<DOCUMENT>
<TYPE>10-K
<SEQUENCE>1
<FILENAME>p19544_10k.txt
<DESCRIPTION>QUARTERLY REPORT
<TEXT>
================================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended July 31, 2005
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: 000-28369
VA Software Corporation
(Exact name of Registrant as specified in its charter)
Delaware 77-0399299
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
46939 Bayside Parkway, Fremont, California, 94538
(Address, including zip code, of principal executive offices)
(510) 687-7000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value
(Title of Class)
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [X] No [ ]
Indicate by check mark whether the Registrant is a shell company (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [ ] No [X]
As of September 30, 2005, there were 61,690,872 shares of the Registrant's
Common Stock outstanding. The aggregate market value of the Common Stock held by
non-affiliates of the Registrant as of January 31, 2005 (based on the closing
price for the Common Stock on the NASDAQ National Market for such date) was
approximately $112,860,976. Shares of common stock held by each of our officers
and directors and by each person or group who owns 5% or more of our outstanding
common stock have been excluded in that such persons or groups may be deemed to
be our affiliate. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2005 Annual Meeting of Stockholders
("Proxy Statement") to be held on December 10, 2005, and to be filed pursuant to
Regulation 14A within 120 days after the Registrant's fiscal year ended July 31,
2005, are incorporated by reference into Part III of this Form 10-K.
================================================================================
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<TABLE>
<CAPTION>
Table of Contents
PART I
<S> <C> <C>
Item 1 Business
Overview.................................................................................................... 4
Sales and Marketing........................................................................................ 6
Research and Development.................................................................................... 6
Competition................................................................................................. 7
Intellectual Property Rights................................................................................ 8
Seasonality................................................................................................. 8
Employees................................................................................................... 9
Item 2 Properties....................................................................................................... 9
Item 3 Legal Proceedings................................................................................................ 9
Item 4 Submission of Matters to a Vote of Security Holders.............................................................. 9
PART II
Item 5 Market for the Registrant's Common Stock and Related Stockholder Matters......................................... 9
Item 6 Selected Consolidated Financial Data............................................................................. 11
Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations............................ 11
Item 7A Quantitative and Qualitative Disclosures About Market Risk....................................................... 40
Item 8 Financial Statements and Supplementary Data...................................................................... 41
Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............................. 64
Item 9A Controls and Procedures.......................................................................................... 64
PART III
Item 10 Directors and Executive Officers of the Registrant............................................................... 71
Item 11 Executive Compensation........................................................................................... 71
Item 12 Security Ownership of Certain Beneficial Owners and Management................................................... 71
Item 13 Certain Relationships and Related Transactions................................................................... 71
Item 14 Principal Accounting Fees and Services. ......................................................................... 71
PART IV
Item 15 Exhibits, Financial Statement Schedules, and Reports on Form 8-K................................................. 72
Signatures....................................................................................................... 72
</TABLE>
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PART I
Item 1. Business
Special Note Regarding Forward-Looking Statements
This Form 10-K contains forward-looking statements that involve risks and
uncertainties. Words such as "intend," "expect," "believe," "in our view," and
variations of such words and similar expressions, are intended to identify such
forward-looking statements, which include, but are not limited to, statements
regarding our expectations and beliefs regarding future revenue growth; gross
margins; financial performance and results of operations; technological trends
in, and emergence of the market for collaborative software development
applications; the future functionality, business potential, demand for,
efficiencies created by and adoption of SourceForge; demand for online
advertising; management's strategy, plans and objectives for future operations;
the impact of our
and the amount of cash utilized by operations;
our intent to continue to invest significant resources in development;
competition, competitors and our ability to compete; liquidity and capital
resources; the outcome of any litigation to which we are a party; our accounting
policies; and sufficiency of our cash resources, cash generated from operations
and investments to meet our operating and working capital requirements. Actual
results may differ materially from those expressed or implied in such
forward-looking statements due to various factors, including those set forth in
this Business section under "Competition" and in the Risk Factors contained in
the section of this Form 10-K entitled "Management's Discussion and Analysis of
Financial Condition and Results of Operations." We undertake no obligation to
update the forward-looking statements to reflect events or circumstances
occurring after the date of this Form 10-K.
Introduction
We were incorporated in California in January 1995 and reincorporated in
Delaware in December 1999. From the date of our incorporation through October
2001, we sold Linux-based hardware systems and services under the name VA Linux
Systems, Inc. On June 27, 2001, we announced our decision to exit our
Linux-based hardware business. Today, we do business under the name VA Software
Corporation (the "Company") and we develop, market and support a software
application known as SourceForge Enterprise Edition ("SourceForge") and also own
and operate OSTG, Inc. ("OSTG") and its wholly-owned subsidiaries, a network of
Internet web sites, offering advertising, retail and animation services and
products.
We are subject to the informational requirements of the Securities Exchange
Act of 1934 (the "Exchange Act"). Therefore, we file periodic reports, proxy
statements and other information with the Securities and Exchange Commission
(the "SEC"). Such reports, proxy statements and other information may be
obtained by visiting the Public Reference Room of the SEC at 100 F Street, NE,
Washington, DC 20549 or by calling the SEC at 1-800-SEC-0330. In addition, the
SEC maintains an Internet site (http://www.sec.gov) that contains reports, proxy
and information statements and other information regarding issuers that file
electronically.
You can access other information at our Investor Relations web site. The
address is www.vasoftware.com/company/. The content of this web site is not
intended to be incorporated by reference into this report or any other report we
file with the SEC. We make available, free of charge, copies of our annual
report on Form 10-K as soon as reasonably practicable after filing such material
electronically or otherwise furnishing it to the SEC, and have made our annual
reports on Form 10-K available on our web site since November 2002.
Business Overview
We currently view our business in four operating segments: SourceForge,
Online Media, E-commerce and Online Images. For segment and geographic financial
information, see Note 10 of the Notes to Consolidated Financial Statements of
this Annual Report on Form 10-K.
SourceForge
Our SourceForge segment focuses on our SourceForge Enterprise Edition
software products and services.
SourceForge is a proprietary, web-based software application designed for
corporate and public-sector information technology ("IT") professionals and
software engineering organizations. SourceForge combines software development
and collaboration tools with the ability to track, measure, and report on
software project activity in real-time. SourceForge improves the software
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development process by capturing and archiving software development code,
documentation and communication in a central location. It enables managers to
gain insight and improved visibility into software development activity, thereby
providing better resource and requirements management, defect tracking and the
ability to resolve critical problems earlier in the development cycle.
Organizations with distributed, offshore and/or outsourced software development
teams can achieve improved productivity, communication, coordination,
collaboration, project clarity and insight through SourceForge's standard set of
development tools and secure, centralized code, documentation and communication
repository.
Our SourceForge segment represented 23%, 17% and 12% of net revenues during
fiscal 2005, 2004 and 2003, respectively.
Online Media
Our Online Media segment consists of a network of Internet web sites
serving the IT professional and software development communities. As of August
30, 2005, OSTG reaches more than 19 million unique visitors and serves more than
290 million page views per month. We believe that OSTG is the most dynamic
community-driven media network on the web and a cornerstone of the open source
software development community. OSTG attracts IT decision-makers and buyers,
from chief technology officers to project managers. Technologists, developers
and system administrators turn to OSTG sites to create debate and make IT news.
OSTG is supported by sponsors and advertisers who want to reach the unique
demographic of IT professionals and developers that visit our OSTG web sites.
Our OSTG web sites include:
o SourceForge.net, our flagship web site and software development
center. As of August 30, 2005, SourceForge.net was the development
home for more than 100,000 software development projects and had more
than 1,000,000 registered users.
o Slashdot.org, our leading discussion site for technologically-inclined
individuals. Slashdot is dedicated to providing the IT and software
development communities with cutting-edge technology, science and
culture news and interactive commentary.
o Linux.com, our comprehensive web site for Linux and open source news
and information. Linux.com caters to business and IT managers looking
for migration strategies to Linux.
o Freshmeat.net, one of the Internet's most comprehensive indices of
downloadable Linux, Unix and cross-platform software.
o NewsForge.com, the online newspaper of record for Linux and open
source software.
o ITManagersJournal.com, a web site delivering strategic and technical
information to help top-level IT professionals implement
enterprise-level open source and proprietary architecture,
applications, and infrastructure solutions.
Our Online Media segment represented 25%, 33% and 43% of net revenues
during fiscal 2005, 2004 and 2003, respectively.
E-commerce
Our E-commerce segment provides online sales of a variety of retail
products of interest to the software development and IT communities through
ThinkGeek, Inc. ("ThinkGeek"), a wholly-owned subsidiary of OSTG. We believe we
offer a significantly broader range of unique products in a centralized location
than are available in traditional stores. We do not have the shelf display space
limitations that brick-and-mortar stores do. Our customers are able to buy
electronics, office gadgets, apparel, caffeinated products and other specialty
items with a single check-out. Consumers can either access the information
directly through our web site, or get free help from our customer care
representatives and experts by contacting them by e-mail at orders@thinkgeek.com
or by telephone at 1-888-GEEKSTUFF.
The E-commerce segment represented 45%, 43% and 35% of net revenues during
fiscal 2005, 2004 and 2003, respectively.
Online Images
Our Online Images segment provides online sales of three-dimensional art,
animations and presentations through Animation Factory, Inc. ("Animation
Factory"), a wholly-owned subsidiary of OSTG. Our online image products are
either sold in the form of a CD or as a subscription which offers subscribers a
dynamic downloadable collection of easy to use animations that work in email,
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web pages and presentations. We believe that we offer an array of unique
animations on the web giving customers access to over 300,000 animations and
50,000 web designs. Consumers can either access the information directly through
our web site, or get free help from our customer care representatives and
experts by contacting them by e-mail through www.animationfactory.com or by
telephone at 1-800-525-2475.
The Online Images segment represented 7% of net revenues during each fiscal
period 2005, 2004 and 2003, respectively.
Sales and Marketing
SourceForge
We primarily market and sell our SourceForge software products (software,
professional services, maintenance and support and training) directly to our end
users through our SourceForge field sales organization, on the Internet at
www.vasoftware.com and on our various OSTG web sites. Our direct sales
organization includes a telesales operation to augment our direct sales
presence.
We maintain a complete customer service and support organization for
SourceForge, which provides support for installation, software usage, updates
and system administration. Customer service and support are typically provided
as part of the SourceForge maintenance contract to ensure end user productivity.
We also release periodic bug or security fix updates and version upgrades.
Online Media
We primarily market and sell our Internet advertisements via OSTG's direct
sales organization and its web sites. In addition, we have entered into
co-marketing agreements with certain third parties with respect to marketing
and/or selling advertising space on OSTG web sites.
E-commerce
Our E-commerce marketing and promotion strategy is designed to increase
customer traffic to our on-line store, add new customers, build strong customer
loyalty, maximize repeat purchases and develop incremental revenue
opportunities. In addition, we have entered into co-marketing agreements with
certain third parties with respect to marketing our E-commerce web site. We
intend to continue to use the unique capabilities of the Internet as a means to
encourage new and repeat customers to our web sites. Our advertising campaigns
are focused on the OSTG web sites which enables OSTG to direct customers to our
products through a link to our web site. In addition, we currently offer a
customer retention program, Geek Points, which is designed to add new customers
and build customer loyalty. Through this program, customers are rewarded for
shopping with us. When the customer signs up for Geek Points, they earn points
on all of their purchases. Rewards for Geek Points participants include special
promotions, discounts and access to products available only to those customers
enrolled in the program.
Online Images
We primarily market and sell our Online Images products through the
Internet on our www.animationfactory.com web site. In addition, we have entered
into co-marketing agreements with certain third parties with respect to
marketing our Animation Factory web site.
Research and Development
SourceForge
We believe that the success of SourceForge will depend partly on our
ability to enhance our product to meet the needs of a rapidly evolving
marketplace and increasingly sophisticated and demanding customers. Therefore,
we have devoted the majority of our research and development budget to the goal
of improving SourceForge. We intend to extend and strengthen our software by
enhancing existing features, adding additional features and offering higher
levels of integration with popular software development tools. Although we
primarily develop SourceForge technology internally, we may, based on timing and
cost considerations, acquire technologies or products from third parties.
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Online Media
We believe that the success of OSTG will depend partly on our ability to
enhance our web sites and underlying technology to meet the needs of a rapidly
evolving marketplace and increasingly sophisticated and demanding customers. We
intend to extend and strengthen the software underlying our online sites by
enhancing existing features and adding additional features. These include adding
the ability to deliver new ad types as they are developed, as well as enhancing
our ability to track ads as they run.
E-commerce
We have implemented a broad array of services and systems for customer
service, product searching, order processing and order fulfillment functions,
including, among other things:
o Accepting and validating customer orders;
o Organizing, placing and managing orders with vendors and fulfillment
partners;
o Receiving product and reserving inventory for specific customer
orders; and
o Managing shipment of products to customers based on various ordering
criteria.
These services and systems use a combination of our own proprietary
technologies and commercially available, licensed technologies. We focus our
internal development efforts on creating and enhancing the specialized,
proprietary software that is unique to our business.
Our core online merchandise catalog, customer interaction, order
collection, fulfillment and back-end systems are proprietary to ThinkGeek. The
systems are designed to provide real-time connectivity to our distribution
center systems. These include an inventory-tracking system, a real-time order
tracking system, an executive information system and an inventory replenishment
system. Our Internet servers use SSL technology to help conduct secure
communications and transactions. We continue to invest in improving the
E-commerce customer service, order processing, shipping and tracking systems.
Competition
SourceForge
We believe SourceForge gives us an opportunity to operate in the
collaborative software development market without an entrenched competitor.
However, we face competition from software development tools and processes
developed internally by customers, including ad hoc integrations of commercial
software development tools and applications as well as open source software.
There are also many entrenched competitors in closely related markets who
compete for customer budget allocations. Such competition could arise from,
among others, Borland Software Corporation, Collabnet, Inc., International
Business Machines Corporation, Microsoft Corporation, Serena Software, Inc., as
well as numerous other public and privately held software application
development and tools suppliers. Additionally, recent and future business
combinations among companies in the software industry will permit the resulting
consolidated companies to offer more extensive suites of software products and
broader arrays of software solutions, some of which may compete directly with
SourceForge. Changes resulting from current and future software industry
consolidation may negatively impact our competitive position and operating
results.
Many of these potential competitors are likely to have substantial
competitive advantages including greater resources that can be devoted to the
development, promotion and sale of their products; more established sales forces
and channels; greater software development experience; and greater name
recognition.
Online Media
The market for Internet services provided by OSTG is highly competitive.
Advertisers have many alternatives available to reach their target audience,
including print (e.g., Ziff Davis Media's eWeek and International Data Group's
Computerworld), general portal sites (e.g., aol.com, yahoo.com, google.com and
msn.com) and other web sites focused on vertical markets (e.g., CNet Networks,
Inc.'s cnet.com and techrepublic.com).
Similar to our potential competitors in our SourceForge business, many of
our competitors in our Online Media business have substantial competitive
advantages including greater resources that can be devoted to the development,
promotion and sale of their online services; more established sales forces and
channels; greater software and web site development experience; and greater name
recognition.
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E-commerce
The market for Internet products provided by ThinkGeek is highly
competitive. We compete with Internet portals and online service providers that
feature shopping services, such as America Online, MSN and Yahoo!, and with
other online or mail-order retailers. We believe that there are a number of
competitive factors in our market, including company credibility, product
selection and availability, convenience, price, privacy, web site features,
functionality and performance, ease of purchasing, customer service and
reliability and speed of order shipment.
Similar to our potential competitors in our SourceForge and Online Media
businesses, many of our competitors in our E-commerce business have substantial
competitive advantages including greater resources that can be devoted to the
development, promotion and sale of their online products; more established sales
forces and channels; greater software and web site development experience; and
greater name recognition.
To be competitive, we must respond promptly and effectively to the
challenges of technological change, evolving standards and our competitors'
innovations by continuing to enhance our products. Any pricing pressures or loss
of potential customers resulting from our failure to compete effectively would
reduce our revenues.
Online Images
The market for online images provided by Animation Factory is competitive.
Competitive factors in this industry include the quality, relevance and
diversity of the image library, customer service, pricing, accessibility of our
images and our speed of fulfillment. Our primary competitor is Jupiter Media
Corporation's site, Animation.com, which offers similar 3-D animation
subscriptions.
Intellectual Property Rights
We protect our intellectual property through a combination of copyright,
trademark, trade-secret laws, employee and third-party nondisclosure agreements,
and other methods of protection.
SourceForge is licensed to our end-user customers as proprietary software
code and documentation. We require our customers to enter into license
agreements that impose restrictions on their ability to reproduce, distribute
and utilize our software. In addition, we seek to avoid disclosure of our trade
secrets through a number of means, including restricting access to our source
code and object code and requiring those entities and persons with access to
agree to confidentiality terms which restrict their use and disclosure.
SourceForge, SourceForge.net, Slashdot, ThinkGeek, Freshmeat, OSTG, VA
Software, the VA logo and Animation Factory are some of our trademarks and/or
registered trademarks that we use in the United States and in other countries.
Because the software industry is characterized by rapid technological
change, we believe that factors such as the technological and creative skills of
our personnel, new product developments, frequent product enhancements, name
recognition and reliable product maintenance are more important to establishing
and maintaining a technology leadership position than the various legal
protections of our technology.
Seasonality
With the exception of our E-commerce business, our revenues have not been
significantly impacted by seasonality. Our E-commerce business, however, is
highly seasonal, reflecting the general pattern associated with the retail
industry of peak sales and earnings during the holiday shopping season.
In the past several years, a substantial portion of our E-commerce revenues
occurred in our second fiscal quarter, which in fiscal year 2006 will begin on
November 1, 2005, and end on January 31, 2006. As is typical in the retail
industry, we generally experience lower E-commerce revenues during the other
quarters. Therefore, our E-commerce revenue in a particular quarter is not
necessarily indicative of future E-commerce revenue for a subsequent quarter or
our full fiscal year.
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Employees
We believe our success will depend in part on our continued ability to
attract and retain highly qualified personnel in a competitive market for
experienced and talented software engineers and sales and marketing personnel.
Our employees are not represented by any collective bargaining organization, we
have never experienced a work stoppage, and we believe that our relations with
our employees are good. As of July 31, 2005, our employee base totaled 127,
including 35 in operations, 35 in sales and marketing, 37 in research and
development and 20 in finance and administration.
Item 2. Properties
<TABLE>
Our principal locations are as follows:
<CAPTION>
Approximate Expiration
Size of
Location Purpose (in square feet) Lease
------------------------------- --------------------------------------------- -------------------- ------------------
<S> <C> <C> <C>
United States of America
Fremont, California 100% sublet through lease expiration date 102,544 2010
Fremont, California Corporate headquarters; SourceForge and 36,767 2010
OSTG sales and marketing, administration,
research & development
Sunnyvale, California 100% sublet through lease expiration date 45,647 2005
San Diego, California 100% sublet through lease expiration date 39,010 2005
Fairfax, Virginia ThinkGeek operations 2,400 2005
Sioux Falls, South Dakota Animation Factory research & development 3,160 2006
</TABLE>
Item 3. Legal Proceedings
Information with respect to this Item may be found in Note 5 of the Notes
to Consolidated Financial Statements of this Annual Report on Form 10-K, which
information is incorporated into this Item 3 by reference.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters
Our common stock is traded on the NASDAQ National Market System under the
symbol LNUX. As of October 10, 2005, there were 865 holders of record of our
common stock. We have not declared any cash dividends since our inception and do
not expect to pay any dividends in the foreseeable future. The high and low
closing sales prices, as reported by NASDAQ, of our common stock are as follows:
High Low
---- ---
Fiscal Year Ended July 31, 2005:
Fourth Quarter.................................. $ 2.00 $ 1.34
Third Quarter................................... $ 2.08 $ 1.32
Second Quarter.................................. $ 2.99 $ 1.84
First Quarter................................... $ 2.13 $ 1.58
Fiscal Year Ended July 31, 2004:
Fourth Quarter.................................. $ 2.48 $ 1.69
Third Quarter................................... $ 4.03 $ 1.98
Second Quarter.................................. $ 5.26 $ 2.98
First Quarter................................... $ 5.84 $ 1.92
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The foregoing reflects interdealer prices without retail markup, markdown,
or commissions and may not necessarily reflect actual transactions.
Equity Compensation Plans
<TABLE>
The following table summarizes our equity compensation plans as of July 31,
2005, all of which have been approved by our stockholders:
<CAPTION>
| A B C
|
Plan Category (1) | Number of securities to Weighted average Number of securities remaining available for
| be issued upon exercise exercise price of future issuance under equity compensation plan
| of outstanding options outstanding options (excluding securities reflected in column A)
<S> <C> <C> <C>
Equity compensation plans |
approved by stockholders | 11,134,549 (2) $2.89 13,970,399 (3) - (6)
<FN>
(1) The table does not include information for equity compensation plans assumed by the Company in acquisitions. As of July 31,
2005, a total of 91,497 shares of the Company's common stock remain issuable and outstanding upon exercise of options
granted under plans assumed by the Company in its acquisition of OSTG. The weighted average exercise price of all
outstanding options granted under these plans at July 31, 2005 is $39.12. The Company does not grant additional awards
under these assumed plans.
(2) Includes 10,552,465 options outstanding under the Company's 1998 Stock Plan and 582,084 options outstanding under the
Company's 1999 Director's Plan.
(3) Includes 2,461,987 shares of common stock reserved for issuance under the Company's 1999 Employee Stock Purchase Plan.
(4) Subject to the terms of the 1998 Stock Plan, an annual increase is to be added on the first day of the Company's fiscal
year equal to the lesser of: 4,000,000 shares, or 4.9% of the outstanding shares on the first day of the new fiscal year or
an amount determined by the Board of Directors.
(5) Subject to the terms of the 1999 Directors Plan, an annual increase is to be added on the first day of the Company's fiscal
year equal to the lesser of: 250,000 shares, or 0.5% of the outstanding shares on the first day of the new fiscal year or
an amount determined by the Board of Directors.
(6) Subject to the terms of the 1999 Employee Stock Purchase Plan, an annual increase is to be added on the first day of the
Company's fiscal year equal to the lesser of: 500,000 shares, or 1% of the outstanding shares on the first day of the new
fiscal year or an amount determined by the Board of Directors.
</FN>
</TABLE>
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Item 6. Selected Consolidated Financial Data
You should read the selected consolidated financial data set forth below in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and our financial statements and the related notes
included elsewhere in this Form 10-K. The statement of operations data for the
fiscal years ended July 31, 2005, July 31, 2004 and July 31, 2003 and the
balance sheet data as of July 31, 2005 and July 31, 2004 are derived from the
audited financial statements and related notes appearing elsewhere in this Form
10-K. The statement of operations data for the fiscal years ended July 27, 2002
and July 28, 2001 and the balance sheet data as of July 31, 2003, July 27, 2002
and July 28, 2001 are derived from audited financial statements not appearing in
this Form 10-K. Historical results are not necessarily indicative of results
that may be expected for any future period.
<TABLE>
<CAPTION>
Summary Financial Information
(In thousands, except per share data)
For the years ended
-------------------------------------------------------------
July 31, July 31, July 31, July 27, July 28,
2005 2004 2003 2002 2001
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Selected Consolidated Statements of Operations Data:
Net revenues ................................................. $ 32,887 $ 29,261 $ 24,228 $ 20,385 $ 134,890
Cost of revenues ............................................. 16,434 15,537 12,780 9,661 154,103
--------- --------- --------- --------- ---------
Gross margin ................................................. 16,453 13,724 11,448 10,724 (19,213)
Loss from operations ......................................... (5,652) (11,007) (14,882) (93,248) (531,798)
Net loss ..................................................... (4,694) (7,640) (13,798) (91,038) (525,268)
========= ========= ========= ========= =========
Net loss attributable to common stockholders ................. $ (4,694) $ (7,640) $ (13,798) $ (91,038) $(525,268)
========= ========= ========= ========= =========
Basic and diluted net loss per share ......................... $ (0.08) $ (0.13) $ (0.25) $ (1.72) $ (10.78)
========= ========= ========= ========= =========
Shares used in computing basic and diluted net loss per share 61,454 59,684 54,110 53,064 48,741
========= ========= ========= ========= =========
Selected Balance Sheet data at year-end:
Cash, cash equivalents and investments ....................... $ 38,420 $ 44,042 $ 38,847 $ 53,046 $ 80,083
Working capital .............................................. $ 34,369 $ 25,866 $ 28,825 $ 33,486 $ 62,444
Total assets ................................................. $ 47,381 $ 53,679 $ 48,495 $ 66,968 $ 173,033
Liabilities, net of current portion .......................... $ 7,378 $ 9,192 $ 11,953 $ 15,575 $ 13,178
Total stockholders' equity (deficit) ......................... $ 31,665 $ 35,770 $ 27,202 $ 39,388 $ 126,362
</TABLE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis should be read in conjunction with
"Selected Financial Data" and our financial statements and the related notes
included elsewhere in this Form 10-K. This discussion contains forward-looking
statements that involve risks and uncertainties. Our actual results could differ
materially from those anticipated in the forward-looking statements as a result
of certain factors including the risks discussed in "Risk Factors" and elsewhere
in this Form 10-K. See Part I -- Item 1 -- "Special Note Regarding Forward
Looking Statements."
Overview
We were incorporated in California in January 1995 and reincorporated in
Delaware in December 1999. From the date of our incorporation through October
2001, we sold Linux-based hardware systems and services under the name VA Linux
Systems, Inc. On June 27, 2001, we announced our decision to exit our
Linux-based hardware business. Today, we do business under the name VA Software
Corporation and we develop, market and support a software application known as
SourceForge Enterprise Edition ("SourceForge") and also own and operate OSTG,
Inc. ("OSTG") and its wholly-owned subsidiaries, a network of Internet web
sites, offering advertising, retail and animation services and products.
We currently view our business in four operating segments: SourceForge,
Online Media, E-commerce and Online Images. Our SourceForge segment focuses on
our SourceForge software products and services. Our Online Media segment
represents a network of Internet web sites serving the IT professional and
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<PAGE>
software development communities. Our E-commerce segment provides online sales
of a variety of retail products of interest to the software development and IT
communities through ThinkGeek, Inc. ("ThinkGeek") a wholly-owned subsidiary of
OSTG. Our Online Images segment provides online sales of digital animation sold
in the form of CD's or as a subscription offered through Animation Factory,
Inc., a wholly-owned subsidiary of OSTG.
Our goals for fiscal 2005 were to continue to add new SourceForge customers
and broaden our advertising base for OSTG while increasing traffic, all with a
focus towards driving the Company towards profitability.
Within the SourceForge segment, we continued to increase the number of
customers to whom we have sold our SourceForge products, totaling 130 at July
31, 2005.
Within the Online Media segment, we reached record levels of page views,
unique visitors and advertisers. As of July 31, 2005, OSTG reached nearly 19
million unique visitors and served more than 290 million page views per month.
Within the E-commerce segment, we continued to increase our customer base,
increasing the number of orders by 17% from the prior year.
Within the Online Images segment, we grew our revenue by 19% from the prior
year.
Net revenues during fiscal 2005 increased as compared to fiscal 2004
primarily due to increased sales in our SourceForge, E-commerce and Online
Images businesses, offset by a decrease in our Online Media business and other
revenue derived from our previous hardware business. SourceForge sales increased
due to an increase in the number of customers to whom we have licensed
SourceForge. E-commerce and Online Images sales increased due to an increase in
our customer base related to these segments.
Net revenues during fiscal 2004 increased as compared to fiscal 2003
primarily due to increased sales in our SourceForge, E-commerce and Online
Images businesses, offset by a decrease in our Online Media business and other
revenue derived from our previous hardware business. SourceForge sales increased
due to an increase in the number of customers to whom we have licensed
SourceForge. E-commerce and Online Images sales increased due to an increase in
our customer base related to these segments.
Our sales continue to be primarily attributable to customers located in the
United States of America.
For total operations, our net loss was $4.7 million, $7.6 million and $13.8
million during fiscal year 2005, 2004 and 2003, respectively, or $0.08, $0.13
and $0.25, respectively, in basic and diluted net loss per share.
Critical Accounting Policies
Accounting policies, methods and estimates are an integral part of the
consolidated financial statements prepared by management and are based upon
management's current judgments. Those judgments are normally based on knowledge
and experience with regard to past and current events and assumptions about
future events. Certain accounting policies, methods and estimates are
particularly sensitive because of their significance to the financial statements
and because of the possibility that future events affecting them may differ
markedly from management's current judgments. While there are a number of
accounting policies, methods and estimates affecting our financial statements,
areas that are particularly significant include revenue recognition policies,
the assessment of impairment of long-lived assets, restructuring reserves for
excess facilities for non-cancelable leases, income taxes, and contingencies and
litigation.
