Item 2.02. Results of Operations and Financial Condition.
A Restatement of Our Historical Financial Statements is Highly Likely
As previously disclosed, our Board of Directors has established a Special
Committee consisting of disinterested members of the Audit Committee to conduct
an internal investigation relating to past stock option grants. Also as
previously disclosed, the Special Committee has reached a preliminary conclusion
that the actual date of determination for certain past stock option grants
differed from the stated grant date for such awards, which would result in
additional charges to our stock-based compensation expenses. The Special
Committee is continuing its investigation, and has not yet determined the exact
magnitude of the additional expenses to be incurred or the specific periods to
be affected. Based on the Special Committee's preliminary determination, we
believe, but have not yet concluded that (i) such charges are highly likely to
be material and (ii) it is highly likely that we will need to restate our
historical financial statements. To the extent a restatement is required it
would result in the accompanying financial information as presented not being
stated in accordance with Generally Accepted Accounting Principles. Based on the
definition of "material weakness" in the Public Company Accounting Oversight
Board's Auditing Standard No. 2, a restatement of financial statements in prior
filings with the Securities and Exchange Commission is a strong indicator of the
existence of a "material weakness" in the design or operation of internal
control over financial reporting. Accordingly, if a restatement is required, we
may need to conclude that we did not maintain effective controls over the
selection of accounting policies and that a material weakness may exist in our
internal control over financial reporting. As previously disclosed, we have
delayed the filing of our quarterly report on Form 10-Q for the quarter ended
June 30, 2005 until (1) the Special Committee has reported the results of its
investigation to our Board of Directors, (2) we have reached a final conclusion
as to the need to restate our historical financial statements, and (3) all
necessary restatements relating to periods covered by our Annual Report on Form
10-K for the year ended December 31, 2004 have been made. We are unable to
determine at this time when the Special Committee will report on its
investigation to our Board of Directors.
As disclosed in our August 12, 2005 press release, we are filing this Current
Report on Form 8-K to furnish information relating to Mercury's second quarter
financial results. The disclosure in this Current Report is not a substitute for
our quarterly report on Form 10-Q and the information provided should be
considered in light of the foregoing disclosure regarding the highly likely
restatement of our historical financial statements. We intend to complete any
required restatement and to file our Form 10-Q for the second quarter as soon as
practicable following the Special Committee's report to our Board of Directors.
Please also note that the financial information contained in this Current Report
does not take into account the effects of our highly likely restatement. We have
specified those line items which would likely be affected by such restatement,
should such restatement be required. We do not believe that any restatement
would have an impact on our historical revenues, cash position or non-stock
option related operating expenses.
Overview of Second Quarter Financial Results
We are the leading provider of business technology optimization (BTO) software
and services. BTO software helps our customers align information technology (IT)
and business goals while optimizing the quality, performance, and business
availability of strategic software applications and systems. We provide BTO
offerings for application delivery, application management, and IT governance.
These offerings are packaged in enterprise suites of software products and
services called Mercury Optimization Centers. Mercury Optimization Centers are
made up of integrated software, services, and best practices. Customers use our
Mercury Optimization Centers to govern the priorities, processes and people of
IT as well as test and manage the quality and performance of business-critical
applications.
We have aligned our enterprise software business model with the way we believe
customers want to license and deploy enterprise software today. We believe our
customers value a choice of perpetual, term, or subscription software licenses.
Customers have the choice between running software in-house or having software
delivered as a hosted or managed service. Mercury's enterprise software business
model enables our customers to license the right software, for the right period
of time, and have it deployed the right way-while giving Mercury the right
financial incentives to expand and/or renew our relationships with customers.
To understand our financial results, it is important to understand our business
model and its impact on the condensed consolidated statement of operations and
the condensed consolidated balance sheet. We continue to offer many of our
products on a perpetual and subscription license basis. Some of these types of
contracts are required to be recorded initially as deferred revenue in the
condensed consolidated balance sheet and then recognized in subsequent periods
over the term of the contract as subscription revenue in our condensed
consolidated statement of operations (see below under Business Model).
