IONA Iona Technologies Adr (MM)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

 

 

 

 

FORM 10-K

 

 

Commission File No. 0-29154

 

IONA Technologies PLC
(Exact name of Registrant as specified in its charter)

 

 

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

 

Yes  o      No  þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

 

Yes  o      No  þ

 

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  þ      No  o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

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

 

 

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

 

Yes  o      No  þ

 

As of June 29, 2007 (the last business day of the registrant’s most recently completed second quarter), the aggregate market value of the voting and non-voting shares held by non-affiliates of the registrant was approximately $146,783,226 (computed based on the closing price of the American Depository Receipts evidencing the registrant’s ordinary shares on the Nasdaq Global Market on June 29, 2007).*

 

As of March 3, 2008, there were 36,447,419** ordinary shares, € 0.0025 par value, outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

 

Information required in response to Part III of Form 10-K (Items 10, 11, 12, 13 and 14) is hereby incorporated by reference to the specified portions of our Proxy Statement for the Annual General Meeting of Shareholders to be held on July 31, 2008. Such Proxy Statement shall not be deemed to be “filed” as part of this Annual Report on Form 10-K, except for those parts therein which have been specifically incorporated by reference herein.

 

* Excludes shares held by directors, officers and holders of greater than 5% of the registrant’s ordinary shares as reported on Forms 3 filed by such parties on January 9, 2008 and Form 4 filed on August 10, 2007. Shares held by the officers and directors of the registrant have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status does not reflect a determination that such persons are affiliates for any other purposes.

 

** Excludes an aggregate of 272,418 ordinary shares issuable as of March 3, 2008 pursuant to contractual obligations of the registrant.

 

 

This annual report on Form 10-K was not prepared for filing in Ireland in compliance with Irish law or the listing rules of the Irish Stock Exchange.

 

Unless otherwise provided herein or required by the context, references to “we,” “us,” “our,” “the Company” or “IONA” in this annual report shall mean IONA Technologies PLC and its world-wide subsidiaries, collectively.

 

We have a secondary listing on the Irish Stock Exchange. For this reason, we are not subject to the same ongoing regulatory requirements as those which would apply to an Irish company with a primary listing on the Irish Stock Exchange, including the requirement that certain transactions require the approval of shareholders. For further information, shareholders should consult their own financial advisor.

 

Our financial statements are presented in U.S. dollars and are prepared in accordance with United States generally accepted accounting principles. All references in this annual report to “dollars” and “$” are to U.S. dollars, and all references to “euro” or “€” are to European Union euro. Except as otherwise stated herein, all monetary amounts in this annual report have been presented in dollars.

 

Except for amounts contained in or derived from our Consolidated Financial Statements and unless otherwise indicated, all conversions of amounts herein from euro to dollars have been made at an exchange rate of 1.4603 dollars to one euro, based upon the noon buying rate in New York City for cable transfers in foreign currencies for customs purposes by the Federal Reserve Bank of New York as of December 31, 2007.

TABLE OF CONTENTS

 

FACTORS THAT MAY AFFECT FUTURE RESULTS

 

This Annual Report on Form 10-K contains forward-looking statements within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995 about our business and future financial performance. In some cases, you can identify forward-looking statements by terminology, such as “may,” “will,” “should,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “project,” “predict,” “intend,” “potential,” or “continue” or the negative of such terms or other comparable terminology, although not all forward-looking statements contain such terms. In addition, these forward-looking statements include, but are not limited to, statements regarding, among other things, our future revenue, operating income (loss), net income (loss) per ordinary share and per ADS, products and services, sources of liquidity, markets, anticipated tax rates, and plans and objectives of management. Such statements are neither promises nor guarantees but rather are subject to a number of risks and uncertainties which could cause actual results to differ materially from those described in the forward-looking statements. Factors that may cause such variation are discussed in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” Item 7A “Quantitative and Qualitative Disclosures about Market Risk,” Item 1A “Risk Factors” and our other reports filed with the Securities and Exchange Commission, or SEC. We disclaim any obligation to update any forward-looking statements contained herein after the date of this Annual Report.

PART I

 

During the fourth quarter of the fiscal year covered by this Annual Report on Form 10-K, IONA determined that as a result of increases in United States share ownership, under the requirements of the United States federal securities laws, it is no longer a “foreign private issuer” as defined under the Securities Exchange Act of 1934, or the Exchange Act, and therefore will file Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, rather than file its Annual Report on Form 20-F and Reports of a Foreign Private Issuer on Form 6-K.

 

We generate revenue from product licenses for our closed source software products, or our Orbix and Artix product lines, as well as from consulting, training and support services for both our closed source software products and our open source software products, or our FUSE product line, which is our branded distribution of certain Apache Software Foundation, or Apache, open source projects. Since our inception, we have licensed our products, directly and indirectly, to thousands of enterprise customers worldwide.

 

Industry Background

 

IT functions within large organizations have spent the last several decades investing in technology, seeking improved productivity and agility through business process automation. As they have invested in computing assets over time, many organizations have not fully addressed how to make their various computing investments work well together or considered the architectural and technological choices that would make it easier to retire or replace assets. As a result, these organizations have a mix of applications and infrastructure technologies based on different programming languages, running on different operating systems on different hardware platforms and managed and mediated by various middleware technologies, the complexities of which impedes their innovation and ability to be competitive.

 

Since the early 1990s, we have built our products around two open industry standards, initially CORBA and more recently Web services, and a unifying approach to designing and implementing large-scale systems referred to as service-oriented architecture, or SOA. SOA describes a technology-independent approach to building applications that focuses particularly on system integration and reuse of existing business computing functionality. SOAs encourage application developers to take a business-focused approach to building systems that ensures that IT organizations and line-of-business organizations have a common frame of reference.

 

Contemporaneous with the adoption of SOA as the next evolution of computing models, open source software technologies have been gaining widespread acceptance. In addition to cost savings, open source software has added value in the transparency afforded by access to source code, enabling more efficient adoption of the technology and greater innovation.

 

The successful use of open source software technologies to support strategic systems has paved the way for an even broader set of infrastructure software to emerge. We actively participate in a number of open source communities, all of which have active projects underway to develop the infrastructure software required to support SOA.

 

Strategy

 

Our objective is to capitalize on our core competencies and become the leading provider of innovative, distributed standards-based enterprise integration and SOA infrastructure solutions for our customers. To accomplish this goal, IONA employs a business strategy that benefits from offering both open source and closed source software products. Our business model is unique in the integration software market and provides IONA with the opportunity to sell its products and services to a wider market. For example, we believe that our ability to generate services revenue from the consulting, training and subscription-based support services for our FUSE product line is enhanced by the network marketing effect of the open source projects that underlie our FUSE products. We also believe that our ability to generate product revenue for our Artix product line is enhanced because FUSE is built to interoperate with Artix, thereby allowing IONA to sell ancillary Artix products into the FUSE installed base. As a result, we believe that IONA has the opportunity to grow its revenue by leveraging the ubiquity of open source projects to sell its products and services to a wider market.

