ITEM 1. BUSINESS
Founded in 1984 and with 2007 annual revenue exceeding one billion dollars, Sybase is a global enterprise software and services company exclusively focused on managing and mobilizing information from the data-center to the point of action. We are a leader in the large and growing Unwired Enterprise market, which combines software and services to enable the end-to-end distribution, analysis and management of enterprise information on any platform, device or network, anytime, anywhere. Sybase solutions combined with our global access and network, allow enterprises unparalleled reach to the broadest base of users and subscribers.
Sybase data management and mobility solutions and services are widely recognized for their superior reliability, security and scalability, enabling easy and effective development in heterogeneous environments. Sybase was founded and incorporated in California on November 15, 1984, and was re-incorporated in Delaware on July 1, 1991.
Our business is organized into three principal operating segments, Infrastructure Platform Group (IPG), iAnywhere Solutions (iAS) and Sybase 365 (Sybase 365). We acquired Sybase 365® (formerly known as Mobile 365, Inc.) in November 2006 for approximately $418.5 million. Below is a brief description of the business of each division:
• Infrastructure Platform Group (IPG) focuses on information management by helping customers build a trusted data infrastructure and create a more intelligent enterprise. IPG offers two lines of enterprise class data servers: Adaptive Server® Enterprise (ASE) a relational database management system for mission-critical transactions and Sybase IQ, a specialized column-based analytics server, for business intelligence applications such as accelerated reporting, advanced analytics and analytics services. IPG also produces solutions for business continuity including the Sybase Replication Server and the Sybase Mirror Activator™ for very high availability data environments. To help customers integrate data from a variety of sources, IPG offers the Data Integration Suite which combines popular data integration techniques with common development and administration. Data Integration Suite components include replication, data federation, real time events and search. IPG offers integrated tooling to design, analyze and develop these environments. Products include PowerDesigner®, a leading modeling tool, PowerBuilder®, a leading Rapid Application Development (RAD) tool, and WorkSpace for integrated development environments. IPG also offers vertical information management solutions for financial services. The Sybase Risk Analytics Platform (RAP) is optimized for the market data needs of capital market institutions by providing multi-year storage and low latency utilization of real-time and historical market data and events. The Sybase Financial Fusion® product line enables banks to provide account access and payment initiation on behalf of their consumer, small business and corporate clients. During 2007, the products of IPG accounted for approximately 69 percent of our license revenue.
• iAnywhere Solutions (iAS) enables success at the front lines of business. iAS holds worldwide market leadership positions in mobile and embedded databases, mobile management and security, mobile middleware and synchronization, and Bluetooth and infrared protocol technologies. Tens of millions of mobile devices, millions of subscribers, and 20,000 customers and partners rely on iAS’s “Always Available” technologies, including SQL Anywhere® and Information Anywhere™ Suite. The products of iAS accounted for approximately 31 percent of our license revenue in 2007.
• Sybase 365, provides mobile messaging interoperability, the delivery and settlement of SMS and MMS content, mobile commerce and enterprise-class messaging services. Sybase 365 enables wireless operators, brands, content providers and enterprises to deliver advanced mobile services to subscribers by addressing the inherent complexities of the wireless ecosystem: incompatible networks, messaging protocols, handsets, and billing systems. Sybase 365 holds worldwide market leadership positions in inter-operator messaging, premium content delivery and settlement, and enterprise messaging. In order to deliver services, Sybase 365 utilizes an operator-grade, secure messaging platform connected via a global private network of IP and SS7 connections to more than 700 mobile operators worldwide. Sybase 365 offers customers unparalleled subscriber reach (approximately 2.4
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billion mobile subscribers) supported by high quality of service and worldwide message delivery, billing, and settlement capabilities. In 2007, Sybase 365 processed more than 89 billion messages.
A summary of financial results for these divisions is found in Note Ten to Consolidated Financial Statements, Part II, Item 8.
UNWIRED ENTERPRISE
We define the Unwired Enterprise as an enterprise that uses information technology to create the seamless flow of information from the data center to any device. An Unwired Enterprise breaks down information technology barriers and delivers critical information and applications to employees, partners, and customers, to any platform, device or network, anytime, anywhere. The benefits for enterprises becoming an Unwired Enterprise are substantial. An Unwired Enterprise is more efficient, more productive, and better able to capitalize on new opportunities because information is moved to the point of action, increasing its relevance and enhancing the power of decisions and transactions.
To enable the Unwired Enterprise, Sybase offers a cohesive platform that leverages our core strength in data management, market leading mobile solutions and operator-grade network infrastructure. This platform provides unique opportunities for Sybase to deliver ongoing value to the enterprise market, while at the same time dominating emerging high-growth markets, such as mobile banking and mobile commerce leveraging Sybase’s global enterprise reach and mobile messaging capabilities.
CUSTOMERS
Our customers are primarily Fortune 1000 companies in North America and their equivalents around the globe. No single customer accounted for more than 10 percent of total revenues during 2007, 2006 or 2005. In 2007 our customers included:
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A hedge fund uses Sybase IQ’s column-based database technology to deliver meaningful information from trade, bond and market data. Developing a customized, in-house analytics solution based on Sybase IQ, the hedge fund increased the ability to customize data for users and the company’s overall data agility. This private investment firm, like many financial service customers, uses Sybase IQ to deliver high speed analytics across large data sets.
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A global leader in medical technology uses Sybase iAnywhere Information Anywhere Suite and SQL Anywhere to support its field sales and marketing team with a mobile solution. The mobile solution is powered by SQL Anywhere’s mobile database and synchronization software, while Information Anywhere’s frontline management software provides the ability to centrally manage and secure these applications.
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One of India’s largest banks recently migrated 200 applications onto Sybase Adaptive Server Enterprise (ASE) in order to reduce their operational costs and improve performance. The bank utilizes Sybase IQ for fast reporting and query performance in their data warehouse applications. In addition, the bank employs Sybase replication technology to implement a reliable disaster recovery solution to ensure high availability. In choosing Sybase, the bank was able to address its strategic data management pain points while ensuring support for a heterogeneous data center environment.
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One of the world’s largest airlines uses Sybase Information Anywhere Suite to support a remote team of field engineers who install, maintain and repair on-site computer equipment and infrastructure across 321 cities in 58 countries and five continents. By using the Suite’s comprehensive mobile platform, field engineers are now able to receive, resolve and report on technology incidents more accurately, efficiently and quickly than ever before.
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A large, prestigious university’s medical system uses Sybase iAnywhere Information Anywhere Suite to manage the use of mobile computing and storage devices while ensuring the confidentiality, integrity, and accessibility of information accessed and stored. Leveraging the Information Anywhere’s frontline management capabilities, the university enforces and ensures compliance with standards governing the use, management, and configuration of all mobile computing and storage devices.
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One of the leading international banks uses Sybase 365 to enhance its Internet banking security and to strengthen online verification procedures through a two-factor authentication at login for all types of Internet banking systems. Sybase 365 provides the SMS connectivity so each time a customer conducts transactions on the bank’s Internet banking platform, a login PIN is required, in addition to a user ID and password. After the customer logs in with their user ID and password, Sybase 365 sends the PIN (a unique number) via SMS to the customer’s registered mobile phone.
PRODUCTS AND SERVICES
Depending on the product, Sybase offers products on an on-premise license model or as hosted services. On-premise license products are available on hardware platforms manufactured by Dell, Hewlett-Packard, IBM, Sun Microsystems, and others. We also make products that connect these platforms to other hardware platforms with large installed bases. These products are also available for a wide range of operating systems including various UNIX environments, Windows, Windows NT, and Linux. Sybase 365 offerings are available as hosted services. A description of our principal products and service offerings follows:
Infrastructure Platform Group (IPG)
Sybase Adaptive Server Enterprise (ASE) is a powerful data management platform for high performance business applications especially in large database, high-transaction, mission-critical environments. ASE combines a low total cost of ownership with excellent reliability, security, and scalability. Sybase ASE 15 key features include patented encryption, partitioning for scalability and new patent-pending query technology for “smarter” transactions, increased performance and enhanced support for unstructured data management.
Sybase IQ is a column-oriented analytics server optimized for outstanding query performance for high volumes of both structured and unstructured data in business intelligence applications such as accelerated reporting, advanced analytics and analytics services. Sybase IQ, which holds the record for the world’s largest data warehouse at one Petabyte of data, improves analytic performance by up to 10 - 100x over traditional solutions while lowering storage and maintenance costs.
Sybase Risk Analytics Platform (RAP) offers the most comprehensive, resilient platform for real-time and historical market data for the capital markets industry. It supports and integrates trade processing applications, such as risk management and algorithmic trading, throughout the trade life-cycle. Sybase RAP enables customers to respond more quickly to market events and increases real-time decision making capability.
Sybase Replication Server® increases the flexibility and lowers the cost of managing multiple data management platforms including Sybase ASE, Oracle, Microsoft, IBM DB2 and mainframes. It provides bi-directional, heterogeneous replication and synchronization across enterprise, client/server, desktop, and mobile systems.
Sybase Data Integration Suite streamlines data integration techniques into a single, out-of-the-box solution. Customers can choose the technology that best meets their needs - extract, transform and load (ETL) replication, federation or event-based integration - to build flexible data flows. With the modular suite, customers can start with today’s projects and scale to address the most serious integration
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challenge. Using smart, easy-to-use tools Sybase Data Integration Suite accelerates the design, development, delivery, and management of seamless data flows. Common modeling, metadata management, development tooling, and administration form the smart “glue” that enables the holistic, controlled method for achieving agility.
Sybase Mirror Activator improves the economics of high-end storage replication systems by reducing network costs, accelerating recovery time and guaranteeing data integrity. It also extends the usefulness of standby systems by utilizing them for reporting and decision support.
Sybase PowerDesigner is a leading data-modeling and application design tool for enterprises that need to build or re-engineer applications quickly, cost-effectively and consistently (also sold as Sybase PowerAMC).
Sybase WorkSpace is an Eclipse-based unified development environment bridging the gap between development of applications for service-oriented-architectures (SOA) and traditional tooling. Sybase WorkSpace combines modeling, data management, services assembly and orchestration, Java development and mobile development.
Sybase PowerBuilder is an industry-leading rapid application development (RAD) tool that increases developer productivity through tight integration of design, modeling, development, and management.
Sybase Financial Fusion Banking Solutions enable financial institutions to offer multiple-delivery channel support to their consumer, small business, and large corporate clients. Features include account access, banking, cash management services, imaging, bill payment and presentment, customer care, and wireless application support.
iAnywhere Solutions (iAS)
SQL Anywhere is an industry leading mobile and embedded database providing data management and data synchronization technologies that operate in frontline environments without onsite IT support. It offers enterprise-caliber features in a database that is easily embedded and widely deployed in server, desktop, remote office and mobile application environments. In addition, our Advantage Database Server™ provides both ISAM table-based and SQL-based data access, enabling application developers to easily chart a growth path for legacy database applications to today’s modern techniques.
Information Anywhere Suite is a secure, scalable mobile software portfolio of products that address the converging IT requirements of enterprises today. By combining email, messaging, mobile device management, enterprise-to-edge security and back-office application extension capabilities, Information Anywhere enables organizations to empower employees to do the work they need to do anywhere, at anytime, on any device. Information Anywhere Suite leverages leading Sybase iAnywhere technologies including Afaria for managing and securing mobile devices, data and applications; OneBridge, which provides a flexible, powerful and secure way to extend email and applications to mobile workers; Information Anywhere Mobile IM, an easy-to-use, secure solution for extending instant messaging (IM) and presence to mobile devices; M-Business Anywhere, which leverages Web technologies to develop mobile applications; and SQL Anywhere, which provides mobile data management and synchronization.
RemoteWare® is an industry leader in polling, file transfer, and content distribution, RemoteWare supports a broad range of frontline systems and networking options, and supports both classic POS devices and contemporary software environments.
RFID Anywhere™ is designed to automate the process of developing and deploying RFID applications, RFID Anywhere is a middleware platform that addresses the physical requirements of the technology, and even provides the ability to simulate and troubleshoot production RFID environments. This frees developers from getting bogged down in the code-level complexities of evolving devices and standards, differing topologies and far-flung reader locations, allowing them to quickly focus their efforts on applying their knowledge of the business to the task at hand.
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Standards-based SDKs iAS provides standards-based software development kits (SDKs) for implementing protocol stack technologies for infrared, Bluetooth, data synchronization and device management. In addition, XTNDConnect® PC is a software application that allows users to synchronize contacts, calendar, tasks, email and notes between mobile devices and popular PC applications such as Microsoft Outlook and ACT! Over the past 10 years, iAS embedded SDKs have been used in hundreds of product designs resulting in tens of millions of iAS-enabled products deployed into the market.
AvantGo® is a free, ad-supported service that delivers rich, personalized mobile websites to smartphones, PDAs, and mobile browsers. Today, hundreds of major brands and media publishers, including Dell, CNET, Rolling Stone and The New York Times, leverage AvantGo to target a highly desirable demographic of millions of registered users with mobile content and mobile advertising. AvantGo offers the convenience of anywhere, anytime access, seamlessly supporting both wireless and “sync and go” connectivity. Until December 31, 2007, AvantGo results were reported as part of iAnywhere. Commencing on January 1, 2008, AvantGo is a part of Sybase 365.
Sybase 365
Operator Services are focused on Short Message Service (SMS) and Multimedia Messaging Service (MMS) messaging interoperability between mobile operators worldwide. Sybase 365 is a global leader in interoperability services. Messages are delivered through a secure operator-grade messaging platform, with advanced protocol conversion, routing, queuing, and transcoding capabilities. Sybase 365 interoperability service reaches over 700 mobile operators, with over 300 direct two-way SMS destinations - greatly simplifying the deployment and delivery of inter-operator messaging over incompatible networks, protocol stacks, and handsets. Services include robust traffic analysis and detailed reporting and statistics.
Brand and Content Provider Services. Sybase 365 is the premier provider of mobile services for media and entertainment brands, content providers, mobile marketers and agencies, enabling customers to monetize premium mobile content and deliver interactive services and mobile marketing campaigns to subscribers globally through SMS, MMS and Wireless Application Protocol (WAP). Services include MMS 365, content delivery gateway to send and receive MMS from multiple sources; application management, content management, global billing, settlement, reporting and analysis.
Enterprise Messaging Services provide secure global messaging services to enterprises across our operator grade network resulting in superior protection, service and support. Enterprise customers include financial corporations, such as Citibank, Standard Chartered, Banco Bilbao Vizcaya Agentina and MasterCard; and directory assistance services and airlines who rely on Sybase 365 to deliver mission critical mobile messaging services over SMS and MMS.
WORLDWIDE SERVICES
Technical Support. Our Customer Service and Support organization offers technical support for our family of IPG and iAS products. We currently maintain regional support centers in North America, South America, Europe, and Asia Pacific that can provide 24 x 7 technical services in all time zones around the world. Our end users and partners have access to technical information sources and newsgroups on our support website, including a “solved cases” database, and software fixes that can be downloaded. Generally, customers can choose technical support programs that best suit their business needs. All of the following support programs are priced on a percentage of net license fee basis and include updates and new version releases that become available during the support period.
• Standard Support is designed for high quality around the clock support for critical issues, access to new releases and online support services.
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• Enterprise Support offers personalized high-availability support for companies with mission-critical projects. Services include priority access to the Enterprise Technical Team, proactive services, and other specialized options. Enterprise Support provides the highest priority of response times.
In addition to the above support offerings, we offer several support services options geared toward developers for designated workplace level and tools products. These programs are priced on a flat-fee annual basis with updates and new version releases available for purchase separately for an additional annual fee. iAS also offers support programs to end users priced on a flat-fee annual basis with updates and new version releases available for purchase separately for an additional fee.
Our IPG and iAS business divisions also offer a variety of support services to their partners and resellers.
Sybase 365 operates two 24x7 Network Operations Centers in Singapore and the Mid-Atlantic to monitor our messaging service infrastructure, direct and monitor global maintenance and repair activities, and provide direct technical support to our customers. Additionally, Sybase 365 maintains a 24x7 customer care facility in Dublin, Ireland that supports customer requests and services inquiries in 13 languages.
Consulting. The Sybase Professional Services (SPS) organization offers customers comprehensive consulting, education and integration services designed to optimize their business solutions using both Sybase IPG and iAS products and non-Sybase products. Service offerings include assistance with data and system migration, custom application design and development, implementation, performance improvement, knowledge transfer and system administration.
Education. We provide a broad education curriculum allowing customers and partners to increase their proficiency in our IPG and iAS products. Basic and advanced courses are offered at Sybase education centers throughout North America, South America, Europe, and Asia Pacific (including Australia and New Zealand). Specially tailored customer classes and self-paced training are also available. A number of our distributors and authorized training providers also provide education in our products.
SALES AND DISTRIBUTION
Licensing and Services Model. Consistent with software industry practice, we do not sell or transfer title to our IPG and iAS software products to our customers. Instead, customers generally purchase non-exclusive, nontransferable perpetual licenses in exchange for a fee that varies depending on the mix of products and services, the number and type of users, the number of servers, and the type of operating system. License fees range from several hundred dollars for single user desktop products to several million dollars for solutions that can support hundreds or thousands of users. We also license many of our products for use in connection with customer applications on the Internet. Our products and services are offered in a wide variety of configurations depending on each customer’s needs and hardware environment. In the case of Sybase 365, we sell hosted, turn-key messaging solutions where revenue is generated primarily on a per message or transactional basis.
Distribution Method. Sybase products and services are sold through our direct sales organizations and our indirect IPG and iAS sales channels. “Indirect sales channels” include value added resellers (VARs), systems integrators (SIs), original equipment manufacturers (OEMs) and international distributors and resellers. Our ability to utilize these channels is demonstrated in our license revenue from indirect sales channels which increased 11 percent in 2007 versus 2006.
International Business. In 2007, 48 percent of our total revenues were from operations outside North America, with operations in EMEA (Europe, Middle East and Africa) accounting for 33 percent, and operations in our Intercontinental region (Asia Pacific and Latin America) accounting for 15 percent. Most of our international sales are made by our foreign subsidiaries. However, certain sales are made in international markets from the United States. We also license our IPG and iAS products through distributors and other resellers throughout the world. A summary of our geographical revenues is set forth in “MD&A - Geographical Revenues,” Part II, Item 7, and Note Ten to Consolidated Financial Statements, Part II, Item 8. For a discussion of the risks associated with our foreign operations, see “Risk Factors - Future Operating Results - We are subject to risks arising from our international operations,” Part I, Item 1 (A).
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INTELLECTUAL PROPERTY RIGHTS
We rely on a combination of trade secret, copyright, patent and trademark laws, as well as contractual terms, to protect our intellectual property rights. As of February 1, 2008, we had 160 issued patents (128 U.S. and 32 non-U.S.) that expire approximately 20 years from the date they were filed. These patents cover various aspects of our technology. We believe that our patents and other intellectual property rights have value. However, any of our proprietary rights could be challenged, invalidated or circumvented, or may not provide us with significant competitive advantage. For a discussion of additional risks associated with our intellectual property, see “Risk Factors - Future Operating Results - Insufficient protection for our intellectual property rights may have a material adverse affect on our results of operations or our ability to compete” and “If third parties claim that we are in violation of their intellectual property rights, it could have a negative impact on our results of operations or ability to compete,” Part I, Item 1(A).
RESEARCH AND DEVELOPMENT
Since inception, we have made substantial investments in software research and product development. We believe that timely development of new products and enhancements to our existing products is essential to maintaining a strong position in our market. During 2007, our investment in research and product development generated expenses of $152.6 million, or 15 percent of our total revenue. These amounts compared to $149.5 million and 17 percent in 2006, and $139.0 million and 17 percent in 2005. In addition, our capitalized software costs were $36.2 million and $37.5 million in 2007 and 2006, respectively. We intend to continue to invest heavily in these areas. However, future operations could be affected if we fail to timely enhance existing products or introduce new products to meet customer demands. For a further discussion of the risks associated with product development, see “Risk Factors - Future Operating Results - The ability to rapidly develop and bring to market advanced products and services that are successful is crucial to maintaining our competitive position” and “We may not receive significant revenues from our current research and development efforts for several years, if at all,” Part I, Item 1(A).
COMPETITION
The market for our products and services is extremely competitive due to various factors including a maturing enterprise infrastructure software market, changes in customer IT spending habits, and the trend toward consolidation of companies within the telecommunications and software industries.
Principal competitors to IPG vary by product type.
Information Management Products. Principal competitors to our Information Management Products include Oracle, IBM and Microsoft. We also compete with specialized vendors such as Teradata and Netezza in data warehousing; Informatica, GoldenGate Software, RedHat and Composite Software in data integration; and CA in modeling.
Financial Fusion Products: Principal competitors for our banking solutions include FiServ, S1, and Intuit.
Principal competitors to iAS vary by product type.
Mobile and Embedded Database Products. Principal competitors to our mobile and embedded database products include Pervasive Software, Progress Software, Intersystems, MySQL, IBM and Oracle.
Mobile Middleware and Device Management Products. Principal competitors to our mobile middleware products include IBM, Nokia’s Intellisync and host of numerous small vendors. For mobile
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device management and security products, we compete with Microsoft, Symantec, iPass, Check Point and Credant.
AvantGo. There are a number of competitors who provide alternatives for viewing content on mobile devices, including extensions of existing Internet portal services such as Yahoo, AOL, and MSN, media publishers own mobile offerings, as well as content provided by carriers.
Principal competitors to Sybase 365 vary by service.
Operator Services. Principal competitors to our interoperability services include VeriSign, Syniverse, Aicent, Iris and Belgacom. While the industry is highly competitive, we and others may “peer” from time to time in order to provide more ubiquitous coverage to our customers.
Brand and Content Provider Services. Principal competitors to our content aggregation services include mBlox, NetSize, VeriSign via its mQube and 3 United acquisitions and Amdocs through its OperMarket division.
Enterprise Messaging Services. Principal competitors to our enterprise messaging services include NetSize, Clikatel, Air 2 Web and operators who already have a sales force or relationships with large enterprises.
We believe that we compete favorably against our competitors in each of these areas. However, some of our competitors have longer operating histories, greater name recognition, stronger relationships with partners, larger technical staffs, established relationships with hardware vendors and/or greater financial, technical and marketing resources. These factors may provide our competitors with an advantage in penetrating markets. For a discussion of certain risks associated with competition, see “Risk Factors - Future Operating Results - Industry consolidation and other competitive pressures could affect prices or demand for our products and services, and our business may be adversely affected,” Part I, Item 1(A).
EMPLOYEES
As of February 1, 2008, Sybase and its subsidiaries had approximately 3,996 regular employees. For information regarding our executive officers, see “Directors, Executive Officers of Registrant and Corporate Governance,” Part III, Item 10.
ITEM 1 (A): RISK FACTORS
Future Operating Results
Our future operating results may vary substantially from period to period due to a variety of significant risks, some of which are discussed below and elsewhere in this report on Form 10-K. We strongly urge current and prospective investors to carefully consider the cautionary statements and risks contained in this report including those regarding forward-looking statements described on page 3.
Significant variation in the timing and amount of our revenues may cause fluctuations in our quarterly operating results and an accurate estimation of our revenues is difficult.
Our operating results have varied from quarter to quarter in the past and may vary in the future depending upon a number of factors described below, including many that are beyond our control. Our revenues, and particularly our new software license revenues, are difficult to forecast, and as a result our quarterly operating results can fluctuate substantially. As a result, we believe that quarter-to-quarter comparisons of our financial results should not be relied on to indicate our future performance. We operate with little or no backlog, and quarterly license revenues for our IPG and iAS businesses depend largely on orders booked and shipped in a quarter. Historically, we have recorded a majority of our quarterly license revenues in the last month of each quarter, particularly during the final two weeks. In the past we have experienced fluctuations in the purchasing patterns of our customers. Although many of our
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customers are larger enterprises, an apparent trend toward more conservative IT spending could result in fewer of these customers making substantial investments in our products and services in any given period. Therefore, if one or more significant orders do not close in a particular quarter, our results of operations could be materially and adversely affected, as was the case in the second quarter of 2007 we refused to accept certain terms in a large transaction, which delayed the closing of this transaction from the second quarter of 2007 to the third quarter of 2007, but resulted in better terms for the Company.
Our operating expenses are based on projected annual and quarterly revenue levels, and are generally incurred ratably throughout each quarter. Since our operating expenses are relatively fixed in the short term, failure to realize projected revenues for a specified period could adversely impact operating results, reducing net income or causing an operating loss for that period. The deferral or non-occurrence of such revenues would materially adversely affect our operating results for that quarter and could impair our business in future periods. Because we do not know when, or if, our potential customers will place orders and finalize contracts, we cannot accurately predict our revenue and operating results for future quarters.
In addition to the above factors, the timing and amount of our revenues are subject to a number of factors that make it difficult to accurately estimate revenues and operating results on a quarterly or annual basis. Our financial forecasts are based on aggregated internal sales forecasts which may incorrectly assess our ability to complete sales within the forecast period, due to competitive pressures, economic conditions or reduced information technology spending. In our experience IPG and iAS revenues in the fourth quarter benefit from large enterprise customers placing orders before the expiration of budgets tied to the calendar year. As a result, revenues from license fees tend to decline from the fourth quarter of one year to the first quarter of the next year. In the past, this seasonality has contributed to lower total revenues and earnings in the first quarter compared to the prior fourth quarter. We cannot assure you that estimates of our revenues and operating results can be made with certain accuracy or predictability. Fluctuations in our operating results may contribute to volatility in our stock price.
Economic and credit market conditions in the U.S. and worldwide could adversely affect our revenues.
Our revenues and operating results depend on the overall demand for our products and services. In part due to strength in the worldwide economy, as well as our acquisition of Mobile 365, our revenues for the quarter ending December 31, 2007 exceeded revenues for the quarter ending December 31, 2006 by 15%. If the U.S. and worldwide economies weaken, either alone or in tandem with other factors beyond our control (including war, political unrest, shifts in market demand for our products, actions by competitors, etc.), we may not be able to maintain or expand our recent revenue growth. Continued weakness in the credit markets and financial services industry may also impact our revenues. While we have not noted a change in buying patterns by financial services customers, the financial services industry is one of the largest markets for our products and services and decreased demand from this industry would adversely affect our revenues and operating results.
