| BORLAND SOFTWARE CORP ITEM 1A RISK FACTORS We are in the midst of focusing the company on the development and distribution of enterprise software development solutions and divesting our individual software development tools |
| If we are unable to successfully complete this change quickly and smoothly, our operating results could be harmed |
| We are undergoing a change from a company that develops and delivers various product lines targeted to multiple individual markets to one that focuses primarily on the development and distribution of enterprise software development solutions |
| In support of this transformation, we acquired Segue Software, Inc |
| (“Segue”) in April 2006 and, in February 2006, we announced our intention to seek a buyer for our IDE products |
| This change involves many aspects (each of which involves substantial risks), including: • Changes in go-to-market strategy |
| To achieve revenue growth, we must enhance our enterprise selling capability, increase sales force productivity and generally complete more large revenue, multi-product sales of our ALM solution set |
| We will also need to further define our roadmaps, integrate the Segue software quality optimization products and other acquired products into our ALM solution set, and generally continue to evolve our ALM offerings to our SDO vision |
| To do so, we must coordinate the efforts of our marketing, sales, services and research and development organizations to focus on the needs of large enterprises |
| These tasks are complicated, involve many people and processes, and require consistency and persistence in the market place to be effective |
| In addition, this “enterprise” go-to-market strategy involves different skills, partners and competencies than the “channel” go-to-market strategy historically used for the IDE products |
| If we fail to coordinate our efforts and deliver broader value to our customers, we will not satisfy the demands of the large enterprise customers that we are targeting and our revenues will suffer |
| 10 ______________________________________________________________________ [38]Table of Contents • Changes in our sales organization and sales leadership |
| The transition to our new business model requires that we focus our sales effort on enterprise customers |
| To drive these changes, we have made and will continue to make changes throughout our global sales force, particularly in Europe and Japan where productivity has been below expectations |
| These efforts may prove unsuccessful in increasing our sales to enterprise customers |
| Sales to large enterprises often involve long and unpredictable sales cycles |
| As we rely more on selling enterprise solutions, we will also become more dependent on large revenue, multi-product transactions to meet our revenue expectations |
| Given our relative inexperience in serving enterprise customers and our increased dependency on larger revenue deals with longer sales cycles, we may be unable to accurately forecast revenues derived from these customers |
| If we fail to accurately forecast revenues, we may not achieve the financial performance that we anticipate, which could harm our business |
| As part of our transition, we have been and are continuing to redefine our marketing strategy |
| Our focus is on increasing lead generation and developing appropriate enterprise-level messaging, all in an effort to provide the necessary tools to our sales organization to sell to the enterprise customer |
| As an organization, we are relatively new at this |
| If we are unable to develop effective marketing programs and increase our pipeline of sales opportunities, or if our sales organization in turn is unable to effectively convert leads into customers, our revenues will suffer |
| • Changes in the make-up of our management team |
| Several members of our management team and senior personnel in a wide range of managerial roles recently joined Borland, including our new President and CEO who joined Borland in November 2005 |
| As a result, our management team has a relatively short history working together, and there is risk that they will be able to manage the company effectively, especially in the face of the dramatic change related to a major acquisition and divestiture of products |
| In addition, we are currently searching for a new head of worldwide research and development |
| Failure to find a suitable candidate in a timely fashion could delay or hamper our efforts to streamline and enhance our research and development activities |
| During this transition in leadership and our business, our customers may decide to defer purchasing or decide not to purchase at all, we may experience employee distraction, or we may see increased competitive pressure as our competitors attempt to use this period of change to their advantage |
| If we are unable to effectively manage through this transition quickly and effectively, our revenues could be harmed |
| The acquisition of Segue and the potential divestiture of the IDE products represent two very different transactions |
| The Segue transaction relates to building on our enterprise software development solutions |
| The IDE products divestiture represents the disposition of individual products delivered to the market largely though a global channel network |
| Both transactions are complex, and carry risks related to both our potential failure to complete them, and our failure to realize the benefits we expect from their completion |
| In addition, executing on both transactions will require a concurrent effort to align our organization, change our business processes, update our financial and IT systems, and generally evolve our day-to-day operations |
| Failure to successfully transition our people and processes and systems could harm our business |
| • Changes in our services organization |
| We are current planning on make significant changes to our services organization |
| We expect to combine our consulting services and sales organizations to better focus on customer engagements |
| We also expect to combine our technical support organization with our research and development organization to more closely align customer feedback on our products with our development efforts |
| Such changes will require careful planning and coordination to ensure we maintain customer satisfaction |
| In addition, such changes may result in loss of key services personnel |
| In the event customer satisfaction is harmed or we lose key personnel, our business could be harmed |
| There are several other types of risks inherent in our transformation, generally described in the following paragraphs and throughout this document |
| While we believe that changing the organization to focus on the development and delivery of comprehensive solutions to enterprise customers is critical to growing our business, 11 ______________________________________________________________________ [39]Table of Contents we may be unable to complete this process smoothly and quickly |
| If we are unable to manage this change smoothly and quickly, our business, results of operations, financial condition and prospects will be harmed |
| Additionally, in consideration of expenses associated with the integration of Segue and those associated with our announced plan to seek a buyer for our IDE products, as well as the resultant changes each will require in our organization, we expect to operate unprofitably for at least the first three quarters of 2006 |
| We may be unable to integrate our operations successfully and realize all of the anticipated benefits of the merger with Segue |
| The acquisition of Segue is a significant transaction for us |
| The acquisition price was approximately dlra105 million in cash, which represented more than half of our cash balances at December 31, 2005 |