 

IONA provides differentiated products to help our customers address their most complex software integration challenges. Our integration infrastructure products are designed to allow IT organizations to implement SOA-based solutions in a truly distributed manner, thereby empowering them to “flatten” their existing infrastructure stacks by transforming them into services that can interact directly with other services in a comprehensive SOA network. Our distributed approach to SOA infrastructure also provides customers with the option to deploy their SOA in an incremental manner, a deployment strategy more in line with the technical and economic realities of SOA adoption. We believe that eliminating the reliance on a centralized

server to support SOA adoption is significantly more cost-effective and frees our customers to be more agile in response to changing business requirements.

 

We believe that, as a result of our experience with and technological leadership in distributed computing models and our innovative approach to building a SOA system, we can deliver value to our customers by enabling them to achieve a greater ROI from existing IT assets, streamline and modernize their IT environments to promote business agility and to do so while reducing total fixed costs of IT ownership.

 

Products

 

We have three principal product lines:

 

Artix

 

Artix is a suite of advanced technology-neutral SOA infrastructure products that work together or independently allowing customers flexibility in SOA adoption. These products include:

 

 

Orbix

 

Orbix exemplifies IONA’s dedication to tackling high-end enterprise integration problems with standards-based solutions. In use in some of the world’s largest integration systems, Orbix is the enterprise CORBA product that organizations turn to when they need extreme performance, high availability, and security and systems management. Many of the world’s largest telecommunications companies and financial institutions have IONA products in their most critical IT systems. Orbix is embedded in telephone switches, online brokerage systems, multimedia news delivery, airline front desk systems, rail and road traffic control, large scale banking systems, credit card clearance, subway management and computer-aided design, or CAD, systems.

 

FUSE

 

FUSE is our open source family of distributed SOA infrastructure products for companies seeking an open source option for system integration and SOA implementation. The components that made up our Celtix open source family of products have been incorporated into our FUSE products. Companies are turning to open source software to reduce license costs while still taking advantage of innovation. FUSE ESB, FUSE Message Broker, FUSE Services Framework and FUSE Mediation Router are certified releases of certain Apache projects, and are integrated, tested and supported to combine the advantages of open source software

with the security and reliability of working with an enterprise-class commercial vendor. Our FUSE products include:

 

 

Services

 

We provide a variety of consulting, training and support services to our customers. Our professional services personnel provide our customers, partners and internal field organizations with product training and support and architectural consulting services and educational services for Orbix, Artix and FUSE. These personnel are senior technologists with substantial knowledge in leading integration and development technologies. Our customer support personnel are dedicated to the ongoing support and maintenance of our products.

 

Customers of our Orbix and Artix products are encouraged to purchase annualized customer support agreements, and customers of our FUSE products are encouraged to purchase annual or multi-year subscriptions for our support services. Under both the annual customer support agreements and the annual or multi-year subscription agreements, customers are entitled to specified levels of support and maintenance, which may include bug fixes, functionality enhancements and if and when available, annual or multi-year upgrades to the technology. We provide our support services via the telephone, on-site assistance, as well as through a self-help comprehensive online database, primarily from our Dublin, Ireland headquarters and our U.S. subsidiary’s offices in Waltham, Massachusetts. Our original equipment manufacturers, value-added resellers and independent software vendors depend on our customer support personnel to provide backup for the front-line support that these vendors provide to their customers.

 

Product Development and Management

 

Our technology and products are the result of (i) internal development by our engineers, (ii) strategic acquisitions and (iii) third party licenses, including from open source communities. We focus our development efforts on improving or adding functionality to our offerings based on the needs of users and changes in the marketplace.

 

Our product management organization collaborates with our marketing and sales organizations to increase sales of products and to develop customer and indirect sales relationships. Our engineers contribute to several open source Apache and other open source community projects which are part of the foundation of our FUSE product line. This involvement enables IONA to remain abreast of, and lead, certain technical advances and plans for development of new features and timing of releases to the projects.

 

Product development and management is concentrated primarily in our Dublin, Ireland headquarters, our St. John’s Newfoundland offices, and in our U.S. subsidiary’s offices in Waltham, Massachusetts. Our research and development expenditures were approximately $20.0 million, $15.9 million and $15.8 million, representing

25.8%, 20.5% and 23.7% of total revenue in 2007, 2006 and 2005, respectively. We expect to continue investing significant resources in research and development in the future.

 

 

Sales to The Boeing Company, or Boeing, represented approximately 18% and 17%, respectively, of our revenue for the years ended December 31, 2007 and 2006. In addition, due in part to industry consolidation in the telecommunications market, sales to AT&T Inc., or AT&T, represented approximately 11% of our revenue for the years ended December 31, 2007 and 2006. Additionally, Boeing accounted for approximately 41% of the Company’s gross accounts receivable balance as of December 31, 2006. No customer accounted for more than 10% of the Company’s gross accounts receivable balance as of December 31, 2007.

 

Sales and Marketing

 

We market and sell our products and services through our marketing and direct sales organizations and through indirect channels including software vendors, system integrators, original equipment manufacturers and value-added resellers.

 

Our sales organization is divided into three geographical regions: the Americas; Europe, the Middle East and Africa; and the Asia-Pacific Rim. Our direct sales force consists of account managers and field and inside sales personnel, complemented by technical pre-sales and high-level product specialists who are available for customer visits. Our sales force and executive team generally maintain relationships with our customers’ developers, and for large-scale projects, with their senior management in order to understand and serve their requirements. In addition, we dedicate members of our sales force to developing strategic relationships with our indirect channel partners.

 

Our indirect distribution channels include leading software vendors, such as Business Objects and Microsoft; global system integrators, such as NEC and CSC; leading original equipment manufacturers, such as Huawei and Nokia Siemens; and resellers and distributors. We believe that relationships with leading software and other technology vendors, as well as system integrators, provide opportunities to gain customers in markets where our products and services are in demand.

 

Our marketing teams execute global marketing programs designed to create demand for our products and services. We rely on a variety of marketing programs for demand creation, including trade shows, limited duration evaluation software, direct marketing communications, Web casts, public relations, product literature and collateral, trade advertising and a corporate Web site.

 

Competition

 

Our sector of the software industry is very dynamic and competitive. The growing industry enthusiasm for SOAs based on Web services and utilizing ESB products has increased competition levels as consumers begin to appreciate the potential value of Web services and Web services technology providers.

We compete with a variety of software vendors, including established providers of broad infrastructure platforms, new and narrowly focused software companies, and even shareware and freeware providers. In some cases, these vendors’ offerings are narrowly defined and compete with our products in a limited set of features or problems. Other vendors target roughly the same range of IT problems as we do. Still others have broad infrastructure offerings that compete with our products in specific scenarios. Our competitors include IBM, Oracle, Software AG and Tibco, as well as smaller enterprise infrastructure providers, enterprise application integration software vendors, Web services integration companies, ESB vendors, and open source software projects and products.