Therefore, to understand the full growth of our business, one must look at both
revenue and the change in deferred revenue.
Business Model
Revenue consists of fees for the license and subscription of our software
products, maintenance fees, and professional service fees. License revenue
consists of license fees charged for the use of our products under perpetual or
multiple-year arrangements in which the license fee is separately determinable
from undelivered items such as maintenance and/or professional services based on
vendor-specific objective evidence (VSOE) of fair market value. Subscription
revenue, including managed service revenue, represents fees to use one or more
software products and to receive maintenance support (such as customer support
and product updates) for a limited period of time. Since subscription licenses
include bundled products and services, which are sold as a combined offering and
for which the fair value of the license fee is not separately determinable from
maintenance, both product and service revenues are generally recognized over the
term of the subscription. Maintenance revenue consists of fees charged for
post-contract customer support, which are determinable based upon substantive
renewal rates quoted in the contracts and, in the absence of stated renewal
rates, upon the fair market value established by separate sales of renewals to
customers. Professional service revenue consists of fees charged for product
training and consulting services, the fair value of which is determinable based
upon separate sales of these services to customers without the bundling of
licenses and other services. If fair value is not established for an undelivered
element such as maintenance and professional services, all revenue from the
arrangement is recognized over the longer of the subscription term or service
term period. Payments for license and subscription of our software products and
maintenance services are generally due within 30-60 days of the invoice date,
are made in advance, and are nonrefundable. Payments for professional services
are generally due within 30-60 days of the invoice date, are made in advance or
after delivery of services, and are nonrefundable.
Due to the different revenue recognition treatment of subscription and perpetual
licenses under applicable accounting rules, each type of license has a different
impact on our condensed consolidated financial statements. When a customer
purchases a subscription license, the majority of the revenue will be recorded
as deferred revenue in our condensed consolidated balance sheet. Our customers
generally pay upfront for both perpetual and subscription licenses. The amount
recorded as deferred revenue is equal to the portion of the subscription license
fee that has been invoiced or paid but not recognized as revenue. Deferred
revenue is reduced as revenue is recognized. Under perpetual licenses (and some
multiple-year arrangements for which separate VSOE of fair value exists for
undelivered elements), license revenue is recognized in the quarter in which the
product is delivered, with only the remaining term of maintenance revenue
recorded as deferred revenue. VSOE of fair value is established by the price
charged when that element is sold separately. Therefore, an order for a
subscription license, or a perpetual license bundled with a subscription
license, will result in significantly lower current-period revenue than an
equal-sized order under a perpetual license. Conversely, an order for a
subscription license will result in higher revenues recognized in future periods
than an equal-sized order for a perpetual license. Furthermore, if a perpetual
license is sold within the same timeframe as a subscription-based license to the
same customer, then generally the two become bundled together and the related
revenue is recognized over the term of the contract.
Our product revenues in any given quarter are dependent upon the volume of
perpetual license orders delivered during the current quarter, the amount of
subscription revenue amortized from deferred revenue from prior quarters, and to
a small degree, revenue recognized on subscription orders received during the
current quarter. We set our revenue targets for any given period based, in part,
upon an assumption that we will achieve a certain level of orders and a certain
mix of perpetual licenses and subscription licenses. The mix of orders is
subject to substantial fluctuation in any given quarter or multiple quarters and
the actual mix of licenses sold affects the revenue we recognize in the period.
