for application integration and information delivery and companies seeking outside vendors to develop, manage and maintain this software for their critical applications. Lower spending by corporate and governmental customers around the world, which has had a disproportionate impact on information technology spending, has led to a reduction in sales in the past and may continue to do so in the future. Many of our potential customers have made significant investments in internally developed systems and would incur significant costs in switching to third-party products, which may substantially inhibit the growth of the market for infrastructure software. If the market fails to grow, or grows more slowly than we expect, our sales will be adversely affected. Also, even as corporate and governmental spending increases and companies make greater investments in information technology and infrastructure software, our revenue may not grow at the same pace.

Our business is subject to seasonal variations which make quarter-to-quarter comparisons difficult.

Our business is subject to variations throughout the year due to seasonal factors in the U.S. and worldwide. These factors include fewer selling days in Europe during the summer vacation season which has a disproportionate effect on sales in Europe, the impact of the holidays and a slow down in capital expenditures by our customers at calendar year-end (during our first fiscal quarter). These factors typically result in lower sales activity in our first and third fiscal quarters compared to the rest of the year and they make quarter-to-quarter comparisons of our operating results less meaningful.

Any failure by us to meet the requirements of current or newly-targeted customers may have a detrimental impact on our business or operating results.

If we fail to meet the expectations or product and service requirements of our current customers, our reputation and business may be harmed. In addition, we may wish to expand our customer base into markets in which we have limited experience. In some cases, customers in different markets, such as financial services or government, have specific regulatory or other requirements which we must meet. For example, in order to maintain contracts with the U.S. Government, we must comply with specific rules and regulations relating to and that govern such contracts. While we have historically met the requirements of our customers, if we fail to meet such requirements in the future, we could be subject to civil or criminal liability or a reduction of revenue which could harm our business, operating results and financial condition.

Any losses we incur as a result of our exposure to the credit risk of our customers could harm our results of operations.

Most of our licenses are sold on an “open credit” basis. We monitor individual customer payment capability in granting such open credit arrangements, seek to limit credit to amounts we believe the customers can pay, and maintain reserves we believe are adequate to cover exposure for doubtful accounts. As we have grown our revenue and customer base, our exposure to credit risk has increased. Although we have not had material losses to date as a result of customer defaults, future defaults, if incurred, could harm our business and have an adverse effect on our business, operating results and financial condition.

 

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We are required to undertake an annual evaluation of our internal control over financial reporting (“ICFR”) that may identify internal control weaknesses requiring remediation, which could harm our reputation and confidence in our financial reporting.

Sarbanes-Oxley imposes duties on us, our executives, and directors. We completed our fiscal year 2005 evaluation of the design, remediation and testing of effectiveness of our ICFR required to comply with the management certification and attestation by our independent registered public accounting firm as required by Section 404 of Sarbanes-Oxley. While our assessment, testing and evaluation of the design and operating effectiveness of our ICFR resulted in our conclusion that as of November 30, 2005, our ICFR were effective, we cannot predict the outcome of our testing in future periods. If we conclude in future periods that our ICFR is not effective, we may be required to change our ICFR to remediate deficiencies, investors may lose confidence in the reliability of our financial statements, and we may be subject to investigation and/or sanctions by regulatory authorities. Also, if we identify areas of our ICFR that require improvement, we could incur additional expenses to implement enhanced processes and controls to address such issues. Any such events could adversely affect our financial results and/or may result in a negative reaction in the stock market.

Regulatory requirements have caused us to incur increased costs and operating expenses, may limit our ability to obtain director and officer liability insurance and may make it more difficult for us to attract and retain qualified officers and directors.

Sarbanes-Oxley and rules enacted by the SEC and Nasdaq have caused us, and we expect will continue to cause us, to incur significant costs as a result of these regulatory requirements. In this regard, achieving and maintaining compliance with Sarbanes-Oxley and other rules and regulations, have caused us to hire additional personnel and use additional outside legal, accounting and advisory services and may require us to do so in the future.

Failure to satisfy the rules could make it more difficult for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, or as executive officers.

We may incur significant expenses in both hiring new employees and reducing or re-aligning our headcount in response to changing market conditions.

