10-Q 1 b50343mse10vq.txt MRO SOFTWARE, INC. UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004 (mark one) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 For the transition period from ______________ to _______________ Commission File Number 0-23852 MRO SOFTWARE, INC. (Exact name of registrant as specified in its charter) MASSACHUSETTS 04-2448516 (State or other jurisdiction (I.R.S employer incorporation or organization) identification number) 100 CROSBY DRIVE, BEDFORD MASSACHUSETTS 01730 (Address of principal executive offices, including zip code) (781) 280-2000 (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) Yes [X] No [ ] Number of shares outstanding of the Registrant's common stock as of the latest practicable date: 24,875,709 shares of common stock, $.01 par value per share, as of May 6, 2004. Page 1 MRO SOFTWARE, INC. 10-Q INDEX
PAGE PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Consolidated Balance Sheets (unaudited) as of March 31, 2004 and 3 September 30, 2003. Consolidated Statements of Operations (unaudited) 4 for the three and six months ended March 31, 2004 and March 31, 2003. Consolidated Statements of Cash Flows (unaudited) 5 for the six months ended March 31, 2004 and March 31, 2003. Notes to Consolidated Financial Statements (unaudited). 6 ITEM 2. Management's Discussion and Analysis of Financial Condition and 14 Results of Operations ITEM 3. Quantitative and Qualitative Disclosures about Market Risk 25 ITEM 4. Controls and Procedures 25 PART II. OTHER INFORMATION Item 1. Legal Proceedings 26 Item 2. Changes in Securities 26 Item 3. Defaults upon Senior Executives 26 Item 4. Submission of Matter to a Vote of Security Holders 26 Item 5. Other Information 27 Item 6. Exhibits and Reports on Form 8-K 27 SIGNATURE 29
Page 2 MRO SOFTWARE, INC. CONSOLIDATED BALANCE SHEETS (UNAUDITED)
MARCH 31, SEPTEMBER 30, (IN THOUSANDS, EXCEPT PER SHARE DATA) 2004 2003 ------------- ------------- ASSETS Current assets: Cash and cash equivalents $ 55,227 $ 73,662 Marketable securities 1,101 1,102 Accounts receivable, trade, less allowance for doubtful accounts of $2,553 at March 31, 2004 and $2,741 at September 30, 2003, respectively 30,590 28,833 Prepaid expenses and other current assets 5,906 4,177 Deferred income taxes 2,438 2,242 ------------- ------------- Total current assets 95,262 110,016 ------------- ------------- Marketable securities 40,177 19,809 Property and equipment, net 8,469 8,239 Goodwill 46,210 46,210 Intangible assets 5,879 7,700 Notes receivable 442 593 Deferred income taxes 8,766 9,267 Other assets 4,424 3,427 ------------- ------------- Total assets $ 209,629 $ 205,261 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses $ 14,836 $ 15,701 Accrued compensation 6,809 8,357 Income Taxes Payable 2,769 4,741 Deferred revenue 31,015 28,734 ------------- ------------- Total current liabilities 55,429 57,533 ------------- ------------- Other long term liabilities 337 35 Deferred revenue 1,116 1,181 Stockholders' equity Preferred stock, $.01 par value;1,000 authorized, none issued and outstanding Common stock, $.01 par value;50,000 authorized; 24,871 and 24,576 issued and outstanding at March 31, 2004 and September 30, 2003, respectively 249 246 Additional paid-in capital 117,507 115,093 Deferred compensation (479) (298) Retained earnings 34,314 31,163 Accumulated other comprehensive income 1,156 308 ------------- ------------- Total stockholders' equity 152,747 146,512 ------------- ------------- Total liabilities and stockholders' equity $ 209,629 $ 205,261 ============= =============
The accompanying notes are an integral part of the consolidated financial statements. 3 MRO SOFTWARE, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED THREE MONTHS ENDED March 31, March 31, (IN THOUSANDS, EXCEPT PER SHARE DATA) 2004 2003 2004 2003 ------------- ------------- ------------- ------------- Revenues: Software $ 11,452 $ 7,652 $ 23,662 $ 20,337 Support and services 33,170 31,736 65,862 62,939 ------------- ------------- ------------- ------------- Total revenues 44,622 39,388 89,524 83,276 ------------- ------------- ------------- ------------- Cost of revenues: Software 1,895 1,355 3,707 3,205 Support and services 15,407 14,513 30,180 29,441 ------------- ------------- ------------- ------------- Total cost of revenues 17,302 15,868 33,887 32,646 ------------- ------------- ------------- ------------- Gross profit 27,320 23,520 55,637 50,630 Operating expenses: Sales and marketing 13,835 14,292 27,545 29,691 Product development 7,097 6,388 14,103 13,144 General and administrative 4,389 3,708 8,854 8,354 Amortization of other intangibles 204 230 409 478 ------------- ------------- ------------- ------------- Total operating expenses 25,525 24,618 50,911 51,667 ------------- ------------- ------------- ------------- Income/(loss) from operations 1,795 (1,098) 4,726 (1,037) Interest income 244 181 448 391 Other income/(expense), net 113 643 (327) 981 ------------- ------------- ------------- ------------- Income/(loss) before income taxes 2,152 (274) 4,847 335 Provision/(benefit) for income taxes 753 (96) 1,696 118 ------------- ------------- ------------- ------------- Net income/(loss) $ 1,399 $ (178) $ 3,151 $ 217 ============= ============= ============= ============= Net income/(loss) per share, basic $ 0.06 $ (0.01) $ 0.13 $ 0.01 ------------- ------------- ------------- ------------- Net income/(loss) per share, diluted $ 0.05 $ (0.01) $ 0.12 $ 0.01 ------------- ------------- ------------- ------------- Shares used to calculate net income/(loss) per share Basic 24,796 24,407 24,713 24,356 Diluted 25,460 24,407 25,330 24,568
The accompanying notes are an integral part of the consolidated financial statements. 4 MRO SOFTWARE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
SIX MONTHS ENDED MARCH 31, ----------------------------- 2004 2003 ------------- ------------- (IN THOUSANDS) Cash flows from operating activities: Net income $ 3,151 $ 217 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 2,329 2,313 Amortization of other intangibles 1,821 2,166 Amortization of premium on marketable securities 70 --- (Gain) on sale and disposal of property and equipment --- (114) Gain on sale of services operations --- (446) Stock-based compensation 105 70 Deferred income taxes 358 486 Changes in operating assets and liabilities: Accounts receivable (847) 7,334 Prepaid expenses and other assets (1,238) (1,057) Accounts payable, accrued expenses and other liabilities (2,100) (4,323) Accrued compensation (1,754) (2,929) Income taxes payable (1,987) (1,003) Deferred revenue 1,318 3,215 ------------- ------------- Net cash provided by operating activities 1,226 5,929 ------------- ------------- Cash flows from investing activities: Acquisitions of property and equipment and other capital expenditures (2,555) (1,367) Purchase of marketable securities (31,200) (1,000) Sale of marketable securities 10,875 --- ------------- ------------- Net cash used in investing activities (22,880) (2,367) ------------- ------------- Cash flows from financing activities: Proceeds from exercise of employee stock options stock purchases 2,132 946 ------------- ------------- Net cash provided by financing activities 2,132 946 ------------- ------------- Effect of exchange rate changes on cash 1,087 959 ------------- ------------- Net (decrease)/increase in cash and cash equivalents (18,435) 5,467 Cash and cash equivalents, beginning of period 73,662 67,315 ------------- ------------- Cash and cash equivalents, end of period $ 55,227 $ 72,782 ============= =============
The accompanying notes are an integral part of the consolidated financial statements. 5 MRO SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) A. BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements include the accounts of MRO Software, Inc. ("MRO") and its majority-owned subsidiaries (collectively, the "Company"), as of March 31, 2004 and have been prepared by the Company in accordance with generally accepted accounting principles for interim reporting and with the instructions to Form 10-Q and Article 10 of Regulation S-X. All intercompany accounts and transactions have been eliminated. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments, consisting only of those of a normal recurring nature, necessary for a fair presentation of the Company's financial position, results of operations and cash flows at the dates and for the periods indicated. The results of operations for the periods presented herein are not necessarily indicative of the results of operations to be expected for the entire fiscal year, which ends on September 30, 2004, or for any other future period. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended September 30, 2003 included in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission on December 29, 2003. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain prior year financial statement items have been reclassified to conform to the current year's format. B. INCOME /(LOSS) PER SHARE Basic income (loss) per share is computed by dividing income or loss available to common shareholders by the weighted average number of common shares outstanding. Diluted income per share is computed by dividing income or loss available to common shareholders by the weighted average number of common shares outstanding plus dilutive potential common shares. For purposes of this calculation, stock options are considered dilutive potential common shares in periods in which they have a dilutive effect. All potential dilutive common shares are excluded from the computation of net loss per share because they are anti-dilutive. Page 6 Basic and diluted income/(loss) per share are calculated as follows:
THREE MONTHS ENDED (IN THOUSANDS, EXCEPT PER SHARE DATA) 03/31/04 03/31/03 ------------------------------------- -------- -------- Net income/(loss) $ 1,399 $ (178) Denominator: Weighted average common shares outstanding-basic 24,796 24,407 Effect of dilutive securities (1) 664 ---- -------- -------- Weighted average common shares outstanding-diluted 25,460 24,407 ======== ======== Net income/(loss) per share, basic $ 0.06 $ (0.01) Net income/(loss) per share, diluted $ 0.05 $ (0.01)
