UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

Commission File Number 000-26565

 

 

LIBERATE TECHNOLOGIES

(Exact name of registrant as specified in its charter)

 

 

 

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 ý  No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes ý  No o

 

104,999,213 shares of the Registrant’s common stock were outstanding as of December 31, 2003.

 

 

LIBERATE TECHNOLOGIES

FORM 10-Q

For The Quarterly Period Ended November 30, 2003

TABLE OF CONTENTS

 

PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	Condensed Consolidated Balance Sheets as of November 30, 2003 and May 31, 2003
	Condensed Consolidated Statements of Operations for the three months and six months ended November 30, 2003 and 2002
	Condensed Consolidated Statements of Cash Flows for the six months ended November 30, 2003 and 2002
	Notes to Condensed Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risk
Item 4.	Controls and Procedures
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings
Item 4.	Submission of Matters to a Vote of Security Holders
Item 5.	Other Information
Item 6.	Exhibits and Reports on Form 8-K
SIGNATURES

 

 

Part I. Financial Information

 

Item 1. Financial Statements

 

LIBERATE TECHNOLOGIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

Unaudited

 

		November 30, 2003			May 31, 2003
Assets
Current assets:
Cash and cash equivalents		$	186,347		$	261,689
Short-term investments		44,987			—
Accounts receivable, net		4,089			3,310
Prepaid expenses and other current assets		2,464			3,069
Assets of discontinued operations		—			6,936
Total current assets		237,887			275,004
Property and equipment, net		4,779			6,113
Intangible assets, net		—			22
Deferred costs related to warrants		5,374			14,449
Restricted cash		9,776			9,249
Other assets		123			131
Total assets		$	257,939		$	304,968
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable		$	1,362		$	1,888
Accrued liabilities		20,596			39,436
Accrued payroll and related expenses		2,084			1,568
Deferred revenues		10,688			10,619
Liabilities of discontinued operations		—			5,375
Total current liabilities		34,730			58,886
Long-term excess facilities charges		20,753			22,330
Other long-term liabilities		2,329			2,242
Total liabilities		57,812			83,458
Commitments and contingencies (Note 7)
Stockholders’ equity:
Common stock		1,050			1,040
Contributed and paid-in-capital		1,492,282			1,490,125
Deferred stock-based compensation		—			(194		)
Accumulated other comprehensive income(loss)		(812		)	1,804
Accumulated deficit		(1,292,393		)	(1,271,265		)
Total stockholders’ equity		200,127			221,510
Total liabilities and stockholders’ equity		$	257,939		$	304,968

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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LIBERATE TECHNOLOGIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

Unaudited

 

		Three months ended November 30,						Six months ended November 30,
		2003			2002			2003			2002
Revenues:
License and royalty		$	(697	)	$	2,549		$	(1,621	)	$	3,556
Service		1,885			3,448			4,354			11,442
Total revenues		1,188			5,997			2,733			14,998
Cost of revenues:
License and royalty		208			412			359			844
Service		1,368			6,164			2,811			17,224
Total cost of revenues		1,576			6,576			3,170			18,068
Gross margin (loss)		(388		)	(579		)	(437		)	(3,070		)
Operating expenses:
Research and development		3,647			8,258			7,314			16,380
Sales and marketing		1,004			6,132			2,433			11,829
General and administrative		4,479			5,371			8,660			9,047
Amortization of deferred costs related to warrants		1,027			1,006			1,831			1,947
Restructuring costs		881			22			1,361			2,058
Amortization and impairment of goodwill and intangible assets		—			478			22			1,054
Impairment of deferred costs related to warrants		4,969			—			4,969			—
Amortization of deferred stock-based compensation		—			352			10			763
Excess facilities charges and related asset impairment		593			(587		)	593			16,503
Total operating expenses		16,600			21,032			27,193			59,581
Loss from operations		(16,988		)	(21,611		)	(27,630		)	(62,651		)
Interest income, net		573			1,976			1,190			4,478
Other income (expense), net		(173		)	(7,110		)	(548		)	(6,568		)
Loss from continuing operations before income tax provision		(16,588		)	(26,745		)	(26,988		)	(64,741		)
Income tax provision		—			407			103			805
Loss from continuing operations		(16,588		)	(27,152		)	(27,091		)	(65,546		)
Loss from discontinued operations		(992		)	(4,460		)	(3,075		)	(6,089		)
Gain on sale of discontinued operations		9,037			—			9,037			—
Cumulative effect of a change in accounting principle		—			—			—			(209,289		)
Net loss		$	(8,543	)	$	(31,612	)	$	(21,129	)	$	(280,924	)
Basic and diluted income(loss) per share:
Continuing operations		$	(0.16	)	$	(0.26	)	$	(0.26	)	$	(0.62	)
Discontinued operations, basic		$	0.08		$	(0.04	)	$	0.06		$	(0.06	)
Discontinued operations, diluted		$	0.07		$	—		$	0.06		$	—
Cumulative effect of a change in accounting principle		$	—		$	—		$	—		$	(1.99	)
Basic and diluted net loss per share		$	(0.08	)	$	(0.30	)	$	(0.20	)	$	(2.68	)
Shares used in computing basic and diluted net loss per share		104,515			103,922			104,248			104,992

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

2

 

LIBERATE TECHNOLOGIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

Unaudited

 

		Six months ended November 30,
		2003			2002
Cash flows from operating activities:
Net loss		$	(21,129	)	$	(280,924	)
Adjustments to reconcile net loss to net cash used in operating activities:
Impairment of deferred costs related to warrants		4,969			—
Amortization of deferred costs related to warrants		4,106			4,172
Discontinued operations		(7,437		)	—
Depreciation and amortization		1,261			3,901
Loss on disposal of property and equipment		91			16
Provision for (recovery of) doubtful accounts		16			(60		)
Asset impairment charges		41			1,517
Amortization and impairment of intangible assets		22			2,081
Stock-based compensation expense		10			763
Write-down of equity investments		—			6,687
Write-off of acquired in-process research and development		—			300
Cumulative effect of a change in accounting principle		—			209,289
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable		(795		)	7,198
Prepaid expenses and other current assets		605			1,484
Notes receivable from officers		—			786
Other assets		15			(142		)
Accounts payable		(526		)	(1,093		)
Accrued liabilities		(18,840		)	(1,644		)
Accrued payroll and related expenses		515			(1,454		)
Deferred revenues		69			(6,423		)
Other long-term liabilities		(1,490		)	12,233
Net cash used in operating activities		(38,497		)	(41,313		)
Cash flows from investing activities:
Purchase of investments		(44,987		)	—
Proceeds from sale of discontinued operations		7,075			—
Increase in restricted cash		(527		)	(29		)
Purchases of property and equipment		(279		)	(1,659		)
Proceeds from maturity of investments		—			133,537
Cash used in acquisitions, net of cash received		—			(38,085		)
Purchase of equity investments		—			(1,771		)
Net cash provided by (used in) investing activities		(38,718		)	91,993
Cash flows from financing activities:
Principal payments on capital lease obligations		(6		)	(247		)
Repurchase of common stock		—			(9,957		)
Proceeds from issuance of common stock		1,728			412
Net cash provided by (used in) financing activities		1,722			(9,792		)
Effect of exchange rate changes on cash		151			(716		)
Net increase (decrease) in cash and cash equivalents		(75,342		)	40,172
Cash and cash equivalents, beginning of period		261,689			111,396
Cash and cash equivalents, end of period		$	186,347		$	151,568

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Unaudited

 

Note 1. Description of Business

 

Liberate Technologies (“Liberate,” “we,” “us,” or “our”) and its wholly owned subsidiaries, is a provider of software and services for digital cable systems. Our software enables cable operators to run multiple services – including high definition television, video on demand, and personal video recorders – on multiple platforms.

 

Note 2. Significant Accounting Policies

 

Basis of Presentation

 

Our unaudited condensed consolidated financial statements include the accounts of Liberate and our subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. These interim financial statements are unaudited and reflect all adjustments that we believe are necessary to provide a fair statement of the financial position and the results of operations for the interim periods in accordance with the rules of the Securities and Exchange Commission (“SEC”).  However, these condensed consolidated statements omit certain information and footnote disclosures necessary to conform to generally accepted accounting principles. These statements should be read in conjunction with the audited consolidated financial statements and notes included in our annual report on Form 10-K for the fiscal year ended May 31, 2003. The results of operations for the interim periods reported do not necessarily indicate the results expected for the full fiscal year or for any future period.

 

In this report, we sometimes use the words “fiscal” or “FY” followed by a year to refer to our fiscal years, which end on May 31 of the specified year. We also sometimes use “Q1,” “Q2,” “Q3,” and “Q4” to refer to our fiscal quarters, which end on August 31, November 30, the last day of February, and May 31 of each fiscal year.