If we fail to maintain or expand our relationships with strategic partners and indirect distribution channels our license revenues could decline.
We currently derive a significant portion of our license revenues from sales of our IPG and iAS products and services through non-exclusive distribution channels, including strategic partners, systems integrators (SIs), original equipment manufacturers (OEMs) and value-added resellers (VARs). We generally anticipate that sales of our products through these channels will account for a substantial portion of our software license revenues in the foreseeable future. Because most of our channel relationships are non-exclusive, there is a risk that some or all of them could promote or sell our competitors’ products instead of ours, or that they will be unwilling or unable to effectively sell new products that we may introduce. Additionally, if we are unable to expand our indirect channels, or these indirect channels fail to generate significant revenues in the future, our business could be harmed.
Our development, marketing and distribution strategies also depend in part on our ability to form strategic relationships with other technology companies. If these companies change their business focus, enter
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into strategic alliances with other companies or are acquired by our competitors or others, support for our products could be reduced or eliminated, which could have a material adverse effect on our business and financial condition.
System failures, delays and other problems could harm our reputation and business, cause us to lose customers and expose us to customer liability.
The success of Sybase 365 is highly dependent on its ability to provide reliable services to customers. These operations could be interrupted by any damage to or failure of our customers, or suppliers, computer software, hardware or networks, and our connections and outsourced service arrangements with third parties.
Sybase 365’s systems and operations may also be vulnerable to damage or interruption from power loss, transmission cable cuts and other telecommunications failures, natural disasters, interruption of service due to potential facility migrations, computer viruses or software defects, physical or electronic break-ins, sabotage, intentional acts of vandalism and similar events and errors by our employees or third-party service providers.
Because many of our services play a mission-critical role for our customers, any damage to or failure of the infrastructure we rely on, including that of our customers and vendors, could disrupt the operation of our network and the provision of our services, result in the loss of current and potential customers and expose us to potential contractual performance and other liabilities.
Industry consolidation and other competitive pressures could affect prices or demand for our products and services, and our business may be adversely affected.
The IT industry and the market for our core database infrastructure products and services is becoming increasingly competitive due to a variety of factors including a maturing enterprise infrastructure software market and changes in customer IT spending habits. There is also a growing trend toward consolidation in the software industry. Continued consolidation within the software industry could create opportunities for larger technology companies, such as IBM, Microsoft and Oracle, to increase their market share through the acquisition of companies that dominate certain lucrative market niches or that have loyal installed customer bases. Continued consolidation activity could pose a significant competitive disadvantage to us.
The significant purchasing and market power of larger companies may also subject us to increased pricing pressures. Many of our competitors have greater financial, technical, sales and marketing resources, and a larger installed customer base than us. In addition, our competitors’ advertising and marketing efforts could overshadow our own and/or adversely influence customer perception of our products and services, and harm our business and prospects as a result. To remain competitive, we must develop and promote new products and solutions, enhance existing products and retain competitive pricing policies, all in a timely manner. Our failure to compete successfully with new or existing competitors in these and other areas could have a material adverse impact on our ability to generate new revenues or sustain existing revenue levels.
We may encounter difficulties in completing the integration of our Mobile 365 acquisition, other acquisitions or strategic relationships and we may incur acquisition-related charges that could adversely affect our operating results.
We regularly explore possible acquisitions and other strategic ventures to expand and enhance our business. We have recently acquired a number of companies.
For example, in November 2006 we acquired Mobile 365, Inc in an all cash transaction with a purchase price of $418 million. In addition, in October 2005 we acquired Extended Systems Incorporated, a NASDAQ listed company. In June 2006 we acquired Solonde AG, a privately-held company and in October 2006 we acquired certain assets of iFoundry, a privately-held company. In August 2007 we
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acquired Coboplan, a privately-held Japanese company. We expect to continue to pursue acquisitions of complimentary or strategic business product lines, assets and technologies.
We may not achieve the desired benefits of our Mobile 365 or other acquisitions and investments. Acquisitions may not further our business strategy or we may pay more for acquired companies or assets than they may prove to be worth. Further, such companies may have limited infrastructure and systems of internal controls. In addition, for portions of the first year after acquisition, acquired companies may not be subject to our established system of internal control or subject to internal control testing by internal and external auditors.
We may be unable to successfully assimilate an acquired company’s management team, employees, business infrastructure or data centers and related systems, capacity requirements, customer mandated requirements, and third party communication provider relationships or implement and maintain effective internal controls. Our acquisition due diligence may not identify technical, legal, financial, internal control or other problems associated with an acquired entity and our ability to seek indemnification may be limited by the acquisition structure or agreement. Also, dedication of additional resources to execute acquisitions and handle integration tasks and management changes accompanying acquisitions could divert attention from other important business. Acquisitions may also result in costs, liabilities, additional expenses or internal control weaknesses that could harm our results of operations, financial condition or internal control assessment. In addition, we may not be able to maintain customer, supplier, employee or other favorable business relationships of ours, or of our acquired operations, or be able to terminate or restructure unfavorable relationships, any of which might reduce our revenue or limit the benefits of an acquisition.
Under Statement of Financial Accounting Standard No. 142 we do not amortize goodwill but evaluate goodwill recorded in connection with acquisitions at least annually for impairment. As of December 31, 2007, we had approximately $533.3 million of goodwill recorded on our balance sheet, none of which was determined to be impaired as of that date. Goodwill impairments are based on the value of our reporting units, and reporting units that previously recognized impairment charges are prone to additional impairment charges if future revenue and expense forecasts or market conditions worsen after an impairment is recognized. We test the impairment of goodwill annually in our fourth fiscal quarter or more frequently if indicators of impairment arise. The timing of the formal annual test may result in charges to our statement of operations in our fourth fiscal quarter that could not have been reasonably foreseen in prior periods. New acquisitions, and any impairment of the value of purchased assets, could have a significant negative impact on our future operating results.
Acquisitions may also result in other charges, including stock-based compensation charges for assumed stock awards, restructuring charges and charges related to in process research and development. The timing and amount of such charges will be dependent on future acquisition and integration activities.
With respect to our investments in other companies, we may not realize a return on our investments, or the value of our investments may decline if the businesses in which we invest are not successful. Future acquisitions may also result in dilutive issuances of equity securities, the incurrence of debt, restructuring charges relating to the consolidation of operations and the creation of other intangible assets that could result in amortization expense or impairment charges, any of which could adversely affect our operating results.
The ability to rapidly develop and bring to market advanced products and services that are successful is crucial to maintaining our competitive position.
Widespread use of the Internet and fast-growing market demand for mobile and wireless solutions may significantly alter the manner in which business is conducted in the future. In light of these developments, our ability to timely meet the demand for new or enhanced products and services to support wireless and mobile business operations at competitive prices could significantly impact our ability to generate future revenues. If the market for unwired solutions does not continue to develop as we anticipate, if our solutions and services do not successfully compete in the relevant markets, or our new products, either
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internally developed or resulting from acquisitions, are not widely adopted and successful, our competitive position and our operating results could be adversely affected.
If our existing customers cancel or fail to renew their technical support agreements, our technical support revenues could be adversely affected.
We currently derive a significant portion of our overall revenues from technical support services, which are included in service revenues. The terms of our standard software license arrangements provide for the payment of license fees and prepayment of first-year technical support fees. Support is renewable annually at the option of the end user. We have recently been experiencing increasing pricing pressure from customers when purchasing or renewing technical support agreements and this pressure may result in our reducing support fees or in lost support fees if we refuse to reduce our pricing, either of which could result in reduced revenue. If our existing customers cancel or fail to renew their technical support agreements, or if we are unable to generate additional support fees through the license of new products to existing or new customers, our business and future operating results could be adversely affected.
Pricing pressure in the mobile messaging market could adversely affect our operating results.
Competition and industry consolidation in the mobile messaging market have resulted in pricing pressure, which we expect to continue in the future. This pricing pressure could cause large reductions in the selling price of our services. For example, consolidation in the wireless services industry could give our customers increased transaction volume leverage in pricing negotiations. Our competitors or our customers’ in-house solutions may also provide services at a lower cost, significantly increasing pricing pressures on us. While historically pricing pressure has been largely offset by volume increases and the introduction of new services, in the future we may not be able to offset the effects of any price reductions.
Unanticipated delays or accelerations in our sales cycles could result in significant fluctuations in our quarterly operating results.
The length of our sales cycles varies significantly from product to product. The sales cycle for some of our IPG and iAS products can take up to 18 months to complete. Any delay or unanticipated acceleration in the closing of a large license or a number of smaller licenses could result in significant fluctuations in our quarterly operating results. For example, in the second quarter of 2007 we refused to accept certain terms in a large transaction, which delayed the closing of this transaction from the second quarter of 2007 to the third quarter of 2007, but resulted in better terms for the Company. The length of the sales cycle may vary depending on a number of factors over which we may have little or no control, including the size and complexity of a potential transaction, the level of competition that we encounter in our selling activities and our potential customers’ internal budgeting process. Our sales cycle can be further extended for product sales made through third party distributors. As a result of the lengthy sales cycle, we may expend significant efforts over a long period of time in an attempt to obtain an order, but ultimately not complete the sale, or the order ultimately received may be smaller than anticipated.
Our mobile messaging customer contracts may not continue to generate revenues at or near our historical levels of revenues from these customers.
If our customers decide for any reason not to continue to purchase services from us at current levels or at current prices, to terminate their contracts with us or not to renew their contracts with us, our revenues would decline.
If we do not adapt to rapid technological change in the telecommunications industry, we could lose customers or market share.
The mobile market is characterized by rapid technological change, frequent new service introductions and changing customer demands. Significant technological changes could make our technology and services obsolete. Our success depends in part on our ability to adapt to our rapidly changing market by continually improving the features, functionality, reliability and responsiveness of our existing services
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and by successfully developing, introducing and marketing new features, services and applications to meet changing customer needs. We cannot assure you that we will be able to adapt to these challenges or respond successfully or in a cost-effective way to adequately meet them. Our failure to do so would impair our ability to compete, retain customers or maintain our financial performance. Our future revenues and profits will depend, in part, on our ability to sell to new market participants.
Restructuring activities and reorganizations in our sales model or business units may not succeed in increasing revenues and operating results.
Since 2000, we have implemented several restructuring plans in an effort to align our expense structure to our expected revenue. As a result of these restructuring activities, we have recorded gross restructuring charges totaling approximately $119 million through December 31, 2007. Our ability to significantly reduce our current cost structure in any material respects through future restructurings may be difficult without fundamentally changing elements of our current business. If we are unable to generate increased revenues or control our operating expenses going forward, our results of operations will be adversely affected.
Our sales model has evolved significantly during the past few years to keep pace with new and developing markets and changing business environments. If we have overestimated demand for our products and services in our target markets, or if we are unable to coordinate our sales efforts in a focused and efficient way, our business and prospects could be materially and adversely affected. For example, in the second quarter of 2005, our FFI business was integrated into IPG in an effort to better support the FFI product line and promote synergies between FFI and IPG technical resources. In the second quarter of 2006 IPG’s International and North American sales organizations were combined to form Worldwide Field Operations. Starting in January 2007, our corporate, product and field marketing operations were consolidated into a new Worldwide Marketing Operations organization. Other organizational changes in our sales or divisional model could have a direct effect on our results of operations depending on whether and how quickly and effectively our employees and management are able to adapt to and maximize the advantages these changes are intended to create. We cannot assure that these or other organizational changes in our sales or divisional model will result in any increase in revenues or profitability, and they could adversely affect our business.
Our results of operations may depend on the compatibility of our products with other software developed by third parties.
Our future results may be affected if our products cannot interoperate and perform well with software products of other companies. Certain leading applications currently are not, and may never be, interoperable with our products. In addition, many of our principal products are designed for use with products offered by competitors. In the future, vendors of non-Sybase products may become less willing to provide us with access to their products, technical information, and marketing and sales support, which could harm our business and prospects.
We are subject to risks arising from our international operations.
We derive a substantial portion of our revenues from our international operations, and we plan to continue expanding our business in international markets in the future. In 2007, revenues outside North America represented 48 percent of our total revenues. As a result of our international operations, we are affected by economic, regulatory and political conditions in foreign countries, including changes in IT spending, the imposition of government controls, changes or limitations in trade protection laws, unfavorable changes in tax treaties or laws, natural disasters, labor unrest, earnings expatriation restrictions, misappropriation of intellectual property, acts of terrorism, continued unrest and war in the Middle East and other factors, which could have a material impact on our international revenues and operations. Our international operations also require that we comply with, any could have liabilities due to, US laws that may not apply to companies that operate only in the United States, including the Foreign Corrupt Practices Act and export control laws. Our revenues outside North America could also fluctuate due to the relative immaturity of some markets, rapid growth in other markets, the strength of local
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economies, the general volatility of worldwide software markets and organizational changes we have made to accommodate these conditions.
We may not receive significant revenues from our current research and development efforts for several years, if at all.
Developing and localizing software is expensive and the investment in product development often involves a long payback cycle. We have and expect to continue making significant investments in software research and development and related product opportunities. Accelerated product introductions and short product life cycles require high levels of expenditures for research and development that could adversely affect our operating results if not offset by revenue increases. We believe that we must continue to dedicate a significant amount of resources to our research and development efforts to maintain our competitive position. Revenues may not be realized from particular research and development expenditures and revenues which are generated may occur significantly later than when the associated research and development costs were incurred.
We might experience significant errors or security flaws in our products and services.
Despite testing prior to their release, software products may contain errors or security flaws, particularly when first introduced or when new versions are released. Errors in our software products could affect the ability of our products to work with other hardware or software products, could delay the development or release of new products or new versions of products and could adversely affect market acceptance of our products. If we experience errors or delays in releasing new products or new versions of products, we could lose revenues. Our customers rely on our products and services for critical parts of their businesses and they may have a greater sensitivity to product errors and security vulnerabilities than customers for software products generally. Software product errors and security flaws in our products or services could expose us to product liability, performance and/or warranty claims as well as harm our reputation, which could impact our future sales of products and services. The detection and correction of any security flaws can be time consuming and costly.
Unanticipated changes in our tax rates could affect our future financial results.
Our future effective tax rates could be favorably or unfavorably affected by unanticipated changes in the valuation of our deferred tax assets and liabilities, the geographic mix of our revenue, or by changes in tax laws or their interpretation. In addition, we are subject to the continuous examination of our income tax returns by tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. There can be no assurance that the outcomes from these continuous examinations will not have an adverse effect on our operating results and financial condition.
We face exposure to adverse movements in foreign currency exchange rates.
We experience foreign exchange translation exposure on our net assets and transactions denominated in currencies other than the U.S. dollar. We do not utilize foreign currency hedging contracts to smooth the impact of converting non-U.S. dollar denominated revenues into U.S. dollars for financial reporting. Because we do not anticipate entering into currency hedges for non-U.S. dollar revenues, our future results will fluctuate based on the appreciation or depreciation of the U.S. dollar against major foreign currencies.
Due to the significance of our business conducted in currencies other than the U.S. dollar, our results of operations could be materially and adversely affected by fluctuations in foreign currency exchange rates, even though we take into account changes in exchange rates over time in our pricing strategy.
As of December 31, 2007, we had identified net assets totaling $272.5 million associated with our EMEA operations, and $115.0 million associated with our Asia Pacific and Latin America operations.
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Accordingly, we may experience fluctuations in operating results as a result of translation gains and losses associated with these asset and liability values. In order to reduce the effect of foreign currency fluctuations on our and certain of our subsidiaries’ balance sheets, we utilize foreign currency forward exchange contracts (forward contracts) to hedge certain foreign currency transaction exposures. Specifically, we enter into forward contracts with a maturity of approximately 30 days to hedge against the foreign exchange exposure created by certain balances that are denominated in a currency other than the principal reporting currency of the entity recording the transaction. The gains and losses on the forward contracts are intended to mitigate the gains and losses on these outstanding foreign currency transactions and we do not enter into forward contracts for trading purposes. However, our efforts to manage these risks may not be successful. Failure to adequately manage our currency exchange rate exposure could adversely impact our financial condition and results of operations.
Growing market acceptance of “open source” software could cause a decline in our revenues and operating margins.
Growing market acceptance of open source software has presented both benefits and challenges to the commercial software industry in recent years. “Open source” software is made widely available by its authors and is licensed “as is” without charge for the license itself (there may be a charge for related services or rights). We have developed certain products to operate on the Linux platform, which has created additional sources of revenues. Additionally, we have incorporated other types of open source software into our products, allowing us to enhance certain solutions without incurring substantial additional research and development costs. Thus far, we have encountered no unanticipated material problems arising from our use of open source software. However, as the use of open source software becomes more widespread, certain open source technology could become competitive with our proprietary technology, which could cause sales of our products to decline or force us to reduce the fees we charge for our products, which could have a material adverse impact on our revenues and operating margins.
Insufficient protection for our intellectual property rights may have a material adverse affect on our results of operations or our ability to compete.
We attempt to protect our intellectual property rights in the United States and in selected foreign countries through a combination of reliance on intellectual property laws (including copyright, patent, trademark and trade secret laws) and registrations of selected patent, trademark and copyright rights in selected jurisdictions, as well as licensing and other agreements preventing the unauthorized disclosure and use of our intellectual property. We cannot assure you that these protections will be adequate to prevent third parties from copying or reverse engineering our products, from engaging in other unauthorized use of our technology, or from independently developing and marketing products or services that are substantially equivalent to or superior to our own. Moreover, third parties may be able to successfully challenge, oppose, invalidate or circumvent our patents, trademarks, copyrights and trade secret rights. We may elect or be unable to obtain or maintain certain protections for certain of our intellectual property in certain jurisdictions, and our intellectual property rights may not receive the same degree of protection in foreign countries as they would in the United States because of the differences in foreign laws concerning intellectual property rights. Lack of protection of certain intellectual property rights for any reason could have a material adverse effect on our business, results of operations and financial condition. Moreover, monitoring and protecting our intellectual property rights is difficult and costly. From time to time, we may be required to initiate litigation or other action to enforce our intellectual property rights or to establish their validity. As an example, Sybase filed a complaint against Vertica Systems, Inc., on January 30, 2008 in the Eastern District of Texas, alleging infringement of Sybase’s patent #5,794,229 (“Database System with Methodology for Storing a Database Table by Vertically Partitioning All Columns of the Table). Such action could result in substantial cost and diversion of resources and management attention and we cannot assure you that any such action will be successful.
If third parties claim that we are in violation of their intellectual property rights, it could have a negative impact on our results of operations or ability to compete.
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Patent litigation involving software and telecom companies has increased significantly in recent years as the number of software and telecom patents has increased and as the number of patent holding companies has increased. We face the risk of claims that products or services that we provide have infringed the intellectual property rights of third parties. We are currently litigating with different parties regarding claims that our products or services violate their patents, we have in the past received similar claims and it is likely that such claims will be asserted in the future. See Footnote 12 in the Notes to the Condensed Consolidated Financial Statements for a discussion of our patent litigation with Telecommunications Systems, Inc. In May 2005, we received a claim from TeliaSonera alleging that iAnywhere’s product now known as Answers Anywhere Mobile Edition infringes a TeliaSonera patent issued in Finland. We are currently involved in litigation in Finland regarding the ownership of the patent. No trial date has been set. Additionally, in February 2006, two Financial Fusion product customers received claims from a patent licensing company, Ablaise, Ltd., alleging that the customers’ websites are infringing. Financial Fusion filed a declaratory judgment action against Ablaise in the Northern District of California which is ongoing. The customers’ websites are based in part on our products and the customers tendered defense of the claims to us under their contractual indemnification provisions. In August 2007 Sybase (along with 20 other defendants, including Microsoft and IBM) was sued by JuxtaComm Technologies, a Canadian company, for infringement of its US patent 6,195,662 (“System for Transforming and Exchanging Data Between Distributed Heterogeneous Computer Systems”). We are in the process of assessing the claims and potential defenses for this matter. We believe that our positions in each of the matters noted above are meritorious and we intend to pursue our positions vigorously.
Regardless of whether patent or other intellectual property claims have merit, they can be time consuming and expensive to defend or settle, and can harm our business and reputation. In particular, such claims may cause us to redesign our products or services, if feasible, or cause us to enter into royalty or licensing agreements in order to obtain the right to use the necessary intellectual property. Patent claimants may seek to obtain injunctions or other permanent or temporary remedies that prevent us from offering our products or services, and such injunctions could be granted by a court before the final resolution of the merits of a claim. Our competitors in both the U.S. and foreign countries, many of which have substantially greater resources than we have and have made substantial investments in competing technologies, may have applied for or obtained, or may in the future apply for and obtain, patents that will prevent, limit or otherwise interfere with our ability to make and sell our products and services. We have not conducted an independent review of patents issued to third parties. The large number of patents, the rapid rate of new patent issuances, the complexities of the technology involved and uncertainty of results and expense of potential litigation increase the risk of business assets and management’s attention being diverted to patent issues.
Laws and regulations affecting our customers and us and future laws and regulations to which they or we may become subject may harm our business.
When Sybase 365 delivers mobile messages on behalf of content owners into our network of wireless carriers, we are subject to legal, regulatory and wireless carrier requirements governing, among other things, the nature of content delivered, as well as necessary notice and disclosure to, and consent from, consumers receiving mobile messages. If we are unable to effectively prevent or detect violations of legal, regulatory or wireless carrier requirements, or otherwise unable to mitigate the effect of these violations, we may be subject to fines or the suspension or termination of some or all of our wireless carrier connections or telecommunications licenses in one or more territories which could materially and adversely affect our business and results of operation. Such suspension or termination may also result in loss of current and potential customers and expose us to potential customer liability. Also, we cannot predict when, or upon what terms and conditions, future regulation might occur or the effect regulation may have on our business or our markets.
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Our key personnel are critical to our business, and we cannot assure that they will remain with us.
Our success depends on the continued service of our executive officers and other key personnel. In recent years, we have made additions and changes to our executive management team. For example, in connection with our acquisition of Mobile 365, Marty Beard was appointed to be the President of Sybase 365 in November 2006. In January 2007, Raj Nathan, formerly the head of IPG was named our Chief Marketing Officer, Billy Ho was promoted to head IPG’s technology operations and Mark Westover was promoted to head Corporate Development. In November 2007, Pieter Van der Vorst, our Chief Financial Officer relocated to London to be our Senior Vice President and General Manager for the EMEA region and Jeff Ross, our Corporate Controller became our Chief Financial Officer. Additionally, Keith Jensen, our current senior director became our Corporate Controller at that time. Further changes involving executives and managers resulting from acquisitions, mergers and other events could increase the current rate of employee turnover, particularly in consulting, engineering and sales. We cannot be certain that we will retain our officers and key employees. In particular, if we are unable to hire and retain qualified technical, managerial, sales, finance and other employees it could adversely affect our product development and sales efforts, other aspects of our operations, and our financial results. Competition for highly skilled personnel in the software industry is intense. Our financial and stock price performance relative to the companies with whom we compete for employees, and the high cost of living in the San Francisco Bay Area, where our headquarters is located, could also impact the degree of future employee turnover.
Our sales to government clients subject us to risks including early termination, audits, investigations, sanctions and penalties.
We derive revenues from contracts with the United States government, state and local governments and their respective agencies, which may terminate most of these contracts at any time, without cause. Federal Government contracts may be affected by political pressure to reduce government spending. Our federal government contracts are subject to the approval of appropriations being made by the United States Congress to fund the expenditures under these contracts. Similarly, our contracts at the state and local levels are subject to government funding authorizations.
Additionally, government contracts are generally subject to audits and investigations which could result in various civil and criminal penalties and administrative sanctions, including termination of contracts, refund of a portion of fees received, forfeiture of profits, suspension of payments, fines and suspensions or debarment from future government business.
Changes in accounting and legal standards could adversely affect our future operating results.
During the past several years, various accounting guidance has been issued with respect to revenue recognition rules in the software industry. However, much of this guidance addresses software revenue recognition primarily from a conceptual level, and is silent as to specific implementation requirements. As a consequence, we have been required to make assumptions and judgments, in certain circumstances, regarding application of the rules to transactions not addressed by the existing rules. We believe our current business arrangements and contract terms have been properly reported under the current rules. However, if final interpretations of, or changes to, these rules necessitate a change in our current revenue recognition practices, our results of operations, financial condition and business could be materially and adversely affected.
In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes: An Interpretation of FASB Statement No. 109, or FIN No. 48. FIN 48 prescribes a recognition and measurement threshold for a tax position taken or expected to be taken in a tax return. We adopted FIN No. 48 on January 1, 2007. It had no material effect on our financial statements.
In addition to the changes discussed above, the U.S. Congress enacted the Sarbanes-Oxley Act of 2002 in July 2002, providing for or mandating the implementation of extensive corporate governance reforms relating to public company financial reporting, internal controls, corporate ethics, and oversight of the
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accounting profession, among other areas. We are also subject to additional rules and regulations, including those enacted by the New York Stock Exchange where our common stock is traded. Compliance with existing or new rules that influence significant adjustments to our business practices and procedures could result in significant expense and may adversely affect our results of operations. Failure to comply with these rules could result in delayed financial statements and might adversely impact the price of our common stock.
In August 2007 the FASB Staff issued for public comment FASB Staff Position 14-a (FSP 14-a), Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement. This proposed FSP would require that the issuer of a convertible debt instrument within its scope separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. The proposed FSP indicated that convertible debt instruments such as those issued by the Company would be required to comply with the new accounting standard during 2008 and would require retrospective application to all periods presented. Subsequent to the end of the comment period, in December 2007 the FASB Staff decided to redeliberate FSP 14-a, Our current accounting and reporting related to our convertible debt instruments are in accordance with current accounting rules. If final interpretations of, or changes to, these rules necessitate a change in our current practices, our previously reported and future results of operations could be adversely affected.