SIX MONTHS ENDED (IN THOUSANDS, EXCEPT PER SHARE DATA) 03/31/04 03/31/03 ------------------------------------- -------- -------- Net income $ 3,151 $ 217 Denominator: Weighted average common shares outstanding-basic 24,713 24,356 Effect of dilutive securities (1) 617 212 -------- -------- Weighted average common shares outstanding-diluted 25,330 24,568 ======== ======== Net income per share, basic $ 0.13 $ 0.01 Net income per share, diluted $ 0.12 $ 0.01
(1) Options to purchase 1,538,000 shares of the Company's Common Stock for the three months ended March 31, 2004 and 1,547,000 shares and 2,632,000 shares for the six months ended March 31, 2004 and 2003, respectively were outstanding but were not included in the computations of diluted net income per share because the exercise price of the options was greater than the weighted average market price of the common stock during the period. Common stock equivalents of 3,114,000 shares are excluded from the computation of diluted net income per share for the three months ended March 31, 2003 as the effect of these shares was anti-dilutive to the Company's net loss. C. ACCOUNTING POLICIES STOCK-BASED COMPENSATION The Company grants stock options to its employees and outside directors. Such grants are for a fixed number of shares with an exercise price equal to the fair value of the shares at the date of grant. The Company accounts for stock-based employee compensation using the intrinsic value method under the recognition and measurement principles of the Accounting Principals Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations. Page 7 PRO FORMA INFORMATION The Company complies with the pro forma disclosure requirements of the Financial Accounting Standards Board ("FASB") SFAS No. 123 as amended by SFAS No. 148. The fair value of the Company's stock options was estimated using the Black-Scholes option-pricing model. This model was developed for use in estimating fair value of traded options that have no vesting restrictions and are fully transferable. This model requires the input of highly subjective assumptions including the expected stock price volatility. Because the Company's stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimates, in management's opinion, the Black-Scholes model does not necessarily provide a reliable single measure of the fair value of its stock options. The following table illustrates the effect on net income and earnings per share on a pro forma basis as if the Company had applied the fair value recognition provisions of SFAS No.123 to stock-based employee compensation:
THREE MONTHS ENDED (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 03/31/04 03/31/03 -------- -------- Net income/(loss) As reported $ 1,399 $ (178) Add: Stock-based employee compensation expense included in net income/(loss) 54 43 Deduct: Stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects (1,230) (2,502) Pro forma net income/(loss) $ 223 $ (2,637) Earnings/(loss) per share: Basic - as reported $ 0.06 $ (0.01) Basic - pro forma $ 0.01 $ (0.11) Diluted - as reported $ 0.05 $ (0.01) Diluted - pro forma $ 0.01 $ (0.11)
SIX MONTHS ENDED (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 03/31/04 03/31/03 -------- -------- Net income As reported $ 3,151 $ 217 Add: Stock-based employee compensation expense included in net income 105 70 Deduct: Stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects (3,803) (5,299) Pro forma net loss $ (547) $ (5,012) Earnings/(loss) per share: Basic - as reported $ 0.13 $ 0.01 Basic - pro forma $ (0.02) $ (0.21) Diluted - as reported $ 0.12 $ 0.01 Diluted - pro forma $ (0.02) $ (0.21)
Page 8 With the exception of restricted stock awards to non-employee members and the Executive Chairman of the board of directors, no stock-based compensation cost is reflected in net income, as all stock-based awards granted under the Company's plans consist of stock options that have an exercise price equal to the market value of the underlying common stock on the date of grant. D. COMPREHENSIVE INCOME/(LOSS): The following table reflects the components of comprehensive net income/(loss):
THREE MONTHS ENDED (IN THOUSANDS) 03/31/04 03/31/03 -------------- -------- -------- Net income/(loss) $ 1,399 $ (178) Other comprehensive net income, Net of tax: Unrealized gain/(loss) on securities arising during period 154 (32) Foreign currency translation adjustment (110) 261 -------- -------- Comprehensive income $ 1,443 $ 51 ======== ========
SIX MONTHS ENDED (IN THOUSANDS) 03/31/04 03/31/03 --------------- -------- -------- Net income $ 3,151 $ 217 Other comprehensive net income, Net of tax: Unrealized gain/(loss) on securities arising during period 72 (32) Foreign currency translation adjustment 776 780 -------- -------- Comprehensive income $ 3,999 $ 965 ======== ========
E. SEGMENT INFORMATION, GEOGRAPHIC DATA AND MAJOR CUSTOMERS The Company reports revenues and income under one reportable industry segment, Strategic Asset Management. Our Strategic Asset Management software products and services include MAXIMO for the Enterprise Asset Management ("EAM") market and MAXIMO MainControl for the IT Asset Management ("ITAM") market. We also offer Online Commerce Services ("OCS") that enable the asset-centric procurement capabilities of our EAM and ITAM software products. The Company does not allocate expenses to these product groups, and all operating results are assessed on an aggregate basis to make decisions about the allocation of resources. The Company manages its business in the following geographic areas: United States, Other Americas (Canada and Latin America), Europe/Middle East and Africa, and Asia Pacific. A summary of the Company's revenues by geographical area is as follows: Page 9
THREE MONTHS ENDED (IN THOUSANDS) 03/31/04 03/31/03 -------- -------- Revenues: United States $ 22,999 $ 23,532 Other Americas 2,896 1,648 Intercompany 2,253 1,451 -------- -------- Subtotal $ 28,148 $ 26,631 Europe/Middle East and Africa 15,493 10,983 Asia/Pacific 3,234 3,225 Intercompany (2,253) (1,451) -------- -------- Total revenues $ 44,622 $ 39,388 ======== ========
SIX MONTHS ENDED (IN THOUSANDS) 03/31/04 03/31/03 -------- -------- Revenues: United States $ 50,501 $ 49,462 Other Americas 5,093 5,303 Intercompany 6,111 3,150 -------- -------- Subtotal $ 61,705 $ 57,915 Europe/Middle East and Africa 28,065 22,191 Asia/Pacific 5,865 6,320 Intercompany (6,111) (3,150) -------- -------- Total revenues $ 89,524 $ 83,276 ======== ========
The Company has subsidiaries in foreign countries, which sell the Company's products and services in their respective geographic areas. Intercompany revenues primarily represent shipments of software to international subsidiaries and are eliminated from consolidated revenues. No one customer accounted for more than 10% of total revenues. F. GOODWILL AND OTHER INTANGIBLE ASSETS Intangible assets as of March 31, 2004 and September 30, 2003 consist of the following:
(IN THOUSANDS) 03/31/04 09/30/03 -------- -------- Goodwill $ 46,210 $ 46,210 Acquired technology 15,744 15,744 Accumulated amortization (10,681) (9,269) -------- -------- Sub-total acquired technology 5,063 6,475 -------- -------- Other intangibles 3,009 3,009 Accumulated amortization (2,193) (1,784) -------- -------- Sub-total other intangibles 816 1,225 -------- --------
Page 10 Total intangible assets, net $ 52,089 $ 53,910 ======== ========
Other intangibles consist of customer contracts, backlog, customer lists and non-compete agreements. Amortization expense of intangible assets was $864 thousand and $1.1 million for the three months ended March 31, 2004 and 2003, respectively and $1.8 million and $2.2 million for the six months ended March 31, 2004 and 2003, respectively. As of March 31, 2004, remaining amortization expense on existing intangibles for the next five years is as follows:
(IN THOUSANDS) ------------- 2004 (remaining 6 mos.) $1,203 2005 2,240 2006 1,383 2007 477 2008 477 2009 99 ------ Total $5,879 ------
G. ACCOUNTING PRONOUNCEMENTS In December 2003, the Financial Accounting Standards Board ("FASB" or the ("Board") issued FASB Interpretation No. 46) (revised December 2003), "Consolidation of Variable Interest Entities" ("FIN 46R"), to address certain implementation issues. FIN 46R clarifies some of the provisions of FIN 46 and exempts certain entities from its requirements. FIN 46R requires the application of either FIN 46 or FIN 46R by "Public Entities" (as defined in paragraph 395 of FASB Statement No. 123, Accounting for Stock-Based Compensation) to all Special Purpose Entities ("SPEs") created prior to February 1, 2003 at the end of the first interim or annual reporting period ending after December 15, 2003. All entities created after January 31, 2003 by Public Entities were already required to be analyzed under FIN 46, and they must continue to do so, unless FIN 46R is adopted early. FIN 46R will be applicable to all non-SPEs created prior to February 1, 2003 by Public Entities that are not small business issuers at the end of the first interim or annual reporting period ending after March 15, 2004. The Company does not enter into transactions involving entities whose activities are primarily related to securitizations or other forms of asset-backed financings or single-lessee leasing arrangements, and thus the required adoption of FIN 46R for all SPE's created prior to February 1, 2003 had no impact on MRO. The Company has not created any entities subsequent to January 31, 2003 that require accounting under FIN 46. The Company believes that it does not have variable entities as defined in FIN 46R. The adoption of FIN 46R has no impact on the Company's financial statements. H. GUARANTOR ARRANGEMENTS In November 2002, the FASB issued Financial Accounting Standards Board Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken by issuing the guarantee. FIN 45 also requires additional disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees it has issued. The accounting requirements for the initial recognition of guarantees are applicable on a prospective basis for guarantees issued or modified after December 31, Page 11 2002. The disclosure requirements are effective for all guarantees