 

Computation of Basic and Diluted Net Loss Per Share

 

We compute basic net loss per share using the weighted average number of shares of common stock outstanding during the periods presented. Our policy is to report net income(loss) per share based on the number of fully diluted shares, which includes the weighted average number of shares of common stock, stock options, and warrants outstanding. As we have recorded a net loss for all periods presented, net loss per share on a diluted basis is equivalent to basic net loss per share because converting outstanding stock options and warrants would be anti-dilutive. Accordingly, we did not include 22,500,595 potential shares in the calculations for the periods ended November 30, 2002, or 12,315,680 potential shares in the calculations for the periods ended November 30, 2003.

 

Stock-Based Compensation

 

We have elected to continue to follow the intrinsic value method of accounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” to account for employee stock options. Under APB 25, we do not recognize compensation expense unless the exercise price of the employee stock option is less than market price of the underlying stock at the date of grant. Except for the amortization of our deferred stock-based compensation related to stock options granted prior to our IPO and more recently, to restricted stock units, we have not recorded stock-based compensation expense in the periods presented because stock options were granted at their fair market

 

4

 

value on the date of grant. See Note 8.

 

The following information regarding net loss and loss per share was prepared in accordance with Statement of Financial Accounting Standards (“FAS”) No. 123 and has been determined as if we had accounted for our employee stock options under the fair value method prescribed by FAS 123. The resulting effect on net loss and loss per share pursuant to FAS 123 is not likely to be representative of the effects on net loss and loss per share pursuant to FAS 123 in future periods, because future periods will include the effects of additional grants and periods of vesting. Our 1999 Employee Stock Purchase Plan (“ESPP”) is currently suspended. We did not issue shares during Q2 FY04 under the ESPP. We issued options to purchase 14,000 shares during Q2 FY04 and we granted 223,528 restricted stock units. See Note 8.  For the periods ended November 30, 2003 and 2002, the fair value of options and the 1999 Employee Stock Purchase Plan shares issued was estimated at the date of grant utilizing a Black-Scholes option valuation model with the following weighted-average assumptions:

 

		Options
		Three months ended November 30,						Six months ended November 30,
		2003			2002			2003			2002
Risk-free interest rate		1.62		%	2.15		%	1.62		%	2.72		%
Average expected life of options granted (in years)		2.26			2.96			2.26			2.64
Dividend yield		0		%	0		%	0		%	0		%
Volatility of common stock		46		%	106		%	46		%	106		%
Weighted average fair value of options granted		$	0.94		$	1.02		$	0.94		$	1.52

 

		ESPP Shares
		Three months ended November 30,					Six months ended November 30,
		2003		2002			2003		2002
Risk-free interest rate		—		2.08		%	—		2.08		%
Average expected life of ESPP shares issued (in years)		—		0.50			—		0.50
Dividend yield		—		0		%	—		0		%
Volatility of common stock		—		94		%	—		94		%
Weighted average fair value of ESPP shares issued		—		$	2.47		—		$	2.47

 

For purposes of disclosure pursuant to FAS 123 as amended by FAS 148, we amortize the estimated fair value of an option over the option’s vesting period.

 

The following table illustrates the effect on reported net loss and loss per share had we applied the fair value recognition provisions of FAS 123 to stock-based compensation (in thousands, except per share data):

 

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		Three months ended November 30,						Six months ended November 30,
		2003			2002			2003			2002
Net loss, as reported		$	(8,543	)	$	(31,612	)	$	(21,292	)	$	(280,924	)
Adjustments:
Stock-based employee compensation expense included in reported loss, net of related tax effects, goodwill, and assembled workforce amortization, net of tax		—			352			10			763
Total stock-based employee compensation expense determined under fair value method for all awards granted since July 1, 1995, net of related tax effects		(981		)	(4,699		)	(921		)	(8,161		)
Pro forma net loss		$	(9,524	)	$	(35,959	)	$	(22,203	)	$	(288,322	)
Basic and diluted net loss per share, as reported		$	(0.08	)	$	(0.30	)	$	(0.20	)	$	(2.68	)
Basic and diluted net loss per share, pro forma		$	(0.09	)	$	(0.35	)	$	(0.21	)	$	(2.75	)

 

Recent Accounting Pronouncements

 

In August 2001, the Financial Accounting Standards Board (“FASB”) issued FAS No. 143, “Accounting for Asset Retirement Obligations.” FAS 143 establishes financial accounting and reporting obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. FAS 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. The liability is accreted to its present value each period while the cost is depreciated over its useful life. We adopted FAS 143 for our quarter ended November 30, 2003, and adoption did not materially affect our financial position, results of operations, or cash flows.

 

In November 2002, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services, and/or rights to use assets. We adopted  EITF No. 00-21 for our quarter ended November 30, 2003, and adoption did not have a significant impact on our financial statements.

 

In January 2003, the FASB issued Interpretation No. (“FIN”) 46, “Consolidation of Variable Interest Entities.” This interpretation of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” addresses consolidation by business enterprises of certain variable interest entities where there is a controlling financial interest in a variable interest entity or where the variable interest entity does not have sufficient equity at risk to finance its activities without additional subordinated financial support from other parties. We have not identified any entities that require disclosure or new

 

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consolidation as a result of  the adoption of FIN 46 for our quarter ended November 30, 2003.

 

In May 2003, the FASB issued FAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” FAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). FAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003 for public companies. The adoption of FAS 150 did not have a material effect on our financial position, results of operations, or cash flows.

 

Cumulative Effect of a Change in Accounting Principle

 

On June 1, 2002, we adopted FAS No. 141, “Business Combinations” and FAS No. 142, “Goodwill and Other Intangible Assets.” FAS 141 requires us to account for all business combinations initiated after June 30, 2001 using the purchase method of accounting. Under FAS 142, we no longer amortize the remaining balances of goodwill. Rather, we tested goodwill for impairment immediately upon the date of adoption and will continue to test goodwill for impairment at least once a year. Under FAS 141 and FAS 142, the value of an assembled workforce is no longer considered an identifiable intangible asset with a definite useful life, and accordingly, we reclassified the net assembled workforce balance of $526,000 to goodwill as of June 1, 2002.

 

FAS 142 requires a different valuation methodology than FAS 121 and is more likely to result in impairment because FAS 142 uses discounted rather than undiscounted cash flows. Based on the criteria of FAS 142, we determined that we had one reporting segment at the time we adopted FAS 142. Our testing and analysis process included obtaining an independent appraisal of the fair value of Liberate based on two valuation approaches. The first valuation approach determined our market capitalization based on our fair value on the date of adoption using our average stock price over a range of days in May and June 2002. This average stock price was increased by a control premium based on premiums paid for control of comparable companies. The second valuation used a discounted cash flows approach.

 

This analysis resulted in an allocation of fair values to identifiable tangible and intangible assets and an implied valuation of goodwill of zero as of June 1, 2002. Comparing this goodwill fair value to the carrying value resulted in a goodwill impairment of $209.3 million, with no income tax effect, at June 1, 2002. We recorded the impairment as the cumulative effect of a change in accounting principle on our condensed consolidated statement of operations for Q1 FY03. Future impairments, if any, will be recorded as operating expenses.

 

As required by FAS 142, a reconciliation of previously reported net loss and net loss per share to the amounts adjusted to exclude the impairment of goodwill and assembled workforce is as follows (in thousands, except per share data):

 

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		Six months ended November 30,
		2002
Net loss, as reported		$	(280,924	)
Add back:
Cumulative effect of a change in accounting principle		209,289
Loss before cumulative effect of a change in accounting principle, as adjusted		$	(71,635	)
Basic and diluted net loss per share, as reported		$	(2.68	)
Add back:
Cumulative effect of a change in accounting principle		1.99
Loss per share before cumulative effect of a change in accounting principle, as adjusted		$	(0.68	)
Shares used in computing per share amounts		104,992

 

Reclassifications

 

Certain reclassifications, primarily resulting from discontinued operations, have been made to previously reported amounts in order to conform to the current period presentations. See Note 3.

 

Note 3. Acquisition

 

In August 2002, we acquired the outstanding capital stock of Sigma Systems Group (Canada) for $60.4 million in cash, before deducting $22.3 million of cash received in connection with the acquisition. We also assumed Sigma Systems’ unvested employee options with a fair value of $1.9 million, agreed to satisfy certain obligations of Sigma Systems to its employees in the aggregate amount of $3.0 million, and incurred acquisition costs of approximately $1.3 million. The total consideration and acquisition costs were $66.6 million and we accounted for the acquisition as a purchase.

 

Sigma Systems developed and marketed operational support systems (“OSS”) software that let network operators create, deploy, monitor, and maintain digital subscriber services. Through this acquisition, we sought to expand our product offerings. In September 2002, Sigma Systems changed its legal name to Liberate Technologies (Toronto) Ltd.

 

We allocated the total purchase price consideration of $66.6 million as follows (in thousands):

 

Cash		$	22,314
Receivables and other current assets		2,232
Property, plant, and equipment		672
Liabilities assumed		(3,586		)
Deferred compensation		184
In-process research and development		300
Intangible assets		9,830
Goodwill		34,630
Total consideration		$	66,576

 

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We immediately wrote off $300,000 of acquired in-process research and development that had not reached technological feasibility and had no alternative future use. The value of Sigma Systems’ in-process research and development was determined by using the income approach, which measures the present worth and anticipated future benefit of the intangible asset.

