10-Q 1 a06-21828_110q.htm QUARTERLY REPORT PURSUANT TO SECTIONS 13 OR 15(D)

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

x

 

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

 

 

 

For the quarterly period ended September 30, 2006

 

 

 

OR

 

 

 

o

 

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

 

 

 

For the transition period from            to            

 

 

 

Commission file number 000-31511

 

@Road, Inc.

(Exact name of registrant as specified in its charter)

Delaware

 

94-3209170

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

47071 Bayside Parkway

Fremont, CA 94538

(Address of principal executive offices, including zip code)

510-668-1638

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x    No  o

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

Large Accelerated Filer o

Accelerated Filer x

Non-Accelerated Filer o

 

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

Yes  o    No    x

As of November 1, 2006 there were 61,800,504 shares of the registrant’s Common Stock outstanding.

 




INDEX

PART I.

FINANCIAL INFORMATION

1

 

Item 1. Financial Statements

1

 

Condensed Consolidated Balance Sheets as of September 30, 2006 and December 31, 2005

1

 

Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2006 and 2005 (As Restated)

2

 

Condensed Consolidated Statements of Stockholders’ Equity for the nine months ended September 30, 2006, December 31, 2005 and September 30, 2005 (As Restated)

3

 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2006 and 2005 (As Restated)

4

 

Notes to Condensed Consolidated Financial Statements

5

 

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

23

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

45

 

Item 4. Controls and Procedures

46

PART II.

OTHER INFORMATION

48

 

Item 1. Legal Proceedings

48

 

Item 1A. Risk Factors

48

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

49

 

Item 3. Defaults Upon Senior Securities

49

 

Item 4. Submission of Matters to a Vote of Security Holders

49

 

Item 5. Other Information

49

 

Item 6. Exhibits

49

 




 

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

@Road, Inc.

Condensed Consolidated Balance Sheets

(In thousands, except per share data) (unaudited)

 

 

September 30,
2006

 

December 31,
2005

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

17,015

 

$

25,773

 

Short-term investments

 

77,458

 

77,643

 

Accounts receivable, net

 

16,950

 

12,475

 

Inventories

 

17,146

 

6,087

 

Deferred product costs

 

16,512

 

16,187

 

Deferred tax assets

 

1,178

 

1,448

 

Prepaid expenses and other

 

1,740

 

2,566

 

Total current assets

 

147,999

 

142,179

 

Property and equipment, net

 

7,673

 

6,195

 

Deferred product costs

 

24,930

 

16,995

 

Deferred tax assets

 

41,000

 

39,843

 

Goodwill

 

13,341

 

13,341

 

Intangible assets, net

 

24,303

 

27,333

 

Other non-current assets

 

737

 

400

 

 

 

 

 

 

 

Total assets

 

$

259,983

 

$

246,286

 

 

 

 

 

 

 

LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

10,744

 

$

6,653

 

Accrued liabilities

 

8,975

 

8,751

 

Deferred revenue and customer deposits

 

20,379

 

15,495

 

Derivative instrument

 

6,899

 

1,457

 

 

 

 

 

 

 

Total current liabilities

 

46,997

 

32,356

 

Deferred revenue

 

22,813

 

17,333

 

Deferred tax liabilities

 

 

323

 

Derivative instrument

 

 

1,457

 

Other long-term liabilities

 

395

 

461

 

Total liabilities

 

70,205

 

51,930

 

 

 

 

 

 

 

Commitments and contingencies (Note 11)

 

 

 

 

 

 

 

 

 

 

 

Preferred stock, $0.001 par value, 10,000 shares authorized, 98 shares designated as redeemable preferred stock, shares issued and outstanding: 77 at September 30, 2006 and December 31, 2005

 

8,556

 

8,184

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common stock, $0.0001 par value, 250,000 shares authorized, shares issued and outstanding: 61,760 at September 30, 2006 and 61,154 at December 31, 2005

 

270,051

 

265,347

 

Note receivable from stockholder

 

(4

)

(7

)

Accumulated other comprehensive loss

 

(23

)

(78

)

Accumulated deficit

 

(88,802

)

(79,090

)

 

 

 

 

 

 

Total stockholders’ equity

 

181,222

 

186,172

 

 

 

 

 

 

 

Total liabilities, redeemable preferred stock and stockholders’ equity

 

$

259,983

 

$

246,286

 

 

See notes to condensed consolidated financial statements.

1




@Road, Inc.
Condensed Consolidated Statements of Operations

(In thousands, except per share data) (unaudited)

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

 

 

As Restated

 

 

 

As Restated

 

 

 

 

 

(See Note 1)

 

 

 

(See Note 1)

 

Revenues:

 

 

 

 

 

 

 

 

 

Hosted

 

$

21,201

 

$

18,965

 

$

61,806

 

$

58,140

 

Licensed

 

3,954

 

6,004

 

11,295

 

7,447

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

25,155

 

24,969

 

73,101

 

65,587

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

Cost of hosted revenue (excluding intangibles amortization included below)

 

11,369

 

10,238

 

33,716

 

28,989

 

Cost of licensed revenue (excluding intangibles amortization included below)

 

1,205

 

1,481

 

3,562

 

3,654

 

Intangibles amortization

 

1,010

 

1,010

 

3,030

 

2,477

 

Sales and marketing

 

5,359

 

5,496

 

16,783

 

15,975

 

Research and development

 

3,922

 

3,487

 

11,801

 

9,911

 

General and administrative

 

4,498

 

4,724

 

14,468

 

13,113

 

In-process research and development

 

 

 

 

5,640

 

 

 

 

 

 

 

 

 

 

 

Total costs and expenses

 

27,363

 

26,436

 

83,360

 

79,759

 

 

 

 

 

 

 

 

 

 

 

Loss from operations

 

(2,208

)

(1,467

)

(10,259

)

(14,172

)

 

 

 

 

 

 

 

 

 

 

Other (expense) income, net:

 

 

 

 

 

 

 

 

 

Interest income, net

 

1,204

 

781

 

3,317

 

2,128

 

Change in derivative instrument liability

 

(2,969

)

4,845

 

(3,985

)

772

 

Other income (expense), net

 

339

 

17

 

317

 

(135

)

 

 

 

 

 

 

 

 

 

 

Total other (expense) income, net

 

(1,426

)

5,643

 

(351

)

2,765

 

 

 

 

 

 

 

 

 

 

 

Net (loss) income before income taxes

 

(3,634

)

4,176

 

(10,610

)

(11,407

)

Benefit from income taxes

 

164

 

33,822

 

898

 

37,017

 

Net (loss) income

 

(3,470

)

37,998

 

(9,712

)

25,610

 

Preferred stock dividends

 

(127

)

(124

)

(377

)

(305

)

 

 

 

 

 

 

 

 

 

 

Net (loss) income attributable to common stockholders

 

$

(3,597

)

$

37,874

 

$

(10,089

)

$

25,305

 

 

 

 

 

 

 

 

 

 

 

Net (loss) income per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.06

)

$

0.62

 

$

(0.16

)

$

0.42

 

 

 

 

 

 

 

 

 

 

 

Diluted

 

$

(0.06

)

$

0.61

 

$

(0.16

)

$

0.41

 

 

 

 

 

 

 

 

 

 

 

Shares used in calculating net (loss) income per share:

 

 

 

 

 

 

 

 

 

Basic

 

61,721

 

60,740

 

61,484

 

59,571

 

 

 

 

 

 

 

 

 

 

 

Diluted

 

61,721

 

62,133

 

61,484

 

60,994

 

 

See notes to condensed consolidated financial statements.

2




@Road, Inc.