outstanding, regardless of when they were issued or modified, during the second quarter of fiscal 2003. The adoption of FIN 45 did not have a material effect on our consolidated financial statements. The following is a summary of our agreements that we have determined are within the scope of FIN 45. On January 17, 2003, the Company sold the industrial data normalization services operations. Prior to the sale, the Company had guaranteed the obligations of services operations under the office lease of the operation's principal place of business. This guaranty remains in full force and effect following the sale. As of March 31, 2004, the maximum potential amount due under this guaranty is $500 thousand. In accordance with the terms of the sale, the buyer has assumed primary liability under the lease and is obligated to indemnify the Company against all obligations arising under the lease. Based on the Company's evaluation of the buyer's ability to make the payments due under this lease, the Company believes that the estimated fair value of this guaranty is minimal. Accordingly, we have no liabilities recorded for this guaranty as of March 31, 2004. We warrant that our software products will perform substantially in accordance with the product specifications as contained in the associated end-user guide, which is provided with the products, for a period of ninety days from initial delivery of the products to the customer. Our sole obligation under this warranty is to use reasonable efforts to correct a verified problem that is brought to our attention during the warranty period, or if we are unable to provide a correction, we are obligated to accept the return of the product and refund the license fee paid. We warrant that our professional services will be provided in accordance with good professional practice, and that any software developed by our services organization will perform substantially in accordance with its approved specifications for a period of thirty days from initial delivery of the services to the customer. Our sole obligation under this warranty is to use reasonable efforts to correct a verified problem that is brought to our attention during the warranty period, or if we are unable to provide a correction, we are obligated to accept the return of the deliverables and refund the fee paid for the services. If necessary, we would provide for the estimated cost of product and services warranties based on specific warranty claims and claim history. However, we have never incurred significant expense under our product or services warranties, our liability for breach of warranty is limited to the amount of the license or services fees actually paid, and we maintain insurance covering such claims in an amount sufficient to cover a refund of the license or services fees paid by any particular customer during the last 12 months. As a result, we believe the estimated fair value of these warranty obligations is minimal. Accordingly, we have no liabilities recorded for these warranty obligations as of March 31, 2004. Under our standard end-user license agreement, we agree to indemnify our customers against infringement claims that may be brought by third parties asserting that our products infringe on certain intellectual property rights. In our services agreements with customers, we will also, as a matter of standard practice, agree to indemnify customers (a) against claims that may be brought by third parties asserting that the results of our services infringe on certain intellectual property rights, (b) against damages caused by our breach of certain confidentiality provisions in the contract, and (c) against damages to personal property, and death, caused by our services personnel while on-site at customer premises. These indemnification provisions are generally based on our standard contractual terms. All such provisions, whether based on our standard contracts or negotiated with a given customer, are entered into in the normal course of business based on an assessment that the risk of loss is remote. The terms of the indemnifications vary in duration and nature, and our obligations to indemnify are frequently unlimited as to amount. There have been no demands for indemnity and the contingencies triggering the obligation to indemnify have not occurred to our knowledge and are not expected to occur. The Company maintains insurance that covers such indemnification obligations, and the amount of coverage that we maintain is sufficient to cover a refund of the services fees received from any particular customer during the last 12 months. Historically, the Company has not made any material payments pursuant to any such indemnity obligations. Accordingly, we have no liabilities recorded for any such indemnity obligations as of March 31, 2004. When as part of an acquisition we acquire a company, we assume liability for certain events or occurrences that took place prior to the date of acquisition. The maximum potential amount of future payments we could be required to make for such obligations is undeterminable at this time. All of these obligations were grand fathered under the provisions of FIN No. 45 as they were in effect prior to December 31, 2002. Page 12 Accordingly, we have no liabilities recorded for the assumption of any such liabilities as of March 31, 2004. Page 13 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS In addition to historical information, this Quarterly Report on Form 10-Q, as well as documents incorporated herein by reference, may contain forward-looking statements (within the meaning of section 27A of the Securities Act of 1933, as amended, and section 21E of the Securities Exchange Act of 1934, as amended). The following and similar expressions identify forward-looking statements: "expects," "anticipates," and "estimates". Forward-looking statements include, without limitation, statements related to: the Company's plans, objectives, expectations and intentions; the timing of, availability and functionality of products under development or recently introduced; and market and general economic conditions. Important factors that could cause actual results to differ materially from those suggested by the forward-looking statements for various reasons, include those discussed under the heading "Factors Affecting Future Performance" below. These forward-looking statements speak only as of the date of this Quarterly Report, and the Company disclaims any obligation to update such forward looking statements as a result of any change in circumstances or otherwise. OVERVIEW MRO Software is a leading global provider of strategic asset management solutions, software and related services. Strategic asset management is the management and optimization of the business processes required to keep our customers' critical assets productive. Critical assets are those that have a significant impact on operations and performance, including assets used in production, facilities, fleet and information technology ("IT") operations. The Company's strategic asset management software products and services allow our customers to manage the complete lifecycle of their strategic assets, including: planning, procurement, deployment, tracking, maintenance and retirement. Our strategic asset management software products and services include MAXIMO for the Enterprise Asset Management ("EAM") market and MAXIMO MainControl for the IT Asset Management ("ITAM") market. We also offer Online Commerce Services ("OCS") that enables the asset-centric procurement capabilities of our EAM software products through the MRO Operations Center. Asset-centric procurement is a combination of products and services designed to support the requirements of industrial asset-related procurement. Using MRO Software's products and services, our customers improve production reliability, labor efficiency, material optimization, software license compliance, lease management, warranty and service management and provisioning across their critical asset base. The Company reports all its revenues in one reportable business segment, the strategic asset management segment. KEY HIGHLIGHTS OF THE COMPANY'S THREE AND SIX MONTHS ENDED MARCH 31, 2004 - Net income increased $1.6 million over the comparable quarter for the prior year and $2.9 million over the comparable prior six month period. - Overall gross margin improved by $3.8 million or 16% over the comparable quarter for the prior year and $5.0 million or 10% over the comparable prior six month period. The improvement is due to an increase in support revenues without a commensurate increase in personnel and operating costs. - Quarterly operating expenses, excluding amortization of intangibles, increased $933 thousand or 4% over the comparable quarter for the prior year and decreased $687 thousand or 1% over the comparable prior six month period. The majority of the increase over the comparable quarter is attributable to increases in product development and general and administrative expenses. Product development expenses increased due to an increase in salaries and related benefits, as well as increases in costs to translate our MAXIMO product into numerous foreign languages. General and administrative expenses increased due to increases in salaries and related benefits, property and business taxes, Page 14 and insurance premiums. Partially offsetting the increases in product development and general and administrative expenses were decreases in sales and marketing expenses due to a reduction in the number of sales and marketing personnel. - Total revenues increased $5.2 million over the comparable quarter for the prior year and $6.2 million over the comparable prior six month period. Revenues for the prior year fell below our expectations while current period revenues reflect traditional levels. International revenues accounted for 48% of total revenues for the current quarter and 44% year to date. Due to the increased strength in certain foreign currencies, especially the Euro, the British Pound and the Australian Dollar, the Company estimates that the current quarters revenues resulted in an increase of approximately $2.7 million as compared to the average prevailing exchange rates of the comparable quarter and $4.6 million over the comparable six month period. However, due to a similar effect of the exchange rates on operating expenses, the overall impact of foreign currency adjustments had an immaterial impact on net income for the current quarter and the prior six month period. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The Company's discussion and analysis of its financial condition and results of operations are based upon its consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires that management make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. These estimates and assumptions are affected by management's application of accounting policies. Critical accounting policies, in which different judgments and estimates by our management could materially affect our reported condition and results of operations, include revenue recognition, estimating the allowance for doubtful accounts, deferred tax assets, and the valuation of long-lived assets. These critical accounting policies and estimates should be read in conjunction with the critical accounting policies and estimates included in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission on December 29, 2003. The Company includes and updates critical accounting policies and estimates in interim periods if a new critical accounting policy is adopted or amended or if there are material changes in related judgments or conditions underlying the Company's estimates in the interim period. RESULTS OF OPERATIONS REVENUES
Three Three Six Six Months Months Months Months Ended Change Ended Ended Change Ended (in thousands) 03/31/04 % 03/31/03 03/31/04 % 03/31/03 -------------- -------- ------ -------- -------- ------ -------- Software licenses $11,452 50% $ 7,652 $23,662 16% $20,337 Percentage of total revenues 26% 19% 26% 24% Support and services $33,170 5% $31,736 $65,862 5% $62,939 Percentage of total revenues 74% 81% 74% 76% Total revenues $44,622 13% $39,388 $89,524 8% $83,276
The Company's revenues are derived primarily from two sources: (i) software licenses, and (ii) fees for support and 50% services. Software license revenues increased 50% to $11.5 million from $7.7 million for the three months ended March 31, 2004 and 2003, respectively and increased 16% to $23.7 million from $20.3 million for the six months ended March 31, 2004 and 2003, respectively. The increases are attributable to increases in Page 15 MAXIMO software license revenues. MAXIMO software license revenues increased 62% to $11.2 million from $6.9 million for the three months ended March 31, 3004 and 2003, respectively and increased 16% to $22.7 million from $19.5 million for the six months ended March 31, 2004 and 2003, respectively. The increase in MAXIMO software licenses is attributable to the positive effect of foreign exchange rates, an increase in the average selling price, and an increase in sales of our MAXIMO Mobile Suite product. ITAM software license revenues were $249 thousand and $719 thousand for the three months ended March 31, 2004 and 2003, respectively and $934 thousand and $719 thousand for the six months ended March 31, 2004 and 2003, respectively. The Company expects that the number of ITAM licenses sold will continue to fluctuate over the next few quarters as a result of the Company's product development plans to replace this product in conjunction with the next version of MAXIMO. Support revenues increased 10% to $17.9 million from $16.3 million for the three months ended March 31, 2004 and 2003, respectively and increased 10% to $35.1 million from $31.9 million for the six months ended March 31, 2004 and 2003, respectively. Support revenues have increased as a result of a cumulative increase in the number of MAXIMO customers and a strong renewal rate (90%) for support contracts. MAXIMO support revenues increased 13% to $17.1 million from $15.2 million for the three months ended March 31, 2004 and 2003, respectively and increased 11% to $33.3 million from $30.0 million for the six months ended March 31, 2004 and 2003, respectively. ITAM support revenues were $767 thousand and $1.1 million for the three months ended March 31, 2004 and 2003, respectively and $1.8 million for both the six months ended March 31, 2004 and 2003, respectively. Service revenues decreased 1% to $15.3 million from $15.4 million for the three months ended March 31, 2004 and 2003, respectively and decreased 1% to $30.7 million from $31.1 million for the six months ended March 31, 2004 and 2003, respectively. The decline in service revenues for the three months ended March 31, 2004 as compared to the three months end March 31, 2003 was comprised of a decline of $614 thousand in ITAM service revenues related to the decreases in software licenses sold, offset by an increase in MAXIMO service revenues of $646 thousand due to an increase in demand for product implementation services. The decline in service revenues for the six months ended March 31, 2004 as compared to the six months ended March 31, 2003 was comprised of a decline of $1.0 million in Enterprise Catalog Management services revenues due to the sale of industrial data normalization services operations in January 2003. ITAM services revenues also declined by $484 thousand. Offsetting the declines in ITAM and Enterprise Catalog Management is an increase in MAXIMO service revenues of $1.4 million. The increase in MAXIMO services revenues was attributable to an increase in demand for product implementation services. COST OF REVENUES
Three Three Six Six Months Months Months Months Ended Change Ended Ended Change Ended (in thousands) 03/31/04 % 03/31/03 03/31/04 % 03/31/03 -------------- -------- ------ -------- -------- ------ -------- Cost of software licenses $ 1,895 40% $ 1,355 $ 3,707 16% $ 3,205 Percentage of software license 17% 18% 16% 16% Cost of support and services $15,407 6% $14,513 $30,180 3% $29,441 Percentage of support and services 46% 46% 46% 47% Total cost of revenues $17,302 9% $15,868 $33,887 4% $32,646 Percentage of total revenues 39% 40% 38% 39%
Cost of software license revenues consists of software purchased for resale, royalties paid to vendors of third party software, the cost of software product packaging and media, certain employee costs related to software duplication, packaging and shipping, and amortization of acquired technology. The increase in cost of software license revenues for the three and six months ended March 31, 2004 and 2003, respectively was primarily attributable to software purchased for resale related to the demand for our MAXIMO Mobile Page 16 Suite product. Partially offsetting this increase was a decrease in the amortization of acquired technology due to cessation of amortization of a fully amortized asset. Amortization of acquired technology was $659 thousand and $844 thousand for the three months ended March 31, 2004 and 2003, respectively and $1.4 million and $1.7 million for the six months ended March 31, 2004 and 2003, respectively. Cost of support and services consists primarily of personnel costs for employees and the related costs of benefits and facilities, costs for utilization of third party consultants, and costs to support the MRO Operations Center. Cost of support revenues increased 4% to $2.8 million from $2.7 million for the three months ended March 31, 2004 and 2003, respectively and increased 2% to $5.3 million from $5.2 million for the six months ended March 31, 2004 and 2003, respectively. Cost of support revenues, as a percentage of total support revenues was 16 % for both the three months ended March 31, 2004 and 2003, respectively and 15% and 16% for the six months ended March 31, 2004 and 2003, respectively. The decrease as a percentage of total support revenues for the six months ended March 31, 2004 was attributable to an increase in support revenues without a commensurate increase in operating expenses and personnel. Cost of service revenues increased 6% to $12.6 million from $11.9 million for the three months ended March 31, 2004 and 2003, respectively and increased 3% to $24.9 million from $24.2 million for the six months ended March 31, 2004 and 2003, respectively. Cost of service revenues, as a percentage of total service revenues was 83% and 77% for the three months ended March 31, 2004 and 2003, respectively and 81% and 78% for the six months ended March 31, 2004 and 2003, respectively. The increases for the three and six months ended March 31, 2004 and 2003, respectively, was primarily attributable to an increase in the utilization of third party consultants implementing the Company's products. OPERATING EXPENSES
Three Three Six Six Months Months Months Months Ended Change Ended Ended Change Ended (in thousands) 03/31/04 % 03/31/03 03/31/04 % 03/31/03 -------------- -------- ------ -------- -------- ------ -------- Sales and marketing $13,835 (3)% $14,292 $27,545 (7)% $29,691 Percentage of total revenues 31% 36% 31% 36% Product development $ 7,097 11% $ 6,388 $14,103 7% $13,144 Percentage of total revenues 16% 16% 16% 16% General and administrative $ 4,389 18% $ 3,708 $ 8,854 6% $ 8,354 Percentage of total revenues 10% 9% 10% 10% Amortization of goodwill and other intangibles Percentage of total revenues $ 204 (11)% $ 230 $ 409 (14)% $ 478 1% 1% 1% 1%