We have increased the scope of our operations both domestically and internationally. Our success is dependent on successfully managing our workforce. As we grow, we must invest significantly in building our sales, marketing and engineering groups. Competition for these people in the software industries is intense, and we may not be able to successfully recruit, train or retain qualified personnel. In addition, we must successfully integrate new employees into our operations and generate sufficient revenues to justify the costs associated with these employees. If we fail to successfully integrate employees or to generate the revenue necessary to offset employee-related expenses, we may be forced to reduce our headcount, which would force us to incur significant expenses and would harm our business and operating results. For example, in the year ended November 30, 2005, we recorded a total of $3.9 million restructuring charge for a workforce reduction to re-align our resources and cost structure. Failure to manage our operations effectively could interfere with the growth of our business as a whole.

If we do not retain our key management personnel and attract, hire and retain other highly skilled employees, we may not be able to execute our business strategy effectively.

If we fail to retain and recruit key management and other skilled employees, our business and our ability to obtain new customers, develop new products and provide acceptable levels of customer service could suffer. The success of our business is heavily dependent on the leadership of our key management personnel, including

 

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Vivek Ranadivé, our President and Chief Executive Officer. The loss of one or more key employees could adversely affect our continued operations. We have experienced changes in our management organization over the past several years and may experience additional management changes in the future. Uncertainty created by turnover of key employees could also result in reduced confidence in our financial performance which could cause fluctuations in our stock price and result in further turnover of our employees.

The value of our equity incentive programs may diminish as a retention tool as a result of the changes in the financial accounting standards and our stock price volatility.

We have historically used equity incentive programs, such as employee stock options and stock purchase plans, as a part of overall employee compensation arrangements. As a result of changes in the financial accounting standards, we have changed our stock purchase plan and may reduce the size and number of stock option grants we give to our employees, both of which may decrease the effectiveness of our plans as employee retention tools. In addition, the volatility of our stock price may negatively impact the value of such equity incentives, thereby diminishing the value of such incentive programs to employees and decreasing the effectiveness of such programs as retention tools.

The inability to upsell to our current customers or the loss of any significant customer could harm our business and cause our stock price to decline.

We do not have long-term sales contracts with any of our customers. Our customers may choose not to purchase our products in the future. As a result, a customer that generates substantial revenue for us in one period may not be a source of revenue in subsequent periods. Any inability on our part to upsell to and generate revenues from our existing customers could adversely affect our business and operating results.

Our products may infringe the intellectual property rights of others, which may cause us to incur unexpected costs or prevent us from selling our products.

We cannot be certain that our products do not infringe issued patents or other intellectual property rights of others. In addition, our use of Open Source components in our products may make us increasingly vulnerable to claims that our products infringe third-party intellectual property rights, in particular because many of the Open Source components we may incorporate with our products are developed by numerous independent parties over whom we exercise no supervision or control. Further, because patent applications in the United States and many other countries are not publicly disclosed until a patent is issued, applications covering technology used in our software products may have been filed without our knowledge. While no claims have been filed against us to date, we may be subject to legal proceedings and claims from time to time, including claims of alleged infringement of the patents, trademarks and other intellectual property rights of third parties by us or our licensees in connection with their use of our products. Although no claims have been made in the past, our software license agreements typically provide for indemnification of our customers for intellectual property infringement claims. Intellectual property litigation is expensive and time-consuming and could divert our management’s attention away from running our business and seriously harm our business. If we were to discover that our products violated the intellectual property rights of others, we would have to obtain licenses from these parties in order to continue marketing our products without substantial reengineering. We might not be able to obtain the necessary licenses on acceptable terms or at all, and if we could not obtain such licenses, we might not be able to reengineer our products successfully or in a timely fashion. If we fail to address any infringement issues successfully, we would be forced to incur significant costs, including damages and potentially satisfying indemnification obligations that we have with our customers, and we could be prevented from selling certain of our products.

Our intellectual property or proprietary rights could be misappropriated, which could force us to become involved in expensive and time-consuming litigation.

We regard our copyrights, service marks, trademarks, trade secrets, patents (licensed or others) and similar intellectual property as critical to our success. Any misappropriation of our proprietary information by third

 

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parties could harm our business, financial condition and operating results. In addition, the laws of some countries do not provide the same level of protection of our proprietary information as do the laws of the United States. If our proprietary information or material were misappropriated, we might have to engage in litigation to protect it. We might not succeed in protecting our proprietary information if we initiate intellectual property litigation, and, in any event, such litigation would be expensive and time-consuming, could divert our management’s attention away from running our business and could seriously harm our business.

