Item 1. Business.
On May 2, 2006, Activant Group Inc. (formerly known as Lone Star Holding Corp.), or Activant Group, Lone Star Merger Corp., or Merger Sub, and Activant Solutions Holdings Inc., or Holdings (the “Predecessor Company”), consummated a merger, whereupon Holdings became wholly owned by Activant Group, which is wholly owned by investment funds affiliated with Hellman & Friedman LLC, or Hellman & Friedman, Thoma Cressey Bravo, Inc., or Thoma Cressey, and JMI Equity and certain members of our management. Following the merger, on May 2, 2006, Holdings merged with and into Activant Solutions Inc., with Activant Solutions Inc. continuing as the surviving corporation and wholly owned subsidiary of Activant Group. These mergers are referred to as the “mergers” and the transactions related to the mergers are referred to collectively as the “transactions.” The transaction was treated as a purchase and thus the assets and liabilities were recorded at their fair value as of the closing date. Activant Group was incorporated on March 7, 2006 for the purpose of acquiring Holdings and did not have any operations prior to May 2, 2006 other than in connection with the Holdings acquisition. Activant Solutions Inc., or Activant, was incorporated in 1972 under the name of Triad Systems Corporation. In 1997, it merged into CCI Acquisition Corp., becoming a Delaware corporation named Cooperative Computing, Inc., and in October 2003, it changed its name to Activant Solutions Inc. Unless the context otherwise requires, references in this report to “we,” “our,” “us” and the “Company” refer to Activant Solutions Inc. and its consolidated subsidiaries.
Overview
We are a leading provider of business management solutions to distribution and retail businesses. With over 30 years of operating history, we have developed substantial expertise in serving businesses in three primary vertical markets: hardlines and lumber; wholesale distribution; and the automotive parts aftermarket. The vertical markets we serve have the shared characteristic of being complex distribution businesses with advanced inventory management needs. Using a combination of proprietary software and extensive expertise in these vertical markets, we provide complete business management solutions consisting of tailored systems, product support, content, supply chain products and services and professional services designed to meet the unique requirements of our customers. Our fully integrated systems and services include point-of-sale, inventory management, general accounting, e-Commerce, and product data that enable our customers to manage their day-to-day business operations. We believe our solutions allow our customers to increase sales, boost productivity, operate more cost efficiently, improve inventory turns and enhance trading partner relationships.
We have built a large base of approximately 14,500 customers on product support, operating in approximately 30,000 business locations. In addition, our electronic automotive parts and applications catalog is used in approximately 27,000 business locations (a subset of which includes certain product support customers). We have developed strategic relationships with many well-known and influential market participants in each of our primary vertical markets who have a significant effect on their customers’ buying decisions. For example, we are a preferred or recommended business management solutions provider for the members of Ace Hardware Corp. and Do it Best Corp. hardware cooperatives and for Aftermarket Auto Parts Alliance, Inc. pursuant to agreements we have entered into with each of them and their members who are our customers. In addition, we have licensing agreements with many well-known participants in each of the vertical markets we serve, including O’Reilly Automotive, Inc. and the Industry Data Exchange Association, each of which is one of our top five customers within their vertical market. No single customer represents more than 10% of our total sales. Based on number of customers and revenues, we believe we have the leading market position in the United States serving the independently owned and operated hardlines and lumber vertical market and the automotive parts aftermarket. We also believe we are one of the leading providers of business management solutions to the domestic wholesale distribution vertical market.
In May 2007, we acquired all of the outstanding common stock of Silk Systems, Inc. for a total purchase price of $6.5 million, net of $0.7 million cash received. In addition, in August 2007, we purchased substantially all of the assets of the Intuit Eclipse Distribution Management Solutions business for cash consideration of $101.3 million.
Market Opportunity
We focus our products and services on distribution and retail customers that operate in three primary vertical markets: hardlines and lumber; wholesale distribution; and the automotive parts aftermarket. We believe that these businesses are increasingly taking advantage of information technology to more effectively manage their operations.
We have identified a number of common factors driving this demand for technology solutions within our vertical market customers:
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Need for turnkey business management solutions with vertical specific functionality. We believe that software applications from vendors such as Intuit Inc., Microsoft Corporation, Oracle Corporation, The Sage Group PLC and SAP AG, with a broad, general
or horizontal approach, do not adequately address the needs of businesses that have specific functionality requirements. In addition, our typical customer generally does not have a dedicated technology team to plan, purchase, integrate and manage highly complex information technology solutions. As a result, these businesses prefer a single vendor to provide and support a large portion of their information technology infrastructure, which may include software, hardware, product support, network management, professional services, and content and supply chain services.
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Complex supply chains. Our customers operate in markets that have multi level supply chains consisting of service dealers, builders and other professional installers and do it yourselfers that purchase parts or products from local or regional stores and distributors. These businesses, in turn, are connected to one or more warehouses or distributors, which, in turn, are connected to manufacturers. Many of these connections are now Internet-based to facilitate e-commerce. Businesses with complex supply chains require more sophisticated systems and services to operate efficiently.
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Inventory management. Our customers operate in complex distribution environments and manage, market and sell large quantities of diverse types of products, requiring them to manage extensive inventory. Their ability to track and manage that inventory more efficiently can improve their operational and financial performance.
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Need for modern technology. Many of the systems currently in use in the vertical markets we serve are older, character-based or in-house systems with limited extensibility or flexibility. These businesses will need to replace their older systems with more modern, comprehensive business management solutions.
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High customer service requirements. Our customers seek to differentiate themselves in their respective marketplaces by providing a high degree of customer service and value added services. Our systems and services are specifically designed to facilitate this level of customer service. For example, professional contractors expect on-time delivery of complex orders to their building sites, the ability to charge the orders to their account and the ability to receive a credit for any unused materials. In order to meet these high service requirements, businesses in the vertical markets we serve are increasingly adopting more advanced and industry tailored business management solutions.
Our Business Model
Our systems revenues are generally derived from one-time sales while our services revenues generally consist of subscription-based sales that are generally recurring in nature. For fiscal year 2007, our systems revenues were approximately 42% of our total revenues and our services revenues accounted for approximately 58% of our total revenues. Our services revenues consist of product support, content and supply chain services and other services. The components of our business management solutions include the following segments:
Systems
We provide proprietary vertical specific software applications, implementation, training, consulting and third party software, hardware and peripherals. Our software applications are tailored to the unique business processes of our target vertical markets. Depending on the vertical market and specific customer requirements, these systems can provide in-store, retail, contractor and distributor based solutions with fully integrated applications that manage the workflows of a customer’s business operations. In addition, our systems include productivity and customer service tools, add-on modules, replacement hardware and upgrade applications for our existing installed base of customers. Our selling prices for systems can range from $10,000 to over $1,000,000 depending on the size of the business, the software applications needed and the complexity of the implementation.
We provide industry specific implementation, training, consulting and custom programming services to our customers to ensure they receive full value from the technology investments they have made with us and to help them run their business using the best practices found in their particular industry.
Product Support
We provide comprehensive maintenance and customer support. We sell a variety of post-sale support programs that can include customer support activities; including support through our advice line, software updates, preventive and remedial on-site maintenance and depot repair services. Our product support is generally provided on a subscription basis, and accordingly, revenues are generally recurring in nature. Virtually all new systems customers subscribe to product support and continue to subscribe as long as they use the system.
Content and Supply Chain Products and Services
We provide a full range of additional value added products and services to our customers. Our content and supply chain products and services include proprietary database and data management products for the vertical markets we serve (such as our comprehensive electronic automotive parts and applications catalog and point-of-sale business analysis data), connectivity services, e-commerce, networking and security monitoring management solutions. We sell a majority of our content and supply chain products and services on a subscription basis.
Other Services
Our other services are comprised primarily of business products, such as forms and other paper products.
Vertical Market Focus
Our business management solutions serve customers that operate in three primary vertical markets where we have developed specific expertise and have a significant presence as a technology provider. The vertical markets we serve have the shared characteristic of being complex distribution businesses with unique needs that our software addresses.
Hardlines and Lumber
The hardlines and lumber vertical market consists of hardware retailers, home improvement centers, paint, glass and wallpaper stores, farm supply stores, retail nurseries and garden centers, and lumber and building material yards.
Independent hardware and lumber retailers are often affiliated with cooperatives, distributors and buying groups, such as Ace Hardware Corp., Do it Best Corp., True Value Company, Orgill Inc, and Lumbermens Merchandising Corporation that enable members to compete through optimized product assortment, buying power, brand and member wide customer loyalty programs and promotions, along with the incorporation of best business practices. These cooperatives, distributors and buying groups also influence the information technology buying decisions of their large groups of members. We work to insure that these key influencers are aware of and recommend our products and services. National chains that are generally larger than our customers such as The Home Depot, Inc., Lowe’s Home Centers, Inc. and Menard, Inc., generally utilize advanced information technology solution within their businesses. Their adoption of advanced technology often creates demand within our hardware and lumber market for similar solutions.
We believe that a number of trends, including new home construction and sales, increased spending on home improvement, favorable demographic trends and generally positive economic conditions, among others, have driven growth in this vertical market. With the current slowing of housing starts and the migration of cooperatives from their legacy systems to our modern systems almost complete, our continued growth will be dependent on products and services that allow independents in the home improvement industry to compete with chains by broadening the services they offer, excelling at customers service, and maximizing pricing, personnel productivity and other efficiencies.
Wholesale Distribution
The wholesale distribution vertical market includes distributors of a range of products including electrical supply, medical supply, plumbing, heating and air conditioning, brick, stone and related materials, roofing, siding, insulation, industrial machinery and equipment, industrial supplies, fluid power, janitorial and sanitation products, paper and packaging and service establishment equipment.
The business of wholesale distributors revolves around tracking and managing product inventory and servicing customers with high service level requirements, such as product knowledge and availability, flexible delivery schedules, returns management and complex invoicing. In addition, wholesale distributors operate in multiple locations. The ability to manage these operations with a single inventory management system is essential to the success of their business. Wholesale distributors are increasingly using more sophisticated information technology systems to improve inventory turns, increase sales, reduce carrying and other operating costs and improve customer service.
We believe that growth in this vertical market is being driven by increased spending on commercial construction and industrial production, among others.
Automotive Parts Aftermarket
There are three distinct distribution channels through which automotive parts distribution occurs: the wholesale, retail and new car manufacturer channels. The automotive parts aftermarket consists of businesses engaged in the manufacture, distribution, sale and installation of new and remanufactured parts used in the maintenance and repair of automobiles and light trucks. Our systems solutions target primarily the wholesale channel and our content and data services target the wholesale and retail channel.
Participants in the automotive parts aftermarket are required to manage large quantities of data. There are over 4.5 million different stock keeping units, or SKUs, available to parts sellers. As a result, most automotive parts aftermarket participants require comprehensive inventory management systems and catalogs to keep track of these parts. In addition, consumer demand for same day repair service and the need to quickly turn repair bays encourage professional installers to require prompt delivery of specific parts from their suppliers. Therefore, the ability of either a warehouse distributor or parts store to access information about a part’s availability and price and to promptly supply the required product is critical to its success.
We believe that growth in the automotive parts aftermarket in the United States will be driven by a number of factors, including growth in the aggregate number of vehicles in use, increases in the average age of vehicles in operation and increased vehicle complexity.
Competitive Strengths
We believe that the following strengths have contributed to the growth of our systems revenues and our high customer retention rate. We believe that systems revenue is a factor that influences growth in our subscription-based product support revenues.
Provide a Turnkey Business Management Solution to the Vertical Markets We Serve. Using a combination of proprietary software and extensive expertise in the vertical markets we serve, we provide complete solutions and services for our customers. Our solutions and services provide tailored systems, product support, professional services, and content and data services that are designed to meet the unique requirements of our customers and enable them to interact with a single vendor for their business management solutions.
Leading Market Position in the Vertical Markets We Serve. With over 30 years of operating history, we have developed substantial expertise in serving businesses with complex distribution requirements. Based on the number of customers and revenues, we believe we have a leading position in the United States serving the hardlines and lumber vertical market and the automotive parts aftermarket. We also believe we are one of the leading providers of business management solutions to the wholesale distribution vertical market in the United States.
Large Base of Customers with High Retention. We have built a large base of approximately 14,500 product support customers operating in approximately 30,000 business locations. Our electronic automotive parts and applications catalog is used in approximately 27,000 business locations (a subset of which includes certain product support customers). In our experience, our systems and services are integral to the operations of our customers’ businesses and switching from our systems generally requires a great deal of time and expense and may present a significant operating risk for our customers. As a result, we have historically had high levels of customer retention. For example, our average annual product support retention rates for the last three fiscal years for our Activant Eagle, Activant Falcon, Prelude and Prophet 21 products, four of our key business management solutions, have been greater than 93%.
Relationships with Well Known Market Participants. We have developed strategic relationships with many well-known market participants in the hardlines and lumber vertical market and the automotive parts aftermarket. For example, we are the preferred or a recommended business management solutions provider for members of Ace Hardware Corp. and Do it Best Corp. cooperatives and for Aftermarket Auto Parts Alliance, Inc. pursuant to agreements we have entered into with each of them and their members who are our customers. In addition, we have licensing agreements with many well-known participants in each of the vertical markets we serve, including O’Reilly Automotive, Inc. and the Industry Data Exchange Association.
Flexible Systems Offerings. Depending on our customers’ size, complexity of business and technology requirements, we have a range of systems offerings. In our hardlines and lumber vertical market, we provide our Activant Eagle product that, while still tailored to the vertical markets it serves, has a more standard functionality for customers with lower complexity of operations and technology needs. In each of the vertical markets we serve, we also provide a higher-end business management solution for customers with more complex operations and technology needs. By providing flexible systems offerings, we are able to access a broader segment of the addressable market in each of the vertical markets we serve. In addition, the modular design of our productivity tools and add-on modules provides our customers with flexibility to deploy all of our add-on offerings at once or to implement our offerings individually or incrementally.
Large Base of Recurring Subscription Revenues. Product support and content and supply chain services revenues comprise nearly all of our services revenues. These revenues are generally recurring in nature since they are derived primarily from subscriptions to our support and maintenance services, our electronic automotive parts and applications catalog, databases, connectivity and other services. Services revenues accounted for approximately 58% of our total revenues for fiscal year 2007. We believe that the generally recurring nature of our product support and content and supply chain revenues provides us with a more predictable and stable stream of revenues relative to systems revenues that are primarily one-time purchases. Virtually all new systems customers subscribe to product support and continue to subscribe as long as they use the system.
Products and Services
Our principal products and services offerings consist of:
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Systems. We provide vertical specific proprietary software applications, consultation, training and implementation services, and third party software, hardware and peripherals.
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Product Support. We sell a variety of post sale support programs that include daily operating support through our advice line, software updates, preventive and remedial on-site maintenance and depot repair services.
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Content and Supply Chain. Our content and supply chain offerings include proprietary database and data management products for the vertical markets we serve (such as our comprehensive electronic automotive parts and applications catalog and point of sale business analysis data), connectivity services, e-commerce, networking and security monitoring management solutions.
Systems
We offer systems consisting of proprietary vertical specific software applications, implementation and training and third party software, hardware and peripherals. Our products provide in-store, retail, distributor and warehouse based solutions with fully integrated applications that manage the workflows and data relating to a customer’s typical sales transactions and automate and streamline a customer’s inventory, sales and distribution operations. These applications include order management and fulfillment, barcode scanning and processing, inventory control, pricing, purchasing, accounts receivables and payables, special order processing, quote and bid processing, vendor and manufacturer communications, payroll, general ledger and credit and debit card authorization. The selling price of our products depends on a variety of factors, including the number of locations and users and the products requirements of the customer.
In addition, we offer productivity tools and add-on modules to our customers to enhance the capabilities of our products. The modular design of our productivity tools and add-on modules, such as business intelligence, credit card signature capture and delivery tracking, provides our customers with flexibility to deploy or implement our offerings individually or incrementally.
When we sell a new system or add-on module, our professional services team works to minimize disruption during the conversion process and to optimize our customers’ use of the product by training them to use the primary and specialized features of the software. In addition, we integrate most of our products with hardware components and software products of third-party vendors prior to distributing the products to our customers. We primarily use Dell Inc.’s industry standard server and workstation hardware to power our software solutions. In addition, we offer hardware solutions from International Business Machines Incorporated and Hewlett Packard Company for certain of our solutions.
The following outlines our primary systems offerings:
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Activant Eagle. Our Activant Eagle product is designed for small and medium sized retail stores across multiple vertical markets, including hardware and home center, lumber and building materials and its sub-verticals and select auto jobber distributors.
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Prophet 21. Our Prophet 21 product, formerly known as CommerceCenter, is designed for distributors across multiple segments of the wholesale distribution vertical market including but not limited to industrial, electrical, fastener, fluid power, tile and floor covering, heating and air conditioning, and medical supply.
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Activant Prism. Our Activant Prism product is designed to meet the needs of both national and independent stores as well as smaller businesses in the automotive parts aftermarket.
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Activant Falcon. Our Activant Falcon product is designed for large multi-location hardlines and lumber operations.
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Activant Vision. Our Activant Vision product is designed for, and targeted to, local, regional and national warehouse distributors in the automotive parts aftermarket and office product market.
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Activant Eclipse. Our Activant Eclipse product is a fully integrated, real-time business management solution specifically designed for plumbing and electrical wholesalers.
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Activant Dimensions Canada. Our Activant Dimensions Canada product is designed for small and medium sized stores across multiple vertical markets within Canada, including hardware and home center, lumber and building materials and its sub-verticals.
Systems We Continue to Support. In addition to our primary system offerings, we also service and maintain, but do not actively sell to new customers, additional legacy systems including:
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Automotive Aftermarket - J-CON , Loadstar, Series 12, Activant ServiceWriter, Eclipse, A-DIS, Ultimate
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Lumber Dealers - CSD, Dimensions, Version 2, 4GL
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Wholesale Distributors - Acclaim, XL, Array, DISC, D2K, FasPac, SDI, StanPak, Turns
Currently, we realize significant product support revenues from customers using these products. We have built upgrade and conversion paths to our primary system offerings for the customers on our legacy products.
Product Support
We provide comprehensive maintenance and customer support for each of our products. Our customers are principally independent businesses that require a high level of service, training and customer support to train users and to maintain their systems. We believe that we offer the broadest set of implementation and support services to businesses in our vertical markets. Our product support offerings include:
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Access to Software Updates. We provide our product support customers with regular software updates, which, among other things, provide bug fixes, selected functionality enhancements and efficiency improvements.
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Advice Line Support. Our team of software and applications specialists provides customers with telephonic and Internet training, troubleshooting and other support related to our software and hardware. This team provides technical and industry specific support for our systems through real time diagnostics, access to our extensive knowledge base and assistance in optimizing our customers’ usage of our systems for their businesses. We offer our customers several service plan options to accommodate their support needs and requirements for their businesses. In addition, our product development team is available to address the most complex systems issues.
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Nationwide Hardware and Networking Specialists. Our field service team can be dispatched throughout the United States, Canada and Puerto Rico to diagnose and repair hardware and software on-site. We believe that this team of service professionals provides us with a competitive advantage. Because these services are provided on-site, the customer often develops a working relationship with its hardware and networking specialist. We do not believe any of our primary competitors offers nationwide on-site support and service.
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Server and Peripheral Repair. We support server and peripheral repair via overnight exchange and other programs from our repair facility and through outsourced peripheral repair services.
We have web-based product support that allows customers direct access to a call tracking system, online product training courses and an online knowledge base. These features allow customers to request support services, review specific calls or their entire call history, increase employee system knowledge through online coursework or search a knowledge base to obtain ready answers to questions. In addition, we provide Advice Line support through e-mail and have recently deployed a new customer relationship management system to improve our call center infrastructure and provide better service to our customers.
Virtually all new systems customers subscribe to product support and continue to subscribe as long as they use the system. Product support subscriptions vary from a monthly to an annual basis depending on the product, and the subscription fees vary by system size, number of users and configuration. In addition, we offer seminars and workshops to assist customers in understanding the capabilities of their systems. We strive to provide comprehensive information technology support to small and medium sized business customers to build customer relationships, enhance customer satisfaction and maximize customer retention rates.
Content and Supply Chain
Our content and supply chain products and services include database services with information and reports related to point-of-sale activity, and connectivity services. These services are specific to the retail and wholesale trade vertical markets we serve and complement our systems offerings.
Automotive Parts Aftermarket: We provide electronic catalogs, barcodes, related repair information and reports based on point of sale activity through a variety of data services. These proprietary database products and services generate recurring revenues through period (generally monthly) subscription fees and differentiate our products from those of our competitors. We offer data services to our automotive parts aftermarket customers, including warehouse distributors, manufacturers and parts stores and professional installers. Our principal content and supply chain products and services are:
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PartExpert. Our electronic automotive parts and application catalog provides access to a database of over 300 million unique automobile part applications for approximately 7,500 automotive parts aftermarket product lines. These products significantly reduce the time consuming and cumbersome use of printed catalogs and are designed to increase productivity and accuracy in parts selection and handling. Our Auto systems are integrated with PartExpert. For our PartExpert product, we acquire, enter, clean, standardize and format data from over 800 nationally branded automotive parts manufacturers in an original, creative and unique manner. This data comes from manufacturers in paper or electronic format. We generally produce catalog updates on compact discs or DVD’s approximately ten to twelve times per year from our facilities in Livermore, California, Austin, Texas and Longford, Ireland.
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Interchange. Our electronic automotive, medium/heavy-duty truck, agricultural and commercial parts interchange product provides access to a database of over 16 million OEM-to-aftermarket and aftermarket-to-aftermarket interchange records.
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Activant Cover-to-Cover. The Activant Cover-to-Cover add-on provides extended automotive aftermarket part information to PartExpert and ePartExpert customers such as product images, specifications, installation instructions, warranty information and technical service bulletins.
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LaborExpert. Our LaborExpert offering provides a powerful electronic labor-estimating tool based on the Mitchell labor database. This product is used primarily by the installer segment.
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Service Intervals Plus. Our Service Intervals Plus offering provides access to a database of service intervals for both routine and severe service maintenance schedules. This product is used primarily by the installer segment.
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Buyer Assist. Our electronic automotive aftermarket buyer’s guide provides vehicle coverage listings, list price, package quantities, manufacturers’ popularity codes and per-car quantities. This product is used primarily by warehouse distributor and part store buyers and inventory managers.
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ePartExpert. Our ePartExpert service enables service professionals and consumers to access our automotive parts database online. This product is used by the manufacturer, warehouse distributor and professional installer segments of the automotive parts aftermarket.
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Price Updating Services. Our pricing distribution and updating services provide automated and timely automotive aftermarket price information updating. These products are targeted primarily at warehouse distributors and parts stores. We acquire, enter, clean, standardize and format data from manufacturers and distributors with custom pricing, then securely distribute price updates via telecommunication or compact discs.