If we achieve the targeted level of total orders, but are unable to achieve our
targeted license mix, we may not meet our revenue targets (if we deliver
more-than-expected subscription licenses) or we may exceed them (if we deliver
more-than-expected perpetual licenses). If we achieve the targeted license mix,
but the overall level of orders is below the target, then we may not meet our
revenue targets. Conversely, if our overall level of orders is below the target,
but our license mix is above our targets (if we deliver more-than-expected
perpetual licenses), our revenues may still meet or even exceed our revenue
targets. Our ability to achieve our revenue targets is also impacted by the mix
of domestic and international sales and fluctuations in foreign currency
exchange rates. If there is an increase in the value of other currencies
relative to the U.S. dollar, our revenues and deferred revenues from
international sales may be positively impacted. On the other hand, if there is a
decrease in the value of other currencies relative to the U.S. dollar, our
revenues and deferred revenues from international sales may be negatively
impacted. In the second quarter of 2005, we did not achieve our targeted level
of overall orders, especially in our Europe, the Middle East, and Africa
geographic region, and our mix of licenses shifted to a higher amount of
perpetual licenses than in the previous quarter. Further, there was a decrease
in the value of certain other currencies relative to the U.S dollar which
negatively impacted our deferred revenues from international sales.
Cost of license and subscription includes direct costs to produce and distribute
our products, such as costs of materials, product packaging and shipping,
equipment depreciation, production personnel, and outsourcing services. It also
includes costs associated with our managed services business, including
personnel-related costs, fees to providers of Internet bandwidth and the related
infrastructure, and depreciation expense of managed services equipment. We have
not separately presented the costs associated with license and subscription
because these costs cannot be reasonably allocated between license and
subscription cost of revenue. Cost of maintenance includes direct costs of
providing customer support, largely consisting of personnel-related costs, and
the cost of providing upgrades to our customers. Cost of professional services
includes direct costs of providing product training and consulting, largely
consisting of personnel-related costs and costs of outsourcing services. License
and subscription, maintenance, and professional services costs also include
allocated facility expenses and allocated IT infrastructure expenses. Cost of
revenue also includes a portion of amortization expenses for intangible assets
associated with our current products. These amortization expenses are recorded
as "Cost of revenue-amortization of intangible assets" in our condensed
consolidated statements of operations. Please note that all of the cost lines
referred to in this paragraph do not take into account our highly likely
restatement referred to above.
Costs associated with subscription licenses, which include the cost of products
and services, are expensed as incurred over the subscription term. We defer a
portion of our sales commission expense related to subscription licenses and
maintenance contracts and amortize the expense over the term of the subscription
or maintenance contract.
Financial Results
The following table sets forth, as a percentage of total revenues, certain
condensed consolidated statements of operations data for the periods indicated.
These operating results are not necessarily indicative of the results for any
future periods.
Three months ended Six months ended
June 30, June 30,
2005 2004 2005 2004
Revenues:
License fees 38 % 38 % 37 % 38 %
Subscription fees 22 22 22 22
Total product revenues 60 60 59 60
Maintenance fees 29 30 29 30
Professional service fees 11 10 12 10
Total revenues 100 100 100 100
Costs and expenses:
Cost of license and subscription 6 6 6 6
Cost of maintenance 2 3 2 2
Cost of professional services (excluding
stock-based compensation) 11 9 11 9
Cost of revenue-amortization of
intangible assets 1 2 1 2
Marketing and selling (excluding
stock-based compensation) 43 48 43 48
Research and development (excluding
stock-based compensation) 11 11 10 11
General and administrative (excluding
stock-based compensation) 8 8 9 8
* Stock-based compensation - - - -
Integration and other related charges - 1 - 1
Amortization of intangible assets 1 - 1 -
Loss on intangible and other assets 8 - 4 -
Excess facilities charge - 6 - 3
Total costs and expenses 91 94 87 90
* Income from operations 9 6 13 10
Interest income 6 6 6 6
Interest expense (3 ) (3 ) (3 ) (3 )
Other expense, net (1 ) (1 ) (1 ) (1 )
Other income, net 2 2 2 2
* Income before provision for income
taxes 11 8 15 12
* Provision for income taxes 2 1 3 2
* Net income 9 % 7 % 12 % 10 %
* The amounts reflected for this line, for all periods presented, do not take
into account the effects of the highly likely restatement.