Condensed Consolidated Statements of Stockholders’ Equity

For the Periods Ended September 30, 2006, December 31, 2005 (As Restated)

and September 30, 2005 (As Restated)

(In thousands) (unaudited)

 

 

Common Stock

 

Note
Receivable
From

 

Accumulated 
Other
Comprehensive

 

Accumulated

 

Stockholders’

 

Total
Comprehensive

 

 

 

Shares

 

Amount

 

Stockholder

 

Loss

 

Deficit

 

Equity

 

Income (Loss)

 

BALANCES, January 1, 2005

 

54,805

 

$

232,016

 

$

 

$

(179

)

$

(107,001

)

$

124,836

 

 

 

Net income (As Restated) (See Note 1)

 

 

 

 

 

 

 

 

 

25,610

 

25,610

 

$

25,610

 

Change in unrealized loss on short-term investments

 

 

 

 

 

 

 

114

 

 

 

114

 

114

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income (As Restated) (See Note 1)

 

 

 

 

 

 

 

 

 

 

 

 

 

$

25,724

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shares issued upon acquisition of Vidus, net of issuance costs of $478

 

5,454

 

24,228

 

 

 

 

 

 

 

24,228

 

 

 

Fully vested options issued upon acquisition of Vidus

 

 

 

531

 

 

 

 

 

 

 

531

 

 

 

Shares issued under employee stock purchase plan

 

295

 

849

 

 

 

 

 

 

 

849

 

 

 

Exercise of stock options

 

213

 

383

 

 

 

 

 

 

 

383

 

 

 

Issuance of note receivable to stockholder

 

 

 

 

 

(11

)

 

 

 

 

(11

)

 

 

Collection of note receivable from stockholder

 

 

 

 

 

3

 

 

 

 

 

3

 

 

 

Dividends on redeemable preferred stock

 

 

 

(305

)

 

 

 

 

 

 

(305

)

 

 

Tax benefit on the exercise of employee stock options

 

 

 

6,671

 

 

 

 

 

 

 

6,671

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCES, September 30, 2005 (As Restated) (See Note 1)

 

60,767

 

264,373

 

(8

)

(65

)

(81,391

)

182,909

 

 

 

Net income

 

 

 

 

 

 

 

 

 

2,301

 

2,301

 

$

2,301

 

Change in unrealized loss on short-term investments

 

 

 

 

 

 

 

(13

)

 

 

(13

)

(13

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

$

2,288

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shares issued under employee stock purchase plan

 

285

 

829

 

 

 

 

 

 

 

829

 

 

 

Exercise of stock options

 

102

 

195

 

 

 

 

 

 

 

195

 

 

 

Collection of note receivable from stockholder

 

 

 

 

 

1

 

 

 

 

 

1

 

 

 

Dividends on redeemable preferred stock

 

 

 

(131

)

 

 

 

 

 

 

(131

)

 

 

Tax benefit on the exercise of employee stock options

 

 

 

81

 

 

 

 

 

 

 

81

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCES, December 31, 2005

 

61,154

 

265,347

 

(7

)

(78

)

(79,090

)

186,172

 

 

 

Net loss

 

 

 

 

 

 

 

 

 

(9,712

)

(9,712

)

$

(9,712

)

Change in unrealized loss on short-term investments

 

 

 

 

 

 

 

55

 

 

 

55

 

55

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

$

(9,657

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shares issued under employee stock purchase plan

 

314

 

941

 

 

 

 

 

 

 

941

 

 

 

Exercise of stock options

 

292

 

763

 

 

 

 

 

 

 

763

 

 

 

Stock-based compensation

 

 

 

3,163

 

 

 

 

 

 

 

3,163

 

 

 

Collection of note receivable from stockholder

 

 

 

 

 

3

 

 

 

 

 

3

 

 

 

Dividends on redeemable preferred stock

 

 

 

(377

)

 

 

 

 

 

 

(377

)

 

 

Excess tax benefit on the exercise of employee stock options

 

 

 

214

 

 

 

 

 

 

 

214

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCES, September 30, 2006

 

61,760

 

$

270,051

 

$

(4

)

$

(23

)

$

(88,802

)

$

181,222

 

 

 

 

See notes to condensed consolidated financial statements.

3




@Road, Inc.

Condensed Consolidated Statements of Cash Flows

(In thousands) (unaudited)

 

 

Nine Months Ended
September 30,

 

 

 

2006

 

2005

 

 

 

 

 

As Restated

 

 

 

 

 

(See Note 1)

 

Cash flows from operating activities:

 

 

 

 

 

Net (loss) income

 

$

(9,712

)

$

25,610

 

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

 

 

 

 

 

Depreciation and amortization

 

5,467

 

4,319

 

Tax benefit on the exercise of employee stock options

 

 

6,671

 

Stock-based compensation

 

3,163

 

 

Change in derivative instrument liability

 

3,985

 

(772

)

Provision for doubtful accounts and sales returns

 

(237

)

58

 

Loss on disposal of property and equipment

 

74

 

48

 

Provision for inventory reserves

 

77

 

337

 

In-process research and development

 

 

5,640

 

Deferred taxes

 

(1,210

)

(43,688

)

Changes in assets and liabilities, net of effect of acquisition:

 

 

 

 

 

Accounts receivable

 

(4,238

)

(6,607

)

Inventories

 

(11,131

)

(2,312

)

Deferred product costs

 

(8,265

)

(15,341

)

Prepaid expenses and other

 

489

 

(571

)

Accounts payable

 

4,091

 

2,589

 

Accrued and other liabilities

 

158

 

657

 

Deferred revenue and customer deposits

 

10,364

 

9,829

 

 

 

 

 

 

 

Net cash used in operating activities

 

(6,925

)

(13,533

)

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchase of property and equipment

 

(3,989

)

(3,101

)

Purchase of short-term investments

 

(54,170

)

(75,341

)

Proceeds from the sale of short-term investments

 

54,410

 

125,723

 

Acquisition of Vidus, net of cash acquired

 

 

(6,851

)

 

 

 

 

 

 

Net cash (used in) provided by investing activities

 

(3,749

)

40,430

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from sale of common stock

 

1,704

 

1,232

 

Proceeds from payment on note receivable issued to stockholder

 

3

 

3

 

Payment for redemption of redeemable preferred stock

 

(5

)

 

Excess tax benefit on the exercise of employee stock options

 

214

 

 

Net cash provided by financing activities

 

1,916

 

1,235

 

 

 

 

 

 

 

Net (decrease) increase in cash and cash equivalents

 

(8,758

)

28,132

 

Cash and cash equivalents:

 

 

 

 

 

Beginning of period

 

25,773

 

14,494

 

End of period

 

$

17,015

 

$

42,626

 

 

 

 

 

 

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Dividends accrued on redeemable preferred stock

 

$

377

 

$

305

 

Change in unrealized loss on short-term investments, net of tax effects

 

$

55

 

$

114

 

Cash paid for income taxes

 

$

116

 

$

30

 

Non-cash investing and financing activities:

 

 

 

 

 

Issuance of common stock, redeemable preferred stock and options in connection with the acquisition of Vidus

 

$

 

$

38,155

 

 

See notes to condensed consolidated financial statements.

 

4




@Road, Inc.
Notes To Condensed Consolidated Financial Statements
(unaudited)

Note 1 —Summary of Significant Accounting Policies

Restatement of Financial Statements

Subsequent to December 31, 2005, the Company determined that its unaudited quarterly condensed consolidated financial statements for the periods ended March 31, 2005, June 30, 2005 and September 30, 2005 contained errors resulting from the improper accounting for the common and redeemable preferred stock issued in connection with the Company’s acquisition of Vidus Limited (“Vidus”) which was completed on February 18, 2005. See “Note 6—Derivative Financial Instrument Liabilities” for further discussion. The Company also identified an error in the benefit for income taxes related to the reversal of the valuation allowance.