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ePartInsight. Our ePartInsight service provides data hub capability that allows large buying groups to access inventory and sales information throughout the buying group simultaneously, which allows better visibility into product sales and inventory trends. This data warehouse product can be connected to our entire automotive parts aftermarket warehouse distributor and parts store products as well as third party software.
We also market the following content and supply chain products and services to our vertical markets.
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Trading Partner Connect. Our Trading Partner Connect offering is an Internet trading network that streamlines the commerce process between distributors, their manufacturers and/or suppliers, and end users, thereby extending geographic reach of a distributor, increasing sales and improving customer service while reducing operating costs. Through Trading Partner Connect, distributors can access millions of items, enabling them to compete on a larger scale and improve customer service. Distributors further benefit from reduced costs related to EDI and surplus inventory. Trading Partner Connect also provides distributors with a web-based storefront designed to give end users online customer service as well as ordering capabilities 24 hours a day, seven days a week (excluding normal maintenance periods). Trading Partner Connect offers several components, including B2B Marketplace, B2B Buyer, B2B Alliance, B2B Gateway and B2B Seller.
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Networking Support & Security Monitoring. Our Networking Support & Security Monitoring offerings are targeted primarily at the hardlines and lumber vertical market and the automotive parts aftermarket, but are applicable to all of our three vertical markets. These offerings provide network installation, provisioning, troubleshooting and problem resolution, firewall installation and configuration and virus protection services.
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VISTA. Our VISTA offering is targeted for manufacturers in all three of the vertical markets we serve. Information provided by the VISTA service gives manufacturers insight into how a specific product or brand performs against its competitors and the market in general based upon actual sales history provided from our systems customers and consumer market surveys and through collaboration with other sources of industry sales data. We provide this data to our customers in a variety of formats.
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IDW and IDX. Our IDW and IDX offerings are targeted at the wholesale distribution vertical market. They enable electrical parts manufacturers and warehouse distributors to exchange product information, purchase orders and related documents using electronic data interchange and Internet technologies.
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Activant Inet. Our Activant Inet offering is targeted at the hardlines and lumber vertical market. Inet provides e-commerce capabilities to our customers such as the ability to conduct business online with their vendors and customers, including e-store ordering, invoicing and e-statement functionality.
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AConneX. We offer Internet and modem based communication services that connect the automotive parts aftermarket from manufacturers through warehouse distributors and parts stores to professional installers. Our flagship service, AConneX, uses the Internet to allow communication between and among our software systems and other companies’ software systems. AConneX enables parts to be ordered by professional installers from eStore partners and creates a trading network among parts stores and warehouse distributors. In addition, we offer an electronic data interchange interface between warehouse distributors and manufacturers.
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Activant B2B Seller. The Activant B2B Seller offering is targeted at the wholesale distribution markets. Activant B2B Seller provides e-commerce capabilities to our customers such as the ability to conduct business on-line with their vendors and customers, including e-store ordering, product catalogs, invoicing, e-statement, remittance and reporting functionality.
Other Offerings
In addition to systems, product support and content and supply chain offerings, we offer our customers migration tools and services, and other business products.
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Productivity Tools and Services. We provide a complete suite of professional services and software tools for customers who wish to migrate their applications and databases from the Hewlett Packard e3000 to Unix or Windows platform systems. In November 2001, the Hewlett Packard Company announced that it is ending sales and support for this platform over a seven year period, which has since been extended by two years, that will likely result in the decline of our migration business as we approach the end of that nine year period.
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Business Products. We offer both standard and custom third-party record keeping and sales forms and other office supplies, primarily to our existing customer base. These forms and supplies include purchase order forms, checks, invoices, ink, toner and ribbons that are compatible with our software and hardware systems.
Sales and Marketing
We have dedicated sales groups to each of the hardlines and lumber, wholesale distribution vertical markets and the automotive parts aftermarket. Our sales and marketing strategy is to provide relevant business expertise to target customers by using sales representatives with strong industry specific knowledge.
Within these vertical markets, we use a combination of field sales, inside sales, value added resellers and national account programs. We seek to partner with large customers or groups of customers and leverage these program groups to sell to their members. Incentive pay is a significant portion of the total compensation package for all sales representatives and sales managers. Our field sales teams generally focus on identifying and selling to new customers, while our inside sales team focuses on selling upgrades and new software applications to our installed base of customers.
Our marketing approach is to develop strategic relationships with many of the well-known market participants in the vertical markets that we service. For example, we are a preferred or recommended business management solutions provider for the members of Ace Hardware Corp. and Do it Best Corp. cooperatives for the hardlines and lumber vertical market, Netplus and NISSCO for the wholesale distribution market, and Aftermarket Auto Parts Alliance, Inc. for the automotive vertical market pursuant to agreements we have entered into with each of them and their members who are our customers. In addition, we have agreements with many of the well-known participants in the vertical markets we serve, including O’Reilly Automotive, Inc. and the Industry Data Exchange Association. This strategy includes obtaining endorsements, warehouse distributor partnerships and other alliances. The goal of these programs is to enhance the productivity of the field sales team and to create leveraged selling opportunities for system sales and content and supply chain offerings. These relationships have allowed us to streamline the distribution channel and to reduce our direct sales costs.
Product Development
Our product development strategy combines innovation and the introduction of new technology with our commitment to the long-term support of the unique needs of our customers. We seek to enhance our existing product lines, offer streamlined upgrade and migration options for our existing customers and develop compelling new products for our existing customer base and prospective new customers.
Our customer base includes long-term customers using our older, character based systems, as well as those who have upgraded to our most recently developed products running on Microsoft Windows, Linux, AIX and several UNIX platforms. A large portion of our current installed customer base is using older character-based systems, especially in the automotive parts aftermarket. We believe there is a significant opportunity for us to migrate these customers to our current generation of systems offerings running on more modern technology platforms. We have developed our current generation of products to provide an efficient migration path for customers operating older systems while preserving existing functionality and offering significant advantages in ease of use and new e-commerce capabilities.
In the development of our software, we use industry standard tools such as .Net, Java, Microsoft and Progress toolsets and a variety of open source based technologies. We are also developing a next generation industry catalog and continuing to expand our next generation e-commerce and connectivity offerings.
We also leverage a set of key technology relationships with third-party vendors to offer or facilitate a complete turnkey business management solution to our customers. We have relationships with several third party vendors including (1) Dell Inc., International Business Machines Incorporated, Hewlett Packard Company and Motorola (Symbol Technologies) for hardware platforms, (2) Microsoft for tools, operating systems and databases, (3) Progress Software for development tools, (4) Sterling Commerce and Inovis for EDI and (5) SonicWALL, Inc. for security solutions.
We have a centrally managed development organization designed to develop shared products and technologies that are used across multiple vertical markets as well as specific vertical markets.
Intellectual Property
We have approximately 268 registered copyrights, 86 registered trademarks and six issued patents. We attempt to protect our intellectual property in a number of ways. First, we distribute, or enable access to, our proprietary software and database products through licensing agreements, which require licensees to acknowledge our ownership of the software and databases and the confidential nature of our proprietary information, and grant limited usage rights. Secondly, all of our personnel are required to assign to us all rights of such personnel to inventions, patents, works of authorship and confidential information developed in conjunction with their employment relationship and agree to keep confidential our proprietary information. Finally, we require that third parties receiving our confidential information execute a non-disclosure agreement.
In general, copyright in a work created on or after January 1, 1978, subsists from its creation and endures for a term consisting of the life of the author and 70 years after the author’s death. The duration of our trademark registrations varies from country to country. In the U.S., we generally are able to maintain our trademark rights and renew trademark registrations for as long as the trademarks are in use. The duration of our patents issued in the U.S. is typically 17 years from the date of issuance of the patent or 20 years from the date of filing of the patent application.
While we believe that our ability to maintain and protect our intellectual property rights is important to our success, we also believe that our business as a whole is not materially dependent on any particular patent, trademark, license or other intellectual property right. Legal protections for some information products may be limited and technical means may not be available to protect against unauthorized use, access, display, reproduction or distribution. We may not be able to adequately protect our technology and competitors may develop similar technology independently.
Customers
For fiscal year 2007, no single customer accounted for more than 10% of our total revenues. Our top ten customers accounted for 6.3% of our total revenues. Some of our top ten customers included (1) Ace Hardware Corp. and True Value Company in the hardlines and lumber vertical market, (2) the Industry Data Exchange Association, a joint venture formed by the National Electrical Manufacturers Association and the National Association of Electrical Distributors, in the wholesale distribution vertical market and (3) General Parts, Inc., Aftermarket Auto Parts Alliance, Inc. and O’Reilly Automotive, Inc. in the automotive parts aftermarket. We have approximately 14,500 systems customers, of which approximately 1,200 were added as a result of the Silk Systems and Eclipse acquisitions.
Competition
The vertical markets we serve are highly fragmented and served by many competitors. In the vertical markets we serve, we primarily compete against smaller software companies with solutions for a single vertical market or with proprietary systems developed by or for industry participants. The key factors influencing customers’ technology purchase decisions in the vertical markets we serve include, among others: ability to provide a turnkey business management solution with vertical specific functionality, depth of vertical expertise, pricing, level of services offered, credibility and scale of the technology vendor and connectivity with chosen industry trading partners. Many of our smaller competitors offer solutions that contain fewer features and compete by pricing their products and services below our prices.
In the hardlines and lumber vertical market, we compete primarily with smaller, niche-focused companies, many of which target specific geographic regions. Some of our competitors in this vertical market include Spruce Computer Systems, Inc., ECI2 and Progressive Solutions, Inc.
We compete with several other vertically focused software providers in the wholesale distribution vertical market, including a division of Infor Global Solutions, Inc., Sage Software and NetSuite Inc. Other competitors include vertically focused software vendors in the building material, distribution and manufacturing markets, as well as independent software vendors, software tool developers and vendors and database vendors in other markets.
In the automotive parts aftermarket we compete primarily with smaller software and content companies that operate regionally or in a specific niche of the market and with proprietary systems developed by or for industry participants. Some of our competitors in this vertical market include Autologue Computer Systems Inc., in systems, and WHI in systems and content and data services. Genuine Parts Company (NAPA) and General Parts, Inc. (“GPI”) each offer its own branded solution to its company owned and independently affiliated stores.
Several large software companies have made public announcements regarding the attractiveness of various markets we serve and their intention to expand their focus in these markets, including Microsoft Corporation, Oracle Corporation, and SAP AG. These large software companies rarely compete directly with us except on larger, national focused transactions. However, these and other large software companies have made public announcements regarding the attractiveness of various small and medium-sized business markets and their intention to expand their focus in these markets. As a result, we expect competition with these large software companies may increase in the future.
Suppliers
For fiscal year 2007, Dell Inc. was our largest supplier of hardware supplies used in our solutions. No other supplier accounted for more than 10% of our total hardware supply expense. We have a number of competitive sources for supplies used in our operations.
Employees
We have approximately 2,200 employees as of September 30, 2007. None of our employees are represented by unions. We have not experienced any labor problems resulting in a work stoppage and believe we have good relations with our employees.
Joint Venture
We own approximately 46% of the outstanding common stock of Internet Autoparts, Inc., or Internet Autoparts, a joint venture among us and some of our key customers and other investors, which was formed in May 2000. Internet Autoparts provides the automotive parts aftermarket with a web-based parts ordering and communications platform linking automotive service providers with wholesale distributors and other trading partners.
We granted certain non-exclusive, perpetual, non-transferable licenses to Internet Autoparts in connection with our investment in Internet Autoparts. Internet Autoparts agreed, subject to certain exceptions, not to compete with us in the businesses in which we are engaged. In addition, we agreed, subject to certain exceptions, not to compete with Internet Autoparts in the business of selling new or rebuilt automotive parts over the Internet to professional installers and consumers.
Internet Autoparts utilizes our web-based parts catalog, ePartExpert, and has access to our Internet communications gateway, AConneX, which provides ready communications among its various business platforms and third-party management systems. AconneX is available for licensing to third-party management systems in addition to Internet Autoparts. The licenses granted to Internet Autoparts provide for the payment to us of royalties based upon a percentage of net sales made by Internet Autoparts using the licensed technology. We have no commitment to invest additional funds in Internet Autoparts, although, we are obligated to provide service and support for AConneX.
Segment Reporting
See Note 14 of Notes to Consolidated Financial Statements.
Item 1A.
Item 1A. Risk Factors.
Any of the following risks could materially and adversely affect our business, financial condition or results of operations. The risks described below are not the only risks facing us. Additional risks and uncertainties not currently known to us or those we currently view to be immaterial may also materially adversely affect our business, financial condition or results of operations.
If we cannot successfully anticipate or respond to our customers’ needs and requirements, our revenues could decline significantly and our operating results could be materially adversely affected.
The business management solutions industry is characterized by technological advances, adoption of evolving industry standards in computer hardware and software technology and new product introductions. Our future success will depend in part on our ability to:
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maintain and enhance our systems and services;
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successfully anticipate or respond to our customers’ needs and requirements, including with regard to advancements in user interface, connectivity and ease of use requirements; and
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develop and market our electronic automotive parts and applications catalog and other products and services in order to meet changing customer needs.
We may not be able to effectively respond to the changing technological requirements of the vertical markets we serve. To the extent we determine that new software and hardware technologies are required to remain competitive or our customers demand more advanced offerings, the development, acquisition and implementation of these technologies are likely to require significant capital investments by us and significant time for development, integration and implementation. Capital may not be available for these purposes and investments in technologies may not timely meet market requirements or result in commercially viable products. In addition, we may not be able to maintain our electronic automotive parts and applications catalog or introduce new versions or releases in a timely manner, and we may not be able to implement these new versions or releases in a manner that will meet the needs of our customers and maintain their proprietary nature. In the event we are not able to respond to changing technological requirements in the vertical markets we serve or our customers’ needs, our revenues could decline significantly and our operating results could be materially adversely affected.
If we do not develop new relationships and maintain our existing relationships with key customers and/or well-known market participants, our revenues could decline significantly and our operating results could be materially adversely affected.
We have developed strategic relationships with many well-known market participants in the hardlines and lumber vertical market and the automotive parts aftermarket. For example, we are an exclusive, a preferred and/or a recommended business management solutions provider for the members of the Ace Hardware Corp. and Do it Best Corp. cooperatives and Aftermarket Auto Parts Alliance, Inc. We believe that our ability to increase revenues depends in part upon maintaining our existing customer and market relationships, including exclusive, preferred and/or recommended provider status, and developing new relationships. We may not be able to renew or replace our existing licensing agreements upon expiration or maintain our market relationships that allow us to market and sell our products effectively. The loss or diminishment of key relationships, in whole or in part, could materially adversely impact our business.
Approximately 58% of our total revenues for fiscal year 2007 was derived from product support, content and supply chain services and other services, which generally are subscription -based and not governed by long-term contracts, and therefore, if our current customers do not continue their subscriptions, our revenues could decline significantly and our operating results could be materially adversely affected.
Our product support and content and supply chain services are typically provided on a subscription basis, subject to cancellation on 30 to 60 days’ notice without penalty. Accordingly, our customers may not continue to subscribe to our services. As we stop actively improving and selling several of our older systems, we experience reduced rates of customer retention, which has been particularly evident in the automotive parts aftermarket. These developments have resulted in a decrease in our automotive parts aftermarket product support revenues from $29.2 million for fiscal year 2006 to $26.2 million for fiscal year 2007, representing a decrease of 10%. We expect the decreases in automotive parts aftermarket product support revenues to continue, although we cannot predict with certainty the magnitude and timing of future decreases.
Our success is dependent in part upon the performance of our new chief executive officer and on the performance and integration of new members of our senior management replacing those members of our senior management who left us in 2006-2007. If we are unable to integrate our new chief executive officer and other members of senior management who replaced members of our senior management who have terminated their employment with us, there could be a negative effect on our ability to operate our business.
Our success and ability to implement our business strategy, including integrating acquisitions, depend upon the continued contributions of our management team and others, including our technical employees. On May 2, 2006, Mr. Pervez A. Qureshi, formerly our chief operating officer, became our chief executive officer and president. Our business and operations are substantially dependent on the performance and integration of our new chief executive officer and president. We also relocated our headquarters to our Livermore, California office. Mr. Greg Petersen resigned as Executive Vice President, effective January 5, 2007, and Mr. Christopher Speltz resigned as Senior Vice President of Finance and Treasurer, effective January 2, 2007, due to their inability to relocate to Livermore. Mr. Richard Rew (our former vice president, general counsel and secretary) resigned for similar reasons effective on July 14, 2006. Mr. Timothy F. Taich joined us as our new Vice President and General Counsel as of September 18, 2006. Mr. Brian E. Agle, who was subsequently hired as our Senior Vice President and Chief Financial Officer, resigned on February 9, 2007. Ms. Kathleen M. Crusco joined us as our new Senior Vice President and Chief Financial Officer as of May 3, 2007. Mr. Peter Donnelly, our former Senior Vice President of Operations, resigned from the Company as of October 31, 2007. We also lost our Senior Vice President of Human Resources, Ms. Beth Taylor, who passed away on November 23, 2007. Our future success also depends on the performance and integration of our new senior management and our ability to attract and retain qualified personnel. A failure to retain members of our senior management team or attract other qualified personnel could reduce our revenues, increase our expenses and reduce our profitability.
Our new Activant Eagle and Activant Vision product extensions for the automotive parts aftermarket are key elements to our strategy to re-establish growth in the automotive parts aftermarket, and if these product extensions do not gain market acceptance within that market our future growth and operating results could be adversely affected.
A component of our business strategy is to re-establish growth in the automotive parts aftermarket through the introduction of new systems and services. We have developed a version of our Activant Eagle product, a Windows-based system that has versions currently targeted at the hardlines and lumber vertical markets, that targets the automotive parts aftermarket. In the event our version of Activant Eagle for the automotive parts aftermarket does not gain acceptance within that market, our future growth and operating results could be adversely affected. In addition, we have introduced the Activant Vision product, which we acquired in conjunction with our acquisition of The System House, Inc. in 2005. If we are unable to successfully introduce the Activant Vision product with features required for the automotive aftermarket, our future growth and operating results could be adversely affected.
Our substantial indebtedness could adversely affect our business.
We have a substantial amount of indebtedness. As of September 30, 2007, we had total debt of $632.8 million and $20.0 million was available for additional borrowing under our senior secured revolving credit facility, including letters of credit up to a maximum of $5.0 million. Our substantial indebtedness has important consequences, including:
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requiring a substantial portion of cash flow from operations to be dedicated to the payment of principal and interest on our indebtedness, therefore reducing our ability to use our cash flow to fund our operations, capital expenditures and future business opportunities;
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exposing us to the risk of increased interest rates as certain of our borrowings, including borrowings under our senior secured credit facilities, the outstanding floating rate senior notes and our receivables facility will be at variable rates of interest;
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restricting us from making strategic acquisitions or causing us to make non-strategic divestitures;
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increasing our vulnerability to general adverse economic and industry conditions;
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limiting our ability to obtain additional financing to fund future working capital, capital expenditures, other general corporate requirements and acquisitions;
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limiting our flexibility in planning for, or reacting to, changes in our business and the industry; and
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placing us at a competitive disadvantage compared to our competitors with less indebtedness.
In addition, our senior secured credit facilities and the indenture governing the notes permit us to incur substantial additional indebtedness in the future. For example, we utilized $20.0 million of our $40.0 million revolving credit facility in conjunction with the acquisition of the Eclipse business described below. If new indebtedness is added to our and our subsidiaries’ current debt levels, the risks described above would intensify.
We may be unable to service our indebtedness.
Our ability to make scheduled payments on or to refinance our obligations with respect to our indebtedness depends on our financial and operating performance, which are affected by general economic, financial, competitive, business and other factors beyond our control. Our business may not generate sufficient cash flow from operations and future borrowings may not be available to us under
our senior secured revolving credit facility in an amount sufficient to enable us to service our debt or to fund our other liquidity needs. If we are unable to meet our debt obligations or fund our other liquidity needs, we may need to restructure or refinance all or a portion of our debt or sell certain of our assets on or before the maturity of our debt. We may not be able to restructure or refinance any of our debt on commercially reasonable terms, if at all, which could cause us to default on our debt obligations and impair our liquidity. Any refinancing of our indebtedness could be at higher interest rates and may require us to comply with more onerous covenants that could further restrict our business operations.
Our operations are substantially restricted by the terms of our indebtedness, which could adversely affect us.
Our senior secured credit facilities and the indenture governing our senior subordinated notes contain a number of significant covenants. These covenants limit our ability and the ability of our restricted subsidiaries to, among other things:
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incur additional indebtedness and issue additional preferred stock;
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make capital expenditures and other investments;
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merge, consolidate or dispose of our assets or the capital stock or assets of any restricted subsidiary;
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engage in sale-leaseback transactions;
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pay dividends, make distributions or redeem capital stock;
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change our line of business;
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enter into transactions with our affiliates; and
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grant liens on our assets or the assets of our restricted subsidiaries.
Our senior secured credit facilities require us to meet certain financial tests. The failure to comply with any of these covenants or tests would cause a default under our senior secured credit facilities. A default, if not waived, could result in acceleration of the outstanding indebtedness under the notes and our senior secured credit facilities, in which case the debt would become immediately due and payable. In addition, a default or acceleration of indebtedness under our senior subordinated notes or our senior secured credit facilities could result in a default or acceleration of other indebtedness we may incur with cross-default or cross-acceleration provisions. If this occurs, we may not be able to pay our debt or borrow sufficient funds to refinance it. Even if new financing is available, it may not be available on terms that are acceptable to us, particularly given the recent trends in the debt market in which the general availability of credit is reduced and the cost of borrowing is generally higher with more restrictive terms Complying with these covenants and tests may cause us to take actions that we otherwise would not take or not take actions that we otherwise could take.
The costs and difficulties of integrating current and future acquisitions could impede our future growth, diminish our competitiveness and materially adversely affect our operations.