Revenue Recognition
SourceForge Revenues
SourceForge software revenues consist principally of fees for licenses of
our SourceForge software products, maintenance, consulting and training. We
recognize all software revenue using the residual method in accordance with
Statement of Position ("SOP") 97-2, "Software Revenue Recognition," as amended
by SOP 98-9, "Modification of SOP 97-2, Software Revenue Recognition with
Respect to Certain Transactions." Under the residual method, the fair value of
the undelivered elements is deferred and the remaining portion of the
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<PAGE>
arrangement fee is recognized as revenue. If evidence of the vendor specific
fair value of one or more undelivered elements does not exist, revenues are
deferred and recognized when delivery of those elements occurs or when fair
value can be established. Company-specific objective evidence of fair value of
maintenance and other services is based on our customary pricing for such
maintenance and/or services when sold separately. At the outset of the
arrangement with the customer, we defer revenue for the fair value of its
undelivered elements (e.g., maintenance, consulting and training) and recognize
revenue for the remainder of the arrangement fee attributable to the elements
initially delivered in the arrangement (i.e., software product) when the basic
criteria in SOP 97-2 have been met. If such evidence of fair value for each
undelivered element of the arrangement does not exist, we defer all revenue from
the arrangement until such time that evidence of fair value does exist or until
all elements of the arrangement are delivered.
Under SOP 97-2, revenue attributable to an element in a customer
arrangement is recognized when (i) persuasive evidence of an arrangement exists,
(ii) delivery has occurred, (iii) the fee is fixed or determinable, (iv)
collectibility is probable and (v) the arrangement does not require services
that are essential to the functionality of the software.
Persuasive evidence of an arrangement exists. We determine that persuasive
evidence of an arrangement exists with respect to a customer when we have a
written contract, which is signed by both us and the customer, or a purchase
order from the customer when the customer has previously executed a standard
license arrangement with us. We do not offer product return rights.
Delivery has occurred. Our software may be either physically or
electronically delivered to the customer. We determine that delivery has
occurred upon shipment of the software pursuant to the billing terms of the
agreement or when the software is made available to the customer through
electronic delivery.
The fee is fixed or determinable. If at the outset of the customer
engagement we determine that the fee is not fixed or determinable, we recognize
revenue when the fee becomes due and payable. Fees due under a contract are
generally deemed not to be fixed or determinable if a significant portion of the
fee is beyond our normal payment terms, which are generally no greater than 120
days from the date of invoice.
Collectibility is probable. We determine whether collectibility is probable
on a case-by-case basis. When assessing probability of collection, we consider
the number of years in business, history of collection, and product acceptance
for each customer. We typically sell to customers, for whom there is a history
of successful collection. New customers are subject to a credit review process,
which evaluates the customer's financial position and ultimately such customer's
ability to pay. If we determine from the outset that collectibility is not
probable based upon our review process, revenue is recognized as payments are
received.
We allocate revenue on software arrangements involving multiple elements to
each element based on the relative fair value of each element. Our determination
of fair value of each element in multiple-element arrangements is based on
vendor-specific objective evidence ("VSOE"). We align our assessment of VSOE for
each element to the price charged when the same element is sold separately. We
have analyzed all of the elements included in our multiple-element arrangements
and determined that we have sufficient VSOE to allocate revenue to the
maintenance, support and professional services components of our perpetual
license arrangements. We sell our professional services separately, and have
established VSOE for professional services on that basis. VSOE for maintenance
and support is determined based upon the customer's annual renewal rates for
these elements. Accordingly, assuming all other revenue recognition criteria are
met, we recognize revenue from perpetual licenses upon delivery using the
residual method in accordance with SOP 98-9.
Services revenues consist of professional services and maintenance fees. In
general, our professional services, which are comprised of software installation
and integration, business process consulting and training, are not essential to
the functionality of the software. Our software products are fully functional
upon delivery and implementation and do not require any significant modification
or alteration of products for customer use. Customers purchase these
professional services to facilitate the adoption of our technology and dedicate
personnel to participate in the services being performed, but they may also
decide to use their own resources or appoint other professional service
organizations to provide these services. Software products are billed separately
from professional services, which are generally billed on a time-and-materials
basis. We recognize revenue from professional services as services are
performed.
Maintenance agreements are typically priced based on a percentage of the
product license fee and have a one-year term, renewable annually. Services
provided to customers under maintenance agreements include technical product
support and unspecified product upgrades. Deferred revenues from advanced
payments for maintenance agreements are recognized ratably over the term of the
agreement, which is typically one year.
13
<PAGE>
We expense all manufacturing, packaging and distribution costs associated
with software license sales as cost of license revenues.
Online Media Revenues
Online Media revenues are derived from the sale of advertising space on our
various web sites. We recognize Online Media revenues over the period in which
the advertisements are displayed, provided that persuasive evidence of an
arrangement exists, no significant obligations remain, the fee is fixed or
determinable, and collection of the receivable is reasonably assured. Our
obligations typically include guarantees of a minimum number of "impressions"
(times that an advertisement is viewed by users of our online services). To the
extent that minimum guaranteed impressions are not met in the specified time
frame, we do not recognize the corresponding revenues until the guaranteed
impressions are achieved. Prior to the fiscal year ended July 31, 2004, we
recorded barter revenue transactions at their estimated fair value based on our
historical experience of selling similar advertising for cash in accordance with
Emerging Issues Task Force ("EITF") Issue 99-17, "Accounting for Advertising
Barter Transactions." We broadcast banner advertising in exchange for similar
banner advertising on third-party web sites. Our barter arrangements are
documented with our standard customer insertion order (and accompanying terms
and conditions) or, in certain limited instances, via an alternative written
contract negotiated between the parties. The standard terms and conditions
include, but are not limited to, the web sites for each company that will
display the impressions, the time frame that the impressions will be displayed,
and the number, type and size of impressions to be delivered.
E-commerce Revenues
E-commerce revenues are derived from the online sale of consumer goods. We
recognize E-commerce revenues from the sale of consumer goods in accordance with
SEC Staff Accounting Bulletin ("SAB") No. 104, "Revenue Recognition." Under SAB
104, product revenues are recognized when persuasive evidence of an arrangement
exists, delivery has occurred, the sale price is fixed or determinable, and
collectibility is reasonably assured. In general, we recognize E-commerce
revenue upon the shipment of goods. We do grant customers a right to return
E-commerce products. Such returns are recorded as incurred and have been
immaterial for the periods presented.
Online Images Revenues
Software revenues related to digital animations consist of fees for
licenses and memberships for our animation software products. We recognize all
software revenue using the residual method in accordance with Statement of
Position ("SOP") 97-2, "Software Revenue Recognition," as amended by SOP 98-9,
"Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain
Transactions" as described in detail above. We offer two Animation Factory
membership agreement options: Gold and Platinum. Both Gold and Platinum
memberships are available for either a three-month or one-year term. Revenues
related to animation memberships are recognized over the life of the membership
term.
Impairment of Long-Lived Assets
We continually evaluate whether events and circumstances have occurred that
indicate the remaining estimated useful life of long-lived assets may warrant
revision or that the remaining balance of long-lived assets may not be
recoverable in accordance with Statement of Financial Accounting Standards
"SFAS" No. 144, "Accounting for Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of." When factors indicate that long-lived
assets should be evaluated for possible impairment, we use an estimate of the
related undiscounted future cash flows over the remaining life of the long-lived
assets in measuring whether they are recoverable. If the estimated undiscounted
future cash flows exceed the carrying value of the asset, a loss is recorded as
the excess of the asset's carrying value over fair value. Long-lived assets and
certain identifiable intangible assets to be disposed of are reported at the
lower of carrying amount or fair value less costs to sell.
Restructuring Costs and Other Special Charges
As discussed in Note 3 of the notes to the consolidated financial
statements, we have recorded significant restructuring charges in connection
with exiting our hardware systems, managed services, and professional services
and Linux software engineering services businesses during the fiscal years ended
2002 and 2001. A significant portion of these charges related to excess
facilities primarily from non-cancelable leases or other costs for the
abandonment or disposal of property and equipment. During the third quarter of
fiscal 2004, in connection with our original 2002 restructuring plan which
included an assumption to sublet all idle facilities, the Company relocated its
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Fremont, California headquarters to a smaller building in the same complex. In
addition, during the third quarter of fiscal 2004, the Company reached an
agreement in principal to sublet unoccupied portions of properties that it
leases in Fremont, California and Sunnyvale, California (also included as part
of the original 2002 restructuring plan). As a result of the change in
circumstances, original accruals were reevaluated and adjusted accordingly. In
the second quarter of fiscal 2005, a minor credit adjustment of $0.1 million was
recorded to accurately reflect the current common area maintenance fees
associated with the Fremont facilities. All charges as a result of restructuring
activities have been recorded in accordance with Emerging Issues Task Force
"EITF" 94-3 "Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (including Certain Costs incurred in a
Restructuring)". Restructuring charges recorded in fiscal 2004 and 2005 were
considered adjustments to the original restructuring plans, therefore,
Statements of Financial Accounting Standards "SFAS" No. 146 "Accounting for
Costs Associated with Exit or Disposal Activities" was not applicable. The
remaining accrual from non-cancelable lease payments is based on current
circumstances. These accruals are subject to change should actual circumstances
change. We will continue to evaluate and update, if applicable, these accruals
quarterly.
Income Taxes
We are required to estimate our income taxes in each of the jurisdictions in
which we operate as part of the process in preparing our consolidated financial
statements. This process involves us estimating our actual current tax exposure
together with assessing temporary differences resulting from differing treatment
of items, such as deferred revenue, for tax and accounting purposes. These
differences result in deferred tax assets or liabilities. We must then assess
the likelihood that our net deferred tax assets will be recovered from future
taxable income and to the extent that we believe recovery is not likely, we must
establish a valuation allowance. While we have considered future taxable income
in assessing the need for the valuation allowance, in the event that we were to
determine that we would be able to realize our deferred tax assets in the future
in excess of its net recorded amount, an adjustment to the deferred tax asset
valuation allowance would be made, increasing income in the period in which such
determination was made.
Contingencies and Litigation
We are subject to proceedings, lawsuits and other claims. We assess the
likelihood of any adverse judgments or outcomes to these matters as well as
ranges of probable losses. A determination of the amount of loss contingency
required, if any, is assessed in accordance with SFAS No. 5, "Contingencies and
Commitments" and recorded if probable after careful analysis of each individual
matter. The required loss contingencies may change in the future as the facts
and circumstances of each matter change.
Results of Operations
We believe that the application of accounting standards is central to a
company's reported financial position, results of operations and cash flows. We
review our annual and quarterly results, along with key accounting policies,
with our audit committee prior to the release of financial results. In addition,
we have not entered into any significant transactions with related parties. We
do not use off-balance-sheet arrangements with unconsolidated related parties,
nor do we use other forms of off-balance-sheet arrangements such as research and
development arrangements.
The following table sets forth our operating results for the periods
indicated as a percentage of net revenues, represented by selected items from
the unaudited condensed consolidated statements of operations. This table should
be read in conjunction with the consolidated financial statements and the
accompanying notes included in this Form 10-K.
For the years ended
----------------------------
July 31, July 31, July 31,
2005 2004 2003
----- ----- -----
Consolidated Statements of Operations Data:
Net revenues .................................... 100.0 100.0 100.0
Cost of revenues ................................ 50.0 53.1 52.7
----- ----- -----
Gross margin .................................... 50.0 46.9 47.3
----- ----- -----
Operating expenses:
Sales and marketing .......................... 30.6 34.5 40.4
Research and development ..................... 18.6 23.0 32.3
General and administrative ................... 18.0 15.9 26.6
Restructuring costs and other special charges (0.3) 11.0 (1.1)
Amortization of deferred stock compensation .. 0.0 0.1 0.6
Amortization of goodwill and intangible assets 0.0 0.0 8.9
Impairment of long-lived assets .............. 0.3 0.0 1.0
----- ----- -----
Total operating expenses ................... 67.2 84.5 107.7
----- ----- -----
Loss from operations ............................ (17.2) (37.6) (60.4)
Remeasurement of warrant liability .............. 0.0 5.4 0.0
Interest and other income, net .................. 2.9 6.2 4.5
----- ----- -----
Net loss ........................................ (14.3)% (26.0)% (56.9)%
===== ===== =====
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<TABLE>
<CAPTION>
Net Revenues
Year Ended % Change % Change
----------------------------------------------------- Fiscal 2004 Fiscal 2003
($ in thousands) July 31, 2005 July 31, 2004 July 31, 2003 to 2005 to 2004
---------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
SourceForge revenues $ 7,555 $ 4,995 $ 2,918 51% 71%
Online Media revenues 8,130 9,728 10,405 (16%) (7%)
E-commerce revenues 14,918 12,567 8,565 19% 47%
Online Images revenues 2,284 1,922 1,580 19% 22%
Other revenues -- 49 760 (100%) (94%)
------- ------- -------
Net revenues $32,887 $29,261 $24,228 12% 21%
======= ======= =======
</TABLE>
Net revenues increased during fiscal 2005 as compared to fiscal 2004 due
primarily to an increase in our SourceForge, E-commerce and Online Images
businesses, offset by a decrease in our Online Media revenue and other revenue
derived from our previous hardware business.
Net revenues increased during fiscal 2004 as compared to fiscal 2003 due
primarily to an increase in our SourceForge, E-commerce and Online Images
businesses, offset by a decrease in our Online Media revenue and other revenue
derived from our previous hardware business.
Sales for the fiscal years ended 2005, 2004, and 2003 were primarily to
customers located in the United States of America.
For the fiscal years ended July 31, 2005 and 2004, respectively no one
customer represented 10% or greater of net revenues. Going forward, we do not
anticipate that any one customer will represent more than 10% of net revenues.
Net Revenues by Segment
SourceForge Revenues
<TABLE>
<CAPTION>
Year Ended % Change % Change
----------------------------------------------------- Fiscal 2004 Fiscal 2003
($ in thousands) July 31, 2005 July 31, 2004 July 31, 2003 to 2005 to 2004
---------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
SourceForge revenues $7,555 $4,995 $ 2,918 51% 71%
Percentage of total
net revenues 23% 17% 12%
Aggregate # of customers sold to 130 97 55 34% 76%
Avg contract value $ 106 $ 75 $ 60 41% 25%
</TABLE>
SourceForge revenues consist principally of fees for licenses of our
SourceForge software products, maintenance, consulting and training.
The growth during fiscal 2005 was primarily related to the SourceForge
licensing and maintenance components of SourceForge revenue. We have increased
the number of customers to whom we have licensed SourceForge to 130 and
increased our average value of contracts sold during fiscal 2005 to $106,000.
This is compared to 97 customers to whom we had licensed SourceForge with an
average value of contracts sold during fiscal 2004 of $75,000.
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<PAGE>
The growth during fiscal 2004 was primarily related to the SourceForge
licensing and maintenance components of SourceForge revenue. We increased the
number of customers to whom we licensed SourceForge to 97 and increased our
average value of contracts sold during fiscal 2004 to $75,000. This is compared
to 55 customers to whom we had licensed SourceForge with an average value of
contracts sold during fiscal 2003 of $60,000.
We expect SourceForge revenues to continue to increase as our new and
returning customer base grows and our average contract value increases.
Online Media Revenues
<TABLE>
<CAPTION>
Year Ended % Change % Change
----------------------------------------------------- Fiscal 2004 Fiscal 2003
($ in thousands) July 31, 2005 July 31, 2004 July 31, 2003 to 2005 to 2004
---------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Online Media revenues $8,130 $9,728 $10,405 (16%) (7%)
Percentage of total
net revenues 25% 33% 43%
</TABLE>
Online Media revenues are primarily derived from cash and barter sales of
advertising space on our various web sites, as well as sponsorship and royalty
related arrangements associated with advertising on these web sites. During
fiscal 2004 and 2003, Online Media revenues also included $1.4 million and $2.0
million of barter revenue, respectively.
<TABLE>
<CAPTION>
Year Ended % Change % Change
----------------------------------------------------- Fiscal 2004 Fiscal 2003
($ in thousands) July 31, 2005 July 31, 2004 July 31, 2003 to 2005 to 2004
---------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Cash advertising $5,805 $6,744 $ 3,944 (14%) 71%
Barter advertising -- 1,427 1,957 (100%) (27%)
Sponsorships 390 715 4,350 (45%) (84%)
Donations 32 412 -- (92%) 100%
Other revenue 1,903 430 154 343% 179%
------------- ------------- -------------
Online Media revenues $8,130 $9,728 $10,405 (16%) (7%)
============= ============= =============
</TABLE>
Cash advertising revenue is derived from the number of impressions
delivered and the average CPM rate (i.e., the average rate at which we receive
revenue per 1,000 banner advertisements (impressions) we display to users of our
online services) charged for the impressions delivered.
Barter advertising is derived from banner advertising delivered in exchange
for similar banner advertising on third-party web sites. Prior to our fiscal
year ended July 31, 2004, we recorded barter revenue transactions at their
estimated fair value based on our historical experience of selling similar
advertising for cash.
Sponsorship revenue is derived from non-CPM rate web marketing programs
that are used to increase brand awareness. Revenue related to sponsorships is
recognized ratably over the term of the marketing program or in conjunction with
the delivery requirements set forth in the contract. Sponsorship revenue in
fiscal 2005 and 2004 relates to certain contracts with one customer, IBM. The
decrease in sponsorship revenue in fiscal 2005 as compared to fiscal 2004 was
due to the expiration of one of those IBM contracts in the fourth quarter of
fiscal 2004. Sponsorship revenue in fiscal 2003 was primarily derived from one
customer, Intel. The decrease in sponsorship revenue in fiscal 2003 as compared
to fiscal 2004 was the result of Intel not renewing its contract for fiscal 2004
and 2005.
Other revenue includes paid search, contextually-relevant advertising, and
referral fees.
<TABLE>
<CAPTION>
Year Ended % Change % Change
----------------------------------------------------- Fiscal 2004 Fiscal 2003
($ in thousands) July 31, 2005 July 31, 2004 July 31, 2003 to 2005 to 2004
---------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Cash advertising $ 5,805 $ 6,744 $ 3,944 (14%) 71%
Impressions delivered 538,151 1,162,028 563,795 (54%) 106%
Average CPM rate $ 10.79 $ 5.80 $ 7.00 86% (17%)
</TABLE>
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<PAGE>
The decrease in cash advertising revenue during fiscal 2005 as compared to
fiscal 2004 was due to a significant decrease in the number of impressions
delivered, offset by a substantial increase in the average contract CPM rate.
The decrease in the number of impressions delivered was primarily due to the
decline in online advertising associated with an individually significant
customer who had received a volume discount. The increase in average CPM rates
was the result of the decline in advertising associated with this individually
significant customer, which drove the average CPM rate for fiscal 2004 down. In
fiscal 2005, this customer represented only 4% of total cash advertising
revenues. However, in fiscal 2004, this same customer represented 29% of cash
advertising revenues.
The increase in cash advertising revenue during fiscal 2004 as compared to
fiscal 2003 was due to a significant increase in the number of impressions
delivered, offset by a decrease in the average contract CPM rate. The increase
in the number of impressions delivered was primarily due to increased online
advertising associated with an individually significant customer who had
received a volume discount. The decrease in average CPM rates was the result of
the increased advertising associated with this individually significant
customer, which drove the average CPM rate for fiscal 2004 down. In fiscal 2004,
this customer represented 29% of total cash advertising revenues. However, in
fiscal 2003, this same customer represented 17% of cash advertising revenues.
We believe that our prominent position in serving the growing open source
software and Linux markets, along with our favorable online visitor
demographics, make us an attractive advertising vehicle for advertising
customers.
E-commerce Revenues
<TABLE>
<CAPTION>
Year Ended % Change % Change
----------------------------------------------------- Fiscal 2004 Fiscal 2003
($ in thousands) July 31, 2005 July 31, 2004 July 31, 2003 to 2005 to 2004
---------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
E-commerce revenues $ 14,918 $ 12,567 $ 8,565 19% 47%
Percentage of total net
revenues 45% 43% 35%
# of Orders (per year) 235,375 201,542 138,495 17% 46%
Avg order size (in whole
dollars) $ 63.38 $ 62.35 $ 61.84 2% 1%
</TABLE>
E-commerce revenues are derived from the online sale of consumer goods,
including shipping, net of any returns and allowances.
The growth in fiscal 2005 and 2004 was primarily due to increased consumer
awareness of our site as a result of expanded advertising, a broader product
offering which attracted a larger customer base, as well as web site
enhancements and affiliate programs that drove more traffic to our site. As a
result of our efforts we experienced a 17% and 46% increase in the number of
orders placed during fiscal 2005 and 2004, respectively.
We expect E-commerce revenues to continue to grow as our E-commerce
customer base grows.
Online Images Revenues
<TABLE>
<CAPTION>
Year Ended % Change % Change
----------------------------------------------------- Fiscal 2004 Fiscal 2003
($ in thousands) July 31, 2005 July 31, 2004 July 31, 2003 to 2005 to 2004
---------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Online Images revenues $ 2,284 $ 1,922 $ 1,580 19% 22%
Percentage of total net
revenues 7% 7% 7%
</TABLE>
Online Images revenues are derived from the online sale of
three-dimensional art, animations and presentations.
The growth in fiscal 2005 and 2004 was primarily due to increased consumer
awareness of our site as a result of a broader product offering which attracted
a larger customer base, as well as web site enhancements and affiliate programs
that drove more traffic to our site.
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<PAGE>
We expect Online Images revenues to continue to grow as our customer base
grows.
Other Revenues
<TABLE>
<CAPTION>
Year Ended % Change % Change
----------------------------------------------------- Fiscal 2004 Fiscal 2003
($ in thousands) July 31, 2005 July 31, 2004 July 31, 2003 to 2005 to 2004
---------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Other revenues $ -- $ 49 $ 760 (100%) (94%)
Percentage of total net
revenues 0.0% 0.2% 3.1%
</TABLE>
Other revenues were derived from our former hardware, and related customer
support, and professional services businesses. The decrease in other revenues in
fiscal 2005 and 2004 is the direct result of exiting these former businesses. We
expect other revenues to remain at zero going forward.
Our revenue recognition policy related to our former hardware systems
business followed SAB 104, "Revenue Recognition." Under SAB 104, we recognized
product revenues from the sale of Linux-based servers, components, and desktop
computers when persuasive evidence of an arrangement existed, delivery occurred,
the sales price was fixed or determinable and collectibility was reasonably
assured. In general, we recognized product revenue upon shipment of the goods.
We did not grant our customers any rights to return these products.
We recognized revenues from hardware related customer support services,
including on-site maintenance and technical support on a pro-rata basis over the
term of the related service agreement. We recognized revenues from hardware
related professional service contracts upon completion of the project, or using
the percentage of completion method of the project where project costs could be
reasonably estimated. We recorded any payments received prior to revenue
recognition as deferred revenue.
Cost of Revenues/Gross Margin
<TABLE>
<CAPTION>
Year Ended % Change % Change
----------------------------------------------------- Fiscal 2004 Fiscal 2003
($ in thousands) July 31, 2005 July 31, 2004 July 31, 2003 to 2005 to 2004
---------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Cost of revenues $16,434 $15,537 $12,780 6% 22%
Gross margin $16,453 $13,724 $11,448 20% 20%
Gross margin % 50% 47% 47%
</TABLE>
Cost of revenues consist of personnel costs and related overhead associated
with providing software professional services, personnel costs and related
overhead associated with providing and running advertising campaigns and product
costs associated with our E-commerce and Online Images businesses. The above
analysis is inclusive of any restructuring charges that were originally
classified as cost of revenues or adjustments to those original restructuring
charges. The below analysis represents cost of revenues, excluding all
restructuring charges and adjustments:
<TABLE>
<CAPTION>
Year Ended % Change % Change
----------------------------------------------------- Fiscal 2004 Fiscal 2003
($ in thousands) July 31, 2005 July 31, 2004 July 31, 2003 to 2005 to 2004
---------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Cost of revenues $16,434 $15,537 $12,780 6% 22%
Add back restructuring
recoveries -- 12 432 (100%) (97%)
Cost of revenues (excl
restructuring) $16,434 $15,549 $13,212 6% 18%
Gross margin (excl
restructuring) $16,453 $13,712 $11,016 20% 24%
Gross margin % (excl
restructuring) 50% 47% 45%
</TABLE>
19
<PAGE>
The restructuring credits in fiscal 2004 and 2003 were related to
adjustments of prior period restructuring charges associated with inventory and
warranty reserves in connection with our former hardware business.
The increase in gross margins excluding the prior period restructuring
reserves adjustments was primarily the result of improvements in the
SourceForge, E-commerce and Online Images businesses, offset by a decline in the
Online Media margins.
Cost of Revenues/Gross Margin by Segment (Excluding Restructuring)
SourceForge Cost of Revenues/Gross Margin
<TABLE>
<CAPTION>
Year Ended % Change % Change
----------------------------------------------------- Fiscal 2004 Fiscal 2003
($ in thousands) July 31, 2005 July 31, 2004 July 31, 2003 to 2005 to 2004
---------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
SourceForge cost of revenues $ 1,028 $ 1,860 $ 1,997 (45%) (7%)
SourceForge gross margin $ 6,527 $ 3,135 $ 921 108% 240%
SourceForge gross margin % 86% 63% 32%
</TABLE>
SourceForge cost of revenues consist of personnel and outside contractor
costs associated with providing software customer and professional services.
The increase in our SourceForge gross margin percentages for fiscal 2005 as
compared to fiscal 2004 was primarily the result of lower outside contractor
costs, decreased personnel costs due to a decrease in headcount and leveraging
our fixed personnel costs while increasing revenue levels. The increased margin
associated with lower outside contractor costs accounted for $0.3 million. The
increased margin associated with decreased personnel accounted for $0.2 million,
and the increased margin associated with leveraging our fixed personnel costs
accounted for $0.3 million.
The increase in our SourceForge gross margin percentages for fiscal 2004 as
compared to fiscal 2003 was primarily the result of decreased personnel costs
due to a decrease in headcount. The increased margin associated with decreased
personnel accounted for $0.2 million.
Online Media Cost of Revenues/Gross Margin
<TABLE>
<CAPTION>
Year Ended % Change % Change
----------------------------------------------------- Fiscal 2004 Fiscal 2003
($ in thousands) July 31, 2005 July 31, 2004 July 31, 2003 to 2005 to 2004
---------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Online Media cost of revenues $3,320 $2,969 $3,852 12% (23%)
Online Media gross margin $4,810 $6,759 $6,553 (29%) 3%
Online Media gross margin % 59% 69% 63%
</TABLE>
Online Media cost of revenues consist of personnel costs and related
overhead associated with developing the editorial content of the sites and
providing and running advertising campaigns.
The decrease in Online Media gross margin percentages for fiscal 2005 as
compared to fiscal 2004 was primarily driven by the increase in Online Media
cost of revenues on lower overall revenue volumes, primarily due to our
elimination of our revenue generating barter programs. The increase in cost of
revenues was primarily due to an increase in personnel costs related to
editorial content contractors of $0.2 million and an increase in corporate
overhead facilities costs of $0.2 million as a result of consolidating
operations, offset by a decrease in depreciation expense and bandwidth costs
associated with delivering advertising of $0.1 million.
The increase in Online Media gross margin percentages for fiscal 2004 as
compared to fiscal 2003 was driven by the decrease in depreciation expense
associated with servers that deliver editorial content and advertising of $0.8
million.
20
<PAGE>
E-commerce Cost of Revenues/Gross Margin
<TABLE>
<CAPTION>
Year Ended % Change % Change
----------------------------------------------------- Fiscal 2004 Fiscal 2003
($ in thousands) July 31, 2005 July 31, 2004 July 31, 2003 to 2005 to 2004
---------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
E-commerce cost of revenues $11,591 $10,225 $7,025 13% 46%
E-commerce gross margin $ 3,327 $ 2,342 $1,540 42% 52%
E-commerce gross margin % 22% 19% 18%
</TABLE>
E-commerce cost of revenues consist of product costs, shipping and
fulfillment costs and personnel costs associated with the operations and
merchandising functions.
E-commerce gross margin percentages increased for fiscal 2005 as compared
to fiscal 2004 as a result of higher product margins due to product mix, offset
by a slight deterioration in shipping and fulfillment margins. The increase in
E-commerce cost of revenues in absolute dollars in fiscal 2005 as compared to
fiscal 2004 was primarily due to increased product costs of $0.6 million,
shipping costs of $0.6 million and fulfillment costs of $0.2 million. The
increase in product costs was the result of increased E-commerce revenue levels.
The increase in shipping costs was partially related to increased revenue levels
and partially due to rate increases and fuel surcharges by both UPS and DHL. The
increase in fulfillment costs was partially related to increased revenue levels
and partially due to the transition associated with changing our third party
fulfillment partner in the later part of the fourth quarter of fiscal year 2004.
E-commerce gross margin percentages remained relatively flat for fiscal
2004 as compared to fiscal 2003. The increase in E-commerce cost of revenues in
absolute dollars in fiscal 2004 as compared to fiscal 2003 increased consistent
with increased E-commerce revenue levels.
We expect E-commerce cost of revenues in absolute dollars to increase
proportionately with E-commerce revenues. In addition, we expect E-commerce
overall gross margins to continue to improve slightly as volume grows.
Online Images Cost of Revenues/Gross Margin
<TABLE>
<CAPTION>
Year Ended % Change % Change
----------------------------------------------------- Fiscal 2004 Fiscal 2003
($ in thousands) July 31, 2005 July 31, 2004 July 31, 2003 to 2005 to 2004
---------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Online Images cost of revenues $ 495 $ 495 $ 339 0% 46%
Online Images gross margin $1,789 $ 1,427 $ 1,241 25% 15%
Online Images gross margin % 78% 74% 79%
</TABLE>
Online Images cost of revenues consist of direct material costs for
animation CDs and personnel costs associated with the operations.