Certain reclassifications have been made to the condensed consolidated
statements of operations for the three and six months ended June 30, 2004
balances to conform to June 30, 2005 presentation, specifically the
reclassification of certain amortization of intangible assets to cost of
revenue. These reclassifications had an immaterial impact on the prior reported
balances and no impact on total revenues, income from operations, or net income.
Revenues
The following table summarizes revenue from license fees, subscription fees,
maintenance fees, and professional service fees for the periods indicated (in
thousands, except percentages):
Three months ended Six months ended
June 30, Increase June 30, Increase
2005 2004 $ % 2005 2004 $ %
License fees $ 79,389 $ 59,942 $ 19,447 32 % $ 150,100 $ 117,515 $ 32,585 28 %
Subscription fees 45,348 34,628 10,720 31 % 91,300 70,535 20,765 29 %
Maintenance fees 59,848 48,143 11,705 24 % 116,422 95,032 21,390 23 %
Professional service fees 22,477 16,334 6,143 38 % 48,002 32,771 15,231 46 %
$ 207,062 $ 159,047 $ 48,015 30 % $ 405,824 $ 315,853 $ 89,971 28 %
License fees
For the three months ended June 30, 2005, the increase in license fee revenue
was attributable to an increase of $9.7 million in license sales of application
management products, an increase of $9.1 million in license sales of application
delivery products, and an increase of $0.7 million in license sales of IT
governance products.
For the six months ended June 30, 2005, the increase in license fee revenue was
primarily attributable to an increase of $24.9 million in license sales of
application delivery products and an increase of $11.1 million in license sales
of application management products. The increase was partially offset by a
decrease of $3.4 million in license sales of IT governance products.
Subscription fees
For the three months ended June 30, 2005, the increase in subscription fee
revenue was attributable to an increase of $7.8 million in license sales of
application management products, an increase of $2.2 million in license sales of
application delivery products, and an increase of $0.7 million in license sales
of IT governance products.
For the six months ended June 30, 2005, the increase in subscription fee revenue
was attributable to an increase of $14.5 million in license sales of application
management products, an increase of $4.5 million in license sales of application
delivery products, and an increase of $1.8 million in license sales of IT
governance products.
Maintenance fees
The increase in maintenance fee revenue for the three and six months ended June
30, 2005 was primarily attributable to renewals of existing maintenance
contracts and sales of first year maintenance contracts for application delivery
products and maintenance fees for IT governance products.
For the three months ended June 30, 2005, the increase in maintenance fee
revenue was attributable to an increase of $8.8 million, $1.6 million, and $1.3
million in maintenance service contracts for application delivery products, IT
governance products, and application management products, respectively.
For the six months ended June 30, 2005, the increase in maintenance fee revenue
was attributable to an increase of $15.5 million, $3.5 million, and $2.4 million
in maintenance service contracts for application delivery products, IT
governance products, and application management products, respectively.
Professional service fees
For the three months ended June 30, 2005, the increase in professional service
fee revenue was primarily attributable to an increase of $3.1 million in fees
for service engagements related to application delivery products and an increase
of $2.4 million fees for service engagements related to IT governance products.
The increase was also attributable to an increase of $0.6 million associated
with application management service engagements.
For the six months ended June 30, 2005, the increase in professional service fee
revenue was primarily attributable to an increase of $8.2 million in fees for
service engagements related to application delivery products and an increase of
$5.6 million in fees for service engagements related to IT governance products.
The increase was also attributable to an increase of $1.4 million associated
with application management service engagements.
International revenues
International revenues include sales to customers located in countries in
Europe, the Middle East, and Africa (EMEA), Asia Pacific (APAC), and Japan.
International revenues also include sales to customers located in Brazil,
Canada, and Mexico, which are included in the Americas geographic region.
International revenues for the three months ended June 30, 2005, compared to the
three months ended June 30, 2004, were affected favorably by a weakening of the
U.S. dollar relative to other currencies, primarily the Euro and British Pound.