In May 2007, we acquired Silk Systems, Inc. (“Silk Systems”) and in August 2007, we acquired the Intuit Eclipse Distribution Management Solutions (“Eclipse”) business. These acquisitions increased the size and geographic scope of our operations. Additionally, we may pursue further acquisitions as part of our expansion strategy or to augment our sales, including additional acquisitions that extend our presence outside of North America. We cannot be certain that our current or future transactions will be successful and will not materially adversely affect the conduct, operating results or financial results of our business. With respect to any future acquisitions, we may be unable to identify additional potential acquisition targets, integrate and manage successfully any acquired businesses or achieve a substantial portion of any anticipated cost savings or other anticipated benefits from other acquisitions in the timeframe we anticipate, or at all. In addition, many transactions are subject to closing conditions, which may not be satisfied, and transactions may not be successfully completed even after their public announcement. Acquisitions, including, Silk Systems and Eclipse, involve numerous risks, such as difficulties in the assimilation of the operations, technologies, services and products of the acquired companies, market acceptance of our integrated product offerings, risks related to potential unknown liabilities associated with acquired businesses, personnel turnover and the diversion of management’s attention from other business concerns. Acquisitions of foreign businesses involve numerous additional risks, including difficulty enforcing agreements and collecting receivables under foreign laws and regulations, unexpected political, legal, trade or economic changes or instability, more stringent regulatory requirements or rules relating to labor or the environment, difficulty enforcing our intellectual property rights and increased exposure to foreign exchange rate fluctuations. We generally have paid cash for our recent acquisitions, including Silk Systems and Eclipse. Any future acquisitions may involve further use of our cash resources, the issuance of equity or debt securities and/or the incurrence of other forms of debt.
A significant portion of our total assets consist of goodwill and other intangible assets, which may be subject to impairment charges in the future depending upon the financial results of our business.
Approximately $599 million of the purchase price paid in connection with the transactions completed in May 2006 was allocated to acquired goodwill. In addition, approximately $75 million of the purchase prices for Silk Systems and Eclipse was allocated to acquired goodwill. Acquired goodwill must be assessed for impairment at least annually. In the future, if our business does not yield expected financial results we may be required to take charges to our earnings based on this impairment assessment process, which could materially adversely affect our financial position.
We rely on third-party information for our electronic automotive parts and applications catalog and we are increasingly facing pressure to present our electronic automotive parts and applications catalog in a flexible format, each of which could expose us to a variety of risks, including increased pressure on our pricing.
We are dependent upon third parties to supply information for our electronic automotive parts and applications catalog. Currently, we obtain most of this information without a contract. In the future, more third-party suppliers may require us to enter into a license agreement and/or pay a fee for the use of the information or may make it more generally available to others. For example, an industry association is currently developing a data collection format that would make this information more accessible to consumers and provide it in a more usable format. We rely on this third-party information to continuously update our catalog. In addition, as a result of competitive pressures, we may begin providing our electronic automotive parts and applications catalog in a flexible format which could make it more difficult for us to maintain control over the way information presented in our catalog is used. Any change in the manner or basis on which we currently receive this information or in which it is made available to others who are or who could become competitors could have a material adverse effect on our electronic automotive parts and applications catalog business, which could have a material adverse effect on our business and results of operations.
If our existing customers who operate systems that we no longer actively sell do not upgrade or delay upgrading to our current generation of systems or upgrade to a system not sold by us, our operating results could be materially adversely affected.
Approximately half of our existing customers currently operate systems that we service and maintain but do not actively sell. Although we have developed upgrade paths to newer technologies for substantially all of these older systems, we cannot predict if or when our customers will upgrade to these newer technologies. If our customers do not upgrade or delay the upgrade cycle, or if they upgrade to a competitive system, our systems sales and services revenues and operating results could be materially adversely affected.
We compete with many other technology providers in connection with the sale of our business management solutions to the retail and wholesale distribution market and our failure to effectively compete may negatively impact our market share and/or revenue.
The retail and wholesale distribution market is highly fragmented and the technology needs in this market are supplied by many competitors. In the hardlines and lumber vertical market we compete primarily with smaller, niche-focused companies, many of which target specific geographic regions. In the automotive parts aftermarket, we compete primarily with smaller software companies that may operate regionally or in a specific niche of the market. In addition, we may also experience future competition from some of our current larger customers to the extent they decide to develop their own systems and/or provide related services to themselves or their respective affiliated companies or members in lieu of obtaining such systems and services from us. We also compete with several companies in the wholesale distribution vertical market that are larger than us, including Infor Global Solutions, Inc. In addition, there are also several niche competitors in the wholesale distribution vertical market. Further, several large software companies have made public announcements regarding the attractiveness of various small and medium-sized business markets and their intention to expand their focus in these markets, including Intuit Inc., Microsoft Corporation, Oracle Corporation, SAP AG and The Sage Group plc. To date, we have rarely competed directly with any of these larger software companies, except on larger, nationally focused transactions. However, we expect such competition may increase in the future.
Many of the competitors described above price their products and services below our prices, which over time may impact our pricing and profit margins. Our present and future competitors may have greater financial and other resources than we do and may develop better solutions than those offered by us. If increased spending is required to maintain market share or a rapid technological change in the industry occurs, we may encounter additional competitive pressures which could materially adversely affect our market share and/or profit margin.
Because of the varying sales cycles applicable to our systems sales, our quarterly systems revenues and other operating results can be difficult to predict and may fluctuate substantially.
Our systems revenues have increased from approximately 27% of our total revenues for fiscal year 2002 to approximately 42% of our total revenues for fiscal year 2007. We expect our systems revenues to continue to represent a material percentage of our total revenues. The sales cycle for our systems generally ranges from 90 days to 12 months, and it may be difficult to predict when a sale will close, if at all. It is therefore difficult to predict the quarter in which a particular sale will occur and to plan our expenditures accordingly.
Because of quarterly fluctuations, we believe that quarter-to-quarter comparisons of our operating results are not necessarily meaningful. The delay or failure to complete systems sales in a particular quarter would reduce our revenues in that quarter and until any such sale is made, and increase revenues in any subsequent quarters over which revenues for any such sale would likely be recognized.
Future consolidation among our customers and other businesses in the markets in which we operate may reduce our revenues, which would negatively impact our financial performance.
The markets we serve are highly fragmented. These markets have in the past and are expected to continue to experience consolidation. For example, the hardlines and lumber vertical market has experienced consolidation as retail hardware stores and lumber and building materials dealers try to compete with mass merchandisers such as The Home Depot Inc., Lowe’s Home Centers, Inc. and Menard, Inc. In addition, some of the mass merchandisers, such as HD Supply (comprised of businesses formerly owned by The Home Depot Inc.), and many large distributors have been acquiring smaller chains and independent stores. We may lose customers as a result of this consolidation. Our customers may be acquired by companies with their own proprietary business management systems or by companies that utilize a competitor’s system, or our customers may be forced to shut down due to this competition. Additionally, if original equipment manufacturers successfully increase sales into the automotive parts aftermarket, our customers in this vertical market may lose revenues, which could adversely affect their ability to purchase and maintain our solutions or stay in business.
If we fail to adequately protect our proprietary rights and intellectual property, we may incur unanticipated costs and our competitive position may suffer.
Our success and ability to compete effectively depend in part on our proprietary technology. We have approximately 268 registered copyrights, 86 registered trademarks and six registered patents in the United States. We attempt to protect our proprietary technology through the use of trademarks, patents, copyrights, trade secrets and confidentiality agreements. Legal protections for information products may be limited and technical means may not be available to protect against unauthorized use, access, display, reproduction or distribution. We may not be able to adequately protect our technology and competitors may develop similar technology independently.
If we become subject to adverse claims alleging infringement of third-party proprietary rights, we may incur unanticipated costs and our competitive position may suffer.
We are subject to the risk that we are infringing on the proprietary rights of third parties. Although we are not aware of any infringement by our technology on the proprietary rights of others and are not currently subject to any legal proceedings involving claimed infringements by our products, we may be subject to such third-party claims, litigation or indemnity demands and these claims may be successful. If a claim or indemnity demand were to be brought against us, it could result in costly litigation or product shipment delays or force us to stop selling such product or providing such services or to enter into royalty or license agreements that may require substantial royalty or licensing payments. There can be no assurance we would be able to enter into these agreements on commercially acceptable terms or at all.
Our software and information services could contain design defects or errors that could affect our reputation, result in significant costs to us and impair our ability to sell our products.
Our software and information services are highly complex and sophisticated and could, from time to time, contain design defects or errors. Additionally, third-party information supplied to us for inclusion in our electronic automotive parts and applications catalog may not be complete, accurate or timely. These defects or errors may delay the release or shipment of our products or, if the defect or error is discovered only after customers have received the products, that these defects or errors could result in increased costs, litigation, customer attrition, reduced market acceptance of our systems and services or damage to our reputation.
If we fail to obtain software and information we license from third parties on acceptable terms, we may experience delays and disruptions that could materially and adversely affect our business and results of operations.
We license and use software and information from third parties in our business. These third party software and information licenses may not continue to be available to us on acceptable terms. In addition, these third parties may, from time to time, receive claims that they have infringed the intellectual property rights of others, including patent and copyright infringement claims, which may affect our ability to continue licensing their software or information. Our inability to use any of this third party software and information could result in shipment delays or other disruptions in our business, which could materially and adversely affect our operating results.
Interruptions in our connectivity applications and our systems could disrupt the services that we provide and materially adversely affect our business and results of operations.
Certain of our customers depend on the efficient and uninterrupted operation of our software connectivity applications, such as AConneX. In addition, our businesses are highly dependent on our ability to communicate with our customers in providing services and
to process, on a daily basis, a large number of transactions. We rely heavily on our telecommunications and information technology infrastructure, as well as payroll, financial, accounting and other data processing systems. These applications and systems are vulnerable to damage or interruption from a variety of sources, including natural disasters, telecommunications failures and electricity brownouts or blackouts. If any of these systems fail to operate properly or become disabled, we could suffer financial loss, a disruption of our businesses, or damage to our reputation. Our insurance policies may not adequately compensate us for any losses that may occur due to any failures in our connectivity applications or in these services. We have disaster recovery plans in place to protect our businesses against natural disasters, security breaches, power or communications failures or similar events. At the same time, we have concluded it is not cost effective at this time to maintain any secondary “off-site” systems to replicate our connectivity applications, and we do not maintain and are not contractually required to maintain a formal disaster recovery plan with respect to these applications. Despite our preparations, in the event of a catastrophic occurrence, our disaster recovery plans may not be successful in preventing loss of customer data, service interruptions, disruptions to our operations or ability to communicate with our customers, or damage to our important locations. To the extent that any disruptions result in a loss or damage to our data center, telecommunications or information technology infrastructure, or our connectivity applications, it could result in damage to our reputation and lost revenues due to service interruptions and adverse customer reactions.
In the event of a failure in a customer’s computer system installed by us, a claim for damages may be made against us regardless of our responsibility for the failure, which could expose us to liability.
We provide business management solutions that we believe are critical to the operations of our customers’ businesses and provide benefits that may be difficult to quantify. Any failure of a customer’s system installed by us could result in a claim for substantial damages against us, regardless of our responsibility for the failure. Although we attempt to limit our contractual liability for damages resulting from negligent acts, errors, mistakes or omissions in rendering our services, the limitations on liability we include in our agreements may not be enforceable in all cases, and those limitations on liability may not otherwise protect us from liability for damages. Furthermore, our insurance coverage may not be adequate and that coverage may not remain available at acceptable costs. Successful claims brought against us in excess of our insurance coverage could seriously harm our business, prospects, financial condition and results of operations. Even if not successful, large claims against us could result in significant legal and other costs and may be a distraction to our senior management.
Because we sell to small and medium-sized retail and wholesale distribution businesses, prolonged unfavorable general economic and market conditions could negatively impact our sales.
We sell our systems and services to a large number of small and medium-sized businesses. These businesses may be more likely to be impacted by unfavorable general economic and market conditions than larger and better capitalized companies. Furthermore, the businesses of our customers in the hardlines and lumber vertical market are affected by trends in the new housing and home improvements market, and our customers in the wholesale distribution vertical market are affected by trends in general construction and industrial production markets, which could be negatively impacted by an increase in interest rates or a decline in the general economy. For example, the general decline in the housing and related financing markets that began during 2006 and has continued into 2007 has adversely affected the new housing and home improvement market. Therefore, unfavorable general economic and market conditions in the United States (including as a result of terrorist activities) could have a negative impact on our sales.
Fluctuations in the value of foreign currencies could result in currency transaction losses.
Generally, our international business is conducted in foreign currencies, principally the British pound, the Euro and the Canadian dollar. Fluctuations in the value of foreign currencies relative to the U.S. dollar will continue to cause currency transaction gains and losses. We cannot predict the effect of exchange rate fluctuations upon future operating results. We may experience currency losses in the future. We monitor our foreign currency exposure and, from time to time, will attempt to reduce our exposure through hedging. At September 30, 2007, we had no foreign currency contracts outstanding.
Natural disasters, terrorist attacks or other catastrophic events could harm our operations and adversely affect our future operating results.
Our operations could be subject to natural disasters and other business disruptions, which could harm our future revenue and financial condition and increase our costs and expenses. For example, our corporate headquarters are located near major earthquake fault lines. In the event that an earthquake, terrorist attack or other natural or manmade catastrophe were to destroy any part of our facilities, destroy or disrupt vital infrastructure systems or interrupt our operations for any extended period of time, our business, financial condition and operating results would be materially adversely affected.
The interests of our controlling stockholders or investors, may differ from the interests of the holders of our other security holders.
We are a wholly-owned subsidiary of Activant Group. Affiliates of Hellman & Freidman LLC, Thoma Cressey Bravo, Inc. and JMI Equity, which we refer to as the “sponsors,” beneficially own, in the aggregate, over 99% of Activant Group’s common stock and an affiliate of Hellman & Friedman LLC beneficially owns the only authorized share of Activant Group’s Series A preferred stock. In addition, a stockholders agreement entered into by Activant Group, us and the sponsors prior to the mergers provides affiliates of Hellman & Friedman LLC with the right to vote the shares of Activant Group common stock held by the other sponsors under certain circumstances. As a result of this ownership of common stock and the share of Series A preferred stock and the terms of the stockholders agreement, these affiliates of Hellman & Friedman LLC are entitled to elect directors with majority voting power with respect to the Activant Group board of directors, to appoint new management and to approve most actions requiring the approval of the holders of outstanding Activant Group voting shares as a single class, including adopting most amendments to the Activant Group certificate of incorporation and approving mergers or sales of all or substantially all of our assets. These affiliates of Hellman & Friedman LLC, through their control of Activant Group, control us and all of our subsidiaries that are guarantors of our senior subordinated notes.
The interests of the sponsors may differ from our other security holders in material respects. For example, if we encounter financial difficulties or are unable to pay our debts as they mature, the interests of the sponsors and their affiliates, as equity holders of Activant Group, might conflict with the interests of the holders of our senior subordinated notes. The sponsors and their affiliates may also have an interest in pursuing acquisitions, divestitures, financings or other transactions that, in their judgment, could enhance their equity investments, even though such transactions might involve risks to the holders of our senior subordinated notes, including the incurrence of additional indebtedness. Additionally, the indentures governing the senior subordinated notes permits us to pay fees, dividends or make other restricted payments under certain circumstances, and the sponsors may have an interest in our doing so.
The sponsors and their affiliates are in the business of making investments in companies and may, from time to time in the future, acquire interests in businesses that directly or indirectly compete with certain portions of our business or are suppliers or customers of ours. You should consider that the interests of the sponsors may differ from yours in material respects. See “Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” and “Item 13. Certain Relationships and Related Transactions, and Director Independence.”
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties.
Our properties are leased, and include integration and distribution, software development and data entry facilities and administrative, executive, sales, and customer support offices. Our principal executive offices are located at 7683 Southfront Road, Livermore, CA 94551. We consider our properties suitable for their present and intended purposes and adequate for our current level of operations.
As of December 21, 2007, our facilities consisted of the principal properties listed in the table below.
In addition, we have short-term leases on over 40 offices and field service locations in the United States, Canada, and the United Kingdom.
Item 3.
Item 3. Legal Proceedings.
We are a party to various legal proceedings and administrative actions, all of which are of an ordinary or routine nature incidental to our operations. We do not believe that such proceedings and actions will, individually or in the aggregate, have a material adverse effect on our results of operations, financial condition or cash flows.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
There is no established public trading market for any class of our common stock. All of our common stock is held by Activant Group Inc., a Delaware corporation. No dividends were declared on our common stock during the fiscal years ended September 30, 2006 and 2007. We have not paid any cash dividends and do not currently have plans to do so in the foreseeable future. Our ability to pay any dividends in the future is limited by the terms of our senior secured credit agreement and the indentures governing our 9 1/2% senior subordinated notes due 2016. See “Item 1A. Risk Factors” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations”.
Equity Compensation Plan Information
The following table provides certain information as of September 30, 2007, with respect to Activant Group’s equity compensation plans in effect on that date under which shares of Activant Group’s common stock are authorized for issuance.
(1)
Includes shares of Activant Group’s common stock to be issued upon the exercise of options granted under the Activant Group Inc. 2006 Stock Incentive Plan and 333,334 shares of Activant Group’s common stock to be issued upon the exercise of certain rollover options granted to Mr. Pervez A. Qureshi in connection with the mergers.
(2)
As of September 30, 2007, we did not have any equity compensation plans that were not approved by Activant Group’s or our stockholders.
Purchases of Equity Securities of the Issuer and Affiliated Purchasers
Neither we nor any affiliated purchaser repurchased any of our equity securities in the fourth quarter of fiscal year 2007.
Item 6.
Item 6. Selected Financial Data.
The following table sets forth our selected financial data for the years ended September 30, 2003, 2004, 2005, the periods from October 1, 2005 to May 2, 2006 and from May 2, 2006 (our “Inception”) to September 30, 2006, and the year ended September 2007. The balance sheet data as of September 30, 2006 and 2007, and the statement of operations data for the year ended September 30, 2005, the periods from October 1, 2005 to May 2, 2006 and from Inception to September 30, 2006 and the year ended September 30, 2007 set forth below are derived from the audited consolidated financial statements of Activant Solutions Holdings Inc. (the “Predecessor Company”) and Activant Solutions Inc. (the “Successor Company”) included elsewhere herein. The balance sheet data as of September 30, 2003, 2004 and 2005 and the statement of operations data for the year ended September 30, 2003 and 2004 set forth below are derived from Predecessor Company audited consolidated financial statements that are not included herein. The selected financial data below should be read in conjunction with the section entitled “Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our results of operations and financial condition includes the Predecessor Company periods prior to the consummation of the transactions. We refer to the operations of both the Predecessor Company and the Successor Company as ours, unless specifically stated otherwise. You should read the following discussion and analysis in conjunction with our financial statements and related notes included herein. This discussion contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of factors, including those set forth under “Risk Factors”.
On May 2, 2006, Activant Group Inc. (formerly known as Lone Star Holding Corp.), or Activant Group, Lone Star Merger Corp., or Merger Sub, and Activant Solutions Holdings Inc., or Holdings, consummated a merger, whereupon, Holdings became wholly owned by Activant Group, which is wholly owned by investment funds affiliated with Hellman & Friedman LLC, Thoma Cressey Bravo, Inc. and JMI Equity, and certain members of our management. Following the merger, on May 2, 2006, Holdings merged with and into Activant Solutions Inc., with Activant Solutions Inc., or the Successor Company, continuing as the surviving corporation and as a wholly-owned subsidiary of Activant Group. These mergers are referred to in this report as the “mergers” and the transactions related to the mergers are referred to collectively in this report as the “transactions.” The transactions closed on May 2, 2006.
In our discussion of our results of operations in 2006, we discuss each line item in the statement of operations on a combined Predecessor/Successor basis for comparative purposes. These combined amounts represent the sum of the financial data for the Predecessor Company and us for the period from October 1, 2005 through September 30, 2006. These combined amounts are for informational purposes only. In this report, the terms the “Company”, “we”, “us” and “our” refer to the combined operations of Activant Solutions Inc. and the Predecessor Company, unless specifically stated otherwise.
Overview
We are a leading provider of business management solutions serving small and medium-sized businesses in three primary vertical markets: hardlines and lumber, wholesale distribution and the automotive parts aftermarket (“Auto”). Using a combination of proprietary software and extensive expertise in these vertical markets, we provide complete business management solutions consisting of tailored systems, product support and content and supply chain services designed to meet the unique requirements of our customers. Our fully integrated systems and services include point-of-sale, inventory management, general accounting and enhanced data management that enable our customers to manage their day-to-day operations. Our revenues are derived from our four reporting segments which are organized around the following business management solutions:
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Systems, which is comprised primarily of proprietary software applications, implementation and training and third-party software, hardware and peripherals. For the year ended September 30, 2007, systems revenues accounted for approximately 42% of our total revenues;
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Product Support, which is comprised primarily of customer support activities, including support through our advice line, software updates, preventive and remedial on-site maintenance and depot repair services. Our product support services are generally provided on a subscription basis, and accordingly, revenues from this segment are generally recurring in nature. For the year ended September 30, 2007, product support revenues accounted for approximately 39% of our total revenues;
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Content and Supply Chain, which is comprised primarily of proprietary database and data management products for the vertical markets we serve (such as our comprehensive electronic automotive parts and applications catalog and point-of-sale business analysis data), connectivity services, e-commerce, networking and security monitoring management solutions. Our content and supply chain products and services are generally provided on a monthly subscription basis and accordingly, revenues from this segment are generally recurring in nature. For the year ended September 30, 2007, content and supply chain revenues accounted for approximately 16% of our total revenues; and
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Other Services, which is comprised primarily of business products, such as forms and other paper products. For the year ended September 30, 2007, other services revenues accounted for approximately 2% of our total revenues.
For the year ended September 30, 2007, our revenues were derived from customers that operate in three vertical markets, hardlines and lumber, wholesale distribution and automotive parts aftermarket, and from our productivity tools business.
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The hardlines and lumber vertical market consists of independent hardware retailers, home improvement centers, paint, glass and wallpaper stores, farm supply stores, retail nurseries and garden centers and independent lumber and building material
dealers primarily in the United States. For the year ended September 30, 2007, we generated approximately 42% of our total revenues from the hardlines and lumber vertical market.
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The wholesale distribution vertical market consists of distributors of a range of products including electrical supply, plumbing, medical supply, heating and air conditioning, brick, stone and related materials, roofing, siding, insulation, industrial machinery and equipment, industrial supplies, fluid power, janitorial and sanitation products, paper and packaging and service establishment equipment vendors, primarily in the United States. For the year ended September 30, 2007, we generated approximately 31% of our total revenues from the wholesale distribution vertical market.
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The automotive parts aftermarket consists of customers involved in the manufacture, distribution, sale and installation of new and remanufactured parts used in the maintenance and repair of automobiles and light trucks, and includes manufacturers, warehouse distributors, parts stores, professional installers and several chains in North America and Europe. For the year ended September 30, 2007, we generated approximately 22% of our total revenues from Auto.
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The productivity tools business, which primarily consists of software migration and application development tools, was acquired as a part of the Speedware acquisition. For the year ended September 30, 2007, we generated approximately 5% of our total revenues from the productivity tools business.