| We have made several assumptions regarding cost and revenue synergies for the combined company, many of which are dependent upon how successful we are in integrating operations of the two companies |
| Segue has its headquarters in Lexington, Massachusetts, and has significant development and technical support centers in Linz, Austria and Belfast, Ireland |
| We do not have a significant presence in any of these locations |
| The acquisition involves the integration of two companies that previously have operated independently, which is a complex, costly and time-consuming process |
| The difficulties of combining the companies’ operations include, among other things: • the necessity of coordinating geographically disparate organizations, systems and facilities; • integrating personnel with diverse business backgrounds; • consolidating corporate and administrative functions; • consolidating research and development operations; • coordinating sales and marketing functions; • persuading employees that the Borland and Segue business cultures are compatible, maintaining morale and retaining key employees, in particular those in sales and software engineering positions; • preserving the research and development, collaboration, distribution, marketing, promotion and other important relationships of Borland and Segue, while coordinating and rationalizing research and development activities to enhance introduction of new products and technologies with reduced costs; • demonstrating to customers that the acquisition will not result in adverse changes in customer service standards or business focus; • training our respective sales forces with regard to each other’s technologies and how to effectively sell them; • coordinating and combining international operations, relationships and facilities, which may be subject to additional risks, costs and constraints imposed by local laws and regulations; • managing integration issues of our acquired businesses shortly after, simultaneously with, or pending the completion of other acquisitions or divestitures; • maintaining productivity and support while consolidating the corporate information technology infrastructure; and • combining product offerings and preventing customers from deferring purchasing decisions or switching to other suppliers due to uncertainty about the direction of our product offerings and our willingness to support and service existing products |
| The process of integrating operations could cause an interruption of, or loss of momentum in, the activities of the combined company’s business and the loss of key personnel |
| The diversion of management’s attention and any delays or difficulties encountered in connection with the acquisition and the integration of the two companies’ operations could harm the business, results of operations, financial condition or prospects of the combined company after the merger |
| 12 ______________________________________________________________________ [40]Table of Contents Among the factors considered by our Board of Directors in connection with its approval of the merger agreement were the opportunities for cost savings from operating efficiencies that could result from the acquisition |
| We can not be certain that these savings will be realized within the time periods contemplated or that they will be realized at all |
| We also can not be certain that the integration of Borland and Segue will result in the realization of the full benefits anticipated by us to result from the acquisition |
| The potential divestiture of our IDE products is important for the future growth and profitability of our business, and our failure to efficiently divest these products or divest them at all could harm our business |
| The potential divestiture of our IDE products is a significant transaction for us |
| The IDE products are generally mature products and require less support and maintenance and therefore carry significant product line margins |
| The go-to-market model for the IDE products however has generally required an extensive management, sales and office presence throughout the world, which has been expensive to maintain |
| The market for our IDE products, particularly JBuilder, has become increasingly commoditized |
| This is due in part to the overall increase in the utilization of open source software technologies, including the growing popularity of Eclipse—an open source initiative that provides, among other things, development tools, frameworks, and foundational IDE technology at little or no charge |
| Revenue from our IDE products has thus declined significantly as a group in recent years |
| If we are unable to efficiently divest the IDE products or unable to find a buyer at all, we will continue to be subject to these market trends and organizational dynamics, which would make it difficult to grow our business overall |
| The IDE products are an integrated part of our overall worldwide operations |
| The process for divesting the product lines will involve many complicated tasks, including identifying and dedicating personnel to the IDE products, shifting work responsibilities among existing personnel, identifying and separating customer and partner relationships, identifying and separating assets, and identifying and separating intellectual property |
| In addition, we anticipate the divestiture will require us to provide a series of transition services to the buyer for a period of time, including access to facilities, network connectivity, communications, development systems, IT systems and financial reporting |
| Any divestiture will thus be difficult, complex and costly to implement, and a failure to implement such divestiture smoothly and efficiently could materially adversely affect our business, results of operations and financial condition |
| The potential divestiture could have a disruptive effect on our current business |
| Customers may decide to delay purchases pending the outcome of the divestiture, and competitors may target our installed base of customers to switch to their products |
| The potential divestiture may cause us to incur material expenses |
| We may also incur indemnification obligations for liabilities, losses or expenses arising in connection with the sale of the IDE products |
| There is no assurance that upon completion of the IDE divestiture we will be able to achieve greater profitability, strengthen our core operations or compete more effectively in existing or new markets |
| Entering into such a divestiture transaction may entail risks and uncertainties in addition to those which may result from the divestiture related changes to our business, including but not limited to extraordinary transaction costs, unknown indemnification liabilities and unforeseen administrative complications, any of which could result in reduced revenues, increased charges or post-transaction administrative costs or could otherwise have a material adverse effect on our business, results of operations and financial condition |
| Furthermore, our failure to complete the divestiture, failure to divest our IDE products on advantageous terms or our inability to successfully implement and execute such divestiture could jeopardize our future growth and profitability |
| We would be forced to determine whether to attempt to divest the IDE products again, continue to operate the IDE products or explore another strategic alternative |
| If we try to divest the IDE products at a later time, we would need to expend significant time and resources that would otherwise be used to operate our business and we would likely have to divest the IDE products on terms that could be less favorable to us than the terms we currently anticipate being able to obtain |
| 13 ______________________________________________________________________ [41]Table of Contents Our plans for the restructuring of our company are complex, and our failure to complete the restructuring effectively could adversely effect our business |
