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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2007
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period to
Commission File Number 000-50640
SUMTOTAL SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware | 42-1607228 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
1808 North Shoreline Boulevard
Mountain View, California 94043
(Address of principal executive offices, including zip code)
(650) 934-9500
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (check one)
¨ Large accelerated filer x Accelerated filer ¨ Non-accelerated filer
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes ¨ No x
The number of shares outstanding of the issuer’s Common Stock, par value $0.001, as of May 1, 2007 was 27,171,308 shares.
Table of Contents
FORM 10–Q
For the Quarter Ended March 31, 2007
TABLE OF CONTENTS
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PART I – FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
SUMTOTAL SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited, in thousands)
March 31, 2007 | December 31, 2006 | |||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 13,683 | $ | 10,176 | ||||
Restricted cash | — | 23 | ||||||
Short-term investments | 3,361 | 5,530 | ||||||
Accounts receivable, net of allowance for sales returns and doubtful accounts of $860 and $899, respectively | 24,134 | 28,516 | ||||||
Prepaid expenses and other current assets | 4,153 | 3,891 | ||||||
Total current assets | 45,331 | 48,136 | ||||||
Property and equipment, net | 6,605 | 5,945 | ||||||
Goodwill | 68,461 | 68,461 | ||||||
Intangible assets, net | 19,078 | 21,327 | ||||||
Other assets | 1,158 | 1,194 | ||||||
Total assets | $ | 140,633 | $ | 145,063 | ||||
Liabilities and Stockholders’ Equity | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 4,440 | $ | 3,991 | ||||
Accrued compensation and benefits | 5,877 | 8,554 | ||||||
Other accrued liabilities | 3,581 | 4,612 | ||||||
Restructuring accrual | 117 | 866 | ||||||
Deferred revenue | 29,791 | 29,958 | ||||||
Notes payable | 6,125 | 6,095 | ||||||
Total current liabilities | 49,931 | 54,076 | ||||||
Non-current liabilities: | ||||||||
Other accrued liabilities, non-current | 235 | 246 | ||||||
Deferred revenue, non-current | 1,066 | 781 | ||||||
Notes payable, non-current | 9,390 | 10,735 | ||||||
Total liabilities | 60,622 | 65,838 | ||||||
Commitments and contingencies | ||||||||
Stockholders’ equity: | ||||||||
Preferred stock | — | — | ||||||
Common stock | 27 | 27 | ||||||
Additional paid-in capital | 357,594 | 354,800 | ||||||
Accumulated other comprehensive loss | (312 | ) | (332 | ) | ||||
Accumulated deficit | (277,298 | ) | (275,270 | ) | ||||
Total stockholders’ equity | 80,011 | 79,225 | ||||||
Total liabilities and stockholders’ equity | $ | 140,633 | $ | 145,063 | ||||
Refer to the accompanying Notes to the Unaudited Condensed Consolidated Financial Statements.
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SUMTOTAL SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands, except per share data)
Three-Months Ended March 31, | ||||||||
2007 | 2006 | |||||||
Revenue: | ||||||||
Subscriptions and support | $ | 14,468 | $ | 10,944 | ||||
Service | 8,233 | 7,083 | ||||||
License | 6,349 | 6,274 | ||||||
Total revenue | 29,050 | 24,301 | ||||||
Cost of revenue: | ||||||||
Subscriptions and support | 4,746 | 3,537 | ||||||
Service | 5,590 | 5,175 | ||||||
License | 92 | 180 | ||||||
Amortization of intangible assets | 2,250 | 2,327 | ||||||
Total cost of revenue | 12,678 | 11,219 | ||||||
Gross margin | 16,372 | 13,082 | ||||||
Operating expenses: | ||||||||
Research and development | 5,039 | 4,099 | ||||||
Sales and marketing | 7,902 | 7,243 | ||||||
General and administrative | 5,006 | 5,811 | ||||||
Total operating expenses | 17,947 | 17,153 | ||||||
Loss from operations | (1,575 | ) | (4,071 | ) | ||||
Interest expense | (378 | ) | (435 | ) | ||||
Interest income | 163 | 163 | ||||||
Other expense, net | (12 | ) | (76 | ) | ||||
Loss before provision for income taxes | (1,802 | ) | (4,419 | ) | ||||
Provision for income taxes | 24 | 17 | ||||||
Net loss | $ | (1,826 | ) | $ | (4,436 | ) | ||
Net loss per share, basic and diluted | $ | (0. 07 | ) | $ | (0.18 | ) | ||
Weighted average common shares outstanding, basic and diluted | 26,839 | 24,698 | ||||||
Refer to the accompanying Notes to the Unaudited Condensed Consolidated Financial Statements.
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SUMTOTAL SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
Three-Months Ended March 31, | ||||||||
2007 | 2006 | |||||||
Cash flows from operating activities: | ||||||||
Net loss | $ | (1,826 | ) | $ | (4,436 | ) | ||
Adjustments to reconcile net loss to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 875 | 637 | ||||||
Amortization of intangible assets | 2,250 | 2,327 | ||||||
Provision for (recovery of) sales returns and doubtful accounts | 17 | (175 | ) | |||||
Accretion of interest on short-term investments | (26 | ) | (12 | ) | ||||
Amortization of discount on notes payable | 71 | 62 | ||||||
Stock-based compensation | 1,052 | 1,006 | ||||||
Changes in assets and liabilities, net of effects of acquisitions: | ||||||||
Accounts receivable, net | 4,407 | 4,731 | ||||||
Prepaid expenses and other assets | (90 | ) | (432 | ) | ||||
Other assets | 42 | 22 | ||||||
Accounts payable | 447 | 187 | ||||||
Accrued compensation and benefits | (2,678 | ) | 6 | |||||
Other accrued liabilities | (1,378 | ) | (1,555 | ) | ||||
Restructuring accrual | (749 | ) | (1,071 | ) | ||||
Deferred revenue | 80 | (368 | ) | |||||
Net cash provided by operating activities | 2,494 | 929 | ||||||
Cash flows from investing activities: | ||||||||
Purchases of property and equipment | (1,476 | ) | (598 | ) | ||||
Purchases of short-term investments | (1,454 | ) | — | |||||
Sales/maturities of short-term investments | 3,605 | — | ||||||
Release of restricted cash | 23 | — | ||||||
Net cash provided by (used in) investing activities | 698 | (598 | ) | |||||
Cash flows from financing activities: | ||||||||
Repayment of credit facility | (1,094 | ) | (1,094 | ) | ||||
Payment on notes payable | (292 | ) | (292 | ) | ||||
Net proceeds from the issuance of common stock pursuant to SumTotal Systems’ Employee Stock Purchase Plan and exercises of common stock options | 1,742 | 376 | ||||||
Net cash provided by (used in) financing activities | 356 | (1,010 | ) | |||||
Effect of foreign exchange rate changes on cash and cash equivalents | (41 | ) | (15 | ) | ||||
Net increase (decrease) in cash and cash equivalents | 3,507 | (694 | ) | |||||
Cash and cash equivalents at beginning of period | 10,176 | 18,356 | ||||||
Cash and cash equivalents at end of period | $ | 13,683 | $ | 17,662 | ||||
Supplemental disclosure of cash flow information | ||||||||
Interest paid | $ | 341 | $ | 332 | ||||
Taxes paid | $ | — | $ | 9 | ||||
Refer to the accompanying Notes to the Unaudited Condensed Consolidated Financial Statements.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1: DESCRIPTION OF BUSINESS
SumTotal Systems, Inc. develops, markets, distributes and supports talent and learning management software products and on-demand subscriptions. SumTotal Systems’ markets are worldwide and include a broad range of industries. SumTotal Systems was formed on March 18, 2004, as a result of the acquisition of Docent by Click2learn. The terms “SumTotal Systems”, “SumTotal” and the “Company” refer to Click2learn prior to March 18, 2004 and SumTotal Systems, Inc. thereafter.
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying financial data as of March 31, 2007, and for the three-months ended March 31, 2007 and 2006 has been prepared by SumTotal Systems, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. Certain other amounts have been reclassified to conform to the current period presentation. The December 31, 2006 Condensed Consolidated Balance Sheet was derived from audited consolidated financial statements, but does not include all disclosures required by GAAP. However, SumTotal Systems believes that the disclosures are adequate to make the information presented not misleading.
In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (which include normal recurring adjustments, except as disclosed herein) necessary to present fairly SumTotal Systems’ financial position, results of operations and cash flows for the interim periods presented. The results of operations for the three-months ended March 31, 2007 are not necessarily indicative of the operating results for the full fiscal year or any future periods.
There were no significant changes in our accounting policies that occurred during our fiscal quarter ending March 31, 2007 from those policies outlined in our Annual Report of Form 10-K which was filed with the Securities and Exchange Commission on March 16, 2007 that have materially affected our financial reporting unless specifically outlined in these unaudited notes to the Condensed Consolidated Financial Statements. This Quarterly Report on Form 10-Q should be read in conjunction with the Company’s audited consolidated financial statements contained in the Company’s Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 16, 2007.
Principles of Consolidation
The accompanying unaudited condensed consolidated financial statements include the financial statements of SumTotal Systems and its wholly owned subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenue and expenses during the reporting period. Such estimates and assumptions are based on historical experience, where applicable, and adequacy of other assumptions. On an ongoing basis, SumTotal Systems evaluates estimates, including those related to revenue recognition, allowance for sales returns and doubtful accounts, potential impairment of intangible assets, restructuring reserves, stock-based compensation and valuation reserves for deferred tax assets and income tax expense. Actual results could differ from those estimates.
Reclassification
Certain amounts in the prior year period’s financial statements and related notes have been reclassified to conform to the 2007 presentation. These reclassifications have no material impact on previously reported net loss.
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Revenue Classification
SumTotal Systems derives its revenue from three sources: (1) Revenue resulting from the sales of on-demand subscriptions, maintenance and support services, hosting arrangements, and term rental arrangements; (2) revenue resulting from the sales of services performed in connection with consulting agreements and other “service transactions” as defined in the American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) No. 97-2, Software Revenue Recognition (“SOP No. 97-2”), as amended; and (3) revenue resulting from the sales of software licenses and related royalty arrangements.
Deferred revenue represents advanced payments for on-demand subscriptions, software licenses, services, maintenance and support, and hosting arrangements in advance of revenue recognition. These deferred amounts are expected to be recognized as the licenses are delivered or ratably over the service period as these services are provided.
Income Taxes
In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation (“FIN”) No. 48,Accounting for Uncertainty in Income Taxes. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 109,Accounting for Income Taxes. This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on de-recognition of tax benefits, classification on the balance sheet, interest and penalties, accounting in interim periods, disclosure, and transition. SumTotal Systems adopted FIN 48 effective January 1, 2007.
As a result of the implementation of FIN 48, SumTotal Systems recognized a $0.3 million increase in liability for unrecognized tax benefits, which was accounted for as a $0.2 million reduction to the January 1, 2007 balance of retained earnings as a $0.1 million increase in deferred tax assets . SumTotal Systems has unrecognized tax benefits of approximately $0.3 million as of January 1, 2007, all of which if recognized would result in a reduction of SumTotal System’s effective tax rate. SumTotal Systems recorded no increase to its unrecognized tax benefits as of March 31, 2007. In accordance with FIN 48, paragraph 19, SumTotal Systems has decided to classify interest and penalties as a component of tax expense. Interest and penalties are immaterial at the date of adoption and are included in the unrecognized tax benefits. SumTotal Systems is subject to audit by various taxing authorities for open returns from 2000 through 2006.
Net Loss Per Share
Basic and diluted net loss per share is computed by dividing the net loss for the period by the weighted average number of shares of common stock outstanding during the period, less outstanding unvested shares. For the three months ended March 31, 2007, 92,500 shares held in escrow for the MindSolve acquisition are not included in the weighted average number of common shares outstanding during the period for both basic and diluted net loss per share. For the three months ended March 31, 2006, 391,665 shares held in escrow for the Pathlore acquisition were not included in the weighted average number of common shares outstanding during the period for both basic and diluted net loss per share. As SumTotal Systems had a net loss for each of the periods presented, basic and diluted net loss per share are the same since the inclusion of potential common stock would be antidilutive. Potential common shares are comprised of common stock subject to repurchase rights, incremental shares of common and preferred stock issuable upon the exercise of stock options or warrants and shares issuable upon conversion of convertible preferred stock.
The following table sets forth the computation of basic and diluted net loss per share for the three months ended March 31, 2007 and 2006 (in thousands, except per share amounts):
Three-Months Ended March 31, | ||||||||
2007 | 2006 | |||||||
Net loss | $ | (1,826 | ) | $ | (4,436 | ) | ||
Weighted average common shares used to compute basic and diluted net loss per share | 26,839 | 24,698 | ||||||
Net loss per share, basic and diluted | $ | (0.07 | ) | $ | (0.18 | ) | ||
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The following table sets forth the common stock options and warrants that have been excluded from the computation of diluted loss per share because their effects would have been anti-dilutive for the three months ended March 31, 2007 and 2006 (in thousands, except per option and warrant amounts):
Three-Months Ended March 31, | ||||||
2007 | 2006 | |||||
Options to acquire shares of common stock | 1,891 | 3,270 | ||||
Weighted average option price | $ | 10.98 | $ | 10.29 | ||
Warrants to acquire shares of common stock | 1,424 | 1,577 | ||||
Weighted average warrant price | $ | 7.81 | $ | 7.67 |
Comprehensive Loss and Accumulated Other Comprehensive Loss
The following table sets forth the components of comprehensive loss for the three-months ended March 31, 2007 and 2006 presented below (in thousands):
Three-Months Ended March 31, | ||||||||
2007 | 2006 | |||||||
Net loss | $ | (1,826 | ) | $ | (4,436 | ) | ||
Foreign currency translation adjustment | 19 | (17 | ) | |||||
$ | (1,807 | ) | $ | (4,453 | ) | |||
SumTotal Systems’ total comprehensive loss for the three months ended March 31, 2007 and 2006 consisted of net loss and the change in foreign currency translation adjustments. The tax effects on the foreign currency translation adjustments have not been significant. Accumulated other comprehensive loss consists of foreign currency translation adjustments of $312,000 and $332,000 at March 31, 2007 and December 31, 2006, respectively.
Stock-Based Compensation
On January 1, 2006, SumTotal Systems adopted SFAS No. 123R,Share Based Payments, which establishes standards for the accounting of transactions in which an entity exchanges its equity instruments for goods or services, primarily focusing on accounting for transactions where an entity obtains employee services in share-based payment transactions. In March 2005, the SEC issued Staff Accounting Bulletin (“SAB”) No. 107,Share-Based Payment relating to SFAS No. 123R. SumTotal Systems applied the provisions of SAB No. 107 in the adoption of SFAS No. 123R.
SumTotal Systems adopted SFAS No. 123R using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of fiscal 2006. The consolidated financial statements as of and for the year ended December 31, 2006 reflect the impact of SFAS No. 123R. In accordance with the modified prospective transition method, the consolidated financial statements for prior periods have not been restated to reflect and do not include, the impact of SFAS No. 123R.