Key Trends
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Growth in our revenues from the hardlines and lumber and wholesale distribution vertical markets. Our systems revenues from the hardlines and lumber and wholesale distribution vertical markets have grown at a compound annual growth rate of approximately 30% from fiscal year 2002 through fiscal year 2007. Our acquisitions of Speedware, Prophet 21, Silk Systems and Eclipse have increased our revenues in the hardlines and lumber and wholesale distribution vertical markets within Canada and the United States. Our organic growth has been a result of the development of stronger relationships and licensing agreements with cooperatives in the hardlines and lumber vertical market, increased sales of upgraded software applications to customers and increased demand for our Activant Eagle and Activant Falcon product in the hardlines and lumber vertical market. Increased systems revenues generally result in increased product support revenues in future years as we add new customers and new products. In each of the last three fiscal years, product support revenues have increased as we added several new customers to our product support business and sold additional add-on modules.
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Lower customer retention in our Auto vertical market. As we stop actively developing and selling several of our older systems, especially in our Auto vertical market, we have experienced reduced rates of customer retention. We have developed various upgrade paths for these customers and have undertaken a specific customer services campaign to increase retention rates for customers who elect to continue to operate with our older systems. Despite our efforts, we have experienced year-over-year decreases in our Auto product support revenues and we expect lower levels of customer retention to continue. We introduced in 2006 our Eagle platform as an upgrade path for our Auto customers on our J-CON system.
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Consolidation of our customers’ vertical markets. Our customers are undergoing consolidation. When one of our customers acquires a company that does not currently use our systems, we typically benefit from new systems sales and increased services revenues associated with that customer. When a company not currently using our systems acquires one of our customers, we typically lose services revenues. We believe that consolidation has been neither a material benefit nor a material detriment to our operating results over the past three years. Recent trends in the automotive marketplace may cause additional consolidation to become detrimental in future years.
Acquisitions
Speedware Corporation Inc. In March and April 2005, we acquired the common stock of Speedware Corporation Inc. (“Speedware”) for cash consideration of $100.8 million. The Speedware acquisition solidifies our position as a provider of business management solutions to the hardlines and lumber vertical market through the addition of over 700 customers in this vertical market.
The Systems House, Inc. On May 16, 2005, we purchased substantially all of the assets of The Systems House, Inc. Their next generation business management solution, Activant Vision, is designed for warehouse distributors in the automotive parts aftermarket. The total consideration paid for the acquisition was approximately $2.6 million in cash.
Prophet 21, Inc. In September 2005, we acquired all of the outstanding capital stock of Prophet 21, Inc. (“Prophet 21”) for cash consideration of $218.2 million. Prophet 21 is a provider of business management solutions to the wholesale distribution vertical
market. The integration of Prophet 21 into our operations has significantly enhanced our position and expertise serving the wholesale distribution vertical market and provided additional systems and service offerings for our customers.
Silk Systems, Inc. In May 2007, we acquired the common stock of Silk Systems, Inc. (“Silk Systems”) for a total purchase price of $6.5 million, net of $0.7 million cash received. Silk Systems is one of the leading computer software solutions providers for the Canadian home improvement, wholesale distribution and building materials industries. This acquisition expands our presence and commitment to the Canadian market while building on current technology and service offerings for customers across North America.
Intuit Eclipse Distribution Management Solutions. In August 2007, we purchased substantially all of the assets of Intuit Eclipse Distribution Management Solutions (“Eclipse”) for cash consideration of approximately $101.3 million. Eclipse is a leading enterprise software provider to the wholesale distribution segment and this acquisition strengthens our position with larger wholesale distribution businesses.
Our results of operations include results of Speedware commencing after the consummation of the Speedware acquisition on March 30, 2005, the results of Prophet 21 commencing after the consummation of the Prophet 21 acquisition on September 13, 2005, the results of Silk commencing after the consummation of the Silk acquisition on May 31, 2007, and the results of Eclipse commencing after the consummation of the Eclipse acquisition on August 17, 2007. Accordingly, our results of operations for the years ended September 30, 2007, 2006 and 2005 are not directly comparable.
Segment Reporting and Classification
We organize our business around four reportable segments (the “Segments”) consisting of (i) Systems, (ii) Product Support, (iii) Content and Supply Chain and (iv) Other Services. We sell our products and services to three distinct vertical markets consisting of hardlines and lumber, wholesale distribution and the automotive parts aftermarket and through our productivity tools business. Revenue for each Segment is also reported by each of these three vertical markets and productivity tools.
Our president and chief executive officer (the “CEO”) has been identified as the chief operating decision maker in assessing the performance of our Segments and the allocation of resources to them. Each Segment is managed separately. The CEO relies on the information derived directly from our management reporting system. The primary financial measure used by the CEO in assessing performance and allocating resources to the Segments is gross profit, a measure that is comprised of revenues less cost of revenues.
Historical Results of Operations
Year Ended September 30, 2007 Compared to Year Ended September 30, 2006
The combined results for the year ended September 30, 2006 represent the combination of the predecessor period from October 1, 2005 through May 2, 2006 and the successor period from Inception through September 30, 2006. This combination does not comply with GAAP but is presented because we believe it provides the most meaningful comparison of our results.
Revenues. The following table sets forth, for the periods indicated, our Segment revenues by vertical market and for productivity tools and the variance thereof.
Total revenues for the year ended September 30, 2007 increased by $19.7 million, or 5.1%, compared to the year ended September 30, 2006. This increase was comprised of $12.6 million increase in Systems revenues, primarily in the Wholesale Distribution and Productivity Tools vertical markets; $4.5 million increase in Product Support revenues, primarily in the Hardlines and Lumber and Wholesale Distribution vertical markets; and $3.6 million increase in Content and Supply Chain revenues, primarily in the Wholesale Distribution vertical market.
Factors affecting Systems revenues for the year ended September 30, 2007.
Systems revenues for the year ended September 30, 2007 increased by $12.6 million, or 7.9%, compared to the year ended September 30, 2006. This increase was primarily attributable to higher Systems revenues in the Hardlines and Lumber, Wholesale Distribution and Productivity Tools vertical markets, partially offset by a decline in Systems revenues in Auto.
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Systems revenue from our Hardlines and Lumber vertical market increased by $2.7 million, or 3.2%, primarily due to increased revenues from co-op members. One of our co-ops announced that they are ending support for their legacy system and have encouraged their stores to purchase our Activant Eagle product in 2007, which resulted in increased sales for the year ended September 30, 2007. This activity had rapidly declined by our fiscal year end.
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The $2.6 million decrease, or 14.6%, in Systems revenues for Auto was primarily due to decreased installations of certain warehouse systems and lower shipments of add-ons and upgrades for our legacy products.
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Systems revenue from our Wholesale Distributions vertical market increased by $6.2 million, or 12.5%, due to a higher percentage of sales to large strategic customers, who generally have a higher average selling price, or ASP, due to their size and complexity.
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The $6.4 million increase, or 77.7%, in Productivity Tools Systems revenues was attributable to an increase in the number of platform migration projects currently being implemented with our customers.
Factors affecting Product Support revenues for the year ended September 30, 2007.
Product Support revenues for the year ended September 30, 2007 increased by $4.5 million, or 2.9%, compared to the year ended September 30, 2006. Increased Product Support revenues from the Hardlines and Lumber and Wholesale Distribution vertical markets were partially offset by a decline in Auto and Productivity Tools Product Support revenues.
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The $4.1 million, or 6.3%, increase in Product Support revenues from our Hardlines and Lumber vertical market was primarily attributable to increased systems sales in prior periods, which over time, results in increased Product Support revenues.
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Auto Product Support revenues declined by $2.9 million or 10.1%. Auto experienced a decline of approximately $1.5 million in Product Support revenues associated with customer attrition from our older systems that we continue to support but do not actively sell to new customers. We expect that Product Support revenues from our older systems will continue to decline. Approximately $1.2 million of the decline was associated with General Parts, Inc.’s decision to replace our J-CON system with its own branded store system as well as a contractual decline in support revenues for their warehouse systems. We do not expect to recapture this Product Support revenue.
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The $4.8 million, or 8.9%, increase in Product Support revenues from our Wholesale Distribution vertical market is primarily attributable to an increase in add-on licenses, support from prior period Systems sales, and increased support fees.
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The $1.4 million decrease in Productivity Tools Product Support revenues is attributable to attrition in legacy products.
Factors affecting Content and Supply Chain revenues for the year ended September 30, 2007.
Content and Supply Chain revenues for the year ended September 30, 2007 increased by $3.6 million, or 5.6%, compared to the year ended September 30, 2006. Increased Content and Supply Chain revenues from the Auto and Wholesale Distribution vertical markets were partially offset by a decline in Hardlines and Lumber Content and Supply Chain revenues.
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Content and Supply Chain revenues from our Hardlines and Lumber vertical market decreased by $1.1 million, or 13.7%, primarily attributable to the reclassification of IDW/IDX revenues to the Wholesale Distribution vertical market.
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Auto Content and Supply Chain revenues increased by $0.8 million, or 1.8%, primarily due to new customers and increased demand from existing customers for Catalog, Data Warehouse and Vista data services.
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Content and Supply Chain revenues from our Wholesale Distribution vertical market increased by $3.9 million, or 49.3%, mainly due to an increase in web hosting services and the reclassification of IDW/IDX revenues from the Hardlines and Lumber vertical market.
Cost of revenues and gross margins as a percentage of revenues.
The following table sets forth, for the periods indicated, our cost of revenues and the variance thereof.
The following table sets forth, for the periods indicated, our gross margin as a percentage of revenues.
Total cost of revenues for the year ended September 30, 2007 increased by $8.0 million, or 4.8%, compared to the year ended September 30, 2006. This increase was comprised primarily of higher System sales. Gross margin as a percentage of revenues increased slightly from 56.9% for the year ended September 30, 2006 to 57.0% for the year ended September 30, 2007.
Operating Expenses. The following table sets forth, for the periods indicated, operating expenses and the variance thereof.
The following table sets forth, for the periods indicated, our operating expenses as a percentage of revenues.
Total operating expenses decreased by $17.8 million, or 9.4%, for the year ended September 30, 2007 compared to the year ended September 30, 2006. Excluding acquisition related costs, operating expenses increased by $14.2 million, or 9.1%, primarily from increased costs in sales and marketing, and general and administrative.
Operating Income. Due to the above factors, total operating income for the year ended September 30, 2007 increased by $29.5 million, or 91.5%. Excluding the transaction costs related to the mergers of $32.4 million, operating income would have decreased by $3.0 million from $64.8 million for the year ended September 30, 2006 to $61.8 million for the year ended September 30, 2007.
Interest Expense Total interest expense for the year ended September 30, 2007 was $48.4 million compared to $53.3 million for the year ended September 30, 2006, a decrease of $4.9 million. The decrease is primarily a result of lower interest rates associated with our debt offerings related to the mergers, which was partially offset by additional debt associated with the Eclipse acquisition.
Income Tax Expense. We recognized an income tax expense of approximately $10.0 million, or 67.0% of pre-tax income for the year ended September 30, 2007.
Year Ended September 30, 2006 Compared to Year Ended September 30, 2005
The combined results for the year ended September 30, 2006 represent the combination of the predecessor period from October 1, 2005 through May 2, 2006 and the successor period from Inception through September 30, 2006. This combination does not comply with GAAP but is presented because we believe it provides the most meaningful comparison of our results.
Revenues. The following table sets forth, for the periods indicated, our Segment revenues by vertical market and for productivity tools and the variance thereof.
Total combined revenues for the year ended September 30, 2006 increased by $123.4 million, or 46.4%, compared to the year ended September 30, 2005. This increase was comprised primarily of $83.6 million in revenues attributable to the Prophet 21 acquisition and $32.2 million in revenues attributable to the Speedware acquisition.
Factors affecting combined systems revenues for the year ended September 30, 2006.
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Systems revenue from our hardlines and lumber vertical market increased by $5.8 million, or 7.2%, primarily due to $4.1 million of revenues attributable to the Speedware acquisition.
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The $2.8 million increase, or 18.7%, in systems revenues for Auto is primarily due to a focus on migrating customers to Activant Prism and Activant Vision platforms as well as higher sales of TPW and Ultimate peripherals and upgrades.
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The $40.4 million increase in Wholesale Distribution systems revenues is due to $38.6 million and $4.3 million of revenues attributable to the Prophet 21 acquisition and the Speedware acquisition, respectively.
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The $6.9 million increase in productivity tools systems revenues is attributable to the Speedware acquisition.
Factors affecting combined product support revenues for the year ended September 30, 2006.
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The $15.5 million, or 31.1%, increase in product support revenues from our hardlines and lumber vertical market is primarily due to $8.4 million of revenues attributable to the Speedware acquisition. Increased systems sales generally result in increased product support revenues over time.
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Auto product support revenues declined by $5.3 million or 15.4%. Auto experienced a decline of approximately $1.5 million in product support revenues associated with customer attrition from our older systems that we continue to support but do not actively sell to prospective customers. We expect that product support revenues from our older systems will continue to decline. Approximately $3.3 million of the decline was associated with General Parts, Inc.’s decision to begin replacing our J-CON parts store system with its own branded store system and approximately $0.4 million of the decline was due to the transfer of several of our product support employees to General Parts, Inc. Prior to the transfer of these employees, General Parts, Inc. paid us a fee substantially equivalent to the salary and benefits of these employees plus a markup. We do not expect to recapture this product support revenue.
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The $45.6 million increase in product support revenues from our wholesale distribution vertical market is primarily attributable to the Speedware and Prophet 21 acquisitions.
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The $3.9 million increase in productivity tools product support revenues is attributable to the Speedware acquisition.
Factors affecting combined content and supply chain revenues for the year ended September 30, 2006.
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Content and supply chain revenues from our hardlines and lumber vertical market increased by $2.9 million, or 54.3%, primarily attributable to increased revenues from our point-of-sale business analysis data and revenues attributable to the Speedware acquisition.
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Auto content and supply chain revenues declined by $2.0 million, or 4.0%, primarily due to a decline of approximately $1.3 million associated with customer attrition from our older systems, that we continue to support but do not actively sell to prospective customers, and a decline of $1.6 million related to a revised contract and simplified service terms with a large customer. These declines were offset by $0.9 million of new electronic automotive parts and applications catalog sales to non-systems customers and a $0.7 million increase in revenues from our AConneX connectivity product.
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Content and supply chain revenues from our wholesale distribution vertical market increased by $5.7 million mainly due to the
Prophet 21 acquisition.
Total combined cost of revenues and gross margins as a percentage of revenues.
The following table sets forth, for the periods indicated, our cost of revenues and the variance thereof.
The following table sets forth, for the periods indicated, our gross margin as a percentage of revenues.
Total combined cost of revenues for the year ended September 30, 2006 increased by $49.9 million, or 42.2%, compared to the year ended September 30, 2005. This increase was comprised primarily of $30.5 million and $13.1 million in costs attributable to Prophet 21 and Speedware product sales, respectively. Approximately $4.0 million of the increase was attributable to increased system sales, primarily our Activant Eagle and Falcon platforms, and $4.5 million of the increase was attributable to higher product support costs for our Activant Eagle platform. Gross margin as a percentage of revenues increased from 55.6% for the year ended September 30, 2005 to 56.9% for the year ended September 30, 2006.
Operating Expenses. The following table sets forth, for the periods indicated, operating expenses and the variance thereof.
Total combined operating expenses increased by $85.5 million, or 82.5%, for the year ended September 30, 2006 compared to the year ended September 30, 2005. The increase was primarily a result of the inclusion of Speedware and Prophet 21 operating expenses subsequent to the acquisitions of $38.1 million, transaction costs related to the mergers of $30.5 million and increased amortization of purchased intangibles of $11.2 million.
Operating Income. Due to the above factors, combined operating income for the year ended September 30, 2006 decreased by $11.9 million, or 27.0%. Excluding the transaction costs related to the mergers of $32.4 million, the $11.2 million increase in depreciation and amortization expense related to the acquisitions of Speedware and Prophet 21, and the mergers, operating income would have increased by $31.7 million from $44.2 million for the year ended September 30, 2005 to $75.9 million for the year ended September 30, 2006.
Interest Expense Combined interest expense for the year ended September 30, 2006 was $53.3 million compared to $25.7 million for the year ended September 30, 2005, an increase of $27.6 million. The increase is primarily a result of interest expense associated with our debt offerings, which we used to finance the Speedware and Prophet 21 acquisitions and the mergers.
Income Tax Expense. We recognized a combined income tax benefit of $20.5 million, or 32.8% of pre-tax losses for the year ended September 30, 2006.
Liquidity and Capital Resources
Our principal liquidity requirements are for debt service, capital expenditures and working capital.
Our ability to service our indebtedness will depend on our ability to generate cash in the future. As of September 30, 2007, our net cash provided by operating activities was $51.2 million. Included in net cash flow from operating activities were depreciation and amortization expenses of $6.0 million and $23.7 million, respectively. We expect to incur approximately $27.8 million per year in amortization of purchased intangible assets.
Our cash balance at September 30, 2007 was $33.4 million. As of September 30, 2007, we had $632.9 million in outstanding indebtedness comprised primarily of $437.9 million of a senior secured term loan pursuant to our senior secured credit agreement, $175.0 million senior subordinated notes due 2016 and $20.0 million aggregate principal amount from our revolving credit facility. Our senior secured credit agreement provides for maximum borrowings of up to $40.0 million, including letters of credit up to a maximum limit of $5.0 million. At September 30, 2007, we had $0.5 million of letters of credit issued and outstanding.
On May 2, 2006, in connection with the consummation of the transactions, we entered into a senior secured credit agreement. The senior secured credit agreement provides for (i) a seven-year term loan in the amount of $390.0 million, amortized at a rate of 1.00% per year on a quarterly basis for the first six and three-quarters years after May 2, 2006, with the balance paid at maturity, and (ii) a five-year revolving credit facility that permits loans in an aggregate amount of up to $40.0 million, which includes a letter of credit facility and a swing line facility. Principal amounts outstanding under the revolving credit facility are due and payable in full at maturity, five years from May 2, 2006. During the year ended September 30, 2007, we repaid $25.0 million in principal towards the $390.0 million term loan, which reduced the future unamortized principal payments due per the amortization schedule. In addition, subject to certain terms and conditions, the senior secured credit agreement initially provided for one or more uncommitted incremental term loan and/or revolving credit facilities in an aggregate amount not to exceed $75.0 million. Proceeds of the term loan on the initial borrowing date were used to partially finance the mergers, to refinance certain of our indebtedness and to pay fees and expenses incurred in connection with the mergers and the related financings and transactions. In August 2007, we borrowed the $75.0 million incremental term loan. permitted under the senior secured credit agreement, as well as $20.0 million of the revolving credit facility. These amounts were used to partially finance the acquisition of Eclipse.
The borrowings under the senior secured credit agreement bear interest at a rate equal to an applicable margin plus, at our option, either (a) a base rate determined by reference to the higher of (1) the prime rate of Deutsche Bank Trust Company Americas, and (2) the federal funds rate plus 1/2 of 1%; or (b) a reserve adjusted Eurodollar rate on deposits for periods of one-, two-, three-, or six-months (or, to the extent agreed to by each applicable lender, nine- or twelve-months or less than one month). The initial applicable margin for borrowings is:
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under the revolving credit facility, 1.25% with respect to base rate borrowings and 2.25% with respect to Eurodollar rate borrowings, which may be reduced subject to our attainment of certain leverage ratios; and
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under the term loan facilities, 1.00% with respect to base rate borrowings and 2.00% with respect to Eurodollar rate borrowings.
In addition to paying interest on outstanding principal under the senior secured credit agreement, we are required to pay a commitment fee to the lenders under the revolving credit facility in respect of the unutilized commitments thereunder. The initial commitment fee rate is 0.50% per annum. The commitment fee rate may be reduced subject to our attaining certain leverage ratios, none of which had been obtained as of September 30, 2007. We must also pay customary letter of credit fees for issued and outstanding letters of credit. For a description of the covenants and certain other terms under our senior secured credit facilities, please refer to the caption below titled “Senior Secured Credit Facilities.”
On April 27, 2006, we issued $175.0 million aggregate principal amount of 91/2% senior subordinated notes due May 2, 2016. Each of our domestic subsidiaries, as primary obligors and not merely as sureties, jointly and severally, irrevocably and unconditionally guaranteed, on an unsecured senior subordinated basis, the performance and full and punctual payment when due, whether at maturity, by acceleration or otherwise, of all of our obligations under the indenture and the notes. The notes are our unsecured senior subordinated obligations and are subordinated in right of payment to all of our existing and future senior indebtedness (including the senior secured credit agreement), are effectively subordinated to all of our secured indebtedness (including the senior secured credit agreement) and senior in right of payment to all of our existing and future subordinated indebtedness. For a description of the covenants under the indenture governing our senior subordinated notes, please refer to the caption below titled “Senior Subordinated Notes.”
We believe that cash flows from operations, together with amounts available under the senior secured credit agreement, will be sufficient to fund our working capital, capital expenditures and debt service requirements for at least the next twelve months. Our ability to meet our working capital and debt service requirements, however, is subject to future economic conditions and to financial, business and other factors, many of which are beyond our control. If we are not able to meet such requirements, we may be required to
seek additional financing. There can be no assurance that we will be able to obtain financing from other sources on terms acceptable to us, if at all.
From time to time, we intend to pursue acquisitions, but the timing, size or success of any acquisition effort and the related potential capital commitments cannot be predicted. We expect to fund future acquisitions primarily with cash flow from operations and borrowings, including borrowing from amounts available under our senior secured credit agreement or through new debt issuances. We may also issue additional equity either directly or in connection with any such acquisitions. There can be no assurance that acquisition funds will be available on terms acceptable to us, or at all.
Year Ended September 30, 2007 Compared to Year Ended September 30, 2006
Our net cash provided by operating activities was $51.2 million and $43.4 million for the fiscal years ended September 30, 2007 and 2006, respectively. Net cash provided by operating activities increased by $7.8 million primarily due to an increase in net income partially offset by changes in working capital. Of the $51.2 million net cash provided by operating activities for the fiscal year ended September 30, 2007, net income provided $4.9 million, noncash depreciation and amortization provided $29.7 million, and stock option expenses further increased cash provided by operating activities by $4.2 million.
Our investing activities used net cash of $119.5 million and $792.9 million during the fiscal years ended September 30, 2007 and 2006, respectively. During the fiscal year ended September 30, 2007, we used $108.2 million in cash to fund the acquisitions of Eclipse and Silk Systems. During the fiscal year ended September 30, 2006, we used $783.0 million in cash to fund the acquisition of Activant Solutions Inc. Our capital expenditures were $12.3 million and $11.2 million for the fiscal years ended September 30, 2007 and 2006, respectively. These amounts included capitalized computer software and database costs of $5.3 million and $5.7 million for the fiscal years ended September 30, 2007 and 2006, respectively.