 

We also used the income approach to determine the value of Sigma Systems’ existing products and technology, customer lists and order backlog, and trademarks. Based on these valuations, we initially recorded $9.8 million of intangible assets. We began amortizing this amount on a straight-line basis over an estimated useful life of three years. Intangible assets consisted of $9.2 million of existing technology and $630,000 of customer lists and order backlog and trademarks. We also initially recorded $34.6 million of goodwill, which represented the purchase price in excess of the identified net tangible and intangible assets. In accordance with FAS 142, we did not amortize goodwill, but reviewed it for impairment at least once a year.  Subsequently, in accordance with the annual test for impairment under FAS 142, in Q4 FY03 we wrote off $31.5 million of goodwill related to our acquisition of Sigma Systems.  See Note 5, Goodwill and Intangible Assets.

 

At the time of the acquisition, Liberate entered into an escrow agreement with Sigma Systems and deposited $9.0 million into an escrow account to secure certain obligations of Sigma Systems and its major shareholders.  On November 19, 2003, Liberate and the representative of such former Sigma Systems major shareholders entered into a settlement agreement and limited release of claims, pursuant to which Liberate received approximately $3.5 million in cash from the escrow account. The return of escrow funds was accounted for as part of the gain on sale of discontinued operations.

 

In May 2003, we sold the Bill-Care unit of Sigma Systems to Sigma Solutions, Inc. a company owned by certain former shareholders of Sigma Systems, for consideration of $1.0 million in cash. On November 26, 2003, we sold the OSS division of Sigma Systems and its assets to Sigma Software Solutions Inc. and affiliated entities for approximately $3.6 million in cash and the assumption of approximately $7.4 million of lease obligations and other liabilities.  See Note 4, “Discontinued Operations.”

 

Note 4. Discontinued Operations

 

In August 2002, we acquired the outstanding capital stock of Sigma Systems. See Note 3. In accordance with FAS 142, we determined that Sigma Systems had two reporting units, OSS and Bill-Care. Subsequently, in May 2003, we sold Bill-Care to a company owned by certain former shareholders of Sigma Systems, for consideration of $1.0 million in cash. In September 2003, we announced that we were actively exploring the sale of the OSS division. On November 26, 2003, we completed the sale of the OSS division and its assets to Sigma Software Solutions Inc. and affiliated entities.  The purchase price included approximately $3.6 million in cash and the assumption of approximately $7.4 million of lease obligations and other liabilities.  In connection with the sale, we received approximately $7.1 million cash in total proceeds from the OSS business sale and return of escrow funds and recognized a gain of $9.0 million. See Note 3.

 

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Computation of gain on sale:

 

		Three and six months ended November 30,
		2003
Proceeds		$	7,075
Expenses of Sales		(715		)
Net liabilities sold		2,678
Gain on sale of discontinued operations		$	9,038

 

Pursuant to the provisions of FAS 144, amounts in the financial statements and related notes have been reclassified to reflect the discounted operations of both Bill-Care and OSS. Operating results for the discontinued operations are reported, net of tax, under “Loss from discontinued operations” on the condensed consolidated statements of operations.  Related assets and liabilities are disclosed in the balance sheet as “Assets of discontinued operations” or “Liabilities of discontinued operations.”

 

The following table reflects the impact of discontinued operations on certain statement of operations data (in thousands except per share information).

 

		Three months ended November 30,						Six months ended November 30,
		2003			2002			2003			2002
Total revenues		$	1,843		$	403		$	2,552		$	763
Cost of revenues		441			1,045			1,275			1,334
Gross margin (loss)		1,402			(642		)	1,277			(571		)
Operating expenses		2,528			2,984			4,357			3,822
Write-off of acquired in-process research and development		—			—			—			300
Amortization of purchased intangibles		136			819			287			1,092
Amortization of deferred stock compensation		23			—			46			—
Restructuring costs		—			—			23			—
Operating loss from discontinued operations		(1,285		)	(4,445		)	(3,436		)	(5,785		)
Interest and other income (expense)		293			(15		)	361			(304		)
Loss from discontinued operations		$	(992	)	$	(4,460	)	$	(3,075	)	$	(6,089	)

 

Note 5. Goodwill and Intangible Assets

 

Under the provisions of FAS 142, we no longer amortize goodwill, but rather test it for impairment at least once a year.  Additionally, FAS 142 defines assembled workforce intangible assets as part of goodwill.  Effective June 1, 2002, with the adoption of FAS 142, we transferred the remaining net book value of assembled workforce intangible assets of $526,000 to goodwill and tested the resulting balance of goodwill for impairment. Based on the results of this testing, we determined that $209.3 million of goodwill was impaired. In Q1 FY03, we acquired Sigma Systems and recorded $34.6 million in goodwill. Sigma Systems net goodwill of $31.5 million was deemed impaired as a result of the annual FAS 142 test performed in Q4 FY03. The remaining Sigma Systems goodwill has been classified in “Assets of Discontinued Operations” on our condensed consolidated balance sheets.Goodwill activity through November 30, 2003 was as follows (in thousands):

 

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		Net book value
Balance at May 31, 2002		$	208,763
Assembled workforce reclassification		526
Impairment upon adoption of FAS 142 (1)		(209,289		)
Sigma Systems acquisition		34,630
Transfer of Sigma System assets to discontinued operations (2)		(34,210		)
Balance at August 31, 2002		420
Q2 FY03 activity		—
Balance at November 30, 2002		420
Q3 FY03 activity		—
Balance at February 28, 2003		420
Goodwill associated with sale of Bill-Care		(420		)
Balance at May 31, 2003		—
Fiscal 2004 activity		—
Balance at November 30, 2003		$	—

 

(1)          Recorded as “Cumulative effect of a change in accounting principle.”

(2)          Subsequently, in FY03, $31.5 million of goodwill was impaired under FAS 142 test.

 

Intangible Assets

 

We amortize intangible assets on a straight-line basis over their estimated useful lives, which are normally three years. In June 2002, with the adoption of FAS 144, we determined that the fair value of the Virtual Modem trademarks that we had acquired in fiscal 2000 was zero. This permanent impairment resulted in a write-down of the carrying value from $66,000 to zero. In August 2002, in connection with the acquisition of Sigma Systems, we acquired intangible assets with a value of $9.8 million. In Q4 FY03, we recorded impairment of $5.6 million of intangible assets related to Sigma Systems under FAS 144. All Sigma Systems goodwill and intangible assets and associated amortization and impairment have been presented as discontinued operations in our condensed consolidated financial statements contained herein. See Note 3, “Discontinued Operations.” As of November 30, 2003 and May 31, 2003, intangible assets were as follows (in thousands):

 

		Net book value
		November 30, 2003			May 31, 2003
Existing products and technology		$	—		$	8
Customer lists and order backlog		—			14
Total		$	—		$	22

 

Amortization expense related to intangible assets was zero in Q2 FY04, $478,000 in Q2 FY03, $22,000 and $1.0 million for the six months ended November 30, 2003 and 2002, respectively.  As of November 30, 2003, our intangible assets had been fully amortized.

 

In Q2 FY04, we recorded warrant-related asset impairment expense of $5.0 million as a result of our realignment of strategy to focus on the U.S. cable market. This impairment charge reduced the carrying value of certain warrant-related assets to a level equal to the expected future revenues from the holders of those warrants during the amortization period of those warrants.

 

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Note 6. Excess Facilities Charges and Related Asset Impairment

 

We have existing commitments to lease office space at our headquarters in San Carlos, California in excess of our needs for the foreseeable future and do not anticipate that we will be able to sublease a substantial portion of our excess office space in the near future. Excess facilities charges represent the remaining lease commitment on those vacant facilities, net of expected sublease income. Each quarter we evaluate our existing needs, the current and estimated future value of our subleases, and other future commitments to determine whether we should recognize additional excess facilities charges. Additionally, each quarter we evaluate our leasehold improvements for impairment and if necessary, we reduce the carrying value using estimates of future cash flows to a level equal to the expected future value at that time. These impairment amounts are included in excess facilities charges and related asset impairment on our condensed consolidated statements of operations.

 

We recorded $593,000 in excess facilities charges and related asset impairment expense in Q2 FY04 and for the six months ended November 30, 2003.  In Q2 FY03, we recorded a reversal of excess facilities charges and related asset impairment of $587,000, related to a change in estimates regarding impairment of our excess facilities, and in the six months ended November 30, 2002, we recorded $15.1 million of excess facilities charges and $1.5 million of related asset impairment charges.

 

Note 7. Commitments and Contingencies

 

Transactions with Executive Officers

 

In June 2003, we entered into an agreement with Coleman Sisson, a former executive officer, under which he received $10,000 per month for his services as an independent contractor. We terminated this agreement in November 2003, although we have agreed to pay the premiums for Mr. Sisson’s health insurance through June 2004.

