UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-Q

(Mark One)

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

For the quarterly period ended December 31, 2006

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: 000-24786


Aspen Technology, Inc.

(Exact name of registrant as specified in its charter)

Delaware

 

04-2739697

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification No.)

Ten Canal Park
Cambridge, Massachusetts

 

02141

(Address of Principal Executive Offices)

 

(Zip Code)

 

(617) 949-1000

(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 twelve months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes x  No o

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

Large Accelerated Filer o

Accelerated Filer x

Non-Accelerated Filer 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 x

As of March 9, 2007, there were 87,749,130 shares of the registrant’s common stock (par value $0.10 per share) outstanding.

 




TABLE OF CONTENTS

 

Page

PART I. FINANCIAL INFORMATION

 

 

 

Explanatory Notes

 

3

 

FINANCIAL INFORMATION

 

4

 

Item 1. 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

 

37

 

Item 4. Controls and Procedures

 

38

 

PART II. OTHER INFORMATION

 

 

 

OTHER INFORMATION

 

43

 

Item 1. Legal Proceedings

 

43

 

Item 1A. Risk Factors

 

45

 

Item 6. Exhibits

 

59

 

SIGNATURES

 

60

 

CERTIFICATIONS

 

 

 

 

2




Explanatory Notes

Subsequent to the issuance of the condensed consolidated financial statements for the three and six months ended December 31, 2005, we identified errors in the accounting for certain items. These errors resulted in the restatement of our financial statements, and are fully described in our annual report on Form 10-K, Amendment No. 2, for the year ended June 30, 2006 and in Note 12 to this report on Form 10-Q.

In order to correct for these errors, we are restating our financial statement for the three and six months ended December 31, 2005, primarily in order to reflect (a) foreign currency transaction losses of $0.2 million and $2.9 million, respectively, (b) additional stock-based compensation of $0.5 million and $1.0 million, respectively, (c) additional interest income of $0.5 million and $1.2 million, respectively, (d) additional amortization of technology related intangible assets of $0.4 million and $0.7 million, respectively, (e) a license revenue increase of $0.2 million and decrease of $0.1 million, respectively, (f) increased service revenue of $0.1 million and $0.1 million, respectively, and (g) lower provision for income taxes of $0.1 million and $1.0 million, respectively.

3




PART I.   FINANCIAL INFORMATION

Item 1.   Financial Statements

ASPEN TECHNOLOGY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited and dollars in thousands)

 

 

December 31,
2006

 

June 30,
2006

 

ASSETS

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

 

$

92,549

 

 

$

86,272

 

Accounts receivable, net

 

 

51,248

 

 

49,163

 

Unbilled services

 

 

10,128

 

 

8,518

 

Current portion of long-term installments receivable, net

 

 

6,593

 

 

12,123

 

Prepaid expenses and other current assets

 

 

8,537

 

 

9,179

 

Total current assets

 

 

169,055

 

 

165,255

 

Long-term installments receivable, net

 

 

15,409

 

 

35,681

 

Retained interest in sold receivables

 

 

29,173

 

 

19,010

 

Property and leasehold improvements, at cost

 

 

45,486

 

 

44,771

 

Accumulated depreciation and amortization

 

 

(38,460

)

 

(36,097

)

Property and leaseholds, net

 

 

7,026

 

 

8,674

 

Computer software development costs, net

 

 

14,682

 

 

15,456

 

Purchased intellectual property, net

 

 

 

 

165

 

Other intangible assets, net

 

 

3,014

 

 

6,711

 

Goodwill

 

 

17,826

 

 

18,035

 

Deferred tax assets

 

 

3,133

 

 

3,097

 

Other assets

 

 

2,597

 

 

2,552

 

Total assets

 

 

$

261,915

 

 

$

274,636

 

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Current portion of long-term debt

 

 

$

266

 

 

$

247

 

Accounts payable

 

 

4,231

 

 

4,613

 

Accrued expenses

 

 

69,748

 

 

77,716

 

Deferred revenue

 

 

54,487

 

 

57,936

 

Total current liabilities

 

 

128,732

 

 

140,512

 

Long-term debt and obligations, less current maturities

 

 

45

 

 

149

 

Deferred revenue, less current portion

 

 

4,558

 

 

2,609

 

Other liabilities

 

 

18,409

 

 

20,446

 

Redeemable Preferred Stock:

 

 

 

 

 

 

 

Outstanding—63,064 shares as of December 31, 2006 and 333,364 as of June 30, 2006

 

 

25,240

 

 

125,475

 

Stockholders’ equity (deficit):

 

 

 

 

 

 

 

Common stock:

 

 

 

 

 

 

 

Outstanding—80,655,498 as of December 31, 2006 and 48,857,035 as of June 30, 2006

 

 

8,090

 

 

4,909

 

Additional paid-in capital

 

 

514,150

 

 

430,811

 

Accumulated deficit

 

 

(441,923

)

 

(457,977

)

Accumulated other comprehensive income

 

 

5,127

 

 

8,215

 

Treasury stock, at cost

 

 

(513

)

 

(513

)

Total stockholders’ equity (deficit)

 

 

84,931

 

 

(14,455

)

Total liabilities and stockholders’ equity (deficit)

 

 

$

261,915

 

 

$

274,636

 

 

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

4




ASPEN TECHNOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited and in thousands, except per share data)

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

 

 

(As restated—
see Note 12)

 

 

 

(As restated—
see Note 12)

 

Software licenses

 

$

60,866

 

 

$

41,870

 

 

$

88,942

 

 

$

65,907

 

 

Service and other

 

35,549

 

 

34,751

 

 

71,795

 

 

70,548

 

 

Total revenues

 

96,415

 

 

76,621

 

 

160,737

 

 

136,455

 

 

Cost of software licenses

 

3,709

 

 

4,244

 

 

6,858

 

 

8,119

 

 

Cost of service and other

 

18,610

 

 

17,962

 

 

36,091

 

 

35,305

 

 

Amortization of technology related intangible assets

 

1,672

 

 

2,128

 

 

3,574

 

 

4,234

 

 

Total cost of revenues

 

23,991

 

 

24,334

 

 

46,523

 

 

47,658

 

 

Gross profit

 

72,424

 

 

52,287

 

 

114,214

 

 

88,797

 

 

Operating costs:

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling and marketing

 

22,118

 

 

20,759

 

 

43,328

 

 

39,517

 

 

Research and development

 

10,729

 

 

11,826

 

 

19,219

 

 

22,009

 

 

General and administrative

 

13,581

 

 

10,101

 

 

23,665

 

 

20,570

 

 

Restructuring charges

 

589

 

 

995

 

 

2,035

 

 

3,194

 

 

(Gain) loss on sales and disposal of assets

 

(194

)

 

316

 

 

5,575

 

 

377

 

 

Total operating costs

 

46,823

 

 

43,997

 

 

93,822

 

 

85,667

 

 

Income from operations

 

25,601

 

 

8,290

 

 

20,392

 

 

3,130

 

 

Interest income

 

2,948

 

 

961

 

 

4,196

 

 

2,008

 

 

Interest expense

 

(128

)

 

(207

)

 

(609

)

 

(438

)

 

Foreign currency exchange gain (loss)

 

2,643

 

 

811

 

 

2,549

 

 

(2,486

)

 

Income before provision for income taxes

 

31,064

 

 

9,855

 

 

26,528

 

 

2,214

 

 

Provision for income taxes

 

(2,449

)

 

(2,011

)

 

(3,330

)

 

(1,702

)

 

Net income

 

28,615

 

 

7,844

 

 

23,198

 

 

512

 

 

Accretion of preferred stock discount and dividend

 

(3,408

)

 

(3,843

)

 

(7,144

)

 

(7,621

)

 

Income (loss) applicable to common shareholders

 

$

25,207

 

 

$

4,001

 

 

$

16,054

 

 

$

(7,109

)

 

Basic income (loss) per share applicable to common shareholders

 

$

0.44

 

 

$

0.09

 

 

$

0.29

 

 

$

(0.16

)

 

Diluted income (loss) per share applicable to common shareholders

 

$

0.32

 

 

$

0.08

 

 

$

0.26

 

 

$

(0.16

)

 

Basic weighted average shares outstanding

 

57,059

 

 

43,743

 

 

54,930

 

 

43,491

 

 

Diluted weighted average shares outstanding

 

90,534

 

 

52,765

 

 

90,677

 

 

43,491

 

 

 