Our financing activities generated cash of $65.3 million for the fiscal year ended September 30, 2007, primarily consisting of $95 million in proceeds from borrowings, comprised of $75 million of a senior secured term loan due 2013 and $20 million revolving line of credit due 2011, related to the acquisition of Eclipse. During the year ended September 30, 2007, we repaid $25.2 million of the senior secured loan and the remaining $2.0 million of the 10 1/2 % senior notes due 2011. In the fiscal year ended September 30, 2006, our financing activities generated cash of $793.3 million, primarily consisting of $565.0 million in proceeds from borrowings, comprised of $390.0 million of a senior secured term loan and $175.0 million senior subordinated notes due 2016, net of $19.5 million of related fees, and $245.6 million in capital contribution from the mergers.
Year Ended September 30, 2006 Compared to Year Ended September 30, 2005
Our net cash provided by operating activities was $43.4 million and $20.2 million for the fiscal years ended September 30, 2006 and 2005, respectively. The increase in cash flow provided by operating activities for the fiscal year ended September 30, 2006 compared to the fiscal year ended September 30, 2005 was primarily due to a $44.7 million difference in the change in operating assets and liabilities compared to the prior period offset by higher interest expense and write-off of prior capitalized expenses.
Our investing activities used net cash of $792.9 million and $330.6 million during the fiscal years ended September 30, 2006 and 2005, respectively. During the fiscal year ended September 30, 2006, we used $783.0 million in cash to fund the acquisition of Activant Solutions Inc. During the fiscal year ended September 30, 2005, we used $321.7 to purchase Speedware, Prophet 21 and The Systems House. Our capital expenditures were $11.2 million and $9.5 million for the fiscal years ended September 30, 2006 and 2005, respectively. These amounts included capitalized computer software and database costs of $5.7 million and $5.1 million for the fiscal years ended September 30, 2006 and 2005, respectively.
Our financing activities generated cash of $793.3 million for the fiscal year ended September 30, 2006, primarily consisting of $565.0 million in proceeds from borrowings, comprised of $390.0 million of a senior secured term loan and $175.0 million senior subordinated notes due 2016, net of $19.5 million of related fees and $245.6 million in capital contribution from the mergers. In the fiscal year ended September 30, 2005, we generated cash of $289.3 million, primarily from borrowings related to the acquisition of Speedware and Prophet 21.
Contractual Obligations and Commercial Commitments
Our current sources of short-term funding are our operating cash flows and our senior secured credit agreement. Our existing senior secured credit agreement contains customary terms and conditions, including minimum levels of debt and interest coverage and limitations on leverage. As of September 30, 2007, we were in compliance with all of the terms and conditions of our senior secured credit agreement.
The following table summarizes our contractual obligations and payments at September 30, 2007:
(1)
See the discussion in Note 11-Commitments and Contingencies in the notes to our financial statements included in this Annual Report.
The following table summarizes our commercial commitments at September 30, 2007:
(1)
There are two standby letters of credit that secure certain demand deposit accounts belonging to our European subsidiaries, and workers compensation insurance.
Senior Secured Credit Facilities
Amortization. We are required to repay installments on the loans under the term loan facility in quarterly principal amounts of 1.0% of their funded total principal amount for the first six years and nine months, with the remaining amount payable on the date that is seven years from the date of the closing of the senior secured credit facilities. In the year ended September 30, 2007, we made a prepayment of $25.0 million in principal towards the $390.0 million term loan under the Senior Secured Credit Agreement. This reduced the future unamortized principal payments due per the amortization schedule.
Certain Covenants and Events of Default. The senior secured credit agreement will contain a number of covenants that, among other things, restrict, subject to certain exceptions, our ability to:
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incur additional indebtedness (including contingent liabilities and seller notes);
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create liens on assets;
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enter into sale-leaseback transactions;
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engage in mergers or acquisitions;
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dispose of assets;
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pay dividends and restricted payments;
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make investments (including joint ventures);
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make capital expenditures;
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prepay other indebtedness (including the notes);
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engage in certain transactions with affiliates;
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amend agreements governing our subordinated indebtedness (including the notes);
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amend organizational documents and other material agreements; and
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change the nature of our business.
In addition, the senior secured credit agreement requires us to maintain the following financial covenants:
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a maximum total net leverage ratio; and
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a minimum interest coverage ratio.
The senior secured credit agreement also contains certain customary affirmative covenants and events of default. See “Item 13. Certain Relationships and Related Transactions, and Directors Independence”.
Covenant Compliance. Under the senior secured credit facilities, we are required to satisfy a maximum total leverage ratio, a minimum interest coverage ratio and other financial conditions tests, which become increasingly stringent over the term of the credit facility. As
of September 30, 2007, we are in compliance with the financial and non-financial covenants. Our continued ability to meet those financial ratios and tests can be affected by events beyond our control or risks in our business (see “Item 1A. Risk Factors”), and we cannot assure you that we will meet those ratios and tests. A breach of any of these covenants could result in a default under the senior secured credit facilities. Upon the occurrence of an event of default under the senior secured credit facilities, the lenders could elect to declare all amounts outstanding under the senior secured credit facilities to be immediately due and payable and terminate all commitments to extend further credit.
Senior Subordinated Notes
The indenture governing our senior subordinated notes limits our (and most or all of our subsidiaries’) ability to:
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incur additional indebtedness;
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pay dividends on or make other distributions or repurchase our capital stock;
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make certain investments;
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enter into certain types of transactions with affiliates;
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use assets as security in other transactions; and
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sell certain assets or merge with or into other companies.
Subject to certain exceptions, the indenture governing the notes permits us and our restricted subsidiaries to incur additional indebtedness, including secured indebtedness.
Income from Partnership Investments
We, as general partner, own an approximate 20% interest in two separate partnerships with certain customers. We provide management information systems and services to these partnerships. The Predecessor Company recorded service revenue from these partnerships of $3.7 million and $1.2 million for the year ended September 2005 and from October 1, 2005 to May 2, 2006, respectively. From Inception to September 30, 2006 and for the year ended September 30, 2007, respectively, we recorded service revenue from these partnerships of $0.4 million and $0.4 million, respectively. The Predecessor Company recorded equity income from these partnerships of $0.3 million and $0.1 million for the year ended September 30, 2005 and the period from October 1, 2005 to May 2, 2006, respectively.
Off-Balance Sheet Arrangements
As of September 30, 2007, we did not have any material off-balance sheet arrangements (as defined in Item 303(a)(4)(ii) of Regulation S-K).
Critical Accounting Policies and Estimates
The preparation of financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an on-going basis, management evaluates estimates, including those discussed below. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
Revenue Recognition
We recognize revenue in accordance with Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, as amended by Staff Accounting Bulletin No. 104, Revenue Recognition, Statement of Position 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts, and Statement of Position 97-2, Software Revenue Recognition. We derive revenue from software license fees, computer hardware, implementation and training, software and hardware maintenance and support, content and data services and other services. We generally utilize written contracts as the means to establish the terms and conditions by which our licenses, products, maintenance and services are sold to our customers. Revenue is recognized when persuasive evidence of an agreement exists, delivery of the product has occurred, no significant obligations remain, the fee is fixed and determinable and collection is probable. We record revenue net of our sales tax obligations.
We use the following revenue recognition policies for sales of our systems, which generally consist of software, hardware, implementation and training:
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Residual method. For the majority of systems sales, we use the residual method of revenue recognition. Under the residual method, we have established vendor specific objective evidence of fair value for each element of the system sale (i.e., software, hardware and implementation and training) and have determined that implementation and training services are not essential to the functionality of the delivered system. The revenues of the undelivered element of the system sale (i.e., implementation and training) are deferred until provided. The revenue for the hardware and software portion of the system sale are recognized upon shipment.
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Percentage of completion. For those systems that include significant customization or modification of the software and where estimates of costs to complete and monitor the progress of the customization or modification are reasonably dependable, percentage of completion contract accounting is applied to both the software and implementation and training elements of the sale. Systems revenue from the software and implementation and training elements are recognized on a percentage-of-completion method with progress-to-completion measured based upon installation hours incurred. Hardware is not essential to the functionality of the overall system and thus the hardware portion of the system is recognized upon delivery. Currently, approximately fourteen percent of our systems revenue and six percent of our total revenues are recognized using percentage of completion accounting.
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Completed contract. For those systems that include significant customization or modification of the software and where costs or estimates are not dependable, systems revenue from these sales are recognized at completion of the implementation and training based upon the completed contract method.
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Upon shipment. When products are shipped to a customer and no contractual obligation exists that would warrant the percentage of completion method or the completed contract method, the revenue is recognized at time of shipment. For example, we recognize revenues when a current customer purchases additional hardware or software licenses.
Product support and content and supply chain are primarily provided on a monthly subscription basis and are therefore recognized on the same monthly basis.
These policies require our management, at the time of the transaction, to assess whether the amounts due are fixed and determinable, collection is reasonably assured and future performance obligations exist. These assessments are based on the terms of the agreement with the customer, past history and the customer’s credit worthiness. If management determines that collection is not reasonably assured or future performance obligations exist, revenue recognition is deferred until these conditions are satisfied.
Software and Database Development Costs
In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 86, Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed, costs incurred internally in creating computer software products are expensed until technological feasibility has been established, which is typically evidenced by a completed program design. Thereafter, applicable software development costs are capitalized and subsequently reported at the lower of amortized cost or net realizable value. Costs incurred related to the accumulation of data for the development of databases are capitalized and subsequently reported at the lower of amortized cost or net realizable value. Capitalized costs are amortized using the greater of the amount computed using (a) the ratio that current gross revenues bear to the total anticipated future gross revenues or (b) the straight-line method over the estimated economic life of the product not to exceed five years. We are required to use our professional judgment in determining whether software development costs meet the criteria for immediate expense or capitalization using the criteria described above and evaluate software and database development costs for impairment at each balance sheet date by comparing the unamortized capitalized costs to the net realizable value. The net realizable value is the estimated future gross revenue from that product reduced by the estimated future costs of completing, maintaining and disposing of the product. The Predecessor Company capitalized approximately $3.5 million software and database development costs and recorded related amortization expense of approximately $3.3 million from October 1, 2005 to May 2, 2006. We did not record any write-offs of software and database development costs during that same period. We capitalized approximately $2.2 million and $5.3 million software and development costs and recorded related amortization expense of approximately $0.1 million and $1.3 million from Inception to September 30, 2006 and for the year ended September 30, 2007, respectively. We had no write-offs of software and database development costs from Inception to September 30, 2006 and for the year ended September 30, 2007.
Allowance for Doubtful Accounts
In accordance with SFAS No. 5, Accounting for Contingencies, we maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers was to deteriorate
due to industry factors, general economic factors or otherwise, resulting in an impairment of their ability to make payments, additional allowances may be required.
Valuation of Goodwill and Other Intangibles
We account for intangible assets in accordance with SFAS No. 141, Business Combinations, SFAS No. 142, Goodwill and Other Intangible Assets, and SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Business acquisitions typically result in goodwill and other intangible assets, and the recorded values of those assets may become impaired in the future. The determination of the value of these intangible assets requires management to make estimates and assumptions that affect our consolidated financial statements. We evaluate goodwill and other intangibles on an annual basis and assess potential impairments to intangible assets when there is evidence that events or changes in circumstances indicate that the carrying amount of an asset may not be recovered. Our judgments regarding the existence of impairment indicators and future cash flows related to intangible assets are based on the operational performance of the acquired businesses, market conditions and other factors. Future events could cause us to conclude that impairment indicators exist and that goodwill associated with the acquired businesses is impaired. Any resulting impairment loss could have a material adverse impact on our results of operations. The Predecessor Company recorded related amortization expense of $10.8 million for the year ended September 30, 2005 and $12.0 million from October 1, 2005 to May 2, 2006. They did not record any write-offs of goodwill or intangibles during that same period. From Inception to September 30, 2006 and for the year ended September 30, 2007, we recorded amortization expense of $9.2 million and $23.7 million, respectively. We had no write-offs of goodwill or other intangibles from Inception to September 30, 2006 and for the year ended September 30, 2007.
Recently Issued Accounting Pronouncements
In February 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No.159 provides companies with an option to report selected financial assets and liabilities at fair value. It also establishes presentation and disclosure requirements to facilitate comparisons between companies using different measurement attributes for similar types of assets and liabilities. The statement is effective for fiscal years beginning after November 15, 2007. Earlier application is permitted provided we also apply the provisions of SFAS No. 157, Fair Value Measurements. We are currently in the process of evaluating the impact SFAS No. 159 will have on our consolidated financial statements.
In September 2006, FASB issued SFAS No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements, rather it applies to existing accounting pronouncements that require or permit fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. We are currently in the process of evaluating the impact SFAS No. 157 will have on our consolidated financial statements.
In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes by prescribing a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for our fiscal year beginning October 1, 2007. We are currently evaluating the impact of adopting FIN 48 on the consolidated financial statements.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Interest Rate Risk
At September 30, 2007, we had outstanding $437.9 million aggregate principal amount of a term loan due 2013, $175.0 million of senior subordinated notes and $20.0 million under our revolving credit facility. The term notes due 2013 and the revolving credit facility bear interest at floating rates. In May 2006, we entered into four interest rate swaps to manage and reduce the risk inherent in interest rate fluctuations and to effectively convert a notional amount of $245.0 million of floating rate debt to fixed rate debt. Giving effect to the interest rate swap, a 0.25% increase in floating rates would increase our interest expense by $0.6 million annually. See Note 4 of Notes to Consolidated Financial Statements, which is incorporated herein by reference.
Foreign Currency Risk
The majority of our operations are based in the United States and, accordingly, the majority of our transactions are denominated in U.S. dollars; however, we do have foreign based operations where transactions are denominated in foreign currencies and are subject to market risk with respect to fluctuations in the relative value of currencies. Currently, we have operations in Canada, the United Kingdom and Ireland and conduct transactions in the local currency of each location.
We monitor our foreign currency exposure and, from time to time, will attempt to reduce our exposure through hedging. At September 30, 2007, we had no foreign currency contracts outstanding.
Item 8.
Item 8. Financial Statements and Supplementary Data.
Index to Consolidated Financial Statements
Activant Solutions Inc.
Audited Consolidated Financial Statements
Report of Independent Auditors
Consolidated Balance Sheets as of September 30, 2006 and September 30, 2007
Consolidated Statements of Operations and Comprehensive Income (Loss) for the year ended September 30, 2005, the period October 1, 2005 to May 2, 2006 (Predecessor), the period from Inception to September 30, 2006, and the year ended September 30, 2007
Consolidated Statements of Stockholders’ Equity (Deficit) for the year ended September 30, 2005, the period October 1, 2005 to May 2, 2006 (Predecessor), the period from Inception to September 30, 2006, and the year ended September 30, 2007
Consolidated Statements of Cash Flows for the year ended September 30, 2005, the period October 1, 2005 to May 2, 2006 (Predecessor), the period from Inception to September 30, 2006 and the year ended September 30, 2007
Notes to Consolidated Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders of
Activant Solutions Inc.
We have audited the accompanying consolidated balance sheets of Activant Solutions Inc. (the Company) as of September 30, 2007 and 2006, and the related consolidated statements of operations and comprehensive income (loss), stockholders’ equity (deficit), and cash flows for the year ended September 30, 2007 and for the period from March 7, 2006 (Inception) to September 2006; and the related statements of operations and comprehensive income (loss), stockholders’ equity (deficit), and cash flows of Activant Solutions Holdings Inc. (Predecessor Company) for the period from October 1, 2005 to May 2, 2006 and for the year ended September 30, 2005. The financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements 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. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and 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 Activant Solutions Inc. at September 30, 2007 and 2006, and the consolidated results of its operations and its cash flows for the year ended September 30, 2007 and for the period from March 7, 2006 (Inception) to September 30, 2006; and the consolidated results of the operations and cash flows for Activant Solutions Holdings Inc. (Predecessor Company) for the period from October 1, 2005 to May 2, 2006 and for the year ended September 30, 2005, in conformity with U.S. generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
Austin, Texas
December 20, 2007
ACTIVANT SOLUTIONS INC.
Consolidated Balance Sheets
The accompanying notes are an integral part of these Consolidated Financial Statements.
ACTIVANT SOLUTIONS INC.
Consolidated Statements of Operations and Comprehensive Income (Loss)
The accompanying notes are an integral part of these Consolidated Financial Statements.
ACTIVANT SOLUTIONS INC.
Consolidated Statements of Stockholders’ Equity (Deficit)
Predecessor Company
Activant Solutions Inc.
The accompanying notes are an integral part of these Consolidated Financial Statements.
ACTIVANT SOLUTIONS INC.
Consolidated Statements of Cash Flows
The accompanying notes are an integral part of these Consolidated Financial Statements.
ACTIVANT SOLUTIONS INC.
Notes to Consolidated Financial Statements
September 30, 2007
Note 1. Summary of Significant Accounting Policies
Basis of Presentation
On May 2, 2006, Activant Group Inc. (formerly known as Lone Star Holding Corp.), or Activant Group, Lone Star Merger Corp., or Merger Sub, and Activant Solutions Holdings Inc., or Holdings (the “Predecessor Company”), consummated a merger, whereupon Holdings became wholly owned by Activant Group, which is wholly owned by investment funds affiliated with Hellman & Friedman LLC, Thoma Cressey Bravo, Inc., or Thoma Cressey, and JMI Equity and certain members of our management. Following the merger, on May 2, 2006, Holdings merged with and into Activant Solutions Inc., with Activant Solutions Inc. continuing as the surviving corporation and wholly owned subsidiary of Activant Group. These mergers are referred to as the “mergers” and the transactions related to the mergers are referred to collectively as the “transactions.” The transaction was treated as a purchase and thus the assets and liabilities were recorded at their fair value as of the closing date. Activant Group was incorporated on March 7, 2006 for the purpose of acquiring Holdings and did not have any operations prior to May 2, 2006 other than in connection with the Holdings acquisition. Unless the context otherwise requires references in this report to “we,” “our,” “us,” and the “Company” refer to Activant Solutions Inc. and its consolidated subsidiaries.
The accompanying consolidated statements of operations and cash flows for the periods ended September 30, 2005 and from October 1, 2005 to May 2, 2006 represent the results of operations and cash flows of the Predecessor Company and its wholly owned subsidiaries. The accompanying consolidated balance sheets as of September 30, 2006 and 2007, consolidated statements of operations and cash flows for the periods from Inception to September 30, 2006 and the year ended September 30, 2007, represent our financial position, results of operations and cash flows. Certain reclassifications have been made to prior periods’ consolidated financial statements to conform to current period presentation.
Description of Business
We are a provider of business management solutions serving small and medium-sized retail and wholesale distribution businesses. We have experience serving businesses with complex distribution requirements in three primary vertical markets: hardlines and lumber; wholesale distribution; and the automotive parts aftermarket. Using a combination of proprietary software and experience in these vertical markets, we provide complete business management solutions consisting of tailored systems, product support, and content and supply chain products and services designed to meet the unique requirements of our customers. Our fully integrated systems and services include point-of-sale, inventory management, general accounting and enhanced data management that enable our customers to manage their day-to-day operations.
The consolidated financial statements include the accounts of our wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated.
Cash Equivalents
We consider all highly liquid investments with maturities of three months or less when purchased to be cash equivalents.
Inventories
Inventories primarily consist of purchased parts and finished goods. Inventories are stated at the lower of cost or market, using the average cost method, and include amounts that ultimately may be transferred to equipment or service parts. Inventories are recorded net of inventory reserves of $0.8 million and $1.1 million at September 30, 2006 and September 30, 2007, respectively.
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets (two to ten years). Leasehold improvements are amortized using the straight-line method over the life of the lease or the estimated useful life, whichever is shorter. Service parts used for servicing installed equipment are stated at cost and are depreciated over a period not exceeding two years using the straight-line method.
Capitalized Computer Software Costs
Costs relating to the conceptual formulation and design of software products are expensed as product development. Costs incurred subsequent to establishing the technological feasibility of software products are capitalized. Amortization of capitalized software costs begins when the products are available for general release to customers. Costs are amortized using the greater of the amount computed using (a) the ratio that current gross revenues bear to the total anticipated future gross revenues or (b) the straight-line method, generally over a period of two to five years. Management assesses the recoverability of its capitalized costs periodically based principally upon comparison of the net book value of
the asset to the expected future revenue stream to be generated by the asset. If management finds evidence of asset impairment, the net book value is adjusted down to its fair value based upon the discounted cash flows. Amortization of capitalized software is included in the depreciation and amortization line of operating expenses. The Predecessor Company recorded capitalized software amortization expense of approximately $1.3 million from October 1, 2005 to May 2, 2006. We recorded capitalized software amortization expense of approximately $0.4 million for the year ended September 30, 2007.
Capitalized Database Costs
Database development costs consist primarily of direct labor costs associated with the accumulation of data received from auto parts manufacturers and the conversion of that information to an electronic format. Costs are amortized using the greater of the amount computed using (a) the ratio that current gross revenues bear to the total anticipated future gross revenues or (b) the straight-line method over the approximate life cycle of the data (generally over a period of two to five years). Management assesses the recoverability of its database costs periodically based principally upon comparison of the net book value of the asset to the expected future revenue stream to be generated by the asset. If management finds evidence of asset impairment, its net book value is adjusted to its fair value. Amortization of databases is included in the depreciation and amortization line of operating expenses. The Predecessor Company recorded capitalized database amortization expense of approximately $2.0 million from October 1, 2005 to May 2, 2006. We recorded capitalized software amortization expense of approximately $0.1 million and $0.9 million from Inception to September 30, 2006 and for the year ended September 30, 2007, respectively.
Deferred Financing Costs
Financing costs are deferred and amortized to interest expense using the straight-line method over the terms of the related debt, which approximates the effective interest method. Amortization of such costs of Predecessor Company for the year ended September 30, 2005 and for the period from October 1, 2005 to May 2, 2006 was $1.4 million and $1.8 million, respectively. From inception to September 30, 2006 and for the year ended September 30, 2007, we recognized amortization costs totaling $0.8 million and $2.2 million, respectively.
Goodwill and Other Intangible Assets
We account for goodwill and other intangible assets in accordance with SFAS No. 142, Goodwill and Other Intangible Assets. Goodwill and indefinite life intangible assets are tested for impairment on an annual basis as of July 1, and between annual tests if indicators of potential impairment exist, using a fair-value-based approach. No impairment of goodwill or indefinite life intangible assets has been identified during any of the periods presented.
We amortize other finite life intangible assets using the straight-line method over their estimated period of benefit, ranging from two to ten years. We evaluate the recoverability of intangible assets periodically and take into account events or circumstances that warrant revised estimates of useful lives or that indicate that impairment exists. No impairments of finite life intangible assets have been identified during any of the periods presented.