In December 2007, the FASB issued Statement of Financial Accounting Standard (“SFAS”) No. 141(R), “Business Combinations.” FAS 141(R) establishes principles and requirements for how an acquirer: (a) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; (b) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and, (c) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The provisions of FAS 141(R) are effective for our fiscal year beginning January 1, 2009. We are currently evaluating the impact of the provisions of FAS 141(R).
The unfavorable outcome of litigation and other claims against us could have a material adverse impact on our financial condition and results of operations.
We are subject to a variety of claims and lawsuits from time to time, some of which arise in the ordinary course of our business. Adverse outcomes in some or all of such pending cases may result in significant monetary damages or injunctive relief against us. While management currently believes that resolution of these matters, individually or in the aggregate, will not have a material adverse impact on our financial position or results of operations, the ultimate outcome of litigation and other claims are subject to inherent uncertainties, and management’s view of these matters may change in the future. It is possible that our financial condition and results of operations could be materially adversely affected in any period in which the effect of an unfavorable final outcome becomes probable and reasonably estimable.
Our operations and financial results could be severely harmed by certain natural disasters.
Our headquarters, some of our offices, and some of our major customers’ facilities are located near major earthquake faults. We have not been able to maintain earthquake insurance coverage at reasonable costs. Instead, we rely on self-insurance and preventative safety measures. We currently ship most of our products from our Dublin, California corporate headquarters. If a major earthquake or other natural disaster occurs, disruption of operations at that facility could directly harm our ability to record revenues for such quarter. This could, in turn, have an adverse impact on operating results.
Provisions of our corporate documents have anti-takeover effects that could prevent a change in control.
Provisions of our certificate of incorporation, bylaws, stockholder rights plan and Delaware law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our
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stockholders. These provisions include authorizing the issuance of preferred stock without stockholder approval, prohibiting cumulative voting in the election of directors, prohibiting the stockholders from calling stockholders meetings and prohibiting stockholder actions by written consent.
ITEM 1 (B): UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
As of December 31, 2007, our field operations, professional service organizations and subsidiaries occupied leased facilities in approximately 94 separate locations throughout North America, Latin America, Europe and the Asia Pacific region (including Australia and New Zealand), aggregating approximately 1.7 million square feet.
On January 28, 2000, we entered into a 15-year non-cancelable lease of our corporate headquarters facility in Dublin, California. The lease commenced with occupancy of the building in January 2002 with a lease expiration date of January 31, 2017. The property consists of approximately 406,000 square feet of administrative and product development facilities. We have the option to renew our Dublin lease for up to two five-year periods, generally at then-fair market value, subject to certain conditions.
In the third quarter of 2004 we commenced occupancy of a 105,000 square foot building housing administrative, R&D and other facilities of our subsidiaries in Waterloo, Canada. This lease expires in 2019 and we have a 10 year renewal option at the end of the lease at then-fair market value.
We lease three buildings totaling approximately 167,000 square feet in Concord, Massachusetts under a lease that terminates in October 2012. In the third quarter of 2004 we offered one of these buildings for sublease, totaling approximately 44,600 square feet in connection with our restructuring activities.
In connection with our Extended Systems acquisition, we acquired a leased property in Boise, Idaho. The property is approximately 96,000 square feet, of which approximately 20,000 square feet are currently sublet. The lease for this facility expires in September 2013. Under the terms of a sale-leaseback transaction Extended Systems entered into, we have the option of purchasing the land and building for $5.1 million at any time prior to the expiration of the lease.
In connection with our Mobile 365 acquisition, we acquired Mobile 365’s 16 leased facilities sites totaling approximately 68,000 square feet. As of December 31, 2007, we continue to hold leases for 9 of those offices totaling approximately 53,000 square feet. In January 2008 we signed a new lease to relocate the Sybase 365 Chantilly office to Reston, VA. The new space will consist of approximately 25,250 square feet.
For a further discussion of our leases, see Note Six to Consolidated Financial Statements, Part II, Item 8.
We continue to lease space at other locations around the world that serve a variety of functions, including professional services, sales, engineering, technical support, and general administration. These include significant facilities in the United States, including New York City, New York; Boulder and Englewood, Colorado; Alpharetta, Georgia and Boise, Idaho; Maidenhead, England; Düsseldorf, Germany, Paris, France, Singapore, Hong Kong, Beijing China and Utrecht, Netherlands. In addition to the facilities noted above, we maintain engineering centers in Englewood, Colorado; Pune, India, and Shanghai and Xian, China.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are involved from time to time in various proceedings, lawsuits and claims involving our customers, products, intellectual property, stockholders and employees, among other parties. We routinely review the status of each significant matter and assess our potential financial exposure. When we reasonably determine that a loss associated with any of these matters is probable, and can reasonably estimate the loss, we record a reserve to provide for such loss contingencies. If we are unable to record a reserve
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because we are not able to estimate the amount of a potential loss in a matter, or if we determine that a loss is not probable, we are nevertheless required to disclose certain information regarding such matter if we determine that there is a reasonable possibility that a loss has been incurred. Because of the inherent uncertainties related to these types of matters, we base our loss reserves on the best information available at the time. As additional information becomes available, we may reevaluate our assessment regarding the probability of a matter or its expected loss. Our financial position, results of operations or cash flows could be materially and adversely affected by such revisions in our estimates. For further discussion of contingencies and liabilities, see “Future Operating Results,” above.
For a discussion of risks related to intellectual property rights and certain pending intellectual property litigation, see “Future Operating Results - If third parties claim that we are in violation of their intellectual property rights, it could have a negative impact on our results of operations or ability to compete,” Part I, Item 1(A).
A former employee, who was terminated as part of position elimination in February 2003, filed a civil action in the Superior Court for the State of California, Alameda County, alleging discrimination on the basis of gender, national origin, and race. The former employee also alleged retaliation for discussing her working conditions with senior managers. The parties were not able to settle the matter and trial commenced on August 27, 2004. Sybase’s motion for non-suit on the retaliation claim was granted and that claim was dismissed. On October 5, 2004, the jury found in favor of the plaintiff on the remaining claims and awarded her $1,845,000 in damages. Sybase filed a motion to set aside the jury verdict or, in the alternative, for a new trial. The motion also asked the judge to set aside the punitive damage part of the award in the amount of $500,000. On December 7, 2004, the judge issued a decision denying the motion to set the verdict aside and order a new trial, but he did grant that part of the motion asking to set aside the $500,000 punitive damage award, reducing the damage amount to $1,345,000. Additional awards for legal fees and costs amounted to $750,000. Sybase filed a notice of appeal of the $1,345,000 jury verdict, as well as the fee and cost awards. Sybase filed its opening brief in the appeal on January 27, 2006. Plaintiff filed their reply brief in April 2006, responding to Sybase’s appeal and appealing the non-suit judgment on the retaliation claim and the judge’s decision to grant Sybase’s motion setting aside the $500,000 punitive damages award. All briefs have been filed in the appeal and oral arguments have occurred. The parties are awaiting a ruling from the court of appeal.
On July 13, 2006, Telecommunications Systems, Inc. (“TCS”), a wireless services provider, filed a complaint for patent infringement in the U.S. District Court for the Eastern District of Virginia, alleging that Mobile 365 infringes U.S. Patent 6,985,748 (the “‘748 patent”). The matter was tried before a jury beginning on May 14, 2007. On May 25, 2007, the jury rendered its verdict, finding that Mobile 365 willfully infringed the ‘748 patent, and awarded TCS a total amount of $12.1 million. TCS has filed post-trial motions for enhanced damages and attorneys’ fees, for an award of prejudgment interest, and for entry of a permanent injunction (although it has requested that any injunction be stayed pending the outcome on appeal). Sybase 365 has filed post-trial motions for a judgment in its favor as a matter of law, for reduction of the jury award, and for entry of judgment in its favor based on TCS’s inequitable conduct before the Patent and Trademark Office in obtaining the patent. The court has granted TCS’s motion for an injunction but stayed it pending the outcome on appeal, and for pre-judgment interest at the rate of prime plus 1%, compounded quarterly. The court has also partially granted Sybase’s motion for remittitur, reducing the pre-issuance damages portion of the jury award by $2.2 million. The court has not yet ruled on the other outstanding motions. If the jury award stands after the court issues its rulings on the remaining motions, Sybase 365 intends to appeal.
The November 2006 merger agreement between Sybase and Mobile 365 established an escrow which provides for indemnification of Sybase by Mobile 365’s former stockholders for certain losses related to the TCS litigation. If both parties post trial motions do not prevail and if damages are limited to the adjusted jury verdict of $9.9 million, Sybase would bear responsibility for approximately $1 million of this amount after reflecting the merger indemnification rights. Sybase believes that the escrow established by the merger agreement will be adequate to address the substantial majority of losses, if any, related to this litigation.
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Since the jury’s verdict, Sybase 365 has developed a design-around so that its service for intercarrier wireless text messaging can operate in a way that avoids the infringement as found by the jury. Sybase 365 is in the process of implementing the design-around.
We currently believe that the ultimate liability, if any, for any pending claims of any type (either alone or combined) will not materially affect our financial position, results of operations or cash flows. We also believe that we would be able to obtain any necessary licenses or other rights to disputed intellectual property rights on commercially reasonable terms. However, the ultimate outcome of any litigation is uncertain and, regardless of outcome, litigation can have an adverse impact on Sybase because of defense costs, negative publicity, diversion of management resources and other factors. Our inability to obtain necessary license or other legal rights, or litigation arising out of intellectual property claims could adversely affect our business.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a stockholder vote in the quarter ended December 31, 2007.
PART II
ITEM 5.
ITEM 5.
MARKET FOR THE REGISTRANT’S COMMON STOCK AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Sybase, Inc. Common Stock, par value $.001, began trading on the New York Stock Exchange (NYSE) on May 22, 2001, under the symbol “SY.” Prior to that, our stock traded on the NASDAQ National Market System under the symbol “SYBS.” Following is the range of low and high closing prices for our stock as reported on the NYSE for the quarters indicated.
We have never paid cash dividends on our capital stock, and we do not anticipate doing so in the foreseeable future. The closing sale price of our Common Stock on the NYSE on February 15, 2008 was $26.99. The number of stockholders of record on that date was 1,407, according to American Stock Transfer and Trust, our transfer agent.
The information required by this item regarding our securities authorized for issuance under equity compensation plans is provided in “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters,” Part III, Item 12, which incorporates information to be disclosed in our 2008 Proxy Statement.
Issuer Purchases of Equity Securities
During the fourth quarter of 2007 we conducted the following repurchases of our common stock pursuant to our publicly announced repurchase program:
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Beginning in 1998 our Board of Directors implemented our stock repurchase program and has authorized an aggregate of $850 million for stock repurchases. After completing the repurchases noted above, $83.1 million remained authorized for repurchase pursuant to our publicly announced repurchase program. For additional information about our historical stock repurchase activities see Note Seven to the Consolidated Financial Statements - Stockholders’ Equity, Part II, Item 8.
On February 25, 2008 the Company agreed to conduct a self-tender offer for $300 million of the Company’s common stock at a price between $28 and $30 in a modified Dutch auction. The Company also agreed to use its best efforts to complete approximately $82.9 million in additional open market repurchases prior to the Company’s 2009 Annual Meeting, this amount represents the remaining authorization in the Company’s Stock Repurchase Program. See Note Sixteen to the Consolidated Financial Statements - Subsequent Events, Part II, Item 8.
PERFORMANCE GRAPH
The graph and table below compare the cumulative total return on a $100 investment in our Common Stock on December 31, 2002, with the cumulative total return on a $100 investment (assuming reinvestment of all dividends) in the indices noted. The six companies comprising the S&P Systems Software index are BMC Software Inc., CA Inc., Microsoft Corporation, Novell, Inc., Oracle Corporation and Symantec Corporation.
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Copyright © 2008, Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. All rights reserved.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial information is not necessarily indicative of the results of our future operations. The comparability of the information is affected by a variety of factors, including share-based compensation, amortization and impairment of intangible assets and goodwill, acquisitions and restructurings, effective tax rates, accounting changes, and repurchases of common stock under our stock repurchase programs.
We adopted Statement of Financial Accounting (SFAS) 123(R), Share-Based Payment, on January 1, 2006 using the modified prospective transition method. Operating income from continuing operations for 2006 included a $13.6 million increase in pre-tax share-based compensation expense for stock options and stock appreciation rights that we recorded as a result of adopting SFAS 123(R). Operating income from continuing operations for 2007 included $13.9 million in pre-tax share-based compensation expense for stock options and stock appreciation rights. Because we elected to use the modified prospective transition method, results for prior periods have not been restated to include share-based compensation for options, and stock appreciation rights. For a further discussion of SFAS 123 (R), see Note Seven to the Consolidated Financial Statements - Stockholders’ Equity, Part II, Item 8.
We undertook restructuring activities in 2004 and 2003 as a means of managing our operating expenses, assumed certain restructuring program liabilities as part of our AvantGo acquisition in 2003 and undertook restructuring activities as part of our acquisition of Mobile 365 in 2006. For descriptions of each restructuring plan, see Note Thirteen to the Consolidated Financial Statements - Restructuring Costs, Part II Item 8.
On November 8, 2006 we acquired Mobile 365, Inc. (which we renamed Sybase 365, Inc.), a privately held mobile messaging and content delivery company for approximately $418.5 million, comprised of $416.2 million in cash and additional purchase related costs of approximately $2.3 million. Sybase 365 delivers mobile data and messaging, premium content, and value-added services for leading mobile operators, content providers, global brands, media companies, and financial institutions worldwide. Total revenues and operating income of Sybase 365 were $136.5 million and $1.8 million, respectively for the year ended December 31, 2007. Total revenues and operating loss of Sybase 365 were $18.2 million and $1.0 million, respectively for period from November 8, 2006 through December 31, 2006.
This data should be read in conjunction the MD&A, Part II, Item 7, as well as the Consolidated Financial Statements and related Notes included in Part II, Item 8 of this Report on Form 10-K.
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Consolidated Statements of Operations Data
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Consolidated Balance Sheet Data
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Our Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) includes the following sections:
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Executive Overview that discusses at a high level our operating results and some of the trends that affect our business.
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Critical Accounting Policies that we believe are important to understanding the assumptions and judgments underlying our financial statements.
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Results of Operations that begins with an overview followed by a more detailed discussion of our revenue and expenses.
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Liquidity and Capital Resources which discusses key aspects of our statements of cash flows, changes in our balance sheets and our financial commitments.
You should note that this MD&A discussion contains forward-looking statements that involve risks and uncertainties. Please see the section entitled “Risk Factors, Future Operating Results” at the beginning of Item 1(A) for important information to consider when evaluating such statements.
You should read this MD&A in conjunction with the Consolidated Financial Statements and related Notes in Part II, Item 8.
We adopted Statement of Financial Accounting (SFAS) 123(R), Share-Based Payment, on January 1, 2006 using the modified prospective transition method. Operating income for 2007 and 2006 included increases in pre-tax share-based compensation expense for stock options and stock appreciation rights that we recorded as a result of adopting SFAS 123(R) $13.9 million and $13.6 million, respectively). Because we elected to use the modified prospective transition method, results for prior periods have not been restated to include share-based compensation for options and stock appreciation rights. For a further discussion of SFAS 123 (R), see Note Seven to the Consolidated Financial Statements - Stockholders’ Equity, Part II, Item 8.
On November 8, 2006 we acquired Mobile 365, Inc. (which we renamed Sybase 365, Inc) for approximately $418.5 million. Sybase 365 delivers mobile data and messaging, premium content, and value-added services for leading mobile operators, content providers, global brands, media companies, and financial institutions worldwide. Total revenues and operating income of Sybase 365 were $136.5 million and $1.8 million, respectively for the year ended December 31, 2007. Total revenues and operating loss of Mobile 365 for period from November 8, 2006 through December 31, 2006, were $18.2 million and $1.0 million, respectively.
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Executive Overview
Our Business
Sybase is a global enterprise software and services company exclusively focused on managing and mobilizing information from the data-center to the point of action. We provide open, cross-platform solutions that securely deliver information anytime, anywhere, enabling customers to create an information edge.
Our value proposition involves enabling the Unwired Enterprise through integrated applications, solutions designed to manage information across the enterprise, allowing customers to extract more value from their information technology (IT) investments. We deliver a full range of solutions to ensure that customer information is securely managed and mobilized to the point of action, including enterprise and mobile databases, middleware, synchronization, encryption and device management software, and mobile messaging services.
During the fourth quarter of 2006 we expanded our reach by acquiring Mobile 365, a privately-held global provider of mobile messaging services and premium content delivery and value added services. Mobile 365 extends our Unwired Enterprise strategy with the addition of two new enterprise channels-leading mobile operators and content providers-and an extensive, operator-grade network with connections to approximately 700 mobile operators around the world. Through Mobile 365’s global footprint, Sybase enables enterprises to deliver data and applications to over 70% of the world’s mobile subscriber population. Mobile 365 operates as a separate business unit, renamed Sybase 365.
Our business is organized into three business segments: IPG, which principally focuses on enterprise class database servers, integration and development products; iAS, which provides mobile database and mobile enterprise solutions; and Sybase 365, which provides global services for mobile messaging interoperability and the management and distribution of mobile content. For further discussion of our business segments, see Consolidated Financial Statements, Note Ten - Segment and Geographical Information, Part II, Item 8.
Our Results
We recorded all time highs in revenue, operating income and net income for the three month and full year period ended December 31, 2007.
Total revenues were $1,026 million for 2007, compared to $876 million for 2006, and $819 million for 2005. The increase in total revenues from 2006 to 2007 was primarily due to the full year operations of Sybase 365 which added an incremental $118 million in messaging revenue to the yearly results, along with an increase of $26 million (3 percent) in IPG revenues and an increase of $13 million (8 percent) in iAS revenues.
The increase in iAS revenues from 2007 to 2006 was primarily driven by a 9 percent increase in license revenue and a 7 percent increase in service revenue. The growth in iAS license revenues was primarily attributed to a 16 percent increase in license revenues from our mobile and embedded database product, while the increase in service revenue was primarily attributable to an increase in technical support services revenue. Going forward, we believe our iAS revenues will be aided by momentum from our Unwired Enterprise initiative.
The increase in IPG revenues from 2007 to 2006 was primarily attributable to a 6 percent increase in license revenues and a 2 percent increase in service revenues. The overall increase in IPG license revenue was attributable to a 9 percent increase in database license revenues which is largely fueled by the momentum from our IQ analytics server.
We reported net income of $149 million for 2007, compared to net income of $95 million for 2006, and $86 million in 2005. Our 2007 operating income was $169 million (16 percent operating margin)
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compared to $134 million (15 percent operating margin) in 2006. The increase in operating income was attributable to a $149 million increase in revenues partially offset by a $115 million increase in expenses. The overall increase in operating expenses was attributable to an increase of $116 million associated with the full year operation of the Sybase 365 business which was acquired in the fourth quarter of 2006.
Our overall financial position is strong. During 2007 we generated net cash from operating activities of $254 million, and had $735 million in cash, cash equivalents and cash investments at December 31, 2007. Our net cash flows from operations were the highest yearly amount in our history. Our days sales outstanding in accounts receivable was 75 days for the quarter ended December 31, 2007 compared to 77 days for the quarter ended December 31, 2006.
For a discussion of certain factors that may impact our business and financial results, see “Risk Factors - Future Operating Results,” above.
Business Trends
Overall, the IT spending patterns we are witnessing support our view that fiscally cautious customers generally are continuing to purchase products and services based on present needs as opposed to fulfilling anticipated future needs. We also see some indications that 2008 IT budgets may be constricted for certain companies in the financial services industry where we have a significant market share and presence. We have not noted a change in buying patterns to date for these customers and remain cautiously optimistic that our business with this sector will not be materially impacted.
Notwithstanding the above we continue to see a proliferation of enterprise data and greater customer willingness to invest resources on new data integration initiatives and analytic solutions. These solutions contributed to a year over year increases of 56 percent in license revenue from these products during 2007 compared to 2006. Our Replication Server product delivers operational data across complex and broadly distributed heterogeneous data infrastructures in near real time to ensure continuous data availability, operational synchronization and timely reporting. Our IQ product offers a highly optimized analytic engine specifically designed to deliver dramatically faster results for business intelligence, analytic and reporting solutions.
The overall environment for new sales of enterprise infrastructure software primarily sold by our IPG segment is limited by a maturing enterprise infrastructure software market which moderates the overall growth potential for this segment. We continue to maintain, however, a strong pipeline for enterprise infrastructure products especially continued high demand for our Adaptive Server® Enterprise (ASE) 15.0. During 2007 we added over 1200 new ASE customers.
With respect to the market for mobility and integration products primarily sold by our iAS segment, we believe these products are gaining market acceptance and will provide us with growth opportunities in the future. We believe that in 2008 we are supported by a strong product cycle with our refreshed iAnywhere product platform that will continue to drive growth in the iAS segment. We also see a growing pipeline associated with extending enterprise level data to handheld devices which we believe supports and validates our Unwired Enterprise initiative.
With respect to the market for messaging services sold by our Sybase 365 segment, we believe that our inter-carrier messaging business will see revenue growth driven by continuing growth in Short Messaging Services (SMS) and Multimedia Messaging Services (MMS) traffic levels and the acquisition of new carriers, especially in new territories. We also believe that enterprises, brands and content providers will focus more of their business towards mobile messaging as an inexpensive means of interacting with their customers on a real time basis. This in turn will drive further growth in the application messaging industry. To handle this demand, we plan to expand our data center capacity and disaster-recovery capabilities, add connectors from our new customers to our network and develop new services.
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Moving forward we will continue to manage our operating margin, pursue synergies between our software and messaging businesses, and aggressively pursue our Unwired Enterprise initiative.
Critical Accounting Policies and Estimates
We prepare our financial statements in accordance with U.S. generally accepted accounting principles (GAAP). These accounting principles require us to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date of our financial statements. We also are required to make certain judgments that affect the reported amounts of revenues and expenses during each reporting period. We periodically evaluate our estimates and assumptions including those relating to software and mobile messaging revenue recognition, impairment of goodwill and intangible assets, valuation of investments without readily available markets and the classification of related impairments, the allowance for doubtful accounts, capitalized software, income taxes, stock-based compensation, purchase accounting, restructuring, and contingencies and liabilities. We base our estimates on historical experience and various other assumptions that we believe to be reasonable based on specific circumstances. Our management has reviewed the development, selection, and disclosure of these estimates with the Audit Committee of our Board of Directors. These estimates and assumptions form the basis for our judgments about the carrying value of certain assets and liabilities that are not readily apparent from other sources. Actual results could differ from these estimates. Further, changes in accounting and legal standards could adversely affect our future operating results (see “Risk Factors - Future Operating Results,” above). Our critical accounting policies include: software and mobile messaging revenue recognition, impairment of goodwill and other intangible assets, valuation of investments without readily available markets and classification of related impairments, allowance for doubtful accounts, capitalized software, income taxes, stock-based compensation, purchase accounting, restructuring and contingencies and liabilities, each of which are discussed below.
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Revenue Recognition
Revenue recognition rules for software and message services companies are very complex. We follow specific and detailed guidance in measuring revenue, although certain judgments affect the application of our revenue recognition policy. These judgments would include, for example, the determination of a customer’s creditworthiness, whether two separate transactions with a customer should be accounted for as a single transaction, reporting certain third party content delivery revenues gross as a principal versus net as an agent, or whether included software services are essential to the functionality of a product.
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License and Service Revenues
We recognize software revenue in accordance with Statement of Position (SOP) 97-2, “Software Revenue Recognition,” and SOP 98-9, and in certain instances in accordance with SOP 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts” or SEC Staff Accounting Bulletin, or SAB, No. 104, “Revenue Recognition.” We license software under non-cancelable license agreements. License fee revenues are recognized when (a) a non-cancelable license agreement is in force, (b) the product has been delivered, (c) the license fee is fixed or determinable, and (d) collection is reasonably assured. If the fee is not fixed or determinable, revenue is recognized as payments become due from the customer and all other revenue recognition criteria have been met.
Residual Method Accounting. In software arrangements that include multiple elements (e.g., license rights and technical support services), we allocate the total fees among each of the elements using the “residual” method of accounting. Under this method, revenue allocated to undelivered elements is based on vendor-specific objective evidence of fair value of such undelivered elements, and the residual revenue is allocated to the delivered elements. Vendor specific objective evidence of fair value for such undelivered elements is based upon the price we charge for such product or service when it is sold separately. We may modify our pricing practices in the future, which could result in changes to our vendor specific objective evidence of fair value for such undelivered elements. As a result, the timing of revenue recognition associated with multiple element arrangements could differ significantly from our historical results.
Percentage of Completion Accounting. Fees from licenses sold together with consulting services are generally recognized upon shipment of the licenses, provided (i) the criteria described in subparagraphs (a) through (d) above are met, (ii) payment of the license fee is not dependent upon performance of the consulting services, and (iii) the consulting services are not essential to the functionality of the licensed software. If the services are essential to the functionality of the software, or performance of services is a condition to payment of license fees, both the software license and consulting fees are recognized under the “percentage of completion” method of accounting. We use labor hours to estimate the progress to completion. Under this method, we are required to estimate the number of total hours needed to complete a project, and revenues are recognized based on the percentage of total contract hours as they are completed while costs are recognized as incurred. Due to the complexity involved in the estimating process, revenues and profits recognized under the percentage of completion method of accounting are subject to revision as contract phases are actually completed. Historically, these revisions have not been material.
Sublicense Revenues. We recognize sublicense fees as reported to us by our licensees. License fees for certain application development and data access tools are recognized upon direct shipment by us to the end user or upon direct shipment to the reseller for resale to the end user. If collection is not reasonably assured in advance, revenue is recognized only when sublicense fees are actually collected and all other revenue recognition criteria have been met.
Service Revenues. Technical support revenues are recognized ratably over the term of the related support agreement, which in most cases is one year. Revenues from consulting services under time and materials contracts, and for education, are recognized as services are performed. Revenues from fixed price consulting agreements are generally recognized based on the proportional performance of the project, with performance measured based on hours of work performed.