Sales and marketing expenses decreased 3% to $13.8 million from $14.3 million for the three months ended March 31, 2004 and 2003, respectively and decreased 7% to $27.5 million from $29.7 million for the six months ended March 31, 2004 and 2003, respectively. The decrease for the three months ended March 31, 2004 as compared to the three months ended March 31, 2003 was primarily attributable to a $600 thousand decrease in salaries and related benefits due to a reduction in the number of sales and marketing personnel and a $350 thousand decrease in advertising expenses. Partially offsetting these decreases was an increase of $525 thousand in sales commissions due to the increase in software licenses sold. The decrease for the six months ended March 31, 2004 as compared to the six months ended March 31, 2003 was primarily attributable to a $2.2 million decrease in salaries and related benefits due to a reduced number of sales and marketing personnel and a $920 thousand decrease in advertising expenses. Partially offsetting these decreases was an increase of $1.1 million in sales commissions due to the increase in software licenses sold. Page 17 Product development expenses increased 11% to $7.1 million from $6.4 million for the three months ended March 31, 2004 and 2003, respectively and increased 7% to $14.1 million from $13.1 million for the six months ended March 31, 2004 and 2003, respectively. The increase for both the three and six months ended March 31, 2004 and 2003, respectively, was primarily attributable to increases in product development salaries and related benefits and increases in the costs to translate our products into foreign languages. The Company expects to continue to make enhancements to MAXIMO 5, integrate MAXIMO MainControl into its overall product architecture, and develop industry-specific functionality, in a manner commensurate with future expectations of revenues and income from sales of the resulting product enhancements and functionality. General and administrative expenses increased 18% to $4.4 million from $3.7 million for the three months ended March 31, 2004 and 2003, respectively and increased 6% to $8.9 million from $8.4 million for the six months ended March 31, 2004 and 2003, respectively. The increase for both the three and six months ended March 31, 2004 and 2003, respectively, was primarily attributable to an increase in salaries and related benefits, property and business taxes, and insurance premiums. The decrease in amortization of other intangibles expense for the three and six months ended March 31, 2004 and 2003, respectively and was due to cessation of amortization of a fully amortized intangible asset. NON-OPERATING EXPENSES
Three Three Six Six Months Months Months Months Ended Change Ended Ended Change Ended (in thousands) 03/31/04 % 03/31/03 03/31/04 % 03/31/03 -------------- -------- ------ -------- -------- ------ -------- Interest income $244 35% $181 $ 448 15% $391 Other income/(expense), net $113 (82)% $643 $(327) (133)% $981
Interest income is attributable to interest earned on marketable securities and cash and cash equivalents. The decrease in other income was due to foreign currency exchange rate transaction losses. Also contributing to the decrease is a one-time gain of approximately $407 thousand for the sale of the Company's industrial data normalizations services operations in January 2003. INCOME TAXES The Company's effective tax rate was a provision of 35% for both the three and six months ended March 31, 2004 and 2003, respectively. The tax provision was calculated on income generated in domestic and foreign tax jurisdictions and changes in the Company's net deferred tax assets and liabilities. LIQUIDITY AND CAPITAL RESOURCES As of March 31, 2004, the Company had cash and cash equivalents of $55.2 million and marketable securities of $41.3 million, and working capital of $39.8 million. Cash provided by operations was $1.2 million for the six months ended March 31, 2004 primarily attributable to income generated by operations, offset by accounts payable and accrued compensation. Cash used in investing activities was $22.9 million for the six months ended March 31, 2004 and was primarily used in the purchase of marketable securities, partially offset by sales of securities. Cash provided by financing activities was $2.1 million for the six months ended March 31, 2004 and represents proceeds from the Company's Employee Stock Option and Purchase Plans. Page 18 As of March 31, 2004, the Company's principal commitments consist primarily of office space and equipment operating leases for its U.S. and European headquarters. The Company's corporate headquarters are under lease through December 31, 2009. The Company leases its other facilities and certain equipment under non-cancelable operating lease agreements that expire at various dates through June 30, 2019. The Company may use a portion of its cash to acquire additional businesses, products or technologies complementary to its business. The Company also plans to make investments over the next year in its products and technology. The Company expects that its cash flow from operations together with its current cash and marketable securities will be sufficient to meet its working capital and capital expenditure requirements through at least March 31, 2005. The Company's liquidity and working capital requirements, including the current portions of any long-term commitments, are satisfied through its cash flow from operations, leaving its cash reserves available for acquisitions, other investments and unanticipated expenditures. The Company has no long-term debt obligations. The factors which might impact the Company's cash flows include those which might impact the Company's business and operations generally, as described below under the heading "Factors Affecting Future Performance." FACTORS AFFECTING FUTURE PERFORMANCE The nature of forward-looking information is that such information involves significant assumptions, risks and uncertainties. Certain public documents of the Company and statements made by our authorized officers, directors, employees, agents and representatives, acting on behalf of the Company, may include forward-looking information, which will be influenced by the factors described below, and by other assumptions, risks and uncertainties. Forward-looking information is based on assumptions, estimates, forecasts and projections regarding the Company's future results as well as the future effectiveness of the Company's strategic plans and future operational decisions. Forward-looking statements made by or on behalf of the Company are subject to the risk that the forecasts, projections, and expectations of management, or assumptions underlying such forecasts, projections and expectations, may prove to be inaccurate. Accordingly, actual results and the Company's implementation of its plans and operations may differ materially from forward-looking statements made by or on behalf of the Company. The following discussion identifies certain important factors that could affect the Company's actual results and actions and could cause such results and actions to differ materially from forward-looking statements. THE TRADITIONAL MARKET FOR OUR MAXIMO PRODUCT IS MATURE AND SATURATED AND PRESENTS LIMITED OPPORTUNITY FOR GROWTH. MAXIMO has been the industry-leading plant floor capital asset maintenance product for a number of years, and we have acquired a large number of customers in this market. However, most large industrial organizations have made significant investments in systems that support the maintenance of their capital assets, and opportunities for new MAXIMO sales in the EAM market are more limited than they have been in the past. In addition, the emergence and growth of this market have attracted a large number of competitors, and most of the largest software companies that sell into complementary markets have developed competing asset maintenance products. It is likely that this market will continue to mature, there will be fewer sales opportunities for the Company, and competitive forces will put downward pressure on our average sales prices and rates of success. While we continue to strengthen our MAXIMO offering, these efforts may not be sufficient to overcome the effects of maturity and saturation in our traditional market, and our revenues, margins, results of operation and financial condition may be materially and adversely impacted. OUR EFFORTS TO REACH INTO NEW MARKETS WITH MAXIMO AND WITH NEW PRODUCTS MAY NOT BE SUCCESSFUL. Given the maturity and saturation of our traditional EAM market, in order to maintain revenues at their current levels and to grow our business, we are attempting to broaden our product offerings and find additional sources of revenues, in two ways. First, we are tailoring and extending MAXIMO to meet the Page 19 needs of specific industries in which the Company has a presence, such as the nuclear, transportation, power transmission and distribution, and other industries. We refer to these industry-specific MAXIMO offerings as "Industry Solutions". Second, we are attempting, through the MainControl acquisition and additional internal development, to deliver products that address markets that are new to the Company, such as the ITAM and consolidated service desk markets. There can be no assurance that we will be able to develop and market our Industry Solutions or new products on time, with acceptable quality and with such functions and features that meet the requirements of customers in these markets. If our Industry Solutions and newly acquired or developed products do not gain market acceptance and generate revenues from new industries or markets, we may not be able to grow our business or maintain revenues at current levels, and our revenues, margins, results of operation and financial condition may be materially and adversely impacted. IF WE ARE UNABLE TO KEEP PACE WITH THE RAPID CHANGES IN TECHNOLOGY AND CUSTOMER DEMAND THAT CHARACTERIZE OUR INDUSTRY, OUR COMPETITIVE POSITION COULD BE IMPAIRED. The computer software industry is characterized by rapid technological advances, changes in customer requirements and frequent product introductions and enhancements by us and by our competitors. Our success depends on our abilities to enhance our current products, to develop and introduce new products that keep pace with technological developments, to respond to evolving customer requirements and changing industry standards, to offer functionality and other innovations that are unique to our products and superior to those of our competitors, and ultimately to achieve market acceptance. In particular, we believe that we must continue to innovate and develop new functionality, to respond quickly to users' needs for new functionality and to advances in hardware and operating systems, and that we must continue to create products that conform to industry standards regarding the communication and interoperability among software, hardware and communications products of different vendors. If we fail to anticipate or respond adequately to