| We are attempting to integrate our acquisition of Segue and to complete the divestiture of our IDE products at substantially the same time |
| Both transactions are complex, and carry risks related both to our potential failure to complete them, and our potential failure to realize the benefits we expect following completion |
| In addition, pursuing such transactions at substantially the same time may entail risks and uncertainties in addition to those which may result from either the acquisition or the divestiture alone, including but not limited to extraordinary transaction costs, unknown indemnification liabilities and unforeseen administrative and operational complications, any of which could result in reduced revenues, increased charges or post-transaction administrative costs or could otherwise have a material adverse effect on our business, results of operations and financial condition |
| Furthermore, the process of purchasing a business and selling assets could cause an interruption of, or loss of momentum in, the activities of the company’s business and the distraction of employees or the loss of key personnel |
| The activities involved are complicated and detailed, and they will put strain on the organization |
| The diversion of management’s attention and any delays or difficulties encountered in connection with completing the merger, the integration of operations, and the divestiture of our IDE products at substantially the same time could harm our overall business, results of operations, financial condition or prospects to an even greater extent than either the acquisition or the divestiture alone |
| There is no guarantee that these transactions will have the anticipated results, or that these transactions will present the advantages that we anticipate towards our goal of becoming a company focused on development and distribution of enterprise software development solutions |
| We will need to realign our research and development organization in connection with the acquisition of Segue and the IDE products divestiture |
| We will have a substantial number of new research and development personnel join us through the Segue acquisition, and we will have a substantial number of existing research and development personnel exit the company through the IDE divestiture |
| In addition, we may need to consolidate or close certain research and development locations |
| These personnel additions and subtractions will occur in different geographical locations around the world and will require a coordinated management and training effort |
| The changes will also affect the mix of personnel and skills in various engineering locations, which will require an evolution and rationalization of the research and development approach |
| There are numerous risks inherent in this process including the potential loss of technical talent, the possibility of disruption or distractions in developing products, delays in shipping products, and the potential for product quality to suffer |
| We are currently searching for a new head of worldwide research and development |
| Failure to find a suitable candidate in a timely fashion could delay or hamper our efforts to streamline and enhance our research and development approach |
| We are relatively new to marketing and selling comprehensive solutions for the application development lifecycle, and we may not be able to successfully compete in this broader market |
| The application development lifecycle market is evolving, and customers are increasingly demanding software that integrates and addresses each stage of the application development lifecycle |
| Historically, we have focused on selling point products for particular segments of the application development lifecycle, most notably IDE development tools |
| We have done this utilizing a combination of an indirect sales channel that sells individual point products and a direct sales force that manages larger accounts on the basis of geography |
| Over the past several quarters, we have focused our sales efforts on selling enterprise solutions to large customers, as our future growth will depend in large measure on our ability to sell comprehensive ALM solutions to these larger enterprises |
| Selling enterprise solutions to large customers represents a fundamentally different go-to-market approach than selling through “the channel |
| ” To that end, we have substantially changed our business model, hired and allocated many new sales personnel dedicated exclusively to named enterprise accounts and built plans around augmenting our selling efforts with and through large technology and market- 14 ______________________________________________________________________ [42]Table of Contents facing partners |
| However, we may be unable to transition effectively to selling these solutions to large enterprises |
| To compete successfully in the enterprise account market, we believe we will need to: • develop stronger relationships with systems integrators and other strategic partners with access to enterprise accounts; • develop stronger relationships with executive-level information technology professionals and other executives responsible for making enterprise-wide purchasing decisions; • develop and reinforce messaging focused on executive-level information technology professionals; • leverage our professional services organization to expand product opportunities within an enterprise customer; and • compete with several very large and well-established companies with more experience in these markets |
| If we are unable to do any of the foregoing, our revenues could suffer |
| Our increasing focus on enterprise customers may lengthen our sales cycles, which may delay sales beyond forecasted quarters and increase fluctuations in our financial results |
| As we seek to license our software directly to large enterprises, we have experienced sales cycles that are substantially more lengthy and uncertain than those associated with our traditional business of licensing software through indirect and retail channels and more modest direct sales |
| As we focus on large transactions that involve multiple elements, enterprise customers generally require us to expend substantial time, effort and money in establishing a relationship and in educating them about our solutions |
| Also, sales to enterprise customers generally require an extensive sales effort throughout many levels within the customer’s organization and often require final approval by several layers of executives, including the customer’s chief information officer, chief financial officer and/or other senior executive employee |
| These factors substantially extend the sales cycle and increase the uncertainty of whether a sale will be made in any particular quarter, or at all |
| We have experienced and expect to continue to experience delays and uncertainties in our sales cycles as well as increased up-front expenses in connection with our enterprise sales efforts |
| The timing of the execution of enterprise volume licenses could cause our results of operations to vary significantly from quarter to quarter, especially when we anticipate that certain transactions will close in a particular quarter |
| Further, industry buying patterns suggest that larger transactions are frequently deferred until later in the quarter, creating increased difficulty in quarterly forecasting |
| Finally, if a sale is never completed despite months or even years of selling efforts, we will have expended substantial time, money and resources during the pre-sales effort without generating any revenue to offset these expenses |