The impact on the Company’s condensed consolidated statements of operations for the three and nine months ended September 30, 2005 was an increase in net income of $4.5 million and $402,000, respectively. As a result, the accompanying condensed consolidated financial statements for the three and nine months ended September 30, 2005 have been restated from the previously reported results to correct for these errors. The following is a summary of the significant effects of the restatement (in thousands, except per share data):

 

Three Months Ended
September 30, 2005

 

Nine Months Ended
September 30, 2005

 

 

 

As Previously
Reported

 

As
Restated

 

Change

 

As Previously
Reported

 

As
Restated

 

Change

 

Change in derivative instrument liability

 

$

 

$

4,845

 

$

4,845

 

$

 

$

772

 

$

772

 

Total other income, net

 

798

 

5,643

 

4,845

 

1,993

 

2,765

 

772

 

Net (loss) income before income taxes

 

(669

)

4,176

 

4,845

 

(12,179

)

(11,407

)

772

 

Benefit from income taxes

 

34,192

 

33,822

 

(370

)

37,387

 

37,017

 

(370

)

Net income

 

33,523

 

37,998

 

4,475

 

25,208

 

25,610

 

402

 

Net income attributable to common stockholders

 

$

33,399

 

$

37,874

 

$

4,475

 

$

24,903

 

$

25,305

 

$

402

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.55

 

$

0.62

 

$

0.07

 

$

0.42

 

$

0.42

 

$

0.00

 

Diluted

 

$

0.54

 

$

0.61

 

$

0.07

 

$

0.41

 

$

0.41

 

$

0.00

 

 

Basis of Consolidation and Presentation

The accompanying condensed consolidated financial statements include @Road, Inc. and its wholly-owned subsidiaries (collectively, the “Company”). Intercompany accounts and transactions are eliminated upon consolidation.

The accompanying condensed consolidated financial statements were prepared by the Company, without an audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations, although the Company believes the disclosures made herein are adequate to make the information presented not misleading.

In the opinion of management, the financial statements include all adjustments, consisting only of normal recurring adjustments (except for the adjustments to restate the financial statements for the three and nine months ended September 30, 2005 discussed above) necessary to fairly present the financial condition, results of operations, and cash flows for the periods presented. Results of operations for the periods presented are not necessarily indicative of results to be expected for any other interim period or for the full year. These condensed consolidated financial statements should be read in conjunction with the Company’s condensed consolidated financial statements and notes thereto in its Annual Report on Form 10-K/A for the year ended December 31, 2005, dated August 9, 2006 and filed with the SEC.

5




Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses during the reporting period. On an on-going basis, the Company evaluates its estimates, including those related to revenue recognition, stock-based compensation, intangible assets and goodwill, allowance for doubtful accounts, income taxes and legal and other contingencies. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results could differ from those estimates.

Certain Significant Risks and Uncertainties

The Company participates in a dynamic high-technology industry and believes that adverse changes in any of the following areas could have a material adverse effect on its future financial position, results of operations or cash flows: the ability of the Company to integrate @Road, Ltd. (formerly Vidus) operations successfully; the ability of the Company to accelerate or continue to grow as a result of its investment initiatives; the ability of the Company and its alliances to market, sell and support the Company solutions; the timing of purchasing and implementation decisions by prospects and customers; competition; the dependence of the Company on mobile data systems technology, wireless networks, network infrastructure and positioning systems owned and controlled by others; advances and trends in new technologies and industry standards; market acceptance of the Company’s existing or new solutions; development of sales channels; changes in third-party manufacturers, key suppliers, certain strategic or customer relationships; litigation or claims against the Company based on intellectual property, product, regulatory or other factors; and the Company’s ability to attract and retain employees necessary to support its growth.

Motorola is the sole supplier of microcontrollers and certain modems used in the Company’s products. Micronet is the sole supplier of our Internet Data TerminalTM (“iDT”) device. Everex is the sole supplier of our Internet Location Manager—WiFi (“iLM®-W”) device. The Company expects to rely on these suppliers as the sole source for these components and devices for the next several years.

Revenue Recognition

The Company follows specific and detailed guidelines in recognizing revenue in accordance with the provisions of AICPA Statement of Position 97-2, Software Revenue Recognition, as amended by Statement of Position 98-4, Deferral of the Effective Date of the Provisions of SOP 97-2 and Statement of Position 98-9, Modification of SOP 97-2, as well as Accounting Research Bulletin No. 45, Long-Term Construction-Type Contracts and Statement of Position 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts. The Company recognizes revenue when the price is fixed and determinable, persuasive evidence of an agreement exists, the obligations under any such agreement are fulfilled and collectibility is probable.

The Company’s revenues are comprised of hosted revenue and licensed revenue. Hosted revenue is derived from monthly fees for the Company’s Field Force Management (“FFM”) and Field Asset Management (“FAM”) solutions and monthly or upfront fees for in-vehicle hardware devices enabling a mobile resource to utilize these FFM or FAM solutions. Licensed revenue is comprised of license fees, installation, training and related post-contract customer support (“PCS”) services fees relating to the Company’s Field Service Management (“FSM”) TaskforceTM software solution.

Monthly fees for the Company’s hosted solutions are recognized ratably over the contract period, which commences (a) upon installation of the Company’s proprietary hardware devices in customers’ mobile worker vehicles, or (b) upon the creation of subscription licenses and a subscriber account on its website where subscribers have elected to use an @ Road solution with a mobile telephone. Upfront fees for the Company’s hosted solution primarily consist of amounts for the in-vehicle enabling hardware device and peripherals, if any. The Company defers upfront fees at installation and recognizes them ratably over the minimum service contract period, generally one to five years. Product costs are also deferred and amortized over such period. Renewal rates for the Company’s hosted solutions are not considered priced at a bargain in comparison to the upfront fees (as described in Staff Accounting Bulletin No. 104, Revenue Recognition). If the Company cannot objectively determine the fair value of any undelivered element included in hosted arrangements, it defers revenue until all elements are delivered, all services have been performed or fair value can objectively be determined.

Licensed revenue associated with the fees for the license of the Company’s FSM Taskforce product and related customization and installation services is generally recognized using the percentage-of-completion method of accounting over the period that services are performed. For agreements accounted for under the percentage-of-completion method, the Company determines progress to

6




completion based on actual direct labor hours incurred to date as a percentage of the estimated total direct labor hours required to complete the project. The Company evaluates the actual status of each project as of each balance sheet date to ensure that the estimates to complete each contract remain accurate. A provision for estimated losses on contracts is made in the period in which the loss becomes probable and can be reasonably estimated. To date, the Company has not incurred any such losses. If the amount of revenue recognized exceeds the amount billed to customers, the excess amount is recorded as unbilled accounts receivable. If the amount billed exceeds the amount of revenue recognized, the excess amount is recorded as customer deposits.

The Company derives PCS fees from PCS agreements, which are generally initially purchased at the same time as a license for its Taskforce product. PCS can include telephone and email support and the right to receive unspecified upgrades on a when-and-if-available basis. PCS agreements may generally be renewed on an annual basis. The Company recognizes revenue for PCS, based on vendor specific objective evidence (“VSOE”) of fair value, ratably over the term of the PCS period. It generally determines VSOE of PCS based on the stated fees for PCS renewal set forth in the original license agreement. If the Company is unable to establish VSOE of fair value, it recognizes all fees ratably over the term of the PCS, when the only remaining undelivered element is PCS.

For arrangements with multiple elements, such as licenses, customization services and PCS services, the Company allocates revenue to each element based upon its fair value as determined by VSOE. VSOE for each element is based on normal pricing and discounting practices when the element is sold separately. VSOE for PCS services is measured by the stated renewal rate. If the Company cannot objectively determine the fair value of any undelivered element included in license arrangements, it defers revenue until the earliest of either: (a) all elements are delivered, (b) all services have been performed or only PCS services remain to be delivered, or (c) fair value can objectively be determined. When the fair value of a delivered element has not been established, the Company uses the residual method to record license revenue if the fair value of all undelivered elements is determinable. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the fee is allocated to the delivered elements and is recognized as revenue, assuming all other criteria have been met.