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

5




ASPEN TECHNOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited and in thousands)

 

 

Six Months Ended
December 31,

 

 

 

2006

 

2005

 

 

 

 

 

(As restated
see Note 12)

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

 

 

Net income

 

$

23,198

 

 

$

512

 

 

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

10,350

 

 

12,439

 

 

Transaction (gain) loss on intercompany accounts

 

(3,614

)

 

3,337

 

 

Stock-based compensation

 

4,738

 

 

4,185

 

 

Loss on securitization of installments receivable

 

5,672

 

 

 

 

(Gain) loss on sales and disposals of assets

 

(97

)

 

377

 

 

Accretion of discount on retained interest in sold receivables

 

(1,872

)

 

(1,420

)

 

Deferred income taxes

 

 

 

100

 

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

Decrease in accounts receivable

 

(1,796

)

 

7,246

 

 

Decrease (increase) in unbilled services

 

(1,539

)

 

168

 

 

Decrease (increase) in installments receivable, including proceeds from securitization

 

12,731

 

 

(14,909

)

 

Decrease in prepaid expenses and other current assets

 

695

 

 

2,099

 

 

Decrease in accounts payable and accrued expenses

 

(8,998

)

 

(19,932

)

 

Decrease in deferred revenue

 

(1,457

)

 

(1,678

)

 

Decrease in other liabilities

 

(2,037

)

 

(906

)

 

Net cash provided by (used in) operating activities

 

35,974

 

 

(8,382

)

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

 

 

Purchase of property and leasehold improvements

 

(1,071

)

 

(1,344

)

 

(Increase) decrease in other long-term assets

 

(45

)

 

119

 

 

Capitalized computer software development costs

 

(3,040

)

 

(3,040

)

 

Net cash used in investing activities

 

(4,156

)

 

(4,265

)

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

 

 

Issuance of common stock under employee stock purchase plan

 

423

 

 

445

 

 

Exercise of stock options

 

1,314

 

 

2,276

 

 

Payments of long-term debt

 

(85

)

 

(644

)

 

Payment of preferred stock dividends

 

(27,391

)

 

 

 

Net cash provided by (used in) financing activities

 

(25,739

)

 

2,077

 

 

EFFECTS OF EXCHANGE RATE CHANGES ON CASH

 

198

 

 

(121

)

 

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

 

6,277

 

 

(10,691

)

 

CASN AND CASH EQUIVALENTS, beginning of period

 

86,272

 

 

68,149

 

 

CASH AND CASH EQUIVALENTS, end of period

 

$

92,549

 

 

$

57,458

 

 

 

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

6




ASPEN TECHNOLOGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

1.                 Interim Condensed and Consolidated Financial Statements

In the opinion of management, the accompanying unaudited interim condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America for interim financial information and pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (the SEC) for reporting on Form 10-Q. Accordingly, certain information and footnote disclosures required for complete financial statements are not included herein. It is suggested that these unaudited interim condensed consolidated financial statements be read in conjunction with the audited consolidated financial statements for the year ended June 30, 2006, which are contained in the Annual Report on Form 10-K, as amended, of Aspen Technology, Inc. (the Company), as previously filed with the SEC. In the opinion of management, all adjustments, consisting of normal and recurring adjustments, considered necessary for a fair presentation of the financial position, results of operations, and cash flows at the dates and for the periods presented have been included. The results of operations for the six-month period ended December 31, 2006 are not necessarily indicative of the results to be expected for the full fiscal year.

2.                 Sale of Installments Receivable

(a)   Traditional Activities

Installments receivable are recorded at the present value of future payments for noncancelable term and perpetual license agreements which provide for payment in installments over a one to five-year period. A portion of each installment payment is recognized as interest income in the accompanying consolidated condensed statements of operations. The interest rate utilized for the three and six months ended December 31, 2006 and 2005 was 8.0%.

The Company has arrangements to sell certain of its installments receivable to three financial institutions. The Company sold certain of its installment contracts for aggregate proceeds of approximately $37.7 million and $46.7 million during the three and six months ended December 31, 2006, respectively, and $25.5 million and $35.2 million during the three and six months ended December 31, 2005, respectively. Generally, no material gain or loss is recognized on the sale of the receivables due to the consistency of the discount rates used by the Company and the financial institutions.

The financial institutions have certain recourse to the Company upon nonpayment by the customer under the installments receivable. The amount of recourse is determined pursuant to the provisions of the Company’s contracts with the financial institutions. Collections of these receivables reduce the Company’s recourse obligations, as defined in the contracts. The Company’s potential recourse obligation related to these contracts is within the range of $0.1 million to $0.9 million. In addition, the Company is obligated to pay additional costs to the financial institutions in the event of default by the customer.

(b)   Securitization of Installments Receivable

On September 29, 2006, the Company entered into a $75.0 million three year revolving securitization facility and securitized certain outstanding installment receivables with a net carrying value of $32.1 million which were not sold in the traditional sales described above. The structure of the transaction was such that the securitization qualified as a sale. The Company received $19.4 million of cash and retained an interest in the sold receivables initially valued at $8.3 million. It also retained certain limited recourse obligations relative to the receivables valued at approximately $0.5 million. Overall, the transaction resulted in a

7




$5.7 million loss on sales and disposals of assets in the quarter ended September 30, 2006 and was recorded as a loss on sales and disposals of assets in the statement of operations.

The amount of the loss was based on the previous carrying amount of the financial assets involved in the transfer, allocated between the assets sold and the retained interests based on their relative fair value at the date of transfer, as well as the immediate recognition of transaction costs.

The retained interest in the sold receivables was recorded at its fair value of $8.3 million at the time of the transaction and is classified as a long-term asset on the Company’s consolidated balance sheet. The Company estimates fair value of the sold and retained interest based on the present value of future expected cash flows, including estimates of principally credit losses and discount rates commensurate with the risks involved.

Key economic assumptions used in subsequently measuring the carrying value of the Company’s retained interests in the license receivables sold during the quarter September 30, 2006 and the effect on the fair value of those interests from adverse changes in those assumptions are as follows (dollars in thousands):

Balance sheet carrying value of retained interest in sold receivables

 

$

8,291

 

Expected credit losses (annual rate):

 

0.82

%

Impact on fair value of 10% adverse change

 

$

(23

)

Impact on fair value of 20% adverse change

 

$

(45

)

Residual cash flow discount rate (annual rate):

 

13.0

%

Impact on fair value of 10% adverse change

 

$

(397

)

Impact on fair value of 20% adverse change

 

$

(773

)

 

These sensitivities are hypothetical and presented for illustrative purposes only. Changes in fair value based on a 10% variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, the effect of a variation in a particular assumption is calculated without changing any other assumption; in reality, changes in one assumption may result in changes in another, which may magnify or counteract the sensitivities.

The Company is recognizing the accretion of its retained interests in the June 2005 and September 2006 securitizations to the estimated cash flow that will be received in interest income. Total interest income from accretion was $1.9 million and $1.4 million for the six months ended December 31, 2006 and 2005, respectively. The Company recognizes an impairment of the carrying value of its retained interest if a decline in the fair value of the retained interest is determined to be other-than-temporary. No such impairments have been recognized through December 31, 2006.

The Company retained the servicing rights relative to the securitized receivables and receives annual servicing fees, which are based on a percentage of outstanding receivables and which total approximately $0.3 million per year. The benefits of the servicing rights approximate the costs estimated to be incurred by the Company, and thus no servicing asset or liability has been recorded.

In connection with the above transaction, the Company incurred an obligation to guarantee that the cash collections from installments receivable denominated in currencies other than the U.S. dollar included in the securitized pool will not be less than the U.S. dollar value on the initial contract date. The Company has entered into forward foreign exchange contracts intended to mitigate the financial exposure due to changes in currency exchange rates which are further described below. The fair value of this obligation at December 31, 2006 is immaterial.

8




3.                 Derivative Instruments and Hedging

The Company follows the provisions of Statement of Financial Accounting Standards (“SFAS”), No. 133 “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 133, as amended by SFAS No. 138, requires that all derivatives, including foreign currency exchange contracts, be recognized on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through earnings. If a derivative is a hedge, depending on the nature of the hedge, changes in the fair value of the derivative are either offset against the change in fair value of assets, liabilities or firm commitments through earnings. The ineffective portion of a derivative’s change in fair value is recognized in earnings in each period reported. The Company does not account for any derivatives under hedge accounting treatment.