Message Revenues
We recognize message revenue in accordance with SAB No. 104, Emerging Issues Task Force No. 00-21, Revenue Arrangements with Multiple Deliverables (“EITF 00-21”) and where applicable in accordance with EITF, No. 99-19, Reporting Revenue Gross as a Principal Versus Net as an Agent (“EITF 99-19”). We recognize revenue when (a) there is persuasive evidence of an arrangement; (b) the service has been provided to the customer; (c) the amount of the fees to be paid by the customer is fixed and determinable; and (d) the collection of the fees is reasonable assured.
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Our agreements with mobile operators and application providers to provide messaging data delivery and settlement services generally have an initial term of one year. We generate a significant portion of our message revenue from per message transaction fees and to a lesser extent, from revenue share agreements related to the delivery of third party content. We recognize revenue from transaction fees based upon the number of messages successfully processed by our platforms and delivered in accordance with the terms of our arrangements.
In some instances third party content providers, and other enterprises enter into revenue sharing arrangements with us. Under a standard revenue sharing transaction we deliver content from a third party provider to the cell phone of a mobile operatior’s subscriber. Third party content includes, among other, ringtones, wallpapers, interactive games, competitions, directory inquiry services, and information services. The subscriber is invoiced by their mobile operator, who upon receipt of payment, remits a portion of the charge to us. Upon payment from the mobile operator, we remit payment to the third party content provider. In accordance with EITF 99-19, we have determined that we act as an agent under these revenue sharing arrangements and accordingly, record as revenue the net amount retained by us. The net amount retained by us reflects the gross amount billed to the operator less amounts due to the content provider.
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Impairment of Goodwill, Non-amortizable Intangible Assets and Other Purchased Intangible Assets
Goodwill and other non-amortizable intangible assets, such as tradenames, have generally resulted from our business combinations accounted for as purchases. We are required to test amounts recorded as goodwill or other non-amortizable intangible assets with indeterminate lives, at least annually for impairment. The review of goodwill and indeterminate lived intangibles for potential impairment is highly subjective and requires us to make numerous estimates, using a discounted cash flow model, to determine the fair values of our reporting units to which goodwill is assigned. For these purposes, our reporting units equate to our reported segments. See Note Ten to Consolidated Financial Statements, Part II, Item 8, incorporated here by reference. If the estimated fair value of a reporting unit is determined to be less than its carrying value, we are required to perform an analysis similar to a purchase price allocation for an acquired business in order to determine the amount of goodwill impairment, if any. This analysis requires a valuation of certain other purchased intangible assets with determinate and indeterminate useful lives including in-process research and development, and developed technology. We performed our annual impairment analysis for each of our historical operating units (IPG, iAS, and SY365) and for each indeterminate lived intangible asset as of December 31, 2007. This analysis indicated that the estimated fair value of each reporting unit or indeterminate lived intangible exceeded its carrying value. Therefore, we were not required to recognize an impairment loss in 2007. As of December 31, 2007, our goodwill balance totaled $533.3 million and our other purchased intangibles totaled $7.1 million. Changes in our internal business structure, increases in the applicable discount rate, changes in our future revenue and expense forecasts, and certain other factors that directly impact the valuation of our reporting units could result in a future impairment charge.
We also continue to separately review our other intangible assets (e.g., purchased technology, customer lists and covenants not to compete) for indications of impairment whenever events or changes in circumstances indicate the carrying amount of any such asset may not be recoverable. For these purposes, recoverability of these assets is measured by comparing their carrying values to the future undiscounted cash flows the assets are expected to generate. This methodology requires us to estimate future cash flows associated with certain assets or groups of assets. Changes in these estimates, technology obsolescence, customer terminations including message customers due to technology interoperability and other factors could result in impairment losses associated with other intangible assets. There were no indicators of impairment during 2007.
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Valuation of Investments
In accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” (SFAS 115) management determines the appropriate classification of debt and equity securities at the time of purchase and re-evaluates such designation as of each balance sheet date. At December 31, 2007, we have classified all debt and equity securities as available-for-sale pursuant to SFAS 115. Such securities are recorded at fair value and unrealized holding gains and losses, net of the related tax effect, if any, are not reflected in earnings but are reported as a separate component of other comprehensive income (loss) until realized. Realized gains and losses are determined on the specific identification method and are reflected in income.
On January 1, 2006 we adopted the FASB Staff positions FAS Nos. 115-1 and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments (the FSPs). The FSPs were issued on November 3, 2005 and nullified certain provisions of EITF No. 03-01 related to evaluating an other-than temporary impairment and clarified the accounting policies set forth in FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities.
During 2006, we did not recognize impairment losses related to unrealized losses on debt securities as a charge to income as we believed that the decline in market value was due to changes in interest rates and not due to increased credit risk and we had the ability and intent to hold the securities until a recovery of fair value, which may be maturity.
As of December 31, 2007, long-term cash investments totaling $36.6 million include six auction rate securities (ARS) with an aggregate par value of $28.9 million. As of December 31, 2007, the temporary impairment associated with three of these ARS representing an aggregate par value of $14.9 million and the other-than-temporary impairment associated with the remaining three ARS representing an aggregate par value of $14.0 million were not material.
Our ARS are floating rate securities with longer-term maturities which are marketed by financial institutions with auction reset dates at 28 day intervals to provide short term liquidity. The underlying collateral of the ARS held by us consist primarily of commercial paper, debt instruments issued by governmental agencies and governmental sponsored entities, and similar assets. Certain of the ARS may have limited direct or indirect investments in mortgage or mortgage related securities. The credit ratings for five of the ARS were AAA and for one of the ARS was AA at the time of purchase. Beginning in August 2007 and into September 2007, each of the ARS auctions began to fail due to a lack of market for these securities. The failed auctions have resulted in higher interest rates being earned on these investments, but the investments currently lack short-term liquidity. We will not be able to access these funds until a future auction for the ARS investments is successful or until we sell the securities in a secondary market which currently does not exist. Based on our cash, cash equivalents and cash investment balances of $734.9 million and expected operating cash flows, we do not anticipate that the lack of liquidity for the ARS to adversely affect our ability to conduct business and believe we have the ability and intent to hold the temporarily impaired securities through the currently estimated recovery period. The fair values of the ARS as of December 31, 2007 are based on an estimation using a discounted cash flow model for each of the six ARS using credit related discount rates and term to recovery as key inputs. The determination if the security is other then temporarily impaired is based on a variety of factors including (i) the quality of the investments held by the trust/issuer; (ii) the financial condition of the credit rating of the trust, issuer, sponsors, and insurers; and, (iii) the frequency of the auction function failing. Changes in assumptions and other factors could result in additional realized and unrealized impairment losses.
These securities are being analyzed each reporting period for changes in estimated fair values and temporary and other-than-temporary impairment factors. We expect additional impairment amounts may be recorded in future periods.
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Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts to reflect the expected non-collection of accounts receivable. In determining the amount of the allowance we consider our historical level of credit losses; judgments about the creditworthiness of significant customers; an assessment current economic and industry trends that might impact the level of credit losses in the future; and other factors. Our allowances have generally been adequate to cover our actual credit losses. However, since we cannot reliably predict future changes in the financial stability of our customers, we cannot guarantee that our allowance will continue to be adequate. For example, our allowance for doubtful accounts totaled $3.7 million at December 31, 2007. If our allowance for doubtful accounts, including identified specific customer matters, changed by 10% our allowance for doubtful accounts and operating results would change by $0.4 million.
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Capitalized Software
We capitalize certain software development costs after a product becomes technologically feasible and before its general release to customers. Our net capitalized software totaled $74.3 million at December 31, 2007. Significant judgment is required in determining when a product becomes “technologically feasible.” Capitalized development costs are then amortized over the product’s estimated life beginning upon general release of the product. Quarterly, we compare a product’s unamortized capitalized cost to the product’s net realizable value. To the extent unamortized capitalized cost exceeds net realizable value based on the product’s estimated future gross revenues (reduced by the estimated future costs of completing and selling the product) the excess is written off. This analysis requires us to estimate future gross revenues associated with certain products and the future costs of completing and selling certain products. Changes in these estimates could result in write-offs of capitalized software costs. See Note One to Consolidated Financial Statements, Part II, Item 8, incorporated here by reference.
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Income Taxes - Estimates of Effective Tax Rates, Deferred Taxes and Valuation Allowance
We use the asset and liability approach to account for income taxes. This methodology recognizes deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. We then record a valuation allowance to reduce deferred tax assets to an amount that likely will be realized. We consider future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance. If we determine in any period that we could realize a larger net deferred tax asset than the recorded amount, we would adjust the deferred tax asset and record a corresponding reduction to our income tax expense for the period. For example, during the quarter ending December 31 2007, management reduced its estimate of foreign subsidiaries’ earnings permanently reinvested. As a result of this change and other projected changes in the Company’s future US taxable income, management re-evaluated the need for valuation allowances for the Company’s US deferred tax assets. As a result of this re-evaluation, during the quarter ending December 31, 2007, the Company released approximately $27.6 million of valuation allowances relating to federal research tax credit and foreign tax credit carryforwards, of which $26.4 million reduced tax expense and approximately $1.2 million reduced goodwill.
Conversely, if we determine that we would be unable to realize a portion of our recorded deferred tax asset, we would adjust the deferred tax asset and record a charge to income tax expense for the period. Significant judgment is required in assessing the future tax consequences of events that have been recognized in our financial statements or tax returns. Fluctuations between the actual outcomes of these future tax consequences (e.g., the income we earn within the United States) could materially impact our financial position or results of operations. See Note Eight to the Consolidated Financial Statements - Income Taxes, Part II, Item 8.
Our effective tax rate is based on expected geographic income, statutory rates and enacted tax rules, including transfer pricing. We are required to exercise significant judgment in determining our effective rate and in evaluating various positions that apply to our worldwide operations. We believe that our tax positions, including intercompany transfer pricing policies, are consistent with the tax laws in the jurisdictions in which we conduct business. It is possible, however, that these positions will be challenged which may have a significant impact on our effective tax rate.
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On January 1, 2007, we adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes: An Interpretation of FASB Statement No. 109, or FIN No. 48. FIN 48 prescribes a recognition and measurement threshold for a tax position taken or expected to be taken in a tax return. The adoption of FIN 48 did not have a material impact on the Company’s consolidated financial position.
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Accounting for Stock-Based Compensation Plans
Prior to January 1, 2006, we accounted for our stock-based employee compensation plans under the measurement and recognition provisions of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations, as permitted by Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation.” Accordingly we were not required to record compensation expense when stock options were granted to eligible participants as long as the exercise price was not less than the fair market value of the stock when the option was granted. Prior to January 1, 2006, we generally recorded stock-based employee compensation relating to restricted stock grants. We recorded no compensation expense in connection with our Employee Stock Purchase Plan as the purchase price of the stock was not less than 85% of the lower of the fair market value of our common stock at the beginning of each offering period or at the end of each purchase period. In accordance with SFAS 123 and SFAS 148, “Accounting for Stock-Based Compensation - Transition and Disclosure,” we disclosed our pro forma net income or loss and net income or loss per share as if we had applied the fair value-based method in measuring compensation expense for our stock-based incentive programs.
Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS 123(R), “Share-Based Payment,” using the modified prospective transition method. Under that transition method, compensation expense that we recognize beginning on that date includes: (a) period compensation expense for all share-based payments granted prior to, but not yet vested as of, January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, adjusted for estimated forfeitures, and (b) period compensation expense for all stock-based payments granted on or after January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R). Because we elected to use the modified prospective transition method, results for prior periods have not been restated.
At December 31, 2007, there was $43.4 million of total unrecognized compensation cost before income tax benefit related to non-vested stock-based compensation arrangements granted under all equity compensation plans which we will amortize to expense in the future. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures. We expect to recognize that cost over a weighted average period of 2.2 years.
We estimate the fair value of options granted using the Black-Scholes option valuation model and the assumptions shown in Note Seven to the Consolidated Financial Statements - Stockholders’ Equity , Part II, Item 8. We estimated the expected term of options granted based on historical exercise patterns. Beginning in the second quarter of 2005 we estimated the volatility of our options and stock appreciation rights considering both the historical volatility of our stock over the average expected life of our options and the prices of publicly traded options, consistent with SFAS 123(R) and Securities and Exchange Commission Staff Accounting Bulletin No. 107. Prior to that, we estimated the volatility factors for stock options and stock appreciation rights considering the historical volatility of our stock over the most recent four year period which was approximately equal to the average expected life of our options. We base the risk-free interest rate that we use in the Black-Scholes option valuation model on the average of the 3 and 5 year treasury rates as published by the Federal Reserve. We have never paid any cash dividends on our common stock and we do not anticipate paying any cash dividends in the foreseeable future. Consequently, we use an expected dividend yield of zero in the Black-Scholes option valuation model. SFAS 123(R) requires us to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We use historical data to estimate pre-vesting option forfeitures and
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record share-based compensation expense only for those awards that are expected to vest. For purposes of calculating pro forma information under SFAS 123 for periods prior to 2006, we accounted for forfeitures as they occurred. We amortize the fair value on a ratable basis over the requisite service periods of the awards, which are generally the vesting periods.
Changes in the subjective input assumptions can materially affect the fair value estimates determined under the Black-Scholes option valuation model. In the future, changes in the assumptions under the Black-Scholes valuation model or our election to use a different valuation model, could result in a significantly different impact on our net income or loss.
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Purchase Accounting
We have made estimates of the fair values of purchased intangible and other assets acquired in conjunction with our purchase of Mobile 365, Inc. as of November 8, 2006, and other acquired companies based primarily on appraisals from third parties and certain internally generated information.
Purchased intangible assets, excluding goodwill, totaled $130.6 million at December 31, 2007. If the subsequent actual and updated projections of the underlying business activity are less as compared to the underlying assumptions and projections used to develop these values, then we could experience impairment losses, as described above. In addition, we have estimated the economic lives of certain of these assets and these lives were used to calculate depreciation and amortization expense. If our estimates of the economic lives change, then additional depreciation or amortization expense could be incurred on an annual basis. Historically, we have not made any changes in these areas. If the estimates of the economic lives of the definite-lived intangible assets acquired as part of our acquisition of Mobile 365 were reduced by one year, our 2007 amortization expense would increase by approximately $1.7 million.
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Restructuring
Historically, we have recorded significant accruals in connection with various restructuring activities. Our remaining restructuring accruals primarily relate to the estimated net costs to settle certain lease obligations based on analysis of independent real estate consultants. While we do not anticipate significant changes to these estimates in the future, the actual costs may differ from estimates. For example, if we are able to negotiate more affordable termination fees, if rental rates increase in the markets where the properties are located, or if we are able to locate suitable sublease tenants more quickly than expected, the actual costs could be lower than our estimates. In that case, we would reduce our restructuring accrual with a corresponding credit to cost of restructuring or goodwill. Alternatively, if we are unable to negotiate affordable termination fees, if rental rates decrease in the markets where the properties are located, or if it takes us longer than expected to find suitable sublease tenants, the actual costs could exceed our estimates See Note Thirteen to Consolidated Financial Statements -Restructuring Costs, Part II, Item 8.
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• Contingencies and Liabilities
We are involved from time to time in various proceedings, lawsuits and claims involving our customers, products, intellectual property, stockholders and employees, among other parties. We routinely review the status of each significant matter and assess our potential financial exposure. When we reasonably determine that a loss associated with any of these matters is probable, and can reasonably estimate the loss, we record a reserve to provide for such loss contingencies. If we are unable to record a reserve because we are not able to estimate the amount of a potential loss in a matter, or if we determine that a loss is not probable, we are nevertheless required to disclose certain information regarding such matter if we determine that there is a reasonable possibility that a loss has been incurred. Because of the inherent uncertainties related to these types of matters, we base our loss reserves on the best information available at the time. As additional information becomes available, we may reevaluate our assessment regarding the probability of a matter or its expected loss. Our financial position, results of operations or cash flows could be materially and adversely affected by such revisions in our estimates. For further discussion of contingencies and liabilities, see “Risk Factors - Future Operating Results,” above.
We currently believe that the ultimate liability, if any, for any pending claims of any type (either alone or combined) will not materially affect our financial position, results of operations or cash flows. We also believe that we would be able to obtain any necessary licenses or other rights to disputed intellectual property rights on commercially reasonable terms. However, the ultimate outcome of any litigation is uncertain and, regardless of outcome, litigation can have an adverse impact on Sybase because of defense costs, negative publicity, diversion of management resources and other factors. Our inability to obtain necessary license or other legal rights, or litigation arising out of intellectual property claims could adversely affect our business.
Results of Operations
Revenues (Dollars in millions)
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Total license fees for 2007 increased $18.0 million (6 percent) from total license fees in 2006 (which had increased $35.1 million (12 percent) from 2005. The increase in license fees during 2007 was primarily attributable to a $8.2 million (9 percent) increase in iAS license fees and to a $14.4 million (6 percent) increase in IPG license fees. The increase in license fees during 2006 was primarily attributable to IPG license revenues.
The increase in iAS license fees during 2007 was primarily attributable to a $10.7 million (16 percent) increase in revenues from our mobile and embedded database products. The increase in iAS license fees during 2006 was related to device management and ESI’s mobile mail products.
The increase in IPG license fees was primarily attributable to a $17.2 million (71 percent) increase in our IQ analytics server product. The increase in IPG license fees during 2006 was primarily attributable to increases in license revenues associated with our Adaptive Server products and our ASE15.0 product released in the third quarter of 2005. We believe that the increasing acceptance of our IQ product and the Data Integration Suite will drive future revenue growth.
Segment license and service revenues include transactions between iAS and IPG, The most common instance relates to the sale of iAS products and services to third parties by IPG. In the case of such a transaction, IPG records the revenue on the sale with a corresponding inter-company expense on the transaction. iAS then records intercompany revenue and continues to bear the costs of providing the product or service. The excess of revenues over inter-company expense recognized by IPG is intended to reflect the costs incurred by IPG to complete the sales transaction. Total transactions between the segments (i.e., intercompany revenue and inter-company expense) are offset in “Eliminations.”
Total service revenues for 2007 (which include revenues from technical support, professional services, and education) increased $13.0 million (2 percent) from total service revenues in 2006. This increase was due to a $4.9 million (7 percent) increase in iAS services and a $11.3 million (2 percent) increase in IPG services. This increase is offset by a $2.0 million (2 percent) decline in consulting revenues and a $1.5 million decline in advertising revenues. The increase in iAS service revenues was primarily due to a $3.4 million (10 percent) increase in iAS technical support revenues, largely related to the technical support revenues associated with device management products and mobile and embedded databases. The increase in IPG service revenues was primarily due to a $12.8 million (3 percent) increase in technical support revenues offset by a $2.0 million (2 percent) decline in professional services revenues.
Technical support revenues comprised 79 percent of total services revenues for 2007 and 78 percent in 2006. Total technical support revenue for 2007 increased $16.2 million (4 percent) from the 2006 total. The deferred revenue balance related to technical support contracts at the end of 2007 increased $16.2 million (9 percent) from 2006.
Services revenues other than technical support decreased 3 percent in 2007 from 2006. The decrease was primarily related to decreases in consulting services performed by IPG for the financial services industry offset by increased consulting services performed by iAS consulting related to unwired enterprise initiatives.
Messaging fees earned in 2007 were $136.5 million resulting from the acquisition of Mobile 365 in November 2006. Messaging fees consist primarily of revenues earned from the provision of inter-carrier messaging (SMS and MMS), premium content delivery and settlement, and enterprise messaging services to wireless operators, brands, content providers and enterprises.
For a description of our technical support, consulting and education services, see “Business - Worldwide Services,” Part I, Item 1.
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Geographical Revenues
(Dollars in millions)
North American revenues (United States, Canada and Mexico) for 2007 increased $58.0 million (12 percent) from 2006. The increase from 2006 was primarily due to a $38.9 million increase in messaging revenues, a $10.7 million (11 percent) increase in license revenues from products in the IPG segment and $9.0 million (20 percent) increase in license revenues from the iAS segment, offset by a $3.8 million (5 percent) decrease in consulting services. In 2006, the increase in North America revenues was primarily due to license revenues from products in the IPG segment offset by a decrease in consulting services.
EMEA (Europe, Middle East and Africa) revenues for 2007 increased $62.7 million (22 percent) from 2006. The increase was primarily due to an $63.8 million increase in messaging revenues and a $12.4 million (11 percent) increase in technical support fees, offset by an $10.5 million (13 percent) decline in license fees from our enterprise database products. The messaging revenues are attributable to our purchase of Mobile 365 in the fourth quarter of 2006. Increased revenues in France, Spain and Germany contributed most to the overall increase for 2007 and were primarily attributable to messaging revenues and growth in services in Germany and France. The increase in 2006 revenues compared to 2005 was due to an increase in license fees revenues from products in the IPG segment, the inclusion of our messaging revenues as a result of our fourth quarter purchase of Mobile 365 and an increase in technical support revenues.
Intercontinental (Asia Pacific and Latin America) revenues for 2007 increased $28.6 million (23 percent) from 2006. The increase was primarily due to a $15.6 million increase in messaging revenues, a $10.0 million (16 percent) increase in license revenues primarily from our IPG products and a $3.0 million (5 percent) increase in service revenues. The results of our operations in Asia Pacific contributed most significantly to the increased revenue. The increase in 2006 Intercontinental revenues compared to 2005 was due to an increase in license fees revenues from products in the IPG segment, the inclusion of our messaging revenues as a result of our fourth quarter purchase of Mobile 365, partially offset by a slight decline in license revenues from our iAS products.
In EMEA and the Intercontinental region, most revenues and expenses are denominated in local currencies. The cumulative impact of changes in foreign currency exchange rates from 2006 to 2007 resulted in a 3 percent increase in our revenues and a 2 percent increase in our operating expenses. The cumulative impact of changes in foreign currency exchange rates from 2005 to 2006 resulted in a 1 percent increase in our total revenues and a 1 percent increase in our total operating expenses. The change for both comparable periods was primarily due to the weakness of the U.S. dollar against certain European and Intercontinental currencies.
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Our business and results of operations could be materially and adversely affected by fluctuations in foreign currency exchange rates, even though we take into account changes in exchange rates over time in our pricing strategy. Additionally, changes in foreign currency exchange rates, the strength of local economies, and the general volatility of worldwide software markets could result in a higher or lower proportion of international revenues as a percentage of total revenues in the future. For additional risks associated with currency fluctuation, see “Financial Risk Management - Foreign Exchange Risk,” below.
Cost and Expenses
(Dollars in millions)
Cost of license fees
Cost of license fees consists primarily of product costs (media and documentation), amortization of capitalized software development costs and purchased technology, and third party royalty costs. The cost of license fees increased $2.6 million (15 percent) in 2007 over 2006, and decreased $1.1 million (15 percent) in 2006 over 2005. The 2007 increase was primarily due to a $1.9 million increase in the amortization of capitalized software development costs and a $1.1 million increase in royalties. The increase in the amortization of capitalized software development costs was primarily related to the development of ASE 15.0.2. The 2006 decrease was primarily due to a $1.8 million decrease in the amortization of purchased technology and other product cost declines partially offset by $1.4 million increase in the amortization of capitalized software development costs. The decline in amortization of purchased technology was due to a $2.8 million decrease in the amortization of purchased technology acquired in the 2000 Home Financial Network acquisition partially offset by increases due to the full year amortization of intangible developed technology assets related to the October 2005 Extended Systems purchase.
The amortization of purchased technology was $9.8 million, $10.1 million and $11.9 million in 2007, 2006 and 2005, respectively.
Amortization of capitalized software costs was $33.1 million, $31.2 million and $29.7 million in 2007, 2006 and 2005, respectively. In 2007, the increase in the amortization of capitalized software costs was primarily related to the ASE 15.0.2 product that began fully amortizing in the fourth quarter of 2006. In 2006, the increase in amortization of capitalized software costs was primarily related to certain products in the IPG segment that began fully amortizing in the last two quarters of 2005. See Note One to the Consolidated Financial Statements - Capitalized Software, Part II, Item 8.
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Cost of services
Cost of services consists primarily of the fully burdened cost of our personnel who provide technical support, education and professional services and, to a lesser degree, services-related product costs (media and documentation). These costs increased $4.8 million (4 percent) in 2007 compared to 2006 and remained at 29 percent as a percentage of service in both 2007 and 2006. The increase was primarily due to a 4 percent increase in payroll and related costs associated with headcount increases offset by a slight decline in media costs. Cost of services decreased approximately 2 percent in 2006 from 2005.
Cost of messaging
Costs of messaging in 2007 were $82.6 million resulting from the acquisition of Mobile 365 in November 2006. Costs of messaging consist primarily of (1) fees payable to non-domestic wireless operators for delivering traffic into their networks; (2) fully burdened cost of personnel who manage and monitor messaging network datacenters; (3) depreciation, fees and other costs associated with the network datacenters; and (4) amortization of purchased technology used internally by the Sybase 365 segment. Cost of messaging increases as more messages are delivered internationally. The amortization of purchased technology was $3.8 million for the year ended December 31, 2007.
Sales and marketing
Sales and marketing expenses increased $3.7 million (1 percent) in 2007 from 2006 and were 26 percent and 30 percent of total revenues in 2007 and 2006, respectively. The increased expenses in 2007 were primarily due to the addition of Mobile 365 and sales commissions on higher revenues, partially offset by a reduction in payroll and related costs caused by a decrease in headcount and a decrease in certain allocated costs and a decrease in advertising costs. The decrease in sales and marketing expenses as a percentage of revenue was due to improved sales productivity and the inclusion of SY365 activities which generally have a lower sales and marketing cost structure. The 5 percent increase in sales and marketing expenses in 2006 compared to 2005 was primarily due to an increase in stock compensation expense as a result of the adoption of FAS123R in 2006, sales commissions on higher revenues and marketing programs.