Valuation and Expense Information under SFAS No. 123R
The weighted-average fair value of stock-based compensation to employees is based on the single option valuation approach. Forfeitures are estimated and it is assumed no dividends will be declared. The estimated fair value of stock-based compensation awards to employees is amortized using the straight-line method over the vesting period of the options, except for restricted stock, which is amortized on a multi-option accelerated method, consistent with the prior year.
The weighted-average fair value calculations for options granted within the period below are based on the following weighted average assumptions:
Three-Months Ended March 31, 2007 | |||
Risk-free interest rate | 4.72 | % | |
Expected volatility | 95.60 | % | |
Expected life (years) | 6.25 | ||
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Options that were granted in prior periods are based on assumptions prevailing at the date of grant.
The weighted-average fair value calculations for the Company’s Employee Stock Purchase Plan (“ESPP”) within the period below are based on the following weighted average assumptions:
Three-Months Ended March 31, 2007 | |||
Risk-free interest rate | 5.16 | % | |
Expected volatility | 51.96 | % | |
Expected life (years) | 0.49 | ||
The following table summarizes stock-based compensation expense related to employee stock options, ESPP and restricted stock units under SFAS No. 123R for the three months ended March 31, 2007 and 2006, respectively, were allocated as follows (in thousands):
Three-Months Ended | Three-Months Ended | |||||
Subscriptions and support | $ | 60 | $ | 47 | ||
Service | 137 | 191 | ||||
Cost of revenue | 197 | 238 | ||||
Research and development | 138 | 123 | ||||
Sales and marketing | 275 | 242 | ||||
General and administrative | 442 | 403 | ||||
Stock-based compensation expense included in operating expenses | 855 | 768 | ||||
Total stock-based compensation expense | $ | 1,052 | $ | 1,006 | ||
A summary of option activity under the Company’s stock equity plans during the three months ended March 31, 2007 is as follows:
Number of (in thousands) | Weighted Average Exercise Price | Weighted Average Remaining Contractual Term (in years) | Aggregate (in thousands) | ||||||||
Outstanding at December 31, 2006 | 6,300 | $ | 6.80 | 7.12 | |||||||
Granted | 150 | 7.54 | |||||||||
Exercised | (251 | ) | 5.24 | ||||||||
Cancelled | (125 | ) | 8.49 | ||||||||
Outstanding at March 31, 2007 | 6,074 | $ | 6.84 | 7.11 | $ | 13,003 | |||||
Exercisable at March 31, 2007 | 4,074 | $ | 7.48 | 6.28 | $ | 8,144 | |||||
A summary of the status of the changes in the Company’s restricted stock units during the three months ended March 31, 2007 is as follows:
Non-vested restricted shares | Number of (in thousands) | Weighted Average Grant – Date Fair Value | |||
Non-vested at December 31, 2006 | 75 | $ | 4.30 | ||
Granted | — | — | |||
Vested | — | — | |||
Cancelled | — | — | |||
Non-vested at March 31, 2007 | 75 | $ | 4.30 | ||
The following table summarizes significant ranges of outstanding and exercisable options as of March 31, 2007.
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Options Outstanding | Options Exercisable | |||||||||||
Range of Exercise Prices | Number (in thousands) | Weighted Average Remaining Contractual Term (in years) | Weighted Average Exercise Price | Number (in thousands) | Weighted Average Exercise Price | |||||||
$1.07 - $4.34 | 1,170 | 6.54 | $ | 3.37 | 1,007 | $ | 3.23 | |||||
$4.39 - $4.65 | 1,116 | 8.10 | 4.50 | 459 | 4.51 | |||||||
$4.67 - $6.45 | 1,061 | 8.41 | 5.66 | 416 | 5.44 | |||||||
$6.49 - $7.60 | 800 | 8.10 | 6.90 | 326 | 7.03 | |||||||
$7.62 - $7.62 | 1,100 | 6.24 | 7.62 | 1,100 | 7.62 | |||||||
$7.68 - $83.42 | 827 | 5.14 | 15.35 | 766 | 15.91 | |||||||
$1.07 - $83.42 | 6,074 | 7.11 | $ | 6.84 | 4,074 | $ | 7.48 | |||||
The total intrinsic value of options exercised during the three months ended March 31, 2007 was approximately $652,000. The total intrinsic value of shares issued under the employee stock purchase plan during the three months ended March 31, 2007 was approximately $141,000. The fair value of options vested was approximately $896,000 for the three months ended March 31, 2007. As of March 31, 2007, total unrecognized compensation costs related to non-vested stock options was $8.4 million, which is expected to be recognized as expense over a weighted average period of approximately 2.7 years. The weighted average grant date fair value of options granted in the first fiscal quarter of 2007 was $6.03.
Adoption of Accounting Standards
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Instruments, which permits, but does not require, fair value accounting for any hybrid financial instrument that contains an embedded derivative that would otherwise require bifurcation in accordance with SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities. The statement was adopted as of January 1, 2007 and did not have a material impact on SumTotal Systems’ results of operations and financial condition.
In September 2006, the SEC issued SAB No. 108,Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, which provides guidance on how prior year misstatements should be taken into consideration when quantifying misstatements in current year financial statements for purposes of determining whether the current year’s financial statements are materially misstated. SAB No. 108 was adopted as of January 1, 2007 and did not have a material impact on SumTotal Systems’ results of operations and financial condition.
Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157,Fair Value Measurements. This statement clarifies the definition of fair value, establishes a framework for measuring fair value and expands the disclosures on fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. SumTotal Systems is currently evaluating the impact of adopting SFAS No. 157 on its financial statements.
In February 2007, the FASB issued Statement No. 159,The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. 159 provides that companies may elect to measure specified financial instruments and warranty and insurance contracts at fair value on a contract-by-contract basis, with changes in fair value recognized in earnings in each reporting period. The election, called the “fair value option” will enable some companies to reduce the variability in reported earnings caused by measuring related assets and liabilities differently. SFAS No. 159 is effective for SumTotal Systems’ first fiscal year beginning after November 15, 2007. Management is currently evaluating whether SFAS No. 159 will have an impact on SumTotal Systems’ results of operations and financial condition.
NOTE 3: ACQUISITIONS AND INTANGIBLE ASSETS
MindSolve Acquisition
On November 14, 2006, SumTotal Systems acquired MindSolve Technologies, Inc. (“MindSolve”), a leading provider of Performance Management products and services for the delivery and administration of performance appraisals, multi-source assessments, career and succession planning, goal tracking functions and accountability management.
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The total purchase price is estimated to be $11,263,000 and is comprised of (in thousands):
Cash consideration for common stockholders | $ | 2,615 | |
Cash consideration for employees | 427 | ||
Fair value of common stock issued (1) | 6,432 | ||
Note payable to shareholder | 1,261 | ||
Estimated acquisition related costs (2) | 528 | ||
Total consideration | $ | 11,263 | |
(1) | The stockholders of MindSolve received $2,615,000 in net cash consideration and 925,000 shares of SumTotal Systems’ common stock. The fair value of SumTotal Systems’ common shares issued is based on a per share value of $6.954, which is equal to SumTotal Systems’ average of the last sale price per share as reported on the National Association of Securities Dealers Automated Quotations (“NASDAQ”) Global Market for the trading-day period beginning two days before and ending two days after November 14, 2006, the date of announcement of the acquisition. |
(2) | The estimated acquisition related costs consist primarily of banking, legal and accounting fees and other directly related costs. |
The total purchase consideration has been allocated to the assets and liabilities acquired, including identifiable intangible assets, based on their respective fair values at the acquisition date and resulting in excess purchase consideration over the net tangible liabilities and identifiable intangible assets acquired of $6.2 million. The following condensed balance sheet data presents the estimated fair value of the assets and liabilities assumed (in thousands):
Assets acquired: | ||||
Cash and cash equivalents | $ | 123 | ||
Accounts receivable | 936 | |||
Prepaid expenses and other assets | 119 | |||
Equipment and leasehold improvements, net | 150 | |||
In-process research and development | 1,120 | |||
Goodwill | 6,155 | |||
Intangible assets | 4,450 | |||
Other assets | 78 | |||
13,131 | ||||
Liabilities assumed: | ||||
Accrued liabilities | (220 | ) | ||
Deferred revenue | (1,648 | ) | ||
(1,868 | ) | |||
Total consideration | $ | 11,263 | ||
Goodwill of $6.2 million, representing the excess of the purchase price over the fair value of tangible and identifiable intangible assets acquired in the acquisition, will not be amortized, but is instead tested for impairment at least annually. In addition, a portion of the purchase price was allocated to the following identifiable intangible assets (in thousands, except years):
Allocated Purchase Price | Estimated Weighted Average Useful Lives in Years | ||||
Core and developed technologies | $ | 2,190 | 3.00 | ||
Customer installed-base relationships | 1,710 | 5.00 | |||
Customer backlog | 550 | 3.00 | |||
Total intangible assets | $ | 4,450 | 3.77 | ||
In connection with the MindSolve acquisition in November 2006, SumTotal Systems has two notes payable to a former MindSolve officer. Total future obligations amount to $1,438,000 and will be paid in two equal installments of $719,000 in December 2007 and 2008, respectively. In addition, effective with the MindSolve acquisition, SumTotal Systems has change of control payments to be made to certain employees of MindSolve who are now employees of SumTotal Systems. These contractual change of control payments are being expensed ratably over the contractual performance period. Total future obligations amount to $1,544,000 with scheduled payments of $956,000 and $588,000 in 2007 and 2008, respectively.
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The results of operations of MindSolve since November 14, 2006 are included in SumTotal Systems’ statement of operations.
NOTE 4: GOODWILL AND INTANGIBLE ASSETS
Goodwill and intangible assets at March 31, 2007 and December 31, 2006 are as follows (in thousands):
March 31, 2007 | ||||||||||
Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | ||||||||
Goodwill | $ | 68,461 | $ | — | $ | 68,461 | ||||
Intangible assets: | ||||||||||
Acquired technology | $ | 13,312 | $ | (9,415 | ) | $ | 3,898 | |||
Customer installed-base relationships | 17,094 | (5,275 | ) | 11,819 | ||||||
Customer hosted relationships | 1,014 | (615 | ) | 399 | ||||||
Customer contract relationships | 8,525 | (5,563 | ) | 2,962 | ||||||
Non-compete covenant | 980 | (980 | ) | — | ||||||
Total goodwill and intangible assets | $ | 40,925 | $ | (21,848 | ) | $ | 19,078 | |||
December 31, 2006 | ||||||||||
Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | ||||||||
Goodwill | $ | 68,461 | $ | — | $ | 68,461 | ||||
Intangible assets: | ||||||||||
Acquired technology | $ | 13,312 | $ | (8,827 | ) | $ | 4,485 | |||
Customer installed-base relationships | 17,094 | (4,418 | ) | 12,676 | ||||||
Customer hosted relationships | 1,014 | (565 | ) | 449 | ||||||
Customer contract relationships | 8,525 | (5,007 | ) | 3,518 | ||||||
Non-compete covenant | 980 | (781 | ) | 199 | ||||||
Total goodwill and intangible assets | $ | 40,925 | $ | (19,598 | ) | $ | 21,327 | |||
There was no impairment of goodwill or intangible assets for the three-months ended March 31, 2007 and 2006, respectively.
The following represents the expected future amortization of intangible assets as of March 31, 2007 (in thousands):
Remainder of 2007 | $ | 6,154 | |
2008 | 5,840 | ||
2009 | 4,038 | ||
2010 | 1,841 | ||
2011 | 1,080 | ||
2012 | 125 | ||
Total expected future amortization of intangible assets | $ | 19,078 | |
Amortization expense related to intangible assets was approximately $2,250,000 and $2,327,000 in the three months ended March 31, 2007 and 2006, respectively.
NOTE 5: BORROWINGS
The current portion of notes payable consists of the following (in thousands):
March 31, 2007 | December 31, 2006 | |||||
Litigation settlement | $ | 1,069 | $ | 1,054 | ||
MindSolve stockholder | 681 | 666 | ||||
Credit facility | 4,375 | 4,375 | ||||
Total current portion of notes payable | $ | 6,125 | $ | 6,095 | ||
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The non-current portion of notes payable consists of the following (in thousands):
March 31, 2007 | December 31, 2006 | |||||
Litigation settlement | $ | 1,111 | $ | 1,375 | ||
MindSolve stockholder | 623 | 610 | ||||
Credit facility | 7,656 | 8,750 | ||||
Total non-current portion of notes payable | $ | 9,390 | $ | 10,735 | ||
Credit Facility
Concurrent with the closing of the Pathlore Acquisition on October 4, 2005, SumTotal Systems entered into a credit facility with Wells Fargo Foothill, Inc. (“Wells Fargo Foothill”), principally to fund a portion of the acquisition price and to provide for its ongoing working capital requirements. Under the terms of the facility, Wells Fargo Foothill loaned SumTotal Systems $17.5 million to complete the acquisition of Pathlore (the “Term Loan”) and provided a revolving credit facility to a maximum of $5.0 million to meet the working capital requirements of the business (the “Revolver”).
The amounts outstanding bear interest at Wells Fargo Foothill’s base rate plus 2%, unless SumTotal Systems elects to be charged at the London Interbank Offered Rate (“LIBOR”) rate plus 3.5%. As of March 31, 2007, SumTotal Systems has elected to be charged at the LIBOR rate, which was 5.35% on March 31, 2007 resulting in a total interest rate of 8.85%. The Term Loan is due in installments of $1,093,750 quarterly commencing January 1, 2006 and is secured by SumTotal Systems’ assets. The Term Loan and any remaining balance on the Revolver are due and payable on October 5, 2009. Any interest due on the Revolver must be paid at least every three months.
The Term Loan is subject to certain restrictive covenants which include, but are not limited to, maintaining certain levels of earnings before interest, taxes, depreciation and amortization (“EBITDA”), leverage ratios, as well as restrictions on capital expenditures, indebtedness, distributions, investments and on change of control. There is no test of the financial covenants if SumTotal Systems maintains a minimum balance of at least $15.0 million between qualified cash accounts (accounts pledged to the lender) and excess availability under the Revolver.As of March 31, 2007, SumTotal Systems had $20.0 million comprising $15.2 million in qualified cash accounts and $4.8 million in excess availability under the Revolver and therefore no test of the covenants was required. In the event that SumTotal Systems’ qualified cash balance falls below the $15.0 million threshold and it cannot achieve the financial results necessary to maintain compliance with these covenants, SumTotal Systems could be declared in default and be required to sell or liquidate its assets to repay outstanding debt of approximately $12.0 million at March 31, 2007.
In accordance with the terms of the Term Loan, during the three-months ended March 31, 2007, SumTotal made total payments of $1.4 million to Wells Fargo Foothill of which $1.1 million and $0.3 million were principal and interest, respectively.
During July 2006, SumTotal Systems entered into an agreement with Wells Fargo Foothill in which SumTotal Systems will enter into forward foreign exchange contracts to mitigate certain foreign exchange exposures SumTotal Systems has related to foreign trade receivables. As part of this agreement the credit facility provides for a 5% reserve against the Revolver. As a result of the 5% reserve requirement, SumTotal will have $250,000 less in funds available for use including debt covenant compliance, under the Revolver. Prospectively, at this time, SumTotal Systems anticipates it will only enter into forward foreign exchange hedging contracts to mitigate foreign currency exposures and will not enter into forward foreign exchange contracts for trading or speculative purposes. At March 28, 2007, SumTotal Systems entered into a forward contract in which SumTotal Systems sold approximately 1.9 million GBP, equivalent $3.8 million U.S. Dollars (“USD”), for a value date of April 30, 2007, for which a hypothetical 10% appreciation of the United Kingdom (“U.K.”) Pound Sterling (“GBP”) to USD would result in a $0.4 million gain and a hypothetical 10% depreciation of GBP to USD would result in a $0.4 million loss.
