FORM 10-Q/A

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 


 

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

 

For the quarterly period ended October 31, 2005

 

OR

 

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

 

For the transition period from          to

 


 

Commission File Number  0-21709

 

INTELLISYNC CORPORATION

(Exact name of Registrant as specified in its charter)

 

Delaware

 

77-0349154

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification Number)

 

2550 North First Street, San Jose, California 95131

(Address of principal executive office and zip code)

 

(408) 321-7650

 (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  ý  No  o

 

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes  ý  No  o

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). 

Yes  o  No  ý

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of December 8, 2005: 67,557,940

 

 



EXPLANATORY NOTE

 

                      This Quarterly Report on Form 10-Q/A (“Form 10-Q/A”) is being filed as Amendment No. 1 to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended October 31, 2005 , which was filed with the Securities and Exchange Commission (“SEC”) on December 12, 2005 (the “Original Filing”).  The Registrant is filing this Form 10-Q/A to: (i) provide a corrected Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 that was filed as Exhibit 31.1 to the Original Filing; (ii) provide a corrected Certificate of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 that was filed as Exhibit 31.2 to the Original Filing; (iii) provide a corrected Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 that was filed as Exhibit 32.1 to the Original Filing; (iv) provide a corrected Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 that was filed as Exhibit 32.2 to the Original Filing and (v) to modify the form to reflect that it is a Form 10-Q/A rather than a Form 10-Q.

 

                      Except for the foregoing amended information, this Form 10-Q/A continues to describe conditions as of the date of the Original Filing, and we have not updated the disclosures contained herein to reflect events that have occurred subsequent to that date. 

 



INTELLISYNC CORPORATION

 

QUARTERLY REPORT ON FORM 10-Q/A

 

INDEX

 

 

 

Page

 

 

Number

 

 

 

PART I - FINANCIAL INFORMATION

1

 

 

 

Item 1.

Unaudited Condensed Consolidated Financial Statements

1

 

 

 

 

Condensed Consolidated Balance Sheets as of

 

 

October 31, 2005 and July 31, 2005

1

 

Condensed Consolidated Statements of Operations for the

 

 

three months ended October 31, 2005 and 2004

2

 

Condensed Consolidated Statements of Cash Flows for the

 

 

three months ended October 31, 2005 and 2004

3

 

 

 

 

Notes to Unaudited Condensed Consolidated Financial Statements

4

 

 

 

Item 2.

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

25

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

56

 

 

 

Item 4.

Controls and Procedures

57

 

 

 

PART II - OTHER INFORMATION

58

 

 

 

Item 1.

Legal Proceedings

58

 

 

 

Item 2.

Changes in Securities and Use of Proceeds

58

 

 

 

Item 3.

Defaults Upon Senior Securities

58

 

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

58

 

 

 

Item 5.

Other Information

59

 

 

 

Item 6.

Exhibits

59

 

 

 

SIGNATURE

 

60

 

 

 

EXHIBIT INDEX

 

 

 



 

INTELLISYNC CORPORATION

 

PART I - FINANCIAL INFORMATION

 

Item 1.           Unaudited Condensed Consolidated Financial Statements

 

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)

(Unaudited)

 

 

 

October 31,

 

July 31,

 

 

 

2005

 

2005

 

 

 

 

 

 

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

19,246

 

$

19,533

 

Short-term investments

 

16,448

 

19,319

 

Accounts receivable, net of allowance for doubtful accounts of $402 and $564

 

14,122

 

13,682

 

Inventories

 

41

 

46

 

Other current assets

 

2,632

 

3,190

 

 

 

 

 

 

 

Total current assets

 

52,489

 

55,770

 

 

 

 

 

 

 

Property and equipment, net

 

3,517

 

3,028

 

Goodwill

 

68,494

 

68,474

 

Other intangible assets, net

 

23,647

 

25,946

 

Restricted cash

 

4,891

 

4,306

 

Other assets

 

3,099

 

3,269

 

Total assets

 

$

156,137

 

$

160,793

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

2,295

 

$

2,584

 

Accrued liabilities

 

7,411

 

7,569

 

Current portion of obligations under capital lease

 

154

 

153

 

Deferred revenue

 

7,608

 

7,396

 

 

 

 

 

 

 

Total current liabilities

 

17,468

 

17,702

 

 

 

 

 

 

 

Obligations under capital lease

 

173

 

206

 

Long term deferred revenue

 

614

 

228

 

Convertible senior notes

 

56,963

 

57,531

 

Other liabilities

 

3,457

 

2,915

 

 

 

 

 

 

 

Total liabilities

 

78,675

 

78,582

 

 

 

 

 

 

 

Commitments and contingencies (Note 7)

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, $0.001 par value; 2,000 shares authorized; none issued and outstanding at October 31, 2005 and July 31, 2005

 

 

 

Common stock, $0.001 par value; 160,000 shares authorized; 67,281 and 66,639 shares issued and outstanding at October 31, 2005 and July 31, 2005

 

67

 

67

 

Additional paid-in capital

 

230,280

 

227,014

 

Accumulated deficit

 

(152,544

)

(144,530

)

Accumulated other comprehensive loss

 

(341

)

(340

)

Total stockholders’ equity

 

77,462

 

82,211

 

Total liabilities and stockholders’ equity

 

$

156,137

 

$

160,793

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

1



 

INTELLISYNC CORPORATION

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

 

 

 

Three Months Ended
October 31,

 

 

 

2005

 

2004

 

 

 

 

 

 

 

Revenue

 

 

 

 

 

License

 

$

10,265

 

$

7,825

 

Services

 

6,080

 

4,477

 

Total revenue

 

16,345

 

12,302

 

 

 

 

 

 

 

Cost and operating expenses:

 

 

 

 

 

Cost of revenue

 

3,073

 

2,341

 

Amortization of developed and core technology

 

1,257

 

1,156

 

Research and development

 

4,981

 

3,329

 

Sales and marketing

 

8,583

 

5,589

 

General and administrative

 

4,201

 

2,049

 

Amortization of other intangibles

 

1,048

 

1,046

 

Restructuring and merger charges

 

606

 

 

Total cost and operating expenses

 

23,749

 

15,510

 

Operating loss

 

(7,404

)

(3,208

)

Other expense, net:

 

 

 

 

 

Interest income

 

310

 

236

 

Interest expense

 

(563

)

(240

)

Other, net

 

(250

)

(179

)

Total other expense, net

 

(503

)

(183

)

 

 

(7,907

)

(3,391

)

Provision for income taxes

 

(107

)

(115

)

Net loss

 

$

(8,014

)

$

(3,506

)

 

 

 

 

 

 

Basic and diluted net loss per common share

 

$

(0.12

)

$

(0.05

)

 

 

 

 

 

 

Shares used in computing basic and diluted net loss per common share

 

66,981

 

64,418

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

2



 

INTELLISYNC CORPORATION

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

 

 

Three Months Ended
October 31,

 

 

 

2005

 

2004

 

Cash flows from operating activities:

 

 

 

 

 

Net loss

 

$

(8,014

)

$

(3,506

)

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

 

 

 

 

 

Allowance for doubtful accounts

 

(162

)

61

 

Depreciation

 

391

 

278

 

Amortization of other intangibles

 

2,305

 

2,202

 

Amortization of debt issuance costs

 

164

 

159

 

Non-cash stock compensation expense (reversal)

 

2,231

 

(65

)

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(278

)

(540

)

Inventories

 

5

 

16

 

Other current assets

 

644

 

831

 

Accounts payable

 

(289

)

891

 

Accrued liabilities

 

(184

)

(1,179

)

Deferred revenue

 

598

 

(246

)

Net cash used in operating activities

 

(2,589

)

(1,098

)

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchase of property and equipment

 

(880

)

(755

)

Purchase of short term investments

 

(192

)

(1,028

)

Proceeds from the sales of short-term investments

 

2,280

 

500

 

Proceeds from the maturities of short-term investments

 

800

 

1,000

 

(Increase) decrease in restricted cash

 

(685

)

416

 

Net cash provided by investing activities

 

1,323

 

133

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Debt issuance costs

 

 

(89

)

Principal payments on capital leases

 

(32

)

(24

)

Proceeds upon exercise of stock options

 

681

 

161

 

Proceeds from ESPP shares issued

 

354

 

300

 

Net cash provided by financing activities

 

1,003

 

348

 

 

 

 

 

 

 

Effect of exchange rate changes on cash and cash equivalents

 

(24

)

105

 

 

 

 

 

 

 

Net decrease in cash and cash equivalents

 

(287

)

(512

)

Cash and cash equivalents at beginning of period

 

19,533

 

12,991

 

Cash and cash equivalents at end of period

 

$

19,246

 

$

12,479

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

3



 

INTELLISYNC CORPORATION

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1  The Company and a Summary of its Significant Accounting Policies

 

The Company

 

Intellisync Corporation (Intellisync or the “Company”) develops, markets and supports desktop, enterprise and mobile carrier-class software that enables consumers, business executives and information technology professionals to extend the capabilities of enterprise groupware and vertical applications, data-enabled mobile devices and other personal communication platforms.  The primary software applications the Company has developed and marketed include push-email, data synchronization and systems management software.  The Company’s software also enables organizations to search, find, match and synchronize identity data within their computer systems and network databases.

 

On November 15, 2005, the Company entered into a merger agreement with Nokia Inc., a Delaware corporation.  Refer to Note 13 – Subsequent Events for more details.

 

Liquidity and Capital Resources

 

The Company has incurred losses and negative cash flows since inception.  The Company incurred a net loss of approximately $8,014,000 and negative cash flows from operations of approximately $2,589,000 for the three months ended October 31, 2005.  The Company’s cash balances may decline further, although the Company believes that the effects of its strategic actions implemented to improve revenue as well as control costs along with existing cash resources will be adequate to fund its operations for at least the next 12 months.  Failure to generate sufficient revenues or control spending could adversely affect the Company’s ability to achieve its business objectives.