 

Indemnification Obligations

 

In November 2002, the FASB issued FIN 45 “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee or indemnification. FIN 45 also requires additional disclosure by a guarantor in its interim and annual financial statements about its obligations under certain guarantees and indemnifications. The initial recognition and measurement provisions of FIN 45 are applicable for guarantees issued or modified after December 31, 2002. The disclosure requirements of FIN 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. We adopted the recognition and measurement provisions of FIN 45 prospectively to guarantees issued or modified after December 31, 2002. The adoption of this standard did not have a material impact on our consolidated results of operations or financial position.

 

Our software license agreements typically provide for indemnification of customers for intellectual property infringement claims. To date, no such claims have been filed against us. We also warrant to customers that software products operate substantially in accordance with specifications. Historically, minimal costs have been incurred related to product warranties, and accordingly, we have not accrued warranty costs. In addition, we are obligated to indemnify our officers and directors under the terms of indemnity agreements entered into with them, as well as pursuant to our certificate of incorporation, bylaws, and applicable Delaware law. We are unable to quantify the charge that could result from officer and director indemnification.

 

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Legal Matters

 

Underwriting Litigation. Beginning on May 16, 2001, a number of class-action lawsuits seeking monetary damages were filed in the United States District Court for the Southern District of New York against several of the firms that underwrote our initial public offering, naming Liberate and certain of our officers and directors as co-defendants. The suits, which have since been consolidated with hundreds of similar suits filed against underwriters and issuers, allege that the underwriters received excessive and improper commissions that were not disclosed in our prospectus and that the underwriters artificially increased the price of our stock. The plaintiffs subsequently added allegations regarding our secondary offering, and named additional officers and directors as co-defendants. While we deny allegations of wrongdoing, we have agreed to enter into a global settlement of these claims, and expect our insurers to cover amounts in excess of our deductible. A suit making similar allegations based on the same facts has also been filed in California state court.

 

OpenTV Patent Litigation. On February 7, 2002, OpenTV filed a lawsuit against Liberate in the United States District Court for Northern California, alleging that Liberate is infringing two of OpenTV’s patents and seeking monetary damages and injunctive relief. We have filed an answer denying OpenTV’s allegations. Our counter-claim alleges that OpenTV infringes one of our patents for information retrieval systems. We are seeking to have OpenTV’s patents invalidated, requesting a finding that our technology does not infringe OpenTV’s patents, and seeking monetary damages and injunctive relief against OpenTV. The court has issued a claim construction ruling, and trial is currently scheduled for 2004. Because litigation is by its nature uncertain, we are unable to predict whether we may face any material exposure for damages or the need to alter our software arising from this case.

 

Restatement Class-Action Litigation. Beginning on October 17, 2002, five securities class-action lawsuits were filed in the United States District Court for the Northern District of California against us and certain officers and directors (collectively, the “Class Action Defendants”), which were subsequently consolidated into a single action (the “Class Action”). The Class Action is based on our announcements in October and November 2002 that we would restate our financial results for fiscal 2002 and that we were investigating other periods. The Class Action generally alleges, among other things, that members of the purported class were damaged when they acquired our securities because, as a result of accounting irregularities, our previously issued financial statements were materially false and misleading, and caused the prices of our securities to be inflated artificially. The Class Action further alleges that, as a result of this conduct, the Class Action Defendants violated Section 10(b) and 20(a) of the Securities Exchange Act of 1934, and SEC Rule 10b-5, promulgated thereunder. The Class Action seeks unspecified monetary damages and other relief from all Class Action Defendants.

 

Restatement Derivative Litigation. In addition, on or about October 29, 2002, a shareholder derivative action was filed in the California Superior Court for the County of San Mateo, naming us as a nominal party and naming certain of our officers and directors as defendants (collectively, the “Derivative Defendants”). A second shareholder derivative action was filed on or about November 6, 2002. On February 26, 2003, these actions were consolidated into a single action (the “Derivative Action”). The Derivative Action is based on substantially the same facts and circumstances as the Class Action and generally alleges that the Derivative Defendants failed to adequately oversee our financial reporting, and thus are liable for breach of their fiduciary duties, abuse of control, gross mismanagement, and waste of corporate assets. The Derivative Action also alleges that certain current or former officers and directors are liable for unjust enrichment. The Derivative Action seeks unspecified monetary damages and other relief.

 

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SEC Investigation. When we announced that we would restate our financial statements, we contacted the SEC and provided them with additional information regarding our findings. In February 2003, we learned that the SEC had initiated a formal, non-public investigation into the events and circumstances that led to the restatement of our financial statements. We have been cooperating with the SEC and will continue to do so.

 

The cost of participating and defending against these actions is substantial and will require the continuing diversion of management’s attention and corporate resources.

 

We cannot predict or determine the outcome or resolution of the Class Action, the Derivative Action, or the SEC investigation, or estimate the amounts of, or potential range of, loss with respect to these proceedings. In addition, the timing of the final resolution of these proceedings is uncertain. The possible resolutions of these proceedings could include judgments against us or settlements that could require substantial payments by us, which could have a material adverse impact on our financial position, results of operations, and cash flows.

 

On August 29, 2003, Liberate purchased a $100 million supplemental loss mitigation insurance policy from a AAA/A++ rated insurance carrier to cover damages that may arise from pending securities and derivative litigation related to Liberate’s restatement. This policy is in addition to Liberate’s existing policies that provide for up to $15 million of coverage. Liberate paid a $17.9 million premium for the loss mitigation policy, with a rebate of up to $4.4 million if an eventual settlement or judgment is less than specified amounts. The expense related to the purchase of this policy was recorded in general and administrative expense in fiscal 2003.  Liberate has certain deductibles under its insurance arrangements for which it is solely responsible, and in Q4 FY03, we accrued an additional $7.1 million of expense to cover anticipated costs related to litigation.

 

Litigation-Related Indemnification Obligations. We have agreed to indemnify our directors and officers to the fullest extent permitted by Delaware law. As a consequence, we are advancing expenses (including reasonable attorneys’ fees) incurred by directors and officers in connection with the Class Action, the Derivative Action, and the SEC investigation, although these payments are subject to reimbursement if such expenses are ultimately found to be non-indemnifiable. Additionally, we may ultimately be obligated to pay indemnifiable judgments, penalties, fines, and amounts paid in settlement in connection with these proceedings.

 

We have notified our various insurance carriers of the Class Action, the Derivative Action, and the SEC investigation. Our insurance, however, may not cover our defense costs, any settlement, any judgment rendered against us, or amounts we are required to pay to any indemnified person in connection with the Class Action, the Derivative Action, the SEC investigation, or any other matter.

 

Note 8. Offerings of Common Stock

 

Common Stock

 

In Q2 FY04 and the six months ended November 30, 2003, we issued 863,758 shares of common stock to employees upon the exercise of stock options, 4,166 shares of common stock upon the vesting and settlement of stock units, and 103,000 shares of common stock to an executive officer.  In Q2 FY03, we issued 43,935 shares of stock to employees upon the exercise of stock options, and in the six months ended November 30, 2002, we issued 182,672 shares of stock to employees upon the exercise of stock options.

 

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Stock Repurchase

 

In July 2002, we repurchased 3,963,780 shares of our common stock beneficially owned by Cisco for an aggregate purchase price of $10.0 million. The purchase price per share of $2.5117 was our average stock price for the ten consecutive trading days prior to July 18, 2002, less a 2% discount. Following the repurchase, the shares were retired and are now authorized and unissued.

 

Warrant Agreements

 

In fiscal 1999, we agreed to issue warrants for the purchase up to 4,599,992 shares of our stock to certain network operators who satisfied specific milestones within specific time frames. We estimated the fair market value of the warrants using the Black-Scholes pricing model as of the earlier of the date the warrants were earned or the date that it became likely that they would be earned. Pursuant to the requirements of EITF 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services,” we revalue the warrants if appropriate.

 

As of November 30, 2003, network operators had earned warrants to purchase 2,396,660 shares. Of this amount, warrants to purchase 552,774 shares had previously been exercised and warrants to purchase 163,890 shares had been retired in connection with those exercises, and warrants to purchase 546,666 had expired unexercised. As of November 30, 2003, there were earned and outstanding warrants to purchase 1,299,996 shares with exercise prices of $4.80 and $6.90 per share and a weighted average exercise price of $6.41 per share. The warrants expire between July 29, 2004 and May 31, 2005.

 

Additionally, in August 2002, we paid $1.1 million to MediaOne of Colorado and MediaOne of Michigan, each a wholly owned subsidiary of AT&T Broadband, to buy back unvested warrants to purchase 400,000 shares.