| Our success is dependent upon our ability to enhance the quality and scalability of our various products, improve the integration and overall functionality of these products as part of our ALM software development solutions, and evolve our ALM solution toward our vision of SDO We produce and sell a broad portfolio of products to manage the software development process |
| The market for these products is characterized by continuous technological advancement, evolving industry standards and changing customer requirements |
| A significant portion of our research and development focus is on integrating many of our existing point products and recently acquired products into a cohesive ALM software development solution |
| Managing our development activities through our enterprise transformation is complex and involves a number of risks, especially with respect to maintaining competitiveness across our individual products while at the same time bolstering the integration and functionality of our products as part of our ALM solution |
| We cannot be certain that we will be successful in designing and marketing new products, integrating acquired products, providing the necessary product enhancements or features to address increasingly sophisticated and varied needs of our customers or in enhancing the integration and functionality of our ALM platform |
| 15 ______________________________________________________________________ [43]Table of Contents In addition, our customers use a wide variety of constantly changing hardware, software and operating platforms, adding to our development challenges |
| We invest and will continue to invest significant resources to develop products for new or emerging software and hardware platforms in the server, desktop, mobile and other environments that may develop from time to time |
| However, there is a risk that a new hardware or software platform for which we do not provide products could rapidly grow in popularity |
| In particular, we believe that this risk is substantial for particular proprietary platforms and languages for which we may not be given economically feasible access or access at all |
| If we fail to introduce new products that address the needs of emerging market segments or if our new products do not achieve market acceptance as a result of delays in development or other factors, our future growth and revenue opportunity could suffer |
| If we are unable to maintain revenue levels for our Deployment Products, our financial results may be harmed |
| We currently have a significant amount of our revenue attributable to our deployment products |
| These products are mature products and we primarily rely on new sales to existing customers, compliance purchases through customer audits and sales through existing ISV and OEM partners to generate revenue |
| We have from time to time experienced unexpected weakness and fluctuations in revenue from these products and believe they may be subject to commoditization |
| Our deployment products are generally based on older standards and technologies, which increasingly are used only in more select industries, networks and applications |
| We devote little marketing to these products and primarily rely on the effectiveness of the sales force and compliance teams to work with customers and partners to generate sales |
| There have been many changes in the sales force over the past several quarters, and we anticipate changes will continue to take place over the coming quarters, especially in Europe where we have historically generated a significant amount of revenue from our deployment products |
| These changes and the activities associated with the acquisition of Segue and the potential divestiture of the IDE products puts pressure on our ability to focus and execute |
| If we are unable to maintain effective sales programs for our deployment products, or if customers begin to migrate away from our deployment products, our business and results of operation will suffer |
| We are new at delivering large services projects and failure to manage these engagements could harm our margins and adversely affect our results of operations |
| We have recently begun entering into large, complex professional services agreements |
| We have little prior experience in services engagements of this scale |
| Our inability to structure and manage services agreements may result in unanticipated changes to the timing of our services revenue |
| In addition, if we bundle services together with our license agreements, this may also affect the timing of recognizing our license revenue |
| We will need to implement new systems or upgrade current systems to manage these large, complex services agreements |
| If our systems fail or if our services agreements lead to unanticipated changes to the timing of revenue recognition, then our results of operations and sufficiency of our internal controls could be harmed |
| Our inability to forecast our revenue pipeline or convert revenue pipeline into contracts could adversely affect our revenues |
| We use a “pipeline” system, a common industry practice, to forecast sales and trends in our business |
| Our sales personnel monitor the status of all potential transactions, including the estimated closing date and potential dollar amount of each transaction |
| We aggregate these estimates periodically to generate a sales pipeline and then evaluate the pipeline to identify trends in our business |
| This pipeline analysis and related estimates of revenue may differ significantly from actual revenues in a particular reporting period |
| For example, we have had difficulties in forecasting our ALM pipeline in Europe and Japan |
| When customers delay purchasing decisions, reduce in amount the purchase or cancel the purchase altogether, it will reduce the rate of conversion of the pipeline into contracts and our revenues will be harmed |
| In addition, because a substantial portion of our software license contracts close in the latter part of a quarter, we may not be able to adjust our cost structure to respond to a variation in the conversion of the pipeline into contracts in a timely manner |
| Our inability to respond to a 16 ______________________________________________________________________ [44]Table of Contents variation in the pipeline or in the conversion of the pipeline into contracts in a timely manner, or at all, could cause us to plan or budget inaccurately and thereby could adversely affect our results of operations |
| Because competition for qualified technical and management personnel is intense, we may not be able to recruit or retain qualified personnel, which could harm our business |
| We believe our ability to successfully grow and manage our business and to develop new products depends, in large part, on our ability to recruit and retain qualified employees, particularly highly skilled software engineers, sales personnel and management personnel |
| Competition for qualified technical and management personnel is intense and in particular, the job market in the Silicon Valley is beginning to recover, offering alternate opportunities to employees |
| In addition, in the past some of our competitors have also utilized their greater resources to provide substantial signing bonuses and other inducements to lure key personnel away from us |
| We employ a variety of measures to retain our key people, including the grant of stock options, restricted stock and use of promotions and bonuses |
| However, due to our financial performance in 2005, no bonus payments were made under our incentive compensation plan in the first half of 2005, which has adversely affected employee morale and which may lead to employee turnover |
| We have made efforts to utilize equity-based compensation as part of an overall retention program to retain certain key employees; however, we are not certain that our efforts will succeed, and our failure to attract and retain key personnel could significantly harm our business |