The effect of foreign exchange rate fluctuations for the three-months ended March 31, 2007 and 2006, was a loss of approximately $11,000 and loss of $84,000, respectively. Due to the substantial volatility of currency exchange rates, among other factors, SumTotal Systems cannot predict the effect of exchange rate fluctuations on its future operating results.
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Litigation Settlement
On March 14, 2006, SumTotal Systems entered into an agreement to settle all patent infringement claims with IpLearn that included, among other terms, a binding mutual release of all claims the parties may have had against each other, certain licenses and covenants not to sue, a payment from SumTotal Systems to IpLearn LLC (“IpLearn”) of $3.5 million, payable over three years and the issuance of 50,000 shares of SumTotal Systems’ common stock to IpLearn valued at $181,000. The settlement was reached with no admission of liability or wrongdoing by any party. The aggregate amount of the settlement was accrued as of December 31, 2005. The remaining liability is included in notes payable on the accompanying unaudited Condensed Consolidated Balance Sheet at March 31, 2007 and totaled $2.2 million, of which $1.1 million and $1.1 million is classified as current and non-current, respectively.
MindSolve Stockholder
In connection with the MindSolve acquisition in November 2006, SumTotal Systems has two notes payable to a former MindSolve stockholder. Refer to Note 3Acquisitions and Intangible Assets for a further discussion of the MindSolve acquisition.
NOTE 6: RESTRUCTURING
The following table depicts restructuring activity for the three months ended March 31, 2007 (in thousands):
Balance at December 31, 2006 | Cash Expenditures | Balance at March 31, 2007 | ||||||||
Vacated facilities | $ | 714 | $ | (698 | ) | $ | 16 | |||
Employee severance | 48 | (20 | ) | 28 | ||||||
Other | 113 | (31 | ) | 82 | ||||||
Total restructuring activity | $ | 875 | $ | (749 | ) | $ | 126 | |||
Obligations for restructured facility leases are accrued on the consolidated balance sheet at their net present values including estimated future sublease rentals based on current market expectations.
NOTE 7: COMMITMENTS AND CONTINGENCIES
Commitments
SumTotal Systems leases office space and certain equipment under non-cancelable operating leases expiring in years through 2015. Rent expense under operating leases was approximately $681,000 and $597,000 during the three-months ended March 31, 2007 and 2006, respectively.
Future payments under operating lease obligations at March 31, 2007 are presented in the table below (in thousands):
Payments Due by Period | |||||||||||||||||||||
Total | Remainder of 2007 | 2008 | 2009 | 2010 | 2011 | Thereafter | |||||||||||||||
Operating leases | $ | 6,009 | $ | 1,603 | $ | 2,023 | $ | 1,006 | $ | 460 | $ | 246 | $ | 671 |
In connection with the MindSolve acquisition in November 2006, SumTotal Systems has two notes payable to a former MindSolve officer. Total future obligations amount to $1,438,000 and will be paid in two equal installments of $719,000 in December 2007 and 2008, respectively. In addition, effective with the MindSolve acquisition, SumTotal Systems has change of control payments to be made to certain employees of MindSolve who are now employees of SumTotal Systems. These contractual change of control payments and are being expensed ratably over the contractual performance period. Total future obligations amount to $1,544,000 with scheduled payments of $956,000 and $588,000 in 2007 and 2008, respectively.
In October 2005, retention bonuses were granted to certain officers of SumTotal Systems. These bonuses were anticipated to be paid in two equal amounts in 2006 and 2007 except for a former officer of SumTotal whose retention bonus was all paid in January 2007. Assuming the remaining affected officers are still employed by SumTotal Systems thru 2007, the future payments of $843,000 will be paid in the fourth quarter of 2007. These retention bonuses are being expensed ratably over the performance period.
SumTotal Systems has entered into various arrangements with hosting services vendors with original periods expiring through 2007 totaling $714,000.
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Contingencies
On August 16, 2006, the Compensation Committee approved and adopted a form of Amended and Restated Change of Control Agreement for each of SumTotal Systems��� Section 16 officers. In the event of a change of control of SumTotal and the subsequent termination of a Section 16 officer in a manner defined as a Termination Event, SumTotal Systems will be obligated to pay the Section 16 officer certain compensation and benefits. If a Termination Event occurs, an officer would be entitled to one year of the officer’s base salary that would be paid in equal semi-monthly installments over a one year period following a Termination Event. Such officer will also be entitled to other benefits as described in Article III of the Amended and Restated Change of Control Agreement. This discussion is qualified in its entirety by the Current Report on Form 8-K filed by SumTotal on August 17, 2006.
From time-to-time, third parties assert patent infringement claims against SumTotal Systems in the forms of letters, litigation, or other forms of communication. In addition, from time-to-time, SumTotal Systems is subject to other legal proceedings and claims in the ordinary course of business, including claims of alleged infringement of trademarks, copyrights and other intellectual property rights. Management does not believe that any of the foregoing claims are likely to have a material adverse effect on its financial position, results of operations or cash flows. However, SumTotal Systems’ analysis of whether a claim may proceed to litigation cannot be predicted with certainty, nor can a claim proceed to litigation, nor can the results of litigation be predicted with certainty. Defending each of these actions, regardless of the outcome, may be costly, time-consuming, distract management personnel and have a negative effect on SumTotal Systems’ business. An adverse outcome in any of these actions, including a judgment or settlement, may cause a material adverse effect on its future business, operating results and/or financial condition.
NOTE 8: GUARANTEES, WARRANTIES AND INDEMNIFICATION
SumTotal Systems has adopted FIN No. 45,Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN No. 45 provides expanded accounting guidance surrounding liability recognition and disclosure requirements related to guarantees. In the ordinary course of business, SumTotal Systems is not subject to potential obligations under guarantees that fall within the scope of FIN No. 45 except for standard indemnification and warranty provisions that are contained within many of its customer license and service agreements and give rise only to the disclosure requirements prescribed by FIN No. 45.
Indemnification and warranty provisions contained within SumTotal Systems’ customer license and service agreements are generally consistent with those prevalent in the industry. The duration of product warranties are generally between 90 to 365 days following delivery of the products. Significant obligations under customer indemnification or warranty provisions have not been incurred historically and are not expected in the future. Accordingly, accruals for potential customer indemnification or warranty-related obligations are not maintained.
SumTotal Systems has entered into indemnification agreements with its directors and certain of its officers that will require SumTotal Systems, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers. SumTotal Systems has also agreed to indemnify certain former officers, directors and employees of acquired companies in connection with the acquisition of such companies. SumTotal Systems maintains director and officer insurance, which may cover certain liabilities arising from its obligation to indemnify its directors and officers and former directors, officers and employees of acquired companies, in certain circumstances.
NOTE 9: SEGMENT INFORMATION
SFAS No. 131,Disclosure about Segments of an Enterprise and Related Information, requires that companies report separately in the financial statements certain financial and descriptive information about operating segments profit or loss, certain specific revenue and expense items and segment assets. The method for determining what information is reported is based on the way that management organizes the operating segments for making operational decisions and assessments of financial performance. SumTotal Systems’ chief operating decision maker is considered to be the CEO. The CEO reviews financial information presented on a consolidated basis for purposes of making operating decisions and assessing financial performance. The consolidated financial information reviewed by the CEO is similar to the information presented in the accompanying unaudited condensed consolidated financial statements of operations. Currently, management does not use product line financial performance as a basis for business operating decisions. Therefore, SumTotal Systems has determined that it operates in a single reportable segment.
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Revenue by international region is based on the direct billing location of the customer and is as follows (in thousands, except percentages):
Three-Months Ended March 31, | ||||||||||||
2007 | 2006 | |||||||||||
Revenue | Percent of Revenue | Revenue | Percent of Revenue | |||||||||
United States | $ | 23,681 | 81.5 | % | $ | 18,984 | 78.1 | % | ||||
Other Americas | 1,272 | 4.4 | % | 964 | 4.0 | % | ||||||
Total Americas | 24,953 | 85.9 | % | 19,948 | 82.1 | % | ||||||
Europe | 3,237 | 11.1 | % | 3,673 | 15.1 | % | ||||||
Asia/Pacific | 860 | 3.0 | % | 680 | 2.8 | % | ||||||
Total revenue | $ | 29,050 | 100.0 | % | $ | 24,301 | 100.0 | % | ||||
Long-lived assets, which represent property, plant and equipment, goodwill and intangible assets, net of accumulated depreciation and amortization, by geographic location are as follows (in thousands):
March 31, 2007 | December 31, 2006 | |||||
United States | $ | 92,409 | $ | 94,344 | ||
Europe | 397 | 384 | ||||
India | 2,362 | 2,063 | ||||
Asia/Pacific | 134 | 136 | ||||
Total long-lived assets | $ | 95,302 | $ | 96,927 | ||
NOTE 10: LEGAL PROCEEDINGS
From time-to-time, SumTotal Systems is involved in legal proceedings or threats of legal proceedings arising in the ordinary course of business. The Company is not currently a party to any litigation or other legal proceeding that, in the opinion of management, is reasonably likely to have a material adverse effect on SumTotal Systems business, operating results and financial condition.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
The following discussion and analysis should be read in conjunction with the unaudited Condensed Consolidated Financial Statements and related Notes contained elsewhere within this document. Operating results for the three-months ended March 31, 2007 are not necessarily indicative of the results that may be expected for any future periods, including the full fiscal year. Reference should also be made to the Annual Consolidated Financial Statements, Notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations and Risk Factors contained in the SumTotal Systems Annual Report on Form 10-K for the year ended December 31, 2006.
This Quarterly Report includes “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. This Act provides a “safe harbor” for forward-looking statements to encourage companies to provide prospective information so long as they identify these statements as forward-looking and provide meaningful cautionary statements identifying important factors that could cause actual results to differ from the projected results. All statements other than statements of historical fact we make in this Quarterly Report are forward-looking. Such forward-looking statements including the words “may”, “plans”, “expects”, “anticipates”, “intends”, “targets”, “goals”, “seeks”, “believes”, “potential”, “continue”, “predict”, “could”, “will”, “estimate” and similar language, including variations of such words and include, but are not limited to, statements regarding the following: our belief that our available cash resources, combined with cash flows generated from revenues, will be sufficient to meet our presently anticipated working capital, capital expense and business expansion requirements for at least the next 12 months; our belief that any current disputes will not result in litigation, but if they do, they will not have a material adverse effect on our business, operating results and/or financial condition; statements about future business operations, including future product launches; marketing statements; industry leadership; internal controls and procedures; statements about our new product, SumTotal 7 Series; revenue recognition; continued growth in our revenues from our professional service organization; financial performance including, but not limited to, estimated revenues, bookings, operating expenses, gross margins, and profit, and market conditions that include risks and uncertainties are based on information that is available to us at the date of this Quarterly Report on Form 10-Q and reflects management’s then current expectations, estimates, beliefs, assumptions and goals and objectives, and are subject to uncertainties that are difficult, if not impossible, to predict. Our actual results may differ significantly from those projected in the forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to those discussed in the section “Management’s Discussion and Analysis of Financial Condition and Results of Operations —
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Factors That May Affect Future Results of Operations.” You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document.
Executive Summary
During the three-months ended March 31, 2007, we continued to implement our growth strategy. Highlights include:
• | Further penetration into our customer base by selling additional licenses and modules; |
• | Acquired new enterprise customers as enterprises increasingly standardize on one Learning Management System (“LMS”) platform; |
• | Continued our sales into the small and medium business (“SMB”) Market through our on-demand solutions; |
• | Expanded our performance management customer base through new customers and selling into our existing customer base; and |
• | Continued the deployment of our products in a hosted or on-demand model which has enabled us to increase our recurring revenue, which includes on-demand and hosting subscriptions, term licenses and maintenance. This has grown from 45% of our revenue in the first quarter of 2006 to 50% in corresponding period in 2007. Typically, these are annual contracts, most of which are renewed at the expiration of their term. |
Total revenue increased from $24.3 million in first fiscal quarter of 2006 to $29.1 million in corresponding period in 2007, and our cash flow from operating activities increased from $0.9 million in the first fiscal quarter of 2006 to $2.5 million in corresponding period in 2007. Our net loss decreased from $4.4 million in 2006 to $1.8 million in 2007, primarily due to the increase in our subscriptions and support revenue during the three-months ended March 31, 2007 as compared to the year ago period. We believe that our recurring revenue will continue to increase as a percentage of our business.
Critical Accounting Policies and Estimates
In most cases, the accounting treatment of a particular transaction is specifically dictated by accounting principles generally accepted in the U.S. and does not require management’s judgment in its application. However, certain of our accounting policies require the application of significant judgment by management in selecting the appropriate assumptions for calculating financial estimates. By their nature, these judgments are subject to an inherent degree of uncertainty. These judgments reflect practices, information provided by our customers and other assumptions that we believe are reasonable under the circumstances. Our estimates and assumptions are reviewed periodically and the effects of revisions are reflected in the unaudited condensed consolidated financial statements in the period in which they are determined to be necessary. Actual results may differ from these estimates under different assumptions or conditions. Our critical accounting policies and estimates include:
• | revenue recognition; |
• | estimating allowances for sales returns and the allowance for doubtful accounts; |
• | goodwill and intangible assets; |
• | restructuring; |
• | allowance for deferred tax assets and income tax expense; |
• | business combinations; and |
• | stock-based compensation. |
Our senior management has reviewed these critical accounting policies and related disclosures with our Disclosure Committee and the Audit Committee of our Board of Directors. Refer to the Notes to the Unaudited Condensed Consolidated Financial Statements, which contain additional information regarding our accounting policies and other disclosures required by GAAP.
We have made no significant changes in our critical accounting policies and estimates since our previous filing on our Annual Report on Form 10-K, as filed with the SEC on March 16, 2007, other than to the income taxes policy discussed below.
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As described in Note 2 Summary of Significant Accounting Policies in the Notes to the unaudited Condensed Consolidated Financial Statements, our accounting policy for income taxes was recently modified due to the adoption of FIN 48 and is described below.
In June 2006, the FASB issued FIN No. 48, which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109. This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 also provides guidance on de-recognition of tax benefits, classification on the balance sheet, interest and penalties, accounting in interim periods, disclosure, and transition. We adopted FIN No. 48 effective January 1, 2007. FIN No. 48 requires significant judgment in determining what constitutes an individual tax position as well as assessing the outcome of each tax position. Changes in judgment as to recognition or measurement of tax positions can materially affect the estimate of the effective tax rate and consequently, affect our operating results.