Market acceptance of new platforms and web services standards may require us to undergo the expense of developing and maintaining compatible product lines.

Our software products can be licensed for use with a variety of platforms. There may be future or existing platforms that achieve popularity in the marketplace which may not be architecturally compatible with our software products. In addition, the effort and expense of developing, testing and maintaining software products will increase as more platforms achieve market acceptance within our target markets. Moreover, future or existing user interfaces that achieve popularity within the enterprise application integration marketplace may not be compatible with our current software products. If we are unable to achieve market acceptance of our software products or adapt to new platforms, our sales and revenues will be adversely affected.

Developing and maintaining different software products could place a significant strain on our resources and software product release schedules, which could harm our revenue and financial condition. If we are not able to develop software for accepted platforms or fail to adopt web services standards, our license and service revenues and our gross margins could be adversely affected. In addition, if the platforms we have developed software for are not accepted, our license and service revenues and our gross margins could be adversely affected.

We may experience foreign currency gains and losses.

Our operating results are subject to fluctuations in foreign currency exchange rates. We attempt to mitigate a portion of these risks through foreign currency hedging, based on our judgment of the appropriate trade-offs among risk, opportunity and expense. We have established a hedging program designed to partially hedge our exposure to foreign currency exchange rate fluctuations, which primarily involves the Euro and the British Pound. We regularly review our hedging program and will make adjustments based on our judgment. Although our hedging activities are designed to offset a portion of the financial impact resulting from the movement in foreign currency exchange rates, if we are unable to offset the effects of currency fluctuation, our operating results could be adversely affected.

Our agreement with Reuters places certain limitations on our ability to conduct our business.

Pursuant to the terms of our agreement with Reuters, we are permitted to market and sell our products, other than risk management and market data distribution products, directly and through third party resellers (other than a few specified resellers) to customers in the financial services market. The limitations on our ability to sell risk management and market data distribution products and on reselling through the specified resellers will continue through May 2008. While we currently do not offer any risk management and market data distribution solutions as part of our product offerings, if we were to develop any such products, we would have to rely on Reuters to sell those products in the financial services market until these restrictions end. Reuters is not required to help us sell any of these products in those markets and Reuters may choose not to sell our products over our competitors’ products.

In addition, we license from Reuters the intellectual property that was incorporated into early versions of some of our software products. We do not own this licensed technology. Because Reuters has access to intellectual property used in our products, it could use this intellectual property to compete with us. Reuters is not restricted from using the licensed technology it has licensed to us to produce products that compete with our products, and it can grant limited licenses to the licensed technology to others who may compete with us. In addition, we must license to Reuters all of the products we own, and the source code for one of our messaging

 

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products, through December 2012. This may place Reuters in a position to more easily develop products that compete with ours.

Natural or other disasters could disrupt our business and result in loss of revenue or in higher expenses.

Natural disasters, terrorist activities and other business disruptions could seriously harm our revenue and financial condition and increase our costs and expenses. Our corporate headquarters and many of our operations are located in California, a seismically active region. In addition, many of our current and potential customers are concentrated in a few geographic areas. A natural disaster in one of these regions could have a material adverse impact on our U.S. and foreign operations, operating results and financial condition. Further, although we have not experienced a disruption to date, any unanticipated business disruption caused by Internet security threats, damage to global communication networks or otherwise could have a material adverse impact on our operating results.

The outcome of litigation pending against us could require us to expend significant resources and could harm our business and financial resources.

In May 2005, three purported shareholder class action complaints were filed against us and several of our officers in the U.S. District Court for the Northern District of California. The plaintiffs in such actions are seeking to represent a class of purchasers of TIBCO’s common stock from September 21, 2004 through March 1, 2005. The complaints generally allege that we made false or misleading statements concerning our operating results, our business and internal controls and the integration of Staffware. The complaints seek unspecified monetary damages. We intend to defend ourselves vigorously; however, we expect to incur significant costs in mounting such defense.

In September 2005, a shareholder derivative complaint was filed against certain of our officers and directors in the Superior Court of the State of California, Santa Clara County. The complaint is based on substantially similar facts and circumstances as the class actions and generally alleged that the named directors and officers breached their fiduciary duties to TIBCO. The complaint seeks unspecified monetary damages. Given the nature of derivative litigation, any recovery in a derivative suit would be to the benefit of TIBCO.