| If we are unable to recruit and retain quality personnel, our ability to provide competitive products could be harmed |
| In addition, the loss of technical talent may result in our being unable to ship new products or product upgrades at the times that we originally planned |
| If we experience delays in the shipment of new products or product upgrades, we may be unable to achieve anticipated sales during a particular period |
| We have historically used stock options and other forms of equity compensation as key components of our employee compensation program in order to align employees’ interest with the interests of our stockholders, encourage employee retention and provide competitive compensation packages |
| The decline of our stock price over the last year has made stock options a less attractive portion of our employee compensation program |
| Hence, we may find it increasingly difficult to attract, retain and motivate employees |
| A number of factors affecting our revenues make our future results for a particular period difficult to predict, and therefore we may not meet expectations for a particular period |
| We believe that our revenues have the potential to vary significantly from time to time |
| These variations could cause our stock price to fluctuate significantly |
| We believe that these variations may result from many factors, including, but not limited to: • issues resulting from the Segue acquisition and from divesting our IDE products; • our limited experience in selling large revenue, multiple-product enterprise solutions; • the size and timing of significant orders and their fulfillment; • commoditization in our deployment products, or shifting buying patterns of customers of those products; • product defects that may be discovered from time to time and other product quality problems; • our limited sophistication in consistently forecasting revenues across our geographic regions in light of our transition to an enterprise software company; • the relative mix of demand for our various products and services, especially in light of our increased focus on our services organization; • timing, and any delay in the introduction, of upgrades or localizations to existing products or releases of new products; and • changes in pricing policies by us or our competitors |
| 17 ______________________________________________________________________ [45]Table of Contents Our revenues may also be affected in the short term as a result of not meeting analyst expectations in recent quarters as customers may defer or delay purchasing decisions |
| As a result of the foregoing, revenues may be difficult to predict, and any shortfall in revenues for a quarterly period may not be known until late in the quarter |
| Additionally, our costs, while based on projected revenues, are relatively fixed in the short term |
| Therefore, if our revenue levels fall below projections, anticipated profitability will suffer |
| Additionally, the significant demands placed on our organization due to the Segue acquisition and announced divestiture could adversely affect our ability to accurately forecast costs to our previous tolerances |
| As a result, we believe that quarterly revenues and operating results will continue to be difficult to forecast, and period-to-period comparisons of our results of operations are not necessarily meaningful and should not be relied upon as indications of trends or our future performance |
| Failure to successfully deliver on large transactions may impair our ability to maintain existing and establish new relationships with enterprise-level customers |
| Our reputation, growth and ability to expand our base of enterprise-level customers, depends on the execution of large-scale transactions |
| Because we are new to providing products and services to enterprise-level customers, our success will depend on our ability to deploy our products across an enterprise and to deliver products that perform as promised |
| To be successful in the enterprise market, we must be able to provide high quality products that can scale across the enterprise |
| In addition, our success will depend on our ability to properly scale our services organization in order to provide the necessary consulting, education and technical support services needed to successfully deploy our products |
| If we are unable to provide acceptable products, or our products are unable to scale effectively with enterprise-level customers, or if we fail to provide adequate professional services to the enterprise customer, we will not be able to execute on our large-scale implementations |
| Should this happen, we may lose existing customers and our reputation would be harmed, each of which would cause our revenues to decline |
| If we fail to establish strategic relationships with systems integrators or if we are unable to offer adequate services to support existing relationships with systems integrators, our ability to sell comprehensive solutions to enterprise customers will be harmed |
| We believe that growth in our license revenues will depend on our ability to provide our customers with professional services that support the utilization of our products |
| This will require establishing stronger relationships with the large systems integrators that have experience implementing enterprise solutions across large organizations |
| We believe these systems integrators are important to our sales, marketing and support activities with enterprise customers given their access to large enterprises |
| If successful, we believe that these relationships will expand the distribution of our products |
| In addition, to succeed in establishing successful relationships with systems integrators, we need to provide services that complement their core service offerings |
| These professional services include maintenance, architectural consulting, training, education, technical support and project management |
| We are presently expanding the breadth and depth of our worldwide services organization |
| If we fail to properly hire and scale our worldwide services organization, and hire talent with the correct skill sets, we may not be able to provide the services that complement the core offerings of these systems integrators |
| If we are unsuccessful in establishing good relations with large systems integrators, our ability to sell our solutions to large enterprises will be greatly diminished, and as a consequence, our revenues will be harmed |
| We may not be able to successfully compete against current and potential competitors |
| Our markets are intensely competitive |
| In the market for comprehensive software development solutions, we face competition from some of the largest software providers in the world |
| For example, IBM, Microsoft, Sun Microsystems, BEA Systems, Mercury Interactive, Computer Associates, BMC and others today provide or have stated they intend to provide more comprehensive enterprise software development and integration solutions |
| Presently, some of these competitors partner with us to enhance the depth of comprehensive solutions and enhance their reach to our established developer customer base; however, if strategies change and a larger market 18 ______________________________________________________________________ [46]Table of Contents overlap results, some of these current partners could become more competitive |
| Many of these competitors have substantially greater financial, management, marketing and technical resources than we have |
| In addition, many of our competitors have well established relationships with our current and potential customers, extensive knowledge of the market, substantial experience in selling enterprise solutions, strong professional services and technical support offerings and extensive product development, sales and marketing resources |