Long-Lived Assets
We periodically review the carrying amounts of property and equipment and other long-lived assets to determine whether current events or circumstances, as defined in SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, warrant adjustments to such carrying amounts by considering, among other things, the future cash inflows expected to result from the use of the asset and its eventual disposition less the future cash outflows expected to be necessary to obtain those inflows. At this time, future cash inflows exceed the carrying value of the assets; thus, no impairment loss has been recognized.
Revenue Recognition
We recognize revenue in accordance with Staff Accounting Bulletin (“SAB”) No. 101, Revenue Recognition in Financial Statements, as amended by SAB No. 104, Revenue Recognition, Statement of Position 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts, and Statement of Position 97-2, Software Revenue Recognition. We derive revenue from software license fees, computer hardware, implementation and training, software and hardware maintenance and support, content and data services and other services. We generally utilize written contracts as the means to establish the terms and conditions by which our licenses, products, maintenance and services are sold to our customers. Revenue is recognized when persuasive evidence of an agreement exists, delivery of the product has occurred, no significant obligations remain, the fee is fixed and determinable and collection is probable. We record revenue net of our sales tax obligations.
We use the following revenue recognition policies for sales of our systems, which generally consist of software, hardware, implementation and training:
§
Residual method. For the majority of systems sales, we use the residual method of revenue recognition. Under the residual method, we have established vendor specific objective evidence of fair value for each undelivered element of the system sale (i.e., implementation and training services) and have determined that these services are not essential to the functionality of the delivered system. The revenues of the undelivered element of the system sale are deferred until provided. The revenue for the hardware and software elements of the system sale are recognized upon shipment.
§
Percentage of completion. For those systems that include significant customization or modification of the software and where estimates of costs to complete and monitor the progress of the customization or modification are reasonably dependable, percentage of completion contract accounting is applied to both the software and implementation and training elements of the sale. Systems revenue from the software and implementation and training elements are recognized on a percentage-of-completion method with progress-to-completion measured based upon output measures. Hardware is not essential to the functionality of the overall system and thus the hardware portion of the system is recognized upon delivery. Currently, approximately fourteen percent of our systems revenue and six percent of our total revenues are recognized using percentage of completion accounting.
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Completed contract. For those systems that include significant customization or modification of the software and where costs or estimates are not dependable, systems revenue from these sales are recognized at completion of the implementation and training based upon the completed contract method.
§
Upon shipment. When products are shipped to a customer and no contractual obligation exists that would warrant the percentage of completion method or the completed contract method, the revenue is recognized at time of shipment. For example, we recognize revenues when a current customer purchases additional hardware or software licenses, when those items are shipped.
Product support, and content and supply chain products and services are primarily provided on a monthly subscription basis and are therefore recognized on the same monthly basis.
These policies require our management, at the time of the transaction, to assess whether the amounts due are fixed and determinable, collection is reasonably assured and future performance obligations exist. These assessments are based on the terms of the agreement with the customer, past history and the customer’s credit worthiness. If management determines that collection is not reasonably assured or future performance obligations exist, revenue recognition is deferred until these conditions are satisfied.
Allowance for Doubtful Accounts
The allowance for doubtful accounts is based on our assessment of the collectibility of customer accounts. We regularly review the allowance by considering factors such as historical experience, credit quality, age of the accounts receivable balance, and current economic conditions that may affect a customer’s ability to pay. A specific reserve for individual accounts is recorded when we become aware of a customer’s inability to meet its financial obligations, such as in the case of a bankruptcy filing or deterioration in the customer’s operating results or financial position.
Product Development Costs
We account for development costs related to products to be sold in accordance with SFAS No. 86, Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed. Development costs are capitalized beginning when a product’s technological feasibility has been established and ending when the product is available for general release to customers. Technological feasibility is achieved when the detailed program design is complete. For the year ended September 30, 2005, the predecessor company capitalized $5.1 million of software and database development costs. During the period from October 1, 2005 to May 2, 2006, Predecessor Company capitalized $3.5 million of software and database development costs. From Inception to September 30, 2006 and for the year ended September 30, 2007, we capitalized $2.2 million and $5.3 million, respectively of software and database development costs. Amortization of capitalized software and database development costs for Predecessor Company was $7.0 million for the year ended September 30, 2005. During the period from October 1, 2005 to May 2, 2006, amortization of software and database development costs was $3.3 million for Predecessor Company. From Inception to September 30, 2006 and for the year ended September 30 2007, we amortized $0.1 million and $1.3 million, respectively of software and database development costs.
Advertising Costs
We expense all advertising costs as incurred and the amounts were not material for any of the periods presented.
Income Taxes
Deferred income taxes are provided for all temporary differences based on differences between financial reporting and tax basis 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. Income taxes are provided on the undistributed earnings of foreign subsidiaries that are not considered to be permanently reinvested.
There are many transactions and calculations for which the ultimate tax determination is uncertain. We establish reserves when, despite our belief that the tax return positions are fully supportable, we believe that certain positions are likely to be challenged and may not be sustained on review by tax authorities. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit. The provision of income taxes includes the impact of reserve provisions and changes to reserves that are considered appropriate.
Fair Value of Financial Instruments
The carrying amounts of certain of our financial instruments including cash and cash equivalents, accounts receivable and accounts payable, approximate fair value because of their short maturities.
Our long-term debt consists of obligations with both variable and fixed interest rates. The carrying value of debt obligations with variable interest rates is considered to approximate fair value. The estimated fair value of debt obligations with fixed interest rates is based on the quoted market prices for such debt obligations. The estimated fair value of long-term debt with fixed interest rates at September 30, 2007 with a carrying value of $175 million is $154 million.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
Certain Risks and Concentrations
We perform ongoing credit evaluations of our customers and generally do not require collateral from our customers. Most of our customers are in the automotive parts aftermarket, hardlines and lumber and wholesale distribution industries.
No customer accounted for more than 10% of our revenues during the years ended September 30, 2005, 2006 and 2007.
For the year ended September 30, 2007, Dell Inc. was our largest supplier of hardware supplies used in our solutions. No other supplier accounted for more than 10% of our total supply expense. We have a number of competitive sources of supply for supplies used in our operations.
Foreign Currency
Assets and liabilities of subsidiary operations denominated in foreign currencies are translated at the year-end rates of exchange and the income statements are translated at the average rates of exchange for the year. Translation adjustments resulting from this process are charged or credited to other comprehensive income. Local currencies are considered to be the functional currencies.
Stock Based Compensation
In December 2004, the FASB issued SFAS No. 123(R), Share-Based Payment, which replaced SFAS No. 123, Accounting for Stock-Based Compensation, and superseded APB Opinion No. 25, Accounting for Stock Issued to Employees. This revised standard addresses the accounting for stock-based payment transactions in which a company receives employee services in exchange for either equity instruments of the company or liabilities that are based on the fair value of the company’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values beginning with the first interim or annual period after June 15, 2005, with early adoption encouraged. The Predecessor Company adopted SFAS 123(R) in the quarter ended December 31, 2005. Prior to SFAS 123(R) adoption, the Predecessor Company accounted for share-based payments under APB 25.
Determining the appropriate fair value model and calculating the fair value of share-based payment awards require the input of highly subjective assumptions, including the expected life of the share-based payment awards and stock price volatility. The assumptions used in calculating the fair value of share-based payment awards represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future. In addition, we are required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest. If our actual forfeiture rate is materially different from our estimate, the stock-based compensation expense could be significantly different from the amount we have recorded in the current period.
Recently Issued Accounting Standards
In February 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No.159 provides companies with an option to report selected financial assets and liabilities at fair value. It also establishes presentation and disclosure requirements to facilitate comparisons between companies using different measurement attributes for similar types of assets and liabilities. The statement is effective for fiscal years beginning after November 15, 2007. Earlier application is permitted provided we also apply the provisions of Statement 157, Fair Value Measurements. We are currently in the process of evaluating the impact SFAS No. 159 will have on our consolidated financial statements.
In September 2006, FASB issued SFAS No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements, rather it applies to existing accounting pronouncements that require or permit fair value measurements.
SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. We are currently in the process of evaluating the impact SFAS No. 157 will have on our consolidated financial statements.
In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes by prescribing a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for our fiscal year beginning October 1, 2007. We are currently evaluating the impact of adopting FIN 48 on the consolidated financial statements.
Reclassifications
Certain prior period amounts have been reclassified to conform to the current presentation.
Note 2. Merger and Related Transactions
On May 2, 2006, Holdings became wholly owned by Activant Group, which is wholly owned by funds affiliated with Hellman & Friedman LLC, Thoma Cressey Bravo, Inc. and JMI Equity and certain members of our management. Following the merger, on May 2, 2006, Holdings merged with and into the Company, with the Company continuing as the surviving corporation and as a wholly-owned subsidiary of Activant Group. The transaction was treated as a purchase and thus the assets and liabilities were recorded at their fair value as of the closing date.
The mergers and related transactions were funded by a combination of approximately $245.7 million proceeds of common stock, a $390.0 million senior secured term loan facility and $175.0 million in senior subordinated notes, less cash received. The mergers have been recorded using the purchase method of accounting. The purchase price allocation was based upon the relative fair values of the identifiable assets acquired and liabilities assumed. The excess purchase price over those fair values was recorded as goodwill. The goodwill recorded as a result of these acquisitions is not expected to be deductible for tax purposes.
Note 3. Acquisitions
Acquisitions have been recorded using the purchase method of accounting, and, accordingly, the results of operations are included in our consolidated results as of the date of each acquisition. We allocate the purchase price of our acquisitions to the tangible assets, liabilities and intangible assets acquired, based on their estimated fair values. The excess purchase price over those fair values is recorded as goodwill. The goodwill recorded as a result of these acquisitions is not expected to be deductible for tax purposes.
Speedware Corporation Inc.
In March and April 2005, the Predecessor Company acquired all of the common stock of Speedware Corporation Inc. (“Speedware”) for $100.8 million in cash.
Prophet 21, Inc.
In September 2005, the Predecessor Company acquired all of the common stock of Prophet 21, Inc. (“Prophet 21”). The Predecessor Company paid $218.2 million in cash for 100% of Prophet 21’s common stock.
The Systems House, Inc.
In May 2005, the Predecessor Company acquired substantially all of the assets of The Systems House, Inc. for a total purchase price of $2.6 million.
Silk Systems, Inc.
On May 31, 2007, we acquired the common stock of Silk Systems, Inc. (“Silk Systems”) for a total purchase price of $6.5 million, net of $0.7 million cash received. Silk Systems is one of the leading computer software solutions providers for the Canadian home improvement, wholesale distribution and building materials industries. This acquisition expands our presence and commitment to the Canadian market while building on current technology and service offerings for customers across North America.
Eclipse Distribution Management Solutions
On August 17, 2007, we acquired substantially all of the assets of Intuit Eclipse Distribution Management Solutions (“Eclipse”) for cash consideration of approximately $101.3 million. Eclipse is a leading enterprise software provider to the wholesale distribution segment and this acquisition strengthens our position with larger wholesale distribution businesses. The purchase price was allocated based on the fair value of net assets acquired as follows (in thousands):
Acquired intangible assets consist primarily of customer contracts, customer lists and acquired technology with a weighted average estimated useful life of ten years. The amortization expense related to the acquired intangible assets is estimated to be approximately $3.0 million per annum. Goodwill is deductible for tax purposes.
The Company is in the process of determining values of certain tangible and intangible assets; thus, the allocation of the purchase price to the assets acquired and liabilities assumed in connection with the acquisition is subject to change. The preliminary purchase price allocation is based upon management’s best estimates of the relative fair values of the identifiable assets acquired and liabilities assumed.
Pro forma results (unaudited)
The following table presents the unaudited pro forma combined results of our operations with Eclipse for the year ended September 30, 2006 and 2007, after giving effect to certain pro forma adjustments primarily related to the elimination of certain Intuit allocations, restructuring activities, amortization of acquired intangible assets and interest expense. These unaudited pro forma results are not necessarily indicative of the actual consolidated results of operations had the acquisition actually occurred on the first day of the respective periods or of future results of operations of the consolidated entities (in thousands).
Note 4. Hedging and Derivative Instruments
In May 2006, we issued $390.0 million of floating rate debt (See Note 8). During the same period, we entered into four interest rate swaps to manage and reduce the risk inherent in interest rate fluctuations and to effectively convert a notional amount of $245.0 million of floating rate debt to fixed rate debt. As of September 30, 2007, the fair value of our interest rate swaps were as follows (in thousands):
We account for the interest rate swaps discussed above as cash flow hedges. The realized gains and losses on these instruments are recorded in earnings as adjustments to interest expense. The unrealized gains and losses are recognized in other comprehensive income. From Inception to September 30, 2006 and for the year ended September 30, 2007, we recorded an unrealized loss of $3.5 million ($2.1 million, net of tax) and $1.3 million ($0.8 million, net of tax), respectively in other comprehensive income on these hedges.
Note 5. Property and Equipment
Property and equipment consist of the following:
Note 6. Goodwill
The carrying amount of goodwill by reportable segment is as follows:
Changes in the carrying amount of goodwill for fiscal 2007 are as follows (in thousands):
We test goodwill for impairment annually during the fourth quarter of each fiscal year at the reporting unit level using a fair value approach, in accordance with the provisions of SFAS No. 142, Goodwill and Other Intangible Assets. Our annual testing resulted in no impairment charges to goodwill in the years ended September 30, 2005, 2006 and 2007. If an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value, goodwill will be evaluated for impairment between annual tests.
For the year ended September 30, 2007, we decreased goodwill by approximately $1.8 million, related to the resolution of additional pre-acquisition income tax uncertainties and basis adjustments related to temporary differences of acquired assets that are not expected to reverse.
Note 7. Intangible Assets
The components of purchased intangible assets are as follows:
During the year ended September 30, 2007, we recorded additions to intangible assets of $37.9 million. We estimate that we have no significant residual value related to our finite-lived intangible assets.
Acquired finite-lived intangibles are generally amortized on a straight-line basis over the weighted average periods. The Predecessor Company recorded related amortization expense of $10.8 million for the year ended September 30, 2005 and $12.0 million from October 1, 2005 to May 2, 2006. From Inception to September 30, 2006 and for the year ended September 30, 2007, we recorded amortization expense of $9.2 million and $23.7 million, respectively. Estimated amortization expense is approximately $27.8 million in each of the next five fiscal years.
We evaluate the purchased intangible assets with an indefinite life on an annual basis as of the beginning of the fourth quarter, and whenever events and changes in circumstances indicate that there may be a potential impairment. Future impairment tests could result in a charge to earnings.
Note 8. Debt
Long-term debt consisted of the following:
Senior Secured Credit Agreement
On May 2, 2006, in connection with the consummation of the mergers, we entered into a senior secured credit agreement. The senior secured credit agreement provides for (i) a seven-year term loan in the amount of $390.0 million, amortized at a rate of 1.00% per year on a quarterly basis for the first six and three-quarters years after May 2, 2006, with the balance paid at maturity, and (ii) a five-year revolving credit facility that permits loans in an aggregate amount of up to $40.0 million, which includes a letter of credit facility and a swing line facility. Principal amounts outstanding under the revolving credit facility are due and payable in full at maturity, five years from May 2, 2006. During the year ended September 30, 2007, we repaid $25.0 million in principal towards the $390.0 million term loan, which reduced the future unamortized principal payments due per the amortization schedule. In addition, subject to certain terms and conditions, the senior secured credit agreement provides for one or more uncommitted incremental term loan and/or revolving credit facilities in an aggregate amount not to exceed $75.0 million. Proceeds of the term loan on the initial borrowing date were used to partially finance the mergers, to refinance certain of our indebtedness and to pay fees and expenses incurred in connection with the mergers and the related financings and transactions. In August 2007, we borrowed the $75.0 million incremental term loan as well as $20.0 million of the revolving credit facility. These amounts were used to partially finance the acquisition of Eclipse.
The borrowings under the senior secured credit agreement bear interest at a rate equal to an applicable margin plus, at our option, either (a) a base rate determined by reference to the higher of (1) the prime rate of Deutsche Bank Trust Company Americas, and (2) the federal funds rate plus 1/2 of 1%; or (b) a reserve adjusted Eurodollar rate on deposits for periods of one-, two-, three-, or six-months (or, to the extent agreed to by each applicable lender, nine- or twelve-months or less than one month). The initial applicable margin for borrowings is:
•
under the revolving credit facility, 1.25% with respect to base rate borrowings and 2.25% with respect to Eurodollar rate borrowings, which may be reduced subject to our attainment of certain leverage ratios; and
In addition to paying interest on outstanding principal under the senior secured credit agreement, we will be required to pay a commitment fee to the lenders under the revolving credit facility in respect of the unutilized commitments thereunder. The initial commitment fee rate is 0.50% per annum. The commitment fee rate may be reduced subject to our attaining certain leverage ratios. We must also pay customary letter of credit fees for issued and outstanding letters of credit.
Substantially all of our assets and those of our subsidiaries are pledged as collateral on the senior secured credit agreement.
Senior Subordinated Notes Due 2016
On April 27, 2006, we issued $175.0 million aggregate principal amount of 9.50% senior subordinated notes due May 2, 2016. The notes were issued in a private transaction that was not subject to the registration requirements of the Securities Act of 1933. The notes were exchanged for substantially identical notes registered with the SEC, pursuant to a registration rights agreement entered into in connection with the indenture.
Each of our domestic subsidiaries, as primary obligors and not merely as sureties, jointly and severally, irrevocably and unconditionally guarantee, on an unsecured senior subordinated basis, the performance and full and punctual payment when due, whether at maturity, by acceleration or otherwise, of all of our obligations under the indenture and the notes. The notes are our unsecured senior subordinated obligations and are subordinated in right of payment to all of our existing and future senior indebtedness (including the senior secured credit agreement), are effectively subordinated to all of our secured indebtedness (including the senior secured credit agreement); and senior in right of payment to all of our existing and future subordinated indebtedness.
The terms of the senior secured credit agreement and the senior subordinated notes restrict certain activities, the most significant of which include limitations on additional indebtedness, liens, guarantees, payment or declaration of dividends, sale of assets and transactions with affiliates. In addition, the senior secured credit agreement requires us to maintain a maximum total net leverage ratio and a minimum interest coverage ratio. The senior secured credit agreement also contains certain customary affirmative covenants and events of default. At September 30, 2007, we were in compliance with all of the senior secured credit agreement’s and the senior subordinated notes’ covenants.
Aggregate maturities of debt are as follows (in thousands):
Note 9. Income Taxes
Significant components of the income tax expense (benefit) attributable to continuing operations are as follows:
The provision for income taxes differs from the expected tax expense (benefit) amount computed by applying the statutory federal income tax rate of 35% to income before income taxes as a result of the following:
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of our deferred taxes are as follows:
As of September 30, 2006 and 2007, we had $14.3 million and $20.4 million, respectively of federal and state net operating loss carry-forwards. As of September 30, 2006 and 2007, we had $10.7 million and $2.8, respectively of federal business tax credit carry-forwards. The valuation allowance increased by approximately $3.9 million during the year and is primarily comprised of allowances against net operating loss carry-forwards. The net operating losses expire between 2009 and 2017.
Substantially all of our operating income was generated from domestic operations during 2006 and 2007. Undistributed earnings, if any, of our foreign subsidiaries is considered to be permanently reinvested and, accordingly, no U.S. Federal or state income taxes have been provided thereon.
Note 10. Employee Stock and Savings Plans
Common Stock Option Plan
Activant Solutions Inc.
During 2006, Activant Group, our parent company, adopted the Activant Group Inc. 2006 Stock Incentive Plan (the “2006 Option Plan”), which as of September 30, 2007 had 7,761,958 authorized shares. The option price may not be less than the fair market value at the date of grant as determined in good faith by the board of directors of Activant Group from time to time. Options vest in varying amounts over a period up to five years and expire ten years from the date of the grant.
The Company estimates the fair value of stock options using a Black-Scholes option pricing model that uses certain assumptions including expected term, expected volatility of the underlying stock, expected dividend pay-out rate and risk-free rate of return. The expected term was based on historical data and represents the period of time that stock options granted were expected to be outstanding. Due to the fact that the common stock underlying the options is not publicly traded, the expected volatility was based on a comparable group of companies for the period. We do not intend to pay dividends on our common stock for the foreseeable future, and accordingly, used a dividend yield of zero. The risk-free rate for periods within the contractual life of the option was based on the Treasury Bill coupon rate for U.S Treasury securities in effect at the time of the grant with a maturity approximating the expected term. From Inception to September 30, 2006, there were no stock options granted and therefore no compensation expense was recognized. For the fiscal year ended September 30, 2007, we recorded share- based payment expense of approximately $4.2 million, with a total income tax benefit recognized in the income statement of approximately $1.7 million.
The fair value of each award granted from the 2006 Option Plan during the year ended September 30, 2007 was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:
The weighted average estimated grant date fair value, as defined by SFAS 123R, for options granted under the 2006 Option Plan during the fiscal year ended September 30, 2007 was $2.46 per share.
Information with respect to stock option activity for the year ended September 30, 2007 is as follows:
At September 30, 2007, the total intrinsic value of outstanding stock options was approximately $3.6 million. At September 30, 2007, there was approximately $12.5 million of total unrecognized shared-based payment expense related to unvested stock options which we expect to recognize as expense in future periods through 2012.
Predecessor Company
In connection with the mergers, Activant Group entered into an option rollover agreement with Mr. Pervez A. Qureshi, our Chief Executive Officer and President, pursuant to which Mr. Qureshi agreed to rollover $1.0 million of spread value of his then outstanding stock options into 333,334 vested stock options to purchase shares of common stock of Activant Group at an exercise price of $1.00 per share. Pursuant to the option rollover agreement, Activant Group agreed to assume these options pursuant to the terms of the Activant Solutions Holdings Inc. Second Amended and Restated Stock Option Plan for Key Employees, as amended (the “Predecessor Company Plan”), which is the stock option plan under which these options were originally granted.
The Predecessor Company adopted SFAS 123R in the quarter ended December 31, 2005 using the prospective method. The Predecessor Company recorded share-based payment expense of approximately $1.4 million for the period from October 1, 2005 to May 2, 2006, with a total income tax benefit recognized in the income statement of approximately $0.5 million.
Information on stock options for the fiscal year ended September 30, 2007 under the Predecessor Company Plan is as follows:
Prior to October 1, 2005, Predecessor Company used the intrinsic value method in accounting for employee stock options. Because the exercise price of the employee stock options was greater than or equal to the market price of the underlying stock, as determined by Predecessor Company’s board of directors, on the date of grant, no compensation expense was recognized.
Pro forma information regarding net income is shown below as if Predecessor Company had accounted for its employee stock options granted under the fair value method prescribed by SFAS No. 123(R). The Predecessor Company used the minimum value method in determining the option value under SFAS 123 for all options granted prior to June 2005. The Company adopted SFAS 123(R) using the prospective method for all options issued after June 2005. The fair value of these options was estimated at the date of grant using the minimum value option pricing model with the following assumptions:
For purposes of pro forma disclosure, the estimated fair value of the options was amortized to expense over the options’ vesting period. The Predecessor Company pro forma information for the year ended September 30, 2005 was as follows:
The weighted average fair value of options granted during the period from October 1, 2005 to May 2, 2006 was $2.09.