Pursuant to Emerging Issues Taskforce Issue 06-3, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (“EITF 06-3”), the Company elected to present taxes collected from customers and remitted to governmental authorities net in its financial statements consistent with the Company’s historical presentation of this information.

Comprehensive Loss

Statement of Financial Accounting Standards (“SFAS”) No. 130, Reporting Comprehensive Income, requires that an enterprise report, by major components and as a single total, the change in its net assets during the period from non-owner sources.  Accumulated other comprehensive loss was comprised of unrealized losses of $23,000 and $78,000 on short-term investments at September 30, 2006 and December 31, 2005, respectively.

Derivative Financial Instruments

The Company does not use derivative instruments to hedge exposures to cash flow, market, or foreign currency risks. In accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS 133”), certain derivatives embedded in our Series B preferred stock are bifurcated and accounted for separately. The original host instruments were initially reported, at fair value, as Preferred Stock and the embedded derivatives were initially reported, at fair value, as liabilities. Because these derivatives do not qualify as hedging instruments, changes in fair values of such derivatives are reported as charges or credits to income.

Major Customers

For the three and nine months ended September 30, 2006 AT&T Inc. represented 16% of total revenues. For the three and nine months ended September 30, 2005, Verizon accounted for 12% and 14% and British Telecom represented 18% and 7% of total revenues, respectively. During the three and nine months ended September 30, 2006 and 2005, no other customer represented 10% or more of total revenues.

Recently Issued Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”), that addresses the accounting for stock-based payment transactions in which an enterprise receives employee services in exchange for either equity instruments of the enterprise or liabilities that are based on the fair value of the

7




enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. The statement eliminates the ability to account for stock-based compensation transactions using the intrinsic value method as prescribed by Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), and generally requires that such transactions be accounted for using a fair value based method and recognized as expense in the condensed consolidated statement of operations. SFAS 123R also requires additional accounting for the tax benefit on employee stock options and for stock issued under the Company’s employee stock purchase plan. The adoption of SFAS 123R on January 1, 2006, had a material impact on the Company’s results of operations and financial position. See “Note 9 — Employee Benefit Plans” for additional disclosure related to SFAS 123R.

In November 2005, the FASB issued FASB Staff Position (“FSP”) Nos. SFAS 115-1 and SFAS 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. This FSP addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary and the measurement of an impairment loss. This FSP also includes accounting considerations subsequent to the recognition of other-than-temporary impairments. The adoption of the FSP did not have a material impact on the Company’s condensed consolidated statement of operations and financial condition.

On June 7, 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20, Accounting Changes, and Statement No. 3, Reporting Accounting Changes in Interim Financial Statements (“SFAS 154”). SFAS 154 changes the requirements for accounting and reporting a change in accounting principle. Previously, most voluntary changes in accounting principles were required to be recognized by way of a cumulative effect adjustment within net income during the period of the change. SFAS 154 requires retrospective application to prior periods’ financial statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005; however, SFAS 154 does not change the transition provisions of any existing accounting pronouncements.

In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). FIN 48 prescribes a comprehensive model for how a company should recognize, measure, present, and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return. Under FIN 48, the financial statements will reflect expected future tax consequences of such positions presuming the taxing authorities' full knowledge of the position and all relevant facts, but without considering time values. FIN 48 is effective for the Company beginning January 1, 2007. The Company has not yet completed its evaluation of the impact that adoption of FIN 48 will have on the Company’s condensed consolidated statement of operations and financial condition.

In September 2006, the SEC issued Staff Accounting Bulletin No. 108, Section N to Topic 1, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108). SAB 108 requires the evaluation of prior-year misstatements using both the balance sheet approach and the income statement approach. In the initial year of adoption should either approach result in quantifying an error that is material in light of quantitative and qualitative factors, SAB 108 guidance allows for a one-time cumulative-effect adjustment to beginning retained earnings. In years subsequent to adoption, previously undetected misstatements deemed material shall result in the restatement of previously issued financial statements in accordance with FAS 154. SAB 108 is effective for the Company on December 31, 2006. The adoption of SAB 108 will not have an impact on our condensed consolidated statement of operations and financial condition.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“FAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosure requirements regarding fair value measurement. Where applicable, SFAS 157 simplifies and codifies fair value related guidance previously issued within generally accepted accounting principles (GAAP). SFAS 157, is effective for the Company beginning January 1, 2008. The Company has not yet completed its evaluation of the impact that adoption of SFAS 157 will have on the Company’s condensed consolidated statement of operations and financial condition.

Note 2 — Basic and Diluted Net (Loss) Income per Share

Basic net (loss) income per share is computed by dividing the net (loss) income attributable to common stockholders for the period by the weighted average number of common shares outstanding during the period. Diluted net (loss) income per share is computed by dividing the net (loss) income attributable to common stockholders for the period by the weighted average number of common shares and potentially dilutive common shares outstanding during the period. Potentially dilutive common shares, composed of unvested restricted common stock and incremental common shares issuable upon the exercise of stock options, are included in diluted net (loss) income per share (using the treasury stock method) to the extent such shares are dilutive. Potentially dilutive shares that are anti-dilutive, as calculated based on the weighted average closing price of the Company’s common stock for the period, are excluded from

8




the calculation of diluted net (loss) income per share. Common share equivalents are excluded from the computation in loss periods, as their effect would be anti-dilutive.

The following table sets forth the computation of basic and diluted net (loss) income per share for the periods indicated (in thousands, except per share amounts):

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

Net (loss) income attributable to common stockholders (numerator)

 

$

(3,597

)

$

37,874

 

$

(10,089

)

$

25,305

 

Shares (denominator):

 

 

 

 

 

 

 

 

 

Basic weighted average common shares outstanding

 

61,721

 

60,740

 

61,484

 

59,571

 

 

 

 

 

 

 

 

 

 

 

Diluted

 

 

 

 

 

 

 

 

 

Dilution impact from option equivalent shares

 

 

1,350

 

 

1,399

 

Dilution impact from employee stock purchase plan

 

 

43

 

 

24

 

 

 

 

 

 

 

 

 

 

 

Shares used in computation

 

61,721

 

62,133

 

61,484

 

60,994

 

 

 

 

 

 

 

 

 

 

 

Net (loss) income  per share

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.06

)

$

0.62

 

$

(0.16

)

$

0.42

 

Diluted

 

$

(0.06

)

$

0.61

 

$

(0.16

)

$

0.41

 

 

For the periods presented, the Company had securities outstanding which could potentially dilute basic income per share in the future, but which were excluded from the computation of diluted net (loss) income per share in the periods presented, as their effect would have been anti-dilutive due to the Company being in a loss position or due to outstanding options with exercise prices greater than the average fair market value for the respective periods presented. Such outstanding securities consist of the following (shares in thousands):

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

Outstanding options

 

10,327

 

5,100

 

10,327

 

4,944

 

Weighted average exercise price of outstanding options

 

$

4.81

 

$

6.81

 

$

4.81

 

$

7.05

 

 

Note 3. Business Combinations, Goodwill and Intangible Assets

On February 18, 2005, the Company completed the acquisition of Vidus Limited (“Vidus”) in a transaction accounted for as a business combination using the purchase method. As consideration for the acquisition, the Company issued approximately 5.5 million shares of its common stock valued at $24.7 million, newly created redeemable preferred stock (“preferred stock”) valued at approximately $12.9 million, extinguished for cash existing debt of approximately $5.5 million in exchange for all of the outstanding shares of Vidus capital stock, and issued approximately 146,000 vested options with a fair value of $531,000. Under the terms of the stock option grants, each option has been classified as a non-qualified stock option, is fully vested, has an exercise price ranging from $0.67 to $2.00 per share and has a one-year term. The Company incurred acquisition related costs of $2.6 million, of which $478,000 was allocated to the issuance of common stock. The purchase price of approximately $46.3 million was allocated among the tangible and identifiable intangible assets acquired and liabilities assumed on the basis of their estimated fair values on the acquisition date.