Total revenues from international sales for the three months ended June 30, 2005
were $81.3 million, an increase of $17.7 million, or 28%, from $63.6 million for
the three months ended June 30, 2004. The increase was primarily attributable to
increased sales in EMEA of $10.4 million and APAC and Japan of $3.3 million, as
well as fluctuations in foreign currency exchange rates of $2.9 million.
International revenues represented 39% and 40% of our total revenues for the
three months ended June 30, 2005 and 2004, respectively.
International revenues for the six months ended June 30, 2005, compared to the
six months ended June 30, 2004, were affected favorably by a weakening of the
U.S. dollar relative to other currencies, primarily the Euro and British Pound.
Total revenues from international sales for the six months ended June 30, 2005
were $164.7 million, an increase of $41.0 million, or 33%, from $123.7 million
for the six months ended June 30, 2004. The increase was primarily attributable
to increased sales in EMEA of $23.1 million and APAC and Japan of $9.4 million,
as well as fluctuations in foreign currency exchange rates of $6.7 million.
International revenues represented 41% and 39% of our total revenues for the six
months ended June 30, 2005 and 2004, respectively.
Cost of revenues and operating expenses
The following table summarizes cost of revenues for the periods indicated (in
thousands, except percentages):
Three months ended Six months ended
June 30, Increase June 30, Increase
2005 2004 $ % 2005 2004 $ %
Cost of license and
subscription $ 11,715 $ 9,883 $ 1,832 19 % $ 22,584 $ 19,702 $ 2,882 15 %
Cost of maintenance 4,520 3,952 568 14 % 8,762 7,544 1,218 16 %
Cost of professional services 23,013 14,855 8,158 55 % 44,085 28,398 15,687 55 %
Cost of revenue - amortization
of intangible assets 2,506 2,402 104 4 % 5,012 5,007 5 *
$ 41,754 $ 31,092 $ 10,662 34 % $ 80,443 $ 60,651 $ 19,792 33 %
Percentage of total revenues 20 % 20 % 20 % 19 %
* Percentage is less than 0.5%
Cost of license and subscription
The increase in cost of license and subscription for the three and six months
ended June 30, 2005 was primarily attributable to higher personnel-related costs
as a result of a growth in headcount and an increase in royalty expenses,
partially offset by a decrease in outsourcing expenses due to greater
utilization of internal resources and a decrease in a reliance on external
resources. To a lesser extent, the increase was also caused by additional
allocated facility expenses and allocated IT infrastructure expenses mainly as a
result of the lease for our headquarters.
For the three months ended June 30, 2005, personnel-related costs, royalty
expenses, allocated IT infrastructure expenses, and allocated facility expenses
increased by $1.1 million, $0.9 million, $0.3 million, and $0.1 million,
respectively. The increase was partially offset by a reduction in outsourcing
expenses of $0.7 million.
For the six months ended June 30, 2005, personnel-related costs, royalty
expenses, allocated IT infrastructure expenses, and allocated facility expenses
increased by $2.4 million, $1.4 million, $0.5 million, and $0.3 million,
respectively. The increase was partially offset by a reduction in outsourcing
expenses of $1.5 million.
Cost of maintenance
The increase of $0.6 million and $1.2 million in cost of maintenance for the
three and six months ended June 30, 2005, respectively, was primarily due to
higher personnel-related costs as a result of additional headcount to support
our overall growth in business.
Cost of professional services
The increase in cost of professional services for the three and six months ended
June 30, 2005 was primarily attributable to higher personnel-related costs as a
result of a growth in headcount and an increase in outsourcing expenses.
Outsourcing expenses increased due to a growth in our professional services and
our increased effort to offer more training and consulting services to customers
who license our products. The increase was also attributable to additional
allocated facility expenses and allocated IT infrastructure expenses mainly as a
result of the lease for our headquarters.