 

We believe that the principal competitive factors that affect the market for our products include:

 

 

Intellectual Property

 

We regard much of our intellectual property as proprietary to us and rely primarily on a combination of copyright, trademark, patent and trade secret laws, employee and third-party non-disclosure agreements and technical measures to establish and protect our proprietary rights. We enter into confidentiality agreements with our employees and consultants, and limit access to, and distribution of, our proprietary information to customers and potential customers.

 

Our technology and products are the result of internal development by our engineers, strategic acquisitions and third party technologies, including open source software.

 

We own numerous registered trademarks and trademark applications pending in the United States, the European Union, Australia and Asia, as well as other jurisdictions throughout the world, as well as approximately 20 patents and patent applications pending in the United States. We do not, however, own any one patent or patent application, or group of patents or patent applications, the loss of which would have a material impact on our business.

 

While we generally use negotiated, signed license agreements or shrink-wrap type licenses to restrict copying and use of our software products, we do not generally embed mechanisms in our software to prevent unauthorized use or copying of our software. We do not rely significantly on patents or other registered intellectual property rights to protect our software. Because shrink-wrap type licenses are not signed by licensees, they may be unenforceable under the laws of certain jurisdictions. In addition, the laws of various countries in which our products may be sold may not protect proprietary rights to the same extent as the laws of the United States and Ireland.

Employees

 

As of January 31, 2008, we had 335 employees worldwide, including 130 in product development and management, 62 in services, 14 in marketing, 75 in sales and 54 in finance and administration. Our employees are not represented by any collective bargaining organizations, and we have not experienced any work stoppages. We believe our relations with our employees are good.

 

Government Regulations

 

We have significant operations and generate a substantial portion of our taxable income in Ireland. In general, the tax rate in Ireland on trading income, which is 12.5%, is significantly lower than U.S. tax rates. Moreover, our Irish taxable income derived from software substantially developed in Ireland is taxed at a 10% effective tax rate through December 31, 2010. Therefore, our effective tax rate is affected by the percentage of revenue that qualifies for these favorable tax treatments. We anticipate that we will continue to benefit from these tax treatments, although the extent of the benefit could vary from period to period, and our tax treatment may change in the future. Any variation in the amount of our benefit from these tax treatments could have a material adverse effect on our business, financial condition and results of operations.

 

For more information regarding the impact of tax regimes on our business, please see Item 1A “Risk Factors—If our effective tax rate increases, our business and financial results would be adversely impacted.”

 

Financial Information about Segments and Principal Markets

 

We operate in one business segment: infrastructure software. For a description of the principal markets in which we compete, including a breakdown of total revenue by category of activity and geographic market for each of the last three fiscal years, see Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

Seasonality and Raw Materials

 

Historically, our product revenue in the first quarter of each year has declined from the fourth quarter of the prior year primarily due to the impact of a decrease in capital expenditures by our customers after calendar year-end. Our products and services do not materially depend on the availability of raw materials.

 

Available Information

 

This Annual Report on Form 10-K and our prior Annual Reports on Form 20-F and Reports of Foreign Private Issuer on Form 6-K filed pursuant to Sections 13(a) and 15(d) of the Exchange Act are made available free of charge on or through our website at www.iona.com as soon as reasonably practicable after such reports are filed with, or furnished to, the SEC. Copies of our future Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments thereto will also be made available free of charge on or through our website at www.iona.com as soon as reasonably practicable after such reports are filed with, or furnished to, the SEC. Copies will be provided to any shareholder upon request. Please send a written request to either IONA Investor Relations, IONA Technologies PLC, The IONA Building, Shelbourne Road, Ballsbridge, Dublin 4, Ireland or IONA Investor Relations, IONA Technologies, Inc., 200 West Street, Waltham, Massachusetts 02451. None of the information posted on our website is incorporated by reference into this Annual Report.

 

customers on IT, which could materially adversely affect demand for our products and services and result in decreased revenue, longer sales cycles or lower growth rates because our sales depend in part on our customers’ level of funding for new or additional IT systems or services. A decrease in overall spending would substantially reduce the number of new software licenses we sell or may cause price erosion for our products, which would reduce the average sales price for these licenses.

 

In addition, actual or threatened terrorist attacks, military actions, and events or effects occurring in response to those developments may negatively affect the climate for spending and may reduce the amount or delay the timing of expenditures by corporations for IT solutions. Accordingly, we cannot be assured that we will be able to maintain or increase our revenue.

 

Our lengthy and variable sales cycle makes it difficult to predict our operating results.

 

Many of our customers use our products for their sophisticated integration and SOA strategies which require them to make complex decisions, including:

 

 

As a result, our prospective customers often dedicate a significant amount of time to evaluating both IONA and our products before entering into a business relationship with us. Our customers and prospective customers give consideration to our financial condition and strategic direction when evaluating whether to license products or purchase services from us. Consequently, the period between initial customer contact and purchase by a customer may extend to twelve months or more. During the evaluation process, prospective customers may decide not to purchase, may delay a purchase or may scale down proposed orders of our products. This lengthy and variable sales cycle makes it difficult to forecast the timing and recognition of our revenue and therefore predict our operating results.

 

We may experience fluctuations in quarterly revenue that could adversely impact our operating results.

 

Our revenue and operating results are difficult to predict and may fluctuate significantly from quarter to quarter. Historically, our product revenue in the first quarter of each year has declined from the fourth quarter of the prior year primarily due to the impact of a decrease in capital expenditures by our customers after calendar year-end. Revenue in any quarter depends substantially upon our ability to sign contracts and our ability to recognize revenue in that quarter in accordance with revenue recognition policies. Therefore, you should not rely on period to period comparisons of revenue or results of operations as an indication of future performance. If our quarterly revenue or operating results fall below expectations of investors or securities analysts, the price of our ordinary shares and American Depository Shares, or ADSs, could fall substantially.

 

Our quarterly revenue may fluctuate as a result of a variety of factors, including the following:

 

 

 

Fluctuations in our quarterly revenue may adversely affect our operating results. In each fiscal quarter our expense levels, operating costs and hiring plans are based on projections of future revenue and are relatively fixed in the short term. If our actual revenue falls below expectations, we could experience a reduction in operating results.

 

We have experienced significant variations in operating results and anticipate that we will continue to do so in the future.

 

Our levels of operating results have varied significantly on a quarterly and annual basis. These variations are attributable to fluctuations in revenue and costs, including costs associated with the development and introduction of new products and services, charges associated with acquisitions, and certain expenses attributable to the settlement of litigation, restructuring and impairment of goodwill, other assets and property and equipment. There can be no certainty that we will not experience similar variations in operating results in future periods for these or other factors, and any such variation could have a significant impact on the market value of our ordinary shares and ADSs.

 

Our future revenue depends upon the evolution and adoption of Web services and related integration and infrastructure solutions in support of new computing models including SOA.