The shares of common stock issued in the acquisition were valued in accordance with Emerging Issues Task Force Issue No. 99-12, Determination of the Measurement Date for the Market Price of Acquirer Securities Issued in a Purchase Business Combination (“EITF 99-12”). In accordance with EITF 99-12, the Company established the first date on which the number of the Company’s shares and the amount of other consideration became fixed as of February 18, 2005. Accordingly, the Company valued the transaction using the average closing price of the Company’s common stock for the two-day period ending on February 18, 2005, or $4.53 per share.

9




At the time of issuance, the shares of redeemable preferred stock issued in the acquisition contained a provision whereby the redemption value may be increased based on the future price of the Company’s common stock (the “top-up” amount) and were recorded at fair value as required by SFAS No. 141, Business Combinations (“SFAS 141”) and Emerging Issues Task Force Issue No. 97-8, Accounting for Contingent Consideration Issued in a Purchase Business Combination (“EITF 97-8”). The fair value of the redeemable preferred stock was determined to be the aggregate of the redemption value of the preferred stock discounted at 6.5%, plus the estimated value of the embedded put and call options and the estimated top-up, discounted at the Company’s estimated cost of equity of 14.87%. See “Note 6—Derivative Financial Instrument Liability” and “Note 7—Redeemable Preferred Stock” for further discussion of the top-up.

The fair value of the stock options was determined using the Black-Scholes option pricing model with the following assumptions: no dividend yield, expected volatility of 96%, expected life of one year and a risk-free interest rate of 3.09%.

The Vidus acquisition was accounted for under SFAS No. 141, and certain specified provisions of SFAS 142. The results of operations of Vidus are included in the Company’s Condensed Consolidated Statement of Operations beginning February 19, 2005.

The following table summarizes the estimated fair values of the tangible assets acquired and the liabilities assumed at the date of acquisition (in thousands):

Cash

 

$

1,269

 

Accounts receivable

 

1,669

 

Prepaid expenses and other

 

412

 

Property and equipment

 

1,022

 

Notes receivable from stockholder

 

11

 

Total tangible assets acquired

 

4,383

 

Accounts payable

 

(540

)

Accrued liabilities

 

(2,148

)

Deferred revenue

 

(4,270

)

Total tangible liabilities assumed

 

(6,958

)

Net tangible liabilities assumed

 

$

(2,575

)

 

Under the purchase method of accounting, the Company allocated the total purchase price to the acquired net tangible and intangible assets based upon their fair market value as of the date of acquisition, February 18, 2005. The intangible assets recognized, apart from goodwill, represented contractual or other legal rights of Vidus and those intangible assets of Vidus that could be clearly identified. These intangible assets were identified and valued through interviews and analysis of data provided by Vidus concerning development projects, their stage of development, the time and resources needed to complete them and, if applicable, their expected income generating ability. There were no other contractual or other legal rights of Vidus clearly identifiable by management, other than those identified below.

The allocation of the purchase price to the tangible and identifiable intangible assets acquired and liabilities assumed was as follows (in thousands):

Fair value of net tangible liabilities assumed

 

$

(2,575

)

Intangible assets acquired:

 

 

 

Core developed technology

 

18,410

 

Order backlog

 

5,500

 

Customer relationships

 

3,660

 

Trademarks

 

3,250

 

Trade names

 

2,270

 

 

 

33,090

 

 

 

 

 

In-process research and development

 

5,640

 

Costs allocated to common stock issued

 

478

 

Deferred tax liability, net

 

(3,693

)

Goodwill

 

13,341

 

Purchase price

 

$

46,281

 

 

10




Core Developed Technology

Core developed technology of approximately $18.4 million relates to the Taskforce technology. At the date of acquisition, the developed technology was complete and had reached technological feasibility. Any costs to be incurred in the future will relate to the ongoing maintenance of the developed technology and will be expensed as incurred. To estimate the fair value of the developed technology, an income approach was used with a discount rate of 35%, which included an analysis of future cash flows and the risks associated with achieving such cash flows. The developed technology is being amortized over its estimated useful life of ten years.

Order Backlog and Customer Relationships

The order backlog of approximately $5.5 million and the customer relationships of approximately $3.7 million represented the fair value of the PCS obligations and existing customer relationships. To estimate the fair value of the order backlog and the customer relationships, an income approach was used with a discount rate of 30%. The order backlog and customer relationships are amortized over their estimated useful lives of three and ten years, respectively.

Trademarks

The Taskforce solution has strong name recognition in European field service management, telecommunications, cable and utilities markets. To estimate the fair value of the trademark an income approach was used with a discount rate of 40%. The Company expects to continue to produce and market the Taskforce product. Therefore, an analysis of various economic factors indicated the period of time the trademark would contribute to future cash flows. Because cash flow is expected to continue indefinitely, the trademark is not being amortized, but is tested for impairment at least annually and whenever events or changes in circumstances indicate that the carrying value may not be recoverable.

Trade Names

The Vidus trade name had strong name recognition in European markets. At the time of the acquisition, the Company expected to continue to utilize the Vidus trade name in Europe. The fair value was determined using an income approach with a discount rate of 40% and based on an analysis of various economic factors the Company determined that the useful life of the trade name was indefinite. During the fourth quarter of 2005, management determined that the acquired Vidus trade name would no longer be utilized. As a result, the Company recorded an impairment charge of $2.3 million.

In-Process Research and Development

Development projects that had reached technological feasibility were classified as developed technology, and the value assigned to developed technology was capitalized. In-process research and development of approximately $5.6 million reflected research projects that had not reached technological feasibility or had no alternative future use at the time of the acquisition and was immediately expensed. In order to achieve technological feasibility, the Company estimated the hours required to complete the projects would cost approximately $5.7 million. The Company estimated the fair value assigned to in-process research and development using the income approach, which discounts to present value the cash flows attributable to the technology once it had reached technological feasibility using a discount rate of 40%. The stages of completion were determined by estimating the costs and time incurred to date relative to the costs and time expected to be incurred to develop the in-process technology into a commercially viable technology or product, while considering the relative difficulty of completing the various tasks and overcoming the obstacles necessary to attain technological feasibility. The weighted average stage of completion for all projects, in the aggregate, was approximately 80% as of the acquisition date. Cash flows from sales of products incorporating those technologies commenced in fiscal 2005. Expenditures to complete the acquired in-process research and development approximated the original estimates.

Goodwill

Goodwill of approximately $13.3 million represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired. The acquisition allows the Company to integrate its technology with Vidus’ technology for dynamic scheduling, dispatching, routing and appointment booking of mobile workers, cross-sell the companies’ solutions and further develop the combined technologies to provide customers with seamlessly integrated solutions. The acquisition also creates the ability to expand the Company’s business to Europe and other international markets. These opportunities, along with the ability to hire the Vidus workforce, were significant contributing factors to the establishment of the purchase price, resulting in the recognition of a significant amount of goodwill. The goodwill and intangible assets were allocated to the licensed reporting segment. The goodwill is not deductible for tax purposes.

11




The Company conducted its annual impairment test of its goodwill and other non-amortizing intangible assets as of August 31, 2006 and determined there was no impairment.