The increase in our Online Images gross margin percentages for fiscal 2005
as compared to fiscal 2004 was primarily due to increased revenues as material
costs remained consistent year over year.
The decrease in our Online Images gross margin percentages for fiscal 2004
as compared to fiscal 2003 was primarily due to increased server capacity and
bandwidth usage as the business had grown from year to year.
Operating Expenses
Sales and Marketing Expenses
Sales and marketing expenses consist primarily of salaries, commissions and
related expenses for personnel engaged in sales, marketing and sales support
functions, as well as costs associated with trade shows, advertising and
promotional activities.
<TABLE>
<CAPTION>
Year Ended % Change % Change
----------------------------------------------------- Fiscal 2004 Fiscal 2003
($ in thousands) July 31, 2005 July 31, 2004 July 31, 2003 to 2005 to 2004
---------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Sales & Marketing $10,060 $10,093 $9,791 --% 3%
Percentage of total net
revenues 31% 34% 40%
Headcount 35 30 27
</TABLE>
21
<PAGE>
The slight decrease in absolute dollars in fiscal 2005 as compared to
fiscal 2004 was primarily related to a decrease in our Online Media marketing
expense related to barter of $1.4 million, offset by increases in employee
expenses of $0.8 million, commission expenses of $0.3 million, credit card fees
of $0.1 million and marketing expense of $0.2 million. The decline in our barter
marketing expense was due to the elimination of our revenue generating barter
related programs in the first quarter of fiscal 2005. The $0.8 million increase
in employee expense was primarily related to an increase in headcount. The $0.3
million in commission expense was a direct result of increased revenue related
to our SourceForge segment. The increase in credit card fees was related to our
ThinkGeek segment and was the result of increased sales volumes. The increase in
marketing expense was related to public relations for our Online Media segment.
The decrease as a percentage of net revenues was due to increased revenue
levels.
The increase in absolute dollars in fiscal 2004 as compared to 2003 was
primarily related to an increase in employee expenses, including commission, of
$0.5 million and an increase in credit card fees associated with our e-commerce
business of $0.3 million. Of the $0.5 million in employee expenses, $0.4 million
was related to commission expense and was a direct result of increased revenue
across all businesses. The increase in credit card fees was directly related to
our increase in E-commerce business year-over-year. These increases were offset
by a decrease in our Online Media marketing expense associated with barter
programs of $0.6 million. The decrease as a percentage of net revenues was due
to increased revenue levels.
Going forward, we do not anticipate any expense related to barter programs.
We believe our sales and marketing expenses in absolute dollars will increase in
the future as we intend to grow our sales force. However, in the future, we
expect sales and marketing expenses to decrease slightly as a percentage of
revenue.
Research and Development Expenses
Research and development ("R&D") expenses consist primarily of salaries and
related expenses for software engineers. We expense all of our research and
development costs as they are incurred.
<TABLE>
<CAPTION>
Year Ended % Change % Change
----------------------------------------------------- Fiscal 2004 Fiscal 2003
($ in thousands) July 31, 2005 July 31, 2004 July 31, 2003 to 2005 to 2004
---------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
SourceForge R&D $3,726 $4,635 $6,186 (20%) (25%)
Online Media R&D 1,799 1,541 1,161 17% 33%
E-commerce R&D 235 178 122 32% 46%
Online Images R&D 362 378 346 (4%) 9%
------------- ------------- -------------
Total Research & Development $6,122 $6,732 $7,815 (9%) (14%)
Percentage of total net
revenues 19% 23% 32%
Headcount 37 36 34
</TABLE>
The decrease in absolute dollars in fiscal 2005 as compared to fiscal 2004
was primarily due to a decrease in allocated facility expenses of $0.6 million.
The decrease in allocated facility expenses was primarily related to rent and
depreciation. Rent expense has decreased in fiscal 2005 as compared to fiscal
2004 as a result of our moving into a smaller facility late in the third quarter
of fiscal 2004. Depreciation expense has decreased as well due to moving into
the smaller facility and writing off the remaining assets associated with the
larger facility occupied in fiscal 2004. The decrease as a percentage of net
revenues was primarily due to our decreased spending levels as described above
as well as increased revenue levels.
The decrease in absolute dollars in fiscal 2004 compared to fiscal 2003 was
primarily due to a decrease in the use of SourceForge outside contractors of
$0.4 million and decreased employee related expenses of $0.7 million. The
decrease in SourceForge contractors was specifically related to Cybernet
Software Solutions, Inc. and was the direct result of completing the development
phase of SourceForge 3.4. The decrease in employee-related expenses was
primarily due to a reduction in salary expense during fiscal 2004 as the average
R&D headcount declined to 38 in fiscal 2004 from 42 in fiscal 2003. The decrease
as a percentage of net revenues was primarily due to our decreased spending
levels as described above as well as increased revenue levels. We expect
research and development expenses to increase slightly in absolute dollars and
decrease as a percentage of revenue in the future.
22
<PAGE>
In accordance with Statement of Financial Accounting Standards ("SFAS") No.
86, "Accounting for the Cost of Computer Software to be Sold, Leased, or
Otherwise Marketed," development costs incurred in the research and development
of new software products are expensed as incurred until technological
feasibility in the form of a working model has been established at which time
such costs are capitalized, subject to a net realizable value evaluation.
Technological feasibility is established upon the completion of an integrated
working model. To date, our software development has been completed concurrent
with the establishment of technological feasibility and, accordingly, all
software development costs have been charged to research and development expense
in the accompanying consolidated statements of operations. Going forward, should
technological feasibility occur prior to the completion of our software
development, all costs incurred between technological feasibility and software
development completion will be capitalized.
General and Administrative Expenses
General and administrative expenses consist of salaries and related
expenses for finance and administrative personnel, bad debts and professional
fees for accounting and legal services.
<TABLE>
<CAPTION>
Year Ended % Change % Change
----------------------------------------------------- Fiscal 2004 Fiscal 2003
($ in thousands) July 31, 2005 July 31, 2004 July 31, 2003 to 2005 to 2004
---------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
General & Administrative $5,925 $4,665 $6,455 27% (28%)
Percentage of total net
revenues 18% 16% 27%
Headcount 20 19 17
</TABLE>
The increase in absolute dollars in fiscal 2005 as compared to fiscal 2004
was primarily related to the reversal of legal expenses in the first quarter of
fiscal 2004 of $1.2 million, $0.9 million of which was associated with the IPO
Securities Litigation that was ultimately paid by one of our insurers and $0.3
million of which related to a lawsuit that was favorably resolved. Excluding
these reversals, general and administrative expenses increased slightly in
fiscal 2005 as compared to fiscal 2004. The increase, excluding reversals of
legal expenses, was primarily related to increased accounting fees, offset by
decreased employee expenses, recruiting expenses and allocated facility
expenses. The increase in accounting fees of $0.9 million was due to additional
costs associated with complying with the Sarbanes-Oxley Act of 2002. The
decrease in employee expenses of $0.3 million was associated with lower bonuses
earned in fiscal 2005 as compared with those earned in fiscal 2004. The decrease
in recruiting expenses of $0.2 million was associated with the placement fee for
one of the company's executives in the second and third quarters of 2004. The
decrease in allocated facility expenses of $0.5 million was primarily related to
rent and depreciation. Rent expense has decreased for fiscal 2005 as compared to
fiscal 2004 as a result of moving into a smaller facility late in the third
quarter of fiscal 2004. Depreciation expense has decreased as well due to moving
into the smaller facility and writing off the remaining assets associated with
the larger facility occupied in fiscal 2004. The increase as a percentage of net
revenues was primarily due to our increased expense levels as described above.
The decrease in absolute dollars in fiscal 2004 as compared to fiscal 2003
was primarily related to the reversal of legal expenses in 2004 of $1.4 million,
$0.9 million of which was associated with the IPO Securities Litigation that was
ultimately paid by one of our insurers, $0.3 million of which related to a
lawsuit that was favorably resolved, and $0.2 million of which related to a
lawsuit that was considered probable at the time of accrual but was considered
highly unlikely at July 31, 2004. In addition, fiscal 2003 expenses included a
charge of $0.3 million resulting from a California Sales Tax audit associated
with our former hardware business. In 2004, no expense was incurred related to
sales tax audits. The decrease as a percentage of net revenues was primarily due
to our decreased expense levels related to prior period accrual reversals as
described above as well as increased revenue levels. We expect general and
administrative expenses to decrease from 2005 levels in absolute dollars and
decrease as a percentage of revenue in the future.
23
<PAGE>
Restructuring Costs and Other Special Charges
In fiscal 2001 and 2002, we adopted plans to exit our hardware systems and
hardware-related software engineering and professional services businesses, as
well as exit a sublease agreement and to reduce our general and administrative
overhead costs. We exited these activities to pursue our current SourceForge,
Online Media, E-commerce and Online Images businesses and reduce our operating
losses to improve cash flow. We recorded restructuring charges of $168.5 million
related to exiting these activities, $160.4 million of which was included in
restructuring charges and other special charges in operating expenses and $8.1
million of which was included in cost of sales. Included in the restructuring
were charges related to excess facilities from non-cancelable leases. During the
third quarter of fiscal 2004, in connection with our original 2002 restructuring
plan which included an assumption to sublet all idle facilities, we relocated
our Fremont, California headquarters to a smaller building in the same complex.
As a result of the change in circumstances, original accruals were reevaluated
and we accordingly recorded a restructuring adjustment of $2.9 million. Included
in the $2.9 million dollar restructuring adjustment was $2.5 million of expense
related to writing off leasehold improvements and fixed assets and an additional
$0.4 million expense related to excess facilities from non-cancelable leases. In
addition, during the third quarter of fiscal 2004, we reached an agreement in
principle to sublet unoccupied portions of properties that we lease in
Sunnyvale, California and Fremont, California, which was finalized in the fourth
quarter of fiscal 2004. As a result of the change in circumstances due to the
agreement in principle, original accruals were reevaluated and we accordingly
recorded a restructuring adjustment of $0.3 million in the third quarter of
fiscal 2004. The $3.2 million total adjustment to restructuring expenses in
fiscal 2004 was recorded in the consolidated statement of operations for that
period. In the second quarter of fiscal 2005, a minor credit adjustment of $0.1
million was recorded to accurately reflect the current common area maintenance
fees associated with the Fremont facilities. The remaining accrual from
non-cancelable lease payments, which continue through 2010, is based on current
circumstances. These accruals are subject to change should actual circumstances
change. We will continue to evaluate and update, if applicable, these accruals
quarterly. As of July 31, 2005, we had an accrual of approximately $7.9 million
outstanding related to these non-cancelable leases, all of which was originally
included in operating expenses.
In addition to the above, we recorded a net restructuring credit of $0.3
million for the fiscal year ended July 31, 2003. This included $0.4 million of
additional charges related to existing excess facilities as a result of the
termination of a subtenant lease and $0.3 million of charges associated with our
fiscal 2002 plan to reduce our general and administrative overhead costs, net of
$1.0 million in credit adjustments to previously recorded restructuring
reserves. As of July 31, 2004, no outstanding accruals remained related to these
net restructuring activities for fiscal year 2003 .
All charges as a result of restructuring activities have been recorded in
accordance with Emerging Issues Task Force "EITF" 94-3 "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs incurred in a Restructuring)". Restructuring charges
recorded in fiscal 2004 were considered adjustments to the original
restructuring plans, therefore, Statements of Financial Accounting Standards
"SFAS" No. 146 "Accounting for Costs Associated with Exit or Disposal
Activities" was not applicable.
Below is a summary of the restructuring charges in operating expenses (in
thousands):
<TABLE>
<CAPTION>
Total Charged Total Charged/ Total
To Operations Total Charged (Credited)To Cash Restructuring
Fiscal To Operations Operations Receipts/ Liabilities at
2001-2003 Fiscal 2004 Fiscal 2005 (Payments) July 31, 2005
--------- ----------- ----------- ---------- -------------
<S> <C> <C> <C> <C> <C>
Cash Provisions:
Other special charges relating to
restructuring activities............................ $ 1,349 $ -- $ -- $ (1,349) $ --
Facilities charges.................................... 16,176 713 (101) (8,933) 7,855
Employee severance and other related charges.......... 5,532 -- -- (5,532) --
-------- -------- ------- --------- -------
Total cash provisions............................. 23,057 713 (101) $ (15,814) $ 7,855
-------- -------- ------- --------- -------
Non-cash:
Write-off of goodwill and intangibles................. 90,355 -- --
Write-off of other special charges relating to
restructuring activities............................. 9,323 2,496 --
Write-off of accelerated options from
terminated employees................................ 1,352 -- --
Acceleration of deferred stock compensation.......... 36,064 -- --
-------- -------- -------
Total non-cash provisions......................... 137,094 2,496 --
-------- -------- -------
Total provisions.................................. $160,151 $ 3,209 $ (101)
======== ======== =======
</TABLE>
24
<PAGE>
<TABLE>
Below is a summary of the changes to the restructuring liability (in thousands):
<CAPTION>
Balance at Charged to Balance at
Beginning Costs and End
Changes in the total accrued restructuring liability of Period Expenses Deductions of Period
---------------------------------------------------- --------- -------- ---------- ---------
<S> <C> <C> <C> <C>
For the year ended July 31, 2003....................... $17,994 $ 306 $ (3,411) $14,889
For the year ended July 31, 2004....................... $14,889 $ 713 $ (4,319) $11,283
For the year ended July 31, 2005....................... $11,283 $ (101) $ (3,327) $ 7,855
Short Long Total
Components of the total accrued restructuring liability Term Term Liability
------------------------------------------------------- ---- ---- ---------
As of July 31, 2003..................................... $ 4,117 $10,772 $ 14,889
As of July 31, 2004..................................... $ 3,440 $ 7,843 $ 11,283
As of July 31, 2005..................................... $ 1,748 $ 6,107 $ 7,855
</TABLE>
Amortization of Deferred Stock Compensation
In connection with the grant of stock options to employees during fiscal
1999 and prior to our initial public offering in fiscal 2000, we recorded
deferred stock compensation within stockholders' equity that was amortized on an
accelerated basis in accordance with Financial Accounting Standards Board
("FASB") Interpretation No. ("FIN") 28 over the vesting period for the
individual award. The amortization expense relates to options awarded to
employees in all operating expense categories, however, the amortization of
deferred stock compensation has not been separately allocated to these
categories. We expensed deferred stock compensation of $20,000 and $0.1 million
for fiscal years 2004 and 2003, respectively. Deferred stock compensation was
fully amortized as of July 31, 2004. As such, there was no deferred stock
compensation expense during fiscal 2005.
In December 2004, the FASB issued SFAS 123--revised 2004 ("SFAS 123R"),
"Share-Based Payment" which requires the measurement of all share-based payments
to employees, including grants of employee stock options, using a
fair-value-based method and the recording of such expense in our consolidated
statements of income. Beginning in the first fiscal quarter of 2006, we will
adopt SFAS 123R. We expect the adoption of SFAS 132R to have a significant
adverse impact on our consolidated statements of income and net income per
share.
On June 8, 2005, our Compensation Committee of the Board of Directors
approved the vesting acceleration of certain unvested, out-of-the-money stock
options outstanding under our employee stock option plans, effective June 7,
2005. Vesting was accelerated for stock options that had exercise prices greater
than $1.67 per share, which was the closing price of our common stock on June 7,
2005. This action was taken to reduce the impact of future compensation expense
that we would otherwise be required to recognize in future consolidated
statements of operations pursuant to SFAS 123R, which is applicable to us
beginning in the first fiscal quarter of 2006. As a result of the acceleration,
we expect to reduce future compensation expense by approximately $8.1 million
over fiscal years 2006, 2007 and 2008.
Intangible Assets
Intangible assets are amortized on a straight-line basis over three to five
years. Intangible asset amortization of $12,000, $12,000 and $2.1 million was
recorded in fiscal 2005, 2004 and 2003, respectively. The intangible asset
carrying value at July 31, 2005 is $7,000 and relates to domain and trade names
associated with our current SourceForge and OSTG businesses. This balance has
been included in "Other Assets" in the Consolidated Balance Sheets. We
continually evaluate whether events or circumstances have occurred that indicate
the remaining estimated useful lives of these intangible assets may not be
recoverable. No events or circumstances occurred during fiscal year 2005 that
would indicate a possible impairment in the carrying value of intangible assets
at July 31, 2005.
Remeasurement of Warrant Liability, Interest and Other Income, Net
On November 6, 2003, we entered into a securities purchase agreement in
which we completed a private placement of 3,529,412 shares of our common stock
with The Riverview Group LLC ("Riverview") at an issue price of $4.25 per share
for aggregate proceeds of approximately $15 million (the "Private Placement").
In connection with the Private Placement, the Company retained Wharton Capital
25
<PAGE>
Partners Ltd. ("Wharton") to act as a financial consultant and placement agent.
Also in connection with the Private Placement, Riverview and Wharton received
three-year warrants to purchase a total of 705,883 and 25,000 shares of our
common stock, respectively, at an exercise price of $6.00 and $6.14 per share,
respectively (collectively, the "Warrants"). We entered into a registration
rights agreement with Riverview on November 6, 2003 (the "Registration Rights
Agreement") in which we agreed to provide certain registration rights under the
Securities Act of 1933, as amended and the rules and regulations promulgated
thereunder, and applicable state securities laws with respect to the common
stock and the Warrants issued to Riverview.
Pursuant to the terms of the Registration Rights Agreement, we filed a
registration statement (the "Registration Statement") on Form S-3 in order to
register the common stock and Warrants issued in the Private Placement. The SEC
declared the Registration Statement effective on April 30, 2004. Before the
effective date of the Registration Statement, the shares of our common stock
sold in the Private Placement and the shares of our common stock underlying the
Warrants did not have the same rights as the other shares which were included in
the Equity section of the Consolidated Balance sheet. Therefore, the shares of
our common stock sold in the Private Placement and the shares of our common
stock underlying the Warrants were classified as liabilities on the Consolidated
Balance sheet. Liabilities must be reported at fair value as of the balance
sheet date. Initially the Warrants were valued as of November 6, 2003, and were
revalued on January 31, 2004 using the Black-Scholes valuation model and then,
on April 30, 2004, the effective date of the Registration Statement, revalued
again using the same Black-Scholes valuation model. As a result of these
remeasurements, a non-cash credit adjustment of $1.9 million was recorded to
properly value the liability. This credit adjustment was offset by a $0.3
million non-cash expense which was recorded as a result of not having the common
stock shares associated with the Private Placement registered. Both adjustments
have been recorded in "Remeasurement of warrant liability" in the Consolidated
Statement of Operations. As a result of the S-3 becoming effective on April 30,
2004, the remaining liability for the Warrants of $0.6 million was reclassified
to equity as of that date. The Company is required to maintain the effectiveness
of the Registration Statement on a commercially reasonable basis.
Related Party Transactions
As of July 31, 2005, we hold an investment of approximately 14% in VA Linux
Systems Japan, K.K. ("VA Linux Japan"). We continually evaluate whether events
or circumstances have occurred that indicate the remaining value of the
investment may be impaired. Based on the valuation performed at July 31, 2005, a
small impairment was recorded for $0.1 million during the fourth quarter of
fiscal 2005. There is no quoted market price for this investment; accordingly,
fair value was estimated by management based on the estimated fair value of the
underlying net assets. This investment is reported under our SourceForge
segment. The impairment has been included in "Impairment of long-lived assets"
in the Consolidated Statements of Operations and Other Comprehensive
Income/(Loss)". As of July 31, 2005, we had an investment balance of $0.4
million. This balance has been included in "Other Assets" in the Consolidated
Balance Sheets. VA Linux Japan acts as a reseller of the our SourceForge
application to customers in Japan and, pursuant to a license agreement with us,
resyndicates certain OSTG Web sites for the Japanese market. There are $59,000
of related-party receivables and $47,000 of related-party deferred revenue
associated with VA Linux Japan as of July 31, 2005 that are included in trade
receivables and deferred revenue in the accompanying Condensed Consolidated
Balance Sheets. There are no related-party receivables and deferred revenue
associated with VA Linux Japan as of July 31, 2004 that are included in trade
receivables and deferred revenue in the accompanying Condensed Consolidated
Balance Sheets. There were $0.5 million, $0.2 million and $0.1 million
related-party revenues associated with VA Linux Japan for the years ended July
31, 2005, July 31, 2004 and July 31, 2003, respectively.
Interest and Other Income, Net
<TABLE>
<CAPTION>
Year Ended % Change % Change
----------------------------------------------------- Fiscal 2004 Fiscal 2003
($ in thousands) July 31, 2005 July 31, 2004 July 31, 2003 to 2005 to 2004
---------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Interest Income $914 $911 $1,132 --% (20%)
Interest Expense $(39) $ (5) $ (8) * (38%)
Other Income (Expense) $ 83 $895 $ (40) * *
<FN>
*Percentage not meaningful
</FN>
</TABLE>
Interest income remained consistent for fiscal 2005 as compared to fiscal
2004 on lower cash levels due to increased returns on our cash.
26
<PAGE>
Although we received an additional $14.5 million in proceeds associated
with a Private Placement offering, net of issuance costs, in the second quarter
of fiscal 2004, we experienced a decline in interest income in fiscal 2004 as
compared to fiscal 2003 as a result of the continuing decline in interest rates.
We expect our cash balance to continue to decrease to support our
operations, however, interest income may fluctuate as interest rates fluctuate.
For additional information, please refer to Item 7A "Quantitative and
Qualitative Disclosures About Market Risk".
The increase in interest expense in fiscal 2005 as compared to fiscal 2004
was due to the equipment capital lease that we entered into in the second
quarter of fiscal 2005. The capital lease expires in October 2005.
Other income and expenses decreased in fiscal 2005 as compared to fiscal
2004 primarily due to proceeds received from a legal settlement in the first
quarter of fiscal 2004 of $1.0 million.
Other income and expenses increased in fiscal 2004 as compared to fiscal
2003 primarily due to proceeds received from a legal settlement in fiscal 2004
of $1.0 million.
Income Taxes
As of July 31, 2005, we had $346.2 million of federal and state net
operating loss carry-forwards for tax reporting purposes available to offset
future taxable income. We have not recognized any benefit from these net
operating loss carry-forwards because a valuation allowance has been recorded
for the total deferred tax assets as a result of uncertainties regarding
realization of the assets based on the lack of profitability to date and the
uncertainty of future profitability. The federal and state net operating loss
carry-forwards expire at various dates through fiscal year 2025 and fiscal year
2015, respectively, to the extent that they are not utilized. The amount of net
operating losses that we can utilize is limited under tax regulations because we
have experienced a cumulative stock ownership change of more than 50% over the
last three years.
Liquidity and Capital Resources
Year Ended
---------------------------------
July 31, July 31, July 31,
(in thousands) 2005 2004 2003
-------- -------- --------
Net cash provided by (used in):
Operating activities $ (6,135) $(10,912) $(15,809)
Investing activities (2,814) (2,322) (14,448)
Financing activities 552 17,840 1,400
Effect of exchange rate changes on cash
and cash equivalents (69) 55 12
-------- -------- --------
Net change in cash and cash equivalents $ (8,466) $ 4,661 $(28,845)
======== ======== ========
Our principal sources of cash as of July 31, 2005 are our existing cash,
cash equivalents, short-term and long-term investments of $38.4 million, which
excludes restricted cash of $1.0 million (refer to financing activities below
for discussion on restricted cash). Cash and cash equivalents decreased by $8.5
million, and short-term and long-term investments increased by $2.8 million at
July 31, 2005 when compared to July 31, 2004. This overall decrease is primarily
due to cash used in operations and payments related to idle facilities and
capital expenditures.
Our net change in cash and cash equivalents was positive during the year
ended July 31, 2004 as the result of raising $14.5 million in net proceeds as a
result of a private placement issuance of shares of our common stock. Excluding
that financing activity, net cash would have declined by $9.8 million.
The cash flow discussion below describes the cash used or provided in one
period as compared to the cash used or provided in the same period for the
previous year. As such, the year to year fluctuations discussed can be
calculated from the Consolidated Statements of Cash Flows.
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Operating Activities
The decrease in cash usage related to operating activities, net of non-cash
expense, in fiscal 2005, as compared to fiscal 2004, was primarily the result of
a decrease in net loss, net of non-cash expense, of $1.4 million, a decrease in
accounts receivable of $1.6 million, a decrease in inventories of $0.9 million,
a decrease in cash payments related to excess facilities of $1.0 million and an
increase in accrued liabilities and other of $2.2 million. The increased cash
inflow related to accounts receivable was primarily the result of increased
collections in fiscal 2005 compared to fiscal 2004. The increased cash inflow
related to inventories was primarily the result of decreased purchasing levels
and increased sales levels compared to fiscal 2004. The increased cash inflow
related to accrued restructuring was due to decreased cash payments related to
excess facilities. Cash payments related to excess facilities in fiscal 2005
were $3.3 million compared to $4.3 million in fiscal 2004. The decreased change
in restructuring liability for fiscal 2004 was due to a $0.7 million adjustment
recorded based on the change in events related to excess facilities in the third
quarter of fiscal 2004. The increased cash inflow related to accrued liabilities
and other was primarily related to the reversal of legal expenses in the first
quarter of fiscal 2004 of $1.2 million and increasing accounting accruals
related to the Company's Sarbanes-Oxley efforts in fiscal 2005 of $0.8 million.
The increase in cash inflow was offset by an increase in accounts payable of
$0.9 million as a result of the timing of payments and deferred revenue of $0.6
million due to increased sales volume.
The decrease in cash usage related to operating activities, net of non-cash
expense, in fiscal 2004, as compared to fiscal 2003, was primarily the result of
a decrease in net loss, net of non-cash expense of $3.4 million, an increase in
accrued liabilities and other of $1.3 million and an increase in accounts
payable of $2.0 million. The increased cash flow from accrued liabilities and
other was primarily related to the growth in SourceForge bookings and therefore
deferred revenue in 2004 as compared to 2003. The increased cash flow from
accounts payable was primarily the result of our continued efforts to decrease
expenses as well as the timing of payments. The increase in cash flow was offset
by an increase in accounts receivable of $0.9 million, an increase in
inventories of $0.6 million and a decrease in accrued restructuring of $0.5
million. The increased cash usage related to accounts receivable was primarily
the result of increased SourceForge sales in July 2004 compared to July 2003.
The increased cash usage related to inventories was primarily the result of
higher volume purchases in the fourth quarter of fiscal 2004 compared to the
fourth quarter of fiscal 2003. These higher volume purchases were made as a
result of long lead times and to secure exclusive inventory that would not be
available later in the year. Finally, the increased cash usage related to
accrued restructuring was the result of increased payments on excess facilities
in 2004 compared to 2003 of $1.4 million, offset by a decrease in cash payments
related to severance agreements of $0.5 million. Cash payments made on excess
facilities in 2004 was $4.3 million, compared to $2.9 million in 2003. The
variance in the restructuring accrual compared to the payments made in 2004 was
the $0.7 million adjustment recorded based on the change in events related to
excess facilities that occurred in the third and fourth quarters of fiscal 2004.
Payments made to former employees for severance agreements in 2003 were $0.5
million. A decrease in cash outflow of $0.5 million in 2004 compared to 2003
resulted as no restructuring related severance payments were made in 2004.
We expect that the above cash utilization trends will continue as we grow
our business and pay off our remaining lease obligations related to excess
facilities.
Investing Activities
Our investing activities primarily include purchases of property and
equipment and purchases and sales of marketable securities.
The increase in cash usage related to investing activities in fiscal 2005,
as compared to the fiscal 2004, was primarily the result of an increase in net
purchases of marketable securities of $2.3 million, offset by a decrease in
capital expenditures of $0.4 million and an increase in cash flow from
restricted cash. During fiscal 2005, we purchased (net) $2.8 million in short
and long-term marketable securities compared to a net purchase of $0.5 million
in fiscal 2004. The decrease in cash usage related to capital expenditures was
primarily related to a significant purchase of servers associated with our
Online Media segment in the first quarter of 2004. The increased cash inflow
from restricted cash was related to the release of restricted cash of $0.5
million in fiscal 2005 compared to an increase in restricted cash of $0.5
million in fiscal 2004.
The decrease in cash usage related to investing activities in fiscal 2004,
as compared to fiscal 2003, was primarily the result of a decrease in net
purchases of marketable securities of $14.1 million. The decrease in net
purchases of marketable securities was the result of our strategic decision in
fiscal 2003 to increase our short- and long-term investments and decrease our
cash equivalent investments in an effort to maximize our rate of return. As a
result, in 2003 we experienced much higher cash outflows related to marketable
security purchases than we did 2004. This decrease was offset by higher capital
expenditures of $0.7 million and an increase in our restricted cash of $1.0
million in fiscal 2004, as compared to 2003, primarily as a result of moving
into a new facility during fiscal 2004.
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Financing Activities
Our investing activities have primarily included cash proceeds from the
sale of our common stock through employee benefit plans and private placement
offerings, and payments on notes payable.
The decrease in cash provided by financing activities in fiscal 2005, as
compared to fiscal 2004, was the result of a private placement issuance of
shares of our common stock during the second quarter of fiscal 2004 and a
decline in the cash generated from the issuance of common stock to our employees
in fiscal 2005 as compared to fiscal 2004. We are uncertain of the level of cash
that will be generated in the future from the issuance of common stock to our
employees as the exercising of options is dependant upon several factors such as
the price of our common stock and the number of employees participating in our
stock option plans.