Comparison of Financial Data for the Three-Months Ended March 31, 2007 and 2006
Results of Operations
The following table presents our results of continuing operations as a percentage of total revenue for the three-months ended March 31, 2007 and 2006:
2007 | 2006 | |||||
Revenue: | ||||||
Subscriptions and support | 49.8 | % | 45.0 | % | ||
Service | 28.3 | 29.2 | ||||
License | 21.9 | 25.8 | ||||
Total revenue | 100 | 100 | ||||
Cost of revenue: | ||||||
Subscriptions and support | 16.3 | 14.6 | ||||
Service | 19.2 | 21.3 | ||||
License | 0.3 | 0.7 | ||||
Amortization of intangible assets | 7.8 | 9.6 | ||||
Total cost of revenue | 43.6 | 46.2 | ||||
Gross margin | 56.4 | 53.8 | ||||
Operating expenses: | ||||||
Research and development | 17.3 | 16.9 | ||||
Sales and marketing | 27.2 | 29.8 | ||||
General and administrative | 17.3 | 23.9 | ||||
Total operating expenses | 61.8 | 70.6 | ||||
Loss from operations | (5.4 | ) | (16.8 | ) | ||
Other expense, net | (0.8 | ) | (1.4 | ) | ||
Loss before income taxes | (6.2 | ) | (18.2 | ) | ||
Provision for income taxes | 0.1 | 0.1 | ||||
Net loss | (6.3 | )% | (18.3 | )% | ||
Revenue
Revenue for the three-months ended March 31, 2007 and 2006 was as follows (in thousands, except percentages):
Three-Months Ended March 31, | Change in Dollars | Change in Percent | ||||||||||||
2007 | 2006 | |||||||||||||
Subscriptions and support | $ | 14,468 | $ | 10,944 | $ | 3,524 | 32.2 | % | ||||||
Percentage of net revenue | 49.8 | % | 45.0 | % | ||||||||||
Services | 8,233 | 7,083 | 1,150 | 16.2 | % | |||||||||
Percentage of net revenue | 28.3 | % | 29.1 | % | ||||||||||
License | 6,349 | 6,274 | 75 | 1.2 | % | |||||||||
Percentage of net revenue | 21.9 | % | 25.8 | % | ||||||||||
Total revenue | $ | 29,050 | $ | 24,301 | $ | 4,749 | 19.5 | % | ||||||
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In the three-months ended March 31, 2007, we were successful in winning and completing installations of large enterprise-wide solutions and generating consulting revenue from existing customers upgrading their legacy systems to the SumTotal 7 Series. The increase in sales of our SumTotal 7 Series products and services to new and existing customers was approximately $4.5 million. The acquisition of MindSolve in November 2006 added $0.6 million of revenue. Revenue from our acquired Pathlore customers decreased $0.4 million as our Pathlore customer base continued its migration to the SumTotal 7 Series.
Subscriptions and Support Revenue.The increase in subscriptions and support revenue in the three-months ended March 31, 2007 over the comparable period in 2006 was as follows (in thousands, except percentages):
Three-Months Ended March 31, | Change in Dollars | Change in Percent | |||||||||||
2007 | 2006 | ||||||||||||
Maintenance | $ | 8,586 | $ | 7,046 | $ | 1,540 | 21.9 | % | |||||
Hosting subscriptions | 3,516 | 2,689 | 827 | 30.8 | % | ||||||||
Term rental arrangements | 939 | 1,005 | (66 | ) | (6.6 | %) | |||||||
On-demand subscriptions | 1,427 | 204 | 1,223 | 600.0 | % | ||||||||
Total subscriptions and support revenue | $ | 14,468 | $ | 10,944 | $ | 3,524 | 32.2 | % | |||||
Approximately $2.4 million of the increase in subscriptions and support revenue in the three months ended March 31, 2007 over the comparable period in 2006 was the result of subscription and support contract sales to new and existing customers related to the SumTotal 7 Series product suite and partner products; $0.6 million of the increase was the result of our acquired MindSolve customers and $0.5 million of the increase was primarily the result of our former Pathlore customers renewing contracts at full value versus the acquired discounted fair value.
Changes to the components of subscriptions and support revenue were as follows:
• | The increase in maintenance revenue was the result of $0.7 million from increased maintenance contract sales to new and existing customers related to the SumTotal 7 Series, $0.8 million from acquired Pathlore customers renewing maintenance contracts at full value versus the deferred revenue that we acquired from Pathlore which was written down on the acquisition date in accordance with acquisition accounting principles and which was recognized in the 2006 period; |
• | The increase in hosting subscriptions revenue was the result of $0.8 million in increased sales of hosting contracts to new and existing customers related to the SumTotal 7 Series; |
• | The decrease in term rental arrangements revenue was the result of a $0.3 million decrease in term rental arrangements revenue from our acquired Pathlore customers; offsetting a $0.2 million increase in rental contract sales to new and existing customers related to the SumTotal 7 Series; |
• | The increase in on-demand subscriptions revenue was the result of $0.6 million from sales of our partner’s performance management product and $0.6 million from our Total Performance product acquired in November 2006. |
Price changes in subscriptions and support revenue had no material effect on the three months ended March 31, 2007 compared to the same period in 2006.
Service Revenue.The increase in service revenue in the three months ended March 31, 2007 over the comparable period in 2006 was primarily due to a $1.8 million increase in consulting revenue from additional consulting contracts to new and existing customers related to the SumTotal 7 Series, offsetting a decrease of $0.6 million in service revenue from our acquired Pathlore customers due to decreased Pathlore license sales and associated service contracts as our customer-base continued its migration to the SumTotal 7 Series. In the three-months ended March 31, 2006, our Pathlore service revenue was related to the completion of installations of the Pathlore products sold prior to the acquisition in October 2005.
Price changes in service revenue had no material effect on our results for the three months ended March 31, 2007 compared to the same period in 2006.
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License Revenue.The increase in license revenue in the three months ended March 31, 2007 over the comparable period in 2006 was primarily due to a $0.4 million increase in sales of the SumTotal 7 Series, offsetting a decrease of $0.3 million in license revenue from our acquired Pathlore customers as they migrated to the SumTotal 7 Series.
Price changes in license revenue had no material effect on our results for the three months ended March 31, 2007 compared to the same period in 2006.
Geographic Region.We sell our product in three geographic regions: Americas; Europe; and Asia/Pacific. Net sales, which include product and service revenue, for each region are summarized in the following table (in thousands, except percentages):
Three-Months Ended March 31, | Change in Dollars | Change in Percent | |||||||||||||
2007 | 2006 | ||||||||||||||
United States | $ | 23,681 | $ | 18,984 | $ | 4,697 | 24.7 | % | |||||||
Percentage of net revenue | 81.5 | % | 78.1 | % | |||||||||||
Other Americas | 1,272 | 964 | 308 | 32.0 | % | ||||||||||
Percentage of net revenue | 4.4 | % | 4.0 | % | |||||||||||
Americas | 24,953 | 19,948 | 5,005 | 25.1 | % | ||||||||||
Percentage of net revenue | 85.9 | % | 82.1 | % | |||||||||||
Europe | 3,237 | 3,673 | (436 | ) | (11.9 | )% | |||||||||
Percentage of net revenue | 11.1 | % | 15.1 | % | |||||||||||
Asia/Pacific | 860 | 680 | 180 | 26.5 | % | ||||||||||
Percentage of net revenue | 3.0 | % | 2.8 | % | |||||||||||
Total revenue | $ | 29,050 | $ | 24,301 | $ | 4,749 | 19.5 | % | |||||||
The $4.7 million increase in total revenue for the three-months ended March 31, 2007 over the comparable period in 2006 was primarily due to increased sales of our software products in the Americas. Revenue in Europe decreased due to unusually high turnover in our sales organization and a change in sales management. Revenue in Asia/Pacific increased primarily due to increased sales of our software products throughout Australia and the Pacific Rim.
Price changes had no material effect on our revenue in any region or revenue type in the three months ended March 31, 2007 over the comparable period in 2006.
No customer accounted for greater than 10% of total revenue in the three months ended March 31, 2007 nor 2006.
Cost of Revenue
The following table is a summary of cost of revenue between license, service and maintenance, and amortization of intangible assets (in thousands, except percentages):
Three-Months Ended | Variance In Dollars | Variance in Percent | |||||||||||||
March 31, 2007 | March 31, 2006 | ||||||||||||||
Subscriptions and Support | $ | 4,746 | $ | 3,537 | $ | 1,209 | 34.2 | % | |||||||
Percentage of total revenue | 16.3 | % | 14.6 | % | |||||||||||
Service | 5,590 | 5,175 | 415 | 8.0 | % | ||||||||||
Percentage of total revenue | 19.2 | % | 21.3 | % | |||||||||||
License | 92 | 180 | (88 | ) | (48.9 | )% | |||||||||
Percentage of total revenue | 0.3 | % | 0.7 | % | |||||||||||
Amortization of intangible assets | 2,250 | 2,327 | (77 | ) | (3.3 | )% | |||||||||
Percentage of total revenue | 7.7 | % | 9.6 | % | |||||||||||
Total cost of revenue | $ | 12,678 | $ | 11,219 | $ | 1,459 | 13.0 | % | |||||||
Cost of Subscriptions and Support.In the three months ended March 31, 2007, total cost of subscriptions and support revenue increased $1.2 million, or 34%, to $4.7 million, from $3.5 million in the comparable period in 2006. The increase is attributable to current quarter expenses for an additional 11 employees of the former MindSolve organization at $0.4 million,
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an increase of $0.4 million for employee related expenses for an additional 16 employees in the U.S., 12 employees in India and one employee in Europe, an increase of $0.3 million in the current quarter due to third party performance management on-demand subscription costs and an increase of $0.1 million in other costs. We expect cost of subscriptions and support to continue to increase in 2007 to support our growing customer base.
Cost of Services.In the three months ended March 31, 2007, total cost of service revenue increased $0.4 million, or 8.0%, to $5.6 million, from $5.2 million in the comparable period in 2006. Expenses related to service personnel increased $0.2 million with the addition of 10 employees in the U.S. and one employee in India. Expenses related to third party consulting increased $0.2 million in the current quarter and were as a result of increased sales of third party partner product. We expect cost of services expenses to increase in 2007 compared to 2006 to support increased revenue expectations.
Cost of license.In the three months ended March 31, 2007, total cost of license revenue declined $0.1 million or 49% to $0.1 million from $0.2 million in the comparable period in 2006 due to lower licensing of e-learning content from third parties. We do not expect the cost to increase significantly during 2007.
Amortization of intangibles.In the three months ended March 31, 2007, amortization of intangible assets decreased $0.1 million, or 3.3%, to $2.2 million, from $2.3 million in the comparable period in 2006. The decrease in the current quarter is attributable to final amortization of certain Docent intangibles during the prior year quarter for $0.2 million, and the decrease in the amortization in the current quarter of Pathlore intangibles for $0.2 million based on cash flow projections from the business at acquisition, offset by $0.3 million increase in the current quarter for MindSolve amortization.
Gross Margin
The following table is the summary of gross margin between license and amortization of intangible assets, and service and maintenance (in thousands, except percentages):
Three-Months Ended | ||||||||
March 31, 2007 | March 31, 2006 | |||||||
Gross margin | ||||||||
Subscriptions and support | $ | 9,722 | $ | 7,407 | ||||
Percentage of subscriptions and support revenue | 67.2 | % | 67.7 | % | ||||
Services | 2,643 | 1,908 | ||||||
Percentage of services revenue | 32.1 | % | 26.9 | % | ||||
License | 6,257 | 6,094 | ||||||
Percentage of license revenue | 98.6 | % | 97.1 | % | ||||
Amortization of intangible assets | (2,250 | ) | (2,327 | ) | ||||
Percentage of license revenue | (35.4 | )% | (37.1 | )% | ||||
Total gross margin | $ | 16,372 | $ | 13,082 | ||||
Percentage of net revenue | 56.4 | % | 53.8 | % | ||||
Gross margin for subscriptions and support decreased to 67% in the three-months ended March 31, 2007 from 68% in the comparable period in 2006. The decrease is attributable to the increase in On-demand revenue of $1.2 million of which $0.6 resulted from sales of our partner’s performance management product which carries a lower margin, and $0.6 million which resulted from sales of our acquired performance management solution which also has a lower margin due to our investment in the related infrastructure.
Gross margin for services increased to 32% in the three-months ended March 31, 2007 from 27% in the comparable period in 2006 as a result of improved productivity from our professional services group. The improvement in productivity reflects the benefit from our increased investment in personnel in 2006.
Gross margin for license, exclusive of amortization of intangible assets, in the three-months ended March 31, 2007, improved slightly to 99% for the current quarter from 97% in the three-months ended March 31, 2006, attributable to increased revenue by 0.1% over the prior year and lower costs of licensing of e-learning content from third parties. Gross margin for license, inclusive of amortization of intangible assets improved to 63% from 60% due to increased revenue by 0.1% over the prior year and slight decreases in license costs and amortization of intangibles as described above.
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Operating Expenses
The following table is a summary of research and development, sales and marketing, general and administrative, restructuring charge, provision for litigation settlement and in-process research and development expenses (in thousands, except percentages):
Three-Months Ended | Variance in Dollars | Variance in Percent | |||||||||||||
March 31, 2007 | March 31, 2006 | ||||||||||||||
Research and development | $ | 5,039 | $ | 4,099 | $ | 940 | 22.9 | % | |||||||
Percentage of net revenue | 17.3 | % | 16.9 | % | |||||||||||
Sales and marketing | 7,902 | 7,243 | 659 | 9.1 | % | ||||||||||
Percentage of net revenue | 27.2 | % | 29.8 | % | |||||||||||
General and administrative | 5,006 | 5,811 | (805 | ) | (13.9 | )% | |||||||||
Percentage of net revenue | 17.2 | % | 23.9 | % | |||||||||||
Total operating expenses | $ | 17,947 | $ | 17,153 | $ | 794 | 4.6 | % | |||||||
Percentage of net revenue | 61.8 | % | 70.6 | % | |||||||||||
Research and development.The increase in the three months ended March 31, 2007 compared to the three months ended March 31, 2006 included $1.0 million in additional employee and related costs associated with the hiring of 64 additional personnel, including hiring related to the acquisition of MindSolve and increased staffing in India. Consulting expense decreased to $0.1 million in the three-months ended March 31, 2007 from $0.5 million in the three-months ended March 31, 2006. Facility and equipment expense increased in the three-months ended March 31, 2007 to $1.0 million from $0.7 million in the three-months ended March 31, 2006. We expect research and development expense to increase in 2007 due to continued investments in future versions of the SumTotal 7 Series.
Sales and marketing. Expense relating to sales and marketing personnel increased $0.6 million, or 11%, to $5.2 million in the three months ended March 31, 2007 from $4.6 million in the three months ended March 31, 2006, due to increased salary costs from additional personnel, including personnel added as a result of the acquisition of MindSolve in November of 2006, and higher commissions. Marketing programs expense in the three months ended March 31, 2007 remained unchanged from the three months ended March 31, 2006. Travel expense associated with increased staff in the three months ended March 31, 2007 increased by $0.1 million from the three months ended March 31, 2006. We expect sales and marketing expenses to increase in 2007 to support increased revenue expectations.
General and administrative.In the three months ended March 31, 2007, accounting, legal and consulting fees associated with compliance with Section 404 of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Section 404”) decreased $0.6 million or 73%, to $0.2 million from $0.8 million in the three months ended March 31, 2006. Expenses relating to general and administrative personnel remained unchanged in the three months ended March 31, 2007 from the three months ended March 31, 2006. The remaining decrease of $0.2 million was related to decreases in miscellaneous and other expenses. We expect general and administrative expenses to increase in 2007 compared to 2006 to meet the demands of our growing business.
