| SUMTOTAL SYSTEMS INC ITEM 1A RISK FACTORS Factors That May Affect Future Results of Operations Set forth below and elsewhere in this report and in other documents we file with the SEC are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this report |
| All forward-looking statements included in this document are based on information available to us on the date hereof |
| We assume no obligation to update any forward-looking statement |
| We have a history of losses, we expect future losses on a generally accepted accounting principles (“GAAP”) basis, and we may not achieve GAAP profitability on a consistent basis |
| We expect to continue to derive substantially all of our revenue from the licensing of our new business performance and learning technology software family of products, the SumTotal 7 |
| x Series, as well as our legacy products, Aspen Learning Management Server and Aspen Learning Content Management Server, Docent Learning Management Server and Docent Learning Content Management System, and Pathlore products (“Legacy Products”) and related services, including without limitation, maintenance, services and hosting |
| We do not expect revenues from these product offerings to be sufficient to achieve and maintain US GAAP profitability on a consistent basis |
| With the exception of the Pathlore products which we acquired in the fall of 2005, we began to transition our Legacy Products to our SumTotal 7 |
| x Series and services related to these offerings at the end of the fourth quarter of 2004 and beginning the first quarter of 2005 |
| If we fail to continue to generate adequate revenues from the SumTotal Systems Suite and related services, we will continue to incur losses |
| In addition, in the future, we expect to continue to incur additional non-cash expenses relating to the amortization of deferred compensation and purchased intangible assets that will contribute to our net losses |
| Further, starting with the first quarter of fiscal 2006, we will be required to record as an expense charges related to all current outstanding and future grants of stock options in our reported results from operations in accordance with Statement of Financial Accounting Standards (“SFAS”) Nodtta 123R, Share Based Payments, which was issued by the Financial Accounting Standards Board (“FASB”) in December 2004 |
| This will have the impact of increasing our reported expenses and our US GAAP losses |
| As a result of all of the foregoing, we expect to incur additional US GAAP basis expenses related to stock based compensation awards for the foreseeable future and these future expenses will adversely impact our ability to achieve profitability on a US GAAP basis |
| Continued losses or failure to meet or exceed our forecasts or industry analysts’ projections could cause the price of our common stock to decline |
| Our operating results are uncertain and may fluctuate significantly from quarter to quarter or year to year, which could negatively affect the value of your investment |
| We have experienced substantial fluctuations in operating results on a quarterly and annual basis and expect these fluctuations will continue in the future |
| Our operating results may be affected by a number of other factors, including: (1) the size and timing of product orders and the timing and execution of professional services engagements for SumTotal 7 |
| x Series and the Legacy Products; (2) the mix of revenue from products and services; (3) the ability to meet client project milestones; (4) market acceptance of our products and services, especially SumTotal 7 |
| x Series and related services; (5) failure to complete fixed-price professional services engagements within budget, on time and to clients’ satisfaction; (6) ongoing costs and efforts in connection with compliance with Section 404 of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Section 404”); (7) the timing of revenue and expense recognition; (8) the overall movement toward industry consolidation among both our competitors and our customers; (9) recognition of impairment of existing assets; and (10) how well we execute on our strategy and operating plans |
| Our future revenue is difficult to predict, and we may not be able to adjust spending in response to revenue shortfalls |
| Our limited operating history with our current business performance and learning management 13 ______________________________________________________________________ [39]Table of Contents solutions, and the rapidly evolving nature of the business performance and learning management market, make prediction of future revenue and expenses difficult |
| Expense levels are based, in part, on expectations as to future revenue and are basically fixed in the short-term |
| Other expenses, as a result of changes in the law or otherwise, such as expenses related to litigation or compliance with Sarbanes-Oxley Section 404, may also increase and cause us to fall short of our forecasts |
| If we are unable to predict future revenue accurately, including, in particular, the timing of future revenue, we may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall, and may therefore fall short of our forecasts |
| Failure to meet our forecasts or industry analysts’ expectations would likely cause a decline in the price of our common stock |
| Sales cycles are lengthy, requiring considerable additional investment with no assurance of generating revenue from our efforts |
| The period between our initial contact with a potential customer and a customer’s purchase of our products and services is lengthy, is getting longer, and often extends over several fiscal quarters or a fiscal year |
| To sell our products and services successfully, we generally must educate our potential customers regarding the use and benefits of our products and services, which typically requires significant time, capital and other resources |
| The delay or failure to complete sales in a particular quarter could reduce our revenue in that quarter, as well as subsequent quarters over which revenue for the sale would likely be recognized |
| If the sales cycle unexpectedly lengthens in general or for one or more large orders, it would negatively affect the timing of our revenue, and our revenue growth would be harmed |
| Many of our potential customers are large enterprises that generally take longer than smaller organizations to make significant business decisions, and the formation and execution of even a relatively small number of large contracts with these enterprise customers may have a significant impact on our revenues |
| In addition, we must expend and allocate resources prior to completing a sales transaction, with no guarantee that a particular sales transaction will be consummated, resulting in a failure to generate any revenue from these activities and potentially affecting our stock price as well |
| Our operating results may be affected by successful warranty claims, refund requests, litigation claims for breach of contract or other claims related to product defects |