For the three months ended June 30, 2005, personnel-related costs and
outsourcing expenses increased by $4.4 million and $2.7 million, respectively.
Allocated IT facility expenses and allocated infrastructure expenses increased
by $0.6 million and $0.5 million, respectively.
For the six months ended June 30, 2005, personnel-related costs and outsourcing
expenses increased by $8.2 million and $5.9 million, respectively. Allocated
facility expenses and allocated IT infrastructure expenses increased by $1.1
million and $0.8 million, respectively.
The following table summarizes operating expenses for the periods indicated (in
thousands, except percentages):
Three months ended Six months ended
June 30, Increase/ (Decrease) June 30, Increase/ (Decrease)
2005 2004 $ % 2005 2004 $ %
Marketing and selling $ 88,588 $ 76,248 $ 12,340 16 % $ 175,507 $ 150,211 $ 25,296 17 %
Research and development 22,759 17,763 4,996 28 % 41,589 35,049 6,540 19 %
General and administrative 17,932 12,024 5,908 49 % 35,270 24,269 11,001 45 %
**Stock-based compensation 55 183 (128 ) (70 %) 172 392 (220 ) (56 %)
Integration and other
related charges - 1,131 (1,131 ) (100 %) - 2,110 (2,110 ) (100 %)
Amortization of intangible
assets 1,353 1,342 11 1 % 2,706 2,677 29 1 %
Loss on intangible and
other assets 15,998 - 15,998 * 15,998 - 15,998 *
Excess facilities charge - 9,178 (9,178 ) (100 %) - 9,178 (9,178 ) (100 %)
$ 146,685 $ 117,869 $ 28,816 24 % $ 271,242 $ 223,886 $ 47,356 21 %
Percentage of total revenues 71 % 74 % 67 % 71 %
* Percentage is not meaningful
** The amounts reflected for this line, for all periods presented, do not take
into account the effects of the highly likely restatement.
Marketing and selling
Marketing and selling expense consists of employee salaries and related costs,
sales commissions, marketing programs, sales training, allocated facility
expenses, and allocated IT infrastructure expenses. The increase in marketing
and selling expense for the three and six months ended June 30, 2005 was
primarily attributable to higher personnel-related costs due to a growth in
headcount and higher commission expense as a result of an increase in revenues.
The increase was also attributable to higher allocated facility expenses and
allocated IT infrastructure expenses mainly as a result of the lease for our
headquarters. The increase was partially offset by a decrease in spending on
marketing programs.
For the three months ended June 30, 2005, personnel-related costs, commission
expense, allocated IT infrastructure expenses, and allocated facility expenses
increased by $7.9 million, $3.4 million, $1.4 million, and $1.0 million,
respectively. The increase for the three months ended June 30, 2005 was
partially offset by a decrease of $1.3 million in other sales and marketing
related activities.
For the six months ended June 30, 2005, personnel-related costs, commission
expense, allocated IT infrastructure expenses, and allocated facility expenses
increased by $15.5 million, $4.8 million, $2.5 million, and $2.3 million,
respectively. The increase for the six months ended June 30, 2005 was partially
offset by a decrease of $0.7 million in other sales and marketing related
activities.
Research and development
Research and development expense associated with the development of new
products, enhancements of existing products, and quality assurance procedures
consists of employee salaries and related costs, consulting costs, equipment
depreciation, allocated facility expenses, and allocated IT infrastructure
expenses.
For the three months ended June 30, 2005, the increase in research and
development expense was primarily attributable to higher personnel-related costs
of $3.2 million as a result of a growth in headcount. The increase was also
attributable to higher allocated IT infrastructure expenses of $0.6 million and
higher allocated facility expenses of $0.5 million. The increase in these
allocated expenses was mainly as a result of the lease for our headquarters. The
increase was also attributable to a devaluation of the U.S. dollar relative to
the Israeli Shekel of $0.5 million as a substantial portion of our research and
development expenses were incurred in Israeli Shekel.