Non-Operating Expenses, Net
The following table is a summary of interest expense, interest income and other expense, net and equity in losses of an affiliate (in thousands, except percentages):
Three-Months Ended | Variance in Dollars | Variance in Percent | ||||||||||||
March 31, 2007 | March 31, 2006 | |||||||||||||
Interest expense | $ | (378 | ) | $ | (435 | ) | $ | 57 | (13.1 | )% | ||||
Percentage of net revenue | (1.3 | )% | (1.8 | )% | ||||||||||
Interest income | 163 | 163 | — | 0 | % | |||||||||
Percentage of net revenue | 0.6 | % | 0.7 | % | ||||||||||
Other expense, net | (12 | ) | (76 | ) | 64 | (84.2 | )% | |||||||
Percentage of net revenue | (0.0 | )% | (0.3 | )% | ||||||||||
Total non-operating expenses | $ | (227 | ) | $ | (348 | ) | $ | 121 | (34.8 | )% | ||||
Percentage of net revenue | (0.8 | )% | (1.4 | )% | ||||||||||
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Interest expense.The decrease in interest expense was attributable to lower principal balance and interest rates on the Wells Fargo Foothill credit facility. We expect this expense to continue over the term of the credit facility; however, it will vary based on the changes in the principal balance and interest rates.
Other income expense, net. The reduction in other expense in the three-months ended March 31, 2007 was primarily due to lower net foreign exchange expense as a result of our adoption of a forward exchange hedging program. In third quarter of 2006, we adopted a forward exchange hedging program for the United States Dollar and Great British Pound contracts which we believe will minimize future fluctuations related to changes in exchange rates.
Interest income. Interest income was relatively unchanged in the three-months ended March 31, 2007 compared to the comparable period in 2006. We expect interest income to continue at comparable levels, subject to interest rate fluctuations, as we maintain cash balances to meet our loan covenant requirements.
Liquidity and Capital Resources
At March 31, 2007, our principal sources of liquidity were $13.7 million of cash, cash equivalents and $3.4 million of short-term investments, and $5 million of available funds under our Revolver with Wells Fargo Foothill.
We believe that our available cash resources, combined with cash flows generated from operations, will be sufficient to meet our presently anticipated working capital and capital expense requirements for at least the next year. We have borrowing capacity available to us in the form of our credit facility with Wells Fargo Foothill that expires in 2009. We may also consider raising capital in the public markets as a means to meet our capital needs and to invest in our business. Our future liquidity and capital requirements will depend on numerous factors, including our future revenue, the timing and extent of spending to support product development efforts and expansion of sales and marketing and general and administrative activities, the success of our existing and new product and service offerings and competing technological and market developments. Although we may need to return to the capital markets, establish new credit facilities, or raise capital in private transactions in order to meet our capital requirements, we can offer no assurances that we will be able to access these potential sources of funds on terms acceptable to us, or at all.
On June 1, 2006, we filed a universal shelf registration statement on Form S-3 with the Securities and Exchange Commission which was declared effective October 2, 2006. The registration statement gives us the flexibility to issue securities, which may consist of common stock, preferred stock, warrants, debt securities or any combination thereof, in one or more future offerings up to a maximum aggregate offering price of $75 million. A prospectus supplement will describe the terms of any particular offering made under the universal shelf registration statement. Unless otherwise indicated in a prospectus supplement, the net proceeds from the sale of securities offered by us under the prospectus may be used for general corporate purposes and working capital requirements. We may also use all or a portion of the net proceeds to fund possible investments in and acquisitions of, companies, businesses, partnerships, minority investments, products or technologies. Currently, there are no commitments or agreements regarding such acquisitions or investments. We may be required under the terms of our credit facility with Wells Fargo Foothill to use a portion of the net proceeds from any such offering to repay or prepay indebtedness under the credit facility, and we may also elect to use a portion of such proceeds for this purpose.
In July 2006, under our Revolver with Wells Fargo Foothill, we entered into an agreement with Wells Fargo Foothill in which we will enter into forward foreign exchange contracts to mitigate certain foreign exchange exposures we have related to foreign trade receivables. As part of this agreement, the credit facility provides for a 5% reserve against the Revolver. As a result of the 5% reserve requirement, we have $250,000 less in funds available for use from the Revolver including debt covenant compliance and, accordingly, only $4,750,000 was available for borrowings at March 31, 2007.
Three-months ended March 31, 2007
Net cash provided by operating activities was $2.5 million in the three months ended March 31, 2007. The cash provided during the period was primarily related to collections of our trade receivables from our increased revenue in the fourth quarter of 2006 and reflected by a net decrease in accounts receivable of $4.4 million, offset by decreases in accrued compensation and benefits as a result of paying out year-end commissions and bonuses of $2.7 million, other accrued liabilities of $1.4 million and restructuring accrual of $0.7 million, and included adjustments to net loss for non-cash items which included intangible assets amortization of $2.2 million, stock-based compensation of $1.1 million and depreciation and amortization of $0.9 million.
Net cash provided by investing activities was $0.7 million in 2006. Purchases of property and equipment in the three months ended March 31, 2007 totaled $1.5 million and were primarily associated with increased staffing levels in our U.S. and India offices and additional leasehold improvements for expanding our facility in Hyderabad, India, and increased investment in our hosting equipment infrastructure. Short-term investments have decreased primarily as a result of a shift in our investment portfolio from short-term investments to cash equivalents from December 31, 2006 to March 31, 2007. As of March 31, 2007, short-term investments had a carrying value of $3.4 million.
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Net cash provided by financing activities was $0.4 million in the three months ended March 31, 2007 and consisted of repayments of indebtedness under the Wells Fargo Foothill credit facility of $1.1 million and a payment of $0.3 million under notes payable for Litigation Settlement, offset by $1.7 million in net proceeds from the issuance of common stock through our employee stock purchase plan (“ESPP”) and exercises of common stock options.
Commitments
Concurrent with the closing of the Pathlore Acquisition on October 4, 2005, we entered into a credit facility with Wells Fargo principally to fund a portion of the acquisition price, and to provide for our ongoing working capital requirements. For terms and details of the credit facility, including the requirement that we maintain certain restrictive covenants, refer to Note 5,Borrowings in the Notes to the unaudited Condensed Consolidated Financial Statements.
SumTotal Systems leases office space and certain equipment under non-cancelable operating leases expiring in years through 2015. Rent expense under operating leases was approximately $681,000 and $597,000 during the three months ended March 31, 2007 and 2006, respectively.
Future payments under operating lease obligations at March 31, 2007 are presented in the table below (in thousands):
Payments Due by Period | |||||||||||||||||||||
Total | Remainder of 2007 | 2008 | 2009 | 2010 | 2011 | Thereafter | |||||||||||||||
Operating leases | $ | 6,009 | $ | 1,603 | $ | 2,023 | $ | 1,006 | $ | 460 | $ | 246 | $ | 671 |
In connection with the MindSolve acquisition in November 2006, we have two notes payable to a former MindSolve officer. Total future obligations amount to $1,438,000 and will be paid in two equal installments of $719,000 in December 2007 and 2008, respectively. In addition, effective with the MindSolve acquisition, SumTotal Systems has change of control payments to be made to certain employees of MindSolve who are now employees of SumTotal Systems. These contractual change of control payments and are being expensed ratably over the contractual performance period. Total future obligations amount to $1,544,000 with scheduled payments of $956,000 and 588,000 in 2007 and 2008, respectively.
In October 2005, retention bonuses were granted to certain officers of SumTotal Systems. These bonuses were anticipated to be paid in two equal amounts in 2006 and 2007 except for a former officer of SumTotal whose retention bonus was all paid in January 2007. Assuming the remaining affected officers are still employed by SumTotal Systems through 2007, the remaining future payments of $843,000 will be paid in the fourth quarter of 2007. These retention bonuses are being expensed ratably over the performance period through 2007.
We have entered into various arrangements with hosting services vendors with original periods expiring through 2007 totaling $714,000.
Contingencies
On August 16, 2006, our Compensation Committee approved and adopted a form of Amended and Restated Change of Control Agreement for each of our Section 16 officers. In the event of a change of control of the Company and the subsequent termination of a Section 16 officer in a manner defined as a Termination Event, we will be obligated to pay the Section 16 officer certain compensation and benefits. If a Termination Event occurs, an officer would be entitled to one year of the officer’s base salary that would be paid in equal semi-monthly installments over a one year period following a Termination Event. Such officer will also be entitled to other benefits as described in Article III of the Amended and Restated Change of Control Agreement. This discussion is qualified in its entirety by the Current Report on Form 8-K filed by us on August 17, 2006.
From time-to-time, third parties assert patent infringement claims against us in the forms of letters, litigation, or other forms of communication. In addition, from time-to-time, we are subject to other legal proceedings and claims in the ordinary course of business, including claims of alleged infringement of trademarks, copyrights and other intellectual property rights. We do not believe that any of the foregoing claims are likely to have a material adverse effect on our financial position, results of operations or cash flows. However, our analysis of whether a claim may proceed to litigation cannot be predicted with certainty, nor can the results of litigation be predicted with certainty. Defending each of these actions, regardless of the outcome, may be costly, time-consuming, distract management personnel and have a negative effect on our business. An adverse outcome in any of these actions, including a judgment or settlement, may cause a material adverse effect on our future business, operating results and/or financial condition.
Employee Stock Options
Our stock option program is a key component of the compensation package we provide to attract and retain talented employees and believe stock options provide our employees a strong link to our long term performance and the interests of our stockholders. The trading price of our common stock has been and is likely to continue to be highly volatile. As a result of this volatility, the trading price of our common stock may exceed the exercise price of options held by some of our employees and the effectiveness of our stock option program may be adversely impacted. For example, at December 31, 2006 and March 31, 2007, 44% and 12%, respectively, of our outstanding stock options had exercise prices in excess of the current market price of our common stock.
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Recent Accounting Pronouncements
Refer to the discussion of recent accounting pronouncements in Note 2Summary of Significant Accounting Policies in the Notes to the unaudited Condensed Consolidated Financial Statements.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market Rate Risk.We are exposed to market risk related to changes in interest rates and foreign currency exchange rates. We do not use derivative financial instruments for speculative or trading purposes.
Interest Rate Risk.We hold our assets primarily in cash and cash equivalents, such as short-term marketable debt securities, money market funds and other cash equivalents and short-term investments such as commercial paper, publicly traded common stock and treasury notes. We minimize risk by investing in financial instruments with original maturities of less than one year. As a result, if market interest rates were to increase immediately and uniformly by 10% from levels at March 31, 2007, the fair value of cash and cash equivalents and short-term investments would not change by a material amount.
Concurrent with the closing of the Pathlore acquisition on October 4, 2005, we entered into a credit facility with Wells Fargo, principally to fund a portion of the acquisition price, and to provide for our ongoing working capital requirements. Under the terms of the facility, Wells Fargo loaned us $17.5 million to complete the acquisition of Pathlore and provided a revolving credit facility to a maximum of $5.0 million to meet the working capital requirements of the business. The amounts outstanding bear interest at Wells Fargo’s base rate plus 2%, unless we elect to be charged at the LIBOR rate plus 3.5%. As of March 31, 2007, we have elected to be charged at the LIBOR rate, which was 5.35% on March 31, 2007, resulting in a total interest rate of 8.85%. If market interest rates were to increase immediately and uniform by 10% from current levels at March 31, 2007, our interest payments on the credit facility over the term of the loan would not change by a material amount.
Foreign Currency Exchange Risk.We have foreign currency risk as a result of sales by our foreign subsidiaries denominated in currencies other than the United States dollar. In the three-months ended March 31, 2007, international revenue from our foreign subsidiaries accounted for approximately 18% of total revenue, down from 22% in the comparable period in 2006, and for the years ended December 31, 2006, 2005, and 2004, these sales amounted to 16%, 21%, and 27%, respectively. All foreign subsidiaries use the local currency as their functional currency.
Our exposure to foreign exchange rate fluctuations arises in part from inter-company accounts in which costs incurred in the U.S. are charged to the foreign subsidiaries. These inter-company accounts are typically denominated in the functional currency of the foreign subsidiary in order to centralize foreign exchange risk with the parent company in the U.S. We are also exposed to foreign exchange rate fluctuations as the financial results of foreign subsidiaries are translated in U.S. dollars in consolidation. As exchange rates vary, certain transaction gains and losses may vary from expectations and adversely impact overall expected profitability. In addition, during the third quarter 2006, we began entering into 30 day forward contracts for United States Dollar (“USD”) and Great British Pound (“GBP”) to hedge anticipated cash flows from our U.K. subsidiary. On March 28, 2007, SumTotal Systems entered into a forward contract in which SumTotal Systems sold approximately 1.9 million GBP, equivalent $3.8 million USD, for a value date of April 30, 2007, for which a hypothetical 10% appreciation of the GBP to USD would result in a $0.4 million gain and a hypothetical 10% depreciation of GBP to USD would result in a $0.4 million loss.
The effect of foreign exchange rate fluctuations in the three-months ended March 31, 2007, was not material. Due to the substantial volatility of currency exchange rates, among other factors, we cannot predict the effect of exchange rate fluctuations on our future operating results.
Item 4. Controls and Procedures
Evaluation of disclosure controls and procedures.
Our management, with the participation of our chief executive officer and our chief financial officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this quarterly report on Form 10-Q.
A control system, no matter how well conceived and operated, can provide only reasonable assurance that the objectives of the control system are met. Our management, including our chief executive officer and chief financial officer,
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does not expect that our disclosure controls and procedures or internal control over financial reporting will prevent all errors and fraud. Further, 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. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues within the company have been detected. These inherent limitations include the reality that judgments in decision-making can be incorrect, and that breakdowns can occur because of simple errors or mistakes. The design of any control system is also based, in part, upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a control system, misstatements due to error or fraud may occur and not be detected.
Based upon their evaluation of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this quarterly report on Form 10-Q, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures are effective based on their evaluation of these controls and procedures required by paragraph (b) of Exchange Act Rules 13a-15 or 15d-15.
Changes in internal controls.
There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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From time-to-time, we are involved in legal proceedings or threats of legal proceedings arising in the ordinary course of business. We are not currently a party to any litigation or other legal proceeding that, in the opinion of management, is reasonably likely to have a material adverse effect on our business, operating results and financial condition.
Factors That May Affect Future Results of Operations
Set forth below and elsewhere in this report and in other documents we file with the SEC are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this report. All forward-looking statements included in this document are based on information available to us on the date hereof. We assume no obligation to update any forward-looking statement.
We have a history of losses, we expect future losses on a GAAP basis, and we may not achieve GAAP profitability on a consistent basis.