technological developments and changes in market definitions or changes in customer requirements within particular market segments, or if we have any significant delays in product development or introduction, then we could lose competitiveness and revenues. We cannot give any assurance that we will be successful in developing and marketing new products or product enhancements, or that we will not experience significant delays in our development efforts. In addition, we cannot give any assurance that our new products and product enhancements will achieve market acceptance. Finally, when we develop new products, or enhancements to our existing products, it is possible that potential customers will defer or delay their decisions to purchase existing products while the newer products and enhancements are being developed, released and proven in the market. Such delays could have a material and adverse impact on ongoing sales of existing products, and on the Company's business and our results of operations. WE DEPEND SUBSTANTIALLY ON OUR MAXIMO PRODUCT, AND ANY DEVELOPMENTS THAT CAUSE REDUCED MARKET ACCEPTANCE OF MAXIMO WOULD HARM OUR BUSINESS. Most of our revenues are derived from the licensing of our MAXIMO family of products and sales of related services and support. Our financial performance depends largely on continued market acceptance of MAXIMO, and on the acceptance and market penetration of MAXIMO 5, our new Internet-centric version of MAXIMO. We believe that continued market acceptance of MAXIMO, and our revenue stability and growth, will largely depend on our ability to continue to enhance and broaden the capabilities of MAXIMO 5, both by broadening the core MAXIMO functionality and by developing specialized functionality targeted at key customer industries. New Internet technologies, standards, applications, functions and features are developing rapidly and are continuously being introduced, competing for acceptance in the market, and changing, and we must accurately anticipate technology and market trends and make the right choices in order to keep MAXIMO 5 at the forefront in its market from a technological perspective. Any factor adversely affecting sales of MAXIMO, such as delays in further development, significant software flaws, incompatibility with significant hardware platforms, operating systems or databases, increased competition, poor technology decisions or negative evaluations of the product, would have a material adverse effect on the Company's business and our results of operations. In addition, in the event that our development efforts are not progressing as intended, or if our new product releases or technologies are not successful in the markets they are intended to address, we may increase our rate of expenditure in this area Page 20 over and above the level of investment experienced in the past or previously projected, which could have a material adverse effect on our results of operation or financial condition. OUR SALES EFFORTS DEPEND IN PART ON STRATEGIC RELATIONSHIPS WITH OTHER COMPANIES. We have entered into strategic relationships with various larger companies, such as IBM Corporation, Deloitte Consulting L.P., Booz Allen & Hamilton, Inc., SAIC, Hewlett-Packard Company and others. In order to generate revenue through these relationships each party must coordinate with and support each other's sales and marketing efforts, and each party must make significant sales and marketing investments. Our ability to generate revenues through these relationships depends in large part upon the efforts of these other companies, which are outside of our control. The efforts of these companies may in turn be influenced by factors internal to these companies, or by developments in their respective industries or markets, that we fail to anticipate. In addition, we have agreed to develop a version of MAXIMO which will operate with IBM's Websphere, AIX and DB2 products, and to market the IBM versions of our products in preference to other versions. MAXIMO sales will therefore be affected by the success and acceptance of the IBM Websphere, AIX and DB2 products relative to those of IBM's competitors. We may experience difficulties in gaining market acceptance of the IBM version of our products, and difficulties in integrating and coordinating our products and sales efforts with those of IBM. Finally, our alliance with IBM may be viewed negatively by customers or prospects that have not adopted the IBM technology platform, and competitive alliances may emerge among other companies that are more attractive to our customers and prospective customers. OUR QUARTERLY OPERATING RESULTS ARE SUBJECT TO FLUCTUATIONS AND TO SEASONAL VARIATION. We have experienced, and may in the future experience, significant period-to-period fluctuations in revenues and operating results, which may negatively impact the price of our stock. In addition, our quarterly revenues and operating results have fluctuated historically due to the number and timing of product introductions and enhancements, customers delaying their purchasing decisions in anticipation of new product releases, the budgeting and purchasing cycles of customers, the timing of product shipments and the timing of marketing and product development expenditures. We typically realize a significant portion of our revenue from sales of software licenses in the last two weeks of each quarter, frequently even in the last few days of a quarter. Failure to close a small number of large software license contracts may have a significant impact on revenues for the quarter and could, therefore, result in significant fluctuations in quarterly revenues and operating results, and divergence of those results from our expectations. Accordingly, we believe that period-to-period comparisons of results of operations are not necessarily meaningful and should not be relied upon as an indication of future performance. WE FACE CHALLENGES WITH THE MAINCONTROL ACQUISITION, AND WE MAY NOT BE SUCCESSFUL IN ADDRESSING A NEW AND BROADER MARKET. When we acquired MainControl, Inc., which developed a product that enables companies to manage, track and maintain their IT assets, such as computers, telephones and networks, one of our assumptions was that our existing customers might be interested in purchasing our new IT product. With the acquisition of MainControl, our positioning with existing and prospective customers has changed in that we are now offering products which can manage more of a company's critical physical assets, such as IT assets, in addition to those managed by MAXIMO, such as plant floor assets, vehicles and facilities. It is possible that our attempts to characterize this combination of target markets as a single or composite market will not be accepted within the industry, by market analysts or by our customers, and as a result we might not gain the cross-market sales opportunities and synergies that we hoped for in the MainControl acquisition. Finally, we have announced our intention to integrate the MAXIMO MainControl product into our MAXIMO 5 platform, utilizing the same leading edge Internet-centric architecture and technologies as contained in MAXIMO 5, in order to provide a common platform from which a customer's critical assets may be managed. It is possible that prospective customers may prefer to wait until this integrated solution is available before purchasing MAXIMO MainControl, and it is possible that during the interim period while the integrated version is under development such customers may decide to purchase a competing Page 21 product; in either case, revenues from MAXIMO MainControl would be deferred or lost entirely, and there could be a material and adverse impact on our business and results of operations. WE FACE INTENSE COMPETITION IN THE MARKETS WE SERVE. The markets for strategic asset management software such as MAXIMO and MAXIMO MainControl are fragmented by geography, by market and industry segments, by hardware platform and by industry orientation, and are characterized by a large number of competitors including both independent software vendors and certain ERP vendors. Independent software vendors include DataStream Systems, Inc. and Indus International, Inc. MAXIMO also competes with integrated ERP systems, which include integrated maintenance modules offered by several large vendors, such as SAP, Oracle, JD Edwards (recently acquired by Peoplesoft) and others. MAXIMO MainControl competes with companies in ITAM market, such as Peregrine Systems and Computer Associates. Currently, MAXIMO competes with products of a number of large vendors, some of which have traditionally provided maintenance software operating in a client/server environment and are now developing or offering systems that are Web-architected. MAXIMO also encounters competition from vendors of low cost maintenance management systems designed initially for use by a single user or limited number of users as vendors of these products upgrade their functionality and performance to enter the enterprise market. Certain of our competitors have greater financial, marketing, service and support and technological resources than we do. To the extent that such competitors increase their focus on the asset maintenance or planning and cost systems markets, or on the industrial supply chain market, we could be at a competitive disadvantage. OUR INTERNATIONAL OPERATIONS SUBJECT US TO SPECIAL RISKS. A significant portion of our total revenues and expenses are derived and incurred from operations outside the U.S. Our ability to sell our products internationally is subject to a number of risks. General economic and political conditions in each country could adversely affect demand for our products and services. Exposure to currency fluctuations and greater difficulty in collecting accounts receivable could affect our sales. We could be affected by the need to comply with a wide variety of foreign import laws, U.S. export laws and regulatory requirements. Trade protection measures and import and export licensing requirements subject us to additional regulation and may prevent us from shipping products to a particular market and increase our operating costs. Page 22 OUR