 

Basis of Presentation and Consolidation

 

The accompanying condensed consolidated financial statements of Intellisync as of October 31, 2005 and for the three months ended October 31, 2005 are unaudited and reflect all normal recurring adjustments which are, in the opinion of management, necessary for the fair statement of such financial statements.  These condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended July 31, 2005.  The condensed consolidated balance sheet as of July 31, 2005 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.  The results of operations for the interim period ended October 31, 2005 are not necessarily indicative of results to be expected for the full year.

 

The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries.  All significant inter-company balances and transactions have been eliminated in consolidation. 

 

Use of Estimates and Assumptions

 

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company 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 condensed consolidated financial statements and the reported amounts of revenue and expenses during the reporting period.  On an on-going basis, the Company evaluates its estimates, including those related to provision for doubtful accounts, channel inventory and product returns, valuation of goodwill and intangibles, investments and other long-lived assets, restructuring accruals, valuation of income taxes, license and services revenue recognition, contingencies and stock-based compensation.  The Company bases its estimates on various factors and information

 

4



 

which may include, but are not limited to, history and prior experience, experience of other enterprises in the same industry, new related events, current economic conditions and information from third party professionals that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from these estimates under different assumptions or conditions.

 

Revenue Recognition

 

Revenue is derived from software licenses and related services, which include implementation and integration of software solutions, post contract support, training, hosting and consulting. 

 

Transactions involving the sale of software products are accounted for under the American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) No. 97-2, “Software Revenue Recognition,” as amended by SOP No. 98-9, “Modification of 97-2, Software Revenue Recognition with Respect to Certain Transactions.”  For contracts with multiple elements, and for which vendor-specific objective evidence of fair value for the undelivered elements exists, revenue is recognized for the delivered elements based upon the residual contract value as prescribed by SOP No. 98-9.  The Company has accumulated relevant information from contracts to use in determining the availability of vendor-specific objective evidence and believes that such information complies with the criteria established in SOP No. 97-2 as follows:

 

                  Customers are required to pay separately for maintenance.  Optional stated future renewal rates are included as a term of the contracts. The Company uses the renewal rate as vendor-specific objective evidence of fair value for maintenance. 

 

                  The Company charges standard hourly rates for consulting services, when such services are sold separately, based upon the nature of the services and experience of the professionals performing the services.

 

                  For training, the Company charges standard rates for each course based upon the duration of the course, and such courses are separately priced in contracts. The Company has a history of selling such courses separately.

 

Revenue from license fees is recognized when persuasive evidence of an arrangement exists, delivery of the product has occurred, no significant Company obligations with regard to implementation or integration exist, the fee is fixed or determinable and collectibility is probable. Arrangements for which the fees are not deemed probable for collection are recognized upon cash collection.  Payments from customers received in advance of revenue recognition are recorded as deferred revenue.

 

Service revenue primarily comprises revenue from consulting fees, maintenance contracts, training and hosting fees.  Service revenue from consulting, hosting and training is recognized as the service is performed.  Maintenance contracts include the right to unspecified upgrades and ongoing support.  Maintenance revenue is deferred and recognized ratably as services are provided over the maintenance period.

 

License and service revenue on contracts involving significant implementation, customization or services, that are essential to the functionality of the software is recognized over the period of each engagement, primarily using the percentage-of-completion method. Costs incurred are generally used as the measure of progress towards completion as prescribed by SOP No. 81-1, “Accounting for Performance of Construction-Type and Certain Product-Type Contracts.” Revenue for these arrangements is classified as license revenue and service revenue based upon estimates of fair value for each element, and the revenue is recognized based on the percentage-of-completion ratio for the arrangement. A provision for estimated losses on engagements is made in the period in which the loss becomes probable and can be reasonably estimated. The Company considers a project completed when all contractual obligations have been met (generally the go live date).

 

The Company currently licenses its products directly to individuals, small businesses and corporations, to original equipment manufacturers, or OEMs, and to distributors and value-added resellers in North America, Europe, the Asia-Pacific region, South America and Africa. Revenue from products distributed indirectly through major

 

5



 

distributors and resellers is recognized on a sell through basis. Agreements with the Company’s major distributors and resellers contain specific product return privileges for stock rotation and obsolete products that are generally limited to contractual amounts. Reserves for estimated future returns are provided for upon revenue recognition. Product returns are recorded as a reduction of revenue. Accordingly, the Company has established a product returns reserve composed of 100% of product inventories held at the Company’s distribution partners, as well as an estimated amount for returns from customers of the distributors and other resellers as a result of stock rotation and obsolete products. Such reserves are based on:

 

                  historical product returns and inventory levels on a product by product basis;

                  current inventory levels and sell through data on a product by product basis as reported by the Company’s major distributors worldwide;

                  demand forecast by product in each of the principal geographic markets, which is impacted by the Company’s product release schedule, seasonal trends and analyses developed by the Company’s internal sales and marketing group; and

                  general economic conditions.

 

The Company licenses rights to use its technology portfolio, whereby licensees, particularly OEMs, typically pay a non-refundable license fee in one or more installments and on-going royalties based on their sales of products incorporating the Company’s technology.  Revenue from OEMs under minimum guaranteed royalty arrangements, which are not subject to future obligations, is recognized when such royalties are earned and become payable.  Royalty revenue is recognized as earned when reasonable estimates of such amounts can be made. Royalty revenue that is subject to future obligations is recognized when such obligations are fulfilled.  Royalty revenue that exceeds minimum guarantees is recognized in the period earned. 

 

Stock-Based Compensation Expense

 

On August 1, 2005, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004) or 123(R), “Share-Based Payment,” which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including employee stock options and employee stock purchases related to the Employee Stock Purchase Plan (“employee stock purchases”) based on estimated fair values. SFAS No. 123(R) supersedes the Company’s previous accounting under Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees” for periods beginning in fiscal 2006. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 107 relating to SFAS No. 123(R). The Company has applied the provisions of SAB No. 107 in its adoption of SFAS No. 123(R).

 

The Company adopted SFAS No. 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of August 1, 2005, the first day of the Company’s fiscal year 2006. The Company’s condensed consolidated financial statements as of and for the three months ended October 31, 2005 reflect the impact of SFAS No. 123(R). In accordance with the modified prospective transition method, the Company’s condensed consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS No. 123(R). Stock-based compensation expense recognized under SFAS No. 123(R) for the three months ended October 31, 2005 was $2,231,000 which consisted of stock-based compensation expense related to employee stock options and employee stock purchases. Stock-based compensation reversal of $65,000 for the three months ended October 31, 2004 was related to employee stock options subject to variable accounting which the Company had been recognizing under previous accounting standards. Refer to Note 8 for additional information.

 

SFAS No. 123(R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s consolidated statement of operations. Prior to the adoption of SFAS No. 123(R), the Company accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB Opinion No. 25 as allowed under SFAS No. 123, “Accounting for Stock-Based Compensation.”  Under the intrinsic value method, no stock-based compensation expense had been recognized in the Company’s consolidated statement of operations, other than as related to stock

 

6



 

options accounted for using variable accounting, because the exercise price of the Company’s stock options granted to employees and directors equaled the fair market value of the underlying stock at the date of grant.

 

Stock-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period. Stock-based compensation expense recognized in the Company’s consolidated statement of operations for the first quarter of fiscal 2006 included compensation expense for share-based payment awards granted prior to, but not yet vested as of July 31, 2005 based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS No. 123 and compensation expense for the share-based payment awards granted subsequent to July 31, 2005 based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R).  Compensation expense for all share-based payment awards are recognized using the accelerated multiple-option approach.  As stock-based compensation expense recognized in the consolidated statement of operations for the first quarter of fiscal 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. In the Company’s pro forma information required under SFAS No. 123 for the periods prior to fiscal 2006, the Company accounted for forfeitures as they occurred.

 

Upon adoption of SFAS No. 123 (R), the Company continued to use the Black-Scholes option-pricing model as its method of valuation for share-based awards.  For additional information, refer to Note 8. The Company’s determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to the Company’s expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors. Option-pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions and are fully transferable. Because the Company’s employee stock options have certain characteristics that are significantly different from traded options, and because changes in the subjective assumptions can materially affect the estimated value, in management’s opinion, the existing valuation models may not provide an accurate measure of the fair value of the Company’s employee stock options. Although the fair value of employee stock options is determined in accordance with SFAS No. 123(R) and SAB No. 107 using an option-pricing model, that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.

 

Note 2  Recently Issued Accounting Pronouncements

 

Share-Based Payment

 

In September 2005, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) No. FAS 123(R)-1, “Classification and Measurement of Freestanding Financial Instruments Originally Issued in Exchange for Employee Services under FASB Statement No. 123(R),” to defer the requirement of SFAS No. 123(R) that a freestanding financial instrument originally subject to SFAS No. 123(R) becomes subject to the recognition and measurement requirements of other applicable GAAP when the rights conveyed by the instrument to the holder are no longer dependent on the holder being an employee of the entity. The rights under stock-based payment awards the Company issued to its employees are all dependent on the recipient being an employee of Intellisync. Therefore, this FSP currently does not have an impact on the Company’s consolidated financial statements and its measurement of stock-based compensation in accordance with SFAS No. 123(R).

 

In October 2005, the FASB issued FSP No. FAS 123(R)-2, “Practical Accommodation to the Application of Grant Date as Defined in FASB Statement No. 123(R),” to provide guidance on determining the grant date for an award as defined in SFAS No. 123(R). This FSP stipulates that assuming all other criteria in the grant date definition are met, a mutual understanding of the key terms and conditions of an award to an individual employee is presumed to exist upon the award’s approval in accordance with the relevant corporate governance requirements, provided that the key terms and conditions of an award (a) cannot be negotiated by the recipient with the employer because the award is a unilateral grant, and (b) are expected to be communicated to an individual recipient within a relatively short time period from the date of approval. The Company has applied the principles set forth in this FSP upon its adoption of SFAS No. 123(R).