| Although we generally attempt to contractually limit our liability for damages arising from defects and other mistakes in rendering professional services, these contractual protections are not always obtained and may not be enforced or otherwise may not protect us from liability for claims such as warranty claims, refund claims, or litigation claims |
| If such a claim is successful, our insurance may not be sufficient to cover these claims |
| Any of these consequences could have a material adverse impact on our financial condition, results of operations, our reputation, or the market value of our common stock |
| We expect that our recent acquisition of Pathlore will enhance our position in the learning industry through the integration of Pathlore’s technologies, products, services, distribution channels and customer contacts into our current product offerings |
| Achieving the expected benefits of the acquisition, however, depends in part on the integration of Pathlore’s legacy technology, products, operations, personnel and distribution channels in a timely and efficient manner |
| The challenges involved in successful integration include: (1) incorporating Pathlore’s legacy technology and products into our offerings, business, and distribution channels; (2) legacy customers of both Pathlore LMS and the Pathlore mainframe business switching to a competitor’s learning management solution or failing to renew their Pathlore LMS service contracts or Pathlore mainframe lease licenses; (3) convincing Pathlore legacy customers to upgrade to the SumTotal 7 |
| x Series, especially if they are using a relatively inexpensive Pathlore product; (4) integrating the former Pathlore operations and financial reporting function into our operations and financial reporting systems; and (5) integrating the former Pathlore technical team and sales organization with our larger and more widely dispersed engineering organization and sales organization |
| 14 ______________________________________________________________________ [40]Table of Contents If we do not realize the anticipated benefits associated with the acquisition in a timely manner or at all, our business and financial results may be harmed |
| For example, if our combined business fails to meet the demands of the marketplace, customer acceptance of products and services of the newly combined company could decline or customer orders could be cancelled |
| In addition, we may not achieve the anticipated benefits of the acquisition as rapidly as, or to the extent, anticipated by our management and certain financial or industry analysts, and others may not perceive the same benefits of the acquisition as our management does |
| For example, the sale of Pathlore’s products may not contribute to our results to the extent we expect for a number of reasons, including the integration risks described above |
| The integration of the two businesses has been and will continue to be complex, time consuming and expensive, may disrupt both companies’ businesses and may result in the loss of customers or key employees or the diversion of the attention of management, any of which could have a negative effect upon our business and stock price |
| Customer and employee uncertainty related to the Pathlore acquisition could harm the combined company |
| Pathlore legacy customers may, in response to the acquisition by us, delay or cancel purchasing decisions |
| Any delay or cancellation in purchasing decisions could seriously harm our business |
| Similarly, our and former Pathlore employees may experience uncertainty about their future role with the combined company |
| This may adversely affect our ability to attract and retain key management, marketing and technical personnel |
| Any future acquisitions we make, or attempt to make, could disrupt our business and harm our financial condition if we are not able to timely and successfully close the acquisition or successfully integrate acquired businesses and technologies |
| We have made and may continue to make acquisitions of business and technologies to enhance our business |
| Acquisitions involve numerous risks, including problems combining the purchased operations and key employees, technologies or products, unanticipated costs, diversion of management’s attention from our core business, adverse effects on existing business relationships with suppliers and customers, risks associated with entering markets in which we have no or limited prior experience and potential loss of key employees |
| The integration of businesses that we have acquired or that we may acquire in the future into our business has been and will continue to be a complex, time consuming and expensive process |
| Failure to operate as a combined organization utilizing common information and communication systems, operating procedures, financial controls and human resources practices could adversely impact the success of any business combination as evidenced in previous combination and acquisition transactions |
| For example, although we completed the combination of Docent and Click2learn in March 2004, the difficulty in integrating financial controls and procedures contributed to our failure to timely file our Annual Report on Form 10-K with the SEC for fiscal 2004 |
| We are only just beginning to integrate the Pathlore financial controls into ours, and we may experience problems with this integration |
| Moreover, the integration of the products, product roadmap, and operations from the combination of Docent, Click2learn and Pathlore is a continuing activity and will be for the foreseeable future |
| Our operating results may suffer because of acquisition-related expenses, amortization of intangible assets and impairment of acquired goodwill or intangible assets |
| Furthermore, we may have to incur debt or issue equity securities to pay for any future acquisitions, or to provide for additional working capital requirements, the issuance of which could be dilutive to our existing shareholders |
| If we are unable to successfully address any of these risks, our business, financial condition or operating results could be harmed |
| There can be no assurance that we will be able to timely close other acquisitions, or other business combinations we may make in the future on favorable terms or on a timely basis, or that we will be able to successfully integrate Pathlore or any other businesses, products, technologies or personnel that we might acquire and failure to do so may negatively affect our financial results, customer, employee and investor confidence, and ultimately our stock price |
| 15 ______________________________________________________________________ [41]Table of Contents Our credit facility requires compliance with certain restrictive covenants, and if we breach the covenants, we will be in default and the lender could demand repayment and foreclose on the loan |
| The credit facility we established in conjunction with our acquisition of Pathlore requires compliance with certain restrictive covenants |
| If we cannot achieve the financial results necessary to maintain compliance with these covenants, we could be declared in default and be required to sell or liquidate our assets to repay outstanding debt of approximately dlra17dtta5 million |