Pro Forma Financial Information

The results of operations of Vidus are included in the Company’s Consolidated Statement of Operations from the date of the acquisition. If the Company had acquired Vidus at the beginning of the periods presented, the Company’s unaudited pro forma revenue, net loss, net loss attributable to common stockholders and net loss per share would have been as follows (in thousands, except per share amount):

 

Nine Months Ended
September 30, 2005

 

Revenue

 

$

66,280

 

Net loss

 

22,925

 

Net loss attributable to common stockholders

 

22,551

 

Net loss per share

 

 

 

Basic

 

0.37

 

Diluted

 

0.36

 

Shares used in computing net income per share

 

 

 

Basic

 

60,530

 

Diluted

 

61,953

 

 

These results are not necessarily indicative of what the actual results of operations would have been if the acquisition of Vidus had in fact occurred on the dates or for the periods indicated, nor do they purport to project the results of operations for any future periods or as of any date. These results do not give effect to any cost savings, operating synergies, and revenue enhancements which may result from the acquisition of Vidus or the costs of achieving these cost savings, operating synergies, and revenue enhancements. The in-process research and development charge of approximately $5.6 million is included in the net loss attributable to common stockholders for the nine months ended September 30, 2005.

Intangible Assets

SFAS 142 requires purchased intangible assets other than goodwill to be amortized over their expected useful lives unless these lives are determined to be indefinite. Purchased intangible assets are carried at cost less accumulated amortization. Amortization is computed over the estimated useful lives of the respective assets, generally two to ten years.

Intangible assets were as follows (in thousands):

 

As of September 30, 2006

 

As of December 31, 2005

 

 

 

Carrying
Amount

 

Accumulated
Amortization

 

Net

 

Carrying
Amount

 

Accumulated
Amortization

 

Net

 

Amortized intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Core developed technology

 

$

23,462

 

$

(8,021

)

$

15,441

 

$

23,462

 

$

(6,641

)

$

16,821

 

Order backlog

 

5,500

 

(2,957

)

2,543

 

5,500

 

(1,582

)

3,918

 

Customer relationships

 

3,660

 

(591

)

3,069

 

3,660

 

(316

)

3,344

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

32,622

 

(11,569

)

21,053

 

32,622

 

(8,539

)

24,083

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unamortized intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Trademarks

 

3,250

 

 

3,250

 

3,250

 

 

3,250

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total intangible assets

 

$

35,872

 

$

(11,569

)

$

24,303

 

$

35,872

 

$

(8,539

)

$

27,333

 

 

During the fourth quarter of 2005, management determined that Vidus Limited would officially change its name to @Road, Ltd. Therefore, the acquired Vidus trade name will no longer be utilized. The name change is intended to leverage the @Road brand equity and more closely reflect the Company’s objective of adding end-to-end MRM solutions offerings in Europe. As a result, the Company reduced the carrying value to zero resulting in an impairment charge of $2.3 million during the three months ended December 31, 2005.

12




For the three and nine months ended September 30, 2006, amortization of intangible assets was $1.0 million and $3.0 million, respectively, compared to $1.0 million and $2.5 million for the three and nine months ended September 30, 2005, respectively. The estimated future amortization expense of purchased intangible assets as of September 30, 2006 is as follows (in thousands):

Remainder of 2006

 

$

1,010

 

2007

 

4,040

 

2008

 

2,458

 

2009

 

2,207

 

2010

 

2,207

 

Thereafter

 

9,131

 

 

 

 

 

Total

 

$

21,053

 

 

Note 4 — Short-Term Investments

Short-term investments included the following available-for-sale securities at September 30, 2006 and December 31, 2005 (in thousands):

 

As of September 30, 2006

 

 

 

Amortized
Cost

 

Unrealized
Gains

 

Unrealized
(Losses)

 

Estimated
Fair Value

 

U.S. Government debt securities

 

$

41,063

 

$

3

 

$

(26

)

$

41,040

 

Municipal debt securities

 

33,327

 

 

 

33,327

 

Corporate debt securities

 

3,091

 

 

 

3,091

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

77,481

 

$

3

 

$

(26

)

$

77,458

 

 

 

As of December 31, 2005

 

 

 

Amortized
Cost

 

Unrealized
Gains

 

Unrealized
(Losses)

 

Estimated
Fair Value

 

U.S. Government debt securities

 

$

39,276

 

$

 

$

(72

)

$

39,204

 

Municipal debt securities

 

36,802

 

 

(6

)

36,796

 

Corporate debt securities

 

1,643

 

 

 

1,643

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

77,721

 

$

 

$

(78

)

$

77,643

 

 

In accordance with EITF 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, the following table shows gross unrealized losses and fair value for those investments that were in an unrealized loss position as of September 30, 2006 and December 31, 2005, aggregated by investment category and the length of time that individual securities have been in a continuous loss position (in thousands):

 

As of September 30, 2006

 

 

 

Less than 12 Months

 

12 Months or Greater

 

Total

 

 

 

Fair Value

 

Unrealized
Loss

 

Fair Value

 

Unrealized
Loss

 

Fair Value

 

Unrealized
Loss

 

U.S. Government debt securities

 

$

41,040

 

$

(26

)

$

 

$

 

$

41,040

 

$

(26

)

Municipal debt securities

 

33,327

 

 

 

 

33,327

 

 

Corporate debt securities

 

3,091

 

 

 

 

3,091

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

77,458

 

$

(26

)

$

 

$

 

$

77,458

 

$

(26

)

 

 

As of December 31, 2005

 

 

 

Less than 12 Months

 

12 Months or Greater

 

Total

 

 

 

Fair Value

 

Unrealized
Loss

 

Fair Value

 

Unrealized
Loss

 

Fair Value

 

Unrealized
Loss

 

U.S. Government debt securities

 

$

39,204

 

$

(72

)

$

 

$

 

$

39,204

 

$

(72

)

Municipal debt securities

 

36,796

 

(6

)

 

 

36,796

 

(6

)

Corporate debt securities

 

1,643

 

 

 

 

1,643

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

77,643

 

$

(78

)

$

 

$

 

$

77,643

 

$

(78

)

 

13




The Company reviews investments in debt securities for other than temporary impairment whenever the fair value of an investment is less than amortized cost and evidence indicates that an investment’s carrying amount is not recoverable within a reasonable period of time. The decline in value of these investments is primarily related to changes in interest rates and is considered to be temporary in nature. When evaluating the investments, the Company considers whether it has the ability and intent to hold the investment until a market recovery and considers whether evidence indicating the cost of the investment is recoverable outweighs evidence to the contrary. Evidence considered in this assessment includes the reasons for the impairment, compliance with the Company’s investment policy, the severity and duration of the impairment, changes in the value subsequent to period-end and forecasted performance of the investee. The Company has reviewed those securities with unrealized losses as of September 30, 2006 and December 31, 2005 for other-than-temporary impairment, and has concluded that no other-than-temporary impairment existed as of September 30, 2006 and December 31, 2005.

Note 5 — Balance Sheet Components

Inventories consist of raw materials, work in process and finished goods, are stated at the lower of cost (average cost) or market and consist of (in thousands): 

 

As of
September 30, 2006

 

As of
December 31, 2005

 

Raw materials

 

$

3,189

 

$

1,796

 

Work in process

 

9,686

 

2,013

 

Finished goods

 

4,271

 

2,278

 

 

 

 

 

 

 

Total

 

$

17,146

 

$

6,087

 

 

Property and equipment, net consist of (in thousands):

 

As of
September 30, 2006

 

As of
December 31, 2005

 

Computers and software

 

$

17,113

 

$

14,424

 

Manufacturing and office equipment

 

1,210

 

663

 

Furniture and fixtures

 

383

 

455

 

Leasehold improvements

 

1,305

 

695

 

 

 

 

 

 

 

Total

 

20,011

 

16,237

 

Accumulated depreciation and amortization

 

(12,338

)

(10,042

)

 

 

 

 

 

 

Property and equipment, net

 

$

7,673

 

$

6,195

 

 

Accrued liabilities consist of (in thousands):

 

As of
September 30, 2006

 

As of
December 31, 2005

 

Accrued compensation and related benefits

 

$

4,521

 

$

3,629

 

Other accrued expenses

 

4,454

 

5,122

 

Total

 

$

8,975

 

$

8,751

 

 

Note 6 — Derivative Financial Instrument Liabilities

In connection with the Vidus acquisition, the Company issued shares of its Series B-1 and B-2 redeemable preferred stock with an embedded feature indexed to the Company’s common stock (the “top-up”) that is payable to the holders of the redeemable preferred stock upon redemption. See “Note 7 -Redeemable Preferred Stock” for further discussion. In accordance with SFAS 133, the top-up amount is considered a derivative instrument that should be bifurcated from the preferred stock host and recognized as either an asset or liability, depending on the rights and obligations under the contract, and should be measured at fair value. The Company accounts for changes in the fair value of the derivative instrument, which is not designated as a hedging instrument, through the current period earnings.