 

We believe that large organizations will continue to adopt Web services and related integration and infrastructure solutions, including ESB products to support their SOA adoption strategies. Therefore, we have invested significant resources in developing and introducing products to meet the development, deployment and integration requirements of enterprises using Web services for integration and SOA. If the enterprise adoption of Web services, and Web services-based ESBs, for these purposes does not evolve as we anticipate or fails to grow as quickly as we expect, we may be unable to implement our strategy or achieve the growth rate that we target.

 

The acceptance of our Artix family of distributed SOA infrastructure products and services and our FUSE family of open source SOA infrastructure products and services also depends upon the development and proliferation of Web services standards for application integration and SOA. If these standards do not continue to develop or are not widely accepted, the demand for our products and services may not materialize. Consequently, our business prospects and financial condition would suffer.

 

Our open source offerings may never become profitable or achieve widespread acceptance.

 

Open source-based business models are new and experimental. We may find that the business offerings that we are developing around open source technology are not as profitable as we anticipate, that the technology adoption and marketing benefits that we expect are not realized or that our open source offerings undermine sales of our other products.

 

Because of the characteristics of open source technology and of development and licensing practices in the open source software community, there are few technology barriers to entry in the open source market. New competitors with greater resources than us may easily enter the open source software market and compete with us. Competitors can modify the existing software or develop new software with lower overhead and lead-time than typically required in the development of traditional proprietary software. It is possible for a competitor to develop its own open source solutions, potentially reducing the demand for our solutions.

As part of our open source initiative we have become involved in the Eclipse Foundation’s SOA Tooling Platform Project and are active in several Apache Software Foundation open source projects. Theses activities are part of the foundation of IONA’s FUSE family of open source distributed SOA infrastructure offerings. The acceptance of FUSE and the success of our open source initiative depend upon the adoption of this technology by others, which we can influence but cannot control. We may be unable to accurately predict the future course of open source technology development, which could reduce the market appeal of our complementary commercial products and damage our reputation.

 

Different groups of open source software programmers compete with one another to develop new technology. Typically, the technology developed by one group will become more widely used than that developed by others. If we acquire or adopt new technology and incorporate it into our products but competing technology becomes more widely used or accepted, the market appeal of our products may be reduced and that could harm our reputation, diminish the IONA brand and result in decreased revenue.

 

In addition, if open source software programmers, most of whom we do not employ, do not continue to develop and enhance the open source technologies that underlie our FUSE products, we may be unable to enhance our products or meet customer requirements for innovation, quality and price.

 

If we fail to keep pace with rapidly evolving technology and changing customer needs, our business will suffer.

 

The market for infrastructure software is characterized by rapidly changing technology, evolving industry standards and changing customer needs. Therefore, our success will depend upon our ability to enhance our existing products and to introduce and market new products to meet changing customer requirements on a timely and cost-effective basis. If we experience delays in the introduction of new or enhanced products, or if we are unable to anticipate or respond adequately to these changes, our products could be rendered obsolete and our business could be materially harmed.

 

The loss of one or more major customers could materially and adversely affect our results of operations and financial condition.

 

Sales to Boeing represented approximately 18% and 17%, respectively, of our revenue for the years ended December 31, 2007 and 2006. In addition, due in part to industry consolidation in the telecommunications market, sales to AT&T represented approximately 11% of our revenue for the years ended December 31, 2007 and 2006. The loss of either or both of these customers could have a material adverse effect on our results of operations or financial condition. If we are unable to maintain our customer relationships or lose their business to a competitor and fail to replace them with new customers, or if any major customer significantly decreases its orders for our products and services, our results of operations and financial condition could be materially and adversely affected. We expect that our largest customers will continue to account for a significant portion of our revenue in fiscal 2008 and for the foreseeable future.

 

We derive a significant amount of revenue from customers in a limited number of industries and our business and results of operations could be adversely affected by significant changes in those industries.

 

We currently derive a significant portion of our revenue from customers in a limited number of industries, including financial services, telecommunications, manufacturing/distribution and government. A general reduction in IT spending in the financial services, telecommunications or manufacturing/distribution industries or by governments and government agencies, or industry-wide changes in our customers’ spending priorities, would adversely impact our business and operating results. In addition, significant changes, including industry consolidation or changes in government spending patterns, could harm our business and operating results as well as increase our dependence on any particular customer.

We depend on large transactions to derive a significant portion of our revenue, and the delay or loss of any large customer order could adversely affect our quarterly or annual operating results.

 

We derive a significant portion of our revenue from large transactions which often involve negotiated terms and conditions. These terms and conditions can extend the sales cycle and, in certain situations, result in deferred recognition of revenue from the sale. Prospective sales are subject to delays or cancellation over which we have little or no control. Moreover, prospective customers give consideration to our financial condition and strategic direction when deciding whether to engage in transactions with us. If any large customer order anticipated for a particular quarter is not realized or is delayed, we may experience an unplanned shortfall in revenue, which could significantly and adversely affect our operating results.

 

We may be unable to attract and retain highly qualified personnel.

 

We depend to a significant extent on the continued service of a limited number of senior executives and personnel with specific technological expertise that is in short supply. We also depend on our ability to develop additional management personnel and hire new qualified employees. We face intense competition for highly qualified personnel. We have historically used equity incentive programs, such as employee stock purchase plans, as part of our overall employee compensation arrangements. The volatility of our stock price may negatively impact the value of such equity incentives, thereby diminishing the value of such incentive programs and decreasing the effectiveness of such programs as retention and recruiting tools. In addition, an employee’s or prospective employee’s perception of our financial condition or the likelihood of our entering into a strategic combination may negatively impact our ability to attract or retain highly qualified personnel. As a result, we may have difficulty attracting highly qualified personnel and may have to change our compensation packages in order to remain competitive. There can be no assurance that we will be successful in retaining existing personnel or recruiting new personnel. If we fail to attract, retain or assimilate key personnel, our business, financial condition and results of operations would materially suffer.

 

Potential defects or errors in our software products could cause our revenue to decrease, cause us to lose customers, damage our reputation, expose us to litigation and harm our revenues or earnings.

 

The products that we offer include both enhancements to existing products and newly launched products with no history of customer adoption. Despite careful engineering, our products may contain undetected defects or errors that may be detected at any point in the product’s life cycle. If we discover a defect or an error in our product, we may experience delays in generating revenue while correcting the problem. In addition, our products are often used in combination with products of other vendors which can make it difficult to identify the source of any problem. When such defects or errors occur, our business has the potential to experience, among other things:

 

 

Although our customer contracts include provisions to limit our exposure to product liability claims, changes in laws or unfavorable judicial decisions may limit or prevent us from being able to avoid or limit liability for disputes relating to product performance or the provision of services.

 

If we do not manage our expenses and geographically dispersed operations successfully, we may be unable to respond to changing market conditions.