We expect to continue to derive substantially all of our revenue from the licensing of our talent and learning management solutions, the SumTotal 7 Series, as well as our legacy products and related services, including without limitation, maintenance, services, on-demand subscriptions and hosting. We have not been GAAP profitable and we may not achieve GAAP profitability. If we fail to continue to generate adequate revenue from the SumTotal 7 Series and related services, especially as we shift our emphasis to a recurring revenue model, we will continue to incur losses. In addition, in the future, we expect to continue to incur additional non-cash expenses relating to stock-based compensation and purchased intangible assets that will contribute to our net losses. Further, starting with the first quarter of fiscal 2006, we were required to record as an expense, charges related to all current non-vested outstanding and future grants of stock options in our reported results from operations in accordance with SFAS No. 123R. This had the impact of increasing our reported expenses and our GAAP losses. We expect to incur additional GAAP expenses related to stock based compensation awards for the foreseeable future and these future expenses will adversely impact our ability to achieve profitability on a GAAP basis.
Our operating results may fluctuate significantly from quarter to quarter and year to year and are difficult to predict, which could negatively affect the value of your investment.
We have experienced substantial fluctuations in operating results on a quarterly and annual basis and expect these fluctuations to continue in the future. Our operating results may be affected by a number of other factors, including:
• | the size and timing of product orders and the timing and execution of professional services engagements for SumTotal 7 Series and the legacy products; |
• | the mix of revenue from products and services; |
• | our ability to meet customer project milestones; |
• | market acceptance of our products and services, especially SumTotal 7 Series and related services; |
• | our ability to complete fixed-price professional services engagements within budget, on time and to our customers’ satisfaction; |
• | our ability to control expenses, especially in our services organization, and implement an operating cost structure that aligns with revenue growth; |
• | ongoing costs and efforts in connection with compliance with Sarbanes-Oxley Section 404; |
• | the timing of revenue and expense recognition; |
• | industry consolidation among both our competitors and our customers; |
• | recognition of impairment of existing assets; and |
• | our ability to execute on our strategy and operating plans. |
Our future revenue is difficult to predict and we may not be able to adjust spending in response to revenue shortfalls. Our limited operating history with performance management and compensation management solutions, and the rapidly evolving nature of the talent management market make prediction of future revenue and expenses difficult. Expense levels are based, in part, on expectations as to future revenue and are essentially fixed in the short-term. Other expenses, as a result of changes in the law or otherwise, such as expenses related to litigation or compliance with Sarbanes-Oxley Section 404, may also increase and cause us to fall short of our forecasts. Failure to meet our forecasts would likely cause a decline in the price of our common stock.
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Our sales cycles in our traditional perpetual license business line are lengthy, making the timing of sales difficult to predict and also requiring considerable resources and expense with no assurance that such sales will occur.
For our traditional perpetual license business line, the period between our initial contact with a potential customer and a customer’s purchase of our products and services is lengthy and often extends over several fiscal quarters or a fiscal year. To sell our products and services successfully, we generally must educate our potential customers regarding the use and benefits of our products and services, which typically requires significant time, capital and other resources. The delay or failure to complete sales in a particular quarter could reduce our revenue for that quarter, as well as subsequent quarters over which revenue for the sale would likely be recognized. If the sales cycle unexpectedly lengthens in general or for one or more large orders, it would negatively affect the timing of a significant portion of our revenue, and our revenue growth would be harmed. Many of our potential customers are large organizations which generally take more time to make significant business decisions, and the formation and execution of even a relatively small number of large contracts with these large organizations may have a significant impact on our revenue. In addition, we must expend and allocate resources prior to completing a sales transaction, with no guarantee that such transaction will result in an actual sale. Furthermore, the lengthening of our sales cycles may create increased difficulties in negotiating such sales on terms favorable to us. This may result in a delay or failure to generate revenue from our sales efforts and may adversely affect our stock price.
Adverse economic conditions, including reduced information technology spending or increased unemployment may adversely impact our business.
Our business depends on the overall demand for talent management and learning management systems solutions, and on the economic health of our current and prospective customers. The purchase of our products is often discretionary and may involve a significant commitment of capital and other resources. To the extent that the budgets for technology spending are reduced, demand for our products will also decrease. Furthermore, the market for our products may be disproportionately affected by weakness in general economic conditions or the broader market for information technology. Moreover, if the unemployment rate increases materially and training and retention of employees becomes less critical, our existing and potential clients may no longer consider improvement of their talent management systems a priority. Weak economic conditions, or a reduction in information technology spending even if economic conditions remain stable, would likely adversely impact our business, operating results and financial condition in a number of ways, including longer sales cycles, lower prices for our products and services and reduced sales.
We recently acquired MindSolve and the anticipated benefits of this acquisition may be delayed or may not be realized.
We expect that our recent acquisition of MindSolve will enhance our position in the talent management industry through the integration of MindSolve’s technologies, products, services, partnerships, and customer contacts into our current product offerings. Achieving the expected benefits of the acquisition, however, depends in part on the integration of MindSolve’s technology, products, operations, partnerships, and personnel in a timely and efficient manner. The challenges involved in successful integration include:
• | incorporating MindSolve’s technology and products into our offerings, business, and distribution channels; |
• | scaling the MindSolve business successfully without significant additional expense; |
• | integrating the MindSolve customer base, operations and financial reporting function into our operations and financial reporting systems; |
• | integrating the MindSolve technical team and sales organization into our larger and more widely dispersed engineering organization and sales organization; and |
• | selling and marketing into the stand-alone performance management market successfully. |
If we do not realize the anticipated benefits associated with the acquisition in a timely manner or at all, our business and financial results may be harmed. For example, if our combined business fails to meet the demands of the marketplace or we fail to build a successful performance management business, customer acceptance of products and services of the newly combined company could decline or customer orders could be cancelled. In addition, we may not achieve the anticipated benefits of the acquisition as rapidly as, or to the extent, anticipated by our management and certain financial or industry analysts. For example, the sale of MindSolve’s products may not contribute to our results to the extent we expect for a number of reasons, including the integration risks described above. In addition, we may incur unexpected costs or delays as
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we transition our sales effort and customers to our performance management product we acquired from MindSolve. The integration of the MindSolve business may disrupt our business and result in the loss of customers or key employees or the diversion of the attention of management, any of which could have a negative effect upon our business and stock price.
Customer and employee uncertainty related to the MindSolve acquisition could harm SumTotal.
Uncertainty about the effect of our acquisition of MindSolve on customers, employees and partners may have an adverse effect on us. Former MindSolve employees may experience challenges in working for a larger public company, and, as a result, we may experience unexpected turnover. Customer concerns about changes or delays in our product roadmap of the combined company may negatively affect customer purchasing decisions, such as deferral of purchase decisions or reduced purchases. Customers could be reluctant to purchase the products and services of the combined company due to uncertainty about the direction of their technology, products and services, and willingness to support and service existing products which may be discontinued. We also amended our pre-existing performance management partnership, resulting in us competing for the same customers as the company with which we previously partnered. As a result, there may be a loss of revenue opportunities and market share for the combined company. If customers delay or defer purchasing decisions, or choose to purchase from a competitor, the revenue of the combined company could materially decline or any anticipated increases in revenue could be lower than expected.
Any future acquisitions we make, or attempt to make, will need to be integrated into our business and require significant time and effort from our management team, which may disrupt our business and harm our operating results or financial condition.
We have made and may continue to make acquisitions of businesses and technologies to enhance our existing business. Acquisitions involve numerous risks, including problems combining the purchased operations and key employees, technologies or products, unanticipated costs, diversion of management’s attention from our core business, adverse effects on existing business relationships with suppliers and customers, risks associated with entering markets in which we have no or limited prior experience and potential loss of key employees. The integration of businesses that we have acquired or that we may acquire in the future into our business has been and will continue to be a complex, time consuming and expensive process. Failure to operate as a combined organization utilizing common information and communication systems, operating procedures, financial controls and human resources practices could adversely impact the success of any business combination as evidenced in previous combination and acquisition transactions. For example, although we completed the combination of Docent and Click2learn in March 2004, the difficulty in integrating financial controls and procedures contributed to our failure to file our Annual Report on Form 10-K for the fiscal year ended December 31, 2004 with the SEC on a timely basis. The acquisition of Pathlore in October 2005 and the related difficulty in integrating the financial controls and procedures resulted in a material control weakness to our accounting for business combinations in fiscal 2005 and contributed to our filing an extension to file our Annual Report on Form 10-K for the fiscal year ended December 31, 2005. We have recently integrated the MindSolve financial controls into ours, and we may experience problems with this integration. Moreover, the integration of the products, product roadmap, and operations from the combination of Docent, Click2learn, Pathlore, MindSolve and any other company we may acquire is a continuing activity and will be for the foreseeable future.
Our operating results may suffer because of acquisition-related expenses, amortization of intangible assets and impairment of acquired goodwill or intangible assets. Furthermore, we may have to incur debt or issue equity securities to pay for any future acquisitions, or to provide for additional working capital requirements, the issuance of which could be dilutive to our existing shareholders.
We rely on partnerships, alliances and other relationships to conduct our business and expect to expand our reliance on such relationships in the future.
Our business relies on a variety of partnerships, alliances and other relationships, such as those with content partners, resellers, original equipment manufacturers, solution integrators, human resource outsourcers and technology partners, to develop, market and sell our products and solutions. As our business grows and evolves, through adding new products and solutions or possible third party or product acquisitions, we have relied, and in the future, we may rely more heavily, on these types of partnerships. As a result, we have had to, and may in the future, have to renegotiate or terminate existing relationships. There can be no assurance that we will be able to enter into new contracts, or amend or terminate our existing contracts on favorable terms, or at all. In addition, if we amend or terminate any of our contracts, our former partners may become our competitors in the future. These former partners may be unhappy with their new relationships, and may, as a result, commence litigation against us, regardless of the merits of such litigation. Litigation is expensive to defend, and even the threat of legal proceedings diverts resources, and management attention from operating our business and causes increases in our expense levels, all of which may negatively affect the price of our common stock.
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There can be no assurance that we will be able consummate future business combinations, if any, on favorable terms or on a timely basis, or that we will be able to integrate successfully businesses, products, technologies or personnel that we might acquire. Failure to do so may negatively affect our financial results, customer, employee and investor confidence, and ultimately, the price of our common stock.
Our credit facility requires compliance with certain restrictive covenants, and if we breach the covenants, we will be in default and the lender could demand immediate repayment and foreclose on the loan.
Our credit facility with Wells Fargo Foothill requires compliance with certain restrictive covenants. These covenants include, but are not limited to, EBITDA levels, leverage ratios, and restrictions related to capital expenditures, indebtedness, distributions, investments and changes of control. If we breach any of these covenants, Wells Fargo Foothill could demand repayment of the outstanding debt, which as of March 31, 2007 was approximately $12.0 million, and could foreclose upon all or substantially all of our assets and the assets of our subsidiaries. These covenants may adversely affect our ability to finance future operations, potential acquisitions or capital needs or to engage in other business activities. As a result of the credit facility, we may have more debt than some of our competitors, which could place us at a competitive disadvantage and make us more susceptible to downturns in our business in the event our income is not sufficient to cover our debt service requirements. Even if we are able to repay the debt, the credit facility provides for penalties for making pre-payments that would otherwise save us substantial future interest payments. The forced premature repayment of the loan could leave us without the ability to control which assets are sold to satisfy the loan or sufficient assets to continue as a going concern. Each of these risks may cause concern among our customers or investors and therefore cause a decrease in our revenue or the price of our common stock.
We may need additional financing in the future, which we may be unable to obtain on favorable terms or at all.
Our acquisitions of Pathlore and MindSolve decreased our cash position. If our business does not generate the cash needed to finance our operations or growth, including potential business acquisitions, we may need to obtain additional financing or take steps to restrict our operations in order to conserve existing cash. In addition, poor financial results or unanticipated expenses could give rise to additional financing requirements. We may be unable to obtain financing on terms favorable to us or at all. Further, it may be more difficult to obtain additional financing because of our credit facility. Unless waived by Wells Fargo Foothill, upon the sale or issuance by us of any shares of our capital stock, the credit facility requires us to prepay the outstanding principal amount of the term loan in an amount equal to 75% of the proceeds received by us in connection with such sale. If we do sell or issue additional shares of our capital stock, we believe we will be able to obtain a waiver from Wells Fargo Foothill. If we need to obtain financing and adequate funds are not available or are not available on acceptable terms, or we are not able to obtain a waiver from Wells Fargo Foothill, we may be required to make further expense reductions, which could significantly restrict our operations and limit our ability to enhance our products, fund expansion, respond to competitive pressures or take advantage of business opportunities, thereby resulting in a decrease in our revenue and stock price.
Undetected product defects may require us to halt sales or shipments of our products, delay introduction of new products, or account for warranty claims.
Our products are highly technical and complex and have contained and may contain undetected errors, bugs, security vulnerabilities or defects, some of which may only be discovered after a product has been installed and used by customers. Our product offerings, both current and future, are complex and often contain undetected errors or bugs, despite internal and third party testing. New product offerings contain new features and functionality which result in a greater likelihood of errors, bugs, security vulnerabilities and frequently these are undetected until the period immediately following introduction and initial shipment of new products or enhancements to existing products. For example, although we attempted to discover and resolve all such defects in our product line that we believed would be considered serious by our customers before shipment to them, SumTotal 7 Series is not error-free and some customers have notified us that they consider some of the defects in the SumTotal 7 Series to be serious. In addition, our products include third party software, and any defects in third party software that we incorporate into our products may compromise our products. It may be difficult for us to determine the source of the problem and correct any errors in third party software because such software is not within our control.
Any bugs, errors, defects or security vulnerabilities discovered in our products after commercial release could result in loss of revenue or delay in revenue recognition, loss of customers and increased service and warranty costs, any of which could adversely affect our business, operating results and financial condition. In addition, we could face claims for product liability, tort or breach of warranty, including claims relating to changes to our products made by our channel partners. Our contracts with customers contain provisions relating to warranty disclaimers and liability limitations, which may not be upheld. Defending a lawsuit, regardless of its merit, is costly and may divert management’s attention and adversely affect the market’s perception of us and our products. In addition, if our business liability insurance coverage proves inadequate or future coverage is unavailable on acceptable terms or at all, our business, operating results and financial condition could be adversely impacted.
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Our operating results may be affected by successful warranty claims, refund requests, litigation claims for breach of contract or other claims related to product defects.
Although we generally attempt to limit contractually our liability for damages arising from defects and other mistakes in our software products and in rendering professional services, these contractual protections are not always available and may not be enforced or otherwise protect us from liability for claims such as warranty claims, refund claims, or litigation claims. If such a claim is successful, our insurance may not be sufficient to cover our liability. Any of these consequences could have a material adverse impact on our financial condition, results of operations, our reputation, or the market value of our common stock.
If we fail to successfully manage our product transition to, or fail to successfully deploy upgrades to, our SumTotal 7 Series on a timely basis, our business and financial results will be harmed.
We introduced SumTotal 7.0 in late December 2004, SumTotal 7.1 in April 2005, SumTotal 7.2 in June 2006, and SumTotal 7.5 in December 2006, and plan to launch subsequent product releases. We face numerous risks relating to product transitions, including customers delaying their purchasing decision until they have confidence in our new product and until we have proven we can successfully install and implement new upgrades. Due to the product transition, we may be unable to accurately forecast revenue from product sales and related services, the number and severity of defects and increased support requirements due to the complexity of the new product. In order to successfully market and sell the product, we must ensure broad-based cooperation from and coordination between multiple departments, including engineering and marketing, and from multiple geographic regions, including Bellevue, Washington; Mountain View, California; and Hyderabad, India. If we fail to successfully manage the transition to new product offerings, our business and financial results may be adversely affected, which may cause a decline in the price of our common stock.