| These covenants include, but are not limited to, earnings before interest, taxes, depreciation and amortization (“EBITDA”) levels, leverage ratios, and restrictions related to capital expenditures, indebtedness, distributions, investments, and change of control |
| If we breach any of these covenants, the lender could demand repayment of the outstanding debt and could foreclose upon all or substantially all of our assets and the assets of our subsidiaries |
| These covenants may adversely affect our ability to finance future operations, potential acquisitions or capital needs or to engage in other business activities that may be in our interest |
| As a result of our credit facility, we may have more debt than some of our competitors, which could place us at a competitive disadvantage and make us more susceptible to downturns in our business in the event our income is not sufficient to cover our debt service requirements |
| Even if we are able to repay the debt, under the terms of the credit facility, there are penalties for making pre-payments that would otherwise save us substantial future interest payments |
| The forced premature repayment of the loan could leave us without: (1) the ability to control which assets are sold to satisfy the loan; and (2) sufficient assets to continue as a going concern |
| Our business may not generate the cash needed to finance our operations or growth, and for that and other reasons we may need additional financing in the future, which we may be unable to obtain |
| Our recent acquisition of Pathlore decreased our cash position |
| If our business does not generate the cash needed to finance our operations or growth, including potential business acquisitions, we may need to obtain additional financing or take steps to restrict our operations in order to conserve existing cash |
| In addition, poor financial results or unanticipated expenses could give rise to additional financing requirements |
| We may be unable to obtain financing on terms favorable to us, or at all |
| Further, it may be more difficult to obtain additional financing because of our credit facility |
| If we need to obtain financing and adequate funds are not available or are not available on acceptable terms, we may be required to make further expense reductions, which could significantly restrict our operations and limit our ability to enhance our products, fund expansion, respond to competitive pressures or take advantage of business opportunities, thereby resulting in a decrease in our revenues and stock price |
| Our products contain defects, and, if we cannot fix any material defects in a timely fashion, we may need to halt further sales or shipments of our products, delay introduction of new products, and/or account for warranty claims |
| Our product offerings, both current and future, are complex and often contain defects, including software and process errors, incorrect code, faulty error handling, incomplete use cases, known and unknown, despite internal and third party testing |
| New product offerings contain new features and functionality which result in a greater likelihood of defects, and frequently, defects are undetected until the period immediately following introduction and initial shipment of new products or enhancements to existing products |
| For example, although we attempted to discover and resolve all defects in our new product line that we believed would be considered serious by our customers before shipment to them, SumTotal 7 |
| x Series is not error-free and some customers have notified us that they consider some of the defects in the SumTotal 7 |
| In addition, our products include third party software, and any defects in third party software that we incorporate in our products will compromise our products |
| It may be difficult for us to correct any errors in third party software because the software is not within our control |
| Accordingly, our revenue could decrease and our costs could increase in the event of any errors in this technology |
| Furthermore, we may become subject to legal 16 ______________________________________________________________________ [42]Table of Contents claims related to defects in our products, including defects in licensed technology, based on product liability, infringement of intellectual property or other legal theories |
| The defects, some of which were unknown to us, some which may yet to be discovered, and others of which may manifest themselves in future releases of our products, could cause performance problems and result in material adverse financial consequences to our customers and us, including without limitation, delay in recognizing, declining or lost revenues and delay in customer acceptance |
| If we fail to successfully manage our product transition to, or fail to successfully deploy upgrades to our SumTotal 7 |
| x Series on a timely basis, our business and financial results will be harmed |
| We introduced SumTotal 7dtta0 in late December 2004, SumTotal 7dtta1 in April 2005, and plan to launch subsequent product releases over the next year |
| We face numerous risks relating to product transitions, including customers delaying their purchasing decision until they have confidence in our new product and until we have proven we can successfully install and implement SumTotal 7 |
| Due to the product transition, we may be unable to accurately forecast revenue from product sales and related services, the number and severity of defects and increased support requirements due to the complexity of the new product |
| In order to successfully market and sell the product, we must ensure broad-based cooperation from and coordination between multiple departments, including engineering and marketing, and from multiple geographic regions, including Bellevue, Washington, Mountain View, California, and Hyderabad, India |
| If we fail to successfully manage the transition to this new product offering, our business and financial results may be adversely affected, which may cause a decline in the price of our common stock |
| Our lack of product diversification, and our reliance on the SumTotal Systems Suite, means that any decline in price or demand for our products and services would seriously harm our business |
| x Series and successor products and related services to continue to account for a significant majority of our revenue for the foreseeable future |
| Consequently, a decline in the price of, or demand for, the SumTotal Systems Suite and successor products or services, or their failure to achieve broad market acceptance, would seriously harm our business and would likely result in the decline of our common stock |
| Our intellectual property is subject to, and may be subject to, legal challenges or unauthorized use or claims of infringement, any of which could diminish the value of our products and services or deter customers from purchasing our products |
| Our success depends in large part on our proprietary technology |
| We rely on a combination of copyrights, trade secret and trademark laws, contractual restrictions, restrictions on disclosure and other methods to protect our proprietary technology |