SOFTWARE PRODUCTS ARE DEPENDENT ON THIRD PARTY PROVIDERS OF SOFTWARE AND SERVICES, AND FAILURE OF THESE PARTIES TO PERFORM AS EXPECTED, OR TERMINATION OF OUR RELATIONSHIPS WITH THEM, COULD HARM OUR BUSINESS. We have entered into nonexclusive license agreements with other software vendors, pursuant to which we incorporate into our products and solutions software providing certain application development, hardware and network discovery, user interface, business intelligence, content and graphics capabilities developed by these companies. We have agreed to develop a version of MAXIMO, which will operate with IBM's Websphere application server, its AIX operating system and DB2 database programs. If we cannot renew these licenses (at all or on commercially reasonable terms), or if any of such vendors were to become unable to support and enhance their products, we could be required to devote additional resources to the enhancement and support of these products or to acquire or develop software providing equivalent capabilities, which could cause delays in the development and introduction of products incorporating such capabilities. WE MAY HAVE EXPOSURE TO ADDITIONAL INCOME TAX LIABILITIES. We are subject to income taxes in both the U.S. and various foreign jurisdictions. The amount of taxes paid is subject to our interpretation of applicable tax laws in the jurisdictions in which we file. Periodically, we are subject to income tax audits. While we believe that we have complied with all applicable tax laws, there can be no assurance that a governing tax authority will not have a different interpretation of the law and assess us with additional taxes. Should we be assessed with additional taxes, there could be a material and adverse effect on our results of operations or financial condition. CHANGES IN REGULATIONS OR CRITICAL ACCOUNTING POLICIES COULD MATERIALLY AND ADVERSELY AFFECT US. New laws, regulations or standards related to us or our products, and new accounting pronouncements, could be implemented or changed in a manner that could adversely affect our business, results of operations or financial condition. WE MAY PERFORM MORE FIXED PRICE SERVICES CONTRACTS. A trend is emerging among customers in our market towards demanding consulting and implementation services on a fixed price basis, whereby the Company agrees to deliver the contract requirements for a fixed fee, regardless of the number of person-hours actually provided, as opposed to our traditional services arrangements where we deliver services on a time and materials basis. In addition, when our Industry Solutions are first delivered, they may not include all of the functionality required by the initial customers, and we may complete the development effort under a services contract with the customer. In cases where services are provided either for the future delivery of functionality or on a fixed price basis and our standard software is licensed at the same time, and if the services are essential to the overall solution desired by the customer or if the Company cannot determine the fair value of the services being delivered, then the Company may not be able to recognize the software license revenue from such transactions at the time the agreements are signed, but rather may be required to recognize such license revenue under the contract or other method of accounting, or to recognize a greater portion (or all) of the revenue from these transactions as services revenue. This would likely result in a postponement of recognition of, or even a reduction in, software license revenues, and have an adverse impact on the results of our operations. WE MAY BE UNABLE TO EFFECTIVELY PROTECT OUR INTELLECTUAL PROPERTY. Our success is dependent upon our proprietary technology. We currently have two U.S. patents (and other corresponding patents or applications pending in various foreign countries), and we protect our technology primarily through copyrights, trademarks, trade secrets and employee and third-party nondisclosure agreements. Our software products are sometimes licensed to customers under "shrink-wrap" or "click- wrap" licenses included as part of the product packaging or acknowledged by customers who register online. Although, in larger sales, our shrink-wrap and click-wrap licenses may be accompanied by specifically negotiated agreements signed by the licensee, in many cases our shrink-wrap and click-wrap Page 23 licenses are not negotiated with or signed by individual licensees. Certain provisions of our shrink-wrap and click-wrap licenses, including provisions protecting against unauthorized use, copying, transfer and disclosure of the licensed program, and limitations or liabilities and exclusions of remedies, may be unenforceable under the laws of certain jurisdictions. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent, as do the laws of the U.S. Finally, we sell our products through distributors and resellers, and are therefore dependent on those companies to take appropriate steps to adequately implement our contractual protections and to enforce and protect our rights. We cannot give any assurance that the steps that we have taken to protect our proprietary rights will be adequate to prevent misappropriation of our technology or development by others of similar technology. Although we believe that our products and technology do not infringe on any valid claim of any patent or any other proprietary rights of others, we cannot give any assurance that third parties will not assert infringement claims in the future. Litigation may be necessary to enforce our intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Such litigation could result in substantial costs and diversion of resources, could result in the deterioration or outright loss of our patent rights, copyrights or other intellectual property, and could potentially have a material adverse result on our operating results and financial condition. LOSS OF THE SERVICES OF ONE OR MORE OF OUR KEY EXECUTIVE OFFICERS OR INABILITY TO RECRUIT NEEDED SALES, SERVICES AND TECHNICAL PERSONNEL COULD ADVERSELY AFFECT OUR BUSINESS. We are highly dependent on certain key executive officers, technical and sales employees, and the loss of one or more of such employees could have an adverse impact on our future operations. We do not have employment contracts with any personnel, and we do not maintain any so-called "key person" life insurance policies on any personnel. We continue to hire a significant number of additional sales, services and technical personnel. Competition for hiring of such personnel in the software industry is intense, and from time to time we may experience difficulty in locating candidates with the appropriate qualifications within the desired geographic locations, or with certain industry specific expertise. There can be no assurance that we will be able to retain our existing personnel or attract additional qualified employees. OTHER RISKS The foregoing is not a complete description of all risks relevant to our future performance, and the foregoing should be read and understood together with and in the context of similar discussions which may be contained in the documents that we file with the SEC in the future. We undertake no obligation to release publicly any revision to the foregoing or any update to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. Page 24 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's primary exposures to market risk are the effect of fluctuations in interest rates earned on its cash equivalents and marketable securities and exposures to foreign currency exchange rate fluctuations. At March 31, 2004, the Company held $96.5 million in cash equivalents and marketable securities consisting of taxable and tax exempt municipal securities. Cash equivalents are classified as available for sale and valued at amortized cost, which approximates fair market value. A hypothetical 10 percent increase in interest rates would not have a material impact on the fair market value of these instruments due to their short maturity. The Company develops its products in the United States and markets them in North America, Europe, Middle East and Africa, Australia, Asia Pacific and Latin America. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. Currently, the Company has no hedging contracts. ITEM 4. CONTROLS AND PROCEDURES MRO Software carries out periodic evaluations, under the supervision of the Company's management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon such evaluations, the Chief Executive Officer and the Chief Financial Officer concluded that, as of March 31, 2004, our disclosure controls and procedures were effective to timely alert them to any material information relating to the Company (including its consolidated subsidiaries) that would be required to be included in our periodic filings with the Securities and Exchange Commission. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to their evaluation. The Company intends to continue to review and evaluate the design and effectiveness of our disclosure controls and procedures on an ongoing basis and to improve our controls and procedures over time and to correct any deficiencies that we may discover in the future. Our goal is to ensure that our senior management has timely access to all material financial and non-financial information concerning our business. While we believe the present design of our disclosure controls and procedures is effective to achieve our goal, future events affecting our business may require us to modify our disclosure controls and procedures. Page 25 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS NONE ITEM 2 RECENT SALES OF UNREGISTERED SECURITIES, USE OF PROCEEDS FROM REGISTERED SECURITIES, CHANGES IN SECURITIES NONE ITEM 3 DEFAULTS UPON SENIOR SECURITIES NONE ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company held the Annual Meeting of Stockholders on March 9, 2004. At the Annual Meeting, the stockholders of the Company voted to approve the following actions by the following votes: 1. To elect Stephen B. Sayre and Alan L. Stanzler as Class II Directors of the Company to serve until the 2007 Annual Meeting.