Forward foreign exchange contracts are used primarily by the Company to offset certain balance sheet exposures resulting from changes in foreign currency exchange rates. Such exposures primarily result from portions of the Company’s accounts and installments receivables that are denominated in currencies other than the U.S. dollar, primarily the Euro, the Japanese Yen, the Canadian dollar and the British Pound Sterling. In addition, the Company incurred exposures as part of the June 2005 and September 2006 securitizations of installments receivable as described above.

Forward foreign exchange contracts are entered into to offset recorded installments receivable, both held and securitized, made in the normal course of business, and accordingly, are not speculative in nature. As part of its overall strategy to manage the level of exposure to the risk of foreign currency exchange rate fluctuations, the Company enters into economic hedges against the majority of its installments receivable denominated in foreign currencies.

The Company’s guarantee to cover the exposure to changes in foreign currency exchange rates in the securitized installments receivable is a derivative. The Company calculates the value of this guarantee at each balance sheet date, and if the value of the guarantee represents an obligation, the fair value is recorded as a liability. As of December 31, 2006, no loss on this obligation existed, and as such, no value was recorded.

At December 31, 2006, the Company had economic hedges with notional forward exchange contracts of $29.1 million of held or securitized installments receivable and accounts receivable denominated in foreign currency. The gross value of the installments receivable that were denominated in foreign currency was $33.8 million and $40.3 million at December 31, 2006 and June 30, 2006, respectively. The installments receivable held as of December 31, 2006 mature at various times through December 2011.

The Company records its foreign currency exchange contracts at fair value in its consolidated balance sheet and the related gains or losses on these contracts are recognized in earnings. During the three and six months ended December 31, 2006 the net loss recognized in the consolidated statements of operations was $0.6 million and $1.0 million, respectively. During the three and six months ended December 31, 2005, the net gain or loss recognized in the consolidated statements of operations was a gain of $0.6 million and a loss of $0.2 million, respectively.

9




The following table provides information about the Company’s foreign currency derivative financial instruments outstanding as of December 31, 2006. The table presents the notional amount at contract exchange rates and the weighted average contractual foreign currency rates (dollars in thousands):

 

 

Notional 
Contract
Amount

 

Estimated
Fair Value(1)

 

Average
Contract Rate

 

Euro

 

$

17,767

 

 

$

18,612

 

 

 

1.28

 

 

British Pound Sterling

 

4,814

 

 

5,111

 

 

 

1.88

 

 

Japanese Yen

 

3,818

 

 

3,679

 

 

 

112.68

 

 

Canadian Dollar

 

2,339

 

 

2,282

 

 

 

1.13

 

 

Swiss Franc

 

358

 

 

355

 

 

 

1.20

 

 

 

 

$

29,096

 

 

$

30,039

 

 

 

 

 

 


(1)          The estimated fair value is based on the estimated amount at which the contracts could be settled based on the forward rates as of December 31, 2006. The Company bears risk in that the banking counterparties may be unable to meet the terms of the agreements and manages such risk by limiting its counterparties to multiple major financial institutions. Management does not expect any loss as a result of default by counter-parties. However, there can be no assurances that the Company will be able to mitigate the risks described above.

4.                 Stock-Based Compensation Plans

The Company issues stock options to its employees and outside directors, restricted stock units to its employees and provides employees the right to purchase stock pursuant to an employee stock purchase plan. Options are generally granted with an exercise price equal to the market price of the Company’s stock at the date of the grant, generally vest over four years and have 7 or 10 year contractual terms. Restricted stock units generally vest over four years and have 7 year contractual terms. There are no vesting requirements for the employee stock purchase plan.

The Company recognizes compensation costs on a straight-line basis over the requisite service period for time vested awards. For awards that vest based on performance conditions, the Company uses the accelerated model for graded vesting awards.

Effective July 1, 2005, the Company adopted the provisions of SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123R), using the statement’s modified prospective application method which affects reporting periods subsequent to the date of adoption. Under the provisions of SFAS No. 123R, the Company recognizes the fair value of stock-based compensation in costs, over the requisite service period of the individual awards, which generally equals the vesting period. All of the Company’s stock-based compensation is accounted for as equity instruments and there have been no liability awards granted. The Company adopted the simplified method related to accounting for the tax effects of share-based payment awards to employees in Financial Accounting Standards Board (FASB) Staff Position 123(R)-3: “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards”.

10




The unrecognized expense of awards not yet vested at the date of adoption is recognized in earnings in the periods after the date of adoption using the same value determined under the original provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” as disclosed in previous filings. Under the provisions of SFAS 123R, the Company recorded $3.0 million and $4.8 million of stock-based compensation for the three and six months ended December 31, 2006 and $2.4 million and $4.2 million for the three and six months ended December 31, 2005, included in the following categories (in thousands):

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

   2006   

 

   2005   

 

2006

 

2005

 

Recorded as expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of service and other

 

 

$

353

 

 

 

$

377

 

 

$

663

 

$

676

 

Selling and marketing

 

 

1,026

 

 

 

675

 

 

1,647

 

1,184

 

Research and development

 

 

391

 

 

 

328

 

 

590

 

536

 

General and administrative

 

 

1,227

 

 

 

997

 

 

1,838

 

1,789

 

 

 

 

2,997

 

 

 

2,377

 

 

4,738

 

4,185

 

Capitalized computer software development costs

 

 

2

 

 

 

18

 

 

57

 

57

 

Total stock-based compensation

 

 

$

2,999

 

 

 

$

2,395

 

 

$

4,795

 

$

4,242

 

 

The weighted-average fair values of the options granted under the stock option plans were $6.94 and $7.02 and of the shares subject to purchase under the employee stock purchase plan were $2.62 for the three and six months ended December 31, 2006, respectively, using the following assumptions and applying the Black-Scholes valuation method:

 

 

Three Months Ended
December 31, 2006

 

Six Months Ended
December 31, 2006

 

 

 

Stock Option

 

 

 

Stock Option

 

 

 

 

 

Plans

 

Purchase Plan

 

Plans

 

Purchase Plan

 

Average risk-free interest rate

 

 

4.58

%

 

 

5.10

%

 

 

4.71

%

 

 

5.10

%

 

Expected dividend yield

 

 

None

 

 

 

None

 

 

 

None

 

 

 

None

 

 

Expected life

 

 

5.0 Years

 

 

 

0.5 Years

 

 

 

5.0 Years

 

 

 

0.5 Years

 

 

Expected volatility

 

 

80

%

 

 

53

%

 

 

80

%

 

 

53

%

 

 

The weighted-average fair values of the options granted under the stock option plans were $4.38 and $3.92 and of the shares subject to purchase under the employee stock purchase plan were $3.53 for the three and six months ended December 31, 2005, respectively, using the following assumptions:

 

 

Three Months Ended
December 31, 2005

 

Six Months Ended
December 31, 2005

 

 

 

Stock Option

 

 

 

Stock Option

 

 

 

 

 

Plans

 

Purchase Plan

 

Plans

 

Purchase Plan

 

Average risk-free interest rate

 

 

4.37

%

 

 

4.03

%

 

 

4.20

%

 

 

3.79

%

 

Expected dividend yield

 

 

None

 

 

 

None

 

 

 

None

 

 

 

None

 

 

Expected life

 

 

6.0 Years

 

 

 

0.5 Years

 

 

 

6.0 Years

 

 

 

0.5 Years

 

 

Expected volatility

 

 

85

%

 

 

42

%

 

 

85

%

 

 

42

%

 

 

The dividend yield of zero is based on the Company’s history of not having paid cash dividends on its common stock and on its present intention not to pay cash dividends on its common stock. Expected volatility is based on the historical volatility of the Company’s common stock over the period commensurate with the expected life of the options. The risk-free interest rate is the U.S. Treasury rate on the date of grant. In fiscal 2007 the expected life was calculated based upon historical option exercise behavior. In fiscal 2006, the expected life was calculated using the method outlined in SEC Staff Accounting Bulletin Topic 14.D.2, “Expected Term”.