 

The demand for IT integration solutions has become increasingly difficult to predict. To manage this unpredictability and to react to global economic conditions generally, we have taken measures to bring our workforce, staffing and structure in line with perceived current demand for our products. If we misjudge our

personnel needs or cannot successfully manage our expenses, then our business, financial condition and results of operations would be materially adversely affected. Our future operating results will depend substantially upon the ability of our management to anticipate changing business conditions and manage personnel and other costs while increasing revenue.

 

We face additional risks in managing geographically dispersed operations. Some of our key executives and managers are based in our Dublin, Ireland headquarters while others are based in our wholly-owned U.S. subsidiary’s Waltham, Massachusetts office. Accordingly, our ability to compete successfully will depend in part on the ability of a limited number of key executives and managers located in geographically dispersed offices to integrate management, to address the needs of our worldwide customer base and to respond to changes in our market. In addition, our ability to manage our operations and financial performance would be materially adversely affected if terrorist attacks or military or other political events prohibit or restrict the travel of our personnel.

 

We may be required to delay the recognition of revenue until future periods, which could adversely impact our operating results.

 

We may have to defer revenue recognition due to several factors, including whether:

 

 

Because of the factors listed above and other specific requirements under United States generally accepted accounting principles, or U.S. GAAP, for software revenue recognition, we must have very precise terms in our license agreements to recognize revenue when we initially deliver our products or perform services. Negotiation of mutually acceptable terms and conditions can extend the sales cycle, and sometimes we do not obtain terms and conditions that permit revenue recognition at the time of delivery or even as work on a project is completed.

 

We currently derive most of our revenue from a limited number of products.

 

To date, we have derived most of our revenue from the licensing of our Orbix and Artix families of products and fees from related services. We expect our Orbix family of products to continue to account for a significant part of our revenue for the foreseeable future as our Artix and FUSE products gain market acceptance. As a result, a reduction in demand for, or sales of, these products would have a material adverse effect on our business, financial condition and results of operations. In addition, our business will depend, in significant part, on the successful development, introduction and customer acceptance of new products and enhanced versions of our existing products. The failure to successfully develop, introduce or market new products or enhancements or additions to our existing products would materially adversely affect our business, financial condition and results of operations.

 

If we do not successfully expand and manage our direct sales force and other distribution channels, we may not be able to increase our revenue.

 

Our ability to achieve revenue growth will depend in large part on our ability to expand and manage our direct sales force, independent software vendors, value-added resellers and system integrators. We plan to continue to invest in, and rely on sales through, these direct and indirect distribution channels. Our ability to expand our direct and indirect distribution channels may be impacted by the perception of our financial condition or the perceived likelihood of a strategic combination. We may not be able to expand or manage successfully our direct sales force or develop and manage other distribution channels. If we have difficulty hiring, retaining and motivating our direct sales force, if our relationships with these software vendors, value-added resellers or system integrators deteriorate or terminate, or if we are unable to form new relationships,

we may lose important sales and marketing opportunities. Further, any such expansion may not result in an increase in revenue or operating income. Use of indirect distribution channels involves a number of risks, including:

 

 

In addition, if our software vendors and system integrators are unable to recruit and adequately train a sufficient number of personnel to support the implementation of our software products, or they otherwise do not adequately perform services, we may lose customers. If we fail to expand and manage our sales and distribution channels successfully, our business, financial condition and results of operations would materially suffer and our competitive position would be weakened.

 

We also may enter into joint arrangements with strategic partners to develop new products or enhancements to our existing products, or to license our offerings as part of integrated solutions. Our business may be adversely affected if these strategic partners change their business priorities or experience difficulties in their operations, which in either case causes them to terminate or reduce their support for these joint arrangements.

 

We operate in highly competitive markets and we may be unable to compete successfully.

 

The market for infrastructure software solutions is highly competitive. We expect this competition to continue to increase. Our products compete with offerings from a number of established infrastructure vendors, as well as offerings from new software companies and even shareware and freeware providers. Some of these companies offer products that compete with single components of our product set, while other companies market a set of products designed to solve broad integration problems.

 

We compete principally against vendors of:

 

 

We believe that our ability to compete depends in part on a number of factors outside of our control, including:

 

 

In addition, a number of our larger competitors have substantially greater technical, financial, sales, marketing, customer support, professional services and other resources, as well as greater name recognition, than we do. As a result, our competitors may be able to adapt more quickly to new or emerging technologies and changes in customer requirements, devote greater resources to the promotion and sale of their products, or establish more successful strategic relationships with industry leaders and other third parties than we can.

Further, certain of our larger competitors may be able to offer competitive products or technologies as part of their broader product or service offerings or may make strategic acquisitions or establish cooperative relationships among themselves or with third parties, thereby increasing the ability of their products to address the needs of our current and prospective customers. Accordingly, it is possible that new competitors or alliances among our current and potential competitors may emerge and rapidly gain significant market share. This type of competition could materially adversely affect our ability to license products and provide services on terms favorable to us.

 

Among our smaller competitors, the competition for retaining market share is intense. Due to competitive pressures, we could be forced to reduce the price of our products and related services or change our pricing models. Any broad-based change to our prices and pricing policies could cause new software license and service revenues to decline or be delayed as our sales force implements and our customers adjust to the new pricing policies. Lower revenue or reduced prices would negatively impact our operating results and financial condition.

 

In addition, many of our competitors have significant installed bases that include our current and potential customers. Once a customer has installed the products of one of our competitors, it may be difficult to convince the customer to adopt or purchase our products. If we are unable to further penetrate our existing customer base or sell to new clients, our business prospects and financial condition would suffer.

 

We face various risks associated with our international operations that could cause our operating results to suffer.

 

We are incorporated in Ireland and substantial portions of our product development, marketing, sales and administrative functions are located in Ireland. Our revenue is derived, and our operations are conducted, worldwide. We expect that operations outside of the U.S. will continue to account for a significant portion of our business and expect to continue to expand our operations outside of the U.S. Because of the international character of our business, we are subject to risks such as:

 

 

Our failure to anticipate, plan for and manage these risks could result in a decrease in revenue derived from customers outside the U.S., and our business, financial condition and results of operations could materially suffer.

 

Acquisitions may be necessary for the continued growth of our business. We may be unable to identify or complete suitable acquisitions, and any acquisitions we do complete may create business difficulties or be dilutive to our current shareholders.

 

As part of our business strategy, we may need or choose to pursue strategic acquisitions with companies that offer complementary products, services or technologies. We may be unable to identify suitable acquisition

candidates. If we do identify suitable acquisition candidates, we may be unable to make acquisitions on commercially acceptable terms or at all. In addition, in the event that we do complete acquisitions of businesses, technologies or products, we will face many potential risks, including:

 

 

These factors could have a material adverse effect on our business, results of operations or financial condition. To the extent that we issue equity or other rights to purchase our securities in connection with any future acquisition, existing shareholders may experience dilution and our earnings per share may decrease.