| These legal protections afford only limited protection for our technology |
| We hold only three issued patents underlying the products developed by Docent prior to the merger of Docent and Click2learn, and do not hold patents for any of the technology underlying Click2learn’s legacy Aspen product offering, any of the technology acquired in the Pathlore acquisition, nor any patents for SumTotal 7 |
| Furthermore, effective protection of intellectual property rights is unavailable or limited in certain foreign countries |
| It may also be possible for third parties to copy or otherwise obtain and use our intellectual property or trade secrets without our authorization and it may be possible for third parties to independently develop substantially equivalent intellectual property |
| We cannot assure you that the protection of our proprietary rights will be adequate or that our competitors will not independently develop similar technology, duplicate our products and services or design around any patents or other intellectual property rights we hold |
| Consequently the value of our products and services to our customers could diminish substantially |
| From time-to-time, we are involved in legal proceedings or threats of legal proceedings |
| Litigation is expensive to defend and even the threat of legal proceedings diverts management attention from operating our business |
| In the event of an adverse judgment against us, we may be required to cease shipping, to pay damages, 17 ______________________________________________________________________ [43]Table of Contents to license technology on terms that may not be favorable to us or to alter our technology, website or software products, any of which may adversely affect our operating results and cause us to meet our forecasts or industry analysts’ forecasts, thereby causing a possible decline in the price of our common stock |
| In addition, from time-to-time, we have received, and may in the future receive, notice of claims of infringement of other parties’ proprietary rights |
| Such claims could result in costly litigation and could divert management and technical resources |
| They could also delay product shipment or require us to develop non-infringing technology or enter into royalty or licensing agreements, which agreements may not be available on reasonable terms, or at all |
| Our products include third party technology, the loss of which could materially harm our business |
| We use some licensed third party technology components in our products |
| Future licenses to this technology may not be available to us on commercially reasonable terms, or at all |
| The loss of or inability to obtain or maintain any of these technology licenses could result in delays in the introduction of new products or could force us to discontinue offering portions of our business performance and learning management solutions until equivalent technology, if available, is identified, licensed and integrated |
| Security and privacy breaches could subject us to litigation and liability |
| We host certain of our customers’ business performance and learning management software implementations and provide access to that software using the Internet |
| Computer viruses could be introduced into our systems or those of our customers, which could disrupt the operation of our hosting systems or make them inaccessible to users and we depend on third parties to provide key components of our networks and systems and Internet service providers and telecommunications companies and the efficient operation of their computer networks and other computer equipment to enable customers to access and use hosted software implementations |
| We could become subject to litigation and liability if third parties penetrate security for our hosting systems or otherwise misappropriate our users’ confidential information, or if customers are unable to access and use hosted software implementations |
| Advances in computer capabilities, new discoveries in the field of cryptography or other technological events or developments could result in compromises or breaches of our security systems |
| Anyone who circumvents our security measures could misappropriate proprietary information or cause interruptions in our services or operations |
| We may be required to expend significant capital and other resources to protect against the threat of security breaches or service interruptions or to alleviate problems caused by breaches or service interruptions |
| Each of our key third party networks and systems component providers, Internet service providers and telecommunications companies partners has experienced significant outages in the past and could experience outages, delays and other difficulties due to system failures unrelated to our systems, which could cause our customers to believe we were at fault and withhold payments due to us, decreased revenue and a decline in the price of our stock |
| We are facing significant resource constraints in our professional services group |
| We expect revenue from our professional services group to continue to grow in terms of absolute dollars and as a percentage of our total revenue |
| For instance, in fiscal 2005, professional services consulting revenue was approximately 24prca of our overall revenue |
| At times, the demand for our professional services exceeds our available resources |
| Even if we are successful in recruiting additional professional services personnel, which we may not be, it will take time for the new personnel to become familiar with our products and to integrate into our company |
| As such, we may not be able to meet customer demands, thereby causing potential delays in, or adverse decisions in, purchasing decisions or upgrade challenges, causing customer dissatisfaction and potential warranty or breach of contract claims, which may harm our operating results and result in a decline in the price of our common stock |
| 18 ______________________________________________________________________ [44]Table of Contents Our disaster recovery plan does not include redundant back-up computer systems, and a disaster could severely damage our operations |
| Our disaster recovery plan does not include redundant back-up computer systems at an alternate site |
| A disaster could severely harm our business because our computer systems could be interrupted for an indeterminate length of time |
| Our operations depend on our ability to maintain and protect the computer systems needed for our day-to-day operations |
| A number of these computer systems are located in Mountain View, California on or near known earthquake fault zones and flood plains |
| Although these systems are designed to be fault tolerant, they are vulnerable to damage from fire, floods, earthquakes, power loss, telecommunications failures and other events |
| Any damage to our facility could lead to interruptions in the services we provide to our customers and loss of customer information, and could impair our ability to operate our business, leading customers to withhold payments due to us and decreased revenue |