 

7



 

Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143

 

In March 2005, the FASB issued Interpretation (FIN) No. 47, “Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143, ‘Accounting for Asset Retirement Obligations.’ ”  FIN No. 47 clarifies when an entity would be required to recognize a liability for the fair value of an asset retirement obligation that is conditional on a future event if the liability’s fair value can be reasonably estimated. Uncertainty surrounding the timing and method of settlement that may be conditional on events occurring in the future would be factored into the measurement of the liability rather than the recognition of the liability.  FIN No. 47 is effective no later than the end of fiscal years ending after December 15, 2005.  The Company does not expect the adoption of this statement will have a material impact on its financial statements.

 

Accounting Changes and Error Corrections

 

In June 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections,” which replaces APB Opinion No. 20, “Accounting Changes,” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements.” SFAS No. 154 changes the requirements for the accounting and reporting of a change in accounting principle. APB Opinion No. 20 previously required that most voluntary changes in an accounting principle be recognized by including the cumulative effect of the new accounting principle in net income of the period of the change. SFAS No. 154 now requires retrospective application of changes in an accounting principle to prior period financial statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The Statement is effective for fiscal years beginning after December 15, 2005. The Company does not expect the adoption of this statement on August 1, 2006 will have a material impact on its financial statements.

 

Other-Than-Temporary Impairment

 

In June 2005, the FASB decided not to provide additional guidance on the meaning of other-than-temporary impairment, and directed the staff to issue proposed FSP EITF 03-1-a, “Implementation Guidance for the Application of Paragraph 16 of EITF Issue No. 03-1,” as final. The final FSP will supersede EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” and EITF Topic No. D-44, “Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value.” The final FSP (retitled FSP FAS No. 115-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”) will replace the guidance set forth in paragraphs 10-18 of EITF No. 03-1 with references to existing other-than-temporary impairment guidance, such as SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” SEC SAB No. 59, “Accounting for Noncurrent Marketable Equity Securities,” and APB Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock.  FSP FAS No. 115-1 will codify the guidance set forth in EITF Topic D-44 and clarify that an investor should recognize an impairment loss no later than when the impairment is deemed other than temporary, even if a decision to sell has not been made. FSP FAS No. 115-1 will be effective for other-than-temporary impairment analysis conducted in periods beginning after September 15, 2005.  The Company does not believe the adoption of FSP FAS No. 115-1 will have a significant impact on its consolidated results of operations or financial position.

 

Amortization Period for Leasehold Improvements

 

In June 2005, the EITF reached a consensus on Issue No. 05-06, “Determining the Amortization Period for Leasehold Improvements.”  The guidance requires that leasehold improvements acquired in a business combination or purchased subsequent to the inception of a lease be amortized over the lesser of the useful life of the assets or a term that includes renewals that are reasonably assured at the date of the business combination or purchase. The guidance is effective for periods beginning after June 29, 2005. The adoption of this guidance did not and is not expected to have an impact on the Company’s financial position, results of operations or cash flows.

 

8



 

Rental Costs Incurred during a Construction Period

 

On October 6, 2005, the FASB issued FSP No. 13-1, “Accounting for Rental Costs Incurred during a Construction Period.”  FSP No. 13-1 requires that rental costs associated with ground or building operating leases that are incurred during a construction period be recognized as rental expense.  FSP No. 13-1 is effective for the first reporting period after December 15, 2005.  The Company has historically expensed rental costs incurred during a construction period; therefore, the adoption of this guidance will not have an impact on its net earnings, cash flows or financial position.

 

Note 3  Balance Sheets Components

 

Inventories consist of the following (in thousands):

 

 

 

October 31, 2005

 

July 31,
2005

 

Raw materials

 

$

35

 

$

11

 

Finished goods and work-in-process

 

6

 

35

 

Inventories

 

$

41

 

$

46

 

 

Note 4  Acquisitions

 

During fiscal 2005, the Company acquired PDAapps, Inc. and Tourmaline Networks, Inc.  The PDAapps, and Tourmaline transactions were accounted for as business combinations pursuant to SFAS No. 141, “Business Combinations.” 

 

PDAapps, Inc.

 

On June 23, 2005, the Company completed its acquisition of all of the issued and outstanding stock of PDAapps, Inc., makers of Intellisync IM (formerly VeriChat), the mobile instant messaging solution for all Palm OS devices, Pocket PC devices, Symbian devices and RIM Blackberry devices.  Under the terms of an Agreement and Plan of Merger, dated as of June 23, 2005, the outstanding shares of PDAapps common stock were converted into the right to receive (i) an aggregate of approximately $4,000,000 in aggregate initial cash consideration and (ii) an aggregate of up to $2,600,000 in cash earnout consideration (based on future revenue generated by the Company from the former PDAapps client base), subject to the deposit of $1,000,000 in escrow to be available to compensate Intellisync pursuant to the indemnification obligations of the holders of PDAapps common stock.  The earnout consideration, if achieved, is due and payable shortly following the first anniversary of the acquisition.  As of October 31, 2005, the Company has not accrued the contingent earnout payment amount.  Any earnout consideration paid will be recorded as additional goodwill.

 

9



 

The condensed consolidated financial statements include the results of operations of PDAapps since the date of acquisition. Under the purchase method of accounting, the total purchase price was allocated to PDAapps’ net tangible and intangible assets based upon their estimated fair value as of the acquisition date. The initial purchase price of $4,150,000 (including estimated acquisition costs of $150,000) was assigned to the fair value of the assets acquired, including the following (in thousands):

 

Tangible assets acquired

 

$

74

 

Deferred tax assets

 

976

 

Liabilities assumed

 

(337

)

Deferred tax liability assumed

 

(976

)

In-process research and development

 

220

 

Developed and core technology

 

2,320

 

Customer base

 

140

 

Covenant-not-to-compete

 

24

 

Goodwill

 

1,709

 

 

 

$

4,150

 

 

In accordance with SFAS No. 109, “Accounting for Income Taxes,” deferred tax liabilities of approximately $976,000 have been recorded for the tax effect of the amortizable intangible assets. Deferred tax assets of $976,000 have also been recorded by the Company to account for the tax effect of the Company’s net operating loss and credit carryforwards.

 

Tangible assets acquired, which includes $46,000 of cash, and liabilities assumed were valued at their respective carrying amounts as the Company believes that these amounts approximated their current fair values at the acquisition date. The valuation of identifiable intangible assets acquired was based on management’s estimates, currently available information and reasonable and supportable assumptions.  This allocation was generally based on the fair value of these assets determined using the income approach.

 

An estimate of $1,709,000 has been allocated to goodwill. Goodwill represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill is not amortized but is tested for impairment at least annually.

 

Of the total purchase price, $2,484,000 was allocated to amortizable intangibles included in the above list. The developed and core technology and customer base are being amortized in proportion with the expected cash flows to be received from the underlying assets over their estimated useful life of five and seven years, respectively.  The covenant-not-to-compete is being amortized using the straight-line method over the estimated useful life of the asset of 30 months. 

 

As of the acquisition date, technological feasibility of the in-process technology had not been established and the technology had no alternative future use. Accordingly, the Company expensed the in-process research and development at the date of the acquisition.

 

The amount of the purchase price allocated to in-process research and development was based on established valuation techniques used in the high-technology software industry. The fair value assigned to the acquired in-process research and development was determined using the income approach, which discounts expected future cash flows to present value. The key assumptions used in the valuation include, among others, expected completion date of the in-process projects identified as of the acquisition date, estimated costs to complete the projects, revenue contributions and expense projections assuming the resulting product has entered the market, and discount rate based on the risks associated with the development life cycle of the in-process technology acquired. The discount rate used in the present value calculations are normally obtained from a weighted-average cost of capital analysis, adjusted upward to account for the inherent uncertainties surrounding the successful development of the in-process research and development, the expected profitability levels of such technology, and the uncertainty of technological advances that could potentially impact the estimates. The Company assumes the pricing model for the resulting product of the

 

10



 

acquired in process research and development to be standard within its industry. The Company, however, did not take into consideration any consequential amount of expense reductions from integrating the acquired in-process technology with other existing in-process or completed technology. Therefore, the valuation assumptions do not include significant anticipated cost savings.

 

The key assumptions underlying the valuation of acquired in-process research and development from PDAapps are as follows (in thousands, except percentage):

 

Project names:  Enhanced version of VeriChat product - to feature J2ME (Java 2 Platform, Micro Edition) and IMode support, presence manager (uses phone state to dictate the status of a user so others can decide if they should send an instant messaging (IM) or place a call), secure enterprise chat and carrier branded chat

Percent completed as of acquisition date: 30-50%

Estimated costs to complete technology at acquisition date: $900

Risk-adjusted discount rate: 25%

First period expected revenue: 2nd quarter of calendar year 2006

 

The development of the above technology remains highly dependent on the remaining efforts to achieve technical viability, rapidly changing customer markets, uncertain standards for a new product, and significant competitive threats from several companies.  The nature of the efforts to develop this technology into a commercially viable product consists primarily of planning, designing, experimenting, and testing activities necessary to determine that the technology can meet market expectations, including functionality and technical requirements. Failure to bring the product to market in a timely manner could result in a loss of market share or a lost opportunity to capitalize on emerging markets, and could have a material adverse impact on the Company’s business and operating results.

 

Subsequent to the acquisition of PDAapps, there have been no significant developments related to the current status of the acquired in-process research and development project that would result in material changes to the assumptions.

 

Tourmaline Networks, Inc.

 

On March 1, 2005, the Company completed its acquisition of all of the issued and outstanding stock of Tourmaline Networks, Inc., a privately held developer and marketer of mobile email based on QUALCOMM’s BREW® solution headquartered in San Diego, California.  Under the terms of an Agreement and Plan of Merger, dated as of February 9, 2005, the outstanding shares of Tourmaline common stock were converted into the right to receive (i) an aggregate of approximately $4,118,000 in aggregate initial cash consideration and (ii) an aggregate of up to $2,881,918 in cash earnout consideration (based on future revenue generated by the Company from the former Tourmaline client base), subject to the deposit of a certain portion of the initial cash consideration and earnout consideration in escrow to be available to compensate Intellisync pursuant to the indemnification obligations of the holders of Tourmaline common stock.  The earnout consideration, if achieved, is due and payable shortly following the first anniversary of the acquisition.  As of October 31, 2005, the Company has not accrued the contingent earnout payment amount.  Any earnout consideration paid will be recorded as additional goodwill.