11




The following table summarizes information about all stock option plans for the six months ended December 31, 2006:

 

 

Number of
Shares

 

Weighted
Average
Exercise
Price

 

Weighted
Average
Remaining
Contractual
Term

 

Aggregate
Intrinsic
Value

 

 

 

 

 

 

 

 

 

($000)

 

Outstanding, June 30, 2006

 

9,460,449

 

 

$

7.37

 

 

 

 

 

 

 

 

 

 

Options granted

 

1,028,700

 

 

10.47

 

 

 

 

 

 

 

 

 

 

Options exercised

 

(337,732

)

 

3.89

 

 

 

 

 

 

 

 

 

 

Options forfeited

 

(453,228

)

 

13.44

 

 

 

 

 

 

 

 

 

 

Outstanding, December 31, 2006

 

9,698,189

 

 

7.53

 

 

 

6.9

 

 

 

$

35,565

 

 

Exercisable at December 31, 2006

 

5,726,907

 

 

$

8.08

 

 

 

5.8

 

 

 

$

17,566

 

 

 

As of December 31, 2006 the total compensation cost related to unvested stock option awards not yet recognized was $19.1 million. The weighted average period over which this will be recognized is approximately 3 years. The Company received $1.3 million from options exercised during the six months ended December 31, 2006; their intrinsic value was $2.4 million.

In December 2006 the Company modified awards for an aggregate of 312,402 options for two executive officers of the company to equal the fair market value on the grant date of the Company’s common stock of such awards to avoid certain adverse tax impacts on the individuals. There was no incremental compensation cost resulting from the modification.

In November 2006, the Company issued a total of 723,400 restricted stock units under the 2005 Stock Incentive Plan to certain officers and management. The restricted stock units are performance awards that will vest 25% if the Company achieves certain financial goals for fiscal 2007. The Company’s management believes that it is probable that such financial criteria will be met and is recognizing compensation cost over the requisite service period. The Company uses the accelerated model to recognize stock-based compensation expense for these restricted stock units as the awards have performance conditions. Once the initial vesting milestone is achieved, the remaining restricted stock units will vest on a straight line basis over the following three years.

The following table summarizes information about restricted stock units for the six months ended December 31, 2006:

 

 

Number of
Shares

 

Weighted
Average
Exercise
Price

 

Aggregate
Intrinsic
Value

 

 

 

 

 

 

 

($000)

 

Outstanding, June 30, 2006

 

 

 

 

 

 

 

 

 

 

 

Units granted

 

 

723,400

 

 

 

$

10.42

 

 

 

 

 

 

Units vesting

 

 

 

 

 

 

 

 

 

 

 

Units forfeited

 

 

(1,400

)

 

 

10.42

 

 

 

 

 

 

Outstanding, December 31, 2006

 

 

722,000

 

 

 

$

10.42

 

 

 

$

7,523

 

 

Vested at December 31, 2006

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2006 the total compensation cost related to unvested restricted stock unit awards not yet recognized was $6.9 million. The weighted average period over which this will be recognized is approximately two years.

12




5.                 Net Income (Loss) Per Common Share

Basic earnings per share was determined by dividing income (loss) attributable to common shareholders by the weighted average common shares outstanding during the period. Diluted earnings per share was determined by dividing income (loss) attributable to common shareholders by diluted weighted average shares outstanding. Diluted weighted average shares reflects the dilutive effect, if any, of potential common shares. To the extent their effect is dilutive, potential common shares include common stock options and warrants, based on the treasury stock method, and preferred stock based on the if-converted method if the impact is dilutive. In the application of the if-converted method, the Company excluded the possible settlement of preferred stock dividends with common shares as the Company intended to settle such dividends with cash (and was currently entitled to cash settlement under the terms of the preferred stock). In December 2006 and January 2007, the Company paid all accrued dividends on preferred stock in cash. Basic and diluted income (loss) attributable to common shareholders per share and basic and diluted weighted average shares outstanding are as follows (in thousands, except per share data):

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2006

 

2005

 

2006

 

2005

 

Income (loss) applicable to common shareholders

 

$

25,207

 

$

4,001

 

$

16,054

 

$

(7,109

)

Plus: Impact of conversions of Series D preferred stock

 

3,408

 

 

7,144

 

 

 

 

28,615

 

4,001

 

23,198

 

(7,109

)

Basic weighted average common shares outstanding

 

57,059

 

43,743

 

54,930

 

43,491

 

Common stock equivalents

 

3,664

 

9,022

 

4,173

 

 

Incremental shares from assumed conversion of preferred stock

 

29,811

 

 

31,574

 

 

Diluted weighted average shares outstanding

 

90,534

 

52,765

 

90,677

 

43,491

 

Basic net income (loss) per share applicable to common shareholders

 

$

0.44

 

$

0.09

 

$

0.29

 

$

(0.16

)

Diluted net income (loss) per share applicable to common shareholders

 

$

0.32

 

$

0.08

 

$

0.26

 

$

(0.16

)

 

The following potential common shares were excluded from the calculation of diluted weighted average shares outstanding as their effect would be anti-dilutive (in thousands):

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

  2006  

 

   2005   

 

2006

 

2005

 

Convertible preferred stock

 

 

 

 

 

36,336

 

 

 

36,336

 

Options and warrants

 

 

2,773

 

 

 

8,630

 

 

2,640

 

21,424

 

Preferred stock dividend, to be settled in common stock

 

 

 

 

 

 

 

 

3,192

 

Total

 

 

2,773

 

 

 

44,966

 

 

2,640

 

60,952

 

 

6.                 Comprehensive Income (Loss)

Comprehensive income (loss) is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. The components of comprehensive income (loss) for the three and six months ended December 31, 2006 and 2005 are as follows (in thousands):

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2006

 

2005

 

2006

 

2005

 

Net income

 

$

28,615

 

$

7,844

 

$

23,198

 

$

512

 

Foreign currency translation adjustments

 

(3,049

)

(288

)

(3,088

)

3,108

 

Total

 

$

25,566

 

$

7,556

 

$

20,110

 

$

3,620

 

 

13




7.                 Restructuring Charges

During the three and six months ended December 31, 2006, the Company recorded $0.6 million and $2.0 million, respectively, in restructuring charges primarily related to severance and relocation expenses under the May 2005 restructuring plan discussed below which are recognized in the period in which the affected employees were notified or the relocation expenses were incurred.

(a)   Restructuring charges originally arising in Q4 FY05.

In May 2005, the Company initiated a plan to consolidate several corporate functions and to reduce its operating expenses. The plan to reduce operating expenses primarily resulted in headcount reductions, and also included the termination of a contract and the consolidation of facilities. These actions resulted in an aggregate restructuring charge of $3.8 million, recorded in the fourth quarter of fiscal 2005. During the year ended June 30, 2006, the Company recorded an additional $1.8 million related to headcount reductions, relocation costs and facility consolidations associated with the May 2005 plan that were recognized in the period in which the affected employees were notified, the relocation expenses were incurred, or the Company ceased use of the affected facilities. During the three and six months ended December 31, 2006, the Company recorded an additional $0.8 million and $2.2 million, respectively, in severance and relocation expenses for employees that were notified or relocation expenses that were incurred during the period.

Under this restructuring plan, the Company has yet to incur charges related to the closure of certain offices and relocation of certain employees. The Company expects that these charges will be approximately $3.2 million and will be completed by September 2007.

As of December 31, 2006, there was $1.5 million remaining in accrued expenses relating to the remaining severance obligations and lease payments. During the six months ended December 31, 2006, the following activity was recorded (in thousands):

Fiscal 2005 Restructuring Plan

 

 

 

Closure/
Consolidation
of Facilities

 

Employee
Severance,
Benefits, and
Related Costs

 

Total

 

Accrued expenses, June 30, 2006

 

 

$

99

 

 

$

513

 

$

612

 

Restructuring charge

 

 

26

 

 

1,369

 

1,395

 

Restructuring charge—Accretion

 

 

1

 

 

 

1

 

Payments

 

 

(64

)

 

(680

)

(744

)

Accrued expenses, September 30, 2006

 

 

62

 

 

1,202

 

1,264

 

Restructuring charge

 

 

(38

)

 

807

 

769

 

Restructuring charge—Accretion

 

 

1

 

 

 

1

 

Payments

 

 

22

 

 

(603

)

(581

)

Accrued expenses, December 31, 2006

 

 

$

47

 

 

$

1,406

 

$

1,453

 

Expected final payment date

 

 

May 2007

 

 

June 2007

 

 

 

 

(b)   Restructuring charges originally arising in Q4 FY04

During fiscal 2004, the Company recorded $15.2 million in net restructuring charges. Of this amount, $23.5 million is associated with a June 2004 restructuring plan, which is offset by $8.3 million in adjustments to prior restructuring accruals and deferred rent balances.