 

Warrant activity through November 30, 2003 was as follows:

 

		Warrant activity
		Available		Earned		Repurchased		Expired		To Be Earned
Balance May 31, 2000		4,599,992		(2,336,660	)	—		—		2,263,332
Fiscal 2001 activity		—		—		—		(50,000	)	(50,000	)
Balance May 31, 2001		4,599,992		(2,336,660	)	—		(50,000	)	2,213,332
Fiscal 2002 activity		—		(60,000	)	—		(170,000	)	(230,000	)
Balance May 31, 2002		4,599,992		(2,396,660	)	—		(220,000	)	1,983,332
Fiscal 2003 activity		—		—		(400,000	)	(933,332	)	(1,333,332	)
Balance May 31, 2003		4,599,992		(2,396,660	)	(400,000	)	(1,153,332	)	650,000
Fiscal 2004 activity		—		—		—		(650,000	)	(650,000	)
Balance November 30, 2003		4,599,992		(2,396,660	)	(400,000	)	(1,803,332	)	—

 

We record amortization expense for deferred costs related to warrants in accordance with EITF 01-09. Under EITF 01-09, warrant amortization expense may be classified as an offset to associated revenues up to the amount of cumulative revenues recognized or to be recognized. Such amortization expense was classified as follows (in thousands):

 

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		Three months ended November 30,						Six months ended November 30,
		2003			2002			2003			2002
Warrant amortization offset to license and royalty revenues		$	1,015		$	1,079		$	2,275		$	2,225
Warrant amortization charged to operating expenses		1,027			1,006			1,831			1,947
		$	2,042		$	2,085		$	4,106		$	4,172

 

In Q2 FY04, we recorded warrant asset impairment expense of $5.0 million. This impairment charge reduced the carrying value of certain warrant-related assets to the expected future revenues from the holders of those warrants based outside of the U.S.

 

Deferred Stock-based Compensation

 

We recorded expenses of zero in Q2 FY04, $352,000 in Q2 FY03, $10,000 in the six months ended November 30, 2003 and $763,000 in the six months ended November 30, 2002 related to deferred stock-based compensation.  There is no deferred stock-based compensation balance in shareholder’s equity as of November 30, 2003. We report amortization of deferred stock-based compensation as a separate line item in the accompanying condensed consolidated statements of operations. Had amortization of deferred stock-based compensation been included in the following expense categories, such expense categories would have increased by the following amounts (in thousands):

 

		Three months ended November 30,						Six months ended November 30,
		2003			2002			2003			2002
Cost of service revenues		$	—		$	65		$	1		$	135
Research and development		—			150			4			341
Sales and marketing		—			63			3			159
General and administrative		—			74			2			128
Total deferred stock-based compensation		$	—		$	352		$	10		$	763

 

Option Grants

 

During the three and six month periods ended November 30, 2003, we issued options to purchase 14,000 shares to employees under our 1999 Equity Incentive Plan.  For the six months ended November 30, 2002, we issued options to purchase 6,179,000 shares to employees under our 1999 Equity Incentive Plan.

 

Stock Award to Executive

 

During the quarter ended November 30, 2003, we entered into a management transition agreement and related stock award agreement with Kent Walker, an executive officer.  Mr. Walker received an award of 103,000 shares of common stock, which had a value of $3.40 per share and were fully vested on the date of the award.  We recorded the value of the shares as a compensation expense in the quarter.

 

Restricted Stock Units

 

During the quarter ended November 30, 2003, we began to implement a program to grant restricted stock units (“RSUs”) to certain employees and non-employee directors as part of our overall stock-based compensation. Each RSU entitles the holder to receive one share on the vesting date of the RSU. The RSUs granted to employees generally vest over a period of four years while those granted to non-employee directors generally vest over 12 months. Stock-based compensation representing the fair

 

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market value of the underlying shares at the date of grant of the RSUs is being recognized evenly over the vesting period. On the vesting dates, the RSUs are settled by the delivery of shares of common stock to the participants. As of November 30, 2003, we had granted 223,528 RSUs to an employee and four non-employee directors, and 4,166 of those RSUs had become vested.

 

The total expenses by functional areas incurred for the three months ended November 30, 2003 pertaining to the amortization of RSUs are as follows (in thousands):

 

		Three Months ended
		November 30, 2003			May 31, 2003
Research and development		$	—		$	—
Sales and marketing		14			—
General and administrative		—			—
Total		$	14		$	—

 

Note 9. Restructuring Costs

 

As part of our ongoing efforts to control costs, we effected a reduction in force in July and August 2002. This action resulted in a headcount reduction of 106 employees. As a result of these actions, we accrued restructuring costs of approximately $2.2 million in Q1 FY03, which were comprised primarily of salary and employee-related expenses.

 

During Q1 FY03, management revised its estimate underlying the restructuring accrual that occurred in February 2002.  Originally, we had accrued restructuring costs of $1.6 million in February 2002, and in Q1 FY03, we reversed $210,000 of that accrual. The reversal primarily pertained to exit costs related to facilities.

 

In January 2003, we announced a further reduction in force and terminated the employment of 228 employees. In Q1 FY04, under FAS 146, we recorded an additional $49,000 in expense related to this January action.

 

In April 2003, we announced another reduction in force. This action resulted in a headcount reduction of 75 employees worldwide. Under FAS 146, in Q1 FY04 we recorded $262,000 of expenses related to this April action, which included a reversal of $34,000 related to employees we decided to retain.

 

During Q1 FY04, we terminated the employment of five employees and recorded $169,000 of restructuring expenses related to severance payments.

 

During Q2 FY04, we terminated the employment of 15 employees, of whom 5 were still on transition assignments as of November 30, 2003. We recorded $881,000 of restructuring expenses related to severance payments.

 

In the periods ended November 30, 2002 and November 30, 2003, our restructuring costs consisted of the following components (in thousands):

 

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		Three months ended November 30,						Six months ended November 30,
		2003			2002			2003			2002
Salaries and employee-related expenses		$	881		$	22		$	1,395		$	2,268
Changes to estimated restructuring expense		—			—			(34		)	(210		)
Restructuring costs		$	881		$	22		$	1,361		$	2,058

 

As of November 30, 2003, accrued restructuring costs were as follows (in thousands):

 

Accrued restructuring costs at May 31, 2003		$	496
Expensed restructuring charges		1,395
Cash payments		(1,524		)
Change to estimated restructuring expense		(34		)
Accrued restructuring costs at November 30, 2003		$	333

 

Note 10. Comprehensive Loss

 

Comprehensive loss consists of net loss on our condensed consolidated statements of operations, foreign currency translation adjustments, and unrealized losses related to our short-term investments. The following table reflects our comprehensive loss (in thousands):

 

		Three months ended November 30,						Six months ended November 30,
		2003			2002			2003			2002
Net loss		$	(8,543	)	$	(31,612	)	$	(21,129	)	$	(280,924	)
Foreign currency translation adjustment		207			61			418			(716		)
Comprehensive loss		$	(8,497	)	$	(31,551	)	$	(20,711	)	$	(281,640	)

 

Note 11. Segment Information

 

As of November 30, 2003, we operated solely in one segment—providing digital infrastructure software and services for cable networks. We derived revenues for this one segment from licenses, royalties, and services, and our long-term assets were located primarily in the United States.

 

We classify our revenues by geographic region based on the country in which the sales order originates. Our North American region includes sales attributable to the United States and Canada. Our EMEA region includes sales attributable to Europe, the Middle East, and Africa. Our Asia Pacific region includes sales attributable to Asia and Australia. The following table details the revenues from significant countries and regions (in thousands):

 

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		Three months ended November 30,						Six months ended November 30,
		2003			2002			2003			2002
United States		$	181		$	1,739		$	(302	)(1)	$	4,714
Canada		(57		)(1)	2,178			(337		)(1)	4,867
United Kingdom		653			1,444			2,545			3,668
Rest of EMEA		351			415			671			1,030
Asia Pacific		60			221			156			719
Total revenues		$	1,188		$	5,997		$	2,733		$	14,998

 

International revenues consist of sales to customers outside of the United States and domestic revenues consist of sales to customers within the United States. International and domestic revenues as a percentage of our total revenues were as follows:

 

		Three months ended November 30,				Six months ended November 30,
		2003		2002		2003		2002
International revenues		85	%	71	%	111	%	69	%
Domestic revenues		15	%	29	%	(11	)%(1)	31	%
Total revenues		100	%	100	%	100	%	100	%

 

(1)          For Q2 FY04 and the six months ended November 30, 2003, negative revenues for Canada included $119,000 and $462,000 of warrant-related offsets to revenue respectively and negative revenues for the United States included $896,000 and $1.8 million of warrant-related offsets to revenue respectively.

 

The table below sets forth information relating to each customer that, for the periods presented, accounted for 10% or more of our total revenues.

 

		Three months ended November 30,				Six months ended November 30,
		2003		2002		2003		2002
Customer A		56	%		*	33	%		*
Customer B		39	%		*	46	%	11	%
Customer C		28	%		*	19	%		*
Customer D		19	%		*		*		*
Customer E		10	%		*		*		*

 

*           Less than 10%

 

The above presentation includes the effects of our adoption of EITF 01-09 in December 2001 and of our reclassification of revenues specifically attributed to discontinued operations for the periods presented.  For all periods presented above, certain customers generated negative revenues as a result of these adjustments.  Consequently, the customer percentages listed above for Q2 FY04 sum to greater than 100%.