The increase in net cash provided by financing activities in fiscal 2004,
as compared to fiscal 2003, was primarily due to the $14.5 million of proceeds
received upon the private placement of 3,529,412 shares of our common stock. In
addition, net cash provided by financing activities increased in fiscal 2004, as
compared to fiscal 2003, due to an increase of $2.0 million in net proceeds from
the sale of common stock through our employee benefit plans.
For the fiscal years ended July 31, 2005, July 31, 2004 and July 31, 2003,
respectively exchange rate changes had an immaterial effect on cash and cash
equivalents. We expect that exchange rate changes will have an immaterial effect
on cash and cash equivalents in the near future due to our focus on US-based
business.
As of July 31, 2005 and July 31, 2004, we had outstanding letters of credit
issued under a line of credit of approximately $1.0 million and $1.5 million,
respectively, related to the corporate facility lease. The amount related to
this letter of credit is recorded in the "Restricted cash" section of the
condensed consolidated balance sheet. The balance declined by $0.5 million in
the fourth quarter of fiscal year 2005 under the terms of our existing lease
agreement. The remaining $1.0 million will decline as the Company meets certain
financial covenants.
Our liquidity and capital requirements depend on numerous factors,
including market acceptance of our software and online products, the resources
we devote to developing, marketing, selling and supporting our software and
online products, the timing and expense associated with expanding our
distribution channels, potential acquisitions and other factors. We expect to
devote capital resources to continue our research and development efforts, to
invest in our sales, support, marketing and product development organizations,
to enhance and introduce marketing programs, and for other general corporate
activities. We believe that our existing cash balances will be sufficient to
fund our operations through fiscal 2006 under our current business strategy.
Contractual Obligations
The contractual obligations presented in the table below represent our estimates
of future payments under fixed contractual obligations and commitments. Changes
in our business needs, cancellation provisions and other factors may result in
actual payments differing from the estimates. We cannot provide certainty
regarding the timing and amounts of payments. The following table summarizes our
fixed contractual obligations and commitments as of July 31, 2005 (in
thousands):
<TABLE>
<CAPTION>
Contractual Obligations Less than More than
Total 1 year 1-3 years 3-5 years 5 years
----- ------ --------- --------- -------
<S> <C> <C> <C> <C> <C>
Gross Operating Lease Obligations $17,821 $3,789 $7,127 $6,905 $ --
Sublease Income 5,276 1,145 2,097 2,034 --
------- ------ ------ ------ -------
Net Operating Lease Obligations 12,545 2,644 5,030 4,871 --
Capital Lease Obligations 11 11 -- -- --
Purchase Obligations 1,194 1,194 -- -- --
------- ------ ------ ------ -------
Total Obligations $13,750 $3,849 $5,030 $4,871 $ --
======= ====== ====== ====== =======
</TABLE>
Sublease income represents our expectations of payments to be received from our
subtenants. As of July 31, 2005, all of our excess facilities are sublet through
the remainder of each facilities lease term.
29
<PAGE>
Financial Risk Management
As a primarily US-centric company, we face limited exposure to adverse
movements in foreign currency exchange rates and we do not engage in hedging
activity. We do not anticipate significant currency gains or losses in the near
term. These exposures may change over time as business practices evolve and
could have a material adverse impact on our financial results.
We maintain investment portfolio holdings of various issuers, types and
maturities. These securities are classified as available-for-sale, and
consequently are recorded on the consolidated balance sheet at fair value with
unrealized gains and losses reported as a separate component of accumulated
other comprehensive income (loss). These securities are not leveraged and are
held for purposes other than trading.
Recent Accounting Pronouncements
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an
amendment of ARB No. 43, Chapter 4. SFAS No. 151 clarifies the accounting for
abnormal amounts of idle facility expense, freight, handling costs and wasted
material. SFAS No. 151 is effective for inventory costs incurred during fiscal
years beginning in our first quarter of fiscal 2006. We do not believe adoption
of SFAS No. 151 will have a material effect on our consolidated financial
position, results of operations or cash flows.
In December, 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary
Assets, an amendment of APB Opinion No. 29. SFAS No. 153 addresses the
measurement of exchanges of nonmonetary assets and redefines the scope of
transactions that should be measured based on the fair value of the assets
exchanged. SFAS No. 153 is effective for nonmonetary asset exchanges beginning
in our first quarter of fiscal 2006. We do not believe adoption of SFAS No. 153
will have a material effect on our consolidated financial position, results of
operations or cash flows.
In December 2004, the FASB issued SFAS 123--revised 2004 ("SFAS 123R"),
"Share-Based Payment" which replaces SFAS 123, "Accounting for Stock-Based
Compensation" and supersedes APB No. 25, "Accounting for Stock Issued to
Employees." SFAS 123R requires the measurement of all employee share-based
payments to employees, including grants of employee stock options, using a
fair-value-based method and the recording of such expense in our consolidated
statements of income. The accounting provisions of SFAS 123R are effective for
reporting periods beginning after June 15, 2005.
We are required to adopt SFAS 123R in the first quarter of fiscal 2006. The
pro forma disclosures previously permitted under SFAS 123 no longer will be an
alternative to financial statement recognition. See Note 2 in our Notes to
Consolidated Financial Statements for the pro forma net income and net income
per share amounts, for fiscal 2004 and fiscal 2005 presented, as if we had used
a fair-value-based method similar to the methods required under SFAS 123R to
measure compensation expense for employee stock incentive awards. Although we
have not yet determined whether the adoption of SFAS 123R will result in amounts
that are similar to the current pro forma disclosures under SFAS 123, we are
evaluating the requirements under SFAS 123R and expect the adoption to have a
significant adverse impact on our consolidated statements of operations and net
loss per share.
In May 2005, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards, or SFAS, No. 154, Accounting
Changes and Error Corrections, which replaces Accounting Principles Board
Opinion, or APB, No. 20, Accounting Changes, and SFAS No. 3, Reporting
Accounting Changes in Interim Financial Statements -- An Amendment of APB
Opinion No. 28. SFAS No. 154 provides guidance on accounting for and reporting
changes in accounting principle and error corrections. SFAS No. 154 requires
that changes in accounting principle be applied retrospectively to prior period
financial statements and is effective for fiscal years beginning after December
15, 2005. We do not expect SFAS No. 154 to have a material impact on our
consolidated financial position, results of operations, or cash flows.
Risk Factors
CURRENT AND PROSPECTIVE INVESTORS IN VA SOFTWARE SECURITIES SHOULD CAREFULLY
CONSIDER THE RISKS DESCRIBED BELOW BEFORE MAKING AN INVESTMENT DECISION. IN
ADDITION, THESE RISKS ARE NOT THE ONLY ONES FACING OUR COMPANY. ADDITIONAL RISKS
30
<PAGE>
OF WHICH WE ARE NOT PRESENTLY AWARE OR THAT WE CURRENTLY BELIEVE ARE IMMATERIAL
MAY ALSO IMPAIR OUR BUSINESS OPERATIONS. OUR BUSINESS COULD BE HARMED BY ANY OF
THESE RISKS. THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE DUE TO ANY OF
THESE RISKS, AND INVESTORS MAY LOSE ALL OR PART OF THEIR INVESTMENT.
Risks Related To Our SourceForge Business
Because the market for our SourceForge application software is still emerging,
we do not know whether existing and potential customers will license SourceForge
in sufficient quantities for us to achieve profitability.
Our future growth and financial performance will depend on market acceptance of
SourceForge and our ability to license our software in sufficient quantities and
under acceptable terms. The number of customers using SourceForge is still
relatively small. We expect that we will continue to need intensive marketing
and sales efforts to educate prospective clients about the uses and benefits of
SourceForge. Various factors could inhibit the growth of the market for and
market acceptance of SourceForge. In particular, potential customers may be
unwilling to make the significant capital investment needed to license
SourceForge. Many of our customers have licensed only limited quantities of
SourceForge, and these or new customers may decide not to deploy our software
more broadly. We cannot be certain that a viable market for SourceForge will
emerge or, if it does emerge, that it will be sustainable. If a sustainable
viable market for SourceForge fails to emerge, this would have a significant,
adverse effect upon our software business and operating results.
We are devoting the majority of our research and development spending to our
SourceForge application, so if this software does not achieve market acceptance
we are likely to experience continued operating losses.
Although in fiscal year 2005, which ended on July 31, 2005, approximately 23% of
our revenue was derived from our SourceForge business, we devoted 61%, or $3.7
million, of our research and development spending to research and development
associated with our SourceForge software application. We expect to continue to
allocate the majority of our research and development resources to SourceForge
for the foreseeable future. There can be no assurance, however, that we will be
sufficiently successful in marketing, licensing, upgrading and supporting
SourceForge to offset our substantial software research and development
expenditures. A failure to grow SourceForge revenue sufficiently to offset
SourceForge's significant research and development costs will materially and
adversely affect our business and operating results.
If we fail to attract and retain larger corporate and enterprise-level
customers, our revenues will not grow and may decline.
We have focused our sales and marketing efforts upon larger corporate and
enterprise-level customers. This strategy may fail to generate sufficient
revenue to offset the substantial demands that this strategy will place on our
business, in particular the longer sales cycles, higher levels of service and
support and volume pricing and terms that larger corporate and enterprise
accounts often demand. In addition, these larger customers generally have
significant financial and personnel resources. As a result, rather than license
SourceForge, our target customers may develop collaborative software development
applications internally, including ad hoc development of applications based on
open source code. A failure to successfully obtain revenues from larger
corporate or enterprise-level customers will materially and adversely affect our
operating results.
If we fail to anticipate or respond adequately to technology developments,
industry standards or practices, and customer requirements, or if we experience
any significant delays in product development, introduction, or integration,
SourceForge may become obsolete or unmarketable, our ability to compete may be
impaired, and our SourceForge revenues may not grow or may decline.
Rapid technological advances, changes in customer requirements, and frequent new
product introductions and enhancements characterize the software industry
generally. We must respond rapidly to developments related to hardware
platforms, operating systems, and software development tools. These developments
will require us to make substantial product development investments. We believe
the success of our SourceForge business will become increasingly dependent on
our ability to:
o support multiple platforms, including Linux, commercial UNIX and
Microsoft Windows;
o use the latest technologies to continue to support web-based
collaborative software development; and
o continually support the rapidly changing standards, tools and
technologies used in software development.
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<PAGE>
Our SourceForge application software has a long and unpredictable sales cycle,
which makes it difficult to forecast our future results and may cause our
operating results to vary significantly.
The period between initial contact with a prospective customer and the licensing
of SourceForge varies and has often exceeded three and occasionally exceeded
twelve months. Additionally, our sales cycle is complex because customers
consider a number of factors before committing to license SourceForge. Factors
that our customers and potential customers have informed us that they considered
when evaluating SourceForge include product benefits, cost and time of
implementation, and the ability to operate with existing and future computer
systems and applications. We have found that customer evaluation, purchasing and
budgeting processes vary significantly from company to company. We spend
significant time and resources informing prospective customers about our
SourceForge products, which may not result in completed transactions and
associated revenue. Even if SourceForge has been chosen by a customer,
completion of the transaction is subject to a number of contingencies, which
make our quarterly revenues difficult to forecast. These contingencies include
but are not limited to the following:
o Our ability to sell SourceForge licenses may be impacted by changes in
the strategic importance of software projects due to our customers'
budgetary constraints or changes in customer personnel;
o A customer's internal approval and expenditure authorization process
can be difficult and time consuming. Delays in approvals, even after
we are selected as a vendor, could impact the timing and amount of
revenues recognized in a quarterly period; and
o The number, timing and significance of enhancements to our SourceForge
products and future introductions of new software by our competitors
and us may affect customer-purchasing decisions.
If we do not continue to receive repeat business from existing SourceForge
customers, our revenue will not grow and may decline.
We generate a significant amount of our SourceForge license revenues from
existing customers. Generally, our customers initially purchase a limited number
of licenses as they evaluate, implement and adopt SourceForge. Even if customers
successfully use SourceForge, such customers may not purchase additional
licenses to expand the use of our product. Purchases of additional licenses by
these customers will depend on their success in deploying SourceForge, their
satisfaction with our product and support services and their use of competitive
alternatives. A customer's decision to widely deploy SourceForge and purchase
additional licenses may also be affected by factors that are outside of our
control or which are not related to our product or services. In addition, as we
deploy new versions of SourceForge, or introduce new products, our current
customers may not require the functionality of our new versions or products and
may decide not to license these products.
Increased utilization and costs of our technical support services may adversely
affect our financial results.
Over the short term, we may be unable to respond to fluctuations in customer
demand for support services. We may also be unable to modify the format of our
support services to compete with changes in support services provided by
competitors. Further, customer demand for these services could cause increases
in the costs of providing such services and adversely affect our operating
results.
Contractual issues may arise during the negotiation process that may delay the
anticipated closure of a transaction and our ability to recognize revenue as
anticipated. The occurrence of such issues might cause our SourceForge revenue
and operating results to fall below our publicly-stated expectations, the
expectations of securities analysts or the expectations of investors. Failure to
meet public expectations is likely to materially and adversely affect the
trading price of our common stock.
Because we focus on selling enterprise solutions, the process of contractual
negotiation is critical and may be lengthy. Additionally, several factors may
require us to defer recognition of license revenue for a significant period of
time after entering into a license agreement, including instances where we are
required to deliver either unspecified additional products or specified upgrades
for which we do not have vendor-specific objective evidence of fair value. While
we have a standard software license agreement that provides for revenue
recognition provided that delivery has taken place, collectibility from the
customer is reasonably assured and assuming no significant future obligations or
customer acceptance rights exist, customer negotiations and revisions to these
terms could impact our ability to recognize revenues at the time of delivery.
32
<PAGE>
Many enterprise customers negotiate software licenses near the end of each
quarter. In part, this is because enterprise customers are able, or believe that
they are able, to negotiate lower prices and more favorable terms at that time.
Our reliance on a large portion of SourceForge revenue occurring at the end of
the quarter and the increase in the dollar value of transactions that occur at
the end of a quarter can result in increased uncertainty relating to quarterly
revenues. Due to end-of-period variances, forecasts may not be achieved, either
because expected sales do not occur or because they occur at lower prices or on
terms that are less favorable to us.
In addition, slowdowns in our quarterly license contracting activities may
impact our service offerings and may result in lower revenues from our customer
training, professional services and customer support organizations. Our ability
to maintain or increase service revenues is highly dependent on our ability to
increase the number of license agreements we enter into with customers.
Risks Related To Our Online Media Business
If our online business fails to continue to deliver original and compelling
content and services, we will be unable to attract and retain users, which will
adversely affect our financial results.
The successful development and production of content and services is subject to
numerous uncertainties, including our ability to:
o anticipate and successfully respond to rapidly changing consumer
tastes and preferences;
o fund new program development; and
o attract and retain qualified editors, writers and technical personnel.
We cannot assure you that our online content and services will be attractive to
a sufficient number of users to generate revenues consistent with our estimates
or sufficient to sustain operations. In addition, we cannot assure you that any
new content or services will be developed in a timely or cost-effective manner.
If we are unable to develop content and services that allow us to attract,
retain and expand a loyal user base that is attractive to advertisers, we will
be unable to generate sufficient revenue to grow our online business.
If our online business fails to deliver innovative marketing programs, we will
be unable to attract and retain advertisers, which will adversely affect our
financial results.
The successful development and production of marketing programs is subject to
numerous uncertainties, including our ability to:
o enable advertisers to showcase products, services and/or brands to
their intended audience;
o anticipate and successfully respond to emerging trends in online
advertising; and
o attract and retain qualified marketing and technical personnel.
We cannot assure you that our online marketing programs will enable us to
attract and retain advertisers and generate revenues consistent with our
estimates or sufficient to sustain operations. In addition, we cannot assure you
that any new marketing programs will be developed in a timely or cost-effective
manner. If we are unable to deliver innovative marketing programs that allow us
to expand our advertiser base, we will be unable to generate sufficient revenue
to grow our online business.
Decreases or delays in advertising spending due to general economic conditions
could harm our ability to generate advertising revenue, which would adversely
affect our financial results.
Expenditures by advertisers tend to be cyclical, reflecting overall economic
conditions as well as budgeting and buying patterns. The overall market for
advertising, including Internet advertising, has been generally characterized in
recent quarters by modest growth of marketing and advertising budgets. Because
we derive a large part of our revenues from advertising fees, decreases in or
delays of advertising spending could reduce our revenues or negatively impact
our ability to grow our revenues. Even if economic conditions continue to
improve, marketing budgets and advertising spending may not increase from
current levels.
33
<PAGE>
If we fail to maintain our strategic relationship with IDG, our advertising
revenue will not grow as anticipated and may decline, and our financial
performance will suffer.
During the first quarter of fiscal year 2005, we entered into a marketing and
sales agreement with International Data Group ("IDG"). Under the agreement with
IDG, IDG's Global Solution's sales force will sell international advertising on
OSTG's network of Web sites, but it is not committed to providing any guaranteed
amount of sales of referrals. If we are unable to expand this strategic
relationship with IDG, our ability to increase our online international
advertising sales may be harmed. In addition, IDG can terminate this
relationship with us, pursue other relationships, or attempt to develop or
acquire Web sites that compete with our Web sites for online advertising
revenue. Even if we succeed in maintaining or expanding our relationship with
IDG, the relationship may not result in additional online advertising customers
or revenues.
Risks Related To Our E-Commerce Business
We cannot predict our E-commerce customers' preferences with certainty and such
preferences may change rapidly. If we fail to accurately assess and predict our
E-commerce customers' preferences, it will adversely impact our financial
results.
Our E-commerce offerings on our ThinkGeek.com web site are designed to appeal to
IT professionals, software developers and others in technical fields. Misjudging
either the market for our products or our customers' purchasing habits will
cause our sales to decline, our inventories to increase and/or require us to
sell our products at lower prices, all of which would have a negative effect on
our business.
We are exposed to significant inventory risks as a result of seasonality, new
product launches, rapid changes in product cycles and changes in consumer tastes
with respect to our products offered at our ThinkGeek E-commerce web site.
Failure to properly assess our inventory needs will adversely affect our
financial results.
In order to be successful, we must accurately predict our customers' tastes and
avoid overstocking or under-stocking products. Demand for products can change
significantly between the time inventory is ordered and the date of sale. In
addition, when we begin selling a new product, it is particularly difficult to
forecast product demand accurately. The acquisition of certain types of
inventory, or inventory from certain sources, may require significant lead-time
and prepayment, and such inventory may not be returnable. We carry a broad
selection and significant inventory levels of certain products and we may be
unable to sell products in sufficient quantities or during the relevant selling
seasons.
If we do not maintain sufficient E-commerce inventory levels, or if we are
unable to deliver our E-commerce products to our customers in sufficient
quantities, our E-commerce business operating results will be adversely
affected.
We must be able to deliver our merchandise in sufficient quantities to meet the
demands of our customers and deliver this merchandise to customers in a timely
manner. We must be able to maintain sufficient inventory levels, particularly
during the peak holiday selling seasons. If we fail to achieve these goals, we
may be unable to meet customer demand, and our financial results will be
adversely affected.
Our ThinkGeek E-commerce web site is dependent upon a single third party
fulfillment and warehouse provider. The satisfaction of our E-commerce customers
is highly dependent upon fulfillment of orders in a professional and timely
manner, so any decrease in the quality of service offered by our fulfillment and
warehouse provider will adversely affect our reputation and the growth of our
E-commerce business.
Our ThinkGeek E-commerce web site's ability to receive inbound inventory and
ship completed orders efficiently to our customers is substantially dependent on
a third-party contract fulfillment and warehouse provider. We currently utilize
the services of Dotcom Distribution, Inc. ("Dotcom Distribution"), located in
Edison, New Jersey. If Dotcom Distribution fails to meet our future distribution
and fulfillment needs, our relationship with and reputation among our E-commerce
customers will suffer and this will adversely affect our E-commerce growth.
Additionally, if Dotcom Distribution cannot meet our distribution and
fulfillment needs, particularly during the peak holiday selling seasons, or our
contract with Dotcom Distribution terminates, we may fail to secure a suitable
replacement or second-source distribution and fulfillment provider on comparable
terms, which would adversely affect our E-commerce financial results.
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Risks Related To Our Financial Results
We cannot predict our Online Images customers' preferences with certainty and
such preferences may change rapidly. If we fail to accurately assess and predict
our Online Images customers' preferences, it will adversely impact our financial
results.
Our Online images offerings on our AnimationFactory.com web site are designed to
appeal to small businesses, educational and religious groups and hobbyists and
individuals. Misjudging either the market for our products or our customers'
purchasing habits will cause our sales to decline.
Risks Related To Our Financial Results
If we fail to adequately monitor and minimize our use of existing cash, we may
need additional capital to fund continued operations beyond fiscal year 2006.
Since becoming a public company, we have experienced negative cash flow from
operations. Our average net monthly cash flow shortfall during fiscal 2005,
which ended July 31, 2005 was approximately $0.5 million. Although this average
net monthly cash flow shortfall approximation should not be relied upon as an
indicator of our average net monthly cash flow shortfall in the future, it
further illustrates that unless we monitor and minimize the level of use of our
existing cash, cash equivalents and marketable securities, we may require
additional capital to fund continued operations beyond our fiscal year 2006.
While we believe we will not require additional capital to fund continued
operations through fiscal year 2006, we may require additional funding within
this time frame, and this additional funding, if needed, may not be available on
terms acceptable to us, or at all. A slowdown in technology or advertising
spending, as well as other factors that may arise, could affect our future
capital requirements and the adequacy of our available funds. As a result, we
may be required to raise additional funds through private or public financing
facilities, strategic relationships or other arrangements. Any additional equity
financing would likely be dilutive to our stockholders. Debt financing, if
available, may involve restrictive covenants on our operations and financial
condition. Our inability to raise capital when needed could seriously harm our
business.
Certain factors specific to our businesses over which we have limited or no
control may nonetheless adversely impact our quarterly total revenues and
financial results.
The primary factors over which we have limited or no control that may adversely
impact our quarterly total revenues and financial results include the following:
o specific economic conditions relating to IT spending;
o the discretionary nature of our software and online media customers'
purchase and budget cycles;
o the size and timing of software and online media customer orders;
o long software and online media sales cycles;
o our ability to retain skilled engineering and sales personnel;
o economic conditions relating to online advertising and sponsorship,
and E-commerce;
o our ability to demonstrate and maintain attractive online user
demographics;
o the addition or loss of specific online advertisers or sponsors, and
the size and timing of advertising or sponsorship purchases by
individual customers; and o our ability to keep our web sites
operational at a reasonable cost.
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If our revenues and operating results fall below our expectations, the
expectations of securities analysts or the expectations of investors, the
trading price of our common stock will likely be materially and adversely
affected. You should not rely on the results of our business in any past periods
as an indication of our future financial performance.
Future guidelines and interpretations regarding software revenue recognition
could cause delays in our ability to recognize revenue, which will adversely
impact our quarterly financial results.
From time to time, the American Institute of Certified Public Accountants
("AICPA"), the Public Company Accounting Oversight Board ("PCAOB") and the SEC
may issue guidelines and interpretations regarding the recognition of revenue
from software and other activities. These new guidelines and interpretations
could result in a delay in our ability to recognize revenue. If the Company has
to delay the recognition of a significant amount of revenue in the future, this
will have a material impact on the Company's reported financial results.
We have a history of losses and expect to continue to incur net losses for the
foreseeable future. Failure to become and remain profitable may materially and
adversely affect the market price of our common stock and our ability to raise
capital and continue operations.
We incurred a loss of $1.0 million for our fourth fiscal quarter ended July 31,
2005, and we had an accumulated deficit of $752.1 million as of July 31, 2005.
We may continue to incur net losses in the future. If we do achieve
profitability, we may not be able to sustain it. Failure to become and remain
profitable may materially and adversely affect the market price of our common
stock and our ability to raise capital and continue operations beyond our fiscal
year 2006.
Despite reductions in the size of our workforce, our business may fail to grow
rapidly enough to offset our ongoing operating expenses.
During fiscal years 2001, 2002 and 2003, we substantially reduced the size of
our workforce. As of July 31, 2005, we had 127 employees. Despite these
reductions in our workforce, our business may fail to grow rapidly enough to
offset our ongoing operating expenses. As a result, our quarterly operating
results could fluctuate, and such fluctuation could adversely affect the market
price of our common stock.
Risks Related To Competition
If we do not effectively compete with new and existing competitors, our revenues
will not grow and may decline, which will adversely impact our financial
results.
We believe that the emerging collaborative software development market continues
to be fragmented, subject to rapid change and highly sensitive to new product
introductions and marketing efforts by industry participants. Competition in
related markets is intense. If our products gain market acceptance, we expect
the competition to rapidly intensify as new competitors enter the marketplace.
Our potential competitors include companies entrenched in closely related
markets who may choose to enter and focus on collaborative software development.
We expect competition to intensify in the future if the market for collaborative
software development applications continues to expand. Our potential competitors
include providers of software and related services as well as providers of
hosted application services. Many of our potential competitors have
significantly more resources, more experience, longer operating histories and
greater financial, technical, sales and marketing resources than we do. In
addition, open source code can be obtained through commercial vendors or
downloaded and used on an ad hoc basis to address some collaborative software
development challenges. We cannot guarantee that we will be able to compete
successfully against current and future competitors or that competitive pressure
and/or the availability of open source code will not result in price reductions,
reduced operating margins and loss of market share, any one of which could
seriously harm our business. Because individual product sales often lead to a
broader customer relationship, our products must be able to successfully compete
with and complement numerous competitors' current and potential offerings.
Moreover, we may be forced to compete with our strategic partners, and potential
strategic partners, and this may adversely impact our relationship with an
individual partner or a number of partners. Consolidation is underway among
companies in the software industry as firms seek to offer more extensive suites
of software products and broader arrays of software solutions. Changes resulting
from this consolidation may negatively impact our competitive position and
operating results.
Online competition is intense. Our failure to compete successfully could
adversely affect our revenue and financial results.
The market for Internet content and services is intensely competitive and
rapidly evolving. It is not difficult to enter this market and current and new
competitors can launch new Internet sites at relatively low cost. We derive
revenue from online advertising and sponsorships, for which we compete with
various media including newspapers, radio, magazines and various Internet sites.
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<PAGE>
We also derive revenue from E-commerce, for which we compete with other
E-commerce companies as well as traditional, "brick and mortar" retailers. We
may fail to compete successfully with current or future competitors. Moreover,
increased competition could result in price reductions, reduced margins or loss
of market share, any of which could have a material adverse effect on our future
revenue and financial results. If we do not compete successfully for new users
and advertisers, our financial results may be materially and adversely affected.
Risks Related To Intellectual Property
We are vulnerable to claims that our products infringe third-party intellectual
property rights. Any resulting claims against us could be costly to defend or
subject us to significant damages.
We expect that our software products will increasingly be subject to
infringement claims as the number of products and competitors in our industry
segment grows and the functionality of products in different industry segments
overlaps. In addition, we may receive patent infringement claims as companies
increasingly seek to patent their software. Our developers may fail to perform
patent searches and may therefore unwittingly infringe on third-party patent
rights. We cannot prevent current or future patent holders or other owners of
intellectual property from suing us and others seeking monetary damages or an
injunction against shipment of our software offerings. A patent holder may deny
us a license or force us to pay royalties. In either event, our operating
results could be seriously harmed. In addition, employees hired from competitors
might utilize proprietary and trade secret information from their former
employers without our knowledge, even though our employment agreements and
policies clearly prohibit such practices.
Any litigation regarding our intellectual property, with or without merit, could
be costly and time consuming to defend, divert the attention of our management
and key personnel from our business operations and cause product shipment
delays. Claims of intellectual property infringement may require us to enter
into royalty and licensing agreements that may not be available on terms
acceptable to us, or at all. In addition, parties making claims against us may
be able to obtain injunctive or other equitable relief that could effectively
block our ability to sell our products in the United States and abroad and could
result in an award of substantial damages against us. Defense of any lawsuit or
failure to obtain any required license could delay shipment of our products and
increase our costs. If a successful claim is made against us and we fail to
develop or license a substitute technology, our business, results of operations,
financial condition or cash flows could be immediately and materially adversely
affected.
If we fail to adequately protect our intellectual property rights, competitors
may use our technology and trademarks, which could weaken our competitive
position, reduce our revenues, and increase our costs.
We rely on a combination of copyright, trademark and trade-secret laws, employee
and third-party nondisclosure agreements, and other arrangements to protect our
proprietary rights. Despite these precautions, it may be possible for
unauthorized third parties to copy our products or obtain and use information
that we regard as proprietary to create products that compete against ours. Some
license provisions protecting against unauthorized use, copying, transfer, and
disclosure of our licensed programs may be unenforceable under the laws of
certain jurisdictions and foreign countries.
In addition, the laws of some countries do not protect proprietary rights to the
same extent as do the laws of the United States. To the extent that we increase
our international activities, our exposure to unauthorized copying and use of
our products and proprietary information will increase.
Our collection of trademarks is important to our business. The protective steps
we take or have taken may be inadequate to deter misappropriation of our
trademark rights. We have filed applications for registration of and registered
some of our trademarks in the United States and internationally. Effective
trademark protection may not be available in every country in which we offer or
intend to offer our products and services. Failure to protect our trademark
rights adequately could damage our brand identity and impair our ability to
compete effectively. Furthermore, defending or enforcing our trademark rights
could result in the expenditure of significant financial and managerial
resources.