In June 2004, the Company initiated a plan to reduce its operating expenses in order to better align its operating cost structure with the current economic environment and to improve operating margins. The plan to reduce operating expenses resulted in the consolidation of facilities, headcount reductions, and the termination of operating contracts. These actions resulted in an aggregate restructuring charge of $23.5 million, recorded in the fourth quarter of fiscal 2004. During the year ended June 30, 2005, the Company recorded $14.4 million related to headcount reductions and facility consolidations associated

14




with the June 2004 restructuring plan, that are recognized in the period in which the affected employees were notified or the Company ceased use of the affected facilities. In addition, the Company recorded $0.4 million in restructuring charges related to the accretion of the discounted restructuring accrual and a $0.8 million decrease to the accrual related to changes in estimates of severance benefits and sublease terms. During the year ended June 30, 2006, the Company recorded a $0.7 million increase to the accrual primarily due to a change in the estimate of future operating costs and sublease assumptions associated with the facilities.

As of December 31, 2006, there was $5.8 million remaining in accrued expenses relating to the remaining severance obligations and lease payments. During the six months ended December 31, 2006, the following activity was recorded (in thousands):

Fiscal 2004 Restructuring Plan

 

 

 

Closure/
Consolidation
of Facilities and
Contract Exit Costs

 

Employee
Severance,
Benefits, and
Related Costs

 

Total

 

Accrued expenses, June 30, 2006

 

$

6,855

 

$

192

 

$

7,047

 

Change in estimate—Revised assumptions

 

21

 

 

21

 

Restructuring charge—Accretion

 

65

 

 

65

 

Payments

 

(583

)

(79

)

(662

)

Accrued expenses, September 30, 2006

 

6,358

 

113

 

6,471

 

Change in estimate—Revised assumptions

 

(209

)

5

 

(204

)

Restructuring charge—Accretion

 

87

 

 

87

 

Payments

 

(588

)

 

(588

)

Accrued expenses, December 31, 2006

 

$

5,648

 

$

118

 

$

5,766

 

Expected final payment date

 

September 2012

 

June 2007

 

 

 

 

(c)   Restructuring charges originally arising in Q2 FY03

In October 2002, management initiated a plan to further reduce operating expenses in response to first quarter revenue results that were below expectations and to general economic uncertainties. The plan to reduce operating expenses resulted in headcount reductions, consolidation of facilities, and discontinuation of development and support for certain non-critical products. These actions resulted in an aggregate restructuring charge of $28.7 million. During fiscal 2004, the Company recorded a $4.9 million decrease to the accrual related to revised assumptions associated with lease exit costs, particularly the buyout of a remaining lease obligation, and severance benefit obligations. During fiscal 2005 and fiscal 2006, the Company recorded $7.0 million and $1.0 million increases, respectively, to the accrual primarily due to a change in the estimate of the facility vacancy term, extending to the term of the lease.

As of December 31, 2006, there was $9.0 million remaining in accrued expenses relating to the remaining lease payments. During the six months ended December 31, 2006, the following activity was recorded (in thousands):

Fiscal 2003 Restructuring Plan

 

 

 

Closure/
Consolidation
of Facilities

 

Accrued expenses, June 30, 2006

 

$

9,966

 

Change in estimate—Revised assumptions

 

(38

)

Payments

 

(387

)

Accrued expenses, September 30, 2006

 

9,541

 

Change in estimate—Revised assumptions

 

(57

)

Payments

 

(467

)

Accrued expenses, December 31, 2006

 

$

9,017

 

Expected final payment date

 

September 2012

 

 

15




8.                 Commitments and Contingencies

Securities and Exchange Commission Action and U.S. Attorney’s Office Criminal Complaint

In January 2007, the Securities and Exchange Commission (“SEC”) filed a civil enforcement action in Massachusetts federal district court alleging securities fraud and other violations against three former officers of the Company, David McQuillin, Lisa Zappala and Lawrence Evans, arising out of six transactions in 1999 through 2002 that were reflected in the Company’s original financial statements, the accounting for which was restated in March 2005 following a self-initiated investigation by the audit committee of the Board of Directors. Those former officers and the Company had previously received Wells Notices of possible enforcement proceedings by the SEC. On the same day the SEC complaint was filed, the United States Attorney for the Southern District of New York filed a criminal complaint against David McQuillin alleging criminal securities fraud violations arising out of two of those transactions. The Company through its audit committee fully investigated the matter in 2004 and 2005, provided information to the United States Attorney and the SEC, and thereafter fully cooperated with them. The SEC enforcement action and the U.S. Attorney’s criminal action are not against the Company or any of its current officers or directors. The Company is unable to state whether any enforcement or other action will be commenced against the Company, and cannot give any assurance in that regard. The Company continues to cooperate with the SEC and the United States Attorney.

Class Action and Opt Out Suits

In March 2006, the Company settled class action litigation, including related derivative claims, arising out of the restated financial statements that include the periods referenced in the SEC complaint and the criminal complaint. See Order and Final Judgment, In re Aspen Technology, Inc. Securities Litigation, Civil Action No. 04-12375 (D. Mass. Mar. 6, 2006) (the “Class Action”). Members of the Class who opted out of the settlement (representing 1,457,969 shares of common stock, or less than 1% of the shares putatively purchased during the Class Action period) may bring their own individual actions (“Opt Out Claims”). To date, Opt Out Claims have been filed, including claims of securities and common law fraud, breach of contract, statutory treble damages, deceptive practices, and/or rescissory damages liability, based on the restated results of one or more fiscal periods included in the restated financial statements referenced in the Class Action. If not dismissed or settled on terms acceptable to the Company, the Company plans to defend the Opt Out Claims vigorously.

On September 6, 2006, the Company announced that, in connection with the preparation of financial statements for the fiscal year ended June 30, 2006, a subcommittee of independent directors reviewed its accounting treatment for stock option grants for prior years. Following that announcement, the Company and certain of its officers and directors were named defendants in a purported federal securities class action lawsuit filed in Massachusetts federal district court, alleging violations of the Securities Exchange Act and claiming material misstatements concerning its financial condition and results. On September 26, 2006, in response to the Company’s motion to dismiss the complaint, the parties stipulated to voluntary dismissal of the plaintiff’s claims with prejudice without any payment by or on behalf of the Company.

Derivative Suits

In December 2004, a derivative action lawsuit was filed in Massachusetts federal district court as a related action to the first filed of the putative class actions subsequently consolidated into the Class Action (described above), captioned Caviness v. Evans, et al., Civil Action No. 04-12524 (D. Mass.) (the “Derivative Action”). The complaint, as subsequently amended, alleged, among other things, that the former and current director and officer defendants caused the Company to issue false and misleading financial statements, and brought derivative claims for the following:  breach of fiduciary duty for insider trading; breach of fiduciary duty; abuse of control; gross mismanagement; waste of corporate assets; and unjust enrichment. In August 2005, the Court granted defendants’ motion to dismiss the Derivative Action for failure of the plaintiff to make a pre-suit demand on the Company’s board of directors to take the

16




actions referenced in the Derivative Action complaint, and the Derivative Action was dismissed with prejudice.

In April 2005, the Company received a letter on behalf of another shareholder, demanding that the board of directors of the Company take actions substantially similar to those referenced in the Derivative Action. In February 2006, the Company received a letter on behalf of the purported shareholder plaintiff in the Derivative Action, demanding that the Company take actions referenced in the Derivative Action complaint. The board of directors responded to both of the foregoing letters that the board has taken the letters under advisement pending further regulatory investigation developments, which the board continues to monitor and with which the Company continues to cooperate. In its responses, the board also requested confirmation of each person’s status as a stockholder of the Company, and, with respect to the most recent letter, also referred the purported stockholder to the March 2006 settlement in the Class Action.

On September 27, 2006, a derivative action lawsuit was filed in Massachusetts Superior Court captioned Rapine v. McCardle, et al., Civil Action No. 06-3455. The complaint alleged, among other things, that the former and current director and officer defendants “authorized, modified, or failed to halt back-dating of options in dereliction of their fiduciary duties to the Company as directors and officers.”  On October 16, 2006, defendants removed the action to Massachusetts federal district court and moved to dismiss the complaint. On October 30, 2006, the purported shareholder plaintiff filed an Amended Complaint, asserting derivative claims for the following:  breach of fiduciary duty; unjust enrichment; insider trading; violation of Sections 10(b), 14 and 20(a) of the Securities and Exchange Act of 1934; and corporate waste. On November 10, 2006, defendants moved to dismiss the Amended Complaint, for, among other things, failing to make a demand on the board of directors. The court has not ruled on the motion to dismiss. The Company cannot estimate the ultimate outcome of the case at this preliminary stage.