 

Financial instruments that potentially subject us to a concentration of credit risk consist principally of accounts receivable. As of November 30, 2003, three customers each accounted for 10% or more of our accounts receivable and as of May 31, 2003, three customers each accounted for 10% or

 

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more of our accounts receivable. The percentage of receivables from significant customers for the periods reported were as follows:

 

		November 30, 2003		May 31, 2003
Customer A		36	%	20	%
Customer B		20	%	14	%
Customer C		12	%	39	%

 

We perform ongoing credit evaluations of our customers’ financial condition and reserve for credit losses as required.

 

Note 12. Subsequent Events

 

Termination of Executive’s Employment. Effective September 30, 2003, we entered into a management transition agreement with Kent Walker, and in January 2004, Mr. Walker resigned as an executive officer of Liberate.

 

Restricted Stock Unit Awards.  In connection with our new restricted stock unit program, in December 2003, we issued 2,067,000 RSUs to a group of approximately 100 employees.  The RSUs will generally vest as to 1/8 of the units on January 15 and July 15 of each year, commencing in 2004.  See Note 8.

 

New Office Lease.  In December 2003, we entered into a new office lease agreement for approximately 15,000 square feet of space in San Mateo, California.  The lease has a term of 60 months.  Rent expense is estimated to be approximately $26,000 per month for the first twelve months.

 

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

 

Overview

 

Liberate Technologies is a provider of software and services for digital cable systems. Our software enables cable operators to run multiple services – including high-definition television, video on demand, and personal video recorders – on multiple platforms. We operate in an industry sector that has been significantly affected by the recent economic downturn, and we believe that our future results of operations will continue to be subject to quarterly variations based upon a wide variety of factors, such as those discussed in “Risk Factors” below.

 

Please note that many statements in this report on Form 10-Q are forward-looking within the meaning of the securities laws of the United States. These statements involve both known and unknown risks and uncertainties, as set forth below, and our actual results in future periods may differ materially from any future performance suggested in this report. This report should be read in conjunction with our report on Form 10-K for the fiscal year ended May 31, 2003.

 

In Q2 FY04, our revenues decreased from the immediately preceding quarter and decreased significantly from Q2 FY03.  We have also seen decreases in our cost of revenues, research and development expenses, sales and marketing expenses, and general and administrative expenses in Q2 FY04 from Q2 FY03 which have declined in part due to several reductions in force as well as our cost cutting efforts to bring expenses in line with revenues.

 

Recent Developments

 

In September 2003, we announced that Christopher Bowick and Dana Evan had resigned from our board of directors and the board decreased in size from seven to five members.

 

Discontinued Operations

 

In August 2002, we acquired the outstanding capital stock of Sigma Systems Group (Canada), a privately held corporation based in Toronto, Canada, for $60.4 million in cash, before deducting $22.3 million of cash received in connection with the acquisition. In accordance with FAS 142, we determined that Sigma Systems had two reporting units, OSS and Bill-Care. Subsequently, in May 2003, we sold Bill-Care to Sigma Software Solutions, Inc., a company owned by certain former shareholders of Sigma Systems, for consideration of $1.0 million in cash. In September 2003, we announced that we were actively exploring the sale of the OSS division and in November 2003, we closed the sale of the OSS division and its assets to Sigma Software Solutions Inc. and affiliated entities.  The purchase price included approximately $3.6 million in cash and the assumption of approximately $7.4 million of lease obligations and other liabilities resulting in a gain on the sale of approximately $9.0 million in the period. The gain also reflects approximately $3.5 million in cash proceeds from the escrow account. See Financial Statements, Note 3.

 

Pursuant to the provisions of FAS 144, revenues, cost of revenues, and expenses related to discontinued operations have been reclassified from each specific line item on our condensed consolidated financial statements and related notes and are now presented as a net loss from discontinued operations in a single line below our provision for income taxes. For comparative purposes, discontinued operations amounts have been reclassified retroactively. Operating results for the discontinued operations of Bill-Care and OSS are reported, net of tax. Assets and liabilities are disclosed on our condensed consolidated balance sheet as either “Assets of discontinued operations” or “Liabilities of discontinued

 

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operations.”

 

The following table reflects the impact of discontinued operations on our condensed statement of operations (in thousands, except per share data):

 

		Three months ended November 30,						Six months ended November 30,
		2003			2002			2003			2002
Total revenues		$	1,843		$	403		$	2,552		$	763
Cost of revenues		441			1,045			1,275			1,334
Gross margin (loss)		1,402			(642		)	1,277			(571		)
Operating expenses		2,528			2,984			4,357			3,822
Write-off of acquired in-process research and development		—			—			—			300
Amortization of purchased intangibles		136			819			287			1,092
Amortization of deferred stock compensation		23			—			46			—
Restructuring costs		—			—			23			—
Operating loss from discontinued operations		(1,285		)	(4,445		)	(3,436		)	(5,785		)
Interest and other income (expense)		293			(15		)	361			(304		)
Loss from discontinued operations		$	(992	)	$	(4,460	)	$	(3,075	)	$	(6,089	)

 

In August 2002, Liberate entered into an escrow agreement in connection with the acquisition of Sigma Systems and deposited $9.0 million into an escrow account to secure certain obligations of Sigma Systems and its major shareholders.  On November 19, 2003, Liberate and the representative of the former Sigma Systems major shareholders entered into a settlement agreement and limited release of claims, pursuant to which Liberate received approximately $3.5 million in cash from the escrow account. The return of escrow funds was accounted for as part of the gain on sale of discontinued operations.

 

Critical Accounting Policies Update

 

There have been no material changes to our critical accounting policies as disclosed on our report on Form 10-K for fiscal 2003 filed with the SEC on September 16, 2003.

 

Recent Accounting Pronouncements

 

In August 2001, the Financial Accounting Standards Board (“FASB”) issued FAS No. 143, “Accounting for Asset Retirement Obligations.” FAS 143 establishes financial accounting and reporting obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. FAS 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. The liability is accreted to its present value each period while the cost is depreciated over its useful life. We adopted FAS 143 for our quarter ended November 30, 2003, and adoption did not did not materially affect our financial position, results of operations, or cash flows.

 

In November 2002, the EITF reached a consensus on EITF No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF 00-21 provides guidance on

 

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how to account for arrangements that involve the delivery or performance of multiple products, services, and/or rights to use assets. We adopted  EITF No. 00-21 for our quarter ended November 30, 2003, and adoption did not have a significant impact on our financial statements.

 

In January 2003, the FASB issued FIN 46, “Consolidation of Variable Interest Entities.” This interpretation of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” addresses consolidation by business enterprises of certain variable interest entities where there is a controlling financial interest in a variable interest entity or where the variable interest entity does not have sufficient equity at risk to finance its activities without additional subordinated financial support from other parties. We have not identified any entities that require disclosure or new consolidation as a result of  the adoption of FIN 46 for our quarter beginning September 1, 2003.

 

In May 2003, the FASB issued FAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” FAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). FAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003 for public companies. The adoption of FAS 150 did not have a material effect on our financial position, results of operations, or cash flows.

 

Cumulative Effect of a Change in Accounting Principle

 

On June 1, 2002, we adopted FAS No. 141, “Business Combinations” and FAS No. 142, “Goodwill and Other Intangible Assets.” FAS 141 requires us to account for all business combinations initiated after June 30, 2001 using the purchase method of accounting. Under FAS 142, we no longer amortize the remaining balances of goodwill. Rather, we tested goodwill for impairment immediately upon the date of adoption and will continue to test goodwill for impairment at least once a year. Under FAS 141 and FAS 142, the value of an assembled workforce is no longer considered an identifiable intangible asset with a definite useful life, and accordingly, we reclassified the net assembled workforce balance of $526,000 to goodwill as of June 1, 2002.

 

FAS 142 requires a different valuation methodology than FAS 121 and is more likely to result in impairment because FAS 142 uses discounted rather than undiscounted cash flows. Based on the criteria of FAS 142, we determined that we had one reporting segment at the time we adopted FAS 142. Our testing and analysis process included obtaining an independent appraisal of the fair value of Liberate based on two valuation approaches. The first valuation approach determined our market capitalization based on our fair value on the date of adoption using our average stock price over a range of days in May and June 2002. This average stock price was increased by a control premium based on premiums paid for control of comparable companies. The second valuation used a discounted cash flows approach.

 

This analysis resulted in an allocation of fair values to identifiable tangible and intangible assets and an implied valuation of goodwill of zero as of June 1, 2002. Comparing this goodwill fair value to the carrying value resulted in a goodwill impairment of $209.3 million, with no income tax effect, at June 1, 2002. We recorded the impairment as the cumulative effect of a change in accounting principle on our condensed consolidated statement of operations for Q1 FY03. Future impairments, if any, will be recorded as an operating expense. See Financial Statements, Note 2.

 

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Results of Operations

 

Revenues

 

We generate license and royalty revenues by licensing our client and server products, applications, and tools, primarily to network operators that provide television services, and, in a small number of cases, to set-top box manufacturers. We generate service revenues from consulting, maintenance, and other services provided in connection with those licenses.