| As a result of their greater resources and established relationships, these competitors may be more successful than we are at developing and marketing products and solutions in our markets |
| In addition, the markets for our individual products are characterized by rapid change, new and emerging technologies, and aggressive competition |
| Some of our competitors include IBM, Telelogic, Mercury Interactive, Compuware, Serena, BEA Systems, Microsoft and Sun Microsystems |
| We attempt to differentiate our products from those of our competitors based on interoperability, total cost of ownership, product quality, performance, level of integration and reliability |
| In the future, we may be unable to successfully differentiate our products from those of our competitors, or we may be unable to compete with the substantially greater resources that many of our competitors have |
| Bundling arrangements or product give-aways by our competitors, including available, cost-free development technologies, may diminish demand for our products or pressure us to reduce our prices |
| Some of our competitors, particularly those that are primarily hardware vendors or platform providers, generate a substantially greater proportion of their sales in markets in which we do not directly compete |
| We believe a number of these competitors view sales of software application lifecycle technologies as important to enhancing the functionality of, and the demand for, their core products |
| As a result, these companies often bundle software products that compete with our offerings, with products such as application servers, work stations, personal computers, operating systems databases and information technology services |
| When competitors do so, the effective price for their software products that compete with our software development platform/solutions are often heavily discounted or offered at no charge |
| This has required us to reduce the price of our products and related services in certain circumstances, sometimes to no avail |
| Similarly, industry alliances and arrangements exist or may be formed in the future under which our competitors ally with companies in markets in which we do not compete to bundle products |
| These arrangements may also result in lower effective prices for our competitors’ products than for our products, putting pressure on our business and diminishing our competitive position |
| The complexity of accounting regulations and related interpretations and policies, particularly those related to revenue recognition, could cause us to defer recognition of revenue, or recognize lower revenue and profits |
| Although we use standard agreements designed to meet current revenue recognition criteria under generally accepted accounting principles, we must often negotiate and revise terms and conditions of these standard agreements, particularly in multi-product license and services transactions |
| As our transactions increase in complexity with the sale of larger, multi-product licenses, negotiation of mutually acceptable terms and conditions may require us to defer recognition of revenue on such licenses |
| We believe that we are in compliance with Statement of Position 97-2, “Software Revenue Recognition,” as amended; however, these future, more complex, multi-product license transactions may require additional accounting analysis to account for them accurately, could lead to unanticipated changes in our current revenue accounting practices and may contain terms affecting the timing of revenue recognition, which could affect the financial results for a given period |
| Our products may contain unknown defects that could result in a loss of revenues, decreased market acceptance, injury to our reputation and product liability claims |
| Software products occasionally contain errors or defects, especially when they are first introduced or when new versions are released |
| We cannot be certain that our products are or in the future will be completely free of defects and errors |
| We could lose revenue as a result of product defects or errors, including defects contained in 19 ______________________________________________________________________ [47]Table of Contents third party products that enable our products to work |
| In addition, the discovery of a defect or error in a new version or product may result in the following consequences, among others: • delayed shipping of the product; • delay in market acceptance; • diversion of development resources; • damage to our reputation; • product liability claims; and • increased service and warranty costs |
| As we move away from selling individual point products towards selling enterprise-wide solutions, we also expect our products to become more critical to our customer |
| Thus, a defect or error in our products could result in a significant disruption to our customer’s business |
| In addition, as we transition to selling larger, more complex solutions, there is also the risk that our current products will not prove scalable without substantial effort or that there is a market perception that our products are too complex |
| If we are unable to develop products that are free of defects or errors or if our products are not able to scale across an enterprise or are perceived to be too complex to scale across an enterprise, our business could be harmed |
| Consolidation in our industry or fluctuation in our stock price may impede our ability to compete effectively |
| Consolidation continues to occur among companies that compete in our markets |
| Additionally, some of the largest software and hardware providers in the world have sought to expand their software and services offerings through acquisitions in the software development, deployment and integration space |
| For instance, in early 2003, IBM acquired Rational Software, a provider of application lifecycle development products, and in 2004 purchased SystemCorp, a provider of software development project and portfolio management products |
| If these large providers, who have significantly greater financial, management, marketing and technical resources than we have, are successful in increasing their offerings in the software development market, then this will put significant pressure on our business and harm our ability to compete effectively |
| Additionally, changes resulting from these and other consolidations may harm our competitive position, particularly as certain products, when offered as part of a bundled suite, are offered for free or are given away to sell more hardware, infrastructure components or information technology services |
| As the trend toward consolidation continues, we may encounter increased competition for attractive acquisition targets and may have to pay higher prices for those businesses or technologies we seek to acquire |
| In addition, we have seen a recent decline in our stock price, which will in turn make it more difficult for us to use stock as a currency for the acquisition of strategic businesses or technologies |
| This will put pressure on our ability to seek out potential acquisition targets which may impede our growth and our ability to compete effectively |
| We depend on technologies licensed to us by third parties, such as Sun Microsystems and Microsoft, and the loss of or inability to maintain these licenses could prevent or delay sales or shipments of certain of our products |
| We depend on licenses from third party suppliers for some elements of our products such as various file libraries |
| In particular, we depend on technology licenses from Sun Microsystems for certain of our Java products, and we depend on licenses from Microsoft for our Delphi, C++Builder, C#Builder and Borland Developer Studio products |