Based on the highest ten consecutive trading days average closing price of the Company’s common stock of $5.73 per share through September 25, 2006, per the terms of the acquisition, the final aggregate top-up amount payable upon redemption of the related preferred stock is $7.1 million.

14




The difference between the fair value of the derivative liability of $6.9 million and the final aggregate top-up amount of $7.1 million at September 30, 2006 represents the fair value of a portion of the derivative to be recognized over the period to the final preferred stock redemption date of February 18, 2007 for Series B-2 redeemable preferred stock.

Prior to the three months ended September 30, 2006, the Company used the Monte Carlo simulation of its stock price with the movements in its stock price following a geometric Brownian motion to value the derivative instrument that is recorded as a derivative liability. In valuing the embedded derivative, the Company used the market price of its common stock on the date of valuation, a historical volatility and the expected remaining period to the expiration date of the top-up period. The Company used the following valuation assumptions:

 

As of

 

As of

 

As of

 

As of

 

As of

 

As of

 

As of

 

 

 

June 30,

 

March 31

 

December 31,

 

September 30,

 

June 30,

 

March 31,

 

February 18,

 

 

 

2006

 

2006

 

2005

 

2005

 

2005

 

2005

 

2005

 

Historical volatility

 

43

%

47

%

54

%

66

%

88

%

88

%

88

%

Expected remaining period

 

3 months

 

6 months

 

9 months

 

12 months

 

15 months

 

15 months

 

15 months

 

Valuation date market price of common stock

 

$

5.52

 

$

5.07

 

$

5.23

 

$

4.59

 

$

2.66

 

$

4.10

 

$

4.50

 

Risk-free interest rate

 

4.95

%

4.75

%

4.33

%

3.97

%

3.42

%

3.32

%

3.07

%

Discount rate

 

15.30

%

15.97

%

16.07

%

15.71

%

15.16

%

15.12

%

14.87

%

 

The fair value of this derivative instrument was $6.9 million at September 30, 2006 and was estimated at $3.9 million at June 30, 2006, $4.1 million at March 31, 2006 and $2.9 million at December 31, 2005. The change in the fair value of $(3.0) million and $(4.0) million was recorded in total other (expense) income, net in the condensed consolidated statements of operations for the three and nine months ended September 30, 2006, respectively. The change in the fair value of $4.8 million and $772,000 was recorded in total other (expense) income, net in the condensed consolidated statements of operations for the three and nine months ended September 30, 2005, respectively.

Note 7 — Redeemable Preferred Stock

On February 18, 2005, the Board of Directors of the Company authorized the creation of four series of preferred stock and designated approximately 44,000, 44,000, 5,000 and 5,000 shares as Series A-1, A-2, B-1 and B-2 preferred stock, respectively, of which approximately 23,000, 44,000, 5,000 and 5,000 shares of Series A-1, A-2, B-1 and B-2 preferred stock, respectively, were issued and outstanding as of September 30, 2006.

Dividends

The holders of the Series A-1, A-2, B-1 and B-2 preferred stock are entitled to receive dividends at the rate of $6.50 per share annually. The dividends accrue day to day, whether or not earned or declared, from February 18, 2005. The dividends are payable when and if declared by the Board of Directors or when shares are redeemed. Any accumulation of unpaid dividends on the preferred stock does not bear interest. Accrued dividends totaled $813,000 as of September 30, 2006.

Redemption

The holders of the Series A-1 and B-1 preferred stock may elect to redeem all or a portion of the shares at any time, and the holders of the Series A-2 and B-2 preferred stock may elect to redeem all or a portion of the shares on or after February 18, 2007.

Each share of Series A-1 and A-2 preferred stock is redeemable for an amount equal to (i) $100 plus (ii) all declared or accumulated but unpaid dividends. Each share of Series B-1 and B-2 preferred stock is redeemable for an amount equal to (i) $100, plus (ii) all declared or accumulated but unpaid dividends, plus (iii) the top-up amount of $731.

On or after February 18, 2009, the Company may redeem all or any portion of the Series A-1, A-2, B-1, and B-2 preferred stock.

Conversion

None of the issued series of preferred stock is convertible.

15




Liquidation

Series A-1, A-2, B-1 and B-2 preferred stockholders are entitled to receive, upon liquidation, an amount equal to their respective redemption price. The holders of the Series A-1, A-2, B-1 and B-2 preferred stock rank on a pari passu basis as to the receipt of such distributions and in preference to the holders of common stock.

Voting

Each outstanding share of preferred stock is entitled to eleven (11) votes on all matters, voting with the shares of common stock as a class.

The following table illustrates the activity for each series of preferred stock through September 30, 2006 (in thousands):

 

Series A-1

 

Series A-2

 

Series B-1

 

Series B-2

 

Total

 

Issued at fair value

 

$

2,352

 

$

4,424

 

$

3,205

 

$

2,937

 

$

12,918

 

Reclass of bifurcated derivative instrument, at fair value at issuance

 

 

 

(2,719

)

(2,451

)

(5,170

)

Amounts accrued for dividends for the nine months ended September 30, 2005

 

93

 

174

 

19

 

19

 

305

 

Balance September 30, 2005 (As Restated) (See Note 1)

 

$

2,445

 

$

4,598

 

$

505

 

$

505

 

$

8,053

 

Amounts accrued for dividends for the three months ended December 31, 2005

 

38

 

75

 

9

 

9

 

131

 

Balance December 31, 2005

 

$

2,483

 

$

4,673

 

$

514

 

$

514

 

$

8,184

 

Amounts accrued for dividends for the nine months ended September 30, 2006

 

116

 

215

 

23

 

23

 

377

 

Redemption of preferred stock

 

(5

)

 

 

 

(5

)

Balance September 30, 2006

 

$

2,594

 

$

4,888

 

$

537

 

$

537

 

$

8,556

 

 

Note 8 — Common Stock

The Company’s Certificate of Incorporation, as amended, authorizes it to issue 250,000,000 shares of common stock. At September 30, 2006 and 2005 there were no shares subject to repurchase rights.

At September 30, 2006, the Company had reserved approximately 16,373,000 shares of common stock available for future issuance under its stock option plans, including approximately 10,327,000 shares related to outstanding stock options. In addition, the Company had reserved approximately 2,108,000 shares of common stock available for future issuance under the employee stock purchase plan.

Note 9 — Employee Benefit Plans

Adoption of SFAS 123R

The Company adopted the provisions of SFAS 123R, on January 1, 2006. Under SFAS 123R, stock-based compensation cost is measured at the grant date, based on the estimated fair value of the award at that date, and is recognized as expense over the employee’s requisite service period (generally over the vesting period of the award) on a straight-line basis. The Company has no awards with market conditions. The Company has one stock option grant under which the vesting schedule will accelerate upon the achievement of certain targets during the year ending December 31, 2006. If the performance conditions are not met during 2006, the options will fully vest five years after issuance. The fair value of this stock option grant is based on the market price of the Company’s

16




stock on the grant-date and assumes that it is not probable that the performance conditions will be achieved. Compensation cost will be adjusted for subsequent changes in the expected outcome of performance-related conditions until the vesting date.