| The business interruption insurance we maintain may not be adequate to cover our losses resulting from disasters or other business interruptions, which would result in increased expenses and a possible decline in our stock price as well |
| Terrorism and US military actions may adversely affect our business |
| In light of recent terrorist activity, political and military instability, and existing and possible US military actions, significant instability and uncertainty in the world may continue to have a material adverse effect on world financial markets, including financial markets in the US In addition, such adverse political effects may have an adverse impact on economic conditions in the US Unfavorable economic conditions in the US may have an adverse effect on our business operations including, but not limited to, our ability to expand the market for our products, obtain financing as needed, enter into strategic relationships and effectively compete in the business performance and learning management markets |
| Such consequences may lead to a decrease in demand for our products and services and as a result our stock price may suffer |
| We may not be able to adapt to rapidly changing technology and evolving industry standards and if, as a result, our products become obsolete or there is a delay in meeting our customer needs, we would lose market share |
| The business performance and learning management software market is characterized by rapidly changing technologies, frequent new product and service introductions, short development cycles and evolving industry standards |
| The introduction of new products and services embodying new technologies and the emergence of new industry standards may render our products and services obsolete |
| Our success depends on our ability to adapt to a rapidly changing landscape and to offer new products and services to address our customers’ changing demands |
| We may experience difficulties that delay or prevent the successful design, development, introduction or marketing of our products and services |
| To the extent we in fact experience such delays, we may experience difficulty in attracting new customers and may lose existing customers |
| Market acceptance of new platforms and operating environments may require us to undergo the expense of developing and maintaining compatible product lines |
| Although our software products can be licensed for use with a variety of popular industry standard relational database management system platforms, specific operating systems, or other combinations of licensed software, there may be currently existing or future platforms or user interfaces that achieve popularity in the marketplace which may not be architecturally compatible with our software product design |
| Developing and maintaining consistent software product performance characteristics across all of these combinations could place a significant strain on our resources and software product release schedules, which could adversely affect revenue and results of operations |
| To maintain software performance across accepted platforms and operating environments, to achieve market acceptance of those that we support, or to adapt to popular new ones, our expenses may increase and our sales and revenues may be adversely affected |
| 19 ______________________________________________________________________ [45]Table of Contents The business performance and learning managed software market is highly competitive, and we may be unable to compete successfully |
| The market for our products and services is intensely competitive, dynamic and subject to rapid technology change |
| While we believe there is a trend toward market consolidation, the business performance and learning management software market is still highly fragmented and competitive, with no single company accounting for a dominant share of the market |
| Our competitors vary in size, scope and the breadth of products and services offered |
| We face competition from: (1) other developers of business performance and learning technology systems; (2) providers of other business performance and learning technology solutions; (3) vendors of other enterprise software applications that are beginning to offer learning delivery and management functionality; (4) large professional consulting firms and in-house information technology departments; and (5) developers of web authoring tools |
| Additionally, companies may choose to develop their own business performance and learning management software internally rather than acquiring it from third parties |
| There are relatively low barriers to entry in the business performance and learning technology market, and we expect the intensity of competition to increase in the future |
| Increased competition may result in price reductions, reduced gross margins or loss of market share, any of which would seriously harm our business and financial results |
| In addition, some of our existing and potential competitors have longer operating histories and significantly greater financial, technical, marketing and other resources and therefore may be able to respond more quickly to new or changing opportunities, technologies, standards and customer requirements to compete more aggressively on pricing, or to sustain prolonged periods of negative cash flows and unfavorable market conditions |
| We may not be able to compete successfully against our current and future competitors, and competitive pressures that we encounter may seriously harm our business |
| The business performance and learning management software market may not grow to a sufficient size or at a sufficient rate to sustain our business |
| Corporate training and education historically have been conducted primarily through classroom instruction |
| Although technology-based training applications have been available for many years, they currently account for only a small portion of the overall corporate learning market |
| Accordingly, our success will depend on the extent to which companies implement business performance and learning management software solutions for the design, development, delivery and management of their corporate learning needs |
| Many companies that have already invested substantial resources in traditional training methods may be reluctant to adopt a new strategy that may limit or compete with their existing investments |
| Even if companies implement business performance and learning management software solutions, they may still choose to develop such solutions internally |
| If the use of business performance and learning management software does not become widespread, or if companies choose to develop such software internally rather than acquiring it from third parties, then our business performance and learning management software may not be commercially successful |
| Our stock price has been and may continue to be volatile |
| The trading price of our common stock has been and is likely to continue to be highly volatile |