On February 23, 2007 a complaint was filed in the United States District Court for the District of Massachusetts, captioned Risberg v. McArdle et al., 07-CV-10354. The plaintiff purports to bring a derivative action on behalf of the Company against several former and current directors and officers of the Company, alleging that the defendants authorized, were aware of, or received allegedly “backdated” stock options. The Complaint asserts claims for breach of fiduciary duty; unjust enrichment; violations of Sections 10(b), 14 and 20(a) of the Securities Exchange Act of 1934; corporate waste; and breach of contract. The Company’s Board of Directors intends to review the allegations and respond appropriately. The Company cannot estimate the ultimate outcome of this case at this preliminary stage.

Other

The Company currently is defending claims that certain of its software products and implementation services have failed to meet customer expectations. These claims amount to more than $10 million in the aggregate. The Company believes these claims to be without merit, and is defending the claims vigorously. Furthermore, from time to time the Company is subject to legal proceedings, claims, and litigation arising in the ordinary course of business.

The Company currently is unable to determine whether resolution of any of the above matters will have a material adverse impact on the Company’s financial position or results of operations, or in many cases reasonably estimate the amount of the loss, if any, that may result from resolution of these matters. However, the ultimate outcome could have a material adverse effect on the Company’s financial position, results of operations, or cash flows.

In connection with the audit committee’s review of the Company’s accounting treatment of all stock option grants since the Company’s initial public offering in fiscal 1995 through fiscal year 2006, the Company recorded estimated payroll withholding tax charges of $1.9 million and an estimated liability of $1.0 million to assist affected employees who are subject to an excise tax on the value of the options in the

17




year in which they vest, for a total estimated liability of $2.9 million recorded in June 2006. The Company adjusted these liabilities to $2.3 million as of December 31, 2006 as a result of changes in estimates of the total expected costs to be incurred.

The Company maintains strategic alliance relationships with third parties, including resellers, agents and systems integrators (collectively "Agents" or “Agent”) that market, sell and/or integrate the Company's products and services. The cessation or termination of certain relationships, by the Company or an Agent, may subject the Company to material liability and/or expense.  This material liability and/or expense includes potential payments due upon the termination or cessation of the relationship by the Company or an Agent, costs related to the establishment of a direct sales presence or development of a new Agent in the territory.

No such events of termination or cessation have occurred. The Company is not able to reasonably estimate the amount of any such liability and/or expense if such event were to occur, given the range of factors that could affect the ultimate determination of the liability. Actual payments could be in the range of zero to twenty million dollars. If the Company reacquires the territorial rights for an applicable sales territory and establishes a direct sales presence, future commissions otherwise payable to an Agent for existing customer maintenance contracts and other intangible assets may be assumed from the Agent. If any of the foregoing were to occur, the Company may be subject to litigation and liability such that its operating results, cash flows and financial condition could be materially and adversely affected

9.                 Preferred Stock Financing

In August 2003, the Company issued and sold 300,300 shares of Series D-1 convertible preferred stock (Series D-1 Preferred), along with warrants to purchase up to 6,006,006 shares of common stock at a price of $3.33 per share, in a private placement to several investment partnerships managed by Advent International Corporation for an aggregate purchase price of $100.0 million and incurred issuance costs of $10.7 million. Concurrently, the Company paid cash of $30.0 million and issued 63,064 shares of Series D-2 convertible preferred stock (Series D-2 Preferred), along with warrants to purchase up to 1,261,280 shares of common stock at a price of $3.33 per share, to repurchase all of the Company’s outstanding Series B-I and B-II convertible preferred stock. In addition, the Company exchanged existing warrants to purchase 791,044 shares of common stock at an exercise price ranging from $20.64 to $23.99 held by the Series B Preferred holders, for new warrants to purchase 791,044 shares of common stock at an exercise price of $4.08.

In May 2006, holders of the Series D-1 Preferred converted 30,000 shares into 3,000,000 shares of common stock and in December 2006 converted their remaining 270,030 shares into 27,030,000 shares of common stock. In December 2006, the Company announced that it would redeem any shares of its Series D-2 Preferred that were not converted by their holders into common shares by January 30, 2007. In January 2007 the remaining 63,064 shares of Series D-2 Preferred were converted by their holder into 6,306,400 shares of common stock. The terms of the Series D-1 and D-2 Preferred required settlement of all accrued and unpaid dividends upon conversion of these shares into common stock and dividend accrual would cease upon such conversion. Accordingly, the Company paid $27.4 million in cash in December 2006 to the holders of the Series D-1 Preferred, and in January 2007 paid $6.6 million in cash in January 2007 to the holders of the Series D-2 Preferred for dividends accumulated subsequent to the conversion of the respective tranches of securities.

As a result of the conversion of the Series D-1 Preferred and the related dividend payment in the three months ended December 31, 2006, the stated value of the Series D-1 Preferred was reduced from $129.2 million to $25.2 million, common stock outstanding was increased by $2.7 million and additional paid-in-capital was increased by $77.3 million.

18




In July 2006, 6,006,006 warrants were exercised in a cashless exercise, resulting in the issuance of 4,369,336 shares of the Company’s common stock. From January to March 13, 2007, 791,044 warrants were exercised in cashless exercises, resulting in the issuance of 496.840 shares of the Company’s common stock.

Registration Rights—In May 2006, the Company received a demand letter from the Series D-1 Preferred holders, in accordance with the terms of their investor rights agreement with us, requesting registration of all of the shares of common stock issued or issuable upon the conversion of Series D-1 Preferred and the exercise of their warrants in connection with an underwritten public offering per the terms defined in the investor rights agreement. The Company is required to register the underlying shares at its expense. As of December 31, 2006, the total number of outstanding shares of common stock that would be included by this registration demand letter is 31,499,336.

In the accompanying consolidated condensed statements of operations, the accretion of preferred stock discount and dividends consist of the following (in thousands):

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2006

 

2005

 

2006

 

2005

 

Accrual of dividends on Series D preferred stock

 

$

(2,575

)

$

(2,864

)

$

(5,387

)

$

(5,672

)

Accretion of discount on Series D preferred stock

 

(833

)

(979

)

(1,757

)

(1,949

)

Total

 

$

(3,408

)

$

(3,843

)

$

(7,144

)

$

(7,621

)

 

10.          Segment Information

SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” establishes standards for reporting information about operating segments. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision maker is the Chief Executive Officer of the Company.

The Company is organized by line of business. The Company has three major lines of business operating segments: license, consulting services and maintenance and training. The Company also evaluates certain subsets of business segments by vertical industries as well as by product categories. While the Executive Management Committee evaluates results in a number of different ways, the line of business management structure is the primary basis for which it assesses financial performance and allocates resources.

19




The accounting policies of the line of business operating segments are the same as those described in the Company’s Annual Report on Form 10-K, as amended, for the fiscal year ended June 30, 2006. The Company does not track assets or capital expenditures by operating segments. Consequently, it is not practical to show assets, capital expenditures, depreciation or amortization by operating segments. The following table presents a summary of operating segments (in thousands):

 

 

License

 

Consulting
Services

 

Maintenance
and Training

 

Total

 

Three Months Ended December 31, 2006—

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues from external customers

 

$

60,866

 

 

$

15,630

 

 

 

$

19,919

 

 

$

96,415

 

Controllable expenses

 

14,949

 

 

12,277

 

 

 

4,452

 

 

31,678

 

Controllable margin(1)

 

$

45,917

 

 

$

3,353

 

 

 

$

15,467

 

 

$

64,737

 

Three Months Ended December 31, 2005—

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues from external customers

 

$

41,870

 

 

$

15,645

 

 

 

$

19,106

 

 

$

76,621

 

Controllable expenses

 

16,913

 

 

11,637

 

 

 

3,623

 

 

32,173

 

Controllable margin(1)

 

$

24,957

 

 

$

4,008

 

 

 

$

15,483

 

 

$

44,448

 

Six Months Ended December 31, 2006—

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues from external customers

 

$

88,942

 

 

$

32,174

 

 

 

$

39,621

 

 

$

160,737

 

Controllable expenses

 

27,575

 

 

23,044

 

 

 

8,236

 

 

58,855

 

Controllable margin(1)

 

$

61,367

 

 

$

9,130

 

 

 

$

31,385

 

 

$

101,882

 

Six Months Ended December 30, 2005—

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues from external customers

 

$

65,907

 

 

$

32,591

 

 

 

$

37,957

 

 

$

136,455

 

Controllable expenses

 

31,840

 

 

22,910

 

 

 

7,064

 

 

61,814

 

Controllable margin(1)

 

$

34,067

 

 

$

9,681

 

 

 

$

30,893

 

 

$

74,641

 


(1)          The controllable margins reported reflect only the expenses of the line of business and do not represent the actual margins for each operating segment since they do not contain an allocation for selling and marketing, general and administrative, research and development and other corporate expenses incurred in support of the line of business.