The Company adopted the provisions of SFAS 123R using a modified-prospective approach. Under the modified prospective approach, prior periods are not revised for comparative purposes. The valuation provisions of SFAS 123R apply to new awards and to awards that are outstanding on the effective date and subsequently modified or cancelled. Estimated compensation expense for awards outstanding at the effective date will be recognized on a straight-line basis over the remaining service period using the compensation cost calculated for pro forma disclosure purposes under SFAS 123 as adjusted for estimated forfeitures. The Company has elected to follow the tax law method of determining realization of excess tax benefits in accordance with SFAS 123R.

The effect of recording stock-based compensation for the three and nine months ended September 30, 2006 was as follows:

 

Three months ended 
September 30, 2006

 

Nine months ended 
September 30, 2006

 

Stock-based compensation expense by type of award:

 

 

 

 

 

Employee stock options

 

$

822

 

$

2,528

 

Employee stock purchase plan

 

219

 

639

 

Amounts capitalized as inventory

 

(2

)

(4

)

Total stock-based compensation

 

$

1,039

 

$

3,163

 

 

 

 

 

 

 

Tax effect on stock-based compensation

 

$

136

 

$

606

 

Net effect on net (loss) income attributable to common stockholders

 

$

903

 

$

2,557

 

 

 

 

 

 

 

Effect on (loss) income per share:

 

 

 

 

 

Basic

 

$

0.01

 

$

0.04

 

Diluted

 

$

0.01

 

$

0.04

 

 

The Company recorded $1.0 million of stock-based compensation expense in its condensed consolidated statement of operations for the three months ended September 30, 2006. A total of $562,000 of this expense relates to prior year awards vesting after January 1, 2006 and $477,000 relates to options granted after the adoption of SFAS 123R. For the nine months ended September 30, 2006, the Company recorded $3.2 million of stock-based compensation expense in its condensed consolidated statement of operations of which $2.4 million relates to prior year awards vesting after January 1, 2006 and $727,000 relates to options granted after the adoption of SFAS 123R.

As of September 30, 2006, there were $5.3 million of total unrecognized compensation cost related to non-vested stock-based employee compensation arrangements. The cost is expected to be recognized over a weighted-average period of 2.6 years. For the three and nine months ended September 30, 2006, stock-based compensation totaling $2,000 and $4,000, respectively, was capitalized as inventory.

Valuation Assumptions

The weighted-average estimated fair value of employee stock options granted during the three months ended September 30, 2006 and 2005 was $2.71 and $1.69 per share, respectively. The weighted-average estimated fair value of employee stock options granted during the nine months ended September 30, 2006 and 2005 was $2.86 and $2.26 per share, respectively. The Company calculated the fair value of each option award on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions (annualized percentages):

 

Three months ended

 

Nine months ended

 

 

 

September 30,
2006

 

September 30,
2005

 

September 30,
2006

 

September 30,
2005

 

Stock option plans:

 

 

 

 

 

 

 

 

 

Volatility

 

68

%

77

%

68

%

106

%

Risk-free interest rate

 

4.8

%

4.1

%

4.8

%

3.4

%

Dividend yield

 

0.0

%

0.0

%

0.0

%

0.0

%

Expected life (in years)

 

5.0

 

2.5

 

5.0

 

5.0

 

Forfeiture rate

 

27

%

0

%

27

%

0

%

 

17




 

 

Three months ended

 

Nine months ended

 

 

 

September 30,
2006

 

September 30,
2005

 

September 30,
2006

 

September 30,
2005

 

Employee stock purchase plans:

 

 

 

 

 

 

 

 

 

Volatility

 

57

%

57

%

72

%

67

%

Risk-free interest rate

 

5.0

%

3.1

%

4.7

%

1.1

%

Dividend yield

 

0.0

%

0.0

%

0.0

%

0.0

%

Expected life (in years)

 

1.2

 

0.5

 

1.1

 

0.5

 

 

Expected volatility is determined using a 50% weighting to both historical volatility of the Company’s common stock over a period of 4.5 to 5.0 years following the Company’s initial public offering and implied volatility based on the Company’s traded stock options. The risk-free interest rate is calculated using zero coupon rates on treasury notes stripped principal for each grant date given the expected life. The dividend yield of zero is based on the fact that the Company expects to invest cash in operations and has never paid cash dividends on common stock. The expected life is calculated for the period from the Company’s initial public offering using the interval between the grant date and the exercise date weighted by the number of shares exercised. The expected life is adjusted for the anticipated behavior in relation to unexercised options.

As stock-based compensation expense recognized in the statements of operations for 2006 is based on awards ultimately expected to vest, it is reduced for estimated forfeitures. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Pre-vesting forfeitures were estimated to be approximately 27% as of September 30, 2006 based on weighted average historical forfeiture rates. Under the provisions of SFAS 123R, the Company will record additional expense if the actual forfeiture rate is lower than estimated, and will record a recovery of prior expense if the actual forfeiture rate is higher than estimated. In the Company’s pro forma information required under SFAS 123 for the periods prior to fiscal 2006, the Company accounted for forfeitures as they occurred.

Pro Forma Information under FAS 123 for Periods Prior to Fiscal 2006

Prior to adopting the provisions of SFAS 123R, the Company provided the disclosures required under SFAS 123 as amended by Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation Transition and Disclosures (“SFAS 148”).

For purposes of pro forma disclosures under SFAS 123 for the three and nine months ended September 30, 2005, the estimated fair value of the stock options was assumed to be amortized to expense over the stock options’ vesting periods. The pro forma effects of recognizing estimated compensation expense under the fair value method on net loss and loss per common share for the three and nine months ended September 30, 2005 were as follows:

 

Three Months Ended

 

Nine Months Ended

 

 

 

   September 30, 2005   

 

September 30, 2005

 

Net income as reported

 

$

37,998

 

$

25,610

 

Add: stock-based employee compensation expense included in reported net loss, net of tax effect

 

 

 

Less: stock-based employee compensation expense determined under fair value based method, net of tax effect

 

(441

)

(4,038

)

 

 

 

 

 

 

Pro forma net income

 

37,557

 

21,572

 

Preferred stock dividends

 

(124

)

(305

)

 

 

 

 

 

 

Pro forma net income attributable to common stockholders

 

$

37,433

 

$

21,267

 

 

 

 

 

 

 

Basic net income per share:

 

 

 

 

 

As reported

 

$

0.62

 

$

0.42

 

 

 

 

 

 

 

Pro forma

 

$

0.62

 

$

0.36

 

 

 

 

 

 

 

Diluted net income per share:

 

 

 

 

 

As reported

 

$

0.61

 

$

0.41

 

 

 

 

 

 

 

Pro forma

 

$

0.60

 

$

0.35

 

 

18




Equity Incentive Plans

The Company has equity incentive plans for directors, officers and employees. Stock options granted under these plans generally vest 25% one year from the date of grant and the remainder vest at a rate of 2.08% per month thereafter. Grants to existing employees generally vest 25% per year on the anniversary of the grant. Non-employee directors upon becoming a director receive an initial grant of options to purchase 40,000 shares vesting over 4 years and annual grants of options to purchase 10,000 shares vesting over one year. Options generally expire 10 years from the date of grant. The Company’s equity incentive plans contain a provision that automatically increases through 2010, on each January 1, the number of shares reserved for issuance under these plans by the lesser of 2,500,000 shares or four percent of the total shares outstanding on the last day of the preceding year.

The following table summarizes activity under the Company’s equity incentive plans for the nine months ended September 30, 2006 (in thousands, except per share amounts):

 

Number of
Shares

 

Weighted
Average
Exercise
Price