| Our stock price is subject to continued fluctuations in response to a number of factors, including: (1) actual or anticipated variations in quarterly operating results; (2) changes in financial estimates or recommendations by securities analysts; (3) compliance with Sarbanes-Oxley and, in particular, Sarbanes-Oxley Section 404, including the cost of identifying and remedying significant deficiencies and material weaknesses in our internal controls; (4) conditions or trends in business performance and learning management markets; (5) announcements by us or 20 ______________________________________________________________________ [46]Table of Contents our competitors of significant customer wins, technological innovations, new products or services, significant acquisitions, strategic partnerships, joint ventures or capital commitments; (6) failure to accurately forecast our sales, especially since we rely on the sales of a small number of relatively large orders; (7) the seasonal fluctuations of our customers’ buying decisions; (8) additions or departures of key personnel, including the recent announcement regarding the future departure of our former President in May 2006, and; (9) general market conditions |
| Fluctuations in the price and trading volume of our common stock may prevent stockholders from reselling their shares above the price at which they purchased their shares |
| In addition, companies that have experienced volatility in the market price of their stock have been subject to securities class action litigation, and we may be the target of this type of litigation in the future |
| Securities litigation, like other litigation against us could result in substantial costs, negative publicity and divert our management’s attention, which could seriously harm our business and stock price |
| Our recent stock performance may impair the carrying value of our goodwill and intangible assets |
| Our common stock has declined from dlra8dtta00 per share on the first trading day following March 18, 2004 when the acquisition of Docent was completed, to dlra4dtta52 per share at the close of market on March 15, 2006 |
| The carrying value of our goodwill and intangible assets on December 31, 2005 was dlra62dtta3 million and dlra25dtta7 million, respectively |
| A further sustained decline in our stock price could help trigger an impairment analysis, which then might result in an impairment based not only on stock price but other factors |
| We have experienced and may continue to experience turnover of senior management and key personnel, which could harm our business or operations |
| Our success depends to a significant degree on the performance of the senior management team and other key employees |
| Our former Chief Executive Officer (“CEO”) resigned in October 2005 and our former President resigned in February 2006, effective May 2006 |
| After the resignation of our former CEO, our Board Chair was appointed as interim CEO and later appointed as the full-time regular CEO There can be no assurance that the new CEO will be able to work with our management team effectively to successfully implement our strategy |
| While our Section 16 officers were granted two-year retention bonuses, there is no guarantee that such officers, as well as other employees, will remain employed with us |
| In addition, the loss of our former CEO and former President may add to employee instability and uncertainty, increasing the likelihood that such officers and employees will not remain employed by us |
| The loss of any of these individuals could harm our business |
| We do not have employment agreements other than offer letters with our executives or with any other key employee, and we do not maintain key person life insurance for any officer or key employee |
| Our success also depends on our ability to attract, integrate, motivate and retain highly skilled technical, sales and marketing and professional services personnel |
| Competition for qualified personnel in the software industry, particularly engineering and other technical personnel, is intense and there can be no assurance that we will be able to attract and retain highly skilled employees in sufficient numbers to sustain our current business or to support future growth |
| A substantial amount of our engineering activities are based in Hyderabad, India and are subject to contingencies and delays that aren’t typically experienced with stateside engineering efforts |
| We rely significantly on our engineering operations in Hyderabad, India to enable us to complete customer implementation projects and new releases of our products on time and within established budgets |
| Our efforts in Hyderabad and elsewhere abroad are subject to a number of risks inherent in international operations, including: (1) difficulties and costs of recruiting and retaining qualified engineers and other personnel 21 ______________________________________________________________________ [47]Table of Contents in our foreign offices; (2) different learning styles and cultures; (3) intense and increasing competition from other technology companies with regard to hiring and retaining qualified personnel; (4) increasing growth and development of the technology market in India generally, and in Hyderabad specifically, increasing competition and costs of hiring and retaining qualified personnel; (5) numerous and potentially conflicting regulatory requirements; (6) export controls; (7) import tariffs and other barriers to trade, changes in laws or governmental policies; (8) reduced protection of intellectual property rights; (9) regional political and economic instability; (10) challenges with reliability in our infrastructure, given that India does not have the same scale and reliability of overall infrastructure relative to stateside; and (11) fluctuations in currency exchange rates which could adversely impact our reported other income and expense |
| If our India or other overseas operations fail, for any reason, to provide adequate and timely product enhancements, updates and fixes to us or customer implementations, our ability to fix defects in our SumTotal 7 |
| x Series, our ability to develop new versions of our SumTotal 7 |
| x Series, and our ability to respond to customer or competitive demands would be harmed and we would lose sales opportunities and customers |
| In addition, our engineering efforts are based primarily out of two offices: Bellevue, Washington and Hyderabad, India |
| If the two offices fail to work together successfully, we may experience delays in fixing defects in SumTotal 7 |
| x Series, customer implementations, or in developing and releasing future versions of our product |
| We rely on independent partners and third parties to help conduct our international operations and provide engineering services, including product development and customer implementation and sales and marketing efforts |
| We rely on independent partners such as distributors, alliance partners, value-added resellers, and system integrators to help conduct our international operations and sales and marketing efforts in many foreign countries |
| We also use independent third parties to provide engineering services |