 

A portion of our revenues for the three and six months ended November 30, 2003 and a portion of our deferred revenue balance as of November 30, 2003 arose from pre-payments we received in fiscal 1999 and 2000 from a limited number of North American network operators. By the end of Q2 FY04, we had $6.3 million remaining in deferred revenue (excluding any impact of warrant-related revenue offsets) from the pre-payments of these large North American network operators. In some cases, we recognize revenue upon termination of a customer’s right to credit these fees for software deployment or future services. Our revenues from these pre-payments continue to decline. We do not expect that our total revenues will equal or exceed historical levels until we receive significant new revenue commitments from existing or new customers.

 

Total revenues for the periods reported were as follows (in thousands):

 

		Three months ended November 30,						Six months ended November 30,
		2003			2002			2003			2002
Total revenues		$	1,188		$	5,997		$	2,733		$	14,998
Decrease, year over year		$	(4,809	)				$	(12,265	)
Percentage decrease, year over year		(80		)%				(82		)%

 

International and domestic revenues as a percentage of our total revenues were as follows:

 

		Three months ended November 30,				Six months ended November 30,
		2003		2002		2003		2002
International revenues		85	%	71	%	111	%	68		%
Domestic revenues		15	%	29	%	(11	)%(1)	32		%
Total revenues		100	%	100	%	100	%	100		%

 

(1)     For the six months ended November 30, 2003, we recognized negative domestic revenues due to $1.8 million of warrant-related offsets to revenue.

 

We anticipate international revenues will continue to represent a significant portion of total revenues for the foreseeable future.

 

License and Royalty Revenues. License and royalty revenues for the periods reported were as follows (in thousands):

 

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		Three months ended November 30,						Six months ended November 30,
		2003			2002			2003			2002
License and royalty revenues		$	(697	)	$	2,549		$	(1,621	)	$	3,556
Percentage of total revenues		(59		)%	43		%	(59		)%	24		%
Decrease, year over year		$	(3,246	)				$	(5,177	)
Percentage decrease, year over year		(127		)%				(146		)%

 

License and royalty revenues decreased from Q2 FY03 to Q2 FY04 and from the six months ended November 30, 2002 to the six months ended November 30, 2003 primarily due to a marked decline in royalty revenues. Royalty revenue decreased by $2.9 million from Q2 FY03 to Q2 FY04 due to lower levels of deployment by our customers and a $1.2 million revenue reserve in Q2 FY04 for potential overpayment of royalties based on correspondence with one of our customers.  License revenues accounted for $371,000 of the decrease.  Offsets from deferred costs related to warrants decreased slightly from $1.1 million in Q2 FY03 to $1.0 million in Q2 FY04.  Total license and royalties revenue is negative in Q2 FY04 and the six months ended November 30, 2003 in part because these warrant related revenue offsets exceeded the amount of new license and royalty revenue recognized during these periods. We expect license and royalty revenue will be less than recent historical levels unless and until we receive significant new revenue commitments from existing or new customers.

 

Service Revenues. The majority of our service revenues in the three and six months ended November 30, 2003 were comprised of support revenues. Service revenues for the periods reported were as follows (in thousands):

 

		Three months ended November 30,						Six months ended November 30,
		2003			2002			2003			2002
Service revenues		$	1,885		$	3,448		$	4,354		$	11,442
Percentage of total revenues		159		%	57		%	159		%	76		%
Decrease, year over year		$	(1,563	)				$	(7,088	)
Percentage decrease, year over year		(45		)%				(62		)%

 

Service revenues decreased from Q2 FY03 to Q2 FY04 and from the six months ended November 30, 2002 to the six months ended November 30, 2003 primarily due to a significant decline in professional services, which decreased from $1.6 million in Q2 FY03 to $418,000 in Q2 FY04.  This decrease reflects much lower activity on billable customer projects in the first six months of FY04 compared to the same period in FY03. We expect that over the long term, service revenues will continue to be a significant portion of our revenues. However, we do not expect service revenues to reach recent historical levels until we receive significant new revenue commitments.

 

Cost of Revenues

 

Total cost of revenues was as follows (in thousands):

 

		Three months ended November 30,						Six months ended November 30,
		2003			2002			2003			2002
Total cost of revenues		$	1,576		$	6,576		$	3,170		$	18,068
Percentage of total revenues		133		%	110		%	116		%	120		%
Decrease, year over year		$	(5,000	)				$	(14,898	)
Percentage decrease, year over year		(76		)%				(82		)%

 

25

 

We anticipate that total cost of revenues will remain relatively flat in the near future.

 

Cost of License and Royalty Revenues. Cost of license and royalty revenues was as follows (in thousands):

 

		Three months ended November 30,						Six months ended November 30,
		2003			2002			2003			2002
Cost of license and royalty revenues		$	208		$	412		$	359		$	844
Percentage of license and royalty revenues		(30		)%	16		%	(22		)%	24		%
Decrease, year over year		$	(204	)				$	(485	)
Percentage decrease, year over year		(50		)%				(57		)%

 

Cost of license and royalty revenues decreased from Q2 FY03 to Q2 FY04 and from the six months ended November 30, 2002 to the six months ended November 30, 2003 primarily due to significantly lower support, royalty and license fees paid for third party technology. We anticipate that cost of license and royalty revenues will fluctuate in future periods to the extent that customers deploy our software and as we integrate third-party technologies in our products.

 

Cost of Service Revenues. Cost of service revenues was as follows (in thousands):

 

		Three months ended November 30,						Six months ended November 30,
		2003			2002			2003			2002
Cost of service revenues		$	1,368		$	6,164		$	2,811		$	17,224
Percentage of service revenues		73		%	179		%	65		%	151		%
Decrease, year over year		$	(4,796	)				$	(14,413	)
Percentage decrease, year over year		(78		)%				(84		)%

 

Cost of service revenues decreased from Q2 FY03 to Q2 FY04 and from the six months ended November 30, 2002 to the six months ended November 30, 2003 primarily due to reduced headcount which resulted from several reductions in force from the end of Q1 FY03 to the end of Q2 FY04. The smaller professional services organization contributed to the lower level of service activity on billable customer projects that we continued to experience in Q2 FY04. We expect cost of service revenues to remain relatively flat in the near term.

 

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Operating Expenses

 

Research and Development. Research and development expenses consist primarily of salary, employee-related expenses, and costs for external contractors, as well as costs related to outsourced development projects necessary to support product development. Research and development expenses were as follows (in thousands):

 

		Three months ended November 30,						Six months ended November 30,
		2003			2002			2003			2002
Research and development		$	3,647		$	8,258		$	7,314		$	16,380
Percentage of total revenues		307		%	138		%	268		%	109		%
Decrease, year over year		$	(4,611	)				$	(9,066	)
Percentage decrease, year over year		(56		)%				(55		)%

 

Research and development expenses decreased from Q2 FY03 to Q2 FY04 and from the six months ended November 30, 2002 to the six months ended November 30, 2003 primarily due to significant reductions in headcount in our development group, whose headcount decreased from approximately 197 employees at the end of Q2 FY03 to approximately 107 employees at the end of Q2 FY04. This reduction in the number of employees resulted in a $2.7 million decrease in employee-related expenses and a $1.5 million decrease in allocated costs from Q2 FY03 to Q2 FY04. Research and development expenses increased as a percentage of total revenues in Q2 FY04, compared to Q2 FY03, primarily due to significant decrease in total revenues in Q2 FY04. In the near term, we expect research and development expenses to be relatively flat. If revenues increase, we expect research and development expenses to decline as a percentage of total revenues in the long term.

 

Sales and Marketing. Sales and marketing expenses consist primarily of salaries and other employee-related expenses for sales and marketing personnel, sales commissions, travel, public relations, marketing materials, tradeshows, and facilities for regional offices. Sales and marketing expenses were as follows (in thousands):

 

		Three months ended November 30,						Six months ended November 30,
		2003			2002			2003			2002
Sales and marketing		$	1,004		$	6,132		$	2,433		$	11,829
Percentage of total revenues		85		%	102		%	89		%	79		%
Decrease, year over year		$	(5,128	)				$	(9,396	)
Percentage decrease, year over year		(84		)%				(79		)%

 

Sales and marketing expenses decreased from Q2 FY03 to Q2 FY04 and from the six months ended November 30, 2002 to the six months ended November 30, 2003 due to reductions in headcount in our sales and marketing groups, which decreased from 74 at the end of Q2 FY03 to 6 at the end of Q2 FY04.  These reductions in the number of employees resulted in a $2.9 million decrease in salaries, management bonuses, and employee related expenses and a $853,000 decrease in allocated costs from Q2 FY03 to Q2 FY04. Our decrease in revenues also resulted in a $114,000 reduction in commission payments to our sales force.  In addition, our marketing communications costs decreased by $816,000, professional fees decreased by $184,000, and facilities and related expenses decreased by $157,000 from

 

27

 

Q2 FY03 to Q2 FY04.  Sales and marketing expenses increased as a percentage of total revenues in Q2 FY04 compared to Q2 FY03 primarily due to a significant decrease in total revenues in Q2 FY04. We believe sales and marketing expenses will remain relatively flat in the near future. If revenues increase, we expect sales and marketing expenses to decline as a percentage of total revenues in the long term.