Product development and engineering
Product development and engineering expenses (net of capitalized software development costs - see discussion below) increased $3.1 million (2 percent) in 2007 from 2006 and as a percentage of total revenue decreased to 15 percent in 2007 from 17 percent 2006. The increase in absolute dollars was primarily due to a $6.4 million increase in payroll and related expenses, partially offset by a $1.4 million increase in capitalized software costs related to labor costs and a $2.0 million decrease in certain allocated common expenses. We allocate various common costs, primarily certain telecommunications, IT infrastructure, and facilities related expenses to sales and marketing, product development and engineering and general and administrative expenses. The increase in payroll and related expenses was primarily due to the Mobile 365 acquisition completed in the fourth quarter of 2006.
The 8 percent increase in product development and engineering expenses in 2006 over 2005 was primarily due to an increase in payroll and related expenses due to headcount increases, an increase in stock compensation expenses related to the adoption of FAS123R in 2006, partially offset by a decrease in capitalized software.
We capitalize product development and engineering costs during the period between a product’s achievement of technological feasibility and its general availability. Our capitalized software costs in 2007 of $36.2 million included costs incurred for the development of the Adaptive Server Enterprise, IQ, Data Integration Suite, Workspace and eBanking. In 2006, our capitalized software costs of $37.5 million
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included costs incurred for the development of Adaptive Server Enterprise, SQL Anywhere 10.0, EAS, Powerbuilder and Workspace.
We believe product development and engineering expenditures are essential to technology and product leadership and expect product development and engineering expenditures to continue to be significant, both in absolute dollars and as a percentage of total revenues.
General and administrative
General and administrative expenses, which include IT, legal, business operations, finance, human resources and administrative functions, increased $23.2 million (22 percent) in 2007 compared to 2006 and increased as a percentage of total revenue to 13 percent in 2007 from 12 percent in 2006. The cause of the increase in absolute dollars was primarily due to the acquisition of Mobile 365 in the fourth quarter of 2006 and a slight increase in stock compensation expense. General and administrative expenses included stock-based compensation expense of $13.7 million and $12.9 million in 2007 and 2006, respectively.
The 5 percent increase in 2006 compared to 2005 was primarily due to an increase in stock-based compensation, the acquisition of Mobile 365 in the fourth quarter of 2006 and an increase in third party services.
Stock-based compensation expense
Stock-based compensation expense reflects non-cash compensation expense associated with restricted stock purchase rights granted to certain Sybase executives. Stock-based compensation expense in 2007 and 2006 also reflects employee stock options and stock appreciation rights accounted for under SFAS123R. (See Note Seven to the Consolidated Financial Statements - Stockholders’ Equity, Part II, Item 8). Stock-based compensation expense was included in costs and expenses as follows:
The increase in stock-based compensation expenses in 2006 resulted from the adoption of FAS123R in 2006. The increase in stock-based compensation expenses in 2007 and 2006 also resulted from the grant of certain performance-based restricted stock described more fully in Note Seven to the Consolidated Financial Statements and the assumption of stock options related to the Mobile 365 acquisition. If the performance targets, which relate to a combination of the growth of our revenues, cash flows, earnings and shareholder return over one to three year periods, are not met, the restricted stock will not vest, and all or a portion of the stock compensation expense related to these instruments will be reversed through the same expense categories detailed above. We currently anticipate that all criteria for vesting will be substantially accomplished.
Amortization of other purchased intangibles
Amortization of other purchased intangibles reflects the amortization of the established customer list associated with our acquisition in 2000 of Home Financial Network, Inc. the amortization of the established customer list and covenant not to compete associated with our acquisition of XcelleNet in 2004, the amortization of the established customer list and other intangible assets associated with our acquisition of Extended Systems in 2005 and the amortization of the developed existing technology and customer contracts and relationship assets associated with our acquisition of Mobile 365 in 2006. See
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Note Four to Consolidated Financial Statements - Goodwill and Other Purchased Intangible Assets, Part II, Item 8.
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Restructuring Activities
We undertook restructuring activities in 2004, 2003, 2002 and 2001 as a means of managing our operating expenses and assumed certain restructuring program liabilities of AvantGo when we acquired that company in 2003.
For descriptions of each restructuring plan, see Note Thirteen to Consolidated Financial Statements - Restructuring Costs, Part II, Item 8.
In connection with the 2002 and 2004 restructuring plans, we assumed certain liabilities related to excess space at facilities in the United States. During the quarter ended December 31, 2007, we recorded additional liabilities related to the expected costs of these facilities.
Operating income
Operating income in 2007 was $168.6 million compared to operating income of $133.8 million in 2006 and $121.9 million in 2005. The increase in the operating margin to 16 percent in 2007 compared to 15 percent in 2006 was primarily the result of the various factors discussed under “Revenues” and “Costs and Expenses” above.
The operating margin for the IPG segment was 22 percent for 2007 compared to 19 percent for 2006. The increase in operating income and margin in the IPG segment for 2007 compared to 2006 was primarily due to a 6 percent increase in license fees, a 3 percent increase in maintenance fees, a 2 percent decrease in lower margin consulting fees and reduced payroll and related costs associate with a 6 percent decrease in total IPG headcount.
The increase in operating income and margin in the IPG segment for 2006 compared to 2005 was primarily due to a 10 percent increase in license revenues and a decrease in the amortization of purchased technology partially offset by a slight increase in lower margin services.
The operating income for the iAS segment was 14 percent for 2007 compared to 10 percent for 2006. The increase in operating margin was to due a 9 percent increase in license fees, a 10 percent increase in maintenance fees and a lower increase in total expenses.
The decrease in operating income and margin for the iAS segment in 2006 compared to 2005 was primarily due to an increase in operating expenses and an increased amortization of purchased technologies and other intangibles, both related to the October 2005 acquisition of Extended Systems, offset by an increase in license fee technical support revenues.
Certain common costs and expenses are allocated to the various segments based on measurable drivers of expense. Unallocated expenses include stock-based compensation expense and other corporate expenditures or cost savings that are not specifically allocated to the segments including reversals or restructuring expenses associated with restructuring activities undertaken prior to 2003.
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Other income (expense), net
In 2007, interest income decreased $5.2 million from 2006. Interest income consists primarily of interest earned on our investments. The decrease is primarily due to lower cash balances due to the acquisition of Mobile 365 in the fourth quarter of 2006. The $13.0 million increase in interest income for 2006 compared to 2005 is due to the increase in the average cash balances invested and investment yields. Our invested cash balances increased primarily due to the full year investment of the net proceeds from our private offering of convertible subordinated notes in the first quarter of 2005 together with investing cash generated from operations during 2005 and 2006 offset by cash balance declines as a result of cash used in our stock repurchase program and for acquisitions. See “Consolidated Statements of Cash Flows,” Part II, Item 8.
Interest expense and other, net, primarily includes: interest expense on the convertible subordinated notes; amortization of deferred offering expenses associated with these notes; net gains and losses resulting from foreign currency transactions and the related hedging activities; the cost of hedging foreign currency exposures; bank fees; and gains from the disposition of certain real estate and investments. The increase in interest expense and other, net from 2007 compared to 2006 was primarily due to a decline in gains on disposition of cash investments in 2007.
The increase from 2006 compared to 2005 was primarily the result of the full year interest expense incurred on the convertible subordinated notes which bear an interest rate of 1.75 percent and the full year’s amortization of capitalized offering fees and expenses associated with the convertible subordinated notes.
Provision for Income Taxes
In 2007 a provision for income taxes was recorded at a rate of approximately 22 percent of income before taxes. Our effective rate differed from the statutory federal rate of 35 percent primarily due to adjustments for the release of valuation allowances on deferred tax assets, the effect of lower effective foreign tax rates, the release of tax reserves upon the expiration of the statute of limitation relating to various exposure items; offset somewhat by the impact of state taxes, the addition of tax reserves relating primarily to foreign transfer pricing exposures and the increase in deferred taxes on foreign earnings permanently reinvested.
The Company records a deferred tax liability for US taxes expected to be incurred on its foreign subsidiaries’ earnings that are not considered to be permanently reinvested overseas. Prior to the quarter ending December 31, 2007, the Company had anticipated a certain amount of foreign earnings to not be permanently reinvested. During the quarter ending December 31, 2007, due to possible share repurchases or acquisitions, management concluded that a total of approximately $60 million of earnings
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of a foreign subsidiary were not considered permanently reinvested. This change had the effect of increasing full year tax expense by approximately $13 million.
As discussed above, during the quarter ending December 31 2007, management increased its estimated US cash needs and reduced its estimate of foreign subsidiaries’ earnings permanently reinvested. As a result of this change and other projected changes in the Company’s future US taxable income, management re-evaluated the need for valuation allowances for the Company’s US deferred tax assets. As a result of this re-evaluation, during the quarter ending December 31, 2007, the Company released approximately $27.6 million of valuation allowances relating to federal research tax credit and foreign tax credit carryforwards, of which $26.4 million reduced tax expense and approximately $1.2 million reduced goodwill.
In 2006 a provision for income taxes was recorded at a rate of approximately 41 percent of income before taxes. Our effective rate differed from the statutory federal rate of 35 percent primarily due to adjustments for the impact of state taxes, the addition of tax reserves relating primarily to foreign transfer pricing exposures; offset somewhat by the effect of lower effective foreign tax rates, the release of tax reserves upon the expiration of the statute of limitation relating to various exposure items, and adjustments for the difference between estimated amounts recorded and actual liabilities resulting from the filing of prior years’ tax returns.
In 2005 a provision for income taxes was recorded at a rate of approximately 37 percent of income before taxes. Our effective rate differed from the statutory federal rate of 35 percent primarily due to adjustments for the impact of state taxes, the addition of tax reserves relating primarily to foreign transfer pricing exposures, tax on foreign subsidiaries’ earnings distributed under the Jobs Creation Act, and certain non-deductible executive compensation; offset somewhat by the release of tax reserves upon the expiration of the statute of limitation relating to various tax exposure items and adjustments for the difference between estimated amounts recorded and actual liabilities resulting from the filing of prior years’ tax returns.
We had a net deferred tax asset of $34 million at December 31, 2007. This deferred tax asset included a valuation allowance of $92 million. In order to realize our net deferred tax assets we must generate sufficient taxable income in future years in appropriate tax jurisdictions to obtain the recorded benefit from the reversal of temporary differences (i.e., between book and tax basis), and from tax credit carryforwards. Based on the plans and estimates we are using to manage the underlying business we believe that sufficient income will be earned in the future to realize these assets. The amount of the deferred tax assets considered realizable is subject to adjustment in future periods if estimates of future taxable income are reduced. Any such adjustments to the deferred tax assets would be charged to income in the period such adjustment was made. See Note Eight to the Consolidated Financial Statements - Income Taxes, Part II, Item 8.
Net income per share
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In 2007 the increase in net income compared to 2006 was due to the various factors discussed above, primarily an increase in revenues, partially offset by an increase in both operating expenses and taxes.
In 2007, the slight increase in shares used for computing basic and diluted net income per share was primarily due to increases in shares re issued under employee stock option plans mostly offset by shares repurchased under our ongoing share repurchase program. During 2007 the shares acquired under our ongoing share repurchase plan exceeded the number of shares reissued under employee stock option plans by 4.1 million shares. The largest portion of which were repurchased in the fourth quarter. In 2006, the decrease in shares used for computing basic and diluted net income per share was due primarily to 2.7 million shares repurchased under our ongoing share repurchase program, partially offset by exercises of employee stock options. (Described in “Liquidity and Capital Resources,” below). See Consolidated Statements of Stockholders’ Equity, Part II, Item 8.
Shares that may be issued to holders of our convertible subordinated debt due to the appreciation of our stock price are included in the calculation of diluted earnings per share using the if converted method, if their inclusion is dilutive to earnings per share. Generally, such shares would be included in periods in which the average price of our common stock exceeds $25.22 per share, the initial conversion price. If some or all of such shares were included in our dilutive earnings per share calculation our diluted earnings per share amounts would be less. In the fourth quarter of 2007, the average of the high closing prices during a specified number of trading days exceeded the $25.22 threshold. As a result, approximately 0.5 million shares were assumed to be converted and included in the calculation of the fully diluted shares outstanding. This had less than a one penny impact on the diluted earnings per share. See Note Fifteen to Consolidated Financial Statements - Convertible Subordinated Notes, Part II, Item 8.
The 2007 diluted earnings per share calculation also includes 0.4 million shares of performance based restricted Common Stock granted to certain executives and employees. This had less than a one penny impact on the diluted earnings per share.
Liquidity and capital resources
Working Capital
The increase in working capital during 2007 was primarily due to cash flows from operations and investing activities of $254.0 million and $86.7 million respectively, offset by net cash flows used for financing activities of $112.6 million, including $166.7 million used to repurchase common stock and the reclassification of auction-rate securities with a par value of $28.9 million from current assets to long-term assets The decrease in working capital during 2006 is primarily due to the net cash payments for the Mobile 365 acquisition.
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Cash Flow
Net cash provided by operating activities increased 18 percent in 2007 compared to 2006 primarily due to a $53.8 million increase in net income. This was partially offset by changes in non-cash expenses related to stock compensation expense, accounts receivable and prepaid taxes. Our days sales outstanding in accounts receivable was 75 days for the quarter ended December 31, 2007 compared to 77 days for the quarter ended December 31, 2006. During 2006 and to a lesser extent 2007, our days sales outstanding encountered upward pressure due to the nature of the Mobile 365 business including the recognition of certain revenues on a net basis, while the related amounts due to and due from wireless operators and content providers appear on the balance sheet on a gross basis We expect the Mobile 365 business to continue to cause such upward pressure on our days sales outstanding in the future. (See Note One to the Consolidated Financial Statements - Summary of Significant Accounting Policies, Message Revenues, Part II, Item 8).
Net cash provided by operating activities increased 26 percent in 2006 compared to 2005 primarily due to a $9.5 million increase in net income and a $20 million increase in non-cash expenses related to stock compensation expense. This was partially offset by changes in deferred tax assets and taxes payable. Our days sales outstanding in accounts receivable was 77 days for the quarter ended December 31, 2006 compared to 68 days for the quarter ended December 31, 2005. The increase in days sales outstanding at December 31, 2006 was primarily attributable to the Mobile 365 business purchased in the fourth quarter of 2006.
Net cash provided by investing activities increased $363.0 million from 2006 to 2007. The increase in net cash used for investing activities is primarily due to the liquidation of marketable securities to fund our acquisition of Mobile 365 in 2006. In 2006, $399.7 million was used in business combinations related primarily to the Mobile 365 acquisition as compared to $6.8 million used in business combinations related to the acquisition of CoboPlan in 2007.
Net cash used for financing activities increased $112.6 million in 2007 compared to a $328.6 million decrease in 2006. The increase in cash used for financing activities in 2007 in primarily due to purchases of treasury stock which increased $106.9 million in 2007 from 2006. In 2007, we repurchased $166.7 million under our Stock Repurchase Program compared to $59.8 million repurchased in 2006.
Our Board of Directors has authorized the repurchase of our outstanding Common Stock from time to time, subject to price and other conditions (Stock Repurchase Program). Through December 31, 2007, aggregate amounts authorized under the Stock Repurchase Program totaled $850 million. During 2007, we repurchased 6.6 million shares at a cost of $166.7 million. In 2006, we repurchased 2.7 million shares at a cost of $59.8 million and in 2005 we repurchased 2.0 million shares at a cost of $44.1 million.
Approximately $83.1 million remained in the Stock Repurchase Program at December 31, 2007. The average price per share of the shares repurchased under the Stock Repurchase Program during 2007 was $25.32, compared to $22.21 in 2006 and $21.54 in 2005.
The repurchase of the shares in conjunction with our convertible debt offering was not part of the Stock Repurchase Program.
We expect to fund expenditures for future capital requirements, liquidity and strategic operating programs, stock repurchases and semi-annual interest payments from a combination of available cash balances and internally generated funds.
We engage in global business operations and are therefore exposed to foreign currency fluctuations that can affect the overall value of the assets (including cash) and liabilities reflected on our balance sheet. For a further discussion of the effect of foreign currency fluctuations on our financial condition, see “Financial Risk Management - Foreign Exchange Risk,” below.
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Cash and Cash Equivalents
Cash and cash equivalents consist of highly liquid investments that are comprised principally of taxable, short-term money market instruments with maturities of three months or less at the time of purchase and demand deposits with financial institutions. The increase in cash and cash equivalents together with cash investments during 2007 is due to increases in cash from operations partially offset by stock repurchases. Approximately 50 percent of the Company’s cash is held outside the U.S. by 39 different foreign entities controlled by the Company. Most of this foreign cash either cannot be repatriated to the U.S. due to foreign governmental and regulatory controls and/or dividend restrictions based on local earnings and profits or would be subject to additional U.S. or foreign taxes when repatriated.
Short-term and Long-term Cash Investments and Auction-Rate Securities
Short-term and long-term cash investments consist principally of commercial paper, corporate bonds, U.S. and Canadian government obligations, and U.S. government sponsored enterprise obligations with maturities between 90 days and up to three years.
As of December 31, 2007, long-term cash investments totaling $36.6 million include six auction rate securities (ARS) with an aggregate par value of $28.9 million. As of December 31, 2007, the temporary impairment associated with three of these ARS representing an aggregate par value of $14.9 million and the other-than-temporary impairment associated with the remaining three ARS representing an aggregate par value of $14.0 million were not material.
Our ARS are floating rate securities with longer-term maturities which are marketed by financial institutions with auction reset dates at 28 day intervals to provide short term liquidity. The underlying collateral of the ARS held by us consist primarily of commercial paper, debt instruments issued by governmental agencies and governmental sponsored entities, and similar assets. Certain of the ARS may have limited direct or indirect investments in mortgage or mortgage related securities. The credit ratings for five of the ARS were AAA and for one of the ARS was AA at the time of purchase. Beginning in August 2007 and into September 2007, each of the ARS auctions began to fail due to a lack of market for these securities. The failed auctions have resulted in higher interest rates being earned on these investments, but the investments currently lack short-term liquidity. We will not be able to access these funds until a future auction for the ARS investments is successful or until we sell the securities in a secondary market which currently does not exist. Based on our cash, cash equivalents and cash investment balances of $734.9 million and expected operating cash flows, we do not anticipate that the lack of liquidity for the ARS to adversely affect our ability to conduct business and believe we have the ability and intent to hold the temporarily impaired securities through the currently estimated recovery period. The fair values of the ARS as of December 31, 2007 are based on an estimation using a discounted cash flow model for each of the six ARS using credit related discount rates and term to recovery as key inputs.
Historically, given the liquidity created by the auctions, ARS were presented as current assets under marketable securities on the company’s balance sheet. Given the failed auctions, the ARS are illiquid until there is a successful auction for them or a secondary market develops. Accordingly, the entire ARS related balance has been reclassified from current to non-current assets.
If uncertainties in the credit and capital markets continue, these markets deteriorate further or the debt insurers experience additional ratings downgrades we may incur additional unrealized losses in or impairments to (realized losses in) our investment portfolio, which could negatively affect our reported earnings. We expect that additional impairments may be recorded in future periods. We believe that based on our cash, cash equivalents and investment balances of $735 million at December 31, 2007 along with our expected future operating cash flows, that we have the ability and intent to hold the securities to estimated recovery.
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Contractual Obligations
Our contractual obligations at December 31, 2007 are summarized as follows:
Upon completion of our acquisition of Extended Systems Incorporated (ESI) in October 2005, we assumed the obligations under a sale-and-leaseback transaction completed by ESI in September 2003 related to ESI’s headquarters building and land in Boise, Idaho. The sale-and-leaseback is recorded as a financing transaction. Under the terms of the agreement we have an option to repurchase the building and land at any time before September 2013 at a price of $5.1 million. The gross proceeds received of $4.8 million are included in other long-term liabilities on our balance sheet at December 31, 2007.
As part of the agreement, ESI entered into a 10-year master lease for the building with annual lease payments, which are recorded as interest expense, equal to 9.2 percent of the sale price, or approximately $442,000. We are also obligated to pay all expenses associated with the building during our lease, including the costs of property taxes, insurance, operating expenses and restoration and other repairs. (See Note Six to Consolidated Financial Statements, Part II, Item 8).
As part of the 15-year capital lease agreement entered into for our Waterloo, Canada facility (see Note Six to Consolidated Financial Statements, Part II, Item 8), we entered into an agreement with the landlord to finance approximately $1.6 million of tenant improvements at an annual interest rate of 8.76%. The loan requires monthly payments of $18,496, which includes both principal and interest commencing October 2004 through October 2019.
On February 22, 2005, we issued through a private offering to qualified institutional buyers in the U.S. $460 million of convertible subordinated notes pursuant to exemptions from registration afforded by the Securities Act of 1933, as amended. These notes have an interest rate of 1.75 percent and are subordinated to all of our future senior indebtedness. The notes mature on February 22, 2025 unless earlier redeemed by us at our option, or converted or put to us at the option of the holders. Interest is payable semi-annually in arrears on February 22 and August 22 of each year, commencing on August 22, 2005. We have used approximately $125 million of the proceeds to repurchase 6.7 million shares of Sybase stock. We intend to use the remaining proceeds for working capital and general corporate purposes which may include the acquisition of businesses, products, product rights or technologies, strategic investments or additional purchases of our common stock. For purposes of determining the total principal and interest payment commitments above, we have assumed the notes will be held until the first day we may redeem the notes, March 1, 2010. See Note Fifteen to Consolidated Financial Statements, Part II, Item 8.
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New Accounting Pronouncements
SFAS 157, “Fair Value Measurements”
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 157, “Fair Value Measurements” (“FAS 157”). SFAS 157 provides enhanced guidance for using fair value to measure assets and liabilities. The standard also responds to investors’ requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value and the effect of fair value measurements on earnings. SFAS 157 applies whenever other standards require or permit assets or liabilities to be measured at fair value. This standard does not expand the use of fair value in any new circumstances. The provisions of FAS 157 are effective for the fiscal year beginning January 1, 2008. We do not expect the adoption of FAS 157 will have material impact on our financial position, results of operations or cash flows.
SFAS 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans”
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“FAS 158”). FAS 158, requires the recognition of the overfunded or underfunded status of certain plans in the statement of financial position, recognition of changes in the funded status through other comprehensive income and requires the measurement of the funded status of a plan as of the date of the year-end financial statements. The recognition of the funded status of a plan is effective for our fiscal year ended December 31, 2006 and the required measurement date of the funded status is effective for our fiscal year ended December 31, 2008. The recognition of the funded status provision of FAS 158 had no material impact on our financial position, results of operations or cash flows. We do not expect the adoption of the measurement date provisions of FAS 158 will have material impact on our financial position, results of operations or cash flows.
SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities”
In February 2007 the FASB issued SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (FAS 159). FAS 159 provides companies with an option to report selected financial assets and liabilities at fair value. The standard’s objective is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. The standard requires companies to provide additional information that will help investors and other users of financial statements to more easily understand the effect of the company’s choice to use fair value on its earnings. It also requires companies to display the fair value of those assets and liabilities for which the company has chosen to use fair value on the face of the balance sheet. The new standard does not eliminate disclosure requirements included in other accounting standards, including requirements for disclosures about fair value measurements included in FAS 157, “Fair Value Measurements,” and FAS 107, “Disclosures about Fair Value of Financial Instruments.” FAS 159 is effective for our fiscal year beginning January 1, 2008. We do not expect the adoption of FAS 159 will have material impact on our financial position, results of operations or cash flows.
SFAS 160, “NonControlling Interests in Consolidated Financial Statements”
In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 160, “NonControlling Interests in Consolidated Financial Statements” FAS 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and deconsolidation of a subsidiary. The provisions of FAS 160 are effective for our fiscal year beginning January 1, 2009. We are currently evaluating the impact of the provisions of FAS 160.
SFAS 141(R), “Business Combinations” In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 141(R), “Business Combinations.” FAS 141(R) establishes principles and requirements for how an acquirer: (a) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; (b) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and, (c) determines what information to disclose to enable users of the financial statements
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to evaluate the nature and financial effects of the business combination. The provisions of FAS 141(R) are effective for our fiscal year beginning January 1, 2009. We are currently evaluating the impact of the provisions of FAS 141(R).
See Note One to Consolidated Financial Statements - Recent Accounting Pronouncements, Part II, Item 8.
Financial Risk Management
Foreign Exchange Risk
The functional currency of our international operating subsidiaries is generally the local currency. We experience foreign exchange translation exposure on our net assets and liabilities denominated in currencies other than the U.S. dollar. The related foreign currency translation gains and losses from translating these amounts into U.S. dollars for subsidiaries that conduct their business in a currency other than the U.S. dollar, are reflected in “Accumulated other comprehensive income” under “Stockholders’ equity” on the balance sheet. Foreign currency transaction gains and losses, which historically have not been material, are included in interest expense and other, net in the consolidated statements of operations. As of December 31, 2007, we had identifiable net assets totaling $272.5 million associated with our EMEA operations and $115.0 million associated with our other operations.
As a global concern, we face exposure to movements in foreign currency exchange rates. These exposures may change over time as business practices evolve and could have material adverse or beneficial impacts on our financial position and results of operations. Historically, our primary exposures have been related to sales and expenses in EMEA, Asia Pacific, and Latin America; intercompany sublicense fess, intercompany messaging revenues and expenses and other intercompany transactions which are denominated in a currency other than the functional currency of the subsidiary recording the transaction. In order to reduce the effect of foreign currency fluctuations, we utilize foreign currency forward exchange contracts (forward contracts) to hedge certain foreign currency transaction exposures. Specifically, we enter into forward contracts with a maturity of approximately 30 days to hedge against the foreign exchange exposure created by certain balances that are denominated in a currency other than the principal reporting currency of the entity recording the transaction. The gains and losses on the forward contracts are meant to mitigate the gains and losses on these outstanding foreign currency transactions. Although the impact of currency fluctuations on our financial results has generally been immaterial in the past, there can be no guarantee the impact of currency fluctuations related to our intercompany messaging revenues and expenses and other activities will not be material in the future.