In addition, certain of our directors and officers and certain investment bank underwriters have been named in a putative class action for violation of the federal securities laws in the U.S. District Court for the Southern District of New York, captioned “In re TIBCO Software Inc. Initial Public Offering Securities Litigation.” This is one of a number of cases challenging underwriting practices in the IPOs of more than 300 companies, which have been coordinated for pretrial proceedings as “In re Initial Public Offering Securities Litigation.” Plaintiffs generally allege that the underwriters engaged in undisclosed and improper underwriting activities, namely the receipt of excessive brokerage commissions and customer agreements regarding post-offering purchases of stock in exchange for allocations of IPO shares. Plaintiffs also allege that various investment bank securities analysts issued false and misleading analyst reports. The complaint against us claims that the purported improper underwriting activities were not disclosed in the registration statements for our IPO and secondary public offering and seeks unspecified damages on behalf of a purported class of persons who purchased our securities or sold put options during the time period from July 13, 1999 to December 6, 2000.

A lawsuit with similar allegations of undisclosed improper underwriting practices, and part of the same coordinated proceedings, is pending against Talarian, which we acquired in 2002. That action is captioned “In re Talarian Corp. Initial Public Offering Securities Litigation.” The complaint against Talarian, certain of its underwriters, and certain of its former directors and officers claims that the purported improper underwriting activities were not disclosed in the registration statement for Talarian’s IPO and seeks unspecified damages on behalf of a purported class of persons who purchased Talarian securities during the time period from July 20, 2000 to December 6, 2000.

 

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A proposal to settle the claims against all of the issuers and individual defendants in the coordinated litigation was accepted by us and given preliminary approval by the U.S. District Court for the Southern District of New York. The completion of the settlement is subject to a number of conditions, including final approval by the U.S. District Court for the Southern District of New York. Under the settlement, the plaintiffs will dismiss and release all claims against participating defendants in exchange for a contingent payment guaranty by the insurance companies collectively responsible for insuring the issuers in the action, and the assignment or surrender to the plaintiffs of certain claims the issuer defendants may have against the underwriters. Under the guaranty, the insurers will be required to pay an amount equal to $1.0 billion less any amounts ultimately collected by the plaintiffs from the underwriter defendants in all the cases. Unlike most of the defendant issuers’ insurance policies, including ours, Talarian’s policy contains a specific self-insured retention in the amount of $0.5 million for IPO “laddering” claims, including those alleged in this matter. Thus, under the proposed settlement, if any payment is required under the insurers’ guaranty, our subsidiary, Talarian, would be responsible for paying its pro rata share of the shortfall, up to $0.5 million of the self-insured retention remaining under its policy.

The uncertainty associated with substantial unresolved lawsuits could harm our business, financial condition and reputation. The defense of the lawsuits could result in the diversion of our management’s time and attention away from business operations, which could harm our business. Negative developments with respect to the lawsuits could cause our stock price to decline. In addition, although we are unable to determine the amount, if any, that we may be required to pay in connection with the resolution of the lawsuits by settlement or otherwise, any such payment could seriously harm our financial condition and liquidity.

The use of Open Source Software in our products may expose us to additional risks.

“Open Source Software” is software that is covered by a license agreement which permits the user to liberally copy, modify and distribute the software for free. Certain Open Source Software is licensed pursuant to license agreements that require a user who intends to distribute the Open Source Software as a component of the user’s software to disclose publicly part or all of the source code to the user’s software. This effectively renders what was previously proprietary software Open Source Software. As competition in our markets increases, we must reduce our product development costs. Many features we may wish to add to our products in the future may be available as Open Source Software and our development team may wish to make use of this software to reduce development costs and speed up the development process. While we monitor the use of all Open Source Software and try to ensure that no Open Source Software is used in such a way as to require us to disclose the source code to the related product, such use could inadvertently occur. Additionally, if a third party has incorporated certain types of Open Source Software into its software, has not disclosed the presence of such Open Source Software and we embed that third party software into one or more of our products, we could, under certain circumstances, be required to disclose the source code to our product. This could have a material adverse effect on our business.

Some provisions in our certificate of incorporation and bylaws, as well as a stockholder rights plan, may have anti-takeover effects.