The scope of United States patent protection in the software industry is not
well defined and will evolve as the United States Patent and Trademark Office
grants additional patents. Because patent applications in the United States are
not publicly disclosed until the patent is issued, applications may have been
filed that would relate to our products.
Our software business success depends significantly upon our proprietary
technology. Despite our efforts to protect our proprietary technology, it may be
possible for unauthorized third parties to copy certain portions of our products
or to reverse engineer or otherwise obtain and use our proprietary information.
We do not have any software patents, and existing copyright laws afford only
limited protection. In addition, we cannot be certain that others will not
37
<PAGE>
develop substantially equivalent or superseding proprietary technology, or that
equivalent products will not be marketed in competition with our products,
thereby substantially reducing the value of our proprietary rights. We cannot
assure you that we will develop proprietary products or technologies that are
patentable, that any patent, if issued, would provide us with any competitive
advantages or would not be challenged by third parties, or that the patents of
others will not adversely affect our ability to do business. Litigation may be
necessary to protect our proprietary technology. This litigation may be
time-consuming and expensive.
Other Risks Related To Our Overall Business
Failure to remediate our material weaknesses in internal control over financial
reporting in a timely manner, or at all, could harm our operating results or
cause us to fail to meet our regulatory or reporting obligations.
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 ("Section 404"), we
evaluated the effectiveness of our internal control over financial reporting as
of July 31, 2005 as well as our disclosure controls and procedures. Based on
this evaluation, management concluded that as of July 31, 2005, neither our
internal control over financial reporting nor our disclosure controls and
procedures were effective because of certain material weaknesses detailed in
Item 9A, Part II (Controls and Procedures) of this Annual Report on Form 10-K.
In particular, the material weaknesses that we identified included lack of
sufficient personnel and technical accounting and financial reporting expertise,
inadequate controls over period-end financial reporting, inadequate controls in
the areas of revenue and accounts receivable, inadequate controls in the area of
purchases, inadequate controls in the area of information technology, and lack
of internal control reports (under SAS 70) from critical external service
providers. While we believe that these material weaknesses did not have a
material effect on our reported results, they nevertheless constituted
deficiencies in our internal controls over financial reporting. In addition, to
remediate the material weaknesses summarized above, we may need to increase
staffing levels, hire personnel with more specialized technical accounting
expertise and/or upgrade our financial systems to a higher degree of automation.
If, despite our remediation efforts, we fail to ameliorate our material
weaknesses, we could be subject to regulatory scrutiny and a loss of public
confidence in our internal controls over financial reporting. These remediation
efforts will likely increase our general and administration expenses and could,
therefore, have an adverse effect on our reported net income.
Even if we are to successfully remediate such material weaknesses, because of
its inherent limitations, our internal control over financial reporting may not
prevent or detect misstatements or material omissions. Projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
We may be subject to claims as a result of information published on, posted on
or accessible from our Internet sites, which could be costly to defend and
subject us to significant damage claims.
We may be subject to claims of defamation, negligence, copyright or trademark
infringement (including contributory infringement) or other claims relating to
the information contained on our Internet sites, whether written by third
parties or us. These types of claims have been brought against online services
in the past and can be costly to defend regardless of the merit of the lawsuit.
Although federal legislation protects online services from some claims when
third parties write the material, this protection is limited. Furthermore, the
law in this area remains in flux and varies from state to state. We receive
notification from time to time of potential claims, but have not been named as a
party to litigation involving such claims. While no formal complaints have been
filed against us to date, our business could be seriously harmed if one were
asserted.
We may be subject to product liability claims if people or property are harmed
by the products we sell on our E-commerce web sites, which could be costly to
defend and subject us to significant damage claims.
Some of the products we offer for sale on our E-commerce web sites, such as
consumer electronics, toys, computers and peripherals, toiletries, beverages and
clothing, may expose us to product liability claims relating to personal injury,
death or property damage caused by such products, and may require us to take
actions such as product recalls. Although we maintain liability insurance, we
cannot be certain that our coverage will be adequate for liabilities actually
incurred or that insurance will continue to be available to us on economically
reasonable terms, or at all. In addition, some of our vendor agreements with our
suppliers do not indemnify us from product liability.
If we are unable to implement appropriate systems, procedures and controls, we
may not be able to successfully offer our services and grow our business.
Our ability to successfully offer our services and grow our business requires an
effective planning and management process. We updated our operations and
financial systems, procedures and controls following our strategic decision to
exit the hardware business. Our systems will continue to require additional
modifications and improvements to respond to current and future changes in our
business. If we cannot grow our businesses, and manage that growth effectively,
or if we fail to implement in a timely manner appropriate internal systems,
procedures, controls and necessary modifications and improvements to these
systems, our businesses will suffer.
If we lose key personnel or fail to integrate replacement personnel
successfully, our ability to manage our business could be impaired.
Our future success depends upon the continued service of our key management,
technical, sales, and other critical personnel. Our officers and other key
personnel are employees-at-will, and we cannot assure you that we will be able
to retain them. Key personnel have left our company in the past and there likely
will be additional departures of key personnel from time to time in the future.
The loss of any key employee could result in significant disruptions to our
operations, including adversely affecting the timeliness of product releases,
the successful implementation and completion of company initiatives, and the
results of our operations. Competition for these individuals is intense, and we
may not be able to attract, assimilate or retain highly qualified personnel.
Competition for qualified personnel in our industry and the San Francisco Bay
Area, as well as other geographic markets in which we recruit, is intense and
characterized by increasing salaries, which may increase our operating expenses
or hinder our ability to recruit qualified candidates. In addition, the
integration of replacement personnel could be time consuming, may cause
additional disruptions to our operations, and may be unsuccessful.
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Our stock price has been volatile historically and may continue to be volatile.
The trading price of our common stock has been and may continue to be subject to
wide fluctuations. During the fourth quarter of fiscal year 2005, the closing
sale prices of our common stock on the Nasdaq ranged from $1.34 to $2.00 per
share and the closing sale price on July 29, 2005 was $1.72 per share. Our stock
price may fluctuate in response to a number of events and factors, such as
quarterly variations in operating results, announcements of technological
innovations or new products and media properties by us or our competitors,
changes in financial estimates and recommendations by securities analysts, the
operating and stock price performance of other companies that investors may deem
comparable to us, and news reports relating to trends in our markets or general
economic conditions.
In addition, the stock market in general, and the market prices for
Internet-related companies in particular, have experienced volatility that often
has been unrelated to the operating performance of such companies. These broad
market and industry fluctuations may adversely affect the price of our stock,
regardless of our operating performance. Additionally, volatility or a lack of
positive performance in our stock price may adversely affect our ability to
retain key employees, all of whom have been granted stock options.
Sales of our common stock by significant stockholders may cause the price of our
common stock to decrease.
Several of our stockholders own significant portions of our common stock. If
these stockholders were to sell significant amounts of their holdings of our
common stock, then the market price of our common stock could be negatively
impacted. The effect of such sales, or of significant portions of our stock
being offered or made available for sale, could result in strong downward
pressure on our stock price. Investors should be aware that they could
experience significant short-term volatility in our stock if such stockholders
decide to sell a substantial amount of their holdings of our common stock at
once or within a short period of time.
Our networks may be vulnerable to unauthorized persons accessing our systems,
which could disrupt our operations and result in the theft of our proprietary
information.
A party who is able to circumvent our security measures could misappropriate
proprietary information or cause interruptions or malfunctions in our Internet
operations. We may be required to expend significant capital and resources to
protect against the threat of security breaches or to alleviate problems caused
by breaches in security.
Increasing regulation of the Internet or imposition of sales and other taxes on
products sold or distributed over the Internet could harm our business.
The electronic commerce market on the Internet is relatively new and rapidly
evolving. While this is an evolving area of the law in the United States and
overseas, currently there are relatively few laws or regulations that directly
apply to commerce on the Internet. Changes in laws or regulations governing the
Internet and electronic commerce, including, without limitation, those governing
an individual's privacy rights, pricing, content, encryption, security,
acceptable payment methods and quality of products or services could have a
material adverse effect on our business, operating results and financial
condition. Taxation of Internet commerce, or other charges imposed by government
agencies or by private organizations, may also be imposed. Any of these
regulations could have an adverse effect on our future sales and revenue growth.
Business disruptions could affect our future operating results.
Our operating results and financial condition could be materially and adversely
affected in the event of a major earthquake, fire or other catastrophic event.
Our corporate headquarters, the majority of our research and development
activities and certain other critical business operations are located in
California, near major earthquake faults. A catastrophic event that results in
the destruction of any of our critical business or information technology
systems could severely affect our ability to conduct normal business operations
and as a result our future operating results could be adversely affected.
System disruptions could adversely affect our future operating results.
Our ability to attract and maintain relationships with users, advertisers,
merchants and strategic partners will depend on the satisfactory performance,
reliability and availability of our Internet channels and network
infrastructure. Our Internet advertising revenues relate directly to the number
of advertisements delivered to our users. System interruptions or delays that
result in the unavailability of Internet channels or slower response times for
users would reduce the number of advertisements and sales leads delivered to
such users and reduce the attractiveness of our Internet channels to users,
strategic partners and advertisers or reduce the number of impressions delivered
and thereby reduce revenue. In the past twelve months, some of our sites have
experienced a small number of brief service interruptions. We will continue to
suffer future interruptions from time to time whether due to natural disasters,
telecommunications failures, other system failures, rolling blackouts, viruses,
hacking or other events. System interruptions or slower response times could
have a material adverse effect on our revenues and financial condition.
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The primary objective of our investment activities is to preserve principal
while at the same time maximizing the income we receive from our investments
without significantly increasing risk. Some of the securities that we have
invested in may be subject to market risk. This means that a change in
prevailing interest rates may cause the principal amount of the investment to
fluctuate. For example, if we hold a security that was issued with a fixed
interest rate at the then-prevailing rate and the prevailing interest rate later
rises, the principal amount of our investment will probably decline. To minimize
this risk, we maintain a portfolio of cash equivalents, short-term investments
and long-term investments in a variety of securities, including commercial
paper, money market funds and government and non-government debt securities. In
general, money market funds are not subject to market risk because the interest
paid on such funds fluctuates with the prevailing interest rate.
The following table presents the amounts of our cash equivalents,
short-term investments and long-term investments (in thousands) that are subject
to market risk and weighted-average interest rates, categorized by expected
maturity dates, as of July 31, 2005. This table does not include money market
funds because those funds are not subject to market risk.
<TABLE>
<CAPTION>
Maturing Maturing within three Maturing
(in thousands) Within three months months to one year Greater than one year
-------------- ------------------- ------------------ ---------------------
<S> <C> <C> <C>
As of July 31, 2005
Cash equivalents $1,550
Weighted-average interest rate 3.28%
Short-term investments $33,126
Weighted-average interest rate 3.72%
Long-term investments $1,806
Weighted-average interest rate 3.66%
</TABLE>
We have operated primarily in the United States, and virtually all sales
have been made in U.S. dollars. Accordingly, we have not had any material
exposure to foreign currency rate fluctuations.
The estimated fair value of our cash, cash equivalents and investments
approximate carrying value. We do not currently hold any derivative instruments
and do not engage in hedging activities.
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Item 8. Consolidated Financial Statements and Supplementary Data
TABLE OF CONTENTS
Page
Reports of Independent Registered Public Accounting Firm............. 42
Consolidated Balance Sheets.......................................... 44
Consolidated Statements of Operations and Other
Comprehensive Income (Loss)........................................ 45
Consolidated Statements of Stockholders' Equity...................... 46
Consolidated Statements of Cash Flows................................ 47
Notes to Consolidated Financial Statements........................... 48
Schedule II - Valuation and Qualifying Accounts...................... 74
All other schedules are omitted because they are not applicable, not
required, or because the required information is included in the consolidated
financial statements or notes thereto.
41
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To The Board of Directors and Stockholders of VA Software Corporation:
We have audited the accompanying consolidated balance sheets of VA Software
Corporation (the "Company") as of July 31, 2005 and 2004, and the related
consolidated statements of operations and other comprehensive income (loss),
stockholders' equity, and cash flows for each of the two years in the period
ended July 31, 2005. We have also audited the financial statement schedule
listed in the Index at Item 15(a) as of July 31, 2005 and 2004, and for each of
the two years in the period ended July 31, 2005. These financial statements and
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and schedule based on our
audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements and schedule are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements and schedule. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall presentation of the financial
statements and schedule. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of VA Software
Corporation at July 31, 2005 and 2004, and the results of its operations and its
cash flows for each of the two years in the period ended July 31, 2005, in
conformity with accounting principles generally accepted in the United States.
Also, in our opinion, the financial statement schedule as of July 31, 2005
and 2004, and for each of the two years in the period then ended, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the VA Software
Corporation's internal control over financial reporting as of July 31, 2005,
based on criteria established in Internal Control--Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO)
and our report dated October 31, 2005 expressed an unqualified opinion on
management's assessment of the effectiveness of internal control over financial
reporting and an adverse opinion on the effectiveness of internal control over
financial reporting due the existence of material weaknesses.
/s/ BDO Seidman, LLP
San Jose, California
October 31, 2005
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REPORT OF INDEPENDENT REGISTERD PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
VA Software Corporation
In our opinion, the consolidated statement of operations and comprehensive
loss, of stockholders' equity and of cash flows present fairly, in all material
respects, the financial position of VA Software Corporation and the results of
their operations and their cash flows for the year ended July 31, 2003 in
conformity with accounting principals generally accepted in the United States of
America. In addition, in our opinion, the financial statement schedule listed in
the index appearing under Item 15 (a)(2) on page 66 presents fairly, in all
material respects, the information set forth therein when read in conjunction
with the related consolidated financial statements. These financial statements
and financial statement schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and financial statement schedule based on our audits. We conducted
our audit of these statements in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audit provide a reasonable basis for
our opinion.
/s/ PricewaterhouseCoopers LLP
San Jose, California
August 20, 2003
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<TABLE>
VA SOFTWARE CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share information)
<CAPTION>
July 31, July 31,
2005 2004
--------- ---------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents ..................................................... $ 2,498 $ 10,964
Short-term investments ........................................................ 34,116 17,145
Restricted cash, current ...................................................... -- 450
Accounts receivable, net of allowances of $166 and $127, respectively ......... 4,306 3,909
Inventories ................................................................... 773 1,069
Prepaid expenses and other assets ............................................. 1,014 1,046
--------- ---------
Total current assets .................................................. 42,707 34,583
Property and equipment, net ..................................................... 736 1,208
Long-term investments ........................................................... 1,806 15,933
Restricted cash, non current .................................................... 1,000 1,000
Other assets .................................................................... 1,132 955
--------- ---------
Total assets .......................................................... $ 47,381 $ 53,679
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable .............................................................. 1,574 1,674
Accrued restructuring liabilities, current portion ............................ 1,748 3,440
Accrued compensation .......................................................... 1,258 981
Deferred revenue .............................................................. 2,134 1,750
Accrued accounting ............................................................ 970 191
Accrued liabilities and other ................................................. 654 681
--------- ---------
Total current liabilities ............................................. 8,338 8,717
Accrued restructuring liabilities, net of current portion ....................... 6,107 7,843
Other long-term liabilities ..................................................... 1,271 1,349
--------- ---------
Total liabilities ..................................................... 15,716 17,909
Commitments and contingencies (Notes 4,5,6 and 7)
Stockholders' equity:
Common stock, $0.001 par value; authorized -- 250,000,000; issued and
outstanding -- 61,659,119 shares in 2005 and 61,184,857 shares in 2004 ..... 62 62
Treasury stock ................................................................ (4) (4)
Additional paid-in capital .................................................... 783,895 783,246
Accumulated other comprehensive gain (loss) ................................... (231) (171)
Accumulated deficit ........................................................... (752,057) (747,363)
--------- ---------
Total stockholders' equity ............................................ 31,665 35,770
--------- ---------
Total liabilities and stockholders' equity ............................ $ 47,381 $ 53,679
========= =========
<FN>
The accompanying notes are an integral part of these consolidated financial statements.
</FN>
</TABLE>
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<TABLE>
VA SOFTWARE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS AND OTHER COMPREHENSIVE INCOME/(LOSS)
(In thousands, except per share amounts)
<CAPTION>
Year Ended
July 31, July 31, July 31,
2005 2004 2003
-------- -------- --------
<S> <C> <C> <C>
Net revenues
SourceForge revenues .............................................. $ 7,555 $ 4,995 $ 2,918
Online Media revenues ............................................. 8,130 9,728 10,405
E-commerce revenues ............................................... 14,918 12,567 8,565
Online Images revenues ............................................ 2,284 1,922 1,580
Other revenues .................................................... -- 49 760
-------- -------- --------
Net revenues ................................................... 32,887 29,261 24,228
Cost of revenues
SourceForge cost of revenues ...................................... 1,028 1,860 1,997
Online Media cost of revenues ..................................... 3,320 2,969 3,802
E-commerce cost of revenues ....................................... 11,591 10,225 7,025
Online Images cost of revenues .................................... 495 495 339
Other cost of revenues ............................................ -- (12) (383)
-------- -------- --------
Cost of revenues .................................................. 16,434 15,537 12,780
-------- -------- --------
Gross margin ................................................... 16,453 13,724 11,448
-------- -------- --------
Operating expenses:
Sales and marketing ............................................... 10,060 10,093 9,791
Research and development .......................................... 6,122 6,732 7,815
General and administrative ........................................ 5,925 4,665 6,455
Restructuring costs and other special charges ..................... (101) 3,209 (263)
Amortization of deferred stock compensation ....................... -- 20 144
Amortization of intangible assets ................................. 12 12 2,149
Impairment of long-lived assets ................................... 87 -- 239
-------- -------- --------
Total operating expenses .................................. 22,105 24,731 26,330
-------- -------- --------
Loss from operations ................................................ (5,652) (11,007) (14,882)
Remeasurement of warrant liability .................................. -- 1,566 --
Interest income ..................................................... 914 911 1,132
Interest expense .................................................... (39) (5) (8)
Other income (expense), net ......................................... 83 895 (40)
-------- -------- --------
Net loss ............................................................ $ (4,694) $ (7,640) $(13,798)
Other comprehensive income (loss):
Unrealized (loss) gain on marketable securities and investments 9 (354) 30
Foreign currency translation gain (loss) ...................... (69) 55 12
-------- -------- --------
Comprehensive loss .................................................. $ (4,754) $ (7,939) $(13,756)
======== ======== ========
Net loss ............................................................ $ (4,694) $ (7,640) $(13,798)
======== ======== ========
Basic and diluted net loss per share ................................ $ (0.08) $ (0.13) $ (0.25)
======== ======== ========
Shares used in computing basic and diluted net loss per share ....... 61,454 59,684 54,110
======== ======== ========
<FN>
The accompanying notes are an integral part of these consolidated financial statements.
</FN>
</TABLE>
45
<PAGE>
VA SOFTWARE CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands)
<TABLE>
<CAPTION>
Common Stock Additional
--------------------- Treasury Paid-in
Shares Amount Stock Capital
------ ------ ----- -------
<S> <C> <C> <C> <C>
BALANCE AT JULY 27, 2002 ............................. 54,165 $ 54 $ (4) $ 765,422
Issuance of common stock for cash related to options . 1,578 2 -- 1,442
Repurchase of common stock for cash related to options (273) -- -- (2)
Amortization of deferred stock compensation .......... -- -- -- (76)
Acceleration and forfeiture of stock options and
deferred stock compensation related to
terminations, restructuring .......................... -- -- -- (21)
Foreign currency translation adjustment and
unrealized gain or loss on marketable securities ... -- -- -- --
---------- ---------- ---------- ----------
Net loss ............................................. -- -- -- --
BALANCE AT JULY 31, 2003 ............................. 55,470 56 (4) 766,765
Issuance of common stock for cash related to options . 2,186 2 -- 3,402
Issuance of common stock related to Private
Placement, net of issuance costs .................... 3,529 4 -- 12,866
Amortization of deferred stock compensation .......... -- -- -- --
Acceleration of stock options related to
terminations ........................................ -- -- -- 213
Foreign currency translation adjustment and
unrealized gain or loss on marketable securities ... -- -- -- --
Net loss ............................................. -- -- -- --
---------- ---------- ---------- ----------
BALANCE AT JULY 31, 2004 ............................. 61,185 62 (4) 783,246
Issuance of common stock for cash related to options . 474 -- -- 595
Issuance costs associated with Private ............... -- -- -- (14)
Placement
Amortization of deferred stock compensation .......... -- -- -- --
Acceleration of stock options related to
terminations ......................................... -- -- -- 68
Foreign currency translation adjustment and
unrealized gain or loss on marketable securities ... -- -- -- --
Net loss ............................................. -- -- -- --
---------- ---------- ---------- ----------
BALANCE AT JULY 31, 2005 ............................. 61,659 $ 62 $ (4) $ 783,895
=== ==== ========== ========== ========== ==========
<FN>
The accompanying notes are an integral part of these consolidated financial statements.
</FN>
</TABLE>
VA SOFTWARE CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands) (cont)
<TABLE>
<CAPTION>
Accumulated
Deferred Other Total
Stock Comprehensive Accumulated Stockholders'
Compensation Income (Loss) Deficit Equity
------------ ------------- ------- ------
<S> <C> <C> <C> <C>
BALANCE AT JULY 27, 2002 ............................. $ (245) $ 86 $(725,925) $ 39,388
Issuance of common stock for cash related to options . -- -- -- 1,444
Repurchase of common stock for cash related to options -- -- -- (2)
Amortization of deferred stock compensation .......... 220 -- -- 144
Acceleration and forfeiture of stock options and
deferred stock compensation related to
terminations, restructuring .......................... 5 -- -- (16)
Foreign currency translation adjustment and
unrealized gain or loss on marketable securities ... -- 42 -- 42
------ ------- --------- ---------
Net loss ............................................. -- -- (13,798) (13,798)
BALANCE AT JULY 31, 2003 ............................. (20) 128 (739,723) 27,202
Issuance of common stock for cash related to options . -- -- -- 3,404
Issuance of common stock related to Private
Placement, net of issuance costs .................... -- -- -- 12,870
Amortization of deferred stock compensation .......... 20 -- -- 20
Acceleration of stock options related to
terminations ........................................ -- -- -- 213
Foreign currency translation adjustment and
unrealized gain or loss on marketable securities ... -- (299) -- (299)
------ ------- --------- ---------
Net loss ............................................. -- -- (7,640) (7,640)
BALANCE AT JULY 31, 2004 ............................. -- (171) (747,363) 35,770
Issuance of common stock for cash related to options . -- -- -- 595
Issuance costs associated with Private ............... -- -- -- (14)
Placement
Amortization of deferred stock compensation .......... -- -- -- --
Acceleration of stock options related to
terminations ......................................... -- -- -- 68
Foreign currency translation adjustment and
unrealized gain or loss on marketable securities ... -- (60) -- (60)
Net loss ............................................. -- -- (4,694) (4,694)
------ ------- --------- ---------
BALANCE AT JULY 31, 2005 ............................. $ -- $ (231) $(752,057) $ 31,665
====== ======= ========= =========
<FN>
The accompanying notes are an integral part of these consolidated financial statements.
</FN>
</TABLE>
46
<PAGE>
VA SOFTWARE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Year Ended
-----------------------------------
July 31, July 31, July 31,
2005 2004 2003
---- ---- ----
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss .................................................................. $ (4,694) $ (7,640) $(13,798)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization ........................................... 941 1,468 5,351
Remeasurement of warrant liability ...................................... -- (1,566) --
Provision for bad debts ................................................. 40 56 (19)
Provision for excess and obsolete inventory ............................. 57 9 (6)
Loss on disposal of assets .............................................. 9 -- 35
Amortization of deferred stock compensation ............................. -- 20 144
Non-cash compensation expense ........................................... 68 213 --
Non-cash restructuring expense .......................................... (101) 2,496 (569)
Impairment of long-lived assets ......................................... 87 -- 239
Changes in assets and liabilities:
Accounts receivable ................................................... (438) (2,036) (1,178)
Inventories ........................................................... 239 (690) (82)
Prepaid expenses and other assets ..................................... (238) 157 286
Accounts payable ...................................................... (101) 812 (1,212)
Accrued restructuring liabilities ..................................... (3,327) (3,606) (3,105)
Accrued liabilities and other ......................................... 1,401 (773) (2,098)
Other long-term liabilities ........................................... (78) 168 203
-------- -------- --------
Net cash used in operating activities .............................. (6,135) (10,912) (15,809)
-------- -------- --------
Cash flows from investing activities:
Change in restricted cash ................................................. 450 (550) 450
Purchase of property and equipment ........................................ (475) (880) (289)
Sale of property and equipment ............................................ 49 -- 8
Purchase of marketable securities ......................................... (25,622) (44,976) (34,335)
Sale of marketable securities ............................................. 22,788 44,443 19,688
Other, net ................................................................ (4) (359) 30
-------- -------- --------
Net cash used in investing activities .............................. (2,814) (2,322) (14,448)
-------- -------- --------
Cash flows from financing activities:
Payments on notes payable ................................................. (29) -- (42)
Proceeds from issuance of common stock .................................... 581 17,840 1,444
Repurchase of common stock ................................................ -- -- (2)
-------- -------- --------
Net cash provided by financing activities .......................... 552 17,840 1,400
-------- -------- --------
Effect of exchange rate changes on cash and cash equivalents ............... (69) 55 12
-------- -------- --------
Net increase (decrease) in cash and cash equivalents ....................... (8,466) 4,661 (28,845)
Cash and cash equivalents, beginning of year ............................... 10,964 6,303 35,148
-------- -------- --------
Cash and cash equivalents, end of year ..................................... $ 2,498 $ 10,964 $ 6,303
======== ======== ========
Supplemental cash flow information:
Cash paid for state taxes .................................................. $ 36 $ 26 $ 16
Cash paid for interest ..................................................... $ 39 $ 5 $ 8
<FN>
The accompanying notes are an integral part of these consolidated financial statements.
</FN>
</TABLE>
47
<PAGE>
VA SOFTWARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Operations of the Company:
Overview
VA Software Corporation ("VA Software" or the "Company") was incorporated
in California in January 1995 and reincorporated in Delaware in December 1999.
From the date of its incorporation through October 2001, the Company sold
Linux-based hardware systems and services under the name VA Linux Systems, Inc.
On June 27, 2001, the Company announced its decision to exit its Linux-based
hardware business. Today, the Company does business under the name VA Software
Corporation and it develops, markets and supports a software application known
as SourceForge Enterprise Edition ("SourceForge") and owns and operates OSTG,
Inc. ("OSTG") and its wholly-owned subsidiaries, a network of Internet web sites
offering advertising, retail and animation services and products.
2. Summary of Significant Accounting Policies:
Use of Estimates in Preparation of Consolidated Financial Statements
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted by the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of such financial statements, as well as the reported
amounts of revenue and expenses during the periods indicated. Actual results
could differ from those estimates.
Reclassifications
Certain reclassifications have been made to the prior year consolidated
financial statements to conform to the current year presentation. These
reclassifications have no impact on previously reported net loss or cash flows.
Principles of Consolidation
These consolidated financial statements include the accounts of VA and its
wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation. In September 2000, the
Company acquired 68% of the outstanding shares of common stock of VA Linux
Systems Japan, K.K. ("VA Linux Japan") for a cash purchase price of
approximately $6.9 million. Effective January 11, 2002, VA sold 13,500 shares of
VA Linux Japan stock to a third party for approximately $5.1 million, the effect
of which decreased the Company's investment in VA Linux Japan to approximately
11%. As of July 31, 2005, VA Software's investment in VA Linux Japan was
approximately 14%. As the Company holds less than 20% of the voting stock of VA
Linux Japan and does not otherwise exercise significant influence, VA Linux
Japan has been accounted for under the cost method as of January 11, 2002 and
thereafter. The operations of VA Linux Japan primarily relate to the Company's
former systems and services business; however VA Linux Japan also acts as a
reseller of the Company's SourceForge application to customers in Japan and,
pursuant to a license agreement with the Company, resyndicates certain OSTG Web
sites for the Japanese market. There are $59,000 of related-party receivables
and $47,000 of related-party deferred revenue associated with VA Linux Japan as
of July 31, 2005 that are included in trade receivables and deferred revenue in
the accompanying Condensed Consolidated Balance Sheets. There are no
related-party receivables and deferred revenue associated with VA Linux Japan as
of July 31, 2004 that are included in trade receivables and deferred revenue in
the accompanying Condensed Consolidated Balance Sheets. There were $0.5 million,
$0.2 million and $0.1 million related-party revenues associated with VA Linux
Japan for the years ended July 31, 2005, July 31, 2004 and July 31, 2003,
respectively.