We do not enter into forward contracts for trading purposes. All foreign currency transactions and all outstanding forward contracts are marked to market at the end of the period with unrealized gains and losses included in interest expense and other, net. Net foreign exchange transaction gains (losses) included in interest expense and other, net were $0.3 million, $0.3 million and ($1.0) million in 2007, 2006 and 2005, respectively. The unrealized gain (loss) on our outstanding forward contracts as of December 31, 2007 was immaterial to our consolidated financial statements. The tables below provide information about our forward contracts as of December 31, 2007 and 2006.
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Interest Income Rate and Investment Level Risk
Our investments consist primarily of taxable short-term money market instruments and debt securities with maturities between 90 days and three years. We do not use derivative financial instruments in our investment portfolio. Based on our intentions regarding investments, we classify our investments as either held-to-maturity or available-for-sale. Held-to-maturity investments are reported on the balance sheet at amortized cost. Available-for-sale securities are reported at market value.
As a majority of our investments are classified as available-for-sale such securities are recorded at fair value and unrealized holding gains and losses, net of the related tax effect, if any, are not reflected in earnings but are reported as a separate component of other comprehensive income (loss) until realized. Declines in fair value judged to be other than temporary are reflected in earnings. Declines in fair value recorded as impairment losses in earnings have not been material in any reporting period. Realized gains and losses are determined on the specific identification method and are reflected in income.
Changes in the overall level of interest rates and investment levels affect our interest income that is generated from our investments. For 2007 total interest income was $33.5 million with investments yielding 4.80% on a worldwide basis on an investment portfolio that totaled $702.4 million on average. This interest rate level was up approximately 0.39 percent from 4.41 % for 2006. If interest rates fell by a similar amount (0.39 Percent) in 2008, our interest income would decline approximately $2.5 million assuming consistent investment levels.
The table below presents the cash, cash equivalents and cash investments and the related weighted average interest rates for our investment portfolio at December 31, 2007. The cash, cash equivalents and cash investments balances approximate fair value at December 31, 2007.
Default Risk
We place our investments with high quality credit issuers and, by policy, limit the amount of credit exposure with any one issuer. We mitigate default risk by investing in safe, high investment grade securities and by monitoring the credit rating of investment issuers. The portfolio includes only marketable securities with active secondary or resale markets to ensure portfolio liquidity, with the exception of failed auction securities described elsewhere. We have no cash flow exposure due to rate changes for our investment portfolio, since all investments are made in securities with fixed interest rates.
Failed Auction Securities
A small proportion of our investment portfolio is held in Auction Rate Securities with credit ratings ranging from AA to AAA at the time of purchase. ARS are floating rate securities with long-term nominal maturities of 25 to 30 years which are marketed by financial institutions with auction reset dates at 28 day intervals to provide short term liquidity. The underlying collateral of the ARS held by us consist primarily of commercial paper, debt instruments issued by governmental agencies and governmental sponsored entities, and similar assets. Certain of the ARS may have limited direct or indirect investments in mortgage or mortgage related securities. Beginning in August and September 2007 each of the ARS auctions related to our investments began to fail. At December 31, 2007 we held approximately $28.9 million in ARS at cost for which the reset auctions have failed. The failed auctions have resulted in higher interest rates being earned on these investments, but the investments currently lack short-term liquidity. We will not be able to access these funds until a future auction for the ARS investments is successful or we sell the securities in a secondary market. Therefore, we have moved the balance sheet classification of these investments from short term to long term. Any future evaluations by the credit agencies could result in downgrades to the credit ratings of the ARS we hold. Based on our current cash,
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investment balances and expected operating cash flows, we do not anticipate that the lack of short-term liquidity for the ARS to adversely affect our ability to conduct business. See Note Two to Consolidated Financial Statements, Part II, Item 8.
Interest Expense Rate Risk
Borrowings, which were at fixed rates, as of December 31, 2007 were $460 million. Interest expense was $11.6 million for 2007. Based on effective interest rates at December 31, 2007, a 50 basis point increase in interest rates of our borrowings subject to variable interest rate fluctuations would increase our interest expense by $2.3 million annually.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item is presented under “MD&A - Financial Risk Management,” Part II, Item 7.
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ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
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Report of Management on Internal Controls over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2007 based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO. Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2007 to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with generally accepted accounting principles. We reviewed the results of management’s assessment with the Audit Committee of our Board of Directors.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Our internal control over financial reporting as of December 31, 2007 has been audited by Ernst & Young LLP, an independent registered public accounting firm, who expressed an unqualified opinion on the effectiveness of internal control over financial reporting as stated in their report which is included elsewhere herein.
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Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting
The Board of Directors and Stockholders of Sybase, Inc.
We have audited Sybase, Inc.’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Sybase, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting in the accompanying Report of Management on Internal Controls over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate
In our opinion, Sybase, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Sybase, Inc. as of December 31, 2007 and 2006, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2007, and our report dated February 27, 2008 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
San Francisco, California
February 27, 2008
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Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of Sybase, Inc.
We have audited the accompanying consolidated balance sheets of Sybase, Inc. as of December 31, 2007 and 2006, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2007. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sybase, Inc. at December 31, 2007 and 2006, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Sybase, Inc.’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 27, 2008 expressed an unqualified opinion thereon.
As discussed in Note One to the Notes to Consolidated Financial Statements, in fiscal 2006 Sybase, Inc. changed its method of accounting for stock-based compensation.
/s/ ERNST & YOUNG LLP
San Francisco, California
February 27, 2008
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Consolidated Balance Sheets
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Consolidated Statements of Operations
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Consolidated Statements of Stockholders’ Equity
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Consolidated Statements of Cash Flows
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Notes to Consolidated Financial Statements
Note One: Summary of Significant Accounting Policies
The Company
Sybase, Inc. (Sybase or the Company) enables the Unwired Enterprise for customers and partners by delivering enterprise and mobile software solutions for information management, development and integration. Sybase solutions integrate platforms, databases, and applications, and extend those applications to mobile workers through mobile and Wi-Fi technologies.
In 2007, the Company’s business was organized into three business segments: Infrastructure Platform Group (IPG), which principally focuses on enterprise class database servers, integration and development products, iAnywhere Solutions, Inc. (iAS), which provides mobile database and mobile enterprise solutions, and Sybase 365 (SY365), which provides application services that allows customers to easily deliver and financially settle mobile data and messages, including short message services or SMS and multimedia messaging services or MMS.
Principles of Consolidation
The consolidated financial statements include the accounts of Sybase and its majority owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.
As discussed later in this Note One, Sybase adopted Statement of Financial Accounting Standards (SFAS) No. 123(R), “Share-Based Payment,” on January 1, 2006 using the modified prospective transition method. Accordingly, the Company’s operating income from continuing operations for the years ended December 31, 2007 and 2006 includes approximately $13.9 million and $13.6 million, respectively, in pre-tax stock-based employee compensation expense for stock options and stock appreciation rights that was recorded as a result of adopting SFAS 123(R). Because the Company elected to use the modified prospective transition method, results for prior periods have not been restated.
Use of Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements. Management is also required to make certain judgments that affect the reported amounts of revenues and expenses during the reporting period. Sybase periodically evaluates its estimates including those relating to revenue recognition, impairments of investments, goodwill and intangible assets, the allowance for doubtful accounts, capitalized software, income taxes, restructuring, stock-based compensation, litigation and other contingencies. The Company bases its estimates on historical experience and various other assumptions that are believed to be reasonable based on the specific
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circumstances. The Company’s management has discussed these estimates with the Audit Committee of Sybase’s Board of Directors. These estimates and assumptions form the basis for making judgments about the carrying value of certain assets and liabilities that are not readily apparent from other sources. Actual results could differ from these estimates.
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable consist primarily of amounts due to the Company from its normal business activities. The Company maintains an allowance for doubtful accounts to reflect the expected non-collection of accounts receivable based on past collection history and specific risks identified in the portfolio. Additional allowances might be required if deteriorating economic conditions or other factors affect Sybase customers’ ability to make timely payments.
Concentration of Credit Risk
Financial instruments that are potentially subject to concentrations of credit risk consist primarily of cash and cash equivalents, marketable securities and trade receivables. Investment policies have been implemented that limit investments to high quality credit instrument issuers at the time of purchase. As of December 31, 2007, investments classified as long-term cash investments includes six Auction Rate Securities (ARS) with a par value of $28.9 million at the time of purchase. ARS are floating rate securities with long-term nominal maturities which are marketed by financial institutions with auction reset dates at 28 day intervals to provide short term liquidity. Beginning in August 2007 and into September 2007, each of ARS auctions began to fail. The failed auctions have resulted in higher interest rates being earned on these investments, but the investments currently lack short-term liquidity. See Note Two - Financial Instruments. The Company does not require collateral to secure accounts receivable. The risk with respect to trade receivables is mitigated by credit evaluations we perform on our customers, the short duration of our payment terms and by the diversification of our customer base.
Capitalized Software
The Company capitalizes software development costs in accordance with SFAS No. 86, “Accounting for Costs of Computer Software to be Sold, Leased or Otherwise Marketed,” (SFAS 86), under which certain software development costs incurred subsequent to the establishment of technological feasibility may be capitalized and amortized over the estimated lives of the related products. The Company determines technological feasibility to be established upon the internal release of a detailed program design as specified by SFAS 86. Upon the general release of the product to customers, development costs for that product are amortized over periods not exceeding three years, based on the estimated economic life of the product. Capitalized software costs amounted to $359.1 million and $322.6 million, at December 31, 2007 and 2006, respectively, and related accumulated amortization was $284.8 million, and $251.4 million, respectively. Software amortization charges included in cost of license fees were $33.1 million, $31.2 million and $29.7 million for 2007, 2006 and 2005, respectively.
SFAS 86 also requires that the unamortized capitalized costs of a computer software product be compared to the net realizable value of such product at each reporting date. To the extent the unamortized capitalized cost exceeds the net realizable value of a software product based upon its estimated future gross revenues reduced by estimated future costs of completing and disposing of the product, the excess is written off. If the estimated future gross revenue associated with certain of the Company’s software products were to be reduced, write-offs of capitalized software costs might be required. There were no significant write-offs in 2007, 2006 or 2005.
Property, Equipment and Improvements
Property, equipment and improvements are stated at cost less accumulated depreciation. Major renewals and improvements are capitalized, and minor replacements, maintenance and repairs are charged to current operations. Depreciation and amortization are computed using the straight - line method over the estimated useful lives of the assets, while leasehold improvements are amortized over the shorter of the
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estimated useful life of the asset or the associated lease term. The Company includes amortization of assets that are recorded under capital leases in depreciation expense.
Costs related to internally developed software and software purchased for internal use, which are required to be capitalized pursuant to Statement of Position (SOP) No. 98-1, “Accounting for Costs of Computer Software Developed or Obtained for Internal Use,“ are included in property, equipment and improvements. Such amounts are amortized over a three-year period which is the estimated economic life, from the time they are placed in service.
Goodwill and Other Purchased Intangible Assets
The Company accounts for goodwill and other purchased intangible assets in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” (SFAS 142). The Company conducted the annual impairment testing required by SFAS 142 of the IPG and iAS Operating units as of December 31, 2007, 2006, and 2005 and for the SY365 Operating Unit as of December 31, 2007. The analysis for these years did not indicate an impairment for any of the Company’s reporting units. Therefore, no impairment loss was recognized for these years. In future years, a reduction of the Company’s estimated future economic benefits to be generated by certain reporting units could result in an impairment loss associated with various intangible assets.
Other purchased intangible assets have generally resulted from business combinations accounted for as purchases (see Note Eleven below). Other purchased intangibles with determinate lives are amortized using the straight-line method over periods of 3 to 10 years. Other purchased intangibles with indeterminate lives (e.g., trade names) are not amortized.
Impairment of Long-Lived Property, Equipment and Improvements
The Company complies with the provisions of SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” (SFAS 144) which generally requires impairment losses to be recorded on long-lived assets (excluding goodwill) used in operations, such as property, equipment and improvements, and other purchased intangible assets, when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amount of the assets. There were no such impairment losses in 2007, 2006 or 2005.
Revenue Recognition
Prior to the fourth quarter of 2006, the Company derived revenues from two primary sources: the licensing of software, primarily under perpetual software licenses, which are recorded as license fee revenue; and the provision of services which primarily include technical support revenues, consulting, and education revenues. Subsequent to the acquisition of Mobile 365, the Company also derived revenues from messaging transactions.
License and Services Revenues
The Company recognizes revenue in accordance with Statement of Position (“SOP”) 97-2, “Software Revenue Recognition,” and SOP 98-9, and in certain instances in accordance with SOP 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts” or SEC Staff Accounting Bulletin, or SAB, No. 104, “Revenue Recognition.” The Company licenses software under non-cancelable license agreements. License fee revenues are recognized when (a) a non-cancelable license agreement is in force, (b) the product has been delivered, (c) the license fee is fixed or determinable, and (d) collectibility is reasonably assured. If the fee is not fixed or determinable, revenue is recognized as payments become due from the customer and all other revenue recognition criteria are met.
In software arrangements that include rights to multiple software products and/or services, the Company allocates the total arrangement fee among each of the deliverables using the residual method, under which revenue is allocated to undelivered elements based on vendor-specific objective evidence of fair value of such undelivered elements and the residual amounts of revenue are allocated to delivered elements.
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Fees from licenses sold together with consulting services are generally recognized upon shipment provided that the above criteria are met, payment of the license fees are not dependent upon the performance of the services, and the consulting services are not essential to the functionality of the licensed software. If the services are essential to the functionality of the software; payment of the license fees are dependent upon the performance of the services; the arrangement includes milestones or customer specific acceptance criteria; or the services include significant modification or customization of the software both the software license and consulting fees are recognized under the “percentage of completion” method of accounting. The Company uses labor hours to estimate the progress to completion. In order to apply the “percentage of completion” method, management is required to estimate the number of hours needed to complete a particular project and revenues are recognized based on the percentage of total contract hours as they are completed while costs are recognized as incurred. As a result, recognized revenues and profits are subject to revisions as the project progresses to completion. When the total cost estimate associated with a contract accounted for under the percentage of completion method exceeds revenues, the Company accrues for the estimated loss based on the amount its estimated cost of completing the contract exceeds the applicable revenues.
Sublicense fees are recognized as reported to the Company by its licensees. License fee revenues from sublicense transactions for certain application development and data access tools are recognized upon direct shipment to the end user or direct shipment to the reseller for the end user. If collectibility is not reasonably assured, revenue is recognized when the fee is collected and all other revenue recognition criteria are met.
Technical support revenues are recognized ratably over the term of the related agreements, which in most cases is one year. Revenues from consulting services under time and materials contracts and for education are recognized as services are performed. Revenues from other contract services (e.g., fixed price arrangements) are recognized based on the proportional performance of the project, with performance measured based on hours of work performed.
Message Revenues
The Company recognizes messaging revenue in accordance with SAB No. 104, Emerging Issues Task Force, No. 00-21, Revenue Arrangements with Multiple Deliverables (“EITF 00-21”) and EITF, No. 99-19, Reporting Revenue Gross as a Principal Versus Net as an Agent (“EITF 99-19”). The Company recognizes revenue when (a) there is persuasive evidence of an arrangement; (b) the service has been provided to the customer; (c) the amount of the fees to be paid by the customer is fixed and determinable; and (d)) the collection of the fees is reasonable assured.
The Company’s agreements with mobile operators and application providers to provide messaging data delivery and settlement services generally have an initial term of one year. The Company generates a significant portion of its messaging revenue from per message transaction fees and, to a lesser extent, from revenue share agreements related to third party content. Assuming all other criteria have been met the Company recognizes revenue from transaction fees based upon the number of messages successfully processed by its platforms and delivered in accordance with the terms of its arrangements.
In some instances mobile operators, content providers, and other enterprises enter into revenue sharing arrangements with the Company. In some instances third party content providers, and other enterprises enter into revenue sharing arrangements with us. Under a standard revenue sharing transaction the Company delivers content from a third party provider to the cell phone of a mobile operator’s subscriber. Third party content includes, among other, ringtones, wallpapers, interactive games, competitions, directory inquiry services, and information services. The subscriber is invoiced by their mobile operator, who upon receipt of payment, remits a portion of the charge to the Company. Upon payment from the mobile operator, the Company remits payment to the third party content provider. In accordance with EITF 99-19, the Company has determined that we act as an agent under these revenue sharing arrangements and accordingly, record as revenue the net amount retained by the Company. The net amount retained by the Company reflects the gross amount billed the operator less amounts due to the third party content provider.
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Foreign Currencies
The Company translates the accounts of its foreign subsidiaries using the local foreign currency as the functional currency. The assets and liabilities of foreign subsidiaries are translated into U.S. dollars using year-end exchange rates, while revenues and expenses are translated into U.S. dollars using the average exchange rate for the period. Gains and losses from this translation process are credited or charged to the “accumulated other comprehensive loss” account included in stockholders’ equity. Foreign currency transaction gains and losses, which historically have not been material, are included in interest expense and other, net in the consolidated statements of operations.
In order to reduce the effect of foreign currency fluctuations on its results of operations, the Company hedges its exposure on certain transactional balances that are denominated in foreign currencies through the use of short-term foreign currency forward exchange contracts. For the most part, these exposures consist of inter-company balances between Sybase entities resulting from software license royalties, intercompany messaging revenues and expenses, and certain management, research, and administrative services. These exposures are denominated in Canadian, European and Asia Pacific currencies, primarily the Canadian dollar, the UK pound, the Euro, Singapore dollar. These forward exchange contracts are recorded at fair value and the resulting gains and the losses, as well as the associated premiums or discounts, are recorded in interest expense and other, net in the consolidated statements of operations and are offset by corresponding gains and losses on hedged balances. All foreign exchange contracts have a life of approximately 30 days. The Company does not enter into forward contracts for trading purposes. All foreign currency transactions and all outstanding forward contracts are marked to market at the end of the period with unrealized gains and losses included in interest expense and other, net. Net foreign exchange transaction gains (losses) included in interest expense and other, net were $0.3 million, $0.3 million and ($1.0) million in 2007, 2006 and 2005, respectively. The unrealized gain (loss) on outstanding forward contracts as of December 31, 2007 was immaterial to the consolidated financial statements.
Income Taxes
The asset and liability approach is used to account for income taxes by recognizing deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax base of assets and liabilities. The Company records a valuation allowance to reduce deferred tax assets to the amount that is more likely than not to be realized. The Company has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance. Additional information regarding the Company’s deferred tax asset and associated valuation allowance is provided in Note Eight below.
Stock-Based Compensation
Our stock-based employee compensation plans are described in Note Seven - Stockholders’ Equity. Prior to January 1, 2006, the Company applied the intrinsic value recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” in accounting for stock-based incentives. Accordingly, the Company was not required to record compensation expense when stock options were granted to eligible participants as long as the exercise price was not less than the fair market value of the stock when the option was granted. The Company in prior periods generally only recorded stock-based employee compensation expense relating to restricted stock grants. The Company was also not required to record compensation expense in connection with its Employee Stock Purchase Plan as long as the purchase price of the stock was not less than 85% of the lower of the fair market value of the stock at the beginning of each offering period or at the end of each purchase period.
In October 1995 the FASB issued SFAS 123, “Accounting for Stock-Based Compensation,” and in December 2002 the FASB issued SFAS 148, “Accounting for Stock-Based Compensation - Transition and Disclosure.” Although these pronouncements allowed the Company to continue to follow the APB 25 guidelines and not record compensation expense for most employee stock-based awards, the Company
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was required to disclose its pro forma net income or loss and net income or loss per share as if it had adopted SFAS 123 and SFAS 148.
Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123(R) using the modified prospective transition method. Under that transition method, compensation expense that was recognized for 2006 included: (a) compensation expense for all stock-based instruments granted prior to, but not yet vested as of, January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, and (b) compensation expense for all stock-based instruments granted on or after January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R). Because the Company elected to use the modified prospective transition method, results for prior periods have not been restated. In March 2005 the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 107, which provides supplemental implementation guidance for SFAS 123(R). We have applied the provisions of SAB 107 in our adoption of SFAS 123(R). See Note Seven for information on the impact of the Company’s adoption of SFAS 123(R) and the assumptions the Company used to calculate the fair value of stock-based employee compensation.
Net Income Per Share
Shares used in computing basic and diluted net income per share are based on the weighted average shares outstanding in each period, excluding treasury stock. Basic net income per share excludes any dilutive effects of stock options and vested restricted stock. Diluted net income per share includes the dilutive effect of the assumed exercise of stock options, restricted stock, and stock appreciation rights using the treasury stock method. The 2007 dilutive effect of stock options, restricted stock, and stock appreciation rights includes 0.4 million shares of performance based restricted Common Stock granted to certain executives and employees. In 2007, the computation of diluted earnings per share includes the dilutive effects of the Company’s convertible subordinated debt due to the appreciation of the Company’s stock price in which the average price of the Company’s common stock exceeded $25.22 per share, the initial conversion price. See Note Fifteen - Convertible Subordinated Notes.
The following shows the computation of basic and diluted net income per share at December 31:
The anti-dilutive weighted average shares that were excluded from the shares used in computing diluted net income per share, were 3.1 million, 5.2 million and 3.7 million in 2007, 2006 and 2005, respectively. The Company excludes shares with combined exercise prices and unamortized fair values that are greater than the average market price for the Company’s common stock from the calculation of diluted net income per share because their effect is anti-dilutive.
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Comprehensive Income
Comprehensive income includes net earnings and other changes to stockholders’ equity not reflected in net income. The Company’s components of other comprehensive income consist of foreign currency translation adjustments, unrealized gain/loss on available-for-sale securities, and adjustment to apply FASB Statement No. 158.
Advertising
The Company expenses its advertising costs as they are incurred. The Company’s advertising expenses for the years ended December 31, 2007, 2006 and 2005 were approximately $6.7 million, $11.1 million and $6.6 million, respectively.
Recent Accounting Pronouncements
SFAS 157, “Fair Value Measurements”
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 157, “Fair Value Measurements” (“FAS 157”). SFAS 157 provides enhanced guidance for using fair value to measure assets and liabilities. The standard also responds to investors’ requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value and the effect of fair value measurements on earnings. SFAS 157 applies whenever other standards require or permit assets or liabilities to be measured at fair value. This standard does not expand the use of fair value in any new circumstances. The provisions of FAS 157 are effective for the fiscal year beginning January 1, 2008. The Company does not expect the adoption of FAS 157 will have material impact on its financial position, results of operations or cash flows.
SFAS 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans”
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“FAS 158”). FAS 158, requires the recognition of the overfunded or underfunded status of certain plans in the statement of financial position, recognition of changes in the funded status through other comprehensive income and requires the measurement of the funded status of a plan as of the date of the year-end financial statements. The recognition of the funded status of a plan is effective for our fiscal year ended December 31, 2006 and the required measurement date of the funded status is effective for the Company’s fiscal year beginning January 1, 2008. The recognition of the funded status provision of FAS 158 had no material impact on our financial position, results of operations or cash flows. The Company does not expect the adoption of the measurement date provisions of FAS 158 will have material impact on its financial position, results of operations or cash flows.
SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities”
In February 2007 the FASB issued SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (FAS 159). FAS 159 provides companies with an option to report selected financial assets and liabilities at fair value. The standard’s objective is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. The standard requires companies to provide additional information that will help investors and other users of financial statements to more easily understand the effect of the company’s choice to use fair value on its earnings. It also requires companies to display the fair value of those assets and liabilities for which the company has chosen to use fair value on the face of the balance sheet. The new standard does not eliminate disclosure requirements included in other accounting standards, including requirements for disclosures about fair value measurements included in FAS 157, “Fair Value Measurements,” and SFAS 107, “Disclosures about Fair Value of Financial Instruments.” FAS 159 is effective for the Company’s fiscal year beginning January 1, 2008. The Company does not expect the adoption of FAS 159 will have material impact on its financial position, results of operations or cash flows.
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SFAS 160, “NonControlling Interests in Consolidated Financial Statements”
In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 160, “NonControlling Interests in Consolidated Financial Statements” FAS 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and deconsolidation of a subsidiary. The provisions of FAS 160 are effective for the fiscal year beginning January 1, 2009. The company is currently evaluating the impact of the provisions of FAS 160.
SFAS 141(R), “Business Combinations”
In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 141(R), “Business Combinations.” FAS 141(R) establishes principles and requirements for how an acquirer: (a) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; (b) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and, (c) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The provisions of FAS 141(R) are effective for the fiscal year beginning January 1, 2009. The Company is currently evaluating the impact of the provisions of FAS 141(R).
Note Two: Financial Instruments
Cash, Cash Equivalents and Cash Investments
In accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” (SFAS 115) management determines the appropriate classification of debt and equity securities at the time of purchase and re-evaluates such designation as of each balance sheet date. At December 31, 2007, the Company has classified all of its debt and equity securities as available-for-sale pursuant to SFAS 115. Such securities are recorded at fair value and unrealized holding gains and losses, net of the related tax effect, if any, are not reflected in earnings but are reported as a separate component of other comprehensive income (loss) until realized. Realized gains and losses are determined on the specific identification method and are reflected in income.
On January 1, 2006 the Company adopted the FASB Staff positions FAS Nos. 115-1 and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments (the FSPs). The FSPs were issued on November 3, 2005 and nullified certain provisions of EITF No. 03-01 related to evaluating an other then temporary impairment and clarified the accounting policies set forth in FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities. In accordance with the provisions of the FSPs, the Company did not realize impairment losses in 2006 related to unrealized losses on debt securities as a charge to income as the Company believes that the decline in market value is due to changes in interest rates and not due to increased credit risk and it has the ability and intent to hold the securities until a recovery of fair value, which may be maturity. Prior to the issuance of the FSPs and the nullification of certain provisions of the EITF, the Company recognized impairment losses as a charge to income when an individual security had been in a loss position for two consecutive quarters. Prior to 2006, declines in fair value recorded as impairment losses in earnings have not been material in any reporting period.