 

General and Administrative. General and administrative expenses consist primarily of salaries and other employee-related expenses for corporate development, finance, human resources, and legal employees; outside legal and other professional fees; and non-income-based taxes. General and administrative expenses were as follows (in thousands):

 

		Three months ended November 30,						Six months ended November 30,
		2003			2002			2003			2002
General and administrative		$	4,479		$	5,371		$	8,660		$	9,047
Percentage of total revenues		377		%	90		%	317		%	60		%
Decrease, year over year		$	(892	)				$	(387	)
Percentage decrease, year over year		(17		)%				(4		)%

 

General and administrative expenses decreased from Q2 FY03 to Q2 FY04 and from the six months ended November 30, 2002 to the six months ended November 30, 2003 primarily due to reductions in headcount, which decreased by approximately 52% as well as a decrease in professional fees of $1.1 million for financial restatement and securities litigation . General and administrative expenses increased as a percentage of total revenues in Q2 FY04 compared to Q2 FY03 due to the significant decrease in total revenues in FY04. We believe general and administrative expenses will be relatively flat in the forseeable future.

 

Amortization of Deferred Costs Related to Warrants.  We amortize deferred costs related to warrants over their estimated useful lives, which are generally five years. Amortization expense includes the portion of periodic expense for warrants that is not an offset to revenues. Amortization included in operating expenses was as follows (in thousands):

 

		Three months ended November 30,						Six months ended November 30,
		2003			2002			2003			2002
Amortization of deferred costs related to warrants		$	1,027		$	1,006		$	1,831		$	1,947
Percentage of total revenues		86		%	17		%	67		%	13		%
Increase (decrease), year over year		$	21					$	(116	)
Percentage increase (decrease), year over year		2		%				(6		)%

 

Amortization expense for deferred costs related to warrants decreased from Q2 FY03 to Q2 FY04 and from the six months ended November 30, 2002 to the six months ended November 30, 2003 as more amortization expense was offset to revenues in FY04. See Financial Statements, Note 8. Amortization expense for deferred costs related to warrants increased as a percentage of total revenues from the periods ended November 30, 2002 to the periods ended November 30, 2003 primarily due to significant decrease in total revenues in FY04. Amortization expense for deferred costs related to

 

28

 

warrants will likely decrease in the future as a result of the impairment charge of $5.0 million in Q2 FY04.

 

Restructuring Costs. Restructuring costs include severance pay and related employee benefit obligations. Restructuring costs for the periods reported were as follows (in thousands):

 

		Three months ended November 30,						Six months ended November 30,
		2003			2002			2003			2002
Salaries and employee-related expenses		$	881		$	22		$	1,395		$	2,058
Changes to estimated restructuring expense		—			—			(34		)	—
Restructuring costs		$	881		$	22		$	1,361		$	2,058
Percentage of total revenues		74		%	0		%	50		%	14		%
Increase (decrease) year over year		$	859					$	(697	)
Percentage increase (decrease), year over year		3905		%				(34		)%

 

As part of our ongoing efforts to control costs, we effected a reduction in force in July and August 2002. This action resulted in a headcount reduction of 106 employees. As a result of these actions, we accrued restructuring costs of approximately $2.2 million in Q1 FY03, which were comprised primarily of salary and employee-related expenses. During Q1 FY03, we revised our estimate underlying the restructuring accrual that occurred in February 2002, and accordingly reversed $210,000 of restructuring accruals. The reversal primarily pertained to exit costs related to facilities.

 

In January 2003, we announced a further reduction in force and terminated the employment of 228 employees. In Q1 FY04, under FAS 146, we recorded an additional $49,000 in expense relating to this January action and we do not expect to record further charges in relation to the January 2003 reduction in force.

 

In April 2003, we announced another reduction in force. This action resulted in a headcount reduction of 75 employees worldwide. Under FAS 146, in Q1 FY04 we recorded $262,000 of expenses related to this April action, which included a change in estimate of $34,000 related to employees we decided to retain. We do not expect to insure further expenses related to this reduction in force.

 

During Q1 FY04, we terminated the employment of five employees and recorded $169,000 of restructuring expenses related to severance payments.

 

During Q2 FY04, we terminated the employment of 15 employees, of whom 5 were still on transition assignments as of November 30, 2003 and recorded $881,000 of restructuring expenses related to severance payments.

 

Amortization and Impairment of Goodwill and Intangible Assets. Intangible assets represent the value assigned to those assets such as existing products and technology, customer lists and order backlog, and trademarks that are acquired as part of the purchase of a company by us. We amortize intangible assets on a straight-line basis over their useful lives, generally three years. Asset impairment charges reduce the carrying value of long-lived assets, including intangible assets, to a level equal to their expected value during their amortization periods. The following table details the amounts of amortization and impairment expense for goodwill and intangible assets (in thousands):

 

29

 

		Three months ended November 30,						Six months ended November 30,
		2003			2002			2003			2002
Amortization expense for intangible assets		$	—		$	478		$	22		$	988
Asset impairment		—			—			—			66
Amortization and impairment of intangible assets		$	—		$	478		$	22		$	1,054
Percentage of total revenues		0		%	8		%	0		%	7		%
Decrease, year over year		$	(478	)				$	(1,032	)
Percentage decrease, year over year		(100		)%				(98		)%

 

Amortization and impairment of goodwill and intangible assets decreased from Q2 FY03 to Q2 FY04 and from the six months ended November 30, 2002 to the six months ended November 30, 2003 as the intangible assets related to acquisitions become fully amortized in June 2003. We expect amortization and of intangible assets to be zero in future periods as all intangible assets attributable to continuing operations have been fully amortized.

 

Impairment of Warrants.  In fiscal 1999, we entered into agreements in which we agreed to issue warrants to certain network operators who satisfy certain milestones within specific time frames. The value of these warrants is estimated using the Black-Scholes pricing model as of the earlier of the grant date or the date that it is likely that the warrants will be earned. The value of the warrants was recorded primarily as a non-current asset and is being amortized over the estimated economic life of the arrangements with the network operators.

 

Management judgment is required in assessing the useful life of our warrant assets and the need for impairment. To make this assessment, management must evaluate historical revenue and deferred revenue remaining and must forecast future revenue streams over the remaining warrant amortization period from those network operators who have earned warrants. These forecasts are used to determine whether the warrant balances should be impaired. To the extent that our projections of revenue streams from those network operators should change, we may be required to further impair those warrants.

 

Impairment of warrant expense was as follows (in thousands):

 

		Three months ended November 30,						Six months ended November 30,
		2003			2002			2003			2002
Impairment of deferred costs related to warrants		$	4,969		$	—		$	4,969		$	—
Percentage of total revenues		418		%	—			418		%	—
Increase, year over year		$	4,969					$	4,969

 

In Q2 FY04, we recorded warrant-related asset impairment expense of $5.0 million as a result of the Company’s realignment of strategy to focus on the U.S. cable market. This impairment charge reduced the carrying value of certain warrant-related assets to a level equal to the expected future revenues from the holders of those warrants based outside the US. We did not record warrant-related asset impairment expense for Q2 FY03, or for the six months ended November 30, 2003.

 

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Amortization of Deferred Stock-based Compensation. Deferred stock-based compensation represents the difference between the estimated fair value of our common stock for accounting purposes and the exercise price of options that were granted prior to our initial public offering. We amortize deferred stock-based compensation for stock options granted to employees and others on a straight-line basis over the vesting periods of such options. See Financial Statements, Note 8. Amortization of deferred stock-based compensation expense was as follows (in thousands):

 

		Three months ended November 30,						Six months ended November 30,
		2003			2002			2003			2002
Amortization of deferred stock-based compensation		$	—		$	352		$	10		$	763
Percentage of total revenues		0		%	6		%	0		%	5		%
Decrease, year over year		$	(352	)				$	(753	)
Percentage decrease, year over year		(100		)%				(99		)%

 

Amortization of deferred stock-based compensation decreased from Q2 FY03 to Q2 FY04 and from the six months ended November 30, 2002 to the six months ended November 30, 2003 due to employee terminations and the completion of vesting of certain employee options.

 

Excess Facilities Charges and Related Asset Impairment. We have existing commitments to lease office space at our headquarters in San Carlos, California in excess of our needs for the foreseeable future and do not anticipate that we will be able to sublease a substantial portion of our excess office space in the near future. The details of excess facilities charges and related asset impairment were as follows (in thousands):

 

		Three months ended November 30,						Six months ended November 30,
		2003			2002			2003			2002
Excess facilities charges		$	593		$	(1,094	)	$	593		$	15,052
Related asset impairment		—			507			—			1,451
Total excess facilities charges and related asset impairment		$	593		$	(587	)	$	593		$	16,503
Percentage of total revenues		50		%	(10		)%	22		%	110		%
Increase (decrease), year over year		$	1,180					$	(15,910	)
Percentage increase (decrease), year over year		201		%