 

11



 

The condensed consolidated financial statements include the results of operations of Tourmaline since the date of acquisition. Under the purchase method of accounting, the total purchase price was allocated to Tourmaline’s net tangible and intangible assets based upon their estimated fair value as of the acquisition date. The initial purchase price of $4,218,000 (including estimated acquisition costs of $100,000) was assigned to the fair value of the assets acquired, including the following (in thousands):

 

Tangible assets acquired

 

$

478

 

Deferred tax assets

 

803

 

Liabilities assumed

 

(275

)

Deferred tax liability assumed

 

(803

)

Developed and core technology

 

800

 

Customer base

 

1,443

 

Goodwill

 

1,772

 

 

 

$

4,218

 

 

In accordance with SFAS No. 109, “Accounting for Income Taxes,” deferred tax liabilities of approximately $803,000 have been recorded for the tax effect of the amortizable intangible assets. Deferred tax assets of $803,000 have also been recorded by the Company to account for the tax effect of the Company’s net operating loss and credit carryforwards.

 

Tangible assets acquired, which includes $23,000 of cash, and liabilities assumed were valued at their respective carrying amounts as the Company believes that these amounts approximated their current fair values at the acquisition date. The valuation of identifiable intangible assets acquired was based on management’s estimates, currently available information and reasonable and supportable assumptions.  This allocation was generally based on the fair value of these assets determined using the income approach.

 

An estimate of $1,772,000 has been allocated to goodwill. Goodwill represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill will not be amortized but will be tested for impairment at least annually.

 

Of the total purchase price, $2,243,000 was allocated to amortizable intangibles included in the above list. The amortizable intangible assets are being amortized using an accelerated method according to the expected cash flows to be received from the underlying assets over their respective estimated useful life of three to six years.

 

Unaudited Pro Forma Consolidated Combined Results

 

The following unaudited pro-forma consolidated financial information reflects the results of operations for the three months ended October 31, 2004, as if Tourmaline acquisition had occurred on August 1, 2004 and after giving effect to purchase accounting adjustments. The effect of PDAapps’ acquisition has been excluded from the pro forma financial information as amounts are considered immaterial to the Company.  Since the acquisitions took place in fiscal 2005, the results of operations of PDAapps and Tourmaline are included in the Company’s condensed consolidated results of operations for the three months ended October 31, 2005.

 

12



 

These pro forma results have been prepared for comparative purposes only and do not purport to be indicative of what operating results would have been had the acquisitions in aggregate actually taken place on August 1, 2004. In addition, these results are not intended to be a projection of future results and do not reflect any synergies that might be achieved from the combined operation (in thousands, except per share data):

 

 

 

Three Months Ended
October 31, 2004

 

 

 

 

 

Pro forma revenue

 

$

12,660

 

 

 

 

 

Pro forma net loss

 

$

(3,576

)

 

 

 

 

Pro forma basic and diluted net loss per common share

 

$

(0.06

)

 

The effect of the in-process research and development charges has been excluded in the above unaudited pro forma consolidated financial information as they represent non-recurring charges directly related to the acquisitions.

 

Note 5  Related Party Transactions

 

On August 29, 2005, the Company entered into a severance agreement and mutual release with its Chief Strategy Officer, Steve Goldberg, in connection with Mr. Goldberg’s resignation from employment by the Company effective August 31, 2005. Pursuant to the terms of the agreement, Mr. Goldberg receives, among other items, a lump sum payment of $110,000, twelve months of accelerated vesting of his options to purchase shares of the Company’s common stock, the right to exercise his vested options until six months following his termination date and six months of COBRA premiums paid by the Company. The agreement includes a general mutual release by the Company and Mr. Goldberg and a non-solicitation agreement by Mr. Goldberg for twelve months following the effective date of the agreement.  The lump sum payment of $110,000 is included in “Restructuring and Merger Charges” in the accompanying condensed consolidated statement of operations for the three months ended October 31, 2005.

 

On October 15, 2005, the Company entered into a severance agreement and mutual release with its Chief Technology Officer, Said Mohammadioun, in connection with Mr. Mohammadioun’s resignation from employment by the Company effective October 15, 2005. Pursuant to the terms of the agreement, Mr. Mohammadioun received, among other items, a lump sum payment of $46,875, two and a half months of accelerated vesting of his options to purchase shares of the Company’s common stock, the right to exercise his vested options until six months following his termination date and two and a half months of COBRA premiums paid by the Company. The agreement includes a general mutual release by the Company and Mr. Mohammadioun and a non-solicitation agreement by Mr. Mohammadioun for twelve months following the effective date of the agreement.  The lump sum payment of $46,875 is included in “Research and Development” in the accompanying condensed consolidated statement of operations for the three months ended October 31, 2005.

 

As a result of the modification of the stock awards described above in the event that an employee terminates prior to the time that the options would have vested under the original terms, the Company will incur additional compensation expense based on the intrinsic value at the time of the acceleration of vesting, reduced by the amounts previously expensed as a result of the acceleration. The terminations of the officers discussed above and the acceleration of their stock options, therefore, resulted in additional equity-based compensation of approximately $55,000.

 

13



 

Note 6  Long-Term Debt

 

The following table sets forth the Company’s long-term obligations, excluding capital lease obligations (in thousands):

 

 

 

October 31,
2005

 

July 31,
2005

 

3% convertible senior notes, interest due semi-annually, principal due in March 2009

 

$

56,963

 

$

57,531

 

Interest rate swaps fair value hedge adjustment on $60 million of 3% convertible senior notes

 

3,037

 

2,469

 

 

 

60,000

 

60,000

 

Less: current portion

 

 

 

Long-term portion

 

$

60,000

 

$

60,000

 

 

3% Convertible Senior Notes

 

During fiscal 2004, the Company completed the offering of $60,000,000 of 3% convertible senior notes to qualified institutional buyers in reliance on Rule 144A under the Securities Act. The notes are senior unsecured obligations of Intellisync and rank junior to any future secured debt, on a parity with all of the Company’s other existing and future senior unsecured debt and prior to any existing or future subordinated debt. As of October 31, 2005, the Company had no other senior or subordinated debt, except for ordinary course trade payables. The Company may not redeem any of the notes prior to their maturity. Holders, however, may require the Company to repurchase the notes upon some types of change in control transactions. The notes will mature on March 1, 2009 unless earlier converted or redeemed. Neither the Company nor any of its subsidiaries are subject to any financial covenants under the indenture. In addition, neither the Company nor any of its subsidiaries are restricted under the indenture from paying dividends, incurring debt, or issuing or repurchasing its securities.

 

The notes are convertible into shares of common stock of the Company at the holders option any time prior to the close of business on the final maturity date of the notes, subject to prior redemption of the notes. The initial conversion rate is 250.0000 shares per each $1,000 principal amount of notes which represents an initial conversion price of $4.00 per share. The conversion rate is subject to adjustment for certain events, including the payment of dividends, and other events specified in the indenture.

 

The notes bear interest at a rate of 3% per annum. Interest on the notes is paid on March 1 and on September 1 of each year.

 

Interest Rate Swap

 

During fiscal 2004, the Company entered into two interest rate swap agreements with a financial institution on a total notional amount of $60,000,000, whereby the Company receives fixed-rate interest of 3% in exchange for variable interest payments.  The interest rate swaps expire upon the maturity of the Company’s $60,000,000, 3% convertible senior notes in March 2009, and effectively convert fixed-rate notes into variable-rate borrowings. The interest rate is reset semi-annually and is equal to the 6-month LIBOR rate less a rate spread. The total variable interest rate was approximately 3.8% at October 31, 2005.  Under the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended, the interest rate swaps have been designated and qualify as an effective fair value hedge of interest rate risk related to the $60,000,000 convertible senior notes. As the terms of the swaps match those of the underlying hedged debt, the changes in the fair value of these swaps are offset by corresponding changes in the carrying value of the hedged debt, and therefore do not impact the Company’s net earnings. As of October 31, 2005, the fair value of the interest rate swaps was approximately $3,037,000 and recorded in “Other Liabilities” with an equal adjustment recorded to the carrying value of the $60,000,000 convertible senior notes.

 

14



 

Refer to Note 7 for the description of the collateral required on the interest rate swaps.

 

Note 7  Commitments and Contingencies

 

Leases

 

During fiscal 2005, the Company entered into a capital lease agreement for computer peripherals, which expires in September 2007.  In addition, during fiscal 2004, the Company entered into a capital lease agreement for a phone system, which expires in February 2008.  The agreements resulted in capitalized costs of $296,000 and $231,000 during fiscal 2005 and 2004, respectively.  Assets and future obligations related to the capital leases are included in the accompanying condensed consolidated balance sheet as of October 31, 2005 in property and equipment and in the respective liability accounts, respectively. Current and long-term portions of the capital leases amounted to $154,000 and $173,000, respectively, at October 31, 2005. Depreciation of assets held under the capital leases is included in depreciation and amortization expense.

 

The Company leases its facilities under operating leases that expire at various dates through December 2008. The total amount of rental payments due over the lease term is being charged to rent on the straight-line method over the term of the lease. The difference between rent expense recorded and the amount paid is credited or charged to “deferred rent” which is included in current liabilities in the accompanying balance sheets. Deferred rent was approximately $203,000 and $259,000 at October 31, 2005 and July 31, 2005, respectively.  Total rent expense was approximately $924,000 and $589,000 for the three months ended October 31, 2005 and 2004, respectively. 