| Moreover, we expect to increasingly rely on these independent partners for the product development, customer implementation, distribution and sale of our branded products globally |
| Our success in international markets consequently will depend to a large degree on the success of these independent partners, with whom we have a limited working experience and over whom we have little control |
| If they are unwilling or unable to dedicate sufficient resources to our relationships, our international operations will suffer so our future success will depend in part on our ability to attract, train and motivate new distributors, resellers, alliance partners and systems integrators and expand our relationships with current independent partners |
| We may not be successful in expanding our distributor and reseller relationships, and our sales would suffer as a result |
| Further, we will be required to invest significant additional resources in order to expand these relationships, and the cost of this investment may exceed the revenues generated from this investment |
| The operations of these partners are based outside the US and are therefore subject to risks distinct from those that face US-based operations, including: (1) the burden of complying with a variety of foreign laws; (2) language barriers; (3) longer payment cycles and greater difficulty in collecting accounts receivable; (4) reduced protection of intellectual property rights; (5) fluctuating exchange rates; (6) price controls and other restrictions on foreign currency; (7) military action or political upheaval in the host countries which could force these partners to terminate the services they are providing to us or to close their operations entirely; and (8) social unrest or disturbances |
| Our internal controls and procedures may not be adequate to prevent or detect misstatements or errors |
| A control system, no matter how well conceived or operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met |
| Our management does not expect that our internal controls and procedures will prevent all errors and all fraud because, in addition to resource constraints, there are inherent limitations of all control systems, including the realities that judgments in decision-making can be 22 ______________________________________________________________________ [48]Table of Contents faulty, and that breakdowns can occur because of simple error or mistake |
| Additionally, controls and procedures can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of a control or procedure |
| The design of any system of controls and procedures is also based in part on certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions |
| Because of the inherent limitations in a control system, misstatements due to error or fraud may occur and not be detected |
| In such event, we may not be able to recognize revenue we expected to recognize; we may not be able to meet our forecasts or industry analysts’ projections; or we may be the subject of litigation, each of which would likely harm our financial results and may result in a decline in the price of our common stock |
| Standards for compliance with Section 404 of the Sarbanes-Oxley Act of 2002 are burdensome and uncertain, and if we fail to comply in a timely manner, our business could be harmed and our stock price could decline |
| Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, our management is required to report on, and our independent registered public accounting firm to attest to, the effectiveness of our internal controls over financial reporting, at least annually |
| The rules governing the standards that must be met for management to assess our internal controls over financial reporting are new, complex and subject to proposed changes |
| Currently, the rules require significant documentation, testing and possible remediation of our internal controls over financial reporting |
| The process of reviewing, documenting and testing our internal controls over financial reporting will likely continue to result in increased expenses and the devotion of significant management and other internal resources |
| As we did in connection with our report on internal controls in 2004, we may encounter problems or delays in completing the implementation of any changes necessary to make a favorable assessment of our internal controls over financial reporting during fiscal 2006 |
| During this process, if we are unable to effectively remediate our material weaknesses, or if our management identifies one or more material weaknesses in our internal control over financial reporting, we will be unable to assert such internal control is effective, and the price of our stock may suffer |
| We were not able to comply with the requirements of Section 404 for fiscal 2004 on a timely basis and had to delay filing our Annual Report on Form 10-K until August 1, 2005 |
| We had numerous material weaknesses, and developed and implemented extensive remediation plans |
| Although we have reduced the number of material weaknesses in 2005 compared to 2004, we still have some material weaknesses, and there is no assurance that our remediation plans will effectively address the material weaknesses, or that such changes in our control procedures will not create other material weaknesses |
| If our management is unable to assert that our internal control over financial reporting is effective (or if our independent registered public accounting firm is unable to attest that our management report is fairly stated or they are unable to express an opinion on the effectiveness of our internal controls) we may not be able to timely file, or file at all, our periodic financial reports, and thus we will be subject to delisting |
| Even if we are able to file such reports, investor confidence in the accuracy and completeness of our financial reports may be lost, leading to an adverse effect on the price of our stock |
| If we are unable to effectively remediate any additional material weaknesses identified by us or our independent registered public accounting firm, we will be unable to assert such internal control is effective |
| If internal controls and procedures are determined to be inadequate and ineffective, this may result in a loss of shareholder confidence and adversely impact our stock price |
| Recently enacted and proposed changes in securities laws and regulations have increased and are likely to continue to increase, our expenses |
| Recently enacted and proposed changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002, have increased, and will continue to increase our expenses as we devote resources to respond to the new requirements |
| The Sarbanes-Oxley Act mandates, among other things, that companies adopt new corporate governance measures, and it imposes comprehensive reporting and 23 ______________________________________________________________________ [49]Table of Contents disclosure requirements; sets stricter independence and financial expertise standards for audit committee members; and imposes increased civil and criminal penalties for companies, their chief executive officers, chief financial officers and directors for securities law violations |