We have a stockholder rights plan providing for one right for each outstanding share of our common stock. Each right, when exercisable, entitles the registered holder to purchase certain securities at a specified purchase price. The rights plan may have the anti-takeover effect of causing substantial dilution to a person or group that attempts to acquire TIBCO on terms not approved by our Board of Directors. The existence of the rights plan could limit the price that certain investors might be willing to pay in the future for shares of our common stock and could discourage, delay or prevent a merger or acquisition that stockholders may consider favorable. In addition, provisions of our current certificate of incorporation and bylaws, as well as Delaware corporate law, could make it more difficult for a third party to acquire us without the support of our Board of Directors, even if doing so would be beneficial to our stockholders.

 

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

ISSUER PURCHASES OF EQUITY SECURITIES

In September 2004, our Board of Directors approved a two-year stock repurchase program pursuant to which we repurchased $50.0 million of our outstanding common stock as of the end of the first quarter of fiscal year 2006. In December 2005, our Board of Directors approved a new eighteen-month stock repurchase program pursuant to which we may repurchase up to $100.0 million of our outstanding common stock. The remaining authorized amount for stock repurchases under this program was approximately $87.8 million as of the end of the first quarter of fiscal year 2006.

 

(In thousands, except per share amounts)

  

Total

Number

of Shares

Purchased

  

Average

Price Paid

per Share

  

Total Number of

Shares Purchased

as Part of Publicly

Announced Plans

Or Programs

  

Approximate Dollar Value
of Shares That May

Yet Be Purchased

under the Plans or

Programs

December 1, 2005 to January 5, 2006

   200    $ 7.47    200    $ 99,505

January 6, 2006 to February 5, 2006

   1,000    $ 7.55    1,000    $ 91,955

February 6, 2006 to March 5, 2006

   500    $ 8.35    500    $ 87,779
               

Total

   1,700    $ 7.78    1,700    $ 87,779
               

 

ITEM 6. EXHIBITS

 

3.1(1)    Certificate of Incorporation of Registrant.
3.2(2)    Bylaws of Registrant.
4.1(3)    Form of Registrant’s Common Stock Certificate.
10.1#    1998 Director Option Plan, as amended.
31.1    Rule 13a-14(a) / 15d-14(a) Certification by Chief Executive Officer.
31.2    Rule 13a-14(a) / 15d-14(a) Certification by Chief Financial Officer.
32.1    Section 1350 Certification by Chief Executive Officer.
32.2    Section 1350 Certification by Chief Financial Officer.

# Indicates management contract or compensatory plan or arrangement.
(1) Incorporated by reference to an exhibit filed with the Registrant’s Registration Statement on Form 8-A, filed with the Commission on February 23, 2004.
(2) Incorporated by reference to an exhibit filed with the Registrant’s Current Report on Form 8-K, filed with the Commission on April 11, 2006.
(3) Incorporated by reference to an exhibit filed with the Registrant’s Registration Statement on Form S-1 (File No. 333-78195), filed with the Commission on June 18, 1999, as amended.

 

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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.

 

TIBCO SOFTWARE INC.
By:   /S/    MURRAY D. RODE        
 

Murray D. Rode

Chief Financial Officer and

Executive Vice President, Strategic Operations

By:   /S/    SYDNEY L. CAREY        
 

Sydney L. Carey

Senior Vice President, Corporate Controller

and Chief Accounting Officer

Date: April 13, 2006

 

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EXHIBIT INDEX

 

Exhibit No.   

Description

3.1(1)    Certificate of Incorporation of Registrant.
3.2(2)    Bylaws of Registrant.
4.1(3)    Form of Registrant’s Common Stock Certificate.
10.1#    1998 Director Option Plan, as amended.
31.1    Rule 13a-14(a) / 15d-14(a) Certification by Chief Executive Officer.
31.2    Rule 13a-14(a) / 15d-14(a) Certification by Chief Financial Officer.
32.1    Section 1350 Certification by Chief Executive Officer.
32.2    Section 1350 Certification by Chief Financial Officer.

# Indicates management contract or compensatory plan or arrangement.
(1) Incorporated by reference to an exhibit filed with the Registrant’s Registration Statement on Form 8-A, filed with the Commission on February 23, 2004.
(2) Incorporated by reference to an exhibit filed with the Registrant’s Current Report on Form 8-K, filed with the Commission on April 11, 2006.
(3) Incorporated by reference to an exhibit filed with the Registrant’s Registration Statement on Form S-1 (File No. 333-78195), filed with the Commission on June 18, 1999, as amended.

 

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