 

If our effective tax rate increases, our business and financial results would be adversely impacted.

 

We have significant operations and generate a substantial portion of our taxable income in Ireland. In general, the tax rate in Ireland on trading income, which is 12.5%, is significantly lower than U.S. tax rates. Moreover, our Irish taxable income derived from software substantially developed in Ireland is taxed at a 10% effective tax rate through December 31, 2010. If our operations no longer qualify for these favorable tax treatments or if the tax laws were rescinded or changed, our effective tax rate would increase and our net income would decrease, thereby materially adversely affecting our results of operations. In addition, we are required to pay taxes in other jurisdictions in which we operate. From time to time, we receive notices that a tax authority to which we are subject has determined that we owe a greater amount of tax than we have accrued, paid or reported, and as a result, we engage in discussions, and sometimes get involved in disputes, with these tax authorities. If these tax authorities were to be successful in their challenge of the manner in which we recognize profits or, more generally, the jurisdiction in which our income is subject to taxation, our effective tax rate could increase and our cash flow and results of operations could be materially adversely affected.

 

Our U.S. holders of our ordinary shares or ADSs could suffer adverse tax consequences if we are characterized as a passive foreign investment company.

 

If, for any taxable year, our passive income or our assets that produce passive income exceed levels provided by law, we may be characterized as a passive foreign investment company, or PFIC, for U.S. federal income tax purposes. This characterization could result in adverse U.S. tax consequences to the holders of our ordinary shares or ADSs. U.S. persons should consult with their own U.S. tax advisors with respect to the U.S. tax consequences of investing in our ordinary shares or ADSs.

The rights of shareholders in Irish corporations may be more limited than the rights of shareholders in U.S. corporations.

 

The rights of holders of our ordinary shares and, therefore, some of the rights of the holders of our ADSs, are governed by Irish law and the laws of the European Union. As a result, the rights of our shareholders differ from, and may be more limited than, the rights of shareholders in typical U.S. corporations. In particular, Irish law significantly limits the circumstances under which shareholders of Irish corporations may bring derivative actions.

 

We have a limited ability to protect our intellectual property rights, and others could obtain and use our technology without our authorization.

 

We regard certain of our technologies as proprietary, and we rely primarily on a combination of patent, copyright, trademark and trade secret laws, employee and third-party non-disclosure agreements, and confidentiality procedures to establish and protect our proprietary rights. However, all of these measures afford only limited protection and may be challenged or circumvented by third parties. In addition, the laws of various countries in which our products may be licensed may not protect our proprietary rights to the same extent as the laws of the U.S. and Ireland. While we generally enter into confidentiality agreements and limit access to, and distribution of our proprietary information, it is possible for a third party to copy or otherwise obtain and use our technology without authorization, or develop similar technology independently. It is possible that our means of protecting our proprietary rights will not be adequate and legal action to protect our proprietary rights could be too costly to pursue or ultimately ineffective if pursued. Any unauthorized reproduction of our software or inadequate protection of our proprietary rights could have a material adverse effect on our business, financial condition or results of operations.

 

If we are unable to obtain rights, or lose existing rights, to use and incorporate third-party technology into our products, we may have to stop selling and shipping products and incur significant development or license expenses to develop or otherwise obtain replacement technology.

 

We use and incorporate third-party technology in our products. If we do not have adequate rights to use this technology or our rights terminate, we could be required to:

 

 

We may not be able to develop technology or identify other technology with functionality similar to this third-party technology. In addition, we may not be able to obtain a license to this third-party technology on acceptable terms or at all, and we may be liable for damages in the event of any unauthorized use. If any of these events occur, our business, financial condition and results of operations could be materially adversely affected.

 

We may be exposed to significant liability if we infringe upon the intellectual property or proprietary rights of others.

 

Third parties have notified us, and others may notify us, from time to time, that they believe we are infringing certain of their patents and other intellectual property rights. The risk of infringement may increase because of our use of and involvement with open source technology. Certain open source software is licensed pursuant to license agreements that require a user who distributes the open source software as a component of the user’s software to disclose publicly part or all of the source code to the user’s software. This effectively renders what was previously proprietary software open source software. We do incorporate open source components into our proprietary products in order to reduce development costs and speed up the development process. While we monitor the use of all open source software and try to ensure that no open source software is used in such a way as to require us to disclose the source code to the related product, such use could

inadvertently occur. Additionally, if a third party incorporates this type of open source software into its software but has failed to disclose the presence of such open source software and we embed that third party software into our products, we could, under certain circumstances, be required to disclose the source code to our product. Disclosure of our source code could have a material adverse effect on our business.

 

Responding to a claim of infringement, regardless of its merit, could be time consuming, result in costly litigation, divert management’s attention and resources, and cause us to incur significant expenses. In the event that any such assertion is resolved adversely to us, we could be required to:

 

 

We may be unable to obtain licenses on acceptable terms or at all. If we fail to obtain licenses, if adverse or protracted litigation arises out of any such assertion, if we are required to disclose our source code, or if litigation damages are assessed, our business, financial condition or results of operations could be materially adversely affected.

 

Regulatory compliance, including the cost of complying with legislative actions and potential new accounting pronouncements, may result in increased costs that would affect our future financial position and results of operations. We have already incurred, and will continue to incur, significant increased costs associated with our compliance with the internal controls requirements of the Sarbanes-Oxley Act of 2002.

 

Regulatory compliance, including the cost of complying with legislative actions and changes in accounting rules may materially increase our operating expenses and adversely affect our operating results.

 

The Sarbanes-Oxley Act requires, among other things, that we maintain effective internal control over financial reporting and disclosure controls and procedures. In 2007, we continued to perform system and process evaluations and testing of our internal control over financial reporting to allow management and our independent registered public accounting firm, to report on the effectiveness of our internal control over financial reporting. We have hired and may need to hire additional personnel and utilize additional outside legal, accounting and advisory services in order to maintain our compliance with this and other requirements, all of which has and will cause our general and administrative costs to increase. Moreover, if we or our independent registered public accounting firm identifies deficiencies in our internal control over financial reporting that are deemed to be material weaknesses, the market price of our stock could decline and we could be subject to sanctions or investigations by the NASDAQ Global Market (formerly known as the NASDAQ National Market), or NASDAQ, the Securities and Exchange Commission or other regulatory authorities, which would require additional financial and management resources.

 

Our transition from “foreign private issuer” status to domestic issuer status under the Exchange Act requires that we comply with certain provisions of the Exchange Act that we were not obligated to comply with as a foreign private issuer, including, among other things, the need to file quarterly reports on Form 10-Q and current reports on Form 8-K. We may need to hire additional personnel and utilize additional outside legal, accounting and advisory services in order to comply with these new requirements, which could materially increase our expenses and adversely affect our operating results.

In addition, increased claims rates or changes in our risk profile could result in higher costs for our insurance, including our directors’ and officers’ insurance policies, which could materially increase our expenses and adversely affect our operating results.