| In addition, the National Association of Securities Dealers Automated Quotations (“NASDAQ”) National Market, on which our common stock is listed, has also adopted comprehensive rules and regulations relating to corporate governance |
| These laws, rules and regulations have increased and will continue to increase the scope, complexity and cost of our corporate governance, reporting and disclosure practices, which could harm our results of operations and divert management’s attention from business operations |
| While we are endeavoring to reduce the costs of compliance, compliance is costly due to the necessity of hiring additional personnel and external consultants and our independent registered public accounting firm |
| For example, we incurred over dlra4dtta0 million dollars in fiscal 2005 on compliance costs related to the Sarbanes-Oxley Act which directly increased our general and administrative operating expenses and contributed to our loss from operations in fiscal 2005 |
| We also expect these developments to make it more difficult and more expensive for us to obtain director and officer liability insurance in the future, and we may be required to accept reduced coverage or incur substantially higher costs to maintain coverage |
| Further, our directors and executive officers could face an increased risk of personal liability in connection with the performance of their duties |
| As a result, we may have difficultly attracting and retaining qualified directors and executive officers, which could adversely affect our business |
| Changes in accounting regulations and related interpretations and policies, particularly those related to revenue recognition and share based payments, could cause us to defer recognition of revenue or recognize lower revenue or to report lower earnings per share |
| While we believe that we are in compliance with American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) Nodtta 97-2, Software Revenue Recognition, as amended, the AICPA continues to issue implementation guidelines for these standards and the accounting profession continues to discuss a wide range of potential interpretations |
| Additional implementation guidelines, and changes in interpretations of such guidelines, could lead to unanticipated changes in our current revenue accounting practices that could cause us to defer the recognition of revenue to future periods or to recognize lower revenue |
| The FASB issued SFAS Nodtta 123 (revised 2004) (“123R”), Share-Based Payment, which requires us to recognize as an expense stock-based compensation to employees based on their fair values, and eliminates the ability to account for stock-based compensation using the intrinsic value method in accordance with APB Opinion (“APB”) Nodtta 25, Accounting for Stock Issued to Employees |
| As a result, when we record an expense for our stock-based compensation plans using the fair value method beginning in fiscal 2006, we may have significant compensation charges |
| For example, for the fiscal years 2005, 2004 and 2003, had we accounted for stock-based compensation plans under SFAS Nodtta 123R using the Black-Scholes option pricing model, we estimate that basic and diluted net loss per share, using the fair value method, would have been increased by dlra0dtta61, dlra0dtta32 and dlra0dtta41 per share, respectively |
| We may become subject to government regulation and legal uncertainties that could result in liability or increase the cost of doing business, thereby adversely affecting our financial results |
| We are not currently subject to direct regulation by any domestic or foreign governmental agency, other than regulations applicable to businesses generally, such as export control laws |
| However, due to the increasing popularity and use of the Internet, it is possible that a number of laws and regulations may become applicable to us or may be adopted in the future with respect to the Internet covering issues such as taxation, user privacy, content, right to access personal data, copyrights, distribution and characteristics and quality of services |
| The applicability of existing laws governing issues such as taxation, property ownership, copyrights, and other intellectual property issues, encryption, libel, export or import matters and personal privacy to the Internet is uncertain |
| The vast majority of these laws were adopted prior to the broad commercial use of the Internet and related technologies |
| As a result, they do not contemplate or address the unique issues of the Internet and related 24 ______________________________________________________________________ [50]Table of Contents technologies |
| Changes to these laws, including some recently proposed changes, could create uncertainty in the Internet marketplace |
| Such uncertainty could reduce demand for our services or increase the cost of doing business due to increased costs of litigation or increased service delivery costs |
| The Federal Trade Commission, the European Union and certain state and local authorities have been investigating certain Internet companies regarding their use of personal information |
| We could incur additional expenses if new regulations regarding the use of personal information are introduced or if these authorities choose to investigate our privacy practices |
| Anti-takeover provisions could make the sale of the company more difficult |
| Our certificate of incorporation and bylaws contain provisions that could make it harder for a third party to acquire us without the consent of our board of directors |
| For example, no potential acquirer would be able to call a special meeting of stockholders to remove our board of directors |
| A potential acquirer would also not be able to act by written consent without a meeting |
| In addition, our board of directors has staggered terms that make it difficult to remove all directors at once |
| The acquirer would also be required to provide advance notice of its proposal to remove directors at an annual meeting |
| The acquirer would not be able to cumulate votes at a meeting, which would require the acquirer to hold more shares to gain representation on our board of directors than if cumulative voting were permitted |
| Subject to its fiduciary duties, our board of directors may in the future adopt a stockholder rights plan |
| If the board adopts a stockholder rights plan, it may discourage a merger or tender offer involving our securities that is not approved by our board of directors by increasing the cost of effecting any such transaction and, accordingly, could have an adverse impact on stockholders who may want to vote in favor of such merger or participate in such tender offer |
| In addition, Section 203 of the Delaware General Corporation Law limits business combination transactions with 15prca stockholders that have not been approved by the issuer’s board of directors |
| These provisions and other similar provisions make it more difficult or impossible for a third party to acquire us without negotiation |
| These provisions may apply even if the offer may be considered beneficial by some stockholders |