For the six months ended June 30, 2005, the increase in research and development
expense was primarily attributable to higher personnel-related costs of $3.7
million as a result of a growth in headcount. The increase was also attributable
to higher allocated IT infrastructure expenses of $0.8 million and higher
allocated facility expenses of $0.8 million. The increase in these allocated
expenses was mainly as a result of the lease for our headquarters. The increase
was also attributable to a devaluation of the U.S. dollar relative to the
Israeli Shekel of $1.0 million as a substantial portion of our research and
development expense was incurred in Israeli Shekel.
General and administrative
General and administrative expense consists of employee salaries and related
costs associated with administration and management, allocated facility
expenses, and allocated IT infrastructure expenses. It also consists of fees for
audit, tax, legal, and consulting services with a significant portion related to
compliance with Section 404 of the Sarbanes-Oxley Act of 2002.
For the three months ended June 30, 2005, the increase in general and
administrative expenses was primarily attributable to higher personnel-related
costs of $3.0 million as a result of a growth in headcount. Additional expenses
of $1.3 million were also incurred for tax and other consulting services, of
which $0.5 million related to projects for compliance with Section 404 of the
Sarbanes-Oxley Act of 2002. For the three months ended June 30, 2005, the
increase was also attributable to $0.9 million of legal and consulting service
fees related to an informal inquiry initiated by the Securities and Exchange
Commission (SEC) and an internal investigation conducted by a Special Committee
relating to our past stock option grants. The Special Committee, consisting of
disinterested members of the Audit Committee, was established by our Board of
Directors in response to this informal inquiry by the SEC.
For the six months ended June 30, 2005, the increase in general and
administrative expenses was primarily attributable to higher personnel-related
costs of $5.3 million as a result of a growth in headcount. Additional expenses
of $3.7 million were also incurred for tax and other consulting services, of
which $1.5 million related to projects for compliance with Section 404 of the
Sarbanes-Oxley Act of 2002. For the six months ended June 30, 2005, the increase
was also attributable to $0.9 million of legal and consulting service fees
related to the informal inquiry initiated by the SEC and the Special Committee
investigation as described above.
Integration and other related charges
Integration and other related charges for the three and six months ended June
30, 2004 were attributable to a milestone bonus plan related to certain research
and development activities associated with the acquisition of Performant in
2003. The plan entitled each eligible employee to receive bonuses, in the form
of cash payments, based on the achievement of certain performance milestones by
applicable target dates. The commitment was earned over time as milestones were
achieved and expensed as a charge to the condensed consolidated statement of
operations. The final payments were made in the fourth quarter of 2004. Total
payments made under the plan were $5.2 million.
Amortization of intangible assets
The increase in amortization of intangible assets was primarily due to a full
period of amortization of intangible assets related to the acquisition of
Appilog in July 2004.
Intangible assets are amortized on a straight-line basis over their useful lives
or based on actual usage, whichever best represents the distribution of the
economic value of the intangible assets.
The following table summarizes amortization of intangible assets related to our
current products that are recorded as costs of revenue for the periods indicated
(in thousands):
Three Months ended Six Months ended
June 30, June 30,
2005 2004 2005 2004
Cost of license and subscription $ 2,192 $ 2,148 $ 4,383 $ 4,498
Cost of maintenance 314 254 629 509
$ 2,506 $ 2,402 $ 5,012 $ 5,007
Loss on intangible and other assets
Loss on intangible and other assets for the three and six months ended June 30,
2005 was related to our write-off of prepaid Motive royalties for $15.0 million,
maintenance and support services associated with the technology licensed from
Motive for $0.4 million, and an impairment loss associated with a technology
purchased from Allerez for $0.6 million.