 

Future minimum lease payments for all non-cancelable capital and operating lease agreements at October 31, 2005, were as follows (in thousands):

 

 

 

 

 

Nine months

 

Fiscal year ending July 31,

 

 

 

Total

 

ending
July 31, 2006

 

2007

 

2008

 

2009

 

2010 and Thereafter

 

Capital lease obligation(1)

 

$

364

 

$

136

 

$

182

 

$

46

 

$

 

$

 

Operating leases:

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating leases

 

4,559

 

2,242

 

1,099

 

849

 

369

 

 

Proceeds from subleases

 

(21

)

(21

)

 

 

 

 

Net operating leases

 

4,538

 

2,221

 

1,099

 

849

 

369

 

 

Future minimum lease payments

 

$

4,902

 

$

2,357

 

$

1,281

 

$

895

 

$

369

 

$

 

 


(1) Includes interest payments due (interest rates ranging from 2.4% to 12.7%).

 

Acquisitions and Potential Earnout Payments

 

In June 2005, the Company completed its acquisition of all of the issued and outstanding stock of PDAapps.  Under the terms of an Agreement and Plan of Merger, dated as of June 23, 2005, the outstanding shares of PDAapps common stock were converted into the right to receive (i) an aggregate of approximately $4,000,000 in aggregate initial cash consideration and (ii) an aggregate of up to $2,600,000 in cash earnout consideration (based on future revenue generated by the Company from the former PDAapps client base), subject to the deposit of $1,000,000 in escrow to be available to compensate Intellisync pursuant to the indemnification obligations of the holders of PDAapps common stock.  The earnout consideration, if achieved, is due and payable shortly following the first anniversary of the acquisition.

 

In March 2005, the Company completed its acquisition of all of the issued and outstanding stock of Tourmaline.  Under the terms of an Agreement and Plan of Merger, dated as of February 9, 2005, the outstanding shares of Tourmaline common stock were converted into the right to receive (i) an aggregate of approximately $4,118,000 in aggregate initial cash consideration and (ii) an aggregate of up to $2,881,918 in cash earnout consideration (based on future revenue generated by the Company from the former Tourmaline client base), subject to the deposit of a certain portion of the initial cash consideration and earnout consideration in escrow to be available to compensate Intellisync

 

15



 

pursuant to the indemnification obligations of the holders of Tourmaline common stock.  The earnout consideration, if achieved, is due and payable shortly following the first anniversary of the acquisition.

 

As of October 31, 2005, the Company has not accrued any contingent earnout payment amounts discussed above.  Any earnout consideration paid will be recorded as additional goodwill associated with the respective acquisition.

 

Guarantees

 

The Company has three letters of credit that collateralize certain operating lease obligations and total approximately $281,000 and $321,000 at October 31, 2005 and July 31, 2005, respectively.  The Company collateralizes these letters of credit with cash deposits made with two of its financial institutions and has classified the short-term and the long-term portions of approximately $211,000 and $70,000 at October 31, 2005, and $196,000 and $125,000 at July 31, 2005 as “Other Current Assets” and “Restricted Cash,” respectively, in the condensed consolidated balance sheets.  The long-term portion expires through June 2006.  The holders of the letters of credit are able to draw on each respective letter of credit in the event that the Company is found to be in default of its obligations under each of its operating leases.

 

Under the terms of the interest rate swap agreement into which the Company entered during fiscal 2004, the Company must provide collateral to match any unfavorable mark-to-market exposure (fair value) on the swaps. The amount of collateral required totals a minimum of $1,800,000 plus an amount equal to the unfavorable mark-to-market exposure on the swaps. Generally, the required collateral will rise as interest rates rise. As of October 31, 2005, and July 31, 2005, the Company has provided approximately $4,821,000 and $4,181,000, respectively, of collateral under this swap agreement which is included in “Restricted Cash” in its condensed consolidated balance sheet.

 

In the event of early termination of the Company’s service agreement with eˆdeltacom, a division of ITC^DeltaCom, Inc. and a managed service provider, the Company may be required to pay eˆdeltacom a penalty fee of up to approximately $45,000.

 

Litigation

 

On October 5, 2005, Spontaneous Technology, Inc. served the Company with a complaint filed in the Third Judicial District Court, of Salt Lake County, State of Utah.  In the Complaint, Spontaneous Technology asserts a cause of action for breach of contract related to the calculation of an earnout payment in the Asset Purchase Agreement entered into between the parties on July 30, 2003.  Spontaneous Technology seeks compensatory damages in the amount of $673,750 and recovery of its attorneys’ fees and costs.  The Company is investigating this matter, and at this time does not believe this matter will have a material adverse effect on its consolidated financial position, results of operation or liquidity.

 

The Company is party to various legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business, including proceedings and claims that relate to acquisitions it has completed or to companies it has acquired, commercial, employment and other matters. While the outcome of these matters cannot be predicted with certainty, the Company does not believe that the outcome of any of these claims or any of the above mentioned legal matters will have a material adverse effect on its consolidated financial position, results of operations or cash flows.  In accordance with generally accepted accounting principles, the Company makes a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated.  These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular case. Litigation is inherently unpredictable. However, the Company believes that it has valid defenses with respect to the legal matters pending against Intellisync.  It is possible, nevertheless, that the Company’s consolidated financial position, cash flows or results of operations could be affected by the resolution of one or more of these contingencies.

 

16



 

Note 8  Stock-Based Compensation

 

Effective August 1, 2005, the Company adopted SFAS No. 123(R), “Share-Based Payment,” using the modified prospective application transition method, which establishes accounting for stock-based awards exchanged for employee services. Accordingly, stock-based compensation cost is measured at grant date, based on the fair value of the award, over the requisite service period. The Company previously applied APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations, as permitted by SFAS No. 123, “Accounting for Stock-Based Compensation.

 

Pro Forma Information Under SFAS No.123 for Periods Prior to Fiscal 2006

 

Prior to the adoption of SFAS No. 123(R), the Company provided the disclosures required under SFAS No. 123, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosures.”  The Company generally did not recognize stock-based compensation expense in its statement of operations for periods prior to the adoption of SFAS No. 123(R) as most options granted had an exercise price equal to the market value of the underlying common stock on the date of grant.

 

Pro forma information regarding option grants made to the Company’s employees and directors and employee stock purchases related to the Employee Stock Purchase Plan is as follows (in thousands, except per-share amounts):

 

 

 

Three Months Ended
October 31, 2004

 

Net loss as reported

 

$

(3,506

)

Add: Stock-based employee compensation expense (reversal) included in reported net loss

 

(65

)

Deduct: Total stock-based employee compensation expense determined under fair value method for all awards

 

(1,207

)

Pro forma net loss

 

$

(4,778

)

 

 

 

 

Basic and diluted net loss per common share as reported

 

$

(0.05

)

 

 

 

 

Basic and diluted pro forma net loss per common share

 

$

(0.07

)

 

The weighted-average estimated value of options granted under the stock option plans and shares granted under the stock purchase plan during the three months ended October 31, 2004 was $1.67 and $1.36 using the Black-Scholes model with the following weighted-average assumptions:

 

 

 

Three Months Ended
October 31, 2004

 

 

 

Stock Option
Plans

 

Employee
Stock Purchase
Plan

 

Expected life (in years)

 

4.1

 

1.0

 

Risk-free interest rate

 

4.05

%

1.97

%

Stock price volatility

 

110

%

125

%

Expected dividend yield

 

 

 

 

The Company estimates the expected life and expected volatility of the stock options based upon historical data.  Prior to fiscal 2006, forfeitures of employee stock options were accounted for on an as-incurred basis.

 

17



 

Valuation and Expense Information under SFAS No. 123(R)

 

The following table summarizes stock-based compensation expense related to employee stock options and employee stock purchases under SFAS No. 123(R) for the three months ended October 31, 2005 which was allocated as follows (in thousands, except per share amount):

 

 

 

Three Months Ended
October 31, 2005

 

Stock-based compensation expense:

 

 

 

Cost of revenue

 

$

175

 

Research and development

 

599

 

Sales and marketing

 

854

 

General and administrative

 

603

 

Total stock-based compensation expense

 

2,231

 

Tax effect on stock-based compensation expense

 

21

 

Net effect on net loss

 

$

2,210

 

Effect on loss per share:

 

 

 

Basic and diluted

 

$

0.03

 

 

As required by SFAS 123(R), management has made an estimate of expected forfeitures and is recognizing compensation costs only for those equity awards expected to vest.

 

Stock Options: During the three months ended October 31, 2005, the Company granted 1,793,000  stock options with an estimated total grant-date fair value of approximately $5,641,000. Of this amount, the Company estimated that the stock-based compensation for the awards not expected to vest was $510,000. During the three months ended October 31, 2005, the Company recorded stock-based compensation expense related to stock options of approximately $1,913,000 million for all unvested options granted prior and after the adoption of SFAS No. 123(R).

 

Employee Stock Purchase Plan (ESPP): The stock-based compensation expense in connection with the plan for the three months ended October 31, 2005 was approximately $318,000. This cost is amortized on a straight-line basis over a weighted-average period of approximately 1.0 year.

 

Valuation Assumptions

 

In connection with the adoption of SFAS No. 123(R), the Company estimated the fair value of stock options using the Black-Scholes valuation model. The fair value of each option grant is estimated on the date of grant and is amortized on an accelerated basis over the remaining vesting period consistent with the method described in FIN No. 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans.”  The weighted-average estimated value of options granted to officers and directors, and to non-officers and directors under the stock option plans was $3.33 and $2.47, respectively, and shares granted under the stock purchase plan was $1.94 during the three months ended October 31, 2005 using the Black-Scholes model with the following weighted-average assumptions:

 

 

 

Three Months Ended
October 31, 2005

 

 

 

Stock Option Plans

 

 

 

 

 

Officers and
Directors

 

Non-officers
and Directors

 

Employee Stock
Purchase Plan

 

Expected life (in years)

 

5.1

 

4.4

 

1.0

 

Risk-free interest rate

 

4.40

%

4.39

%

4.31

%

Stock price volatility

 

111

%

106

%

79

%

Expected dividend yield

 

 

 

 

Forfeiture rate (per year)

 

4.0

%

5.5

%

 

 

18



 

Expected Term: The Company’s expected term represents the period that the Company’s stock-based awards are expected to be outstanding and was determined based on historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior as influenced by changes to the terms of its stock-based awards.