Profit Reconciliation (in thousands):

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2006

 

2005

 

2006

 

2005

 

Total controllable margin for reportable segments

 

$

64,737

 

$

44,448

 

$

101,882

 

$

74,641

 

Expenses not included above:

 

 

 

 

 

 

 

 

 

Selling and marketing

 

(19,099

)

(17,191

)

(36,728

)

(32,526

)

General and administrative and overhead

 

(19,642

)

(17,656

)

(37,152

)

(35,414

)

Restructuring charges

 

(589

)

(995

)

(2,035

)

(3,194

)

Gain/(loss) on sales of assets

 

194

 

(316

)

(5,575

)

(377

)

Interest and other income and expense, net

 

5,463

 

1,565

 

6,136

 

(916

)

Income before provision for income taxes

 

$

31,064

 

$

9,855

 

$

26,528

 

$

2,214

 

 

11.          Recent Accounting Pronouncements

In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertain Tax Positions,” an Interpretation of FAS 109 (FIN 48), which clarifies the criteria for recognition and measurement of benefits from uncertain tax positions. Under FIN 48, an entity should recognize a tax benefit when it is “more-likely-than-not” based on the technical merits, that the position would be sustained upon examination by a taxing authority. The amount to be recognized should be measured as the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with a taxing

20




authority that has full knowledge of all relevant information. Furthermore, any change in the recognition, derecognition or measurement of a tax position should be recognized in the interim period in which the change occurs. The Company expects to adopt FIN 48 as of July 1, 2007, and any change in net assets as a result of applying FIN 48 will be recognized as an adjustment to retained earnings on that date. The Company is in the process of evaluating its uncertain tax positions in accordance with FIN 48 and has not determined the effect that application of FIN 48 will have on its financial statements.

In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (SAB 108), which provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of materiality. SAB 108 is effective for fiscal years beginning after November 15, 2006. The Company believes that the initial adoption of SAB 108 will not have a material impact on its consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements (SFAS 157). SFAS No. 157 establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company has not yet determined the effect, if any, that the application of SFAS No. 157 will have on its consolidated financial statements.

In February 2007 the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS 159).  SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value and provides entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions.  SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company has not yet determined the effect, if any, that the application of SFAS No. 159 will have on its consolidated financial statements.

12.          Restatement of Condensed Consolidated Financial Statements

In connection with the preparation of the consolidated financial statements for the fiscal year ended June 30, 2006, a subcommittee of independent members of the board of directors reviewed the Company’s accounting treatment for all stock options granted since the Company completed its initial public offering in fiscal 1995. Based upon the subcommittee’s review, the Audit Committee of the Company’s Board of Directors and Company management determined that certain option grants during fiscal years 1995 through 2004 were accounted for improperly, and concluded that stock-based compensation associated with certain grants was misstated in fiscal years 1995 through 2005, and in the nine months ended March 31, 2006. The subcommittee identified errors related to the determination of the measurement dates for grants of options allocated among a pool of employees when the specific number of options to be awarded to specific employees had not been finalized, and other measurement date errors. As a result of the errors in determining measurement dates, the Company also recorded payroll withholding tax-related adjustments for certain options formerly classified as Incentive Stock Option (ISO) grants under Internal Revenue Service regulations. These options were determined to have been granted with an exercise price below the fair market value of the Company’s stock on the actual grant date, and, as a result do not qualify for ISO tax treatment. The disqualification of ISO classification and the resulting conversion to non-qualified status results in additional withholding taxes on exercise of those options. The Company recorded estimated payroll withholding tax charges of $0.5 million, $0.2 million, and $1.2 million for the years ended June 30, 2004, 2005, and 2006, respectively, in connection with the disqualification of such ISO tax treatment. The stock-based compensation charges, including the aforementioned withholding tax adjustments, increased the net loss by $0.1 million and $0.3 million for the three and six months ended December 31, 2005, respectively, relative to amounts previously reported for those periods.

21




In addition, as a result of the errors in determining measurement dates, certain options were determined to have been granted with an exercise price below the fair market value of the Company’s stock on the actual grant date. Discounted options vesting subsequent to December 2004 result in nonqualified deferred compensation for purposes of Section 409A of the Internal Revenue Code, and holders are subject to an excise tax on the value of the options in the year in which they vest. Management has implemented a plan to assist affected employees for the amount of this tax, and to adjust the terms of the original option grant to cure potential non-qualified deferred compensation related to these option grants. The Company recorded an estimated liability of approximately $1.0 million in June 2006 in connection with this contingency.

In the course of preparing the condensed consolidated financial statements for the three months ended September 30, 2006, the Company identified errors in the accounting for stock-based compensation and certain revenue transactions in the fiscal year ended June 30, 2006. The stock-based compensation error was due to a calculation error associated with forfeiture rates upon the adoption of SFAS No. 123(R), as of July 1, 2005. The effect of correcting this error increased the net loss by $0.4 million and reduced net income by $0.7 million during the three and six months ended December 31, 2005, relative to amounts previously reported for those periods.

The restatement of the condensed consolidated financial statements for the three and six months ended December 31, 2005 also included adjustments for other errors identified after the periods had originally been reported. These errors primarily related to the timing of revenue recognition, interest income, and the calculation of foreign currency gains and losses. The effect of correcting these errors increased net income by $0.1 million during both the three and six months ended December 31, 2005 relative to amounts previously reported for those periods.

Subsequent to the issuance of restated consolidated financial statements for the year ended June 30, 2006, and in the course of preparing the condensed consolidated financial statements for the three and six months ended December 31, 2006, the Company identified errors in the accounting for foreign currency denominated transactions in the three and six months ended December 31, 2005. The Company incorrectly accounted for transaction gains and losses on intercompany balances denominated in currencies other than the functional currency as if such balances were of a long term investment nature and included the impact as a component of accumulated other comprehensive income (loss) rather than earnings. These transaction gains and losses should have been included in earnings as the conditions for accounting for these intercompany balances as a long term investment were not met. In addition, the Company identified errors in the recording of purchase accounting entries in other than the functional currency of the acquired entity. These purchase accounting adjustments should have been denominated in the currency of the applicable subsidiary and translated to United States Dollars and were incorrectly recorded as United States Dollar denominated net assets in the consolidated financial statements. Accordingly, foreign currency translation of the amortization of intangible assets was not recorded. The tax effect of correcting all of the above errors has been also been recorded.

In order to correct these errors, the Company has restated its condensed consolidated financial statements for the three and six months ended December 31, 2005, in order to reflect (a) foreign currency transaction losses of $0.2 million and $3.3 million, respectively, (b) additional amortization of technology related intangible assets of $0.4 million and $0.7 million, respectively, (c) income tax provision decreases of  $0.1 million and $1.0 million, respectively, and (d) additional facility lease costs of less than $0.1 million in each period.

22




Impact of the Financial Statement Adjustments on the Condensed Consolidated Statement of Operations

The following tables present the impact of the financial statement adjustments on the Company’s previously reported condensed consolidated statement of operations for the three and six months ended December 31, 2005 (in thousands, except per share data).