Foreign Currency Translation
The functional currency of all the Company's foreign subsidiaries is the
country's local currency. Operations related to all of the Company's foreign
subsidiaries were discontinued in 2001 and were included in the fiscal 2001
restructuring plan. Although the legal entities still exist as of July 31, 2005,
no revenues were generated from these entities for any of the periods presented
and the expenses were administrative in nature and were immaterial to the
48
<PAGE>
consolidated results of operations for all periods presented. Minimal cash
balances have been maintained in these entities for legal purposes. Remaining
balance sheet accounts are translated into U.S. dollars at exchange rates
prevailing at balance sheet dates. Expenses are translated into U.S. dollars at
average rates for the period. Gains and losses resulting from translation are
charged or credited in other comprehensive income as a component of
stockholders' equity. As of July 31, 2005 the Company did not hold any foreign
currency derivative instruments. The Company is in the process of formally
liquidating all of its foreign subsidiaries.
Segment and Geographic Information
Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures
about Segments of an Enterprise and Related Information," establishes standards
for reporting information regarding operating segments in annual financial
statements and requires selected information for those segments to be presented
in interim financial reports issued to stockholders. SFAS No. 131 also
establishes standards for related disclosures about products and services and
geographic areas. Operating segments are identified as components of an
enterprise about which separate discrete financial information is available for
evaluation by the chief operating decision-maker, or decision-making group, in
making decisions how to allocate resources and assess performance. The Company's
chief decision-making group, as defined under SFAS No. 131, are the Chief
Executive Officer and the executive team. The Company currently operates as four
reportable business segments: SourceForge, Online Media, E-commerce and Online
Images.
The Company markets its products in the United States through its direct
sales force and online web sites. Revenues for each of the years ended July 31,
2005, July 31, 2004 and July 31, 2003 were primarily generated from sales to end
users in the United States.
Cash, Cash Equivalents, Short-Term Investments and Long-Term Investments
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents. Cash and cash
equivalents consist principally of cash deposited in money market and checking
accounts.
The Company accounts for its investments under the provisions of SFAS No.
115, "Accounting for Certain Investments in Debt and Equity Securities."
Investments in highly liquid financial instruments with remaining maturities
greater than three months and maturities of less than one year are classified as
short-term investments. Financial instruments with remaining maturities greater
than one year are classified as long-term investments. All investments are
classified as available-for-sale and are reported at fair value with net
unrealized gains (losses) reported, net of tax, using the specific
identification method as other comprehensive gain/(loss) in stockholders'
equity. The cost of the investments was not significantly different than the
fair value for the fiscal years presented. The fair value of the Company's
available-for-sale securities are based on quoted market prices at the balance
sheet dates.
Cash, cash equivalents and investments, of which $35.5 million mature within
one year, consist of the following (in thousands) at market value:
July 31, July 31,
2005 2004
------- -------
Government securities .................................... $22,103 $22,465
Corporate securities ..................................... 12,357 14,134
Asset backed securities .................................. 2,021 2,731
Money market funds ....................................... 788 1,056
Commercial paper ......................................... -- 911
------- -------
Total Investments .............................. $37,269 $41,297
------- -------
Operating cash ........................................... 1,151 2,745
Restricted cash .......................................... 1,000 1,450
------- -------
Total cash, cash equivalents, short-term investments &
long-term investments .................................... $39,420 $45,492
======= =======
Included in cash and cash equivalents .................... $ 1,347 $ 8,219
Included in short-term investments ....................... 34,116 17,145
Included in long-term investments ........................ 1,806 15,933
------- -------
Total Investments .............................. $37,269 $41,297
======= =======
49
<PAGE>
Restricted Cash
During fiscal year 2000, the Company established letters of credit of
approximately $2.3 million that are used to collateralize payments related to
the Fremont building lease, which had been reduced to $0.9 million at July 31,
2003. During fiscal year 2004, the Company revised the remaining letter of
credit used to collateralize the Fremont building lease as a result of
subletting the unoccupied space and moving into the smaller facility in the same
complex. The revised letter of credit associated with this lease was $1.5
million at July 31, 2004. In the fourth quarter of fiscal 2005, $0.5 million had
been released from restricted cash in accordance with the terms of the lease.
The remaining amount restricted at July 31, 2005 was $1.0 million.
Trade Accounts Receivable
Trade accounts receivable are recorded at the invoiced amount and are not
interest bearing. The Company maintains an allowance for doubtful accounts to
reserve for potentially uncollectible trade receivables. The Company also
reviews its trade receivables by aging category to identify specific customers
with known disputes or collectibility issues. The Company exercises judgment
when determining the adequacy of these reserves and evaluates historical bad
debt trends, general economic conditions in the United States and
internationally, and changes in customer financial conditions.
Inventories
Inventories related to the Company's E-commerce and Online Images segments
consist solely of finished goods that are valued using the average cost method.
Provisions, when required, are made to reduce excess and obsolete inventories to
their estimated net realizable values.
Property and Equipment
Property and equipment are stated at cost and are depreciated using the
straight-line method over the estimated useful lives of the assets. Leasehold
improvements are amortized over the lesser of the estimated useful lives or the
corresponding lease term. Property and equipment consist of the following (in
thousands):
<TABLE>
<CAPTION>
July 31, July 31,
2005 2004
-------- --------
<S> <C> <C>
Computer and office equipment (useful lives of 2 to 3 years) .................. $ 3,811 $ 6,820
Furniture and fixtures (useful lives of 2 to 4 years) ......................... 484 1,199
Leasehold improvements (useful lives of lesser of estimated life or lease term) 285 271
Software (useful lives of 2 to 5 years) ...................................... 2,064 2,092
-------- --------
Total property and equipment ........................................ 6,644 10,382
Less: Accumulated depreciation and amortization ............................... (5,908) (9,174)
-------- --------
Property and equipment, net ......................................... $ 736 $ 1,208
======== ========
</TABLE>
Depreciation expense for the years ended July 31, 2005, July 31, 2004, and
July 31, 2003 was $0.9 million, $1.4 million, and $3.2 million, respectively.
Intangible Assets
Intangible assets are amortized on a straight-line basis over three to five
years. Intangible asset amortization of $12,000, $12,000 and $2.1 million was
recorded in fiscal 2005, 2004 and 2003, respectively. The intangible asset
carrying value at July 31, 2005 is $7,000 and relates to domain and trade names
associated with our current SourceForge and OSTG businesses. This balance has
been included in "Other Assets" in the Consolidated Balance Sheets. The Company
continually evaluates whether events or circumstances have occurred that
indicate the remaining estimated useful lives of these intangible assets may not
be recoverable. No events or circumstances occurred during fiscal year 2005 that
would indicate a possible impairment in the carrying value of intangible assets
at July 31, 2005.
50
<PAGE>
The changes in the carrying amount of the intangible assets are as follows
(in thousands):
<TABLE>
<CAPTION>
As of July 31, 2005 As of July 31, 2004
------------------- -------------------
Gross Carrying Accumulated Gross Carrying Accumulated
Amount Amortization Amount Amortization
------ ------------ ------ ------------
<S> <C> <C> <C> <C>
Domain and trade names ...... $ 5,932 $(5,925) $ 5,927 $(5,913)
Purchased technology ......... 2,534 (2,534) 2,534 (2,534)
------- ------- ------- -------
Total intangible assets ...... $ 8,466 $(8,459) $ 8,461 $(8,447)
======= ======= ======= =======
</TABLE>
Impairment of Long-Lived Assets
As of July 31, 2005, the Company held an investment of approximately 14% in
VA Linux Systems Japan, K.K. ("VA Linux Japan"). The Company continually
evaluates whether events or circumstances have occurred that indicate the
remaining value of the investment may be impaired. Based on the valuation
performed at July 31, 2005, a small impairment was recorded for $0.1 million
during the fourth quarter of fiscal 2005. There is no quoted market price for
this investment; accordingly, fair value was estimated by management based on
the estimated fair value of the underlying net assets. This investment is
reported under our SourceForge segment. The impairment has been included in
"Impairment of long-lived assets" in the Consolidated Statements of Operations
and Other Comprehensive Income/(Loss)". As of July 31, 2005, the Company had an
investment balance of $0.4 million in VA Linux Japan. This balance has been
included in "Other Assets" in the Consolidated Balance Sheets.
Revenue Recognition
SourceForge Revenues
Software revenues are derived from fees for licenses of the Company's
SourceForge software products, maintenance, consulting and training. The Company
recognizes all software revenue using the residual method in accordance with
Statement of Position ("SOP") 97-2, "Software Revenue Recognition," as amended
by SOP 98-9, "Modification of SOP 97-2, Software Revenue Recognition with
Respect to Certain Transactions." Under the residual method, the fair value of
the undelivered elements is deferred and the remaining portion of the
arrangement fee is recognized as revenue. If evidence of the vendor specific
fair value of one or more undelivered elements does not exist, revenues are
deferred and recognized when delivery of those elements occurs or when fair
value can be established. Company-specific objective evidence of fair value of
maintenance and other services is based on our customary pricing for such
maintenance and/or services when sold separately. At the outset of the
arrangement with the customer, the Company defers revenue for the fair value of
its undelivered elements (e.g., maintenance, consulting and training) and
recognizes revenue for the remainder of the arrangement fee attributable to the
elements initially delivered in the arrangement (i.e., software product) when
the basic criteria in SOP 97-2 have been met. If such evidence of fair value for
each undelivered element of the arrangement does not exist, the Company defers
all revenue from the arrangement until such time that evidence of fair value
does exist or until all elements of the arrangement are delivered.
Under SOP 97-2, revenue attributable to an element in a customer
arrangement is recognized when (i) persuasive evidence of an arrangement exists,
(ii) delivery has occurred, (iii) the fee is fixed or determinable, (iv)
collectibility is probable and (v) the arrangement does not require services
that are essential to the functionality of the software.
Persuasive evidence of an arrangement exists. The Company determines that
persuasive evidence of an arrangement exists with respect to a customer when the
Company has a written contract, which is signed by both the Company and the
customer, or a purchase order from the customer when the customer has previously
executed a standard license arrangement with the Company. The Company does not
offer product return rights.
Delivery has occurred. The Company's software may be either physically or
electronically delivered to the customer. The Company determines that delivery
has occurred upon shipment of the software pursuant to the billing terms of the
agreement or when the software is made available to the customer through
electronic delivery.
The fee is fixed or determinable. If at the outset of the customer
engagement the Company determines that the fee is not fixed or determinable, the
Company recognizes revenue when the fee becomes due and payable. Fees due under
a contract are generally deemed not to be fixed or determinable if a significant
portion of the fee is beyond the Company's normal payment terms, which are
generally no greater than 120 days from the date of invoice.
Collectibility is probable. The Company determines whether collectibility
is probable on a case-by-case basis. When assessing probability of collection,
the Company considers the number of years in business, history of collection,
and product acceptance for each customer. The Company typically sells to
customers, for whom there is a history of successful collection. New customers
are subject to a credit review process, which evaluates the customer's financial
position and ultimately such customer's ability to pay. If the Company
determines from the outset that collectibility is not probable based upon its
review process, revenue is recognized as payments are received.
51
<PAGE>
The Company allocates revenue on software arrangements involving multiple
elements to each element based on the relative fair value of each element. The
Company's determination of fair value of each element in multiple-element
arrangements is based on vendor-specific objective evidence ("VSOE"). The
Company aligns its assessment of VSOE for each element to the price charged when
the same element is sold separately. The Company has analyzed all of the
elements included in its multiple-element arrangements and determined that it
has sufficient VSOE to allocate revenue to the maintenance, support and
professional services components of its perpetual license arrangements. The
Company sells its professional services separately, and has established VSOE for
professional services on that basis. VSOE for maintenance and support is
determined based upon the customer's annual renewal rates for these elements.
Accordingly, assuming all other revenue recognition criteria are met, the
Company recognizes revenue from perpetual licenses upon delivery using the
residual method in accordance with SOP 98-9.
Services revenues consist of professional services and maintenance fees. In
general, the Company's professional services, which are comprised of software
installation and integration, business process consulting and training, are not
essential to the functionality of the software. The Company's software products
are fully functional upon delivery and implementation and do not require any
significant modification or alteration of products for customer use. Customers
purchase these professional services to facilitate the adoption of the Company's
technology and dedicate personnel to participate in the services being
performed, but they may also decide to use their own resources or appoint other
professional service organizations to provide these services. Software products
are billed separately from professional services, which are generally billed on
a time-and-materials basis. The Company recognizes revenue from professional
services as services are performed.
Maintenance agreements are typically priced based on a percentage of the
product license fee and have a one-year term, renewable annually. Services
provided to customers under maintenance agreements include technical product
support and unspecified product upgrades. Deferred revenues from advanced
payments for maintenance agreements are recognized ratably over the term of the
agreement, which is typically one year.
Online Media Revenues
Online media revenues are primarily derived from cash and barter sales of
advertising space on the Company's various web sites, as well as sponsorship and
royalty related arrangements associated with advertising on these web sites. The
Company recognizes Online Media revenues over the period in which the
advertisements are displayed, provided that persuasive evidence of an
arrangement exists, no significant obligations remain, the fee is fixed or
determinable, and collection of the receivable is reasonably assured. The
Company's obligations typically include guarantees of a minimum number of
"impressions" (times that an advertisement is viewed by users of our online
services). To the extent that minimum guaranteed impressions are not met in the
specified time frame, the Company does not recognize the corresponding revenues
until the guaranteed impressions are achieved. Prior to the year ended July 31,
2004, the Company recorded barter revenue transactions at their estimated fair
value based on our historical experience of selling similar advertising for cash
in accordance with Emerging Issues Task Force ("EITF") Issue 99-17, "Accounting
for Advertising Barter Transactions." The Company broadcasts banner advertising
in exchange for similar banner advertising on third-party web sites. The
Company's barter arrangements are documented with its standard customer
insertion order (and accompanying terms and conditions) or, in certain limited
instances, via an alternative written contract negotiated between the parties.
The standard terms and conditions include, but are not limited to, the web sites
for each company that will display the impressions, the time frame that the
impressions will be displayed, and the number, type and size of impressions to
be delivered. There were no barter revenue transactions for the fiscal year
ended July 31, 2005. Barter revenue transactions totaled $1.4 million and $2.0
million for the fiscal years ended July 31, 2004 and July 31, 2003,
respectively.
E-commerce Revenues
E-commerce revenues are derived from the online sale of consumer goods. The
Company recognizes E-commerce revenues from the sale of consumer goods in
accordance with SEC Staff Accounting Bulletin ("SAB") No. 104, "Revenue
Recognition." Under SAB 104, product revenues are recognized when persuasive
evidence of an arrangement exists, delivery has occurred, the sale price is
fixed or determinable, and collectibility is reasonably assured. In general, the
Company recognizes E-commerce revenue upon the shipment of goods. The Company
does grant customers a right to return E-commerce products. Such returns are
recorded as incurred and have been immaterial for the periods presented.
52
<PAGE>
Online Images Revenues
Online Images revenues are derived from the online sale of
three-dimensional art, animations and presentations that consist of fees for
software licenses and memberships for these animation software products.
Software revenues related to digital animations are recognized using the
residual method in accordance with Statement of Position ("SOP") 97-2, "Software
Revenue Recognition," as amended by SOP 98-9, "Modification of SOP 97-2,
Software Revenue Recognition with Respect to Certain Transactions" as described
in detail above. Revenues recognized related to animation memberships are
recognized over the life of the membership, typically 3 months or 12 months.
Other Revenues
The Company's revenue recognition policy related to its former hardware
systems business followed SEC SAB No. 104, "Revenue Recognition." Under SAB No.
104, the Company recognized product revenues from the sale of Linux-based
servers, components, and desktop computers when persuasive evidence of an
arrangement existed, delivery occurred, the sales price was fixed or
determinable and collectibility was reasonably assured. In general, the Company
recognized product revenue upon shipment of the goods. The Company did not grant
customers any rights to return these products.
The Company recognized revenues from hardware related customer support
services, including on-site maintenance and technical support on a pro-rata
basis over the term of the related service agreement. The Company recognized
revenues from hardware related professional service contracts upon completion of
the project, or using the percentage of completion method of the project where
project costs could be reasonably estimated. The Company recorded any payments
received prior to revenue recognition as deferred revenue.
Advertising Expenses
The Company expenses advertising costs as incurred. Total advertising
expenses were $0.9 million, $2.1 million and $2.5 million for fiscal years
ending July 31, 2005, July 31, 2004 and July 31, 2003, respectively.
Stock-Based Compensation
The Company has elected to account for its employee stock-based
compensation plans in accordance with Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees," and Financial
Accounting Standards Board ("FASB") Interpretation No. ("FIN") 44, "Accounting
for Certain Transactions Involving Stock Compensation--an Interpretation of APB
Opinion No. 25," and complies with the disclosure provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation." Accordingly, no compensation cost is
recognized for any of the Company's fixed stock options granted to employees
when the exercise price of the option equals or exceeds the fair value of the
underlying common stock as of the grant date for each stock option. The Company
accounts for equity instruments issued to non-employees in accordance with the
provisions of SFAS No. 123 and 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". Deferred stock-based compensation
is included as a component of stockholders' equity and is being amortized by
charges to operations over the vesting period of the options and restricted
stock consistent with the method described in FIN No. 28, "Accounting for Stock
Appreciation Rights and Other Variable Stock Option or Award Plans."
The following table illustrates the effect if the Company had accounted for
its stock option plans and Employee Stock Purchase Plan under the fair value
method of accounting under Statement 123, as amended by Statement 148,
"Accounting for Stock-Based Compensation--Transition and Disclosure" (SFAS
148)(in thousands, except per share amounts):
<TABLE>
<CAPTION>
Fiscal Year Ended
-----------------------------------
July 31, July 31, July 31,
2005 2004 2003
-------- -------- --------
<S> <C> <C> <C>
Net loss as reported ........................................... ($ 4,694) ($ 7,640) ($13,798)
Add back employee stock-based compensation expense related to
stock options included in reported net loss ................ 68 213 144
Less employee stock-based compensation expense determined under
fair value based method for all employee stock option awards,
net of related tax effects ................................... (13,335) (6,410) (8,774)
-------- -------- --------
Pro forma net loss ............................................. ($17,961) ($13,837) ($22,428)
======== ======== ========
Basic and diluted net loss per share ........................... ($ 0.08) ($ 0.13) ($ 0.25)
-------- -------- --------
Pro forma basic and diluted net loss per share ................. ($ 0.29) ($ 0.23) ($ 0.41)
-------- -------- --------
</TABLE>
53
<PAGE>
The Company calculated the fair value of each option grant on the date of
the grant and stock purchase right using the Black-Scholes option-pricing model
as prescribed by SFAS. No. 123 using the following assumptions:
<TABLE>
<CAPTION>
Stock option Plans ESPP Plans
For the fiscal year ended For the fiscal year ended
------------------------- -------------------------
July 31, July 31, July 31, July 31, July 31, July 31,
2005 2004 2003 2005 2004 2003
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Expected life (years) ..... 4.8 4.9 4.8 0.5 0.5 0.5
Risk-free interest rate ... 3.6% 3.5% 3.0% 2.1% 1.0% 1.1%
Volatility ................ 98% 106% 108% 64% 98% 95%
Dividend yield ............ None None None None None None
</TABLE>
The weighted average fair value of options granted during fiscal years
2005, 2004 and 2003 was $1.51, $2.24 and $0.97, respectively.
For purposes of pro forma disclosure, the estimated fair value of the
options was amortized to expense over the options' vesting period for employee
stock options, and the six-month purchase period, for stock purchases under the
Employee Stock Purchase Plan and were included in the pro forma information
above.
On June 8, 2005, the Compensation Committee of the Board of Directors of VA
Software approved the vesting acceleration of certain unvested, out-of-the-money
stock options outstanding under VA Software's employee stock option plans,
effective June 7, 2005. Vesting was accelerated for stock options that had
exercise prices greater than $1.67 per share, which was the closing price of VA
Software's common stock on June 7, 2005. This action was taken to reduce the
impact of future compensation expense that VA Software would otherwise be
required to recognize in future consolidated statements of operations pursuant
to SFAS 123R, which is applicable to VA Software beginning in the first fiscal
quarter of 2006. As a result of the acceleration, VA Software expects to reduce
future compensation expense by approximately $8.1 million over fiscal years
2006, 2007 and 2008.
Software Development Costs
In accordance with SFAS No. 86, "Accounting for the Cost of Computer
Software to be Sold, Leased, or Otherwise Marketed," development costs incurred
in the research and development of new software products are expensed as
incurred until technological feasibility in the form of a working model has been
established at which time such costs are capitalized, subject to a net
realizable value evaluation. Technological feasibility is established upon the
completion of an integrated working model. To date, the Company's software
development has been completed concurrent with the establishment of
technological feasibility and, accordingly, all software development costs have
been charged to research and development expense in the accompanying
consolidated statements of operations.
In accordance with SOP 98-1 "Accounting for the Cost of Computer Software
Developed or Obtained for Internal Use," costs incurred related to internal use
software are capitalized and amortized over their useful lives.
Computation of Per Share Amounts
In accordance with SFAS No. 128 "Earnings Per Share," basic net loss per
common share has been calculated using the weighted-average number of shares of
common stock outstanding during the period, less shares subject to repurchase.
For the fiscal years ended July 31, 2004, July 31, 2003 and July 27, 2002, the
Company has excluded all stock options and warrants from the calculation of
diluted net loss per common share because all such securities are antidilutive
for those periods.
54
<PAGE>
The following table presents the calculation of basic and diluted net loss
per share (in thousands, except per share data):
<TABLE>
<CAPTION>
Year Ended
------------------------------------
July 31, July 31, July 31,
2005 2004 2003
-------- -------- --------
<S> <C> <C> <C>
Net loss ...................................................... $ (4,694) $ (7,640) $(13,798)
======== ======== ========
Basic and diluted:
Weighted average shares of common stock outstanding ......... 61,454 59,684 54,117
Less: Weighted average shares subject to repurchase ......... -- -- (7)
-------- -------- --------
Shares used in computing basic and diluted net loss per share 61,454 59,684 54,110
======== ======== ========
Basic and diluted net loss per share ........................ $ (0.08) $ (0.13) $ (0.25)
======== ======== ========
</TABLE>
The following potential common shares have been excluded from the
calculation of diluted net loss per share for all periods presented because they
are anti-dilutive (in thousands):
Year Ended
--------------------------------
July 31, July 31, July 31,
2005 2004 2003
------ ------ -----
Anti-dilutive securities:
Options to purchase common stock ...... 11,226 12,132 9,433
Warrants .............................. 731 731 --
------ ------ -----
Total Anti-dilutive securities ............. 11,957 12,863 9,433
====== ====== =====
Comprehensive Loss
Comprehensive loss is comprised of net loss and other non-owner changes in
stockholders' equity, including foreign currency translation gains or loss and
unrealized gains or losses on available-for sale marketable securities.
Income Taxes
The Company accounts for income taxes using the liability method in
accordance with SFAS No. 109, "Accounting for Income Taxes." Due to the
Company's loss position in fiscal years 2005, 2004 and 2003, there was no
provision for income taxes in these years. Deferred tax assets are recognized
for anticipated future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and their respective tax
bases. A valuation allowance has been recorded for the total deferred tax assets
as management believes it is more likely than not that these assets will not be
realized as a result of uncertainties regarding realization of the assets based
on the lack of profitability to date and the uncertainty of future
profitability.
Recent Accounting Pronouncements
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an
amendment of ARB No. 43, Chapter 4. SFAS No. 151 clarifies the accounting for
abnormal amounts of idle facility expense, freight, handling costs and wasted
material. SFAS No. 151 is effective for inventory costs incurred during fiscal
years beginning in our first quarter of fiscal 2006. The Company does not
believe adoption of SFAS No. 151 will have a material effect on our consolidated
financial position, results of operations or cash flows.
In December, 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary
Assets, an amendment of APB Opinion No. 29. SFAS No. 153 addresses the
measurement of exchanges of nonmonetary assets and redefines the scope of
transactions that should be measured based on the fair value of the assets
exchanged. SFAS No. 153 is effective for nonmonetary asset exchanges beginning
in our first quarter of fiscal 2006. The Company does not believe adoption of
SFAS No. 153 will have a material effect on our consolidated financial position,
results of operations or cash flows.
In December 2004, the FASB issued SFAS 123--revised 2004 ("SFAS 123R"),
"Share-Based Payment" which replaces SFAS 123, "Accounting for Stock-Based
Compensation" and supersedes APB No. 25, "Accounting for Stock Issued to
Employees." SFAS 123R requires the measurement of all employee share-based
payments to employees, including grants of employee stock options, using a
fair-value-based method and the recording of such expense in our consolidated
statements of income. The accounting provisions of SFAS 123R are effective for
reporting periods beginning after June 15, 2005.
The Company is required to adopt SFAS 123R in the first quarter of fiscal
2006. The pro forma disclosures previously permitted under SFAS 123 no longer
will be an alternative to financial statement recognition. See Note 2 "Stock
Based Compensation" in our Notes to Consolidated Financial Statements for the
pro forma net income and net income
55
<PAGE>
per share amounts, for fiscal 2004 and fiscal 2005 presented, as if we had used
a fair-value-based method similar to the methods required under SFAS 123R to
measure compensation expense for employee stock incentive awards. Although we
have not yet determined whether the adoption of SFAS 123R will result in amounts
that are similar to the current pro forma disclosures under SFAS 123, the
Company is evaluating the requirements under SFAS 123R and expect the adoption
to have a significant adverse impact on our consolidated statements of
operations and net loss per share.
In May 2005, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards, or SFAS, No. 154, Accounting
Changes and Error Corrections, which replaces Accounting Principles Board
Opinion, or APB, No. 20, Accounting Changes, and SFAS No. 3, Reporting
Accounting Changes in Interim Financial Statements -- An Amendment of APB
Opinion No. 28. SFAS No. 154 provides guidance on accounting for and reporting
changes in accounting principle and error corrections. SFAS No. 154 requires
that changes in accounting principle be applied retrospectively to prior period
financial statements and is effective for fiscal years beginning after December
15, 2005. The Company does not expect SFAS No. 154 to have a material impact on
our consolidated financial position, results of operations, or cash flows.
Supplier Concentration
No supplier concentration exists in the Company's SourceForge, Online
Media, E-commerce and Online Images businesses.
Concentrations of Credit Risk and Significant Customers
The Company's investments are held with two reputable financial
institutions; both institutions are headquartered in the United States. The
Company's investment policy limits the amount of risk exposure. Financial
instruments that potentially subject the Company to concentrations of credit
risk consist primarily of cash trade receivables. The Company provides credit,
in the normal course of business, to a number of companies and performs ongoing
credit evaluations of its customers. The credit risk in the Company's trade
receivables is substantially mitigated by its credit evaluation process and
reasonably short collection terms. The Company maintains reserves for potential
credit losses and such losses have been within management's expectations. As of
July 31, 2005 and July 31, 2004, no gross accounts receivables were concentrated
with one customer.
For the fiscal years ended July 31, 2005 and July 31, 2004 no one customer
represented more than 10% of net revenues. For the fiscal year ended July 31,
2003, one customer, Intel Corporation, accounted for approximately 17% of net
revenues. Going forward, the company does not anticipate that any one customer
will represent more than 10% of net revenues.
3. Restructuring Costs and Other Special Charges
In fiscal 2001 and 2002, the Company adopted plans to exit its hardware
systems and hardware-related software engineering and professional services
businesses, as well as exit a sublease agreement and reduce its general and
administrative overhead costs. The Company exited these activities to pursue its
SourceForge, Online Media, E-commerce and Online Images businesses and reduce
its operating losses to improve cash flow. The Company recorded restructuring
charges of $168.5 million related to exiting these activities, $160.4 million of
which was included in restructuring charges and other special charges in
operating expenses and $8.1 million of which was included in cost of sales.
Included in the restructuring were charges related to excess facilities from
non-cancelable leases. During the third quarter of fiscal 2004, in connection
with its original 2002 restructuring plan which included an assumption to sublet
all idle facilities, the Company relocated its Fremont, California headquarters
to a smaller building in the same complex. As a result of the change in
circumstances, original accruals were reevaluated and accordingly the Company
recorded a restructuring adjustment of $2.9 million. Included in the $2.9
million dollar restructuring adjustment was $2.5 million of expense related to
writing off leasehold improvements and fixed assets and an additional $0.4
million expense related to excess facilities from non-cancelable leases. In
addition, during the third quarter of fiscal 2004, the Company reached an
agreement in principal to sublet unoccupied portions of properties that it
56
<PAGE>
leases in Sunnyvale, California and Fremont, California. As a result of the
change in circumstances due to the agreement in principal, original accruals
were reevaluated and, accordingly, the Company recorded a restructuring
adjustment of $0.3 million in the third quarter of fiscal 2004. The $3.2 million
total adjustment to restructuring expenses in fiscal 2004 has been recorded in
the consolidated statement of operations for that period. In the second quarter
of fiscal 2005, a minor credit adjustment of $0.1 million was recorded to
accurately reflect the current common area maintenance fees associated with the
Fremont facilities. The remaining accrual from non-cancelable lease payments,
which continue through 2010, is based on current circumstances. These accruals
are subject to change should actual circumstances change. The Company will
continue to evaluate and update, if applicable, these accruals quarterly. As of
July 31, 2005, the Company had an accrual of approximately $7.9 million
outstanding related to these non-cancelable leases, all of which was originally
included in operating expenses.
In addition to the above, the Company recorded a net restructuring credit
of $0.3 million for the fiscal year ended July 31, 2003. This included $0.4
million of additional charges related to existing excess facilities as a result
of the termination of a subtenant lease and $0.3 million of charges associated
with the Company's fiscal 2002 plan to reduce its general and administrative
overhead costs, net of $1.0 million in credit adjustments to previously recorded
restructuring reserves. As of July 31, 2005, no outstanding accruals remained
related to these restructuring charges.