| If any of these licenses or other third party licenses were terminated or were not renewed, or if these third parties failed to notify us in a timely manner of any new or updated technology, we might not be able to ship such products as planned or provide support for such products, including upgrades |
| We would then have to seek an alternative to the third party’s technology and, in some cases, an alternative may not 20 ______________________________________________________________________ [48]Table of Contents exist |
| This could result in delays in releasing and/or shipping our products, increased costs by having to secure unfavorable royalty arrangements or reduced functionality of our products, which in turn could substantially reduce our revenues |
| Our future success depends upon enhancing existing relationships and establishing new technology alliances |
| The market for enterprise software application development and deployment solutions is broad, and our products and solutions must integrate with a wide variety of technologies |
| To be successful, we must establish and enhance strategic alliances with a wide variety of companies in the software development ecosystem |
| Many of these companies have competitive products or have stated a desire to move broadly into the software development lifecycle space |
| In addition, many of these companies are competitive with one another and approach partnering with us cautiously |
| This has made it difficult in some cases to establish or enhance desired relationships or achieve intended objectives |
| We currently have a number of important strategic alliances and technology relationships with industry leaders |
| Where we have established working relationships, our allies may choose to terminate their arrangements with us where no binding contractual arrangements exist |
| The failure to develop or maintain our strategic alliances and technology relationships or our allies’ decision to opt out of their arrangements with us may impede our ability to introduce new products or enter new markets, and consequently harm our revenue prospects |
| Failure to manage our international operations could harm our financial results |
| A substantial portion of our revenues is from international sales |
| International sales accounted for 57prca of our revenues during the year ended December 31, 2005, with each of Germany and the United Kingdom accounting for significant portions of our total revenue |
| In addition, a significant portion of our operations consists of activities outside the United States |
| We now have research and development facilities in several domestic and international locations, and we have a direct sales force in place in more than twenty countries around the world |
| We have a complicated corporate structure, and historically have had geographically dispersed operational controls |
| In particular, we rely on personnel in our international locations to properly account for and manage our international operations, which introduces inherent difficulties in management and control |
| Given this, we may experience difficulty in efficiently and effectively managing our dispersed and complicated organization |
| As a result, our results of operations may suffer |
| In addition, we are subject to other risks inherent in doing business internationally, including: • fluctuations in foreign currency exchange rates; • the difficulty of staffing and managing an organization spread over various countries and continents; • potentially reduced or less certain protection for intellectual property rights than is available under the laws of the United States; • longer payment cycles in some countries and greater difficulty in collecting accounts receivable; • restrictions on the expatriation of currency; • foreign taxes, export restrictions, tariffs, duties and other trade barriers; • changes in regulatory requirements and resulting costs; • differing cultures and business practices not consistent with our regulatory obligations in the United States; • compliance with various conflicting laws and regulations, including employment laws, and resulting costs; and • war, threats of war, terrorist activity or political or economic instability in certain parts of the world |
| One or more of these risks could harm our future research operations and international sales |
| If we are unable to manage these risks of doing business internationally, our results of operations could suffer |
| 21 ______________________________________________________________________ [49]Table of Contents We have begun the process of upgrading our Oracle financial system in the United States and if we are unsuccessful in deploying the system or, if it takes longer than anticipated to deploy the system, we may incur significant additional costs which would negatively impact our financial results as well as potentially weaken our internal controls |
| We anticipate upgrading our Oracle financial system in the United States this year |
| System upgrades are expensive and time consuming undertakings that impact all areas of the company |
| While a successful implementation will provide us with many benefits, an unsuccessful or delayed implementation will cost us significant time and resources, as well as expense |
| Implementing a new financial system raises costs and risks inherent in any upgrade to a computer system, including, but not limited to, disruption to our normal accounting procedures such as order entry, fulfillment and billing, as well as problems achieving accuracy in data conversion |
| Failure to properly or adequately address these issues could result in increased costs, the diversion of management’s attention and resources and the inability to forecast revenues and record and report financial and management information on a timely and accurate basis |
| This may result in increased costs and could negatively impact our financial results |
| In addition, due to the systemic internal control features within financial systems, any changes in our financial system will have an impact on the testing of our internal control over financial reporting as required by Section 404 of the Sarbanes-Oxley Act of 2002 (“SOX 404”) |
| We, and our independent registered public accounting firm, have determined that we have material weaknesses in our internal control over financial reporting as of December 31, 2005 |
| As a result, current and potential stockholders could lose confidence in our financial reporting, which would harm our business and the trading price of our stock |
| Under Section 404 of the Sarbanes-Oxley Act of 2002, we are required to evaluate and determine the effectiveness of our internal control over financial reporting |
| We have dedicated a significant amount of time and resources to ensure compliance with this legislation for the year ended December 31, 2005 and will continue to do so for future fiscal periods |
| We may encounter problems or delays in completing the review and evaluation, the implementation of improvements and the receipt of a positive attestation, or any attestation at all, by our independent registered public accounting firm |
| Additionally, management’s assessment of our internal control over financial reporting may identify deficiencies that need to be addressed in our internal control over financial reporting or other matters that may raise concerns for investors |
| We announced on March 31, 2006 that we were delaying our filing of our Annual Report on Form 10-K for the fiscal year ended December 31, 2005 in order for the Audit Committee of our Board of Directors to conduct a review, with the assistance of outside advisors, of third-party contractor liabilities and accrued expenses and a potential customer refund obligation (the “Review”) |
| The Audit Committee’s Review is now complete |