 

Expected Volatility: The fair value of stock based payments made through the quarter ended October 31, 2005, were valued using the Black-Scholes valuation method with a volatility factor based on the Company’s historical stock prices over the most recent period commensurate with the estimated expected life of the stock options. 

 

Expected Dividend: The Black-Scholes valuation model calls for a single expected dividend yield as an input. The Company has not issued any dividends.

 

Risk-Free Interest Rate : The Company bases the risk-free interest rate used in the Black-Scholes valuation method on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term.

 

Estimated Pre-vesting Forfeitures: When estimating forfeitures, the Company considers voluntary termination behavior as well as future workforce reduction programs.

 

Stock Option Activity

 

The following is a summary of options activities:

 

 

 

 

 

Outstanding Options

 

Exercisable Options

 

 

 

Options Available
For Grant

 

Number of Shares

 

Range of Price
Per Share

 

Weighted
Average Exercise
Price Per Share

 

Number of Shares

 

Weighted
Average Exercise
Price Per Share

 

 

 

(In thousands)

 

(In thousands)

 

 

 

 

 

(In thousands)

 

 

 

Balance at July 31, 2005

 

1,947

 

12,756

 

$ 0.09 - $ 14.25

 

$

2.29

 

5,093

 

$

1.99

 

Increase in shares authorized

 

700

 

 

 

 

 

 

 

 

 

 

Granted

 

(1,793

)

1,793

 

$ 2.52 - $ 4.60

 

$

3.96

 

 

 

 

 

Exercised

 

 

(459

)

$ 0.09 - $ 4.23

 

$

1.48

 

 

 

 

 

Canceled

 

896

 

(896

)

$ 0.36.- $ 7.51

 

$

2.85

 

 

 

 

 

Expired

 

(40

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at October 31, 2005

 

1,710

 

13,194

 

$ 0.09 - $ 14.25

 

$

2.51

 

5,362

 

$

2.08

 

 

The options outstanding and exercisable at October 31, 2005 were in the following exercise price ranges:

 

 

 

Options Outstanding

 

 

 

 

 

 

 

Weighted-Average

 

 

 

 

 

Options Exercisable

 

Range of
Exercise
Prices

 

Number
Outstanding
 (In thousands)

 

Remaining
Contractual Life
(In years)

 

Weighted-Average
Exercise Price

 

Aggregate Intrinsic Value

 

Number
Exercisable
(In thousands)

 

Weighted-Average
Exercise Price

 

Aggregate Intrinsic Value

 

$ 0.09 - $ 0.59

 

2,031

 

6.89

 

$

0.45

 

$

7,962

 

1,928

 

$

0.45

 

$

7,558

 

$ 0.61 - $ 1.85

 

968

 

4.52

 

1.24

 

3,030

 

872

 

1.18

 

2,782

 

$ 2.00

 

1,950

 

9.06

 

2.00

 

4,622

 

306

 

2.00

 

725

 

$ 2.04 - $ 2.15

 

529

 

7.73

 

2.11

 

1,196

 

288

 

2.11

 

651

 

$ 2.17

 

1,997

 

9.22

 

2.17

 

4,393

 

54

 

2.17

 

119

 

$ 2.24 - $ 2.76

 

1,483

 

8.95

 

2.60

 

2,625

 

268

 

2.60

 

474

 

$ 2.90 - $ 3.94

 

1,353

 

8.72

 

3.40

 

1,312

 

427

 

3.39

 

418

 

$ 3.96 - $ 4.60

 

1,846

 

9.17

 

4.36

 

18

 

419

 

4.22

 

63

 

$ 4.65 - $ 8.10

 

1,027

 

7.90

 

4.88

 

 

790

 

4.88

 

 

$ 14.25

 

10

 

4.94

 

14.25

 

 

10

 

14.25

 

 

 

 

13,194

 

8.24

 

$

2.51

 

$

25,158

 

5,362

 

$

2.08

 

$

12,790

 

 

The aggregate intrinsic value in the preceding table represents the total pretax intrinsic value, based on the Company’s closing stock price of $4.37 as of October 31, 2005, which would have been received by the option holders had all option holders exercised their in-the-money options as of that date. The total number of in-the-money

 

19



 

options exercisable as of October 31, 2005 was 4,556,821, with a weighted average exercise price of $1.56.  As of July 31, 2005, approximately 5,093,000 outstanding options were exercisable, and the weighted average exercise price was $1.99.

 

The weighted average exercise price of options granted during the three months ended October 31, 2005 was $3.96 per share.  The total intrinsic value of options exercised during the three month period ended October 31, 2005 was approximately $761,000. The total cash received from employees as a result of employee stock option exercises and employee stock purchase plan during the three months ended October 31, 2005 was approximately $1,035,000. In connection with these exercises, there was zero tax benefit realized by the Company due to the Company’s current loss position.

 

The Company issues new shares of common stock upon exercise of stock options.

 

ESPP Activity

 

The following table shows the shares issued, and their respective exercise price, pursuant to the employee stock purchase plan during the three months ended October 31, 2005.

 

Purchase date

 

August 31, 2005

 

Shares Issued

 

181,614

 

Weighted average purchase price per share

 

$

1.95

 

 

Stock-Based Benefit Plans

 

Inducement Option Agreements.  In addition to the equity compensation plans described in the Company’s Annual Report on Form 10-K/A, on October 3, 2005, the Company granted inducement options outside of the Company’s existing equity compensation plans to David Eichler and Blair Hankins to purchase 500,000 and 200,000 shares of the Company’s common stock, respectively. The shares subject to each of these options vest as to one-fourth of the total number of shares subject to the option on October 3, 2006 and 1/48th of the total number of shares subject to the option each month thereafter, so that the option shall be fully vested and exercisable on October 3, 2009 (assuming the optionholder remains in a continuous service relationship with the Company through that date).  These grants provide for acceleration of vesting upon change of control.  Shareholder approval was not required for either of these option grants and no such approval was obtained.

 

Also refer to Note 13 – Subsequent Events for information on the changes made to the Company’s 2002 Stock Option Plan.

 

Note 9  Restructuring and Merger Charges

 

Restructuring Charge

 

The Company implemented a number of cost-reduction plans aimed at reducing costs that were not integral to its overall strategy, better aligning its expense levels with current revenue levels and ensuring conservative spending during periods of economic uncertainty.  These initiatives included a reduction in workforce and facilities consolidation. 

 

During the first fiscal quarter of 2006, the Company implemented reduction in workforce aimed at reducing excess capacity in its continued effort to streamline its operations, affecting 19 employees in various business functions (four in research and development, six in sales and marketing, four in general and administrative and five in information technology).  The program was completed by the end of September 2005, and the associated severance costs incurred were approximately $334,000 for the 19 employees, including Steve Goldberg as described in Note 5.  Approximately $31,000 of the severance costs remained unused as of October 31, 2005.  The remaining unpaid amount was paid in November 2005. 

 

20



 

In addition, the Company recorded $135,000 additional exit costs for its idle facility in Santa Cruz, California.

 

The following table sets forth the activities in the restructuring accrual account during the first quarter of fiscal 2006 (in thousands):

 

 

 

Workforce
Reduction

 

Consolidation
of Excess
Facilities

 

Total

 

Balance at July 31, 2005

 

$

 

$

86

 

$

86

 

Restructuring provision

 

334

 

 

334

 

Adjustment

 

 

135

 

135

 

Cash payments

 

(303

)

(54

)

(357

)

Balance at October 31, 2005

 

$

31

 

$

167

 

$

198

 

 

The remaining unpaid amount as of October 31, 2005 of $167,000 related to the net lease expense due to the consolidation of excess facilities, will be paid over the respective lease terms through June 2006 using cash from operations.  The total restructuring accrual of $198,000 is reflected accordingly in “Accrued Liabilities” in the condensed consolidated balance sheet as of October 31, 2005.

 

The Company continually evaluates the balance of the restructuring reserve it records in prior periods based on the remaining estimated amounts to be paid.  Differences, if any, between the estimated amounts accrued and the actual amounts paid will be reflected in operating expenses in future periods.

 

Costs Relating to Potential Merger with Nokia

 

The Company incurred approximately $272,000 for operating expenses, mainly legal, relating to the proposed merger with Nokia, Inc. during the first quarter of fiscal 2006.  Refer to Note 13 – Subsequent Events.  The Company expects to incur additional merger related costs of approximately $1,800,000 during the second quarter of fiscal 2006.

 

Note 10  Net Loss Per Common Share

 

Basic net loss per common share is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding for the period.  Diluted net loss per common share is computed by dividing net loss by the weighted average number of dilutive potential common shares that were outstanding during the period.  Diluted weighted average shares reflect the dilutive effect, if any, of potential common shares based on the treasury stock method.

 

Basic and diluted net loss per common share were calculated as follows (in thousands, except per common share amounts):

 

 

 

Three Months Ended
October 31,

 

 

 

2005

 

2004

 

Numerator:

 

 

 

 

 

Net loss

 

$

(8,014

)

$

(3,506

)

 

 

 

 

 

 

Denominator:

 

 

 

 

 

Weighted average shares outstanding used to compute basic and diluted net loss per common share

 

66,981

 

64,418

 

 

 

 

 

 

 

Basic and diluted net loss per common share

 

$

(0.12

)

$

(0.05

)

 

21



 

All common shares that were held in escrow or that were subject to repurchase by the Company, totaling approximately zero and 1,360,000 as of October 31, 2005 and 2004, respectively, were excluded from basic and diluted net loss per common share calculations.

 

Potential common shares attributable to stock options, convertible senior notes, shares held in escrow and shares subject to repurchase by the Company of 27,756,240 and 24,492,427  were outstanding at October 31, 2005 and 2004, respectively. However, as a result of a net loss incurred by the Company in the three months ended October 31, 2005 and 2004, none of the in-the-money potential common shares were included in the weighted average outstanding shares (using the treasury stock method or the if-converted method, as applicable) used to calculate net loss per common share because the effect would have been antidilutive.