During the second quarter of 2005, as part of our review of our operational
effectiveness and to better align our people, resources, and assets with our new
business objectives, management decided to discontinue efforts to develop the
technology we licensed from Motive. This decision to discontinue the development
project triggered an impairment review of the prepaid Motive royalties of $15.0
million. The licensed technology was originally intended to be combined with our
existing products, which were expected to be available in early 2006. Based upon
management's decision to discontinue development efforts of the Motive
technology, combined with the fact that Motive-based products had not yet been
available for sale, there are no projected revenues or cash flows associated
with the Motive technology. Since we have determined that we have no alternative
use for the licensed technology, the prepaid royalties were not recoverable and
were charged to expense. In conjunction with the license agreement with Motive,
we also have a commitment to pay an additional $0.4 million on December 31, 2005
for continued maintenance and support services for the Motive licensed
technology for which we do not expect to realize any benefits. As such, we
recorded a charge of $0.4 million in the second quarter of 2005 associated with
this commitment.
The impairment loss associated with a technology purchased from Allerez was also
attributable to our review of our operational effectiveness during the second
quarter of 2005. In an effort to better align our people, resources, and assets
with our new business objectives, management decided to discontinue selling
products with the purchased technology. The related maintenance renewal
offerings will also be discontinued. We estimated the fair value of the acquired
technology using the discounted cash flow method. Based on our impairment
review, we reduced the carrying value of the intangible asset to nil resulting
in an impairment loss of $0.6 million.
Other income (expense)
The following table summarizes other income (expense) for the periods indicated
(in thousands, except percentages):
Increase/ (Decrease) Increase
Three months ended -------------------------- Six months ended ------------
June 30, in in June 30, in in
2005 2004 $ % 2005 2004 $ %
Interest income $ 12,632 $ 9,803 $ 2,829 29 % $ 23,490 $ 19,063 $ 4,427 23 %
Interest expense (6,289 ) (4,811 ) 1,478 31 % (12,152 ) (9,622 ) 2,530 26 %
Other expense, net (1,454 ) (1,640 ) (186 ) (11 %) (3,203 ) (2,845 ) 358 13 %
$ 4,889 $ 3,352 $ 1,537 46 % $ 8,135 $ 6,596 $ 1,539 23 %
Percentage of total revenues 2 % 2 % 2 % 2 %
Interest income
The increase in interest income was attributable to an improvement in the
average yields of our investments during the three and six months ended June 30,
2005.
Interest expense
Interest expense for the three and six months ended June 30, 2005 and 2004
primarily consisted of interest expense associated with the interest rate swap
and the 4.75% Convertible Subordinated Notes due July 2007 (2000 Notes) which we
issued in July 2000. The increase in interest expense in the second quarter of
2005 was due to an increase in the London Interbank Offering Rate (LIBOR)
associated with our interest rate swap agreement.
In 2002, we entered into an interest rate swap with Goldman Sachs Capital
Markets, L.P. The interest rate swap is designated as an effective hedge of the
change in the fair value attributable to the London Interbank Offering Rate
(LIBOR) with respect to $300.0 million of our 2000 Notes. The objective of the
swap is to convert the 4.75% fixed interest rate on the 2000 Notes to a variable
interest rate based on the 3-month LIBOR plus 48.5 basis points. The interest
rate swap qualifies for hedge accounting treatment in accordance with Statement
of Financial Accounting Standard No. 133, Accounting for Derivative Instruments
and Hedging Activities and the related amendment.
Other expense, net
Other expense, net primarily consists of net gains or losses on investments in
non-consolidated companies and a warrant to purchase common stock of Motive,
amortization of debt issuance costs associated with the issuance of our Zero
Coupon Senior Convertible Notes due 2008 (2003 Notes) and 2000 Notes, and
foreign currency gains or losses.
The increase in other expense, net for the six months ended June 30, 2005, was
primarily attributable to an increase in foreign currency loss from
remeasurement of intercompany balances of $1.2 million, partially offset by a
gain on investment of $1.0 million.
Second Quarter Un-audited Financial Statements
The following un-audited financial statements are those included in our press
release dated July 28, 2005, and do not take into account the effects of our
highly likely restatement described above.
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