| As a result of this Review, management identified material weaknesses insofar as we did not maintain effective controls over third-party contractor invoices and contracts and we did not maintain an effective control environment based on the criteria established in Internal Control - Integrated Framework Issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) with respect to senior management’s role in promoting compliance with policies and procedures and the prevention or detection of the override of our controls |
| A material weakness is a control deficiency, or combination of control deficiencies, that results in a more than remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected |
| Because of these material weaknesses, our management concluded that, as of December 31, 2005, we did not maintain effective internal control over financial reporting |
| As a result, PricewaterhouseCoopers LLP has issued an adverse opinion with respect to our internal control over financial reporting and their report is included in this Annual Report on Form 10-K 22 ______________________________________________________________________ [50]Table of Contents We assign a high priority to the improvement of our internal control over financial reporting |
| We currently expect to implement new training courses for senior personnel throughout the company attended by our Chief Executive Officer |
| In addition, we intend to institute procedures that will require that third-party contractor hours be tracked in a separate system and reconciled with the time recorded on invoices received |
| We also intend to require new certifications of our senior personnel concerning invoicing, billing and customer commitments |
| We intend to finalize and implement these measures at the earliest practicable date |
| If we fail to remedy our material weaknesses or should we, or our independent registered public accounting firm, determine in future fiscal periods that we have additional material weaknesses in our internal control over financial reporting, the reliability of our financial reports may be impacted, and our results of operations or financial condition may be harmed and the price of our common stock may decline |
| We may incur future impairment losses related to intangible assets from prior acquisitions that could harm our future operating results |
| In the past few years, we have acquired significant assets and businesses |
| If the assets and businesses do not perform as expected, we may be required to take impairment charges related to the intangible assets from these acquisitions |
| Such charges could harm our operating results |
| Recent changes in accounting for equity compensation could adversely affect our earnings and could require a modification to our equity compensation strategy, which could impact our ability to attract and retain employees |
| We accounted for stock options under APB 25 through the end of fiscal 2005 and, accordingly, recorded compensation expense related to stock options if the current market price of the underlying stock exceeds the exercise price of the stock option on the date of grant |
| On December 15, 2004, the FASB issued SFAS 123R, which will require us to expense stock options in our statement of operations |
| On April 14, 2005, the SEC adopted a new rule amending the compliance dates for SFAS 123R which will delay the effective date of compliance for us to fiscal 2006 |
| SFAS 123R applies to all outstanding stock options that are not vested at the effective date and grants of new stock options made subsequent to the effective date |
| Compensation charges under SFAS 123R will be affected by our stock price as well as assumptions regarding a number of complex and subjective variables and the related tax impact |
| These variables include, but are not limited to, the volatility of our stock price and employee stock option exercise behaviors |
| We estimate that our earnings in 2006 could be reduced significantly, which will make it substantially more likely that we could experience net losses |
| We have historically used stock options and other forms of equity compensation as key components of our employee compensation program in order to align employees’ interests with the interests of our stockholders, encourage employee retention, and provide competitive compensation packages |
| The changing regulatory landscape could make it more difficult and expensive for us to grant stock options to employees in the future |
| If employees believe that the incentives that they would receive under a modified strategy are less attractive, we may find it difficult to attract, retain and motivate employees |
| In addition, the use of alternative equity incentives may increase our compensation expense and may negatively impact our earnings |
| To the extent that new regulations make it more difficult or expensive to grant equity instruments to employees, we may incur increased compensation costs, further change our equity compensation strategy or find it increasingly difficult to attract, retain and motivate employees, each of which could materially and adversely affect our business, financial condition or results of operations |
| If we are unable to protect our intellectual property, we may lose valuable assets |
| As a software company, our intellectual property rights are among our most valuable assets |
| We rely on a combination of patent, copyright, trademark, trade secret laws, confidentiality agreements and other contractual arrangements and other methods to protect our intellectual property rights, but these measures may provide only 23 ______________________________________________________________________ [51]Table of Contents limited protection |
| The protective steps we have taken may be inadequate to deter misappropriations of our intellectual property rights |
| In addition, it may be possible for an unauthorized third party to reverse-engineer or decompile our software products |
| We may be unable to detect the unauthorized use of, or take appropriate steps to enforce, our intellectual property rights, particularly in certain international markets, making misappropriation of our intellectual property more likely |
| Litigation may be necessary to protect our intellectual property rights, and such litigation can be time consuming and expensive |
| Third party claims of intellectual property infringement may subject us to costly litigation or settlement terms or limit the sales of our products |
| From time to time, we have received notices claiming that we have infringed a third party’s patent or other intellectual property right |
| We expect that software products in general will increasingly be subject to these claims as the number of products and competitors increase, the functionality of products overlap and as the patenting of software functionality becomes more widespread |
| Further, the receipt of a notice alleging infringement may require in some situations that a costly opinion of counsel be obtained to prevent an allegation of intentional infringement |
| Regardless of its merits, responding to any claim can be time consuming and costly and divert the efforts of our technical and management personnel from productive tasks |
| In the event of a successful claim against us, we may be required to pay significant monetary damages, including treble damages if we are held to have willfully infringed, discontinue the use and sale of the infringing products, expend significant resources to develop non-infringing technology and/or enter into royalty and licensing agreements that might not be offered or be available on acceptable terms |
| If a successful claim were made against us and we failed to commercially develop or license a substitute technology, our business could be harmed |
| In addition, we may not have insurance coverage for these types of claims or our insurance coverage for these types of claims may not be adequate |