Cash and cash equivalents consist of highly liquid investments that are comprised principally of taxable, short-term money market instruments with maturities of three months or less at the time of purchase and demand deposits with financial institutions. These instruments carry insignificant interest rate risk because of the short-term maturities. Cash equivalents are stated at amounts that approximate fair value based on quoted market prices. Current and long-term cash investments consist principally of commercial paper, corporate bonds, U.S. and Canadian government obligations and U.S. government sponsored enterprise obligations with stated maturities between 90 days and up to three years and are recorded at amounts that approximate fair value. With the exception of certain auction-rate securities, fair value estimates are based on quoted market prices. No individual investment security equaled or exceeded two percent of total assets.
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At December 31, 2007 cash equivalents, short term and long term cash investments and their amortized costs, unrealized gains and losses and approximate fair values are as follows:
During 2006, the Company did not recognize impairment losses related to unrealized losses on debt securities as a charge to income as the Company believed that the decline in market value was due to changes in interest rates and not due to increased credit risk and it had the ability and intent to hold the securities until a recovery of fair value, which may be maturity.
As of December 31, 2007, long-term cash investments totaling $36.6 million include six auction rate securities (ARS) with an aggregate par value of $28.9 million. As of December 31, 2007, the temporary impairment associated with three of these ARS representing an aggregate par value of $14.9 million and the other-than-temporary impairment associated with the remaining three ARS representing an aggregate par value of $14.0 million were not material.
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ARS are floating rate securities with longer-term maturities which are marketed by financial institutions with auction reset dates at 28 day intervals to provide short term liquidity. The underlying collateral of the ARS held by the Company consists primarily of commercial paper, debt instruments issued by governmental agencies and governmental sponsored entities, and similar assets. Certain of the ARS may have limited direct or indirect investments in mortgage or mortgage related securities. The credit ratings for five of the ARS were AAA and for one of the ARS was AA at the time of purchase. Beginning in August 2007 and into September 2007, each of the ARS auctions began to fail due to a lack of market for these securities. The failed auctions have resulted in higher interest rates being earned on these investments, but the investments currently lack short-term liquidity. The Company will not be able to access these funds until a future auction for the ARS investments is successful or until the Company sells the securities in a secondary market which currently does not exist. Based on the Company’s cash, cash equivalents and cash investment balances of $734.9 million and expected operating cash flows, the Company does not anticipate that the lack of liquidity for the ARS will adversely affect its ability to conduct business and it has the ability and intent to hold the temporarily impaired securities through the currently estimated recovery period. The fair values of the ARS as of December 31, 2007 are based on an estimation using a discounted cash flow model for each of the six ARS using credit related discount rates and term to recovery as key inputs. The determination if the security is other then temporarily impaired is based on a variety of factors including (i) the quality of the investments held by the trust/issuer; (ii) the financial condition of the credit rating of the trust, issuer, sponsors, and insurers; and, (iii) the frequency of the auction function failing. Changes in these assumptions and other factors could result in additional realized and unrealized impairment losses.
The following table summarizes the fair value and gross unrealized losses related to 14 available for sale marketable securities, aggregated by type of investment and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2007:
The following table summarizes the fair value and gross unrealized losses related to 40 available for sale marketable securities, aggregated by type of investment and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2006:
Restricted Cash
At December 31, 2007, the Company had approximately $3.4 million in restricted cash set aside for a guarantee against certain payroll and lease obligations in France, United Kingdom, Sweden, Norway, Denmark, and Australia.
Foreign Currency Forward Exchange Contracts
At December 31, 2007, the Company had outstanding forward contracts, all having maturities of approximately 30 days, to exchange various foreign currencies for U.S. dollars and Euros in the amounts of $24.3 million and $33.5 million, respectively, to exchange U.S. dollars into various foreign currencies in the amount of $35.5 million, and to exchange British Pounds for South African Rand in the amount of $1.3 million. At December 31, 2006, the Company had outstanding forward exchange contracts, all
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having maturities of approximately 30 days, to exchange various foreign currencies for U.S. dollars and Euros in the amounts of $4.1 million and $14.9 million, respectively, and to exchange U.S. dollars into various foreign currencies in the amount of $31.0 million. All foreign currency forward contracts are marked-to-market at the end of each reporting period with unrealized gains and losses included in other income. Neither the cost nor the fair value of these foreign currency forward contracts was material at December 31, 2007 or 2006. A major U.S. based multinational bank was counter party to all of these contracts during both 2007 and 2006.
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Note Three: Property, Equipment and Improvements
Depreciation expense amounted to $27.5 million, $24.2 million and $25.4 million in 2007, 2006 and 2005, respectively.
Note Four: Goodwill and Other Purchased Intangibles
The following table reflects the changes in the carrying amount of goodwill (including assembled workforce) by reporting unit.
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The following table reflects the carrying amounts and accumulated amortization of other purchased intangible assets:
Purchased technology is amortized over a period of 4 to 7 years; covenant not to compete is amortized over a period of 3 years; customer lists are amortized over a period of 6 to 10 years. The AvantGo and XcelleNet tradenames are assigned an indeterminate life and are not amortized but instead tested for impairment in the same manner as goodwill. At December 31, 2007, the weighted average amortization period of the gross carrying value of other purchased intangible assets was 7.1 years. At December 31, 2007, the weighted average amortization period of the gross carrying value of purchased technology and customer lists were 6.6 years and 7.5 years, respectively. Amortization expense for other purchased intangibles totaled $27.4 million, $17.4 million and $18.5 million in 2007, 2006 and 2005, respectively.
Estimated amortization expense for other purchased intangibles in each of the next five years ending December 31, is as follows (in thousands):
Note Five: Other Assets
Other assets consist of the following (in thousands):
Deposits include an $13.9 million security deposit on a 15-year non-cancelable lease for the Company’s Dublin, California facility. Other includes $4.2 million of capitalized note issuance costs related to the Company’s issuance of convertible subordinated notes in 2005. See Note Fifteen to Consolidated Financial Statements.
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Note Six: Lease Obligations, Other Liabilities and Commitments
Capital Lease
The Company leases office space and equipment under non-cancelable capital leases that expire through October 2019.
In May of 2003, the Company entered into a 15-year capital lease for a new facility in Waterloo, Canada. The lease requires monthly payments of approximately $97,913, which includes both principal and interest commencing October 2004 through October 2019. Gross assets of approximately $9.8 million and accumulated depreciation of $2.1 million have been recorded in relation to this capital lease as of December 31, 2007. This capital lease asset is captured on the Company’s balance sheet within property, equipment and improvements, net. The corresponding liability is captured within other liabilities.
Future minimum lease payments under capital lease obligations at December 31, 2007 are as follows (dollars in thousands):
Sale-and-Leaseback
Upon completion of the Company’s acquisition of Extended Systems Incorporated (ESI) in October 2005, the Company assumed the obligations under a sale-and-leaseback transaction completed by ESI in September 2003 related to ESI’s headquarters in Boise, Idaho. The sale-and-leaseback is recorded as a financing transaction. Under the terms of the agreement the Company has an option to repurchase the building and land at any time before September 2013 at a price of $5.1 million. The gross proceeds received of $4.8 million are included in other long-term liabilities on the balance sheet at December 31, 2007.
As part of the agreement, ESI entered into a 10-year master lease for the building with annual lease payments, which are recorded as interest expense, equal to 9.2 percent of the sale price, or approximately $442,000. The Company is also obligated to pay all expenses associated with the building during the lease, including the costs of property taxes, insurance, operating expenses and repairs.
Leasehold Improvements Note
As part of the 15-year capital lease agreement entered into for the Company’s Waterloo, Canada facility, the Company entered into an agreement with the landlord to finance approximately $1.8 million of leasehold improvements at an annual interest rate of 8.76%. The loan requires monthly principal and interest payments of $18,496, commencing October 2004 through October 2019. The corresponding liabilities of $0.1 million and $1.5 million at December 31, 2007 have been recorded in the current and long-term portions of other liabilities, respectively.
Operating leases and Commitments
The Company leases, or has committed to lease, certain office facilities and equipment under operating leases expiring through 2017, which generally require Sybase to pay operating costs, including property taxes, insurance and maintenance. The facility leases generally contain renewal options and provisions adjusting the lease payments based upon changes in the consumer price index, increases in real estate
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taxes and operating expenses or in fixed increments. Rent expense is reflected on a straight-line basis over the term of the lease.
Future minimum lease payments under non-cancelable operating leases having initial terms in excess of one year as of December 31, 2007 (including those provided for in the Company’s restructuring accrual) are as follows (dollars in thousands):
*
Minimum payments have not been reduced by minimum sublease rentals of $7.5 million due in the future under non-cancelable subleases.
The following schedule shows the composition of total rent expenses for all operating leases:
Letters of Credit
At December 31, 2007, the Company had outstanding letters of credit in the amount of $0.3 million. These letters of credit have never been accessed, and related to lease obligations of the Company.
Note Seven: Stockholders’ Equity
Preferred Stock Rights
Pursuant to a Preferred Stock Rights Agreement between the Company and American Stock Transfer and Trust Company, as rights agent, the Company’s Board of Directors declared a dividend of one right (a Right) to purchase one one-thousandth share of the Company’s Series A Participating Preferred Stock for each outstanding share of the Company’s Common Stock outstanding on August 15, 2002. Each Right entitles the registered holder to purchase one one-thousandth of a share of Series A Participating Preferred Stock at an exercise price of $90, subject to certain adjustments, upon the acquisition of, or announcement of the intent to acquire, 15 percent of the Company’s Common Stock by a person or group of affiliated or associated persons. The Rights plan is intended to maximize the value of the Company in the event of an unsolicited attempt to take over the Company in a manner or on terms not approved by the Company’s Board of Directors.
Restricted Stock Grants
During 2007, 2006, and 2005, the Company issued service-based restricted Common Stock under the 2003 Stock Plan to certain senior executives and employees totaling 129,000, 92,786, and 60,000
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shares, respectively. The service-based restricted shares are subject to be returned to the Company over a period of three years from date of grant. The Company’s return right is triggered in the event a restricted shareholder’s recipient’s employment is terminated any time during the three year period. As of December 31, 2007, 30,675 of these service-based restricted shares have been returned to the Company. The Company has amortized the fair market value of the underlying shares on the date the service-based restricted shares were granted pro rata over the term of the applicable return right period.
During 2007, 2006, and 2005 the Company issued performance-based restricted Common Stock under the 2003 Stock Plan to certain executives and employees totaling 422,437, 335,264, and 582,000 shares, respectively. The performance-based restricted shares are subject to be returned to the Company over a period of three years from date of grant. The Company’s return right is triggered in the event a restricted shareholder’s recipient’s employment is terminated any time during the three year period. As of December 31, 2007, performance-based restricted shares returned to the Company due to terminations were 12,800, 37,686, and 35,000 respectively. In addition, the percentage of shares, if any, that will vest will be determined based on the Company’s percentage achievement of certain specified one to three year performance targets. Up to 125% of the shares issued in 2007 and 2006 can vest if the performance achievement exceeds the performance targets. The Company has estimated that vested shares related to the 2007, 2006 and 2005 issuances were 409,637, 297,578, and 547,000 respectively. The Company has amortized the current fair market value of the underlying shares expected to vest pro rata over the term of the applicable return right period. The fair value amortization is adjusted periodically for any changes to the amount of performance-based restricted shares expected to vest as a result of the Company’s return right triggers.
Stock Repurchase Program
Beginning in 1998, the Company’s Board of Directors authorized the repurchase of Sybase outstanding Common Stock from time to time, subject to price and other conditions (Stock Repurchase Program). Through December 31, 2007, aggregate amounts authorized under the Stock Repurchase Program totaled $850.0 million. During 2007, 2006, and 2005 the Company repurchased 6.6 million shares, 2.7 million shares and 2.0 million shares, respectively at costs of $166.7 million, $59.8 million, and $44.1 million, respectively.
During the first quarter of 2005, the Company also repurchased approximately 6.7 million shares at a cost of $125.0 million using a portion of the net proceeds received from its private offering of convertible subordinated notes (See Note Fifteen - Convertible Subordinated Notes). The repurchase of these shares are not part of the Company’s stock repurchase program and was authorized by the Board of Directors in connection with the convertible subordinated note offering.
On February 25, 2008 the Company agreed to conduct a self-tender offer for $300 million of the Company’s common stock at a price between $28 and $30 in a modified Dutch auction. The Company also agreed to use its best efforts to complete approximately $82.9 million in additional open market repurchases prior to the Company’s 2009 Annual Meeting, this amount represents the remaining authorization in the Company’s Stock Repurchase Program (See Note Sixteen - Subsequent Events).
Employee Stock Purchase Plans
The Company’s 1991 Employee Stock Purchase Plan and 1991 Foreign Subsidiary Employee Stock Purchase Plan, as amended (collectively the ESPP), allow eligible employees to purchase our Common Stock through payroll deductions. The ESPP consists of 6-month exercise periods. The shares can be purchased at 95 percent of the fair market value of the Common Stock on the last day of each 6-month exercise period. Purchases are limited to 10 percent of an employee’s eligible compensation, subject to an annual maximum, as defined in the ESPP.
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As of December 31, 2007, an aggregate of 13,400,000 shares of Common Stock had been reserved under the ESPP, of which 1,169,978 shares remained available for issuance. Employees purchased 129,591 shares, 165,554 shares and 300,616 shares in 2007, 2006, 2005, respectively.
Stock Option Plans
An aggregate of 700,000 and 300,000 shares of Common Stock have been issued or reserved for issuance under the 1992 Director Option Plan, as amended (the 1992 Director Plan), and the 2001 Director Option Plan, respectively as of December 31, 2007. Options expire ten years from the date of grant and vest ratably over four years from the grant date. The 1992 Director Plan expired in February 2002, and no further options are available for grant under the 1992 Director Plan, but optionees are able to exercise their vested options before those options expire. As of December 31, 2007, 280,000 unexercised options remain outstanding under the 1992 Director Plan.
An aggregate of 12,141,893 shares of Common Stock have been reserved for issuance upon the exercise of options granted to qualified employees, directors and consultants of the Company pursuant to the 2003 Stock Plan (2003 Stock Plan) at December 31, 2007. The Board of Directors, directly or through committees, administers the Plan and establishes the terms of option grants. Options expire on terms set forth in the grant notice (generally 10 years from the grant date, and for options granted after May 25, 2005 not more than 7 years from the grant date), three months after termination of employment, two years after death, or one year after permanent disability. Options are exercisable to the extent vested. Vesting occurs at various rates and over various time periods, but generally vest over four years.
On May 27, 2004, the Company’s stockholders approved the transfer of all shares available for grant pursuant to the Company’s 1996 Stock Plan and the Company’s 1999 Stock Plan to the 2003 Stock Plan along with all remaining shares represented by grants that are cancelled or forfeited without exercise under these plans and the 1992 Director Plan and the 2001 Director Option Plan. The Company’s 1988 Stock Plan terminated in June 1998 in accordance with its terms, at that time no further grants were made under the 1998 Stock Plan, but optionees may exercise vested options prior to their expiration. As of December 31, 2007, 301,492 unexercised options remain outstanding under the 1988 Stock Plan.
FFI Stock Option Plans
In February of 2000, the Company established the 2000 FFI Stock Option Plan (2000 FFI Plan). At December 31, 2007, an aggregate of 7,088,870 shares of Common Stock have been reserved for issuance upon the exercise of options granted to qualified employees and consultants of FFI, a majority-owned subsidiary of the Company, and certain employees of Sybase, Inc. As FFI is not a public company, the fair market value of the shares issued under the plan has been determined by the Company and supported by a valuation prepared by an independent valuation expert. All options issued under the 2000 FFI Plan were granted at the estimated fair market value of the option at the date of grant. Options expire ten years from the grant date. In March 2001, the 2000 FFI Plan was terminated and no further options were granted under the Plan. As of December 31, 2007, there were 853,724 unexercised options outstanding under the 2000 Plan.
In March 2001, FFI established the 2001 FFI Stock Option Plan (2001 FFI Plan). At December 31, 2007, an aggregate of 6,175,360 shares of FFI’s common stock have been reserved for issuance upon the exercise of options granted to qualified employees and consultants of FFI, and certain employees of Sybase, Inc. As FFI is not a public company, the fair market value of the shares issued under the plan has been determined by the Company and supported by a valuation prepared by an independent valuation expert. FFI’s Board of Directors, directly or through committees, administers the 2001 FFI Plan and establishes the terms of option grants. No options were issued during 2007. Options expire ten years from the grant date. Vesting occurs at the rate of at least 20 percent per year over 5 years from the date options are granted.
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iAS Stock Option Plan
In March 2001, iAS established the 2001 iAS Stock Option Plan (iAS Plan) and reserved for issuance an aggregate of 15,250,000 shares of iAS common stock upon the exercise of options granted to qualified employees and consultants of iAnywhere Solutions, Inc., a majority-owned subsidiary of the Company, and certain employees of Sybase, Inc. iAS’s Board of Directors, directly or through committees, administers the iAS Plan and establishes the terms of option grants. Because iAS is not a public company, the fair market value of the shares issued under the plan has been determined by iAS’s Board of Directors and supported by a valuation prepared by the Company. No options were issued during 2007. Options expire ten years from the grant date, or three months after termination of employment, or two years after death, or one year after permanent disability. Vesting occurs at the rate of at least 20 percent per year over 5 years from the date options are granted.
Impact of the Adoption of SFAS 123(R)
Stock-Based Compensation Expense
The following table summarizes the total stock-based compensation expense for stock options, restricted option and stock grants, and stock appreciation rights that was recorded on the Company’s results of operations in accordance with SFAS 123(R).
Prior to the adoption of SFAS 123(R), the Company presented unearned stock compensation as a separate component of stockholders’ equity. In accordance with the provisions of SFAS 123(R), on January 1, 2006 the Company reclassified the balance in unearned compensation to additional paid-in capital on its balance sheet.
Prior to the adoption of SFAS 123(R), the Company presented all tax benefits for deductions resulting from the exercise of stock options as operating cash flows on its statement of cash flows. SFAS 123(R) requires the cash flows resulting from the tax benefits for tax deductions in excess of the compensation expense recorded for stock-based compensation (excess tax benefits) to be classified as financing cash flows. Accordingly, the Company classified $14.5 million and $9.6 million in excess tax benefits as financing cash inflows rather than as operating cash inflows on its statement of cash flows for 2007 and 2006, respectively.
Determining Fair Value
Valuation and Amortization Method. The Company estimates the fair value of stock options and stock appreciation rights granted using the Black-Scholes option valuation model and a single option award approach. The fair value on all options is amortized on a ratable basis over the requisite service periods of the awards, which are generally the vesting periods.
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Expected Term. The expected term of options and stock appreciation rights granted represents the period of time that they are expected to be outstanding. The Company estimated the expected term of options granted based on historical exercise patterns, which the Company believes are representative of future behavior.
Expected Volatility. Prior to the second quarter of 2005, the Company estimated the volatility factors for stock options and stock appreciation rights considering the historical volatility of its stock over the most recent four year period, which was approximately equal to the average expected life of its options. Beginning in the second quarter of 2005 the Company estimated the volatility of its options and stock appreciation rights considering both the historical volatility of its stock over periods that were equal to the expected term of our options and the prices of its publicly traded options, which the Company believes provides a more accurate estimate of expected volatility factors over the life of the options.
Risk-Free Interest Rate. The Company based its risk free interest rate on the average of the 3 and 5 year treasury rates as published by the Federal Reserve.
Dividends. The Company has never paid any cash dividends on its common stock and does not anticipate paying any cash dividends in the foreseeable future. Consequently, the Company used an expected dividend yield of zero in the Black-Scholes option valuation model.
Forfeitures. SFAS 123(R) requires the Company to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. The Company used historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest. For purposes of calculating pro forma information under SFAS 123 for periods prior to 2006, the Company accounted for forfeitures as they occurred.
The Company used the following assumptions to estimate the fair value of options and stock appreciation rights granted for the periods indicated:
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Equity Compensation Plans
Price data and activity for the Company’s equity compensation plans, including options assumed by the Company in mergers with other companies (adjusted for the merger exchange ratio) are summarized as follows:
The total number of shares granted in 2006 includes 549,728 options assumed by the Company due to its acquisition of Mobile 365, Inc. The weighted average fair value of options, restricted stock, and stock appreciation rights granted in 2007, 2006 and 2005 was $11.68, $10.00, and $9.83 per share, respectively.
At December 31, 2007, options and stock appreciation rights to purchase 7,648,485 shares were exercisable at prices ranging from $0.00 to $28.13. All 5,225,964 shares available for grant at December 31, 2007 were available under the 2003 Stock Plan.
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Equity compensation plans outstanding and exercisable at December 31, 2007 were as follows:
The Company defines in-the-money options at December 31, 2007 as options that had exercise prices that were lower than the $26.09 market price of its common stock at that date. The aggregate intrinsic value of options outstanding at December 31, 2007 is calculated as the difference between the exercise price of the underlying options and the market price of its common stock for the 12.3 million shares that were in-the-money at that date. There were 7.4 million in-the-money options exercisable at December 31, 2007. The total intrinsic value of options exercised during 2007 was $38.1 million and during 2006 was $30.8 million, determined as of the date of exercise.
Nonvested restricted stock grants as of December 31, 2007 and changes during 2007 were as follows:
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Price data and activity for the FFI stock option plans and the iAS Plan are summarized as follows:
No FFI options were granted in 2007, 2006, and 2005. Forfeitures in 2006 include 1,650,008 returned by senior executives of the Company. The weighted average fair value of the iAS options granted in 2005 was $1.06. No iAS options were granted in 2007 and 2006.
The following table summarizes information about the FFI stock options outstanding at December 31, 2007:
There are no intrinsic values for FFI stock options as of December 31, 2007
At December 31, 2007, there were 9,063,856 shares exercisable under the iAS Plan all at an exercise price of $2.51 per share. The weighted average remaining contractual life of the options outstanding at December 31, 2007 was 4.00 years. The weighted average remaining contractual life of the options exercisable at December 31, 2007 was 3.97 years. There are no intrinsic values for iAS stock options as of December 31, 2007.
The Company recorded $13.9 million in stock-based compensation expense before income tax benefit for stock options and stock appreciation rights and $10.2 million in stock-based compensation expense before income tax benefit for restricted stock grants in its results of operations for 2007. The total tax benefit related to this stock-based compensation was $6.8 million. The Company recorded $13.6 million in stock-based compensation expense before income tax benefit for stock options and stock appreciation rights and $8.1 million in stock-based compensation expense before income tax benefit for restricted stock grants in its results of operations for 2006. The total tax benefit related to this stock-based compensation was $5.7 million. As of December 31, 2007, there was $43.4 million of total unrecognized compensation cost before income tax benefit related to non-vested stock-based compensation
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arrangements granted under all equity compensation plans. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures. The Company expects to recognize that cost over a weighted average period of 2.2 years.
The Company received $41.2 million and $50.6 million in cash from option exercises and its Employee Stock Purchase Plan in 2007 and 2006, respectively. The actual tax benefits that the Company realized related to tax deductions for non-qualified option exercises and disqualifying dispositions under all stock-based payment arrangements totaled $7.3 million during 2007 and $12.0 million during 2006.
Due primarily to the Company’s ongoing program of repurchasing its common stock on the open market, at December 31, 2007 the Company had 18.1 million treasury shares. The Company satisfies option exercises from this pool of treasury shares.
Comparable Disclosures
As discussed above, the Company accounted for stock-based employee compensation under SFAS 123(R)’s fair value method during 2006. Prior to January 1, 2006, the Company accounted for stock-based employee compensation under the provisions of APB 25. Accordingly, the Company had recorded no stock-based compensation expense for the Company’s fixed stock option plans (including the FFI and iAS stock plans) and the Company’s employee stock purchase plan for 2005. The following table illustrates the effect on the Company’s net income and net income per share for 2005 had the Company applied the fair value recognition provisions of SFAS 123 to stock-based compensation using the Black-Scholes valuation model.
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Note Eight: Income Taxes
The Company accounts for income taxes under the liability method. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and income tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.
The following is a geographical breakdown of consolidated income (loss) before the cumulative effect of an accounting change and income taxes (In thousands):
The provisions (credits) for income taxes consist of the following (In thousands):
During the quarter ending December 31 2007, due to possible share repurchases or acquisitions, management reduced its estimate of foreign subsidiaries’ earnings permanently reinvested. This change could have the effect of increasing the Company’s future dividends from its foreign subsidiaries and thus its future US taxable income. As a result of this change and other projected changes in the Company’s future US taxable income, management re-evaluated the need for valuation allowances for the Company’s US deferred tax assets. As a result of this re-evaluation, during the quarter ending December 31, 2007, the Company released approximately $27.6 million of valuation allowances relating to federal research tax credit and foreign tax credit carryforwards, of which $26.4 million reduced tax expense and approximately $1.2 million reduced goodwill.
The American Jobs Creation Act of 2004 (the “Jobs Creation Act”) created a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85 percent dividends received deduction for certain dividends from controlled foreign corporations. In 2005 the Company distributed cash from certain foreign subsidiaries and reported an extraordinary dividend (as defined in the Jobs Creation Act) of approximately $94 million. This extraordinary dividend generated an income tax
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expense of approximately $3.1 million relating to the Company’s 2005 results. This tax incentive did not apply in 2007 or in 2006.
The provision for income taxes differs from the amount computed by applying the statutory federal income tax rate to income before income taxes. The sources and tax effects of the differences are as follows (In thousands):
Deferred income taxes result principally from temporary differences between years in the recognition of certain revenue and expense items for financial and tax reporting purposes. Significant components of the Company’s net deferred tax assets were as follows at December 31 (In thousands):
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The valuation allowance decreased by $78.4 million in 2007 and increased by $37.4 million and $36.4 million in 2006 and 2005, respectively. This valuation allowance primarily relates to the deferred tax assets that the Company believes are unlikely to be realized. These deferred tax assets include net operating loss carryforwards, capital loss carryforwards, State research and development tax credits. In addition, a valuation allowance is maintained for deferred tax assets associated with stock option activity until such time as the tax assets reduce current tax payable. The movement was primarily related to the following items (In thousands):
Approximately $48 million of the valuation allowance relates to deferred tax assets associated with net operating losses acquired in, or attributable to, acquisitions. If the associated deferred tax assets are realized, the benefit from their realization will reduce goodwill carried on the Company’s books associated with these acquisitions rather than future income tax expense. The valuation allowance also includes approximately $16 million associated with stock option activity for which any recognized tax benefits will be credited directly to shareholders’ equity. The remaining valuation allowance relates primarily to State net operating loss and tax credit carryforwards.