Condensed Consolidated Statement of Operations

 

 

Three Months ended December 31, 2005

 

 

 

As Previously
Reported

 

Restatement
Adjustments

 

As Restated

 

Software licenses

 

 

$

41,690

 

 

 

$

180

 

 

 

$

41,870

 

 

Service and other

 

 

34,701

 

 

 

50

 

 

 

34,751

 

 

Total revenues

 

 

76,391

 

 

 

230

 

 

 

76,621

 

 

Cost of software licenses

 

 

4,244

 

 

 

 

 

 

4,244

 

 

Cost of service and other

 

 

17,859

 

 

 

103

 

 

 

17,962

 

 

Amortization of technology related intangible assets

 

 

1,773

 

 

 

355

 

 

 

2,128

 

 

Total cost of revenues

 

 

23,876

 

 

 

458

 

 

 

24,334

 

 

Gross profit

 

 

52,515

 

 

 

(228

)

 

 

52,287

 

 

Operating costs:

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling and marketing

 

 

20,624

 

 

 

135

 

 

 

20,759

 

 

Research and development

 

 

11,771

 

 

 

55

 

 

 

11,826

 

 

General and administrative

 

 

9,884

 

 

 

217

 

 

 

10,101

 

 

Restructuring charges

 

 

995

 

 

 

 

 

 

995

 

 

Loss on sales and disposals of assets

 

 

316

 

 

 

 

 

 

316

 

 

Total operating costs

 

 

43,590

 

 

 

407

 

 

 

43,997

 

 

Income (loss) from operations

 

 

8,925

 

 

 

(635

)

 

 

8,290

 

 

Interest income, net

 

 

244

 

 

 

510

 

 

 

754

 

 

Foreign currency exchange gain (loss)

 

 

1,055

 

 

 

(244

)

 

 

811

 

 

Income before provision for income taxes

 

 

10,224

 

 

 

(369

)

 

 

9,855

 

 

Provision for income taxes

 

 

(2,080

)

 

 

69

 

 

 

(2,011

)

 

Net income

 

 

8,144

 

 

 

(300

)

 

 

7,844

 

 

Accretion of preferred stock discount and dividend

 

 

(3,843

)

 

 

 

 

 

(3,843

)

 

Income applicable to common shareholders

 

 

$

4,301

 

 

 

$

(300

)

 

 

$

4,001

 

 

Basic income per share applicable to common shareholders

 

 

$

0.10

 

 

 

$

(0.01

)

 

 

$

0.09

 

 

Basic weighted average shares outstanding

 

 

43,743

 

 

 

 

 

 

43,743

 

 

Diluted income per share applicable to common shareholders

 

 

$

0.08

 

 

 

$

(0.00

)

 

 

$

0.08

 

 

Diluted weighted average shares outstanding

 

 

52,765

 

 

 

 

 

 

52,765

 

 

 

23




 

 

 

Six Months ended December 31, 2005

 

 

 

As Previously
Reported

 

Restatement
Adjustments

 

As Restated

 

Software licenses

 

 

$

66,007

 

 

 

$

(100

)

 

 

$

65,907

 

 

Service and other

 

 

70,437

 

 

 

111

 

 

 

70,548

 

 

Total revenues

 

 

136,444

 

 

 

11

 

 

 

136,455

 

 

Cost of software licenses

 

 

8,026

 

 

 

93

 

 

 

8,119

 

 

Cost of service and other

 

 

35,103

 

 

 

202

 

 

 

35,305

 

 

Amortization of technology related intangible assets

 

 

3,555

 

 

 

679

 

 

 

4,234

 

 

Total cost of revenues

 

 

46,684

 

 

 

974

 

 

 

47,658

 

 

Gross profit

 

 

89,760

 

 

 

(963

)

 

 

88,797

 

 

Operating costs:

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling and marketing

 

 

39,271

 

 

 

246

 

 

 

39,517

 

 

Research and development

 

 

21,905

 

 

 

104

 

 

 

22,009

 

 

General and administrative

 

 

20,069

 

 

 

501

 

 

 

20,570

 

 

Restructuring charges

 

 

3,194

 

 

 

 

 

 

3,194

 

 

Loss on sales and disposals of assets

 

 

377

 

 

 

 

 

 

377

 

 

Total operating costs

 

 

84,816

 

 

 

851

 

 

 

85,667

 

 

Income (loss) from operations

 

 

4,944

 

 

 

(1,814

)

 

 

3,130

 

 

Interest income, net

 

 

395

 

 

 

1,175

 

 

 

1,570

 

 

Foreign currency exchange gain (loss)

 

 

392

 

 

 

(2,878

)

 

 

(2,486

)

 

Income before provision for income taxes

 

 

5,731

 

 

 

(3,517

)

 

 

2,214

 

 

Provision for income taxes

 

 

(2,720

)

 

 

1,018

 

 

 

(1,702

)

 

Net income

 

 

3,011

 

 

 

(2,499

)

 

 

512

 

 

Accretion of preferred stock discount and dividend

 

 

(7,621

)

 

 

 

 

 

(7,621

)

 

Income applicable to common shareholders

 

 

$

(4,610

)

 

 

$

(2,499

)

 

 

$

(7,109

)

 

Basic income per share applicable to common shareholders

 

 

$

(0.11

)

 

 

$

(0.05

)

 

 

$

(0.16

)

 

Basic weighted average shares outstanding

 

 

43,491

 

 

 

 

 

 

43,491

 

 

Diluted income per share applicable to common shareholders

 

 

$

(0.11

)

 

 

$

(0.05

)

 

 

$

(0.16

)

 

Diluted weighted average shares outstanding

 

 

43,491

 

 

 

 

 

 

43,491

 

 

 

24




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

The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes appearing elsewhere in this Form 10-Q and in our annual report on Form 10-K, as amended, for the fiscal year ended June 30, 2006. This discussion contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth in “Item 1A. Risk Factors” in Part II of this Form 10-Q.

The following discussion gives effect to the restatement discussed in Note 12 to the condensed consolidated financial statements included in this Form 10-Q. Our fiscal year ends on June 30, and references in this Form 10-Q to a specific fiscal year are the twelve months ended June 30 of such year (for example, “fiscal 2007” refers to the year ending June 30, 2007).

Overview

We are a leading supplier of integrated software and services to the process industries, which consist of oil and gas, petroleum, chemicals, pharmaceuticals and other industries that manufacture and produce products from a chemical process. We provide a comprehensive, integrated suite of software applications that utilize proprietary empirical models of chemical manufacturing and supply chain processes to improve plant and process design, economic evaluation, production planning and scheduling, and operational performance, and an array of services designed to optimize the utilization of these products by our customers.

Critical Accounting Estimates and Judgments

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of our financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. We base our estimates on historical experience and various other assumptions that we believe 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. The significant accounting policies that we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:

·       revenue recognition for both software licenses and fixed-fee consulting services;

·       impairment of long-lived assets, goodwill and intangible assets;

·       accrual of legal fees associated with outstanding litigation;

·       accounting for income taxes;

·       allowance for doubtful accounts;

·       accounting for securitization of installments receivable and subsequent valuation;

·       restructuring accruals; and

·       accounting for stock-based compensation.

Revenue Recognition—Software Licenses

We recognize software license revenue in accordance with AICPA Statement of Position, or SOP, No. 97-2, “Software Revenue Recognition,” as amended by SOP No. 98-4 and SOP No. 98-9, as well as the various interpretations and clarifications of those statements. When we provide professional services

25




considered not essential to the functionality of the software, and for which Vendor Specific Objective Evidence, or VSOE, of fair value has been established, we recognize revenue for the delivered software when the basic criteria of SOP No. 97-2 are met. VSOE has been established for software maintenance services, training and professional services rates. When we provide professional services considered essential to the functionality of the software, we recognize revenue when the basic criteria of SOP No. 97-2 are met and when the services have been completed. When we provide professional services which involve significant production, modification or customization of the licensed software, we recognize such revenue and any related software licenses in accordance with SOP No. 81-1, “Accounting for Performance of Construction Type and Certain Performance Type Contracts.” These statements require that four basic criteria must be satisfied before software license revenue can be recognized:

·       Persuasive evidence of an arrangement between us and a third party exists;

·       Delivery of our product has occurred;

·       The sales price for the product is fixed or determinable; and

·       Collection of the sales price is reasonably assured.

Our management uses its judgment concerning the satisfaction of these criteria, particularly the criteria relating to the determination of whether the fee is fixed and determinable and the criteria relating to the collectibility of the receivables, particularly the installments receivable, relating to such sales. These two criteria are particularly relevant to reseller transactions where, specifically, revenue is only recognized upon delivery to the end user, since the determination of whether the fee is fixed or determinable and whether collection is probable is more difficult. Should changes and conditions cause management to determine that these criteria are not met for certain future transactions, all or substantially all of the software license revenue recognized for such transactions could be deferred.

Revenue Recognition—Fixed-Fee Consulting Services

We recognize revenue associated with fixed-fee service contracts in accordance with the proportional performance method, measured by the percentage of costs (primarily labor) incurred to date as compared to the estimated total costs (primarily labor) for each contract. When a loss is ant