Our lack of product diversification, and our reliance on the SumTotal Systems 7 Series, means that any decline in price or demand for our products and services would seriously harm our business.
We expect the SumTotal 7 Series and successor products and related services to continue to account for a significant majority of our revenue for the foreseeable future. Consequently, a decline in the price of, or demand for, the SumTotal 7 Series and successor products or services, or their failure to achieve broad market acceptance, would seriously harm our business and would likely result in a decline in the price of our common stock.
Third parties have claimed, and may claim in the future, that we are infringing their intellectual property which could diminish the value of our products and services or deter customers from purchasing our products regardless of whether these claims are successful
From time-to-time, we are involved in legal proceedings or threats of legal proceedings. Litigation is expensive to defend and even the threat of legal proceedings, regardless of their merit, diverts management attention from operating our business and causes increases in our expense levels. In addition, from time-to-time, we have received, and may in the future receive, threatening letters and notice of claims of infringement of other parties’ proprietary rights. Such claims could result in costly litigation and could divert management and technical resources. They could also delay product shipment or require us to develop non-infringing technology or enter into royalty or licensing agreements, which agreements may not be available on reasonable terms, or at all. In the event of an adverse judgment against us (including a judgment or settlement which may impose adverse conditions on us), we may be required to cease shipping, to pay damages, to license technology on terms that may not be favorable to us or to alter our technology, website or software products, any of which may adversely affect our operating results and cause us to miss our forecasts or industry analysts’ forecasts, thereby causing a possible decline in the price of our common stock.
If third parties infringe our intellectual property or if we are unable to secure and protect our intellectual property, we may expend significant resources enforcing our rights or suffer competitive harm.
Our success depends in large part on our proprietary technology. We rely on a combination of copyrights, trade secret and trademark laws, contractual restrictions, restrictions on disclosure and other methods to protect our proprietary technology. In addition, as part of our acquisition of MindSolve, we acquired its “Drag and Drop” patent and, as a result, patent protection may become a more important component of the methods we use to protect our proprietary technology. These legal protections afford only limited protection for our technology. Furthermore, effective protection of intellectual property rights is unavailable or limited in certain foreign countries. It may also be possible for third parties to copy or otherwise obtain and use our intellectual property or trade secrets without our authorization and it may be possible for third
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parties to independently develop substantially equivalent intellectual property. We cannot assure you that the protection of our proprietary rights will be adequate or that our competitors will not independently develop similar technology, duplicate our products and services or design around any patents or other intellectual property rights we hold. Consequently the value of our products and services to our customers could diminish substantially.
Our products include third party technology, the loss of which could materially harm our business.
We use licensed third party technology components in our products. Future licenses to this technology may not be available to us on commercially reasonable terms, or at all. The loss of or inability to obtain or maintain any of these technology licenses could result in delays in the introduction of new products or could force us to discontinue offering portions of our talent and learning management solutions until equivalent technology, if available, is identified, licensed and integrated.
Security and privacy breaches could subject us to litigation and liability.
We host certain of our customers’ talent and learning management software implementations and provide access to that software using the Internet. Computer viruses could be introduced into our systems or those of our customers which could disrupt the operation of our hosting systems or make them inaccessible to users. We also depend on third parties to provide key components of our networks and systems and Internet service providers and telecommunications companies and the efficient operation of their computer networks and other computer equipment to enable customers to access and use hosted software implementations.
We could become subject to litigation and liability if third parties penetrate security for our hosting systems or otherwise misappropriate our users’ confidential information, or if customers are unable to access and use hosted software implementations. Advances in computer capabilities, new discoveries in the field of cryptography or other technological events or developments could result in compromises or breaches of our security systems. Anyone who circumvents our security measures could misappropriate proprietary information or cause interruptions in our services or operations. We may be required to expend significant capital and other resources to protect against the threat of security breaches or service interruptions or to alleviate problems caused by breaches or service interruptions. Each of our key third party networks and systems component providers, Internet service providers and telecommunications companies partners has experienced significant outages in the past and could, in the future, experience outages, delays and other difficulties due to system failures unrelated to our systems, which could cause our customers to believe we were at fault and withhold payments due to us or sue us for breach of contract, which would result in decreased revenue and a possible decline in the price of our common stock
Our disaster recovery plan does not include redundant back-up computer systems, and a disaster could severely damage our operations.
Our disaster recovery plan does not include redundant back-up computer systems at an alternate site. A disaster could severely harm our business because our computer systems could be interrupted for an indeterminate length of time. Our operations, including software solutions we host for some of our customers, depend on our ability to maintain and protect the computer systems needed for our day-to-day operations. For instance, a number of these computer systems are located in Mountain View, California on or near known earthquake fault zones and flood plains, or in Hyderabad, India where the infrastructure is not as robust as in the United States. Although these systems are designed to be fault tolerant, they are vulnerable to damage from fire, floods, earthquakes, power loss, telecommunications failures and other events. Any damage to our facility could lead to interruptions in the services we provide to our customers and loss of customer information, and could impair our ability to operate our business, leading customers to withhold payments due to us and decreased revenue. The business interruption insurance we maintain may not be adequate to cover our losses resulting from disasters or other business interruptions, which would result in increased expenses and a possible decline in the price of our common stock.
If we are not able to adapt to rapidly changing technology and evolving industry standards or we do not meet our customer’s needs on a timely basis, our products may become obsolete and we would lose market share.
The talent and learning management software markets are characterized by rapidly changing technologies, frequent new product and service introductions, short development cycles and evolving industry standards. The introduction of new products and services embodying new technologies and the emergence of new industry standards may render our products and services obsolete. Our success depends on our ability to adapt to a rapidly changing landscape and to offer new products and services to address our customers’ changing demands. We may also experience difficulties that delay or prevent the successful design, development, introduction or marketing of our products and services, which may harm our ability to attract new customers and retain existing customers.
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Our products must be compatible with our customers’ platforms and operating environments and to the extent commercially accepted platforms and operating systems change, we may need to develop new product lines in order to remain competitive.
Although our software products can be licensed for use with a variety of popular industry standard relational database management system platforms, specific operating systems, or other combinations of licensed software, there may be existing or future platforms or user interfaces that achieve popularity in the marketplace which may not be architecturally compatible with our software product design. Developing and maintaining consistent software product performance characteristics across all of these combinations could place a significant strain on our resources and software product release schedules, which could adversely affect revenue and results of operations.
The talent management and learning management systems software market is highly competitive, and we may be unable to compete successfully.
The market for our products and services is intensely competitive, dynamic and subject to rapid technology change. Our competitors vary in size, scope and the breadth of products and services offered. We face competition from:
• | other developers of talent management and learning management systems; |
• | providers of other talent management and learning management systems solutions; |
• | vendors of other enterprise software applications that are beginning to offer learning delivery and management functionality; |
• | large professional consulting firms and in-house information technology departments; and |
• | developers of web authoring tools. |
Additionally, companies may choose to develop their own talent management software internally rather than acquiring it from third parties.
There are relatively low barriers to entry in the talent management and learning management systems market, and we expect the intensity of competition to increase in the future. Increased competition may result in price reductions, reduced gross margins or loss of market share, any of which would seriously harm our business and financial results.
Our core offering, the SumTotal 7 Series, integrates solutions addressing the learning management, performance management and compensation management segments of the talent management market; however, our performance management solution was acquired in our acquisition of MindSolve and has only recently been integrated into our offering. Furthermore, our compensation management offering is not as fully developed and does not have the same market acceptance as the other modules of the SumTotal 7 Series. As a result, we may have difficulty competing against companies which focus on these segments rather than the entire talent management market, or selling to customers who only need solutions in a specific segment.
Certain of our competitors have greater resources to develop or acquire the products and technologies necessary to compete against us
The market for our products and services is highly competitive and subject to rapid change, with no single company accounting for a dominant share of the market. Nevertheless, several market research firms have predicted continued vendor consolidation over the next several years. Some of our existing and potential competitors, such as Oracle Corporation and SAP AG, have longer operating histories and significantly greater financial, technical, marketing and other resources. These companies not only have more resources to develop their own products and technologies internally but can also use such resources to acquire competing products and technologies through acquisitions or other strategic transactions and quickly enter the talent and learning management market and compete with us on both product offerings and pricing. As a result, we may not be able to compete successfully against such current and future competitors, and competitive pressures that we encounter may seriously harm our business.
The talent management and learning management systems software markets may not grow to a sufficient size or at a sufficient rate to sustain our business.
Corporate training and education historically have been conducted primarily through classroom instruction and performance management solutions have traditionally been done using paper-based systems, desktop applications, spreadsheets, classroom settings, and human resource management systems. Although technology-based training applications have been available for many years, they currently account for only a small portion of the overall corporate learning market. Accordingly, our success depends on the extent to which companies implement talent and learning management software solutions for the design, development, delivery and management of their corporate learning needs and performance management solutions for rating, reviewing and evaluating individuals.
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Many companies that have already invested substantial resources in traditional training methods may be reluctant to adopt a new strategy that may limit or compete with their existing investments. Even if companies implement talent and learning management software solutions or performance management solutions, they may still choose to develop such solutions internally. If the use of talent and learning management software does not become widespread, or if companies choose to develop such software or solutions internally rather than acquiring them from third parties, then our talent and learning management software and performance management solutions will not be commercially successful.
Our operating results could be harmed by economic, political, regulatory and other risks associated with international sales and operations.
We, as well as our customers and our partners, are increasingly doing business outside of the United States. Accordingly, our business is subject to a number of risks inherent in international operations, including:
• | difficulties and costs of recruiting and retaining qualified personnel in our offices outside of the United States; |
• | difficulties managing a geographically dispersed workforce with different learning styles and cultures; |
• | export controls, import tariffs and other barriers to trade; |
• | changes in laws or regulatory requirements, including tax laws; |
• | reduced protection of intellectual property rights; |
• | political and economic instability; |
• | reliability of infrastructure; |
• | difficulties managing a geographically dispersed sales organization; and |
• | fluctuations in currency exchange rates. |
While we sell our products worldwide and we have experienced international partners, we have limited experience with sales and marketing in some countries, such as China, where we have recently opened a representative office. There can be no assurance that we will be able to market and sell our products in all of our targeted international markets. If our international efforts are not successful, our business and results of operations could be harmed.
Due to our significant operations in India, which has a rapidly growing technology market, our business is subject to certain risks that are not typically experienced to the same degree in the United States or elsewhere abroad.
We rely significantly on our research and development, professional services and technical support operations in Hyderabad, India to enable us to develop new products, complete customer implementation projects and new releases of our products on time and within established budgets and provide technical support. In recent years, increased growth and development of the technology market in general, and in Hyderabad specifically, has made it more difficult for us to hire and retain qualified technical employees and other personnel. In addition, it may be difficult to acquire additional space to support future growth.
Our efforts in Hyderabad are subject to a number of risks inherent in international operations. However, certain risks are particularly acute in India, such as:
• | employee turnover; |
• | increasing salaries; and |
• | less reliable infrastructure. |
If our India operations fail, for any reason, to provide adequate and timely product enhancements, updates and fixes to us or customer implementations, our ability to fix defects in our SumTotal 7 Series, our ability to develop new versions of our SumTotal 7 Series and new products, and our ability to respond to customer or competitive demands would be harmed and we would lose sales opportunities and customers and might negatively impact our customer satisfaction.
In addition, our engineering efforts are based primarily out of two offices: Bellevue, Washington and Hyderabad, India. If the two offices fail to work together successfully, we may experience delays in fixing defects in SumTotal 7 Series, customer implementations, or in developing and releasing future versions of our product.
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Our stock price has been and may continue to be volatile.
The trading price of our common stock has been and is likely to continue to be highly volatile. Our stock price is subject to continued fluctuations in response to a number of factors, including:
• | actual or anticipated variations in our operating results; |
• | changes in the estimates of our operating results or changes in recommendations by securities analysts; |
• | changes in conditions or trends in the talent management market; |
• | announcements by us or our competitors of significant customer wins, technological innovations, new products or services, significant acquisitions, strategic partnerships, joint ventures or capital commitments; |
• | fluctuations in demand for our products, including due to seasonality; |
• | additions or departures of key personnel; |
• | foreign currency, interest rate, and fixed income risks, and; |
• | market conditions in our industry, the industries of our customers and the economy as a whole. |
Fluctuations in the price and trading volume of our common stock may prevent stockholders from selling their shares above the price at which they purchased their shares.
In addition, companies that have experienced volatility in the market price of their stock have been subject to securities class action litigation, and we may be the target of this type of litigation in the future. Securities litigation, like other litigation against us could result in substantial costs, negative publicity and divert our management’s attention, which could seriously harm our business and stock price.
Finally, a sustained decline in our stock price could help trigger an impairment analysis for the value of our goodwill and intangible assets, which then might result in an impairment based not only on stock price but other factors. The carrying value of our goodwill and intangible assets on March 31, 2007 was $68.5 million and $19.1 million, respectively.
We have experienced and may continue to experience turnover of senior management and key personnel, which could harm our business or operations.
Our success depends to a significant degree on the performance of the senior management team and other key employees. While certain of our Section 16 officers were granted two-year retention agreements in October 2005, at approximately the time our former chief executive officer resigned, there is no guarantee that such officers, will remain employed with us either through the duration of the retention agreements or upon their expiration in October 2007. The loss of any of these individuals, or other employees, could harm our business. We do not have employment agreements other than offer letters with our Section 16 officers or with any other key employee, and we do not maintain key person life insurance for any Section 16 officer or key employee.
Our success also depends on our ability to attract, integrate, motivate and retain highly skilled technical, sales and marketing and professional services personnel. Competition for qualified personnel in the software industry, particularly engineering and other technical personnel, is intense and is increasing, and there can be no assurance that we will be able to attract and retain highly skilled employees in sufficient numbers to sustain our current business or to support future growth.
We rely on independent partners and third parties to help conduct our international operations and provide engineering services, including product development and customer implementation and sales and marketing efforts.
We rely on independent partners such as distributors, alliance partners, value-added resellers and system integrators to help conduct our international operations and sales and marketing efforts in many foreign countries. We also use independent third parties to provide engineering services, including customer implementation and product development, including customer implementation and product development. Moreover, we expect to rely increasingly on these independent partners for the product development, customer implementation, distribution and sale of our branded products globally. Our success in international markets consequently will depend to a large degree on the success of these independent partners, with whom we have a limited working experience and over whom we have little control. If they are unwilling or unable to dedicate sufficient resources to our relationships, our international operations will suffer so our future success will depend in part on our ability to attract, train and motivate new distributors, resellers, alliance partners and systems integrators and expand our relationships with current independent partners. We may not be successful in expanding our distributor and reseller relationships, and our sales would suffer as a result. Further, we will be required to invest significant additional resources in order to expand these relationships, and the cost of this investment may exceed the revenue generated from this investment.
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Our internal controls and procedures may not be adequate to prevent or detect misstatements or errors.