All charges as a result of restructuring activities have been recorded in
accordance with EITF 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs incurred in a Restructuring)." Restructuring charges recorded in fiscal
2004 were considered adjustments to the original restructuring plans, therefore,
SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities," was not applicable.
Below is a summary of the restructuring charges in operating expenses (in
thousands):
<TABLE>
<CAPTION>
Total
Charged Total Total Restructuring
To Operations Total Charged Charged To Cash Liabilities
Fiscal To Operations Operations Receipts/ at
2001-2003 Fiscal 2004 Fiscal 2005 (Payments) July 31, 2005
--------- ----------- ----------- ---------- -------------
<S> <C> <C> <C> <C> <C>
Cash Provisions:
Other special charges relating to
restructuring activities ............................... $ 1,349 $ -- $ -- $ (1,349) $ --
Facilities charges ....................................... 16,176 713 (101) (8,933) 7,855
Employee severance and other related charges ............. 5,532 -- -- (5,532) --
-------- -------- -------- -------- --------
Total cash provisions ................................ 23,057 713 (101) $(15,814) $ 7,855
-------- -------- -------- ======== ========
Non-cash:
Write-off of goodwill and intangibles .................... 90,355 -- --
Write-off of other special charges relating to
restructuring activities ................................ 9,323 2,496 --
Write-off of accelerated options from
terminated employees ................................... 1,352 -- --
Acceleration of deferred stock compensation ............. 36,064 -- --
-------- -------- --------
Total non-cash provisions ............................ 137,094 2,496 --
-------- -------- --------
Total provisions ..................................... $160,151 $ 3,209 $ (101)
======== ======== ========
</TABLE>
Below is a summary of the changes to the restructuring liability (in
thousands):
<TABLE>
<CAPTION>
Changes in the total accrued restructuring liability Balance at Charged to Balance at
----------------------------------------------------- Beginning Costs and End
of Period Expenses Deductions of Period
--------- -------- ---------- ---------
<S> <C> <C> <C> <C>
For the year ended July 31, 2003............................. $17,994 $ 306 $ (3,411) $ 14,889
For the year ended July 31, 2004............................. $14,889 $ 713 $ (4,319) $ 11,283
For the year ended July 31, 2005............................. $11,283 $ (101) $ (3,327) $ 7,855
Components of the total accrued restructuring liability Short Long Total
------------------------------------------------------- Term Term Liability
---- ---- ---------
As of July 31, 2003.......................................... $ 4,117 $10,772 $ 14,889
As of July 31, 2004.......................................... $ 3,440 $ 7,843 $ 11,283
As of July 31, 2005.......................................... $ 1,748 $ 6,107 $ 7,855
</TABLE>
57
<PAGE>
4. Commitments and Contingencies
The Company leases its facilities under operating leases that expire at
various dates through fiscal year 2010. Future minimum lease payments under
non-cancelable operating leases, net of sublease income, as of July 31, 2004 are
as follows (in thousands):
<TABLE>
<CAPTION>
Gross Operating Net Operating
Leases Sublease Income Leases
<C> <C> <C> <C>
2006.............................................................. $3,789 $1,145 $2,644
2007.............................................................. 3,511 1,033 2,478
2008.............................................................. 3,616 1,064 2,552
2009.............................................................. 3,724 1,096 2,628
2010.............................................................. 3,181 938 2,243
------- ------ -------
Total minimum lease payments......................... $17,821 $5,276 $12,545
======= ====== =======
</TABLE>
Gross rent expense for the years ended July 31, 2005, July 31, 2004 and
July 31, 2003 was approximately $2.8 million, $3.0 million and $3.9 million,
respectively. This rent expense was offset by sublease income of $1.8 million,
$1.1 million and $2.4 million for the years ended July 31, 2005, July 31, 2004
and July 31, 2003, respectively. In addition, rent expense of $0.7 million and
$0.1 million was recorded as a result of idle facilities charges for the years
ended July 31, 2004 and July 31, 2003, respectively. No rent expense as a result
of idle facilities charges was recorded for the year ended July 31, 2005. The
idle facilities charges for the years ended July 31, 2004 and July 31, 2003 have
been recorded as restructuring costs and other special charges in the
consolidated statements of operations.
5. Litigation
The Company, two of its former officers (the "Former Officers"), and the
lead underwriter in its initial public offering ("IPO") were named as defendants
in a consolidated shareholder lawsuit in the United States District Court for
the Southern District of New York, captioned In re VA Software Corp. Initial
Public Offering Securities Litigation, 01-CV-0242. This is one of a number of
actions coordinated for pretrial purposes as In re Initial Public Offering
Securities Litigation, 21 MC 92 with the first action filed on January 12, 2001.
Plaintiffs in the coordinated proceeding are bringing claims under the federal
securities laws against numerous underwriters, companies, and individuals,
alleging generally that defendant underwriters engaged in improper and
undisclosed activities concerning the allocation of shares in the IPOs of more
than 300 companies during late 1998 through 2000. Among other things, the
plaintiffs allege that the underwriters' customers had to pay excessive
brokerage commissions and purchase additional shares of stock in the aftermarket
in order to receive favorable allocations of shares in an IPO. The consolidated
amended complaint in the Company's case seeks unspecified damages on behalf of a
purported class of purchasers of its common stock between December 9, 1999 and
December 6, 2000. Pursuant to a tolling agreement, the individual defendants
were dismissed without prejudice. On February 19, 2003, the court denied the
Company's motion to dismiss the claims against it. The litigation is now in
discovery. In June 2004, a stipulation of settlement and release of claims
against the issuer defendants, including the Company, was submitted to the court
for approval. The terms of the settlement if approved, would dismiss and release
all claims against the participating defendants (including the Company). In
exchange for this dismissal, D&O insurance carriers would agree to guarantee a
recovery by the plaintiffs from the underwriter defendants of at least $1
billion, and the issuer defendants would agree to an assignment or surrender to
the plaintiffs of certain claims the issuer defendants may have against the
underwriters. On August 31, 2005, the court confirmed preliminary approval of
the settlement. The proposed settlement remains subject to a number of
conditions, including receipt of final approval of the court. If the settlement
does not occur, and litigation against the Company continues, the Company
believes it has meritorious defenses and intends to defend the case vigorously.
On Nov 9, 2001, a former employee of the Company, who had worked as a sales
person in the Company's former hardware business, filed a complaint captioned
Okerman v. VA Linux Systems, Inc. & Larry Augustin, Civil No. 01-01825 (Norfolk
Superior Court), in the Commonwealth of Massachusetts. As amended, the complaint
alleges that changes made to certain commission and bonus plans during the
plaintiff's tenure at the Company entitled him to recover damages for Breach of
Contract, Breach of the Implied Covenant of Good Faith and Fair Dealing,
violation of the Massachusetts Wage Act Statute, Promissory Estoppel, and
Quantum Meruit. On June 25, 2002, the Court dismissed the Massachusetts Wage Act
claim brought against the Company's former chief executive officer. On July 26,
2002, dismissal of the Wage Act claim in favor of the Company's former chief
executive officer was upheld on interlocutory appeal. On July 9, 2003, the Court
granted summary judgment in the Company's favor regarding claims for Breach of
Contract, Promissory Estoppel, and Quantum Meruit, and granted judgment on the
pleadings in favor of the Company regarding the Massachusetts Wage Act claim. On
September 24, 2004, following a jury trial on the sole remaining claim for
Breach of the Covenant of Good Faith and Fair Dealing, a jury awarded damages of
$136,876 to the plaintiff, which have been included in accrued liabilities and
other in the Company's Condensed Consolidated Balance Sheets as of April 30,
2005. The plaintiff has since filed a notice of appeal of his
previously-dismissed claims and the judgment for Breach of Contract and Breach
of the Covenant of Good Faith and Fair Dealing, and the Company has filed a
notice of appeal of the judgment for Breach of the Covenant of Good Faith and
Fair Dealing.
58
<PAGE>
The Company is subject to various claims and legal actions arising in the
ordinary course of business. The Company has accrued for estimated losses in the
accompanying consolidated financial statements for those matters where it
believes that the likelihood that a loss will occur is probable and the amount
of loss is reasonably estimable.
6. Guarantees and Indemnifications
As permitted under Delaware law, the Company has agreements whereby the
Company's officers and directors are indemnified for certain events or
occurrences while the officer or director is, or was, serving at the Company's
request in such capacity. The maximum potential amount of future payments the
Company could be required to make under these indemnification agreements is
unlimited; however, the Company has director and officer liability insurance
designed to limit the Company's exposure and to enable the Company to recover a
portion of any future amounts paid. As a result of the Company's insurance
policy coverage, the Company believes the estimated fair value of these
indemnification agreements is minimal. Accordingly, the Company has no
liabilities recorded for these agreements as of July 31, 2005.
The Company enters into standard indemnification agreements in the ordinary
course of business. Pursuant to these agreements, the Company indemnifies, holds
harmless, and agrees to reimburse the indemnified party for losses suffered or
incurred by the indemnified party, generally, the Company's business partners,
subsidiaries and/or customers, in connection with any patent, copyright or other
intellectual property infringement claim by any third party with respect to the
Company's products. The term of these indemnification agreements is generally
perpetual any time after execution of the agreement. The maximum potential
amount of future payments the Company could be required to make under these
indemnification agreements is unlimited. The Company has not incurred
significant costs to defend lawsuits or settle claims related to these
indemnification agreements. As a result, the Company believes the estimated fair
value of these agreements is insignificant. Accordingly, the Company has no
liabilities recorded for these agreements as of July 31, 2005.
The Company warrants that its software products will perform in all
material respects in accordance with the Company's standard published
specifications in effect at the time of delivery of the licensed products to the
customer for a specified period, which generally does not exceed ninety days.
Additionally, the Company warrants that its maintenance services will be
performed consistent with generally accepted industry standards through the
completion of the agreed upon services. If necessary, the Company would provide
for the estimated cost of product and service warranties based on specific
warranty claims and claim history, however, the Company has not incurred
significant expense under its product or services warranties. As a result, the
Company believes the estimated fair value of these agreements is minimal.
Accordingly, the Company has no liabilities recorded for these agreements as of
July 31, 2005.
7. Retirement Savings Plan
The Company maintains an employee savings and retirement plan which is
qualified under Section 401(k) of the Internal Revenue Code and is available to
substantially all full-time employees of the Company. The plan provides for tax
deferred salary deductions and after-tax employee contributions. Contributions
include employee salary deferral contributions and discretionary employer
contributions. To date, there have been no employer discretionary contributions.
8. Common Stock
In October 1999, the Company's board of directors approved the
reincorporation into Delaware by way of a merger with a newly-formed Delaware
subsidiary in connection with the Company's IPO. In conjunction with the IPO,
the Company issued 4,400,000 shares of common stock with an initial public
offering price of $30.00 per share. Upon closing of the initial public offering,
all of the outstanding shares of convertible preferred stock were automatically
converted into 19,921,322 shares of common stock. In addition, the underwriters
exercised their option to purchase 660,000 additional shares to cover the
over-allotments of shares at the $30.00 per share offering price. The IPO raised
approximately $141,000,000 after underwriting fees and $139,000,000 after all
other direct costs. In fiscal year 2005, the Company did not cancel any shares
of its common stock. In fiscal year 2004, the Company cancelled 104,127 shares
of its common stock, which had been recorded as treasury stock in the
consolidated balance sheets and statement of stockholders' equity. In fiscal
2003, the Company cancelled 270,407 shares of its common stock which had been
recorded as treasury stock in the consolidated balance sheets and statement of
stockholders' equity.
On November 6, 2003, the company entered into a securities purchase
agreement in which the company completed a private placement of 3,529,412 shares
of its common stock with The Riverview Group LLC ("Riverview") at an issue price
of $4.25 per share for aggregate proceeds of approximately $15 million (the
"Private Placement"). In connection with the Private Placement, the Company
retained Wharton Capital Partners Ltd. ("Wharton") to act as a financial
consultant and placement agent. Also in connection with the Private Placement,
Riverview and Wharton received three-year warrants to purchase a total of
705,883 and 25,000 shares of the company's common stock, respectively, at an
exercise price of $6.00 and $6.14 per share, respectively (collectively, the
"Warrants"). The company entered into a registration rights agreement with
Riverview on November 6, 2003 (the "Registration Rights Agreement") in which the
company agreed to provide certain registration rights under the Securities Act
of 1933, as amended and the rules and regulations promulgated thereunder, and
applicable state securities laws with respect to the common stock and the
Warrants issued to Riverview.
Pursuant to the terms of the Registration Rights Agreement, the company
filed a registration statement (the "Registration Statement") on Form S-3 in
order to register the common stock and Warrants issued in the Private Placement.
The SEC declared the Registration Statement effective on April 30, 2004. Before
the effective date of the Registration Statement, the shares of the company's
common stock sold in the Private Placement and the shares of the common stock
underlying the Warrants did not have the same rights as the other shares which
were included in the Equity section of the Consolidated Balance sheet.
Therefore, the shares of the company's common stock sold in the Private
Placement and the shares of the common stock underlying the Warrants were
classified as liabilities on the Consolidated Balance sheet. Liabilities must be
reported at fair value as of the balance sheet date. Initially the Warrants were
valued as of November 6, 2003, and were revalued on January 31, 2004 using the
Black-Scholes valuation model and then, on April 30, 2004, the effective date of
the Registration Statement, revalued again using the same Black-Scholes
valuation model. As a result of these remeasurements, a non-cash credit
adjustment of $1.9 million was recorded to properly value the liability. This
credit adjustment was offset by a $0.3 million non-cash expense which was
recorded as a result of not having the common stock shares associated with the
Private Placement registered. Both adjustments have been recorded in
"Remeasurement of warrant liability" in the Consolidated Statement of
Operations. As a result of the S-3 becoming effective on April 30, 2004, the
remaining liability for the Warrants of $0.6 million was reclassified to equity
as of that date.
As of July 31, 2005 there were 61,659,119 shares of common stock issued and
outstanding. The Company is authorized to issue 250,000,000 shares of common
stock, $0.001 par value. Each share of common stock has the right to one vote.
59
<PAGE>
The holders of common stock are also entitled to receive dividends whenever
funds are available and when declared by the Board of Directors. No cash
dividends have been declared or paid through July 31, 2005.
As of July 31, 2005, the Company had reserved shares of its common stock
for future issuance as follows:
1998 Stock Option Plan and Assumed Plans.......... 21,397,374
1999 Director Option Plan......................... 1,337,084
1999 Employee Stock Purchase Plan................. 2,461,987
-----------
25,196,445
===========
Warrants
On November 6, 2003, the Company issued two warrants to purchase up to
705,883 and 25,000 shares of common stock to The Riverview Group LLC and Wharton
Capital Partners Ltd., respectively in connection with a private placement of
the Company's common stock. These warrants are exercisable at exercise prices of
$6.00 and $6.14 per share. The terms of these warrants expire in November 2006.
At July 31, 2005 both of these warrants remained outstanding.
Stock Option Plan
In fiscal year 1999, the Company adopted and the board of directors
approved the 1998 Stock Option Plan (the "1998 Plan"). Since inception, a total
of 37,824,386 shares of common stock have been reserved for issuance under the
1998 Plan, subject to an annual increase of the lesser of 4,000,000 shares or
4.9% of the then outstanding common stock or an amount to be determined by the
board of directors. Through July, 31, 2005, 45,843,687 options have been granted
under the 1998 Plan. Under the 1998 Plan, the board of directors may grant to
employees and consultants options and/or stock purchase rights to purchase the
Company's common stock at terms and prices determined by the board of directors.
The 1998 Plan will terminate in 2008. Nonqualified options granted under the
1998 Plan must be issued at a price equal to at least 85% of the fair market
value of the Company's common stock at the date of grant. All options may be
exercised at any time within 10 years of the date of grant or within one month
of termination of employment, or such shorter time as may be provided in the
stock option agreement, and vest over a vesting schedule determined by the board
of directors.
The Company's 1999 Director's Option Plan (the "Directors' Plan") was
adopted by the Company's board of directors in October 1999. Since inception, a
total of 1,500,000 shares of common stock have been reserved for issuance under
the Directors' Plan, subject to an annual increase of the lesser of 250,000
shares, or 0.5% of the then outstanding common stock or an amount determined by
the board of directors. Through July 31, 2005, 890,000 options have been granted
under the Directors' Plan. Under the Directors' Plan, options are granted when a
non-employee director joins the board of directors and at each annual meeting
where the director continues to serve on the board of directors. The Directors'
Plan establishes an automatic grant of 80,000 shares of common stock to each
non-employee director who is elected. The Directors' Plan also provides that
upon the date of each annual stockholders' meeting, each non-employee director
who has been a member of the board of directors for at least six months prior to
the date of the stockholders' meeting will receive automatic annual grants of
options to acquire 20,000 shares of common stock. Each automatic grant has an
exercise price per share equal to the fair market value of the common stock at
the date of grant, vest 25% immediately upon the grant date, one thirty-sixth
per month thereafter and become fully vested three years after the date of
grant. Each automatic grant has a term of ten years. In the event of a merger
with another corporation or the sale of substantially all of its assets, each
non-employee director's outstanding options will become fully vested and
exercisable. Options granted under the Directors' Plan must be exercised within
3 months of the end of the non-employee director's tenure as a member of the
board of directors, or within 12 months after a non-employee director's
termination by death or disability, provided that the option does not terminate
by its terms earlier. Unless terminated sooner, the Directors' Plan terminates
automatically in 2009.
The Company has assumed certain option plans and the underlying options of
companies which the Company has acquired (the "Assumed Plans"). Options under
the Assumed Plans have been converted into the Company's options and adjusted to
effect the appropriate conversion ratio as specified by the applicable
acquisition agreement, but are otherwise administered in accordance with the
terms of the Assumed Plans. Options under the Assumed Plans generally vest over
four years and expire ten years from the date of grant. No additional options
will be granted under the Assumed Plans.
60
<PAGE>
The following is a summary of the option activity under all of the stock
option plans for the years ended July 31, 2005, July 31, 2004 and July 31, 2003.
<TABLE>
<CAPTION>
Options Outstanding
---------------------------
Options Weighted
Available Number of Average
for Grant Shares Exercise Price
---------- ---------- --------------
<S> <C> <C> <C>
Balance at July 27, 2002......................................... 8,628,437 12,307,901 4.94
Authorized..................................................... 2,904,105 -- --
Granted........................................................ (1,584,600) 1,584,600 1.25
Exercised...................................................... -- (1,499,274) 0.92
Cancelled...................................................... 2,906,164 (2,960,715) 9.24
Repurchases.................................................... 2,500 -- --
---------- ----------
Balance at July 31, 2003......................................... 12,856,606 9,432,512 3.61
========== ==========
Authorized..................................................... 2,968,033 -- --
Granted........................................................ (6,226,221) 6,226,221 2.87
Exercised...................................................... -- (2,199,992) 1.47
Cancelled...................................................... 1,310,209 (1,326,869) 3.95
Repurchases.................................................... -- -- --
---------- ----------
Balance at July 31, 2004......................................... 10,908,627 12,131,872 3.58
========== ==========
Authorized..................................................... -- -- --
Granted........................................................ (1,552,900) 1,552,900 2.05
Exercised...................................................... -- (300,374) 1.09
Cancelled...................................................... 2,152,685 (2,158,352) 5.27
Repurchases.................................................... -- -- --
---------- ----------
Balance at July 31, 2005......................................... 11,508,412 11,226,046 3.11
========== ==========
</TABLE>
<TABLE>
<CAPTION>
Outstanding Options Options Exercisable
-------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Number Life (in Exercise Exercise
Exercise Prices Outstanding years) Price Shares Price
--------------- ----------- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C>
$ 0.02 - $ 0.96........................... 631,304 3.51 $ 0.09 598,156 $ 0.05
$ 0.99 - $ 0.99........................... 1,381,677 6.20 $ 0.99 1,217,792 $ 0.99
$ 1.00 - $ 1.77........................... 1,123,502 7.68 $ 1.37 769,491 $ 1.37
$ 1.79 - $ 2.24........................... 1,201,209 9.12 $ 1.99 1,157,875 $ 1.99
$ 2.26 - $ 2.33........................... 857,226 8.21 $ 2.28 857,226 $ 2.28
$ 2.45 - $ 2.45........................... 2,094,077 8.92 $ 2.45 2,094,077 $ 2.45
$ 2.49 - $ 2.93........................... 355,850 8.57 $ 2.68 283,346 $ 2.64
$ 2.98 - $ 2.98........................... 1,207,659 8.36 $ 2.98 1,207,659 $ 2.98
$ 3.00 - $ 4.57........................... 1,560,161 6.97 $ 3.67 1,517,657 $ 3.66
$ 4.90 - $64.12........................... 813,381 5.29 $ 14.98 813,381 $ 14.98
---------- ----------
$ 0.02 - $64.12........................... 11,226,046 7.52 $ 3.11 10,516,660 $ 3.21
========== ==========
</TABLE>
During fiscal years 2005, 2004 and 2003, there were no options or stock
purchase rights granted outside of either the 1998 Plan or the Directors' Plan
outstanding. Total options exercisable at July 31, 2005 and July 31, 2004 were
10,516,660 and 4,536,731, respectively.
Employee Stock Purchase Plan
In October 1999, the Company adopted an Employee Stock Purchase Plan
("ESPP"). Under the terms of the ESPP, as authorized by the Board of Directors
in September 2003, the maximum aggregate number of shares of stock that may be
issued under the ESPP is 3,000,000, cumulatively increased annually by an amount
equal to the lesser of (a) 1% of the then issued and outstanding shares of
common stock, (b) an amount determined by the board of directors, or (c) 500,000
shares of common stock. During each six-month offering period, employees can
choose to have up to 10% of their annual base earnings withheld to purchase the
Company's common stock. The purchase price of the common stock is 85% of the
lesser of the fair value as of the beginning or ending of the offering period. A
total of 173,888 shares of common stock were issued under the ESPP through July
31, 2005. At July 31, 2005, 2,461,987 shares were available for issuance. The
Company cancelled its Employee Stock Purchase Plan on July 28, 2005.
61
<PAGE>
Deferred Stock Compensation
In connection with the grant of stock options to employees during fiscal
1999 and prior to the Company's initial public offering in fiscal 2000, the
Company recorded deferred stock compensation within stockholders' equity that
was amortized on an accelerated basis in accordance with Financial Accounting
Standards Board ("FASB") Interpretation No. ("FIN") 28 over the vesting period
for the individual award. The amortization expense relates to options awarded to
employees in all operating expense categories, however, the amortization of
deferred stock compensation has not been separately allocated to these
categories. The Company expensed deferred stock compensation of $20,000 and $0.1
million for fiscal years 2004 and 2003, respectively. Deferred stock
compensation was fully amortized as of July 31, 2004. As such, there was no
deferred stock compensation expense during fiscal 2005.
9. Income Taxes
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes." Due to the Company's loss position in fiscal
years 2005, 2004 and 2003, there was no provision for federal income taxes for
those years. A valuation allowance has been recorded for the total deferred tax
assets as management believes there are uncertainties regarding realization of
the assets based on the lack of consistent profitability to date and the
uncertainty of future profitability.
The components of the net deferred tax assets are as follows (in thousands):
July 31, July 31, July 31,
2005 2004 2003
---- ---- ----
Net operating loss carryforwards....... $ 94,519 $ 86,796 $ 83,577
Other reserves and accruals............ 9,092 12,722 13,081
--------- -------- ---------
103,611 99,518 96,658
Valuation allowance.................... (103,611) (99,518) (96,658)
--------- -------- ---------
Net deferred income tax asset.......... $ -- $ -- $ --
========= ======== =========
As of July 31, 2005, the Company has net operating loss carryforwards of
approximately $263.2 million to offset future federal taxable income, which
expire at various dates through fiscal year 2025. This amount includes
approximately $12.5 million of net operating loss carryforwards from the
acquisition of OSTG. The deferred tax assets related to the acquisition of OSTG
of approximately $5.6 million as of June 7, 2000, will be used to reduce the tax
provision if and when realized. The Company also has California net operating
loss carryforwards of approximately $83.0 million to offset future California
taxable income, which expire at various dates through fiscal year 2015. The net
operating loss carryforwards also include approximately $29.1 million resulting
from employee exercises of non-qualified stock options or disqualifying
dispositions, the tax benefits of which, when realized, will be recorded as an
addition to additional paid-in capital rather than a reduction of the provision
for income taxes. The operating loss carryforwards to be used in future years is
limited in accordance with the provisions of the Tax Reform Act of 1986 as the
Company has experienced a cumulative stock ownership change of more than 50%
over the last three years. The net operating loss carryforwards stated above are
reflective of various federal and state tax limitations.
10. Segment and Geographic Information
The Company's operating segments are significant strategic business units
that offer different products and services. The Company has four operating
segments: SourceForge, Online Media, E-commerce and Online Images.
The Company's SourceForge segment focuses on its SourceForge software
products. The Company's Online Media segment represents a network of Internet
web sites serving the IT professional and software development communities. The
Company's E-commerce segment provides online sales of a variety of retail
products of interest to the software development and IT communities. The
Company's Online Images segment provides online sales of three-dimensional art,
animations and presentations. Other includes revenues and costs associated with
the Company's former hardware business as well as all corporate expenses, such
as restructuring charges, legal judgments and settlements, amortization of
goodwill and intangibles, amortization of deferred stock, impairment of
long-lived assets and interest income, that are not allocated to the individual
operating segments and are not considered by the Company's chief decision-making
group in evaluating the performance of the operating segments.
The accounting policies of the segments are consistent with those described
in the summary of significant accounting policies. All intersegment sales have
been stated separately in the table below. The Company's chief decision-making
group, as defined under SFAS No. 131, consists of the Chief Executive Officer
62
<PAGE>
and the executive team. The Company's chief decision-making group excludes all
intersegment sales when evaluating the performance of the segments. The
Company's assets and liabilities are not discretely allocated or reviewed by
operating segment. The depreciation of the Company's property, equipment and
leasehold improvements are allocated based on headcount, unless specifically
identified by operating segment.
<TABLE>
<CAPTION>
Online Online Total
(in thousands) SourceForge Media E-commerce Images Other Eliminations Company
-------------- ----------- ----- ---------- ------ ----- ------------ -------
<S> <C> <C> <C> <C> <C> <C> <C>
Year Ended July 31, 2005
Revenue from external customers .......... $ 7,555 $ 8,130 $ 14,918 $ 2,284 $ -- $ -- $ 32,887
Revenue from intersegments ............. $ -- $ 279 $ -- $ 1 $ -- $ (280) $ --
Cost of revenues ....................... $ 1,028 $ 3,320 $ 11,591 $ 495 $ -- $ -- $ 16,434
Gross margin ........................... $ 6,527 $ 5,089 $ 3,327 $ 1,790 $ -- $ (280) $ 16,453
Operating income (loss) ................ $ (5,392) $ (1,624) $ 673 $ 955 $ (264) $ -- $ (5,652)
Depreciation expense ................... $ 550 $ 346 $ 29 $ 4 $ -- $ -- $ 929
Year Ended July 31, 2004
Revenue from external customers .......... $ 4,995 $ 9,728 $ 12,567 $ 1,922 $ 49 $ -- $ 29,261
Revenue from intersegments ............. $ -- $ 238 $ -- $ -- $ -- $ (238) $ --
Cost of revenues ....................... $ 1,860 $ 2,969 $ 10,225 $ 495 $ (12) $ -- $ 15,537
Gross margin ........................... $ 3,135 $ 6,997 $ 2,342 $ 1,427 $ 61 $ (238) $ 13,724
Operating income (loss) ................ $ (8,900) $ (431) $ 79 $ 622 $ (2,377) $ -- $(11,007)
Depreciation expense ................... $ 1,123 $ 260 $ 30 $ 43 $ -- $ -- $ 1,456
Year Ended July 31, 2003
Revenue from external customers ........ $ 2,918 $ 10,405 $ 8,565 $ 1,580 $ 760 $ -- $ 24,228
Revenue from intersegments ............. $ -- $ 163 $ -- $ -- $ -- $ (163) $ --
Cost of revenues ....................... $ 1,997 $ 3,852 $ 7,025 $ 338 $ (432) $ -- $ 12,780
Gross margin ........................... $ 921 $ 6,716 $ 1,540 $ 1,242 $ 1,192 $ (163) $ 11,448
Operating income (loss) ................ $(13,575) $ (376) $ (162) $ 353 $ (1,122) $ -- $(14,882)
Depreciation expense ................... $ 2,129 $ 1,049 $ 12 $ 12 $ -- $ -- $ 3,202
</TABLE>
During the time period covered by the table above, the Company marketed its
products in the United States through its direct sales force and its online web
sites. Revenues for each of the fiscal years ended July 31, 2005, July 31, 2004
and July 31, 2003 were primarily generated from sales to end users in the United
States of America.