401(k) Plan
We have a savings and investment plan known as the Activant Solutions Inc. Savings and Investment Plan (the “Plan”) as allowed under Sections 401(k) and 401(a) of the Internal Revenue Code. The Plan provides employees with tax deferred salary deductions and alternative investment options. Employees are eligible to participate the first day of hire and are able to apply for and secure loans from their account in the Plan.
The Plan provides for contributions as determined annually by the board of directors. We match 50% of the first 6% of compensation contributed by each employee and the deferred amount cannot exceed 25% of the annual aggregate salaries of those employees eligible for participation. Highly compensated executive participants are limited to a maximum of 10%. Contributions to the Plan amounted to $1.4 million in the year ended September 30, 2005. We contributed $1.0 million for the period from October 1, 2005 to May 2, 2006 and $1.0 million from Inception to September 30, 2006. For the year ended September 30, 2007 contributions amounted to $2.7 million.
Note 11. Commitments and Contingencies
Operating Leases
We rent integration and distribution, software development and data entry facilities; administrative, executive, sales, and customer support offices; and, certain office equipment under non-cancelable operating lease agreements. Certain lease agreements contain renewal options and rate adjustments. Predecessor Company recorded rental expense of $7.5 million and $5.9 million for the year ended September 30, 2005 and the period from October 1, 2005 to May 2, 2006, respectively. We recorded rental expense of $4.1 million and $10.2 million from Inception to
September 30, 2006 and the year ended September 30, 2007, respectively. Future minimum rental commitments under all non-cancelable operating leases are as follows (in thousands):
Legal Matters
We are involved in litigation arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the resolution of these matters is not expected to have a material adverse effect on our results of operations or financial position.
Note 12. Restructuring Costs
During the year ended September 30, 2007, our management approved a restructuring plan for eliminating certain positions associated with outsourcing certain activities to third-party providers. In accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, we recorded a charge of approximately $0.3 million related to workforce reductions, which events were communicated to the impacted employees or incurred during the period. The charge was comprised of severance and other employee termination benefits related to these workforce reductions. Approximately $0.2 million remains to be paid as of September 30, 2007 related to these actions and are anticipated to be paid over the next twelve months.
During the year ended September 30, 2007, our management also approved a restructuring plan for eliminating certain positions with the intent to streamline and focus our efforts and more properly align our cost structure with our projected revenue streams. In accordance with SFAS 146, we recorded a charge of approximately $0.5 million related to this workforce reduction, which was communicated to impacted employees during the period. All payments related to this action are anticipated to be made over the next twelve months.
During the periods from October 1, 2006 to May 2, 2006 and Inception to September 30, 2006, the Predecessor Company and we, incurred, in accordance with SFAS 146, restructuring costs of $0.9 million. These were one-time benefits paid to certain employees separated in connection with the relocation of our corporate offices from Austin, Texas to Livermore, California. We also incurred $0.3 million in costs related to this action during the year ended September 30, 2007. All payments related to this action were made by September 30, 2007.
Note 13. Related Party Transactions
As of September 30, 2007, we owned approximately 46% of Internet Autoparts, Inc. (“Internet Autoparts”), a web-based parts ordering and communication company. For the year ended September 30, 2007, we received a dividend from Internet Autoparts of approximately $0.5 million. Currently, we have an accumulated loss in our investment in Internet Autoparts and have temporarily discontinued applying the equity method of recording investment earnings in accordance with APB No. 18, The Equity Method of Accounting for Investments in Common Stock, as we have no requirement to fund future losses. If Internet Autoparts becomes profitable, and we are able to recover the net losses accumulated over the years, we will then resume applying the equity method to our investment in Internet Autoparts.
We, as general partner, own an approximate 20% interest in two separate partnerships with certain customers. We provide management information systems and services to these partnerships. The Predecessor Company recorded service revenue from these partnerships of $3.7 million and $1.2 million for the year ended September 2005 and from October 1, 2005 to May 2, 2006, respectively. From Inception to September 30, 2006 and for the year ended September 30, 2007, respectively, we recorded service revenue from these partnerships of $0.4 million and $0.4 million, respectively. The Predecessor Company recorded equity income from these partnerships of $0.3 million and $0.1 million for the year ended September 30, 2005 and the period from October 1, 2005 to May 2, 2006, respectively.
Note 14. Segment Reporting
We have organized our business around our products and services (“Segments”) as follows:
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Systems, which is comprised primarily of proprietary software applications, third-party hardware and peripherals and implementation and training;
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Product Support, which is comprised of daily operating support through our advice line, software updates, preventive and remedial on-site maintenance and depot repair services;
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Content and Supply Chain, which is comprised primarily of databases, exchanges and other information services, including our electronic catalog in the automotive parts aftermarket; and
•
Other Services, which is comprised primarily of business products, such as forms and other paper products.
Each reportable Segment is managed separately on a revenue and gross profit basis. We do not allocate operating expenses, interest expense, other expenses or assets to each Segment, as this information is not used to measure the operating performance of the Segments.
Organizationally, the functional operating areas that support all of our Segments, including systems integration, installation and training, product support, data services, product development and sales and marketing, are integrated under a common reporting and management structure to achieve operating efficiencies.
The following tables set forth, for the periods indicated, our revenues, cost of revenues, gross profit and gross profit as a percentage of revenue by Segment:
Geographic segments
A breakdown by geographic area of revenues and total assets is shown below. The Americas geographic area covers the United States and Canada. The Europe geographic area covers the United Kingdom, Ireland and France.
Note 15. Guarantor Consolidation
The senior secured credit agreement and the senior subordinated notes are guaranteed by our existing, wholly-owned domestic subsidiaries HM COOP LLC, Speedware USA, Inc., Prelude Systems Inc., Activant Wholesale Distribution Solutions Inc., and Greenland Holding Corp. Since September 30, 2006, (i) the following subsidiaries have been merged into Activant Solutions Inc.: Triad Systems Financial Corporation, Triad Data Corporation, CCI/TRIAD Gem, Inc., Enterprise Computing Inc., Speedware Holdings, Inc., and CCI/ARD, Inc.; and (ii) the following subsidiaries have been merged into Activant Wholesale Distribution Solutions Inc. (formerly known as Prophet 21 New Jersey, Inc.): Prophet 21 Investment Corporation, Prophet 21 Canada, Inc., SDI Merger Corporation, Distributor Information Systems Corporation, Trade Services Systems, Inc., and STANPak Systems, Inc. Our other subsidiaries (the “Non-Guarantors”) are not guarantors of the senior secured credit agreement and the senior subordinated notes. The following consolidated statements of operations and cash flows for the year ended September 30, 2005 and the period from October 1, 2005 to May 2, 2006, represent the results of operations and cash flows of the Predecessor Company’s Guarantors and Non-Guarantors. The accompanying consolidated balance sheet as of September 30, 2006 and 2007 and the accompanying consolidated statements of operations and cash flows from Inception to September 30, 2006 and the year ended September 30, 2007 represent the financial position, results of operations and cash flows of the Company’s Guarantors and Non-Guarantors.
Consolidating Balance Sheet as of September 30, 2007
Consolidating Balance Sheet as of September 30, 2006
Consolidating Statement of Operations for the Year Ended September 30, 2007
Consolidating Statement of Operations from Inception to September 30, 2006
Predecessor Company
Condensed Consolidating Statement of Operations for the period from October 1, 2005 to May 2, 2006
Predecessor Company
Consolidating Statement of Operations for the Year Ended September 30, 2005
Consolidating Statement of Cash Flows for the year ended September 30, 2007
Consolidating Statement of Cash Flows from Inception to September 30, 2006
Predecessor Company
Condensed Consolidating Statement of Cash Flows for the period from October 1, 2005 to May 2, 2006
Predecessor Company
Consolidating Statement of Cash Flows for the Year Ended September 30, 2005
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None
Item 9A.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
An evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer (CEO) and Principal Financial Officer (CFO), of the effectiveness of the design and operation of our disclosure controls and procedures. Our disclosure controls and procedures are the controls and other procedures that we have designed to ensure that information required to be disclosed by us in the reports that we file with or submit to the SEC is recorded, processed, summarized and reported within the time periods specified by the SEC. Our disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file with or submit to the SEC is accumulated and communicated too our management, including our CEO and CFO, to allow timely decisions regarding required disclosure. Based on the evaluation of our disclosure controls and procedures as described above, our CEO and CFO have concluded that as of September 30, 2007 our disclosure controls and procedures were effective.
Internal Controls Over Financial Reporting
During our fiscal quarter ended September 30, 2007, there have been no changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
This Annual Report on Form 10-K does not include a report of management’s assessment regarding internal control over financial reporting or an attestation report of the company’s registered public accounting firm regarding internal control over financial reporting due to a transition period established by rules of the SEC for companies that were not required to file an annual report pursuant to section 13(a) or 15(d) of the Exchange Act for the prior fiscal year or had not filed an annual report with the SEC for the prior fiscal year.
Limitations on Effectiveness of Controls
Our management, including our Chief Executive Officer and the Chief Financial Officer, does not expect that our disclosure controls and procedures or internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can only provide reasonable, not absolute, assurances that the objectives of the control system are met. The design of a control system reflects resource constraints, and the benefits of controls must be considered relative to their costs. Because there are inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of error or fraud, if any, have been or will be detected.
Item 9B.
Item 9B. Other Information.
Ernst & Young LLP (“E&Y”) has a business relationship with a company other than us that is also controlled by affiliates of Hellman & Friedman, LLC, our majority stockholder. The other company provides expert services to E&Y in connection with E&Y’s defense of certain professional liability litigation matters. E&Y is not the auditor of the other company, and does not believe the services provided, or the amounts paid therefore, are material to either the other company or E&Y. This relationship does not involve Activant nor have any impact on its consolidated financial statements. Our audit committee and E&Y have separately considered the impact that this relationship may have had on E&Y’s independence with respect to us. Both our audit committee and E&Y have concluded that this relationship with the other company does not impact E&Y’s independence. In making this determination, both our audit committee and E&Y considered, among other things, the immaterial, indirect nature of the relationship as it relates to us.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
Set forth below are the names, ages and positions of our and Activant Group’s directors and executive officers as of December 21, 2007. All directors hold office until the next annual meeting our stockholders or Activant Group, as the case may be, or until their successors are duly elected and qualified.
(1)
Denotes a member of the Audit Committee, “*” denotes Chair of Audit Committee.
(2)
Denotes a member of the Compensation Committee, “**” denotes Chair of Compensation Committee.
Mr. Qureshi has been employed by us since 1994. He was appointed as our President and Chief Executive Officer at the effective time of the mergers, or May 2, 2006. Mr. Qureshi joined us as Director of Marketing in 1994. He became Senior Vice President and General Manager of our Hardlines and Lumber division in 1999. He became Group President of our vertical markets in 2004, Senior Vice President and Chief Operating Officer in April 2005, and Executive Vice President in October 2005. Prior to joining us, Mr. Qureshi was President of a management consulting company he founded and was Vice President of Marketing at Harvest Software. He has also held management positions at Metaphor Computer Systems and Hewlett-Packard Company and engineering positions at International Business Machines Incorporated. Mr. Qureshi holds a B.S.E.E. degree from the University of Lowell, in Lowell, Massachusetts and an M.B.A. from the Darden Graduate School of Business at the University of Virginia.
Ms. Crusco joined us as Senior Vice President and Chief Financial Officer on May 3, 2007. Prior to joining us, Ms. Crusco was Vice President, Finance at Polycom, Inc. from March 2005 to May 2007 and Vice President, Worldwide Controller from January 2002 to March 2005. In addition, Ms. Crusco served as Chief Accounting Officer from August 2002 through March 2005. From April 1999 through January 2002, Ms. Crusco served as Vice President, Worldwide Controller at Documentum, Inc. and from July 1997 through April 1999 as Director of Finance at Adaptec, Inc. Ms. Crusco also spent 10 years at Price Waterhouse LLP in various management roles. Ms. Crusco has a B.S. in Business Administration with an emphasis in accounting from California State University of Chico.
Mr. Wilson joined us in 1981 as a software engineer. He became Vice President of Product Development for our non-automotive vertical markets in 1999 and for all of our vertical markets in 2004. Mr. Wilson was promoted to Senior Vice President of Product Development in October 2005. Prior to joining us, Mr. Wilson worked at the consulting firm of Towers Perrin. Mr. Wilson has a B.A. from Yale University.
Mr. McLaughlin has been employed by us since 1982 and has been our Senior Vice President and General Manager of the Wholesale Distribution Group since October 2005. Mr. McLaughlin joined us as a Sales Representative in our Automotive/Tire Division in 1982 and has served in several sales and sales management capacities since then. Mr. McLaughlin became Vice President and General Manager of the Lumber and Building Materials Group in October 1999 and held that role until October 2005. Mr. McLaughlin has a B.S. in Business Economics from the University of San Francisco.
Mr. Hanson has been employed by us since June 1, 1978 and has been our Senior Vice President of Hardlines and Lumber since October 2007. Mr. Hanson joined us as a Sales Representative in our Automotive Division in 1978 and has served in several sales and management capacities since then. Mr. Hanson became Vice President of Sales in 1998 and held that role until becoming Vice President of Marketing in 2001. In 2004, he became Vice President National Accounts and Customer Sales and held that role until 2005. He then served as Vice President and General Manager of Hardware and Home Center from 2006 to 2007.
Mr. Petroni joined us on December 11, 2006 as Senior Vice President of Corporate Development. Prior to joining us, Mr. Petroni served as Vice President of Corporate Development for Valchemy Inc. during 2006 and Chief Financial Officer from 2004 through 2005. From 2001 to 2004, Mr. Petroni also served as Vice President of Corporate Business Development at PeopleSoft, Inc. Prior to PeopleSoft, Mr. Petroni held senior M&A and finance roles for Vignette Corporation, OnDisplay, Inc., General Electric Company, and National Semiconductor, Inc. Mr. Petroni holds both a B.S. in Agricultural Managerial Economics and a B.A. in Political Science from the University of California at Davis. Mr. Petroni also holds an M.B.A. from Georgetown University.
Mr. Taich joined us on September 18, 2006 as Vice President, General Counsel and Secretary. Prior to joining us, Mr. Taich served as acting General Counsel at Maxtor Corporation, where he held various positions in the Legal Department from 2001 to 2006. Mr. Taich served as Corporate Legal Counsel for Triad Systems Corporation from 1991 to 1997, a publicly traded company and predecessor of Activant. Mr. Taich also served in the Legal Department of Compaq Computer Corporation (and previously Tandem Computers, which was acquired by Compaq in 1998) from 1997 to 1999, and as a principal and venture partner of Palo Alto Ventures and Wingspring, Inc., respectively. Mr. Taich began his career as an associate at the law firm of Ware & Friedenrich (now DLA Piper Rudnick) from 1986 to 1991. He is a member of the State Bar of California and holds a J.D. from the University of California, Berkeley (Boalt Hall) and a B.S. in Business from the University of Colorado, Boulder.
Mr. Henske became one of our directors, and the Chairman of our Board of Directors, on November 2, 2007. Mr. Henske has served as a Managing Director of Hellman & Friedman LLC since July 2007. From May 2005 until July 2007, he served as Senior Vice President and General Manager of the Consumer Tax Group of Intuit Inc. He was Intuit’s Chief Financial Officer from January 2003 to September 2005. Prior to joining Intuit, he served as Senior Vice President and Chief Financial Officer of Synopsys, Inc., a supplier of electronic design automation software, from May 2000 until January 2003. From January 1997 to May 2000, Mr. Henske was at Oak Hill Capital Management, a Robert M. Bass Group private equity investment firm, where he was a partner. Mr. Henske also serves on the board of directors of VeriFone, Inc. Mr. Henske holds a B.S. in Chemical Engineering from Rice University and an M.B.A. in Finance and Strategic Management from The Wharton School of Business, University of Pennsylvania.
Mr. Ballard became one of our directors on May 2, 2006. Mr. Ballard is a Managing Director at Hellman & Friedman LLC. He also serves as a director of DoubleClick, Inc., Vertafore, Inc. and Catalina Marketing, Inc. Prior to joining Hellman & Friedman in 2004, Mr. Ballard was employed by Bain Capital in San Francisco and Boston. Prior to that, he worked for Bain & Company. Mr. Ballard graduated cum laude from Harvard College and has an M.B.A. from the Stanford Graduate School of Business.
Mr. Barber became one of our directors on May 2, 2006. Mr. Barber is a General Partner of JMI Equity. Mr. Barber joined JMI in 1998. He serves on the board of directors of Blackbaud, Inc., Burr Wolff Management, Inc., DoubleClick, Inc., Service-now.com, TC3 Health, Inc. and Vertafore, Inc. Mr. Barber was formerly a Director of Blackbaud, Inc., Mitchell International, Inc. and Sterling Software, Inc. and a Trustee of Stanford University. From 1990 to 1998, Mr. Barber was employed by Alex.Brown serving as a Managing Director and Head of the Software Investment Banking Practice. In 1989, Mr. Barber worked in Product Marketing at Microsoft Corporation. Mr. Barber began his career at Merrill Lynch & Co. Mr. Barber received an A.B. from Stanford University and an M.B.A. from the Harvard Business School.
Mr. Bernard became one of our directors on May 2, 2006. Mr. Bernard is an executive business consultant. From 1994 to 2000, Mr. Bernard was Corporate Vice President, Operations, of Geac Computer Corporation, a performance management software company, where he was responsible for the management and overall performance of several company businesses located in North America, Europe and the United Kingdom, representing $250 million in annual revenues. From 1992 to 1994, Mr. Bernard was Senior Vice President, Ontario Division, of St. Lawrence Cement, a Canadian producer and supplier of products and services to the construction industry. At St. Lawrence Cement, Mr. Bernard was responsible for the management of all Ontario business units, representing over $400 million in revenues. From 1991 to 1992, Mr. Bernard was President and CEO of SaskTel, Saskatchewan’s largest phone company with $600 million in revenues and over 4,200 employees. Prior to this, Mr. Bernard occupied various positions at Motorola, most notably as President of Motorola Canada from 1982 to 1991. Mr. Bernard serves or has served on the board of several organizations, including most recently Datatel, Inc., Prophet 21, Inc., VECTORsgi, Inc. (now a subsidiary of Metavante), Vision Solutions, Inc., and Embarcadero Technologies, Inc.
Mr. Bravo became one of our directors on May 2, 2006. Mr. Bravo is a Managing Partner at Thoma Cressey Bravo, Inc. Mr. Bravo joined Thoma Cressey Bravo at its formation in 1998. He previously worked in the Mergers & Acquisitions group of Morgan Stanley & Co. based in New York. He is a director of Datatel, Inc., JDA Software Group, Inc., Consona, Inc., Hyland Software Inc., Embarcadero Technologies, Inc. and Sirius Computer Solutions, Inc. Mr. Bravo was the former Chairman of Prophet 21, Inc. and former director of VECTORsgi, Inc. Mr. Bravo has undergraduate degrees in Economics and Political Science from Brown University, a J.D. from the Stanford Law School and an M.B.A. from the Stanford Graduate School of Business.
Mr. Crabill became one of our directors on May 2, 2006. Mr. Crabill is a Partner at Thoma Cressey Bravo Inc. Mr. Crabill joined Thoma Cressey from Summit Partners, a leading private equity firm, where he invested in and worked with companies in many growth sectors, including software, electronics and IT services. Previously, he was with the private equity firm of Whitney & Co., Stamford, Connecticut, where he was active in middle-market buyouts and growth equity financings. His other experience includes employment with Hewlett-Packard Company as a product manager and with Alex.Brown & Sons in corporate finance and mergers & acquisitions. He is a Director of AttachmateWRQ, Inc. Mr. Crabill earned a B.S. in Industrial Engineering from Stanford University and an M.B.A. from Stanford’s Graduate School of Business.
Mr. Tunnell became one of our directors on May 2, 2006. Mr. Tunnell is a Managing Director at Hellman & Friedman LLC. He is also a director of GeoVera Insurance Group Holdings, Ltd., as well as the Chairman of the Board of Directors of Vertafore, Inc. He was formerly a director of Arch Capital Group Ltd., Blackbaud, Inc., and Eastern Sea Laem Chabang Terminal Co., Ltd. Mr. Tunnell is also a Term Member of the Council on Foreign Relations. Prior to joining Hellman & Friedman in 1994, Mr. Tunnell was employed by the Banking Group of Lazard Frères & Co. in New York. Mr. Tunnell graduated magna cum laude from Harvard College and has an M.B.A. from the Harvard Business School.
Board Composition and Governance
The composition of our board of directors is established by the terms of the stockholders agreement entered into by us, Activant Group, funds affiliated with Hellman & Friedman, Thoma Cressey and JMI Equity and certain members of our management. Among other things, this stockholders agreement provides that, prior to an initial public offering of the shares of Activant Group’s common stock, the parties that beneficially own shares of Activant Group common stock will vote those shares to elect a board of directors comprised of the following persons:
•
our chief executive officer;
•
up to two board members designated by Thoma Cressey (currently Messrs. Bravo and Crabill);
•
one board member designated by JMI (currently Mr. Barber); and
•
the remaining board members designated by Hellman & Friedman (currently Messrs. Ballard, Bernard, Henske and Tunnell).
For a discussion regarding the stockholders agreement, please refer to “Item 13. Certain Relationships and Related Transactions, and Director Independence-Stockholders Agreement.”
The committees of our board of directors currently consist of an audit committee and a compensation committee. None of the members of our audit committee and compensation committee is independent. Our board of directors is not comprised of a majority of independent directors, and its committees are not comprised entirely of independent directors, because we are a privately held company and not subject to applicable listing standards. Please see “Item 13. Certain Relationships and Related Transactions, and Director Independence.”
Audit Committee Financial Expert
Our board of directors has determined that Mr. Ballard and Mr. Barber each, qualify as an “audit committee financial expert,” as this term has been defined by the SEC in Item 407(d)(5) of Regulation S-K. Messrs. Ballard and Barber were determined by our board to meet the qualifications of an “audit committee financial expert” in accordance with SEC rules, including based on his prior experience of actively supervising chief financial officers.
Our board of directors determined that Mr. Ballard acquired the required attributes for such designation as a result of the following relevant experience, which forms of experience are not listed in any order of importance and were not assigned any relative weights or values by our board in making such determination:
•
experience overseeing or assessing the performance of companies or public accountants with respect to the preparation, auditing or evaluation of financial statements, including experience serving as Audit Committee Chair for DoubleClick, Inc. from July 2005 to date and Audit Committee Chair for Vertafore, Inc. from December 2004 to date;
•
experience as a private equity investor for ten years, including managing all aspects and facets of accounting due diligence and issuing accounting statements;
•
M.B.A. from Stanford University, including advanced accounting coursework; and
•
continued periodic study of recent accounting pronouncements.