No. of Shares/Votes ---------------------------------- For Authority Withheld ---------- ------------------ Stephen B. Sayre 21,930,275 723,288 Alan L. Stanzler 16,902,168 5,751,395
The names of each other director whose term of office as a director continued after the meeting are: Norman E. Drapeau, Jr., Robert L. Daniels, Richard P. Fishman and John A. McMullen. 2. To approve an amendment to the Company's Amended and Restated 1999 Equity Incentive Plan to increase the number of shares issuable thereunder by an additional 1,200,000 shares.
No. of Shares/Votes ------------------- For 18,096,703 Against 1,879,432 Abstain 49,450 Non-Vote 2,627,978
3. To ratify the selection of PricewaterhouseCoopers LLP as the Company's independent auditors for the 2004 fiscal year.
No. of Shares/Votes ------------------- For 22,425,115 Against 225,648 Abstain 2,800
Page 26 ITEM 5. OTHER INFORMATION CERTIFICATION UNDER SARBANES-OXLEY ACT OUR CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER HAVE FURNISHED TO THE SEC THE CERTIFICATION WITH RESPECT TO THIS REPORT THAT IS REQUIRED BY SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 3. Instruments Defining the Rights of Security-Holders 3.1 Amended and Restated Articles of Organization of the Company (included as Exhibit 3.3 to the Company's Registration Statement on Form S-1, Registration No. 33-76420, and incorporated herein by reference) 3.2 Restated By-Laws of the Company, as amended (included as Exhibit 3.2 to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1996, File No. 0-23852, and incorporated herein by reference) 3.3 Amendment to By-Laws adopted on February 1, 2001 (included as Exhibit 3.3 to the Company's Current Report on Form 10-Q for the quarter ended March 31, 2001, File No. 0-23852 and incorporated herein by reference) 3.4 Form of Certificate of Designation of Series A Junior Participating Preferred Stock of MRO Software, Inc. (which is attached as Exhibit A to the Rights Agreement included as Exhibit 4 (b) to the Company's Current Report on Form 8-K dated February 2, 1998, File No. 0-23852, and incorporated herein by reference) 3.5 Amendment to Articles of Organization adopted on December 15, 1999 (included as Exhibit 3.4 to the Company's Form 10-Q for the quarter ended December 31, 1999, File No. 0-23852, and incorporated herein by reference) 3.6 Amendment to Articles of Organization, dated March 6, 2001 (included as Exhibit 3.4 to the Company's Current Report on Form 8-K dated March 9, 2001, File No. 0-23852, and incorporated herein by reference) 4. Instruments Defining the Rights of Security Holders, Including Indentures 4.1 Specimen certificate for the Common Stock, $.01 par value, of the Company (included as Exhibit 4.1 to the Company's Current Report on Form 10-Q for the quarter ended December 31,2001, File No. 0-23852 and incorporated herein by references) 4.2 Article 4B of the Amended and Restated Articles of Organization of the Company (included as Exhibit 4.1 to the Company's Registration Statement on Form S-1, Registration No. 33-76420, and incorporated herein by reference) 4.3 Rights Agreement dated as of January 27, 1998, between the Company and BankBoston, N.A. as Rights Agent (included as Exhibit 4 (a) to the Company's Current Report on Form 8-K dated February 2, 1998, File No. 0-23852, an incorporated herein by reference) 4.4 Form of Certificate of Designation of Series A Junior Participating Preferred Stock of the Company (included as Exhibit 4 (b) to the Company's Current report on Form 8-K dated February 2, 1998, File No. 0-23852, and incorporated herein by reference) Page 27 4.5 Form of Rights Certificate (included as Exhibit 4 (c) to the Company's Current Report on Form 8-K dated February 2, 1998, File No. 0-23852, and incorporated herein by reference) 9. Voting Trust Agreements 9.1 Shareholders Agreement between Robert L. Daniels and Susan H. Daniels dated August 1, 2001 (included as Exhibit 9.1 to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2001 File No. 0-23852, and incorporated herein by reference) 31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, Rule 13a-14(a)/15d-14(a), by Chief Executive Officer. 31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, Rule 13a-14(a)/15d-14(a), by Chief Financial Officer. 32.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350 by Chief Executive Officer and Chief Financial Officer. (b) Reports on Form 8-K On January 22, 2004, the Company filed a current report on Form 8-K disclosing its results of operations for the quarter ended December 31, 2003. On April 15, 2004, the Company filed a current report on Form 8-K disclosing its results of operations for the quarter ended March 31, 2004. The Company will furnish a copy of any exhibit listed to requesting stockholders upon payment of the Company's reasonable expense in furnishing those materials. Page 28 SIGNATURES Pursuant to the requirements 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. MRO SOFTWARE, INC. Date: May 14, 2004 By: /s/ Peter J. Rice ------------------------------ Peter J. Rice Executive Vice President - Finance and Administration, Chief Financial Officer and Treasurer (Principal Financial Officer) Page 29 EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION PAGE --- ----------- ---- 3.1 Amended and Restated Articles of Organization of the Company (included as Exhibit 3.3 to the Company's Registration Statement on Form S-1, Registration No. 33-76420, and incorporated herein by reference) 3.2 Restated By-Laws of the Company, as amended (included as Exhibit 3.2 to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1996 File No. 0-23852 and incorporated herein by reference) 3.3 Amendment to By-Laws adopted on February 1, 2001 (included as Exhibit 3.3 to the Company's Current Report on Form 10-Q for the quarter ended March 31, 2001, File No. 0-23852 and incorporated herein by reference) 3.4 Form of Certificate of Designation of Series A Junior Participating Preferred Stock of MRO Software, Inc. (which is attached as Exhibit A to the Rights Agreement included as Exhibit 4 (b) to the Company's Current Report on Form 8-K dated February 2, 1998, File No. 0-23852, and incorporated herein by reference) 4.1 Specimen certificate for the Common Stock, $.01, of the Company (included as Exhibit 4.1 to the Company's Current Report on Form 10-Q for the quarter ended December 31, 2001, File No. 0-23852 and incorporated herein by reference) 4.2 Article 4B of the Amended and Restated Articles of Organization of the Company (included as Exhibit 4.1 to the Company's Registration Statement on Form S-1, Registration No. 33-76420, and incorporated herein by reference) 4.3 Rights Agreement dated as of January 27, 1998, between the Company and BankBoston, N.A. as Rights Agent (included as Exhibit 4 (a) to the Company's Current Report on Form 8-K dated February 2, 1998, File No. 0-23852, and incorporated herein by reference) 4.4 Form of Certificate of Designation of Series A Junior Participating Preferred Stock of MRO Software, Inc. (included as Exhibit 4 (b) to the Company's Current Report on Form 8-K dated February 2, 1998, File No. 0-23852, and incorporated herein by reference) 4.5 Form of Rights Certificate (included as Exhibit 4 (c) to the Company's Current Report on Form 8-K dated February 2, 1998, File No. 0-23852, and incorporated herein by reference) 9.1 Shareholders Agreement between Robert L. Daniels and Susan H. Daniels dated August 1, 2001 (included as Exhibit 9.1 to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2001 File No. 0-23852, and incorporated herein by reference) 31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, Rule 13a-14(a)/15d-14(a), by Chief Executive Officer. 31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, Rule 13a-14(a)/15d-14(a), by Chief Financial Officer. 32.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350 by Chief Executive Officer and Chief Financial Officer.
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