<TABLE>
Quarterly Financial Data
<CAPTION>
Fiscal Year 2005
----------------
For the three months ended
------------------------------------------------------
October 31 January 31 April 30 July 31
---------- ---------- -------- -------
<S> <C> <C> <C> <C>
Net revenues .................................................. $ 6,998 $ 9,927 $ 7,611 $ 8,351
Gross margin .................................................. 3,479 4,316 4,029 4,629
Loss from operations .......................................... (1,871) (918) (1,617) (1,246)
Net loss attributable to common stockholders .................. $ (1,616) $ (702) $ (1,376) $ (1,000)
Per share amounts:
Basic and diluted net loss per share ........................ $ (0.03) $ (0.01) $ (0.02) $ (0.02)
Shares used in computing basic and diluted net loss per share 61,296 61,412 61,523 61,586
</TABLE>
<TABLE>
<CAPTION>
Fiscal Year 2004
----------------
For the three months ended
------------------------------------------------------
October 31 January 31 April 30 July 31
---------- ---------- -------- -------
<S> <C> <C> <C> <C>
Net revenues .................................................. $ 5,797 $ 8,856 $ 7,291 $ 7,317
Gross margin .................................................. 2,547 3,542 3,778 3,857
Loss from operations .......................................... (2,402) (2,309) (5,265) (1,031)
Net loss attributable to common stockholders .................. $ (1,223) $ (1,431) $ (4,125) $ (861)
Per share amounts:
Basic and diluted net loss per share ........................ $ (0.02) $ (0.02) $ (0.07) $ (0.01)
Shares used in computing basic and diluted net loss per share 56,255 60,355 60,882 61,141
</TABLE>
63
<PAGE>
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
During its review of the Company's interim financial statements for the
fiscal third quarter ended April 30, 2005, a disagreement arose between the
Company and BDO regarding the application of accounting principles, which
disagreement ultimately was resolved to BDO's satisfaction. The disagreement
concerned the accounting for one of the Company's volume-based sales incentive
programs, specifically, whether the Company had developed sufficient historical
experience to begin calculating the amount of the accrued liability pertaining
to such programs based on estimated future expiration rates versus continuing to
calculate the liability based on actual expirations. The Audit Committee
discussed this disagreement with BDO.
As disclosed in the Company's Form 10-Q for the period ended April 30, 2005,
BDO notified the Company's Audit Committee and the Company's management of a
control deficiency in the Company's internal control structure involving the
design or operation of the Company's internal controls over financial reporting
that BDO considered to be a material weakness, because the control deficiency
resulted in more than a remote likelihood that a material misstatement could
occur in the Company's annual or interim financial statements and not be
prevented or detected. The material weakness identified by BDO pertained to the
need for additional resources and technical accounting expertise to be available
to the Company's accounting and financial reporting function to assist the
Company in addressing relatively complex transactions and/or accounting issues
that arise from time to time in the course of the Company's operations.
In addition, on October 10, 2005, the Company filed a current report on Form
8-K to report a change in the Company's independent registered public accounting
firm.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Company's management, with the participation of the Company's chief
executive officer and chief financial officer, evaluated the effectiveness of
the Company's disclosure controls and procedures (as defined in Rules 13a-15(e)
and 15d-15(e) under the Exchange Act) as of July 31, 2005. Based on this
evaluation, the Company's chief executive officer and chief financial officer
concluded that as of July 31, 2005, the Company's disclosure controls and
procedures were not effective because of the material weaknesses described
below.
Management's Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal
control over financial reporting and for the assessment of the effectiveness of
internal control over financial reporting. As defined by the SEC, internal
control over financial reporting is a process designed by, or under the
supervision of, the Company's principal executive and principal financial
officers and effected by the Company's board of directors, management and other
personnel, to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles.
The Company's internal control over financial reporting is supported by written
policies and procedures that: (1) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and
dispositions of the Company's assets; (2) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles and that
receipts and expenditures of the company are being made only in accordance with
authorizations of the Company's management and directors; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use or disposition of the Company's assets that could have a
material effect on the financial statements.
64
<PAGE>
In connection with the preparation of the Company's annual financial statements,
management of the Company has undertaken an assessment of the effectiveness of
the Company's internal control over financial reporting as of July 31, 2005
based on criteria established in Internal Control - Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (the
"COSO Framework"). Management's assessment included an evaluation of the design
of the Company's internal control over financial reporting and testing of the
operational effectiveness of the Company's internal control over financial
reporting. As a result of the material weaknesses described in the following
paragraphs, management has concluded that, as of July 31, 2005, the Company's
internal control over financial reporting was not effective based on those
criteria. As defined by Public Company Accounting Oversight Board ("PCAOB")
Auditing Standard No. 2, a material weakness is a significant control deficiency
or a combination of significant control deficiencies that results in there being
more than a remote likelihood that a material misstatement of the annual or
interim financial statements will not be prevented or detected.
Based upon our management's assessment of our internal control over financial
reporting as of July 31, 2005, we have identified the following material
weaknesses:
o Lack of sufficient personnel and technical accounting and financial
reporting expertise within the Company's accounting and finance
function. As of July 31, 2005, we did not have sufficient personnel and
technical accounting and financial reporting expertise within our
accounting function to sufficiently address relatively complex
transactions and/or accounting and financial reporting issues that arise
from time to time in the course of our operations. This situation was
exacerbated by the additional demands placed upon our accounting and
finance personnel as we worked to meet the internal control requirements
under Section 404 of the Sarbanes-Oxley Act of 2002. We previously
disclosed this material weakness in our Quarterly Report on Form 10-Q
for the quarter ended April 30, 2005. At that time, the material
weakness was identified as a result of our misapplication of generally
accepted accounting principles pertaining to the accounting for our
volume-based sales incentive programs. Further, in connection with
preparing our fiscal 2005 annual financial statements, we did not
initially classify a material amount of deferred sublease income and
prepaid royalties correctly between current assets and long-term assets.
The proper classification was identified by our independent registered
public accounting firm and was adjusted in the Company's balance sheet
at July 31, 2005.
This material weakness resulted in adjustments to our fiscal year 2005
annual and interim financial statements. Further, this material weakness
could result in material misstatements to our annual or interim
financial statements that would not be prevented or detected.
o Inadequate controls over period-end financial reporting. As of July 31,
2005, our Chief Financial Officer was responsible for preparing or
compiling certain critical portions of the quarterly and annual internal
financial information and was also responsible for performing a review
of this information to monitor the results of operations. This review
represents an important detective control in our internal control over
financial reporting. Because there was no separate independent detailed
review of this critical financial information, there is a risk that
inaccurate information may be reported and errors may not be identified.
This material weakness did not result in adjustments to our fiscal year
2005 annual or interim financial statements. However, this material
weakness could result in material misstatements to our annual or interim
financial statements that would not be prevented or detected.
o Inadequate controls in the areas of revenue and accounts receivable.
During the fiscal year ended July 31, 2005, there were certain instances
in which fully executed contracts were not obtained in a timely manner
in connection with providing online advertising services. Further, in a
limited number of situations, revenue was not adjusted to properly
reflect below-estimated "click-throughs" on certain advertising
sponsorship buttons and links. In addition, in certain instances the
same individual had authority for activities which should be segregated,
such as processing of orders and authorization of shipping; and
invoicing and collections. Furthermore, we did not have adequate
oversight and review of these personnel to compensate for the inadequate
segregation of duties. These weaknesses individually represent
significant deficiencies and, in the aggregate, represent a material
weakness.
This material weakness did not result in adjustments to our fiscal year
2005 annual or interim financial statements. However, this material
weakness could result in material misstatements to our annual or interim
financial statements that would not be prevented or detected.
65
<PAGE>
o Inadequate controls in the area of purchases. During the fiscal year
ended July 31, 2005, management did not ensure that the Company's
Purchasing Policy was strictly enforced, including instances where the
purchasing manager did not obtain appropriate approvals for purchasing
and the facilities manager did not always sign off on the packing slips
to provide evidence of the actual quantity received. In addition, we did
not maintain adequate segregation of duties among members of our
purchasing and receiving departments. In several instances, we had the
same personnel performing duties that were not compatible. Furthermore,
we did not have adequate oversight and review of these personnel to
compensate for the inadequate segregation of duties. We determined that
we have compensating controls in place to mitigate the risk that these
control deficiencies could result in a material misstatement to our
annual or interim financial statements; however, due to the opportunity
for invalid and unauthorized purchases, we determined that these control
deficiencies, in the aggregate, represent a material weakness.
This material weakness did not result in adjustments to our fiscal year
2005 annual or interim financial statements. However, this material
weakness could result in material misstatements to our annual or interim
financial statements that would not be prevented or detected.
o Inadequate controls in the area of information technology. As of July
31, 2005, we did not maintain effective controls over access to the
accounting system and in some cases did not maintain complete
documentation regarding these access rights. Specifically, certain of
our accounting users with financial, accounting and reporting
responsibilities also had inappropriate access to financial application
programs and data. Such access was not in compliance with segregation of
duties requirements nor was this access independently monitored. In
addition, the documentation regarding access privileges of certain
individuals to the accounting system was not reflective of actual access
privileges. Further, we did not maintain adequate controls in the areas
of system development life cycle, or SDLC, and Change Management.
Management determined that these weaknesses individually represent
significant deficiencies and, in the aggregate, represent a material
weakness.
This material weakness did not result in adjustments to our fiscal year
2005 annual or interim financial statements. However, this material
weakness could result in material misstatements to our annual or interim
financial statements that would not be prevented or detected. .
o Lack of internal control reports (under SAS 70) from critical external
service providers. As of July 31, 2005, we were unable to obtain proper
"Report on Controls Placed in Operation and Test of Operating
Effectiveness" (issued under SAS 70) from two external service
providers. These include the provider of our hosted accounting system
and the provider of our hosted advertising servicing system. The
services performed by these service providers were deemed material and
significant to the Company's business and accurate financial reporting.
This material weakness did not result in adjustments to our fiscal year
2005 annual or interim financial statements. However, this material
weakness could result in a risk that integrity of critical company data
could be compromised at external service providers which could result in
material misstatements to our annual or interim financial statements
that would not be prevented or detected.
In light of these material weaknesses and the requirements enacted by the
Sarbanes-Oxley Act of 2002 and the related rules and regulations adopted by the
SEC, our chief executive officer and chief financial officer concluded that, as
of July 31, 2005, our internal control over financial reporting was not
effective.
Our independent registered public accounting firm, BDO Seidman, LLP, has issued
an attestation report on management's assessment of our internal control over
financial reporting, which is included in this Annual Report on Form 10-K on
page 68.
66
<PAGE>
Completed and Planned Remediation Actions to Address Internal Control
Deficiencies
Management believes the actions that we have taken since July 31, 2005 and
actions that will be taken in fiscal year 2006, along with other improvements
yet to be formally identified, will address the material weaknesses in our
internal control over financial reporting noted above. Some of these remediation
actions are discussed below.
o In relation to the material weakness in the area of lack of sufficient
personnel and technical accounting and financial reporting expertise
within the Company's accounting and finance function, we are committed
to hiring a sufficient number of technically-qualified employees and/or
consultants to ensure that all significant accounting issues, both
routine and non-routine, are identified, researched and properly
concluded upon. Further, we will implement a detailed review of balance
sheet classifications.
o In relation to the material weakness in the area of inadequate controls
over period-end financial reporting, to remedy this deficiency, we will
ensure that the internal reporting package is reviewed and signed off by
a person other than the preparer.
o In relation to the material weakness in the area of inadequate controls
in the area of revenue and accounts receivable, we are strictly
enforcing the policy of obtaining fully-executed contracts from each
customer before running the customer's ads and have put in place
processes to independently review all sponsorship and "non-standard"
impression contracts to ensure that they are captured and accounted for
correctly. In addition, we will monitor job responsibilities for all
accounting personnel and ensure that employees are not expected to take
on multiple conflicting duties.
o In relation to the material weakness in the area of inadequate controls
in the area of purchases, we are strictly enforcing the purchasing
policy, including, but not limited to, requiring that approvals be
obtained before the Company issues a purchase order and requiring that
all packing slips be signed off as evidence of quantities purchased. We
will also monitor job responsibilities for all accounting personnel and
ensure that employees are not expected to take on multiple conflicting
duties.
o In relation to the material weakness in the area of inadequate controls
in the area of information technology, we are periodically reviewing
access rights and are enforcing compliance to our SDLC and Change
Management policies. In addition, we will update documentation regarding
access privileges of certain individuals to the accounting system to
reflect actual access privileges.
o In relation to the material weakness in the area of a lack of internal
control reports (under SAS 70) from critical external service providers,
we received a SAS 70 report from the provider of our hosted accounting
system in October 2005 and expect to receive a SAS 70 report from the
provider of our hosted ad servicing system in March 2006. In addition,
we will work with our external service providers to obtain timely SAS 70
reports; in those instances where a timely report is unavailable, we
will undertake additional testing to ensure adequate controls are in
place and effective.
Limitations on Effectiveness of Controls
VA Software's management, including our chief executive officer and chief
financial officer, does not expect that our disclosure controls or our internal
control over financial reporting will prevent or detect all error and all fraud.
A control system, no matter how well designed and operated, can provide only
reasonable, not absolute, assurance that the control system's objectives will be
met. The design of a control system must reflect the fact that there are
resource constraints, and the benefits of controls must be considered relative
to their costs. Further, because of the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that
misstatements due to error or fraud will not occur or that all control issues
and instances of fraud, if any, within the Company have been detected. These
inherent limitations include the realities that judgments in decision-making can
be faulty and that breakdowns can occur because of simple error or mistake.
Controls can also be circumvented by the individual acts of some persons, by
collusion of two or more people, or by management override of the controls. The
design of any system of controls is based in part on 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. Projections of any evaluation of the effectiveness of controls to
future periods are subject to risks. Over time, controls may become inadequate
because of changes in conditions or deterioration in the degree of compliance
with policies or procedures.
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Report of Independent Registered Public Accounting Firm
To The Board of Directors and Stockholders of VA Software, Corporation:
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control over Financial Reporting, that VA
Software Corporation did not maintain effective internal control over financial
reporting as of July 31, 2005, because of the effects of the material weaknesses
identified in management's assessment, based on criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). VA Software Corporation's
management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on
management's assessment and an opinion on the effectiveness of the Company's
internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management's assessment, testing
and evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinions.
A company's internal control over financial reporting is a process designed
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with accounting principles generally accepted in the United States of America. A
company's internal control over financial reporting includes those policies and
procedures that (1) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the
assets of the company; (2) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in
accordance with accounting principles generally accepted in the United States of
America, and that receipts and expenditures of the company are being made only
in accordance with authorizations of management and directors of the company;
and (3) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the company's assets that could
have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
A material weakness is a control deficiency, or combination of control
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected. The following material weaknesses have been identified and included
in management's assessment:
o Lack of sufficient personnel and technical accounting and financial
reporting expertise within the Company's accounting and finance
function. As of July 31, 2005, the Company did not have sufficient
personnel and technical accounting and financial reporting expertise
within its accounting function to sufficiently address relatively
complex transactions and/or accounting and financial reporting issues
that arise from time to time in the course of its operations. This
situation was exacerbated by the additional demands placed upon the
Company's accounting and finance personnel as it worked to meet the
internal control requirements under Section 404 of the Sarbanes-Oxley
Act of 2002. The Company previously disclosed this material weakness in
the Company's Quarterly Report on Form 10-Q for the quarter ended April
30, 2005. At that time, the material weakness was identified as a result
of the Company's misapplication of generally accepted accounting
principles pertaining to the accounting for its volume-based sales
incentive programs. Further, in connection with preparing its fiscal
2005 annual financial statements, the Company did not initially classify
a material amount of deferred sublease income and prepaid royalties
correctly between current assets and long-term assets. The proper
classification was ultimately adjusted in the Company's balance sheet at
July 31, 2005.
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<PAGE>
This material weakness resulted in adjustments to the Company's fiscal
year 2005 annual and interim financial statements. Further, this
material weakness could result in material misstatements to the
Company's annual or interim financial statements that would not be
prevented or detected.
o Inadequate controls over period-end financial reporting. As of July 31,
2005, the Company's Chief Financial Officer was responsible for
preparing or compiling certain critical portions of the quarterly and
annual internal financial information and was also responsible for
performing a review of this information to monitor the results of
operations. This review represents an important detective control in the
Company's internal control over financial reporting. Because there was
no separate independent detailed review of this critical financial
information, there is a risk that inaccurate information may be reported
and errors may not be identified.
This material weakness did not result in adjustments to the Company's
fiscal year 2005 annual or interim financial statements. However, this
material weakness could result in material misstatements to the
Company's annual or interim financial statements that would not be
prevented or detected.
o Inadequate controls in the areas of revenue and accounts receivable.
During the fiscal year ended July 31, 2005, there were certain instances
in which fully executed contracts were not obtained in a timely manner
in connection with providing online advertising services. Further, in a
limited number of situations, revenue was not adjusted to properly
reflect below-estimated "click-throughs" on certain advertising
sponsorship buttons and links. In addition, in certain instances the
same individual had authority for activities which should be segregated,
such as processing of orders and authorization of shipping; and
invoicing and collections. Furthermore, management did not have adequate
oversight and review of these personnel to compensate for the inadequate
segregation of duties. These weaknesses individually represent
significant deficiencies and, in the aggregate, represent a material
weakness.
This material weakness did not result in adjustments to the Company's
fiscal year 2005 annual or interim financial statements. However, this
material weakness could result in material misstatements to the
Company's annual or interim financial statements that would not be
prevented or detected.
o Inadequate controls in the area of purchases. During the fiscal year
ended July 31, 2005, management did not ensure that the Company's
Purchasing Policy was strictly enforced, including instances where the
purchasing manager did not obtain appropriate approvals for purchasing
and the facilities manager did not always sign off on the packing slips
to provide evidence of the actual quantity received. In addition, the
Company did not maintain adequate segregation of duties among members of
its purchasing and receiving departments. In several instances, the
Company had the same personnel performing duties that were not
compatible, such as purchasing and receiving. Furthermore, management
did not have adequate oversight and review of these personnel to
compensate for the inadequate segregation of duties. These weaknesses
individually represent significant deficiencies and, in the aggregate,
represent a material weakness.
This material weakness did not result in adjustments to the Company's
fiscal year 2005 annual or interim financial statements. However, this
material weakness could result in material misstatements to the
Company's annual or interim financial statements that would not be
prevented or detected.
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<PAGE>
o Inadequate controls in the area of information technology. As of July
31, 2005, the Company did not maintain effective controls over access to
the accounting system and in some cases did not maintain complete
documentation regarding these access rights. Specifically, certain of
the Company's accounting users with financial, accounting and reporting
responsibilities also had inappropriate access to financial application
programs and data. Such access was not in compliance with segregation of
duties requirements nor was this access independently monitored. In
addition, the documentation regarding access privileges of certain
individuals to the accounting system was not reflective of actual access
privileges. Further, the Company did not maintain adequate controls in
the areas of system development life cycle, or SDLC, and Change
Management. These weaknesses individually represent significant
deficiencies and, in the aggregate, represent a material weakness.
This material weakness did not result in adjustments to the Company's
fiscal year 2005 annual or interim financial statements. However, this
material weakness could result in material misstatements to the
Company's annual or interim financial statements that would not be
prevented or detected.
o Lack of internal control reports (under SAS 70) from critical external
service providers. As of July 31, 2005, the Company was unable to obtain
proper "Report on Controls Placed in Operation and Test of Operating
Effectiveness" (issued under SAS 70) from two external service
providers. These include the provider of the Company's hosted accounting
system and the provider of its hosted advertising servicing system. The
services performed by these service providers were deemed material and
significant to the Company's business and accurate financial reporting.
This material weakness did not result in adjustments to the Company's
fiscal year 2005 annual or interim financial statements. However, this
material weakness could result in material misstatements to the
Company's annual or interim financial statements that would not be
prevented or detected.
These material weaknesses were considered in determining the nature, timing, and
extent of audit tests applied in our audit of VA Software Corporation's
consolidated financial statements as of and for the year ended July 31, 2005,
and this report does not affect our report dated October 31, 2005 on those
consolidated financial statements.
In our opinion, management's assessment that VA Software Corporation did not
maintain effective internal control over financial reporting as of July 31,
2005, is fairly stated, in all material respects, based on the criteria
established in Internal Control--Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO). Also in our opinion,
because of the effects of the material weaknesses described above on the
achievement of the objectives of the control criteria, VA Software Corporation
has not maintained effective internal control over financial reporting as of
July 31, 2005, based on the criteria established in Internal Control--Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO).
We do not express an opinion or any other form of assurance on management's
statements regarding corrective actions taken by the Company after July 31,
2005.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the accompanying consolidated
balance sheets of VA Software Corporation as of July 31, 2005 and 2004, and the
related consolidated statements of operations, stockholders' equity and
comprehensive income (loss), and cash flows for each of the two years in the
period ended July 31, 2005 and our report dated October 31, 2005 expressed an
unqualified opinion thereon.
/s/ BDO Seidman, LLP
San Jose, California
October 31, 2005
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<PAGE>
PART III
Item 10. Directors and Executive Officers of the Registrant
The information called for by this item is incorporated by reference to the
sections entitled "Certain Beneficial Owners", "Security Ownership of Directors
and Executive Officers" and "Information About The Directors, Nominees And
Executive Officers" in the Company's 2005 Proxy Statement, which will be
delivered to stockholders in connection with the Company's annual stockholders'
meeting to be held on December 7, 2005.
Code of Ethics
In addition to the Company's Code of Business Conduct and Ethics that is
applicable to all employees and directors, the Company has adopted a Code of
Ethics for Principal Executive and Senior Financial Officers. The Company has
posted the text of its Code of Ethics for Principal Executive and Senior
Financial Officers on its Internet Web site at: http://www.
vasoftware.com/company/docs/Code_of_Ethics_for_Senior_Financial_Officers.pdf.
Item 11. Executive Compensation
The information called for by this item is incorporated by reference to the
section entitled "Compensation of Directors and Executive Officers" in the
Company's 2005 Proxy Statement, which will be delivered to stockholders in
connection with the Company's annual stockholders' meeting to be held on
December 7, 2005.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information called for by this item is incorporated by reference to the
sections entitled "Certain Beneficial Owners" and "Security Ownership of
Directors and Executive Officers" in the Company's 2005 Proxy Statement, which
will be delivered to stockholders in connection with the Company's annual
stockholders' meeting to be held on December 7, 2005.
Item 13. Certain Relationships and Related Transactions
The information called for by this item is incorporated by reference to the
section entitled "Certain Relationships and Related Transactions" in the
Company's 2005 Proxy Statement, which will be delivered to stockholders in
connection with the Company's annual stockholders' meeting to be held on
December 7, 2005.
Item 14. Principal Accountant Fees and Services.
The information called for by this item is incorporated by reference to the
section entitled "Principal Accountant Fees and Services" in the Company's 2005
Proxy Statement, which will be delivered to stockholders in connection with the
Company's annual stockholders' meeting to be held on December 7, 2005
71
<PAGE>
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) The following documents are filed as part of this report:
1. All Financial Statements:
See the Consolidated Financial Statements and notes thereto in Item 8 above.
2. Schedule II -- Valuation and Qualifying Accounts are filed as part of
this Form 10-K.
3. Exhibits:
See the Exhibit Index.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
VA SOFTWARE CORPORATION
By: /s/ ALI JENAB
-------------------------------------
Ali Jenab
Chief Executive Officer and President
Date: October 31, 2005
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<PAGE>
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below hereby constitutes and appoints Ali Jenab and Kathleen R. McElwee,
and each of them, his true and lawful attorneys-in-fact, each with full power of
substitution, for him and all capacities, to sign any amendments to this report
on Form 10-K and to file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission and does
hereby ratify and confirm all that each of said attorneys-in-fact or their
substitute or substitutes may do or cause to be done by virtue hereof.
Pursuant to the requirement of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ ALI JENAB Chief Executive Officer, President October 31, 2005
------------------------------------ (principle executive officer) and Director
Ali Jenab
/s/ KATHLEEN R. MCELWEE Senior Vice President and Chief Financial Officer October 31, 2005
------------------------------------ (principle accounting officer)
Kathleen R. McElwee
/s/ ANDREW ANKER Director October 31, 2005
------------------------------------
Andrew Anker
/s/ LARRY M. AUGUSTIN Chairman of the Board of Directors October 31, 2005
------------------------------------
Larry M. Augustin
/s/ ANDRE M. BOISVERT Director October 31, 2005
------------------------------------
Andre M. Boisvert
/s/ RAM GUPTA Director October 31, 2005
------------------------------------
Ram Gupta
/s/ ROBERT M. NEUMEISTER, JR. Director October 31, 2005
------------------------------------
Robert M. Neumeister, Jr.
/s/ CARL REDFIELD Director October 31, 2005
------------------------------------
Carl Redfield
/s/ DAVID B. WRIGHT Director October 31, 2005
------------------------------------
David B. Wright
</TABLE>
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<PAGE>
VA SOFTWARE CORPORATION
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
<TABLE>
<CAPTION>
Balance at Charged to Balance at
Beginning Costs and End
Description of Period Expenses Deductions of Period
----------- --------- -------- ---------- ---------
<S> <C> <C> <C> <C>
Year Ended July 27, 2003
Allowance for doubtful accounts........................ $ 1,166 $ (19) $ 1,003 $ 144
Allowance for excess and obsolete inventory............ $ 30 $ (6) $ -- $ 24
Year Ended July 31, 2004
Allowance for doubtful accounts........................ $ 144 $ 56 $ 73 $ 127
Allowance for excess and obsolete inventory............ $ 24 $ 9 $ -- $ 33
Year Ended July 31, 2005
Allowance for doubtful accounts........................ $ 127 $ 40 $ 1 $ 166
Allowance for excess and obsolete inventory............ $ 33 $ 57 $ 31 $ 59
</TABLE>
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<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number
------
<S> <C> <C>
3.1(1) -- Amended and Restated Certificate of Incorporation of the Registrant
3.2(1) -- Bylaws of the Registrant
4.1(1) -- Specimen Common Stock Certificate
4.2(2) -- Warrant to Purchase Shares of Common Stock issued to The Riverview Group LLC
10.1(1) ++ -- Form of Indemnification Agreement between the Registrant and each of its directors and officers
10.2(1) ++ -- 1998 Stock Plan and forms of agreement thereunder
10.3(1) ++ -- 1999 Employee Stock Purchase Plan
10.4(1) ++ -- 1999 Director Option Plan
10.6+(3) -- Master Lease Agreement between Boca Global, Inc. and Bordeaux Partners LLC
10.7+(4) -- Master Lease Agreement between Registrant and Renco Investment Company
10.8(5) -- Consent of Linus Torvalds
10.9 (7) -- Sublease between registrant and @Road, Inc., dated June 9, 2004.
10.10 (8) -- Consent to Sublease Agreement between registrant, @Road, Inc. and Renco Investment Company,
dated June 9, 2004.
10.11(6) -- Registration Rights Agreement between Registrant and certain holders of Common Stock,
dated November 6, 2003
10.12 (9) -- First Amendment to Registration Rights Agreement between Registrant and certain holders of Common
Stock, dated October 13, 2004
23.1 -- Consent of BDO Seidman, LLP, Independent Registered Public Accounting Firm
23.2 -- Consent of PricewaterhouseCoopers, LLP, Independent Registered Public Accounting Firm
24.1 -- Power of Attorney (see signature page)
31.01 -- Certification Of Chief Executive Officer Pursuant To Section 302 Of The Sarbanes-Oxley Act Of 2002
31.02 -- Certification Of Chief Financial Officer Pursuant To Section 302 Of The Sarbanes-Oxley Act Of 2002
32.01 Certification Of Chief Executive Officer Pursuant To Section 906 Of The Sarbanes-Oxley Act Of 2002
32.02 Certification Of Chief Financial Officer Pursuant To Section 906 Of The Sarbanes-Oxley Act Of 2002
</TABLE>
____________
+ Confidential treatment has been requested by the Registrant as to certain
portions of this exhibit. The omitted portions have been separately filed
with the Commission.
(1) Incorporated by reference to the corresponding exhibit of Registrant's form
S-1 and the amendment thereto (Commission registration no. 333-88687).
(2) Incorporated by reference from Exhibit 4.1 of Registrant's Current Report on
Form 8-K filed on November 7, 2003.
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<PAGE>
(3) Incorporated by reference from Exhibit 10.16 of Registrant's form S-1 and
the amendments thereto (Commission registration no. 333-88687).
(4) Incorporated by reference from Exhibit 10.14 of Registrant's Annual Report
on Form 10-K for the period ended June 28, 2000 filed on October 26, 2000
(Commission file number 000-28369).
(5) Incorporated by reference from Exhibit 10.18 of Registrant's Quarterly
Report on Form 10-Q for the period ended January 28, 2000 filed on March 13,
2000 (Commission file number 000-28369).
(6) Incorporated by reference from Exhibit 10.2 of Registrant's Current Report
on Form 8-K filed on November 7, 2003.
(7) Incorporated by reference from Exhibit 10.42 of Registrant's Annual Report
on Form 10-K for the period ended July 31, 2004 filed on October 28, 2005
(Commission file number 000-28369).
(8) Incorporated by reference from Exhibit 10.43 of Registrant's Annual Report
on Form 10-K for the period ended July 31, 2004 filed on October 28, 2005
(Commission file number 000-28369).
(9) Incorporated by reference from Exhibit 10.12 of Registrant's Annual Report
on Form 10-K for the period ended July 31, 2004 filed on October 28, 2005
(Commission file number 000-28369).
++ Denotes a management contract or compensatory plan or arrangement.
76
</TEXT>
</DOCUMENT>