Our board of directors determined that Mr. Barber acquired the required attributes for such designation as a result of the following relevant experience, which forms of experience are not listed in any order of importance and were not assigned any relative weights or values by our board in making such determination:
•
experience as a private equity investor for over nine years, including managing all aspects and facets of accounting due diligence and issuing accounting statements;
•
M.B.A. from Harvard University; and
•
continued periodic study of recent accounting pronouncements.
Code of Ethics for Senior Financial Management
We have adopted a Code of Ethics for Senior Financial Management (the “Code of Ethics”) which is applicable to our Chief Executive Officer, Chief Financial Officer, Vice President of Finance and Controller. To date, we have not granted any waivers to the Code of Ethics. We have filed a copy of our Code of Ethics as Exhibit 14.1 to this Annual Report on Form 10-K. A free copy of our Code of Ethics may be obtained by directing your request to Activant Solutions Inc., 7683 Southfront Road, Livermore, CA 94551 Attn: General Counsel.
Item 11.
Item 11. Executive Compensation.
Compensation Discussion and Analysis
Our executive compensation program, including with respect to our Named Executive Officers, is overseen and administered by the Compensation Committee of our Board of Directors (“Board”). Our “Named Executive Officers” are (1) our current chief executive officer, (2) our current chief financial officer, (3) each of our three other most highly compensated executive officers who were serving as executive officers at the end of September 30, 2007 and (4) our former chief financial officers, each of whom would have been one of our three most highly compensated executive officers but for the fact that he or she was not serving as one of our executive officers at September 30, 2007.
The Board has appointed Messrs. Henske, Ballard, Bravo and Tunnell to serve on the Compensation Committee. None of our executive officers has served as a member of the Compensation Committee (or other committee serving an equivalent function) of any other entity, whose executive officers served as a director of our company or member of our Compensation Committee. Messrs. Ballard, Henske and Tunnell are managing directors of Hellman & Friedman LLC and Mr. Bravo is a partner of Thoma Cressey Bravo, Inc. Affiliates of Hellman & Friedman LLC and Thoma Cressey Bravo, Inc. together beneficially own approximately 95.5% of the outstanding common stock of Activant Group. See “Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
We are a wholly owned subsidiary of Activant Group, which owns all of our issued and outstanding capital stock. All of Activant Group’s issued and outstanding capital stock is owned by funds affiliated with Hellman & Friedman LLC, Thoma Cressey Bravo, Inc. and JMI Equity, which funds we refer to as the “sponsors” and certain members of our management, which we refer to as the “management investors.”
The sponsors are able to control all actions by the board of directors of Activant Group by virtue of their being able to appoint a majority of the directors, their rights under the stockholders agreement to which they and Activant Group are parties and the beneficial ownership by an affiliate of Hellman & Friedman LLC of the only authorized and outstanding share of Series A preferred stock issued in connection with the mergers. In addition, as a result of the voting and transfer provisions of the stockholders agreement, the sponsors may be deemed to constitute a group within the meaning of Section 13(d)(3) of the Exchange Act. Accordingly, each of the members of this group may be deemed to beneficially own all of the shares of Activant Group common stock held by the sponsors and the management investors. Each of the sponsors disclaims any beneficial ownership of shares of Activant Group common stock held by the other sponsors and the management investors. See “Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
Certain Relationships and Related Transactions
Since October 1, 2004, there has not been, nor is there currently planned, any transaction or series of similar transactions to which we were or are a party in which the amount involved exceeds $120,000 and in which any director, executive officer or holder of more than 5% of our capital stock or any member of such persons’ immediate families had or will have a direct or indirect material interest, other than agreements and transactions which are described under “Compensation Discussion and Analysis-Employment Agreements and Severance and Change of Control Benefits” and the transactions described below.
Agreements Related to the Mergers
We entered into several related party agreements in contemplation of the mergers, to which the company succeeded by operation of law as a result of the mergers.
Merger Agreement
On March 12, 2006, Activant Group, Merger Sub and Holdings entered into an agreement and plan of merger pursuant to which Merger Sub merged with and into Holdings, subject to the terms and conditions set forth in the merger agreement. The survivor then merged with and into Activant Solutions, Inc. At the effective time of the merger of Merger Sub into Holdings, each share of (a) Holdings common stock issued and outstanding immediately prior to the effective time of that merger (other than shares held in the treasury of Holdings, owned by Merger Sub, Activant Group or any direct or indirect wholly-owned subsidiary of Holdings or held by Holdings stockholders who were entitled to and who properly exercised appraisal rights under Delaware law) were converted into the right to receive $4.00 in cash, without interest, and (b) Holdings Class A common stock issued and outstanding immediately prior to the effective time of that merger (other than shares held in the treasury of Holdings, owned by Merger Sub, Activant Group or any direct or indirect wholly-owned subsidiary of Holdings or held by Holdings stockholders who were entitled to and who properly exercised appraisal rights under Delaware law) were converted into the right to receive $7.2965 per share in cash, without interest.
In addition, except with respect to Mr. Pervez A. Qureshi, our president and chief executive officer, who agreed prior to the merger of Merger Sub with and into Holdings to rollover a portion of his existing options to acquire Holdings common stock into options to acquire Activant Group common stock in lieu of such rollover options being cancelled and converted into the right to receive a cash payment, all options to acquire Holdings common stock that were vested and exercisable immediately prior to that merger were cancelled and converted into the right to receive a payment in cash, without interest, equal to the product of (A) the total number of shares of Holdings common stock as to which the option is vested and exercisable immediately prior to that merger and (B) the excess, if any, of $4.00 over the exercise price per share of Holdings common stock subject to such option, less applicable withholding taxes. All other options were cancelled and terminated without the right to receive any payment. As a result of the foregoing, the following payments in excess of $120,000 were received by our current or former executive officers:
Equity Commitment Letter and Subscription Agreement
In connection with the mergers, Activant Group and certain funds affiliated with Hellman & Friedman LLC, or Hellman & Friedman, and Thoma Cressey Bravo, Inc., or Thoma Cressey, which we together refer to as the “sponsors” entered into an equity commitment letter agreement, dated March 12, 2006, pursuant to which the parties to the agreement agreed to make cash investments in Activant Group immediately prior to the completion of the mergers. In connection with the closing of the mergers, the funds affiliated with Hellman & Friedman invested approximately $195.0 million and the funds affiliated with Thoma Cressey invested approximately $48.7 million. The commitments of the sponsors were reduced on a pro rata basis by the amount of equity investments in Activant Group by the management investors. Prior to the mergers, the funds affiliated with Hellman & Friedman assigned an aggregate of approximately $10.0 million of the amount they committed to invest to affiliates of JMI Equity, at which time these affiliates of JMI Equity became “sponsors” along with the funds affiliated with Hellman & Friedman and Thoma Cressey that made investments in Activant Group pursuant to a Subscription Agreement dated May 2, 2006. In exchange for these investments, Activant Group issued shares of its common stock to the sponsors, at a price of $4.00 per share, and issued one share of its Series A preferred stock to a fund affiliated with Hellman & Friedman.
The one share of Series A preferred stock, which ranks senior to Activant Group common stock as to rights of payment upon liquidation, is the only outstanding share of Series A preferred stock of Activant Group. The share of Series A preferred stock is not entitled to receive or participate in any dividends. The holder of the Series A preferred stock, voting as a separate class, has the right to elect one director of Activant Group, and the director designated by the holder of the series A preferred stock is entitled at any meeting of the board of directors to exercise
one vote more than all votes entitled to be cast by all other directors at such time. Activant Group is required to redeem the series A preferred stock for $1.00 upon the earliest of the following to occur:
•
Hellman & Friedman and its affiliates, in the aggregate, no longer beneficially own a number of outstanding share equivalents that is at least (a) 40% of Activant Group’s outstanding ‘‘share equivalents’’ and (b) 200% more than the number of outstanding share equivalents beneficially owned by Thomas Cressey and its affiliates, in the aggregate;
•
Hellman & Friedman and their affiliates, in the aggregate, no longer beneficially own at least 20% of the outstanding share equivalents of Activant Group; or
•
the consummation of an underwritten public offering of Activant Group common stock registered under the Securities Act.
For purposes of the Series A preferred stock and the stockholders agreement described below, “share equivalents’’ are shares of Activant Group common stock and the number of shares of common stock issuable, without payment to Activant Group of additional consideration, upon exercise, conversion or exchange of any other security.
Stockholders Agreement
In connection with the closing of the mergers, we, Activant Group, funds affiliated with Hellman & Friedman, which we refer to as the “Hellman & Friedman Investors,” funds affiliated with Thoma Cressey, which we refer to as the “Thoma Cressey Investors,” funds affiliated with JMI Equity, which we refer to as the “JMI Investors,” and certain members of our management, which we refer to as the “management investors,” entered into a stockholders agreement that generally contains the following provisions:
Board of Directors. The stockholders agreement requires that, until an initial public offering of shares of Activant Group’s common stock, the parties that beneficially own shares of Activant Group common stock will vote those shares to elect a board of directors of Activant Group comprised of the following persons:
•
the chief executive officer of Activant Group,
•
up to two board members designated by the Thoma Cressey Investors,
•
one board member designated by the JMI Investors, and
•
the remaining board members designated by the Hellman & Friedman Investors.
In addition, in the event that the Thoma Cressey Investors are only entitled to designate one director, the Thoma Cressey Investors will have the right to designate one non-voting observer to the board of directors of Activant Group. The board representation rights of the Thoma Cressey Investors and the JMI Investors are subject to reduction if their beneficial ownership of Activant Group share equivalents decreases below specified thresholds and are not transferable in connection with any transfer of Activant Group shares.
As described in greater detail in the section above titled ‘‘Equity Commitment Letter,’’ the share of Series A preferred stock held by one of the Hellman & Friedman Investors entitle it to elect a director of Activant Group with the power to determine the outcome of all votes of the board of directors prior to an initial public offering. After an initial public offering of common stock of Activant Group:
•
the Thoma Cressey Investors will have the right to nominate one individual for election to the board of directors, provided the Thoma Cressey Investors and its permitted transferees beneficially own at least a specified amount of the outstanding share equivalents of Activant Group;
•
the JMI Investors will have the right to nominate one individual for election to the board of directors, provided the JMI Investors and its permitted transferees beneficially own at least a specified amount of the outstanding share equivalents of Activant Group; and
•
the Hellman & Friedman Investors and their affiliates will have the right to nominate the number of individuals for election to the board of directors that is equal to the product of the percentage of share equivalents of Activant Group held by the Hellman & Friedman Investors and their affiliates, multiplied by the number of directors then on the board, rounded up to the nearest whole number.
For so long as the Thoma Cressey Investors, the JMI Investors and/or the Hellman & Friedman Investors are entitled to nominate an individual for election to the board of directors, Activant Group is required to nominate such individual for election as a director as part of the slate that is included in the proxy statement or consent solicitation relating to such election and provide the highest level of support for the election of such individual as it provides to any other individual standing for election as part of Activant Group’s slate.
Voting Rights and Minority Rights. For as long as the Hellman & Friedman Investors own at least 20% of all outstanding share equivalents of Activant Group, all of the other sponsors must vote their shares in the same manner as the Hellman & Friedman Investors vote their shares of common stock with respect to any of the following:
•
altering or amending the Activant Group certificate of incorporation or bylaws (except with respect to any alteration or amendment that is detrimental to the rights of the Thoma Cressey Investors or the JMI Investors relative to the Hellman & Friedman Investors);
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engaging in any liquidation or dissolution; or
•
approving any employee benefit, stock option or equity incentive plan recommended by the board of directors of Activant Group.
The stockholders agreement also provides the following minority rights with respect to certain of the sponsors that will apply prior to an initial public offering:
•
the consent of the Thoma Cressey Investors and the JMI Investors is required with respect to specified types of transactions between the Hellman & Friedman Investors or their affiliates, on the one hand, and Activant Group or any of its subsidiaries, on the other hand;
•
for so long as the Thoma Cressey Investors beneficially own, in the aggregate, at least 5% of the outstanding share equivalents of Activant Group, the consent of the Thoma Cressey Investors are required with respect to any acquisition by Activant Group or its subsidiaries involving a purchase price of less than $100.0 million; and
•
with respect to certain future issuances of equity securities to the Hellman & Friedman Investors or their affiliates, the Thoma Cressey Investors are able to require Activant Group to engage an independent third party to establish the fair market value of such securities.
Indemnification. We and Activant Group are required to indemnify and hold harmless each of the stockholders that is party to the stockholders agreement, together with its partners, stockholders, members, affiliates, directors, officers, fiduciaries, controlling persons, employees and agents from any losses arising out of either of the following, subject to limited exceptions:
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the stockholder’s or its affiliate’s ownership of securities of Activant Group and us or its ability to control or influence Activant Group and us, and
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the business, operations, properties, assets or other rights or liabilities of Activant Group, us or any of our subsidiaries.
Participation Rights. Subject to specified exceptions, until an initial public offering, Activant Group may not issue equity securities without permitting each sponsor the opportunity to purchase a pro rata share of the securities being issued. Also prior to an initial public offering, if Activant Group or any of its subsidiaries issues debt securities to the Hellman & Friedman Investors or their affiliates, each of the other sponsors will be provided the opportunity to purchase a pro rata portion of such debt securities, based on the sponsor’s respective ownership of share equivalents at that time.
Transfer Provisions and Registration Rights. The stockholders agreement also contains (1) transfer restrictions applicable to the share equivalents held by the Thoma Cressey Investors, the JMI Investors and the management investors, (2) tag-along rights in favor of the Thoma Cressey Investors, the JMI Investors and the management investors, (3) drag-along rights in favor of the Hellman & Friedman Investors, (4) repurchase rights in favor of Activant Group and the sponsors with respect to the shares equivalents of the management investors, including any share equivalents they receive upon exercise of options, in the event of the termination of a management investor’s employment with Activant Group and (5) certain registration rights (including customary indemnification) and Rule 144 sale provisions applicable to the sponsors and their affiliates and the management investors.
Qureshi Letter Agreement
In connection with entering into the Merger Agreement and in contemplation of the mergers, as of March 12, 2006, Mr. Pervez A. Qureshi, who is our chief executive officer and president, entered into a letter agreement with Activant Group, pursuant to which:
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At the effective time of the mergers, Mr. Qureshi became our chief executive officer and president.;
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At the effective time of the mergers, Mr. Qureshi rolled over $1 million of the spread value of his current stock options in Holdings into 333,334 stock options to purchase shares of common stock of Activant Group, with an exercise price of $1.00 per share pursuant to the terms of an option rollover agreement, which is described under “Item 11. Executive Compensation-Employment Agreements and Severance and Change of Control Benefits Employment Agreements-Rollover Options.” These options and the additional stock options granted to Mr. Qureshi pursuant to his new employment agreement became subject to the stockholders agreement described above;
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Activant Group and Mr. Qureshi agreed to the terms and conditions of Mr. Qureshi’s employment after the closing of the mergers, which are described under “Item 11. Executive Compensation-Employment Agreements and Severance and Change of Control Benefits.”
Management Subscription Agreements
Prior to the consummation of the transactions, certain members of our management entered into management subscription agreements pursuant to which, upon the terms and subject to the conditions set forth in the agreements, these members of management agreed to assign to Activant Group a portion of the proceeds they would otherwise be entitled to receive pursuant to the merger agreement for their options to acquire Holdings common stock as consideration for the acquisition of newly-issued shares of common stock of Activant Group for a price of $4.00 per share. The members of our management that entered into management subscription agreements included the following:
•
Stephen McLaughlin, our senior vice president and general manager of wholesale distribution, who assigned an aggregate of $250,000 of proceeds he would have been entitled to receive for his options in exchange for the issuance to him of 62,500 shares of Activant Group common stock.
•
Scott B. Hanson, our senior vice president and general manager of hardlines and lumber, who assigned an aggregate of $150,000 of proceeds he would have been entitled to receive for his options in exchange for the issuance to him of 37,500 shares of Activant Group common stock.
Transition Agreement
Soon after the consummation of the mergers, we relocated our headquarters to our Livermore, California office. Mr. Petersen indicated that he was unable to relocate to Livermore. Mr. Petersen an executed agreement that provided for lump sum severance payment in the amount of $500,000, in addition to certain other benefits and the termination of his employment with us in early 2007.
Cash Incentive Payments
We entered into letter agreements with certain of our employees that provided for the payment of cash incentive bonuses to them in an aggregate amount of $16,960,000 upon the consummation of the mergers, which were subject to prior approval of such payments by our stockholders. These cash payments were in lieu of the granting of shares of our restricted common stock as previously disclosed in our Current Report on Form 8-K filed with the SEC on January 30, 2006. A portion of these cash incentive bonus payments were made to our “Named Executive Officers” (as defined in “Item 11. Executive Compensation”) as follows: $3,200,000 to Pervez A. Qureshi; $2,200,000 to Greg Petersen; $1,400,000 to William Wilson; $1,000,000 to Stephen A. McLaughlin and $1,000,000 to Scott B. Hanson.
Policies and Procedures for Review and Approval of Related Party Transactions
We do not have a formal policy and related procedures for the review, approval and ratification of transactions that are required to be reported pursuant to this Item 13. Since the completion of the mergers, if and when any such transactions have been proposed, they have been reviewed by our board of directors and subject to its approval. We expect to continue this policy in the future.
Indemnification of Directors and Officers
Activant Group, as the surviving corporation of the mergers, agreed that for a period of six years following the effective time of the mergers, or May 2, 2006, it will indemnify each of the present and former directors and officers of Holdings to the fullest extent permitted by Delaware law against claims arising out of or pertaining to the fact that the person is or was an officer or director of Holdings or any of its subsidiaries prior to the mergers. Our certificate of incorporation provides that it will indemnify each of our directors and officers to the fullest extent permitted under the General Corporation Law of the State of Delaware for claims arising by reason of the fact that he or she is a director, officer, employee, or agent of the Company or any of its subsidiaries
In addition, each of our executive officers and directors has entered into an indemnification agreement with Activant Group and us, or “Activant.” Each of the indemnification agreements provides that we will indemnify and advance expenses to the indemnified officers and directors, or the indemnitees, to the fullest extent provided under our certificate of incorporation and bylaws, as in effect from time to time. We will not, without the prior written consent of each indemnitee, adopt any amendment to their respective certificates of incorporation, which would adversely affect the rights of the indemnitees, except as required by law. The right of such indemnitee to receive indemnification and advancement of expenses under this agreement is not exclusive of any other right, to which the indemnitee may, at any time be entitled. The agreement is valid for so long as such indemnitee serves as an officer or director of Activant, or at its request, any other entity, and terminates upon the later of (a) the expiration of six (6) years after the latest date that such indemnitee ceases to serve as an officer or director, (b) the final termination of all pending proceedings in respect of which such indemnitee is granted rights of indemnification or advancement of expenses, or
(c) the expiration of all statutes of limitation applicable to possible claims arising out of such indemnitee’s status as an officer or director of Activant. The terms and provisions of the indemnification agreement are binding upon Activant’s successors and assigns.
Director Independence
Our board of directors has determined that Mr. Marcel Bernard is an “independent” director as defined under Nasdaq Marketplace Rule 4200-1(a)(15), which is the definition used by our board of directors for determining the independence of its directors. Mr. Bernard is our sole independent director. None of the members of our audit committee and compensation committee are independent. Our board of directors is not comprised of a majority of independent directors, and its committees are not comprised solely of independent directors, because we are a privately held company and not subject to applicable listing standards. The terms of the stockholders agreement described above require that certain members of our board of directors be comprised of persons affiliated with our company and the one share of Series A preferred stock held by an affiliate of Hellman & Friedman LLC, entitles the holder to designate one director with the power to cast one more vote than all votes entitled to be cast by all other directors.
Item 14.
Item 14. Principal Accountant Fees and Services.
The audit committee of the board of directors has selected Ernst & Young LLP as registered independent public accounting firm to audit our consolidated financial statements for the fiscal year ending September 30, 2007. Ernst & Young LLP currently serves as our registered independent public accounting firm. Fees paid to Ernst & Young for each of the last two fiscal years were as follows:
(1)
Audit fees include the annual audit and quarterly reviews of our financial statements, consultation on new accounting standards and current transactions and normal assistance with annual and periodic filings with the SEC or internet postings of our financial statements.
(2)
Audit-related fees consist of fees for assurance and related services that are reasonably related to the performance of the audit and the review of our financial statements and which are not reported under “Audit Fees”. These services primarily relate to the registration statement filings for financing activities and consultations concerning registration statement filings.
(3)
Tax fees include assistance in the preparation of our federal, state and foreign income and franchise tax returns and in the periodic examinations thereof by regulatory authorities and consultation on the tax treatment for transactions.
Audit Committee Pre-Approval Policy for Services Provided by Independent Registered Public Accounting Firm
All services provided by the registered independent public accounting firm have been pre-approved by our audit committee. Under the pre-approval policy, the committee pre-approves, by type and amount, the services expected to be provided by the registered independent public accounting firm during the coming year. This pre-approval is done annually and is documented as an exhibit to the minutes of the audit committee meeting. Any services to be provided by the registered independent public accounting firm that are not pre-approved as part of the annual process must be separately pre-approved by the audit committee, including the related fees. The audit committee must separately pre-approve any significant changes in scope or fees for any approved service. Pre-approval authority may not be delegated to management. Although pre-approval authority may be delegated to one or more members of the audit committee, no such delegation has been made.
The types of services the Committee pre-approves annually are audit, audit-related and certain tax services. Audit services include the annual audit and quarterly reviews, statutory audits, and normal assistance with periodic SEC filings. Audit-related services include consultation on the application of proposed accounting standards and consultation on the accounting for proposed transactions. Tax services include assistance in the preparation of sale tax returns and consultation on related tax matters.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules.
(a)
(1) Financial Statements - the consolidated financial statements of Activant Solutions Inc. are incorporated by reference to Part II, Item 8 of this report.
(2) Financial Statement Schedules - See Schedule II - Valuation and Qualifying Accounts below.
All other schedules have been omitted because they are not applicable, not required under the instructions, or the information requested is set forth in the consolidated financial statements or related notes included in Part II, Item 8 of this report..
EXHIBIT INDEX
*
Represents a management contract or compensatory plan.
**
This certification is not deemed “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section. Such certification will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.
ACTIVANT SOLUTIONS INC.
Schedule II - Valuation and Qualifying Accounts
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Pervez A. Qureshi and Kathleen M. Crusco, 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 amendments 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 substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.