 

We have recently undertaken cost reduction actions. Any failure by us to execute planned cost reductions successfully may have an adverse effect on our sales, profitability and results of operations.

 

In January 2008, we initiated plans to streamline operations and reduce expenses, which included cuts in discretionary spending, reductions in capital expenditures, reductions in the work force and consolidation of certain office locations, as well as other steps to reduce expenses. The impact of these cost-reduction actions on our sales and profitability may be influenced by factors including, but not limited to: (1) our ability to successfully complete these ongoing efforts; (2) our ability to generate the level of cost savings we expect due to implementation challenges in carrying out planned cost reduction activities or delays in implementation of anticipated workforce reductions in highly-regulated locations outside of the United States, particularly in Asia; and (3) decreases in employee morale and the failure to meet operational targets due to an inability to retain key employees or recruit new employees.

 

If we experience any of these difficulties in carrying out our restructuring plan, our expenses could remain at a level higher than anticipated or increase more quickly than projected. There can be no assurance that our cost reductions will achieve the anticipated results or achieve the anticipated results in the expected timeframe. If we find that our restructuring plan does not achieve our objectives, it may be necessary to implement a further reduction of our expenses, to perform additional reductions in our headcount, or to undertake additional restructurings of our business.

 

 

 

PART II

 

Holders of Record

 

As of March 3, 2008, there were 613 holders of record of our ordinary shares.

 

Dividends

 

We have never paid dividends and do not expect to pay dividends in the foreseeable future.

 

 

 

Stock Performance Graph

 

The following graph compares the five-year cumulative total return to shareholders on our ordinary shares for the period ended December 31, 2007, with the cumulative return of the NASDAQ Composite Index and the NASDAQ Computer Index. The graph assumes that $100.00 was invested on December 31, 2002 in each of our ordinary shares, the NASDAQ Composite Index and the NASDAQ Computer Index, and that all dividends were reinvested. No cash dividends have been declared or paid on our ordinary shares. The comparisons in the table are required by the SEC and are not intended to forecast or be indicative of possible future performance of our ordinary shares.

 

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among IONA Technologies, The NASDAQ Composite Index
And The NASDAQ Computer Index

 

 

Fiscal year ending December 31.

 

 

Source : Research Data Group, Inc.

 

Note:  This graph shall not be deemed “filed” for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, or otherwise subject to the liabilities of that section nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933, as amended, or the Securities and Exchange Act of 1934, as amended, regardless of any general incorporation language in such filing .

 

The following selected consolidated financial data as of December 31, 2007 and 2006, and for each of the years ended December 31, 2007, 2006 and 2005, have been derived from, and should be read in conjunction with, our audited Consolidated Financial Statements and Notes thereto set forth in Item 8 of this Annual Report. These financial statements have been prepared in accordance with U.S. GAAP. The selected financial data as of December 31, 2005, 2004 and 2003, and for each of the years ended December 31, 2004 and 2003 have been derived from our audited Consolidated Financial Statements not appearing in this Annual Report, but appearing in previously filed Annual Reports, which have also been prepared in accordance with U.S. GAAP.

 

 

 

Certain amounts reported in the prior year have been reclassified to conform with the presentation in 2007.

 

Century 24 Solutions Limited, or C24, a software development firm specializing in data management and transformation technology, for approximately $7.3 million. Approximately $1.4 million of the purchase price is being held in escrow in accordance with the terms and conditions of an escrow agreement. The acquisitions were accounted for as purchases, and accordingly, the assets purchased and liabilities assumed are included in the consolidated balance sheet as of December 31, 2007, and the operating results of LogicBlaze and C24 are included in the consolidated statement of operations since the date of each respective acquisition.

 

In 2001, we acquired Netfish Technologies, Inc., or Netfish, for consideration consisting of 5,036,318 newly-issued ordinary shares (815,102 of which were issuable upon the exercise of replacement options) and $30.9 million in closing costs. Of the newly-issued ordinary shares, 504,598 were held back to fund indemnification claims made by us against Netfish. In May 2002, we released 236,403 of the 504,598 ordinary shares being held in escrow. The remaining 268,195 ordinary shares remain in escrow to cover indemnification claims made by us. If the pending indemnification claims are resolved in a manner unfavorable to us, up to 268,195 ordinary shares held back by us could be distributed to the former holders of Netfish shares.

 

Critical Accounting Policies and Estimates

 

Our Consolidated Financial Statements are prepared in accordance with U.S. GAAP. These accounting principles require us to make certain estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions upon which we rely are reasonable based upon information available to us at the time that these estimates, judgments and assumptions are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of our Consolidated Financial Statements, as well as the reported amounts of revenue and expenses during the periods presented. To the extent there are material differences between these estimates, judgments or assumptions and actual results, our financial statements will be affected. The significant accounting policies that we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:

 

 

In many cases, the accounting treatment of a particular transaction is specifically dictated by U.S. GAAP and does not require management’s judgment in its application. There are also areas in which management’s judgment in selecting among available alternatives would not produce a materially different result. Our senior management has reviewed these critical accounting policies and related disclosures with the Audit Committee of our Board of Directors. See Notes to our Consolidated Financial Statements, which contain additional information regarding our accounting policies and other disclosures required by U.S. GAAP.

 

Revenue Recognition

 

We recognize the majority of our revenue pursuant to software license and support agreements. While the basis for software license revenue recognition is governed by the provisions of Statement of Position (SOP) 97-2, Software Revenue Recognition , as amended by SOP 98-4 and SOP 98-9 and related interpretations, we exercise judgment and use estimates in connection with the determination of the amount of software license and services revenue to be recognized in each accounting period.

 

We do not enter into arrangements to deliver software requiring significant production, modification or customization to our software products.

For our software license arrangements we recognize revenue when:

 

 

For arrangements with multiple elements, we allocate revenue to each element of a transaction based upon its fair value as determined by vendor specific objective evidence of fair value, or VSOE. VSOE of fair value for each element of an arrangement is based upon the normal pricing and discounting practices for each element when sold separately, including the renewal rate for support services. We maintain management approved price lists for our product licenses, customer support and professional services. We infrequently offer discounts on our customer support or professional services, and if offered, such discounts are usually insignificant. If we cannot objectively determine the fair value of any undelivered element included in the multiple element arrangement, we defer revenue until all elements are delivered, services have been performed, or until fair value can be objectively determined. When the fair value of a delivered element cannot be established, we use the residual method to record revenue, provided the fair value of all undelivered elements is determinable. Under the residual method, the fair value of the undelivered elements is deferred and recognized as they are delivered and the remaining portion of the arrangement fee is allocated to the delivered elements and is recognized as revenue.

 

We believe that our normal pricing and discounting practices provide a basis for establishing VSOE of fair value for the undelivered elements based on the following facts:

 

 

We perform an annual analysis of all contracts to ensure that the actual allocation of fair value to undelivered elements is not significantly different from the established VSOE rates for the individual elements. The analysis is segmented by level of support and type of customer (i.e., end-user licensee or licensee with rights of distribution).