As of December 31, 2007, the Company had federal research and development tax credits of approximately $28 million, which expire in years from 2009 through 2027, foreign tax credits of approximately $26 million expiring primarily in year 2015, minimum tax credits of approximately $6 million currently not subject to expiration dates, and approximately $126 million of net operating losses which expire in years from 2019 through 2025. As of December 31, 2007, the Company had State net operating losses of $89 million expiring in years 2012 through 2027 and $35 million of State research credits, a portion of which expire in 2012 and a portion of which currently have no expiration period.
No provision has been made for income taxes and foreign withholding taxes on approximately $91 million of undistributed earnings from non-US operations as of December 31, 2007 because the Company currently plans to permanently reinvest all such earnings. If the Company did not plan on permanently reinvesting these earnings, the additional deferred tax liability would be approximately $19 million. When excess cash accumulates in the Company’s non-US subsidiaries, the subsidiary’s earnings are remitted if it is advantageous for business, tax and foreign exchange reasons.
The Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” (“FIN 48”) on January 1, 2007. As a result of adopting FIN 48, the Company did not record any cumulative effect adjustment to the opening balance of retained earnings and additional paid-in-capital. Under FIN 48, the Company recognizes the tax benefit of a tax position that the Company takes or expects to take in a tax return, when it is more likely than not, based on the technical merits, that the position will be sustained upon examination. For these positions, the Company recognizes an amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with the tax authority. Tax benefits for tax positions that are not more likely than
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not of being sustained upon examination are recognized, generally, when the tax position is resolved through examination or upon the expiration of the statute of limitations. The difference between the tax benefit of tax positions taken in tax returns and the amount of tax benefit recognized in our financial statements represents unrecognized tax benefits. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (In thousands):
The total amount of unrecognized tax benefits that would affect our effective tax rate if recognized is $45 million as of December 31, 2007 and $39 million as of January 1, 2007.
We recognize interest and penalties related to uncertain tax positions in income tax expense. The liability for unrecognized tax benefits included accrued interest of $3.5 million and $3 million and no penalties at December 31, 2007 and January 1, 2007, respectively. Tax expense for the year ending December 31, 2007 includes approximately $960 thousand of interest and no penalties.
The Company believes that it has provided adequate accruals for all anticipated tax audit adjustments in the U.S., State and foreign tax jurisdictions based on our estimate of whether, and the extent to which, additional taxes and interest may be due. If events occur which indicate that payment of these amounts are unnecessary, the reversal of these liabilities would result in tax benefits being recognized in the period when the Company determines the liabilities are no longer necessary. If the Company’s estimate of tax liabilities proves to be less than the ultimate assessment, a further charge to expense would result. The Company believes that there are no tax positions for which it is reasonably possible that the unrecognized tax benefits will significantly increase or decrease during the next 12 months.
Sybase, Inc. or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions. With a few exceptions, the Company is no longer subject to U.S. federal, state and local, or foreign income tax examinations by tax authorities for years before 2004. The Company is no longer subject to Canadian income tax examination for years before 2000. Income tax returns filed in certain state and foreign jurisdictions are under examination.
Note Nine: Retirement Plan
401(k) Defined Contribution Retirement Plan
The Company maintains a defined contribution retirement plan pursuant to Section 401(k) of the Internal Revenue Code (the 401(k) Plan) that allows eligible employees to contribute up to a certain percentage of their annual compensation to the Plan, subject to the annual IRS limit. In 2007 and 2006, 401(k) Plan participants who (i) attained the age of 50 during the calendar year and (ii) had made the maximum plan or IRS pre-tax contribution were able to make an additional “catch-up” contribution up to a maximum of $5,000. In 2007, 2006 and 2005, the Company matched employee contribution at a rate of $0.50 for each dollar up to the first $4,000 of salary contributed by the employee, with a maximum employer match of $2,000 for the year fully vested. The Plan also allows the Company to make discretionary contributions. There were no such discretionary contributions made in 2007, 2006 or 2005.
Note Ten: Segment and Geographical Information
Through the first quarter of 2005, the Company was organized into three separate reportable business segments each of which focused on one of three key market segments: Infrastructure Platform Group (IPG), which principally focuses on enterprise class database servers, integration and development
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products; iAnywhere Solutions, Inc. (iAS), which provides mobile database and mobile enterprise solutions; and Financial Fusion, Inc. (FFI), which delivers integrated banking, payment and trade messaging solutions to large financial institutions. Beginning in the second quarter of 2005, the FFI segment was integrated into the IPG segment to enable the Company to better leverage and optimize its engineering, R&D and technical resources to support the FFI product line and to promote synergies between the FFI and IPG technical resources. The results of the FFI business are now reported in the results of the IPG segment. The Company has restated all earlier periods reported to reflect the segment change made in the second quarter of 2005.
On November 8, 2006, the Company acquired Mobile 365, Inc. which provides application services that allows customers to easily deliver and financially settle mobile data and messages, including short message services or SMS and multimedia messaging services or MMS. Beginning in the fourth quarter of 2006, the results of Mobile 365, Inc. are included in the Company’s new reportable business segment Sybase 365 (SY365). There were no changes to the IPG and iAS segments
Sybase’s chief operating decision maker is the President and Chief Executive Officer (CEO). While the CEO is apprised of a variety of financial metrics and information, the Sybase business is principally managed on a segment basis, with the CEO evaluating performance based upon segment operating profit or loss that includes an allocation of common expenses, but excludes certain unallocated expenses primarily stock based compensation. The CEO does not view segment results below operating profit (loss) before unallocated costs, and therefore unallocated expenses or savings; interest income, interest expense and other, net; the provision for income taxes, and minority interests are not broken out by segment. Sybase does not account for, or report to the CEO, assets or capital expenditures by segment.
Certain common costs and expenses are allocated based on measurable drivers of expense. Unallocated expenses or savings represent corporate transactions/activities (expenditures or cost savings) that are not specifically allocated to the segments including stock-based compensation expenses and reversals of restructuring expenses associated with restructuring activities undertaken prior to 2003. Unallocated costs for 2007 and 2006 consisted primarily of stock-based compensation expenses.
Segment license and service revenues include transactions between iAS and IPG, The most common instance relates to the sale of iAS products and services to third parties by IPG. In the case of such a transaction, IPG records the revenue on the sale with a corresponding inter-company expense on the transaction. iAS then records intercompany revenue and continues to bear the costs of providing the product or service. The excess of revenues over inter-company expense recognized by IPG is intended to reflect the costs incurred by IPG to complete the sales transaction. Total transactions between the segments (i.e., intercompany revenue and inter-company expense) are captured in “Eliminations.”
A summary of the segment financial information reported to the CEO for the year ended December 31, 2007 is presented below (in thousands):
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A summary of the segment financial information reported to the CEO for the year ended December 31, 2006 is presented below (in thousands):
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A summary of the segment financial information for the year ended December 31, 2005 based on the Company’s 2007 and 2006 segments is presented below (in thousands):
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Geographic Information
The Company has historically operated in one industry (the development and marketing of computer software and related services). With the acquisition of Mobile 365 in 2006, the Company has begun operations in the mobile messaging services industry. The company markets its products and services internationally through both foreign subsidiaries and distributors located in the United States, Europe, Asia, Australia, Canada, New Zealand and Latin America. Other includes operations in Asia, Australia, Canada, New Zealand and Latin America. The following table presents a summary of annual revenues and net long-lived assets excluding deferred tax assets by geographic region (in thousands):
Note Eleven: Business Combinations
On August 13, 2007, the Company acquired Japan-based Coboplan, a privately held provider of mapping software solutions, also known as Geographic Information System (GIS) software solutions, for approximately $6.4 million in cash. This purchase price exceeds the fair value of the net tangible assets acquired by $6.1 million. Of this excess, $2.6 million was allocated to developed technology with a useful life of five years, and $3.5 million was assigned to goodwill. The Company expects to use Coboplan’s technology to enhance its current offerings for mobile applications. The results of Coboplan are included in the Company’s IAS reporting segment from August 13, 2007 onward.
On November 8, 2006, the Company completed its acquisition of Mobile 365 Inc, a privately held mobile messaging and content delivery company for approximately $418.5 million comprised of $416.2 million in cash and additional purchase related costs of approximately $2.3 million. As a result of the acquisition, the Company expects to extend its Unwired Enterprise vision with the addition of two new enterprise channels, wireless carriers and global content providers. This acquisition provides Sybase with an extensive carrier channel of approximately 700 operators, a portfolio of financial, media and entertainment customers, and new opportunities to leverage its AvantGo mobile Internet service, mFolio™ Web content mobilization service, and data analytics capabilities. The results of Mobile 365 are included in the Company’s Sybase 365 reporting segment from November 8, 2006 onward.
The estimated excess of the purchase price over the fair value of the net tangible assets acquired is approximately $413.8 million. Of the estimated $413.8 million excess, $25.2 million was allocated to developed existing technology, $50.7 million was allocated to customer contracts and relationships, and $337.9 million was allocated to goodwill. The developed existing technology and customer contracts and relationships were assigned useful lives of seven years. The Company’s basis for determining its allocation included consideration of a valuation prepared by an independent third-party appraiser. This independent appraiser also assisted the Company in determining the appropriate useful life with the intangible assets acquired. Included in goodwill is approximately $28.3 million which has an offsetting
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amount allocated to long-term deferred tax liability for the amortization of the developed technology, and customer lists, which is not deductible for tax purposes.
In connection with Mobile 365, included in other current accrued liabilities are accrued operating costs due to mobile operators and content providers totaling $37.6 million and $34.3 million at December 31, 2007 and 2006, respectively.
Note Twelve: Litigation
A former employee, who was terminated as part of position elimination in February 2003, filed a civil action in the Superior Court for the State of California, Alameda County, alleging discrimination on the basis of gender, national origin, and race. The former employee also alleged retaliation for discussing her working conditions with senior managers. The parties were not able to settle the matter and trial commenced on August 27, 2004. Sybase’s motion for non-suit on the retaliation claim was granted and that claim was dismissed. On October 5, 2004, the jury found in favor of the plaintiff on the remaining claims and awarded her $1,845,000 in damages. Sybase filed a motion to set aside the jury verdict or, in the alternative, for a new trial. The motion also asked the judge to set aside the punitive damage part of the award in the amount of $500,000. On December 7, 2004, the judge issued a decision denying the motion to set the verdict aside and order a new trial, but he did grant that part of the motion asking to set aside the $500,000 punitive damage award, reducing the damage amount to $1,345,000. Additional awards for legal fees and costs amounted to $750,000. Sybase filed a notice of appeal of the $1,345,000 jury verdict, as well as the fee and cost awards. Sybase filed its opening brief in the appeal on January 27, 2006. Plaintiff filed their reply brief in April 2006, responding to Sybase’s appeal and appealing the non-suit judgment on the retaliation claim and the judge’s decision to grant Sybase’s motion setting aside the $500,000 punitive damages award. All briefs have been filed in the appeal and oral arguments have occurred. The parties are awaiting a ruling from the court of appeal.
On July 13, 2006, Telecommunications Systems, Inc. (“TCS”), a wireless services provider, filed a complaint for patent infringement in the U.S. District Court for the Eastern District of Virginia, alleging that Mobile 365 infringes U.S. Patent 6,985,748 (the “‘748 patent”). The matter was tried before a jury beginning on May 14, 2007. On May 25, 2007, the jury rendered its verdict, finding that Mobile 365 willfully infringed the ‘748 patent, and awarded TCS a total amount of $12.1 million. TCS has filed post-trial motions for enhanced damages and attorneys’ fees, for an award of prejudgment interest, and for entry of a permanent injunction (although it has requested that any injunction be stayed pending the outcome on appeal). Sybase 365 has filed post-trial motions for a judgment in its favor as a matter of law, for reduction of the jury award, and for entry of judgment in its favor based on TCS’s inequitable conduct before the Patent and Trademark Office in obtaining the patent. The court has granted TCS’s motion for an injunction but stayed it pending the outcome on appeal, and for pre-judgment interest at the rate of prime plus 1%, compounded quarterly. The court has also partially granted Sybase’s motion for remittitur, reducing the pre-issuance damages portion of the jury award by $2.2 million. The court has not yet ruled on the other outstanding motions. If the jury award stands after the court issues its rulings on the remaining motions, Sybase 365 intends to appeal.
The November 2006 merger agreement between Sybase and Mobile 365 established an escrow which provides for indemnification of Sybase by Mobile 365’s former stockholders for certain losses related to the TCS litigation. If both parties post trial motions do not prevail and if damages are limited to the adjusted jury verdict of $9.9 million, Sybase would bear responsibility for approximately $1 million of this amount after reflecting the merger indemnification rights. Sybase believes that the escrow established by the merger agreement will be adequate to address the substantial majority of losses, if any, related to this litigation.
Since the jury’s verdict, Sybase 365 has developed a design-around so that its service for intercarrier wireless text messaging can operate in a way that avoids the infringement as found by the jury. Sybase 365 is in the process of implementing the design-around.
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Sybase is a party to various other legal disputes and proceedings arising in the ordinary course of business. In the opinion of management, resolution of these matters, including the above mentioned legal matters, is not expected to have a material adverse effect on our consolidated financial position or results of operations as the Company believes it has adequately accrued for these matters at December 31, 2007. However, depending on the amount and timing of such resolution, an unfavorable resolution of some or all of these matters could materially affect our future results of operations or cash flows in a particular period.
Note Thirteen: Restructuring Costs
In 2004, 2003, 2002 and 2001 the Company embarked on restructuring aimed at reducing its annual expenses. The Company recorded restructuring charges to reflect these activities including future lease costs, reduced by estimated sublease payments. In connection with the 2003 acquisition of AvantGo, the Company assumed certain liabilities associated with AvantGo’s 2001 and 2002 restructuring programs and accrued additional amounts primarily related to excess space at AvantGo’s facilities, net of expected sublease revenues.
In connection with the acquisition of Mobile 365 the Company recorded restructuring obligations totaling $1.3 million primarily related to the closure or consolidation of several existing Mobile 365 facilities, net of expected sublease revenue, the termination of a small number of Mobile 365 employees and costs associated with the liquidation of Mobile 365 subsidiaries.
The following table summarizes the activity associated with the balance of the accrued restructuring charges related to the plans through December 31, 2007 (Dollars in millions):
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The remaining restructuring accrual for each plan primarily relates to certain lease costs the Company is contractually required to pay on certain closed facilities, net of estimated associated sublease amounts. Sybase’s payments (net of sublease income) toward the accruals relating to lease cancellations and commitments are dependent upon market conditions and the Company’s ability to negotiate acceptable lease buy-outs or to locate suitable subtenants.
These payments will be made over various remaining lease terms over a shorter period as the Company may negotiate with its lessors. Such lease terms under the 2004 Plan, 2002 Plan and 2001 Plan generally expire through October 2012, May 2010 and September 2010, respectively.
During 2007, 2006 and 2005, the Company recognized additional restructuring charges under the plans related to revisions to expected sublease and amounts reflect the difference between the discounted amounts accrued and the actual payments.
Due to the length of some of the lease terms and the uncertainty of the real estate market, the Company expects to make periodic adjustments to the accrual balance to reflect changes in its estimates, and to reflect actual events as they occur.
Note Fourteen: Guarantees
Under its standard software license agreement (SWLA), the Company agrees to indemnify, defend and hold harmless its licensees from and against certain losses, damages and costs arising from claims alleging the licensees’ use of Company software infringes the intellectual property rights of a third party. Historically, the Company has not been required to pay material amounts in connection with claims asserted under these provisions and, accordingly, the Company has not recorded a liability relating to such provisions. Under the SWLA, the Company also represents and warrants to licensees that its software products operate substantially in accordance with published specifications. Under its standard consulting and development agreement, the Company warrants that the services it performs will be undertaken by qualified personnel in a professional manner conforming to generally accepted industry standards and practices. Historically, only minimal costs have been incurred relating to the satisfaction of product warranty claims and, as such, no accruals for warranty claims have been made. Other guarantees include promises to indemnify, defend and hold harmless each of the Company’s executive officers, non-employee directors and certain key employees from and against losses, damages and costs incurred by each such individual in administrative, legal or investigative proceedings arising from alleged wrongdoing by the individual while acting in good faith within the scope of his or her job duties on behalf of the Company. Historically minimal costs have been incurred relating to such indemnifications and, as such, no accruals for these guarantees have been made.
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Contingent Change of Control Provisions
During the fourth quarter of 2003, FFI, a wholly owned subsidiary of the Company included in the IPG segment entered into a software license and support agreement with an end user customer containing certain change of control provisions that will be triggered if the Company or its customer undergoes a full or partial change of control within five years from the contract date. For example, if an unrelated third party acquires all of the stock or assets of FFI so that Sybase can no longer include any portion of, or any material interest in, the results of FFI (or the acquiring entity) in its consolidated financial statements or its results of operations, the acquiring party will be required to pay the end user customer $10.0 million.
Note Fifteen: Convertible Subordinated Notes
On February 22, 2005, the Company issued through a private offering to qualified institutional buyers in the U.S. $460 million of convertible subordinated notes (“Notes”) pursuant to exemptions from registration afforded by the Securities Act of 1933, as amended. These notes have an interest rate of 1.75 percent and are subordinated to all of the Company’s future senior indebtedness. The notes mature on February 22, 2025 unless earlier redeemed by the Company at its option, or converted or put to the Company at the option of the holders. Interest is payable semi-annually in arrears on February 22 and August 22 of each year, commencing on August 22, 2005. In 2007 and 2006, the Company recognized interest expense of $8.0 million, excluding amortization of debt issuance costs totaling $2.0 million. In 2005, the Company recognized interest expense of $6.9 million, excluding amortization of debt issuance costs totaling $1.7 million.
The Company may redeem all or a portion of the notes at par on and after March 1, 2010. The holders may require that the Company repurchase notes at par on February 22, 2010, February 22, 2015 and February 22, 2020.
The holders may convert the notes into the right to receive the conversion value (i) when the Company’s stock price exceeds 130% of the $25.22 per share initial conversion price for a specified time, (ii) in certain change in control transactions, (iii) if the notes are redeemed by the Company, (iv) in certain specified corporate transactions, and (v) when the trading price of the notes does not exceed a minimum price level. For each $1,000 principal amount of notes, the conversion value represents the amount equal to 39.6511 shares multiplied by the per share price of the Company’s common stock at the time of conversion. If the conversion value exceeds $1,000 per $1,000 in principal of notes, the Company will pay $1,000 in cash and may pay the amount exceeding $1,000 in cash, stock or a combination of cash and stock, at the Company’s election.
The Company has recorded these notes as long-term debt. Offering fees and expenses associated with the debt offering were approximately $9.8 million and are included in “other assets” in the Company’s consolidated Balance Sheets at December 31, 2007. This asset will be amortized into interest expenses on a straight-line basis over a five-year period which corresponds to the earliest put date. This approximates the effective interest method. Unamortized offering fees and expenses were $4.2 million and $6.1 million at December 31, 2007 and 2006, respectively.
Note Sixteen: Subsequent Events
On February 25, 2008 the Company entered into an agreement with one of its stockholders, Sandell Asset Management Corp. (Sandell) pursuant to which, subject to certain conditions, (i) the Company agreed to undertake a self-tender offer to purchase $300 million worth of its common stock at a price between $28 and $30 per share in a modified Dutch auction and to complete such tender offer by April 15, 2008, and the Company agreed to use its best efforts to complete approximately $82.9 million in additional open market repurchases prior to the Company’s 2009 Annual Meeting; and (ii) Sandell agreed to withdraw its nominees to the Company’s Board, to terminate its current proxy solicitation, and to vote in favor of the Company’s nominees for directors, at the 2008 Annual Meeting and the 2009 Annual Meeting, and agreed to certain other restrictions on the future acquisition of Company shares, participation in proxy contests involving the Company, public announcements concerning the Company and certain other restrictions until the Company’s 2009 Annual Meeting.
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Quarterly Financial Information (Unaudited)
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ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Report of Management on Internal Controls over Financial Reporting
See Financial Statements and Supplementary Data - Report of Management on Internal Controls over Financial Reporting. Part II, Item 8.
Evaluation of Disclosure Controls and Procedures
An evaluation was performed under the supervision and with the participation of our management, including the Chief Executive Officer (CEO) and Chief Financial Officer (CFO), of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based on that evaluation, our CEO and CFO concluded that our disclosure controls and procedures at December 31, 2007 were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in reports we file or submit under the Exchange Act is accumulated and communicated to our management, including our CEO and CFO as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during our fourth quarter of 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS OF REGISTRANT AND CORPORATE GOVERNANCE
Current Executive Officers
Our executive officers are identified in our definitive Proxy Statement for the Annual Meeting of Stockholders to be held April 15, 2008 (Proxy Statement), to be filed with the SEC within 120 days after our fiscal year ended December 31, 2007.
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Identification of Directors
Our directors are identified under the section entitled “Election of Directors” in our Proxy Statement.
Compliance with Section 16(a) of the Exchange Act
The information required under Item 405 of Regulation S-K is incorporated here by reference to “Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement.
Audit Committee Financial Expert
Our Board of Directors has determined that Audit Committee members Robert P. Wayman and Jack E. Sum are both audit committee financial experts as defined in Item 407(d)(5) of Regulation S-K, and are independent within the meaning of Item 7(d)(3)(iv) of Schedule 14A of the Exchange Act.
Standing Audit Committee
The information required under Item 407 of Regulation S-K and Item 7(d)(1) of Schedule 14A of the Exchange Act pertaining to the standing Audit Committee of the Board of Directors is incorporated by reference to “Election of Directors” in the Proxy Statement.
Corporate Governance Guidelines
We have adopted Corporate Governance Guidelines that are available on our website at www.sybase.com under “Investor Relations.” Stockholders may request a free copy of the guidelines by contacting Investor Relations at the same address set forth under “Code of Ethics,” below.
Certifications
Pursuant to NYSE Rule 303A.12 (a), in 2006 the Company submitted a CEO certification to the NYSE regarding compliance with NYSE Corporate Governance Listing Standards. No qualifications were included in this report. Exhibits 31.1 and 31.2 to this Form 10-K contain certifications of the Company’s CEO and CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Exhibit 32 to this Form 10-K contains certifications of the Company’s CEO and CFO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Code of Ethics
Our code of ethics, entitled “Statement of Values and Business Ethics,” applies to all of our employees, directors and officers (including the chief executive officer, chief financial officer and principal accounting officer), and is available by clicking on the “Code of Ethics” link at the bottom of any page at our website at www.sybase.com. Stockholders may request a free copy of the Statement of Values and Business Ethics from:
Sybase, Inc.
Attention: Investor Relations
One Sybase Drive
Dublin, CA 94568
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to “Executive Compensation” in the Proxy Statement.
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ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this item is incorporated by reference to “Stock Ownership of Management and Beneficial Owners” in the Proxy Statement.
Information required under Item 201(d) of Regulation S-K regarding our equity compensation plans (both stockholder and non-stockholder approved plans) is set forth in the following table with aggregated information regarding our equity compensation plans as of December 31, 2007.
At December 31, 2007, the Company had a total of 11,197,350 options and SARs outstanding with a weighted average exercise price of $18.6188. As of December 31, 2007 the outstanding options and SARs had an average remaining contractual life of 4.71 years. At December 31, 2007 the Company had a total of 1,505,326 shares of outstanding and unvested restricted stock (including performance-based and service-based restricted stock).
(1)
Includes all equity compensation plans in each category that were assumed by the Company in connection with merger, consolidation and acquisition transactions pursuant to which the Company may make subsequent grants or awards of Company securities in the appropriate category.
(2)
A description of the Company’s equity compensation plans, including the 1999 Plan, the Company’s only non-stockholder approved equity plan, is set forth in Note Seven to the Company’s Consolidated Financial Statements, Part II, Item 8. The Company has not made grants under the 1999 Plan since April 2, 2004 and no shares remain available for grant in the 1999 Plan.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information required by this item is incorporated by reference to “Employment and Change of Control Agreements” and “Policies and Procedures for Related Party Transactions” in the Proxy Statement.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is incorporated by reference to “Ratification of Appointment of Independent Registered Public Accounting Firm” in the Proxy Statement.
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PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this Report on Form 10-K:
1. Financial Statements. See financial statements listed in the table of contents at the beginning of Part II, Item 8.
2. Financial Statement Schedules. The following financial statement schedules of Sybase, Inc. for the years ended December 31, 2007, 2006, and 2005 are filed as part of this Report on Form 10-K and should be read in conjunction with the Consolidated Financial Statements and related notes in Part II, Item 8.
3. Exhibits. See the response under Item 15(c) below. All management contracts and compensatory plans filed as exhibits are indicated as such in Item 15(c).
(b) Exhibits. The exhibits required by Item 601 of Regulation S-K are listed in the Exhibit Index to this Report on Form 10-K.
(c) Schedules.
Schedules not listed above have been omitted because they are either (i) not applicable or are not required, or (ii) the information is included in the Consolidated Financial Statements and related Notes, Part II, Item 8.
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SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
SYBASE, INC.
A
Sales returns and credit memos allowances
B
Uncollectible accounts written off and recoveries
The required information regarding the valuation allowance for deferred tax assets is included in Note Eight to the Consolidated Financial Statements.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act, the Registrant has duly caused this Report on Form 10-K to be signed on its behalf of the undersigned, thereunto duly authorized.
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints John S. Chen, Charles Chen and Daniel Cohen, jointly and severally, his or her attorneys-in-fact, each with the power of substitution, for him or her in any and all capacities, to sign any amendment to this Report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this Report on Form 10-K has been signed by the following persons in the capacities and as of the dates indicated:
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EXHIBIT INDEX
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