 

Note 11  Comprehensive Loss

 

Accumulated other comprehensive loss consists of net unrealized gain/loss on available for sale investments and foreign currency translation adjustments.  Total comprehensive loss for the three months ended October 31, 2005 and 2004, respectively, is presented in the following table (in thousands):

 

 

 

Three Months Ended
October 31,

 

 

 

2005

 

2004

 

Net loss

 

$

(8,014

)

$

(3,506

)

Other comprehensive income (loss):

 

 

 

 

 

Change in net unrealized gain on investments

 

17

 

19

 

Change in currency translation adjustments

 

(18

)

629

 

Total other comprehensive income (loss)

 

(1

)

648

 

Total comprehensive loss

 

$

(8,015

)

$

(2,858

)

 

Note 12  Business Segments

 

Operating segments are identified as components of an enterprise about which separate, discrete financial information is available that is evaluated by the chief operating decision maker or decision-making group to make decisions about how to allocate resources and assess performance. The Company’s chief operating decision maker is the chief executive officer. To date, the Company has reviewed its operations principally in a single segment.

 

The Company operates in a single industry segment encompassing the development, marketing and support of software and services that provide synchronization, wireless messaging, mobile application development, application/device management, real-time remote information access, secure VPN and identity searching/matching/screening capabilities.  The Company’s customer base consists primarily of corporate organizations, business development organizations, industry associations, mobile carriers, resellers, international system integrators, large OEMs in the personal computer market and selected distributors, which primarily market to the retail channel, in North America, Europe, the Asia-Pacific region, South America, and Africa.

 

22



 

Revenue is attributed to regions based on the location of customers.  Revenue information by geographic region is as follows (in thousands):

 

 

 

Three Months Ended
October 31,

 

 

 

2005

 

2004

 

United States

 

$

11,223

 

$

8,131

 

Japan

 

2,106

 

1,060

 

Other International

 

3,016

 

3,111

 

Total revenue

 

$

16,345

 

$

12,302

 

 

Revenue information by customer group is as follows (in thousands):

 

 

 

Three Months Ended
October 31,

 

 

 

2005

 

2004

 

Enterprise and retail

 

$

7,795

 

$

7,522

 

OEMs

 

3,612

 

3,663

 

Mobile carriers

 

4,938

 

1,117

 

Total revenue

 

$

16,345

 

$

12,302

 

 

Revenue from Verizon Wireless accounted for greater than 10% of the Company’s total revenue for the three months ended October 31, 2005.  No customers accounted for more than 10% of the Company’s total revenue for the three months ended October 31, 2004.  No other customers accounted for more than 10% of total revenue during these periods.  Verizon Wireless accounted for greater than 10% and 10% of the total accounts receivable balance at October 31, 2005 and July 31, 2005, respectively.  No other customers accounted for more than 10% of total of accounts receivable during the same periods.

 

Goodwill information by geographic region is as follows (in thousands):

 

 

 

October 31,
2005

 

July 31,
2005

 

United States

 

$

62,050

 

$

62,050

 

United Kingdom

 

4,764

 

4,744

 

Other International

 

1,680

 

1,680

 

Total revenue

 

$

68,494

 

$

68,474

 

 

Other long-lived asset information by geographic region is as follows (in thousands):

 

 

 

October 31, 2005

 

July 31,
2005

 

United States

 

$

3,059

 

$

2,651

 

Romania

 

177

 

156

 

Japan

 

100

 

45

 

Other International

 

181

 

176

 

Total long-lived assets

 

$

3,517

 

$

3,028

 

 

23



 

Note 13   Subsequent Events

 

Merger Agreement with Nokia

 

Pursuant to the merger agreement the Company entered into with Nokia Inc., a Delaware corporation, on November 15, 2005, each issued and outstanding share of common stock of the Company, shall be automatically converted into the right to receive $5.25 in cash per share, without interest, at the effective time of the merger.  The merger is conditioned upon, among other things, the adoption of the merger agreement by the stockholders of the Company pursuant to applicable law, the termination or expiration of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, and the termination or expiration of the applicable waiting periods of antitrust laws of certain foreign jurisdictions and other conditions.

 

Concurrently with the execution of the merger agreement with Nokia, each director and officer of the Company entered into a voting agreement with Nokia pursuant to which such director or officer agreed to vote his or her Common Stock in favor of approving and adopting the merger.  Also, simultaneously with the execution of the merger agreement, certain key employees of the Company entered into employment-related or consulting agreements with Nokia (which contain non-competition and non-solicitation provisions), which agreements will take effect as of the effective time of the merger.

 

Resignation of Officer

 

On November 21, 2005, J. Keith Kitchen resigned his position as the Company’s Principal Accounting Officer, but will remain as the Company’s Controller.  The Board of Directors appointed David Eichler as the Company’s Principal Accounting Officer effective the same day.

 

Changes Made to the 2002 Stock Option Plan

 

On December 2, 2005, the Company’s stockholders approved the following changes made to the Company’s 2002 Stock Option Plan (the “2002 Plan”):

 

                  Permit the award of restricted stock units.

 

                  Establish new annual limitations on the number of stock options and restricted stock units that may be granted to any participant in the 2002 Plan in any single fiscal year. No participant will be able to be granted options covering more than 1,000,000 shares during any of the Company’s fiscal years; and no participant will be granted more than 500,000 shares of restricted stock units during any fiscal year.

 

                  Allow the administrator of the 2002 Plan to grant options and restricted stock units under the amended 2002 Plan to qualify as “performance-based compensation” under Section 162(m) of the Internal Revenue Code.

 

The amended version of the 2002 Plan does not differ from the old version of the 2002 Plan in any other material respect.

 

24



 

Item 2.      Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following information should be read in conjunction with the condensed consolidated financial statements and the notes thereto contained elsewhere in this Form 10-Q/A and in conjunction with the consolidated financial statements and management’s discussion and analysis of financial condition and results of operations in our Annual Report on Form 10-K.  This quarterly report on Form 10-Q/A, and in particular management’s discussion and analysis of financial condition and results of operations, contains forward-looking statements regarding future events or our future performance that involve certain risks and uncertainties including those discussed in “Factors That May Affect Future Operating Results” below.  In this Form 10-Q/A, the words “anticipates,” “believes,” “expects,” “intends,” “future” and similar expressions identify forward-looking statements.  All statements that address operating performance, our stock price, events or developments that we expect or anticipate will occur in the future, including statements relating to planned product releases and composition of revenue, both in terms of segment and geographical source, are forward-looking statements.  Such forward-looking statements are based on management’s current views and assumptions regarding future events and operating performance, and speak only as of the date hereof.  We undertake no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise.  Actual events or our actual future results may differ materially from any forward-looking statements due to the risks and uncertainties outlined below. 

 

Business Overview

 

We develop, market and support desktop, enterprise and mobile carrier-class software that enables consumers, business executives and information technology professionals to extend the capabilities of enterprise groupware and vertical applications, data-enabled mobile devices and other personal communication platforms.  The primary software applications we have developed and marketed include push-email, data synchronization and systems management software.  Our software also enables organizations to search, find, match and synchronize identity data within their computer systems and network databases.

 

We have organized our operations into a single operating segment encompassing the development, marketing and support of software and services that provide synchronization, wireless messaging, mobile application development, database application/device management, real-time remote information access, secure VPN, and identity synchronization capabilities. 

 

We license our software products directly to corporations, mobile carriers, original equipment manufacturers, or OEMs, and business development organizations worldwide.  In addition, we sell our retail products through several distribution channels both in the United States and internationally, including major distributors, resellers, computer dealers, retailers and mail-order companies.  Internationally, we are represented by over 150 distributors, resellers and retailers in North America, Europe, the Asia-Pacific region, South America and Africa.

 

Recent Event

 

On November 15, 2005, we entered into an agreement and plan of merger with Nokia Inc., a Delaware corporation, whereby, at the effective time of the merger, each issued and outstanding share of common stock of Intellisync shall be automatically converted into the right to receive $5.25 in cash per share, without interest.

 

The merger is conditioned upon, among other things, the adoption of the merger agreement by our stockholders pursuant to applicable law, the termination or expiration of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, the termination or expiration of the applicable waiting periods of antitrust laws of certain foreign jurisdictions and other conditions.

 

Estimates, Assumptions and Critical Accounting Policies

 

Our financial statements and accompanying notes are prepared in accordance with generally accepted accounting principles in the United States of America.  Preparing financial statements require management to make estimates and assumptions that affect the reported amounts of assets, liabilities, sales and expenses. These estimates

 

25



 

and assumptions are affected by management’s application of accounting policies.  Our critical accounting policies include license and service revenue recognition, channel inventory and product returns, valuation of goodwill, other intangibles, investments and other long-lived assets, restructuring accruals, loss contingencies and provision for doubtful accounts which are discussed in more detail under the caption “Estimates, Assumptions and Critical Accounting Policies” in our 2005 Annual Report on Form 10-K. 

 

One other policy that we believe is as critical as the others to aid in fully understanding and evaluating our reported financial results is as follows:

 

                  Stock-based Compensation.  We estimate the fair value of stock options granted using the Black-Scholes option-pricing formula and a multiple-option award approach. This fair value is then amortized on an accelerated basis over the requisite service periods of the awards, which is generally the vesting period. This option-pricing model requires the input of highly subjective assumptions, including the option’s expected life and the price volatility of the underlying stock. The expected stock price volatility assumption was determined using historical volatility of our common stock.

 

Results of Operations

 

The following table sets forth items included in the condensed consolidated statements of operations as a percentage of revenue for the periods indicated. 