A control system, no matter how well conceived or operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Our management does not expect that our internal controls and procedures will prevent all errors and all fraud, if any, because, in addition to resource constraints, there are inherent limitations of all control systems, including the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls and procedures can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of a control or procedure. The design of any system of controls and procedures is also 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. Because of the inherent limitations in a control system, misstatements due to error or fraud may occur and not be detected. In such event, we may not be able to recognize revenue we expected to recognize; we may not be able to meet our forecasts or industry analysts’ projections; or we may be the subject of litigation, each of which would likely harm our financial results and may result in a decline in the price of our common stock.
Standards for compliance with Sarbanes-Oxley Section 404 are burdensome and uncertain, and if we fail to comply in a timely manner, our business could be harmed and our stock price could decline.
Pursuant to Sarbanes-Oxley Section 404, our management is required to report on and our independent registered public accounting firm to attest to, the effectiveness of our internal controls over financial reporting, at least annually. The rules governing the standards that must be met for management to assess our internal controls over financial reporting are new, complex and subject to proposed changes. Currently, the rules require significant documentation, testing and possible remediation of our internal controls over financial reporting. The process of reviewing, documenting and testing our internal controls over financial reporting will likely continue to result in increased expenses and the devotion of significant management and other internal resources. As we did in connection with our report on internal controls in 2004 and 2005, we may encounter problems or delays in completing the implementation of any changes necessary to make a favorable assessment of our internal controls over financial reporting during fiscal 2007. During this process if our management identifies one or more material weaknesses in our internal control over financial reporting, we will be unable to assert such internal control is effective and the price of our stock may suffer.
We were not able to comply with the requirements of Sarbanes-Oxley Section 404 for fiscal 2004 on a timely basis and had to delay filing our Annual Report on Form 10-K until August 1, 2005. We had numerous material weaknesses and developed and implemented extensive remediation plans in fiscal 2005 and 2006. Although we have remediated all of our material weaknesses in 2006, there is no assurance that future changes in our control procedures will not create other material weaknesses or that other material weaknesses will not be discovered in the future. If our management is unable to assert that our internal control over financial reporting is effective (or if our independent registered public accounting firm is unable to attest that our management report is fairly stated or they are unable to express an opinion on the effectiveness of our internal controls) we may not be able to timely file, or file at all, our periodic financial reports and thus we will be subject to delisting. Even if we are able to file such reports, investor confidence in the accuracy and completeness of our financial reports may be lost, leading to an adverse effect on the price of our stock.
If we are unable to effectively remediate any future material weaknesses identified by us or our independent registered public accounting firm, we will be unable to assert such internal control is effective. If internal controls and procedures are determined to be inadequate and ineffective, this may result in a loss of shareholder confidence and adversely impact our stock price.
Recently enacted and proposed changes in securities laws and regulations have increased and are likely to continue to increase, our expenses.
Changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and the listing standards of the NASDAQ Global Market, have increased, and will continue to increase our expenses as we devote resources to respond to the requirements. While we are endeavoring to reduce the costs of compliance, compliance is costly due to the necessity of hiring additional personnel and external consultants and our independent registered public accounting firm. We also expect these developments to make it more difficult and more expensive for us to obtain director and officer liability insurance in the future, and we may be required to accept reduced coverage or incur substantially higher costs to maintain coverage. Further, our directors and executive officers could face an increased risk of personal liability in connection with the performance of their duties. As a result, we may have difficultly attracting and retaining qualified directors and executive officers, which could adversely affect our business.
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Our operating expenses may be negatively affected by the impairment of goodwill and the impairment and amortization of intangible assets.
Goodwill represents the excess of costs over the net fair value of net identifiable assets acquired in a business combination. Goodwill is not amortized, but is instead tested for impairment at least annually in accordance with the provisions of SFAS No. 142. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives using straight-line and accelerated methods designed to match the amortization to the benefits received where applicable. They are reviewed for impairment in accordance with SFAS No. 144. Recoverability of goodwill is measured by a comparison of the carrying amount of a reporting unit, which is a component representing a segment or one level below a segment, to the estimated undiscounted future cash flows expected to be generated by the reporting unit. If the carrying amount of a reporting unit, after any adjustments required for other long-lived assets, exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the unit exceeds its fair value.
Purchased intangible assets subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset group to the estimated undiscounted future cash flows expected to be generated by the asset group. If the carrying amount of an asset group exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset group exceeds the fair value of the asset group.
Any significant adverse changes to the key assumptions about acquired businesses and their prospects or an adverse change in market conditions could result in a change to the estimation of fair value that could result in an impairment charge. Given the significance of the intangible assets as a percent of our total asset balance, an adverse change to the estimated fair value of intangible assets could result in an impairment charge that would be material to our reported assets and results of operations.
Changes in accounting regulations and related interpretations and policies, particularly those related to revenue recognition and share based payments, could cause us to defer recognition of revenue or recognize lower revenue or to report lower earnings per share.
While we believe that we are in compliance with SOP No. 97-2, as amended, the AICPA continues to issue implementation guidelines for these standards and the accounting profession continues to discuss a wide range of potential interpretations. Additional implementation guidelines, and changes in interpretations of such guidelines, could lead to unanticipated changes in our current revenue accounting practices that could cause us to defer the recognition of revenue to future periods or to recognize lower revenue.
The FASB issued SFAS No. 123R, which requires us to recognize as an expense stock-based compensation to employees based on their fair values, and eliminates the ability to account for stock-based compensation using the intrinsic value method in accordance with APB No. 25. As a result, when we recorded an expense for our stock-based compensation plans using the fair value method beginning in fiscal 2006, we had significantly increased stock-compensation charges in the amount of $4.2 million, or $0.16 per share on a basic and diluted basis. For fiscal 2005 and 2004, had we accounted for stock-based compensation plans under SFAS No. 123R using the Black-Scholes option pricing model, we estimate that basic and diluted net loss per share, using the fair value method, would have been increased by $0.61 and $0.32 per share, respectively.
In June 2006, the FASB issued FIN No. 48, which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109. This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 also provides guidance on de-recognition of tax benefits, classification on the balance sheet, interest and penalties, accounting in interim periods, disclosure, and transition. We adopted FIN No. 48 effective January 1, 2007. FIN No. 48 requires significant judgment in determining what constitutes an individual tax position as well as assessing the outcome of each tax position. Changes in judgment as to recognition or measurement of tax positions can materially affect the estimate of the effective tax rate and consequently, affect our operating results.
As a result of the implementation of FIN 48, SumTotal Systems recognized a $0.3 million increase in liability for unrecognized tax benefits, which was accounted for as a $0.2 million reduction to the January 1, 2007 balance of retained earnings as a $0.1 million increase in deferred tax assets . SumTotal Systems has unrecognized tax benefits of approximately $0.3 million as of January 1, 2007, all of which if recognized would result in a reduction of SumTotal System’s effective tax rate. SumTotal Systems recorded no increase to its unrecognized tax benefits as of March 31, 2007. In accordance with FIN 48, paragraph 19, SumTotal Systems has decided to classify interest and penalties as a component of tax expense. Interest and penalties are immaterial at the date of adoption and are included in the unrecognized tax benefits. SumTotal Systems is subject to audit by taxing authorities for all years since inception.
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We may be limited in our use of net operating losses carry forwards.
Our ability to benefit from our deferred tax assets depends on us having sufficient future earnings to utilize our net operating loss (“NOL”) carryforwards before they expire. We have established a valuation allowance against the future tax benefit for a number of our federal and state NOL carryforwards. We could be required to record an additional valuation allowance against our foreign or U.S. deferred tax assets if market conditions change materially and, as a result, our future earnings are, or are projected to be, significantly less than we currently estimate. Our NOL carryforwards are subject to review and potential disallowance upon audit by the tax authorities of the jurisdictions where the NOLs were incurred.
As of December 31, 2006, we had federal NOL and research and development (“R&D”) tax credit carry-forwards available to offset future taxable income. Our ability to utilize net operating losses and credits may be subject to a substantial limitation due to the change in ownership, as defined in the Internal Revenue Code Section 382 and similar state provisions. The annual limitation may result in the expiration of net operating losses and credits before utilization.
We may become subject to government regulation and legal uncertainties that could result in liability or increase the cost of doing business, thereby adversely affecting our financial result.
We are not currently subject to direct regulation by any domestic or foreign governmental agency, other than regulations applicable to businesses generally, such as export control laws. However, due to the increasing popularity and use of the Internet, it is possible that a number of laws and regulations may become applicable to us or may be adopted in the future with respect to the Internet covering issues such as taxation, user privacy, content, right to access personal data, copyrights, distribution and characteristics and quality of services.
The applicability of existing laws governing issues such as taxation, property ownership, copyrights, and other intellectual property issues, encryption, libel, export or import matters and personal privacy to the Internet is uncertain. The vast majority of these laws were adopted prior to the broad commercial use of the Internet and related technologies. As a result, they do not contemplate or address the unique issues of the Internet and related technologies. Changes to these laws, including some recently proposed changes, could create uncertainty in the Internet marketplace. Such uncertainty could reduce demand for our services or increase the cost of doing business due to increased costs of litigation or increased service delivery costs.
In addition, we could be liable for the misuse of personal information. The Federal Trade Commission, the European Union and certain state and local authorities have been investigating certain Internet companies regarding their use of personal information. Further, the European Union has adopted various data protection regulations related to the confidentiality of personal data. We also, as of March 31, 2007, are not qualified for the European Union Safe Harbor which regulates the collection of personal data. Failure to comply with the various regulations could subject us to fines, and cause customers to lose confidence in our software products, thereby negatively affecting our revenue and expense
Terrorism and United States military actions may adversely affect our business.
In light of recent terrorist activity, political and military instability, and existing and possible United States military actions, significant instability and uncertainty in the world may continue to have a material adverse effect on world financial markets, including financial markets in the United States. In addition, such adverse political effects may have an adverse impact on economic conditions in the United States. Unfavorable economic conditions in the United States may have an adverse effect on our business operations including, but not limited to, our ability to expand the market for our products, obtain financing as needed, enter into strategic relationships and compete effectively in the talent and learning management markets. Such consequences may lead to a decrease in demand for our products and services and as a result our stock price may suffer.
Anti-takeover provisions in our charter documents could make the sale of the company more difficult.
Our certificate of incorporation and bylaws contain provisions that could make it harder for a third party to acquire us without the consent of our board of directors. For example, no potential acquirer would be able to call a special meeting of stockholders to remove our board of directors. A potential acquirer would also not be able to act by written consent without a meeting. In addition, our board of directors has staggered terms that make it difficult to remove all directors at once. The acquirer would also be required to provide advance notice of its proposal to remove directors at an annual meeting. The acquirer would not be able to cumulate votes at a meeting, which would require the acquirer to hold more shares to gain representation on our board of directors than if cumulative voting were permitted. In addition, our certificate of incorporation authorizes our Board of Directors, without stockholder approval, to issue up to 5,000,000 shares of undesignated preferred stock, which could be used to dilute the stock ownership of a potential hostile acquirer.
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Subject to its fiduciary duties, our board of directors may in the future adopt a stockholder rights plan. If the board adopts a stockholder rights plan, it may discourage a merger or tender offer involving our securities that is not approved by our board of directors by increasing the cost of effecting any such transaction and, accordingly, could have an adverse impact on stockholders who may want to vote in favor of such merger or participate in such tender offer.
In addition, Section 203 of the Delaware General Corporation Law limits business combination transactions with 15% stockholders that have not been approved by the issuer’s board of directors. These provisions and other similar provisions make it more difficult or impossible for a third party to acquire us without negotiation. These provisions may apply even if the offer may be considered beneficial by some stockholders.
(a) Exhibits
3.1 | Amended and Restated Certificate of Incorporation, filed with the Secretary of State of Delaware on March 18, 2004 (incorporated by reference to Form 8-K filed on March 19, 2004) | |
3.2 | Amended and Restated Bylaws (incorporated by reference to Form 8-K filed on March 19, 2004) | |
4.1 | Registration Rights Agreement dated as of November 15, 2001 by and between Click2learn and various investors (incorporated by reference to Click2learn’s Current Report on Form 8-K dated November 15, 2001) | |
4.2 | Form of Warrant to Purchase Common Stock dated as of November 20, 2001 from Click2learn to various investors (incorporated by reference to Click2learn’s Current Report on Form 8-K dated November 15, 2001) | |
4.3 | Registration Rights Agreement dated as of June 20, 2003 by and between Click2learn and various investors (incorporated by reference to Click2learn’s Current Report on Form 8-K dated June 20, 2003) | |
4.4 | Form of Warrant to Purchase Common Stock dated as June 20, 2003 from Click2learn to various investors (incorporated by reference to Click2learn’s Current Report on Form 8-K dated June 20, 2003) | |
4.5 | Registration Rights Agreement between SumTotal, Inc. and certain stockholders of Pathlore Software Corporation dated August 3, 2005 (incorporated by reference to Exhibit 4.5 to Form 10-K filed March 28, 2006) | |
10.1 | *2007 Executive and Management Bonus Plan (incorporated by reference to Exhibit 10.1 to Form 8-K filed on February 6, 2007) | |
31.1 | Certifications of Chief Executive Officer Pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.2 | Certifications of Chief Financial Officer Pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
32.1 | Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
* | Each exhibit marked with a (*) is a compensatory contract, plan or other arrangement in which one or more directors and/or executive officers are eligible to participate. |
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
SUMTOTAL SYSTEMS, INC. | ||
May 9, 2007 Date | /s/ NEIL J. LAIRD | |
Neil J. Laird | ||
Chief Financial Officer | ||
(Duly Authorized Officer and | ||
Chief Financial and Chief Accounting Officer) |
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Exhibit Index
3.1 | Amended and Restated Certificate of Incorporation, filed with the Secretary of State of Delaware on March 18, 2004 (incorporated by reference to Form 8-K filed on March 19, 2004) | |
3.2 | Amended and Restated Bylaws (incorporated by reference to Form 8-K filed on March 19, 2004) | |
4.1 | Registration Rights Agreement dated as of November 15, 2001 by and between Click2learn and various investors (incorporated by reference to Click2learn’s Current Report on Form 8-K dated November 15, 2001) | |
4.2 | Form of Warrant to Purchase Common Stock dated as of November 20, 2001 from Click2learn to various investors (incorporated by reference to Click2learn’s Current Report on Form 8-K dated November 15, 2001) | |
4.3 | Registration Rights Agreement dated as of June 20, 2003 by and between Click2learn and various investors (incorporated by reference to Click2learn’s Current Report on Form 8-K dated June 20, 2003) | |
4.4 | Form of Warrant to Purchase Common Stock dated as June 20, 2003 from Click2learn to various investors (incorporated by reference to Click2learn’s Current Report on Form 8-K dated June 20, 2003) | |
4.5 | Registration Rights Agreement between SumTotal, Inc. and certain stockholders of Pathlore Software Corporation dated August 3, 2005 (incorporated by reference to Exhibit 4.5 to Form 10-K filed March 28, 2006) | |
10.1 | *2007 Executive and Management Bonus Plan (incorporated by reference to Exhibit 10.1 to Form 8-K filed on February 6, 2007) | |
31.1 | Certifications of Chief Executive Officer Pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.2 | Certifications of Chief Financial Officer Pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
32.1 | Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
* | Each exhibit marked with a (*) is a compensatory contract, plan or other arrangement in which one or more directors and/or executive officers are eligible to participate. |
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