 

 

 

Three Months Ended
October 31,

 

 

 

2005

 

2004

 

 

 

 

 

 

 

Revenue

 

 

 

 

 

License

 

62.8

%

63.6

%

Services

 

37.2

 

36.4

 

Total revenue

 

100.0

%

100.0

%

 

 

 

 

 

 

Cost and operating expenses:

 

 

 

 

 

Cost of revenue

 

18.8

 

19.0

 

Amortization of developed and core technology

 

7.7

 

9.4

 

Research and development

 

30.5

 

27.1

 

Sales and marketing

 

52.5

 

45.4

 

General and administrative

 

25.7

 

16.7

 

Amortization of intangibles

 

6.4

 

8.5

 

Restructuring and merger charges

 

3.7

 

 

Total cost and operating expenses

 

145.3

 

126.1

 

Operating loss

 

(45.3

)

(26.1

)

Other income (expense):

 

 

 

 

 

Interest income

 

1.9

 

1.9

 

Interest expense

 

(3.5

)

(1.9

)

Other, net

 

(1.5

)

(1.5

)

Total other income (expense)

 

(3.1

)

(1.5

)

Loss before income taxes

 

(48.4

)

(27.6

)

Provision for income taxes

 

(0.6

)

(0.9

)

Net loss

 

(49.0

)%

(28.5

)%

 

26



 

Revenue

 

 

 

Three Months Ended October 31,

 

 

 

2005

 

Percent
Change

 

2004

 

 

 

(In thousands, except percentage)

 

Total revenue

 

$

16,345

 

32.9

%

$

12,302

 

 

 

We derive revenue from two primary sources: software licenses and fees for services. 

 

                  License Revenue

 

 

 

Three Months Ended October 31,

 

 

 

2005

 

Percent
Change

 

2004

 

 

 

(In thousands, except percentages)

 

License revenue

 

$

10,265

 

31.2

%

$

7,825

 

As percentage of total revenue

 

62.8

%

 

 

63.6

%

 

License revenue is earned from the sale and use of software products (including our technology licensing components) and royalty agreements with OEMs. The 31.2% increased in license revenue for the first quarter of fiscal 2006 was primarily the result of increased license revenue from our mobile carrier customers ($2,731,000 or 418% increase), increased license revenue from OEM customers ($490,000 or 16% increase) offset in part by continued decreased sales in wired or traditional PDA (personal digital assistant) sales through our retail channel of approximately $300,000 or 31%.  We expect that the decreasing revenue from PDAs will continue as more consumers move to smartphones and other wireless mobile devices.

 

                  Service Revenue.

 

 

 

Three Months Ended October 31,

 

 

 

2005

 

Percent
Change

 

2004

 

 

 

(In thousands, except percentages)

 

Service revenue

 

$

6,080

 

35.8

%

$

4,477

 

As percentage of total revenue

 

37.2

%

 

 

36.4

%

 

Service revenue is derived from fees for services, including fixed-price and time-and-materials professional services arrangements, amortization of maintenance contract programs and hosting fees.  The increase in service revenue for the first quarter of fiscal 2006 as compared with that for the corresponding quarter of fiscal 2005 was due to increased maintenance contract revenues of approximately $1,100,000, which relate to the increase in license revenue, plus a net $200,000 increase in professional service revenue primarily from carriers as well as an increase in hosting fees from carriers of approximately $300,000. 

 

In any period, service revenue from time and materials contracts is dependent, among other things, on license transactions closed during the current and preceding quarters and customer decisions regarding implementations of licensed software.

 

27



 

Revenue by Customer Group

 

 

 

Year Ended August 31,

 

 

 

2005

 

Percent
Change

 

2004

 

 

 

(In thousands, except percentage)

 

Enterprise and retail

 

$

7,795

 

3.6

%

$

7,522

 

As percentage of total revenue

 

47.7

%

 

 

61.1

%

OEMs

 

$

3,612

 

(1.4

)%

$

3,663

 

As percentage of total revenue

 

22.1

%

 

 

29.8

%

Mobile carriers

 

$

4,938

 

342.1

%

$

1,117

 

As percentage of total revenue

 

30.2

%

 

 

9.1

%

Total revenue

 

$

16,345

 

 

 

$

12,302

 

 

Our enterprise and retail products revenue includes sales to retail distribution channels, as well as direct sales of our personal and server products licensed to corporations for internal use.  The 3.6% net increase in revenue from enterprise and retail for the first quarter of fiscal 2006 as compared with that for the corresponding quarter of fiscal 2005 was largely due to a $500,000, or 17% increase in sales of our identity matching and verification products, offset in part by a decrease of approximately $300,000, or 31%, in retail revenue as a result of overall decline in sales of wired or traditional PDAs.  Enterprise sales frequently involve large up-front license fees, which can result in lengthy sales cycles and uncertainties as to the timing of sales driven by customers’ budgetary processes. As a result, we generally have less visibility into future enterprise sales than is typically the case with OEMs in our royalty-based technology licensing business. In addition, while enterprise sales generally result in ongoing maintenance revenue and may lead to follow-on purchases or upgrades, we are typically dependent on sales to new customers for a significant portion of our enterprise revenue in a given quarter.

 

Our revenue from OEMs remained relatively flat for the first quarter of fiscal 2006 as compared with that for the corresponding quarter of fiscal 2005.

 

Our mobile carrier revenue, license and service, increased by 342% in absolute dollars during the first quarter of fiscal 2006 compared with that for the corresponding quarter of 2005 reflecting increased license, hosting and professional service volume from existing as well as new customers during the first quarter of fiscal year 2006.  Revenue from Verizon Wireless accounted for greater than 10% of total revenues in the first quarter of fiscal year 2006 compared to 8% of total revenues in the comparable period of fiscal year 2005.

 

International Revenue

 

 

 

Three Months Ended October 31,

 

 

 

2005

 

Percent
Change

 

2004

 

 

 

(In thousands, except percentages)

 

International revenue

 

$

5,122

 

22.8

%

$

4,171

 

As percentage of total revenue

 

31.3

%

 

 

33.9

%

 

International revenue represented approximately 31% of our total revenue during the first quarter of fiscal year 2006 compared to approximately 34% in the corresponding period in fiscal year 2005.  However, in terms of absolute dollars international revenues accounted for 23% of our total revenue increase for the first quarter of fiscal 2006.  Our international revenue growth was a result of a number of factors including an increase in the number of our international technology licensing partners and closing of certain contracts associated with our new products, particularly in Japan; and the effect of foreign exchange fluctuation.  The slight decrease in international revenue as a percentage of total revenue for the first quarter of fiscal 2006 was primarily due to increased revenue from mobile carrier customers in the United States. We believe that international revenue will fluctuate on a quarter to quarter basis as we periodically enter into new agreements for professional services and new international partner contracts for technology licensing. International revenue may be subject to certain risks not normally encountered in operations in the United States, including exposure to tariffs, various trade regulations, fluctuations in currency

 

28



 

exchange rates, as well as international software piracy as described more fully in “Factors That May Affect Future Operating Results” set forth below. We believe that continued growth will require further expansion in international markets. We have utilized and will likely continue to utilize substantial resources both to expand and establish international operations in the future.

 

Top Customers

 

Revenue from Verizon Wireless accounted for greater than 10% of our total revenue for the first quarter of fiscal 2006.  No other customers accounted for more than 10% of total revenue during this period.  No customers accounted for more than 10% of our total revenue for the corresponding quarter of fiscal 2005.

 

Cost of Revenue

 

 

 

Three Months Ended October 31,

 

 

 

2005

 

Percent
Change

 

2004

 

 

 

(In thousands, except percentages)

 

Cost of revenue

 

$

3,073

 

31.3

%

$

2,341

 

As percentage of total revenue

 

18.8

%

 

 

19.0

%

 

Cost of revenue consists of license costs and service costs.  License costs comprise product-packaging expenses such as product media and duplication, manuals, packing supplies, and shipping costs.  Service costs comprise personnel-related expenses such as salaries and other related costs associated with work performed under professional service contracts, non-recurring engineering agreements, post-sales customer support costs and hosting costs for hosting services associated with technology licensing partners and end users. Hosting costs include expenses related to bandwidth for hosting, tape backup, security and storage, third-party fees and internal personnel costs associated with logistics and operational support of the hosting services. Service costs can be expected to vary significantly from period to period depending on the mix of services we provide.

 

In general, license revenue costs represent a smaller percentage of license revenue when compared with services revenue costs as a percentage of services revenue; this is due to the high cost structure of services revenue. Additionally, license costs tend to be variable based on license revenue volumes, whereas service costs tend to be fixed within certain services revenue volume ranges. We would expect that an increase in services revenue as a percentage of our total revenue would generate lower overall gross margins as a percentage of total revenue. Also, given the high level of fixed costs associated with the professional services group and our hosting operations, our inability to generate revenue sufficient to absorb these fixed costs could lead to low or negative service gross margins.

 

The increase in cost of service revenue in absolute dollars reflected an increase of approximately $200,000 in costs associated with the increase in our revenue from mobile hosting, $100,000 in post-sales support infrastructure for our carrier customers, $191,000 in noncash stock compensation expense (further discussed below) and $240,000 in other related expenses.  In future periods, cost of revenue may further fluctuate from quarter to quarter due to potential changes in the internal infrastructure and other requirements of our hosting operations to meet carriers demand. These changes, which may be costly, are difficult to forecast. In addition, our cost of revenue is primarily driven by our expectation for different margin characteristics within and between license and service revenue as well as the expected mix between products and channels.

 

29



 

Amortization of Developed and Core Technology

 

 

 

Three Months Ended October 31,

 

 

 

2005

 

Percent Change

 

2004

 

 

 

(In thousands, except percentages)

 

Amortization of developed and core technology

 

$

1,257

 

8.7

%

$

1,156

 

As percentage of total revenue

 

7.7

%

 

 

9.4

%

 

The increase in the amortization of developed and core technology was primarily due to the impact of recently purchased technology from PDAapps, Inc. and Tourmaline Networks, Inc., which were acquired during the second half of fiscal 2005.  Based on acquisitions completed as of October 31, 2005, we expect the future amortization expense of developed and core technology is as follows (in thousands):

 

Nine months ending July 31, 2006

 

$

3,735

 

Fiscal year ending July 31,

 

 

 

2007

 

4,872

 

2008

 

2,568

 

2009

 

1,195

 

2010 and thereafter

 

925

 

 

 

$

13,295

 

 

We expect that we may acquire additional developed and core technology associated with any acquisitions we may complete in the future.  As a result, we may further increase our amortization expense of developed and core technology.

 

Research and Development

 

 

 

Three Months Ended October 31,

 

 

 

2005

 

Percent Change