 

We assess whether fees are fixed or determinable at the time of sale and recognize revenue if all other revenue recognition requirements are met. Our standard payment terms are typically net 30 days. Payment terms, however, may vary based on the country in which the agreement is executed. Payments that extend beyond 30 days from the contract date, but that are due within twelve months, are generally deemed to be fixed or determinable based on our successful collection history on such arrangements, and thereby satisfy the required criteria for revenue recognition.

 

We assess whether collection is probable at the time of the transaction based on a number of factors, including the customer’s past transaction history and credit-worthiness. If we determine that the collection of the fee is not probable, we defer the fee and recognize revenue at the time collection becomes probable, which is generally upon the receipt of cash.

 

We deliver products electronically or by overnight courier F.O.B. origin, and our software arrangements typically do not contain acceptance provisions. Accordingly, delivery is usually satisfied when the customers have been provided with access codes to allow them to take immediate possession of the software, or when shipped by courier, when the product leaves our premises.

Revenue from royalty arrangements in excess of guaranteed amounts is recognized upon notification of such royalties payable by the customer.

 

Allowances for Doubtful Accounts

 

We maintain allowances for doubtful accounts, as a reduction of accounts receivable, based on our analyses of the likelihood that our customers will not pay all amounts due to us. In circumstances where there is knowledge of a specific customer’s inability to meet its financial obligations, a specific reserve is recorded against amounts due to reduce the net recognized receivable to the amount that is reasonably believed to be collectable. For all our customers, we perform analyses of the likelihood of payment, which includes a review of their credit profiles, the terms and conditions of the contracts with our customers, current economic trends and payment history. We reassess these allowances each accounting period. Historically, our actual losses and credits have been consistent with these provisions. If actual payment experience with our customers is different than our estimates, adjustments to these allowances may be necessary resulting in additional charges to our Consolidated Financial Statements.

 

Share-Based Compensation

 

We grant share options to purchase our ordinary shares to our employees and directors under our equity incentive plans. We may also grant other types of equity incentives, including share appreciation rights, restricted share awards, unrestricted share awards, phantom share units and performance based awards to certain key employees under our 2006 Share Incentive Plan. Eligible employees may also purchase our ordinary shares at 85% of the lower of the fair market value on the first or the last day of the offering period under our employee share purchase plan. Our practice, in general, is to issue ordinary shares or ADRs from previously unissued shares upon exercise or settlement of options and in connection with the employee share purchase plan. The benefits provided under these plans are share-based payments subject to the provisions of Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), Share-Based Payment, or SFAS 123R.

 

On January 1, 2006, we adopted the fair value recognition provisions of SFAS 123R. Prior to January 1, 2006, we accounted for share-based payments under the recognition and measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees, or APB 25, and related Interpretations, as permitted by SFAS No. 123, Accounting for Share-based Compensation, or SFAS 123. In accordance with APB 25, no compensation cost was required to be recognized for options granted that had an exercise price equal to the market value of the underlying shares on the date of grant.

 

We adopted SFAS 123R using the modified prospective transition method. Under the modified prospective transition method, compensation cost recognized in the year ended December 31, 2006, included: a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant-date fair value estimated in accordance with the original provisions of SFAS 123, and b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. The results for the prior periods have not been restated.

 

Share-based compensation expense recognized under SFAS 123R for the years ended December 31, 2007 and 2006 was $4.7 million and $4.6 million, respectively. At December 31, 2007, the total unamortized fair value of share options expected to vest was $6.7 million. The weighted average period over which the unamortized fair value of share options will be recognized is 1.4 years.

 

The fair value of each option is estimated on the date of grant using the Black-Scholes option valuation model. The Black-Scholes option valuation model requires the input of highly subjective assumptions, including the expected life of the share-based award and share price volatility. The assumptions used in calculating the fair value of share-based compensation represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if other assumptions had been used or are used in the future, our share-based compensation expense could be materially different. In addition, we are required to estimate the expected option forfeiture rate and only

recognize expense for those shares expected to vest. If our actual option forfeiture rate is materially different from our estimate, the share-based compensation expense could be materially different. Our weighted average estimated option forfeiture rate, based on our historical option forfeiture experience, is approximately 9%. We will record additional expense if the actual option forfeitures are lower than estimated and will record a recovery of prior expense if the actual option forfeitures are higher than estimated.

 

The expected term of options granted is derived from historical data on employee exercise and post-vesting employment termination behavior. This methodology results in a weighted average expected term calculation of 3.8 years. The risk-free rate for periods within the contractual life of the option is based on the U.S. treasury yield curve in effect at the time of grant. This methodology results in a weighted average risk free rate of approximately 4.6%. Expected volatility is based on the historical volatility of IONA’s shares. This methodology results in a volatility calculation of 66.9%. We used the straight-line method for expense attribution.

 

Accounting for Income Taxes

 

Significant judgment is required in determining our worldwide income tax expense provision. In the ordinary course of a global business, there are many transactions and calculations where the ultimate tax outcome is uncertain. Some of these uncertainties arise as a consequence of income sharing and cost reimbursement arrangements among related entities, the process of identifying items of income and expense that qualify for preferential tax treatment, and segregation of foreign and domestic income and expense to avoid double taxation.

 

Deferred tax assets and liabilities are determined using enacted tax rates for the effects of net operating losses and temporary differences between the book and tax bases of assets and liabilities. We record a valuation allowance to reduce our deferred tax assets by the amount of tax benefits we estimate are not expected to be realized. Tax benefits will not be realized if we do not generate sufficient taxable income in the future to apply against the deferred tax balance.

 

Based upon our U.S. operating results and an assessment of our expected future U.S. results, we concluded that it was more likely than not that we would be able to realize a portion of our U.S. deferred tax assets and net operating loss carryforwards prior to their expiration. As a result, we reduced our deferred tax asset valuation allowance related to U.S. deferred tax assets in 2007, resulting in recognition of a deferred tax asset of $2.0 million. This has been partially offset by the recognition of $0.1 million in deferred tax liabilities in Japan. We will continue to review our operating results to determine if it becomes more likely than not that our deferred tax assets will be realized in the future, at which time we would release some or all of the valuation allowance. The reduction in our valuation allowance results in an income tax benefit in the current period and could have a negative impact on our results in future periods as we would expect to begin recording an increase in the provision for income taxes.

 

In evaluating our ability to recover our deferred tax assets, we consider all available positive and negative evidence including our past operating results, the existence of cumulative income in the most recent fiscal years, changes in the business in which we operate and our forecast of future taxable income. In determining future taxable income, we are responsible for assumptions utilized including the amount of state, federal and international pre-tax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates we are using to manage the underlying businesses.

 

The majority of our unbenefited deferred tax assets relate to net operating loss carryforwards in the U.S. and Ireland and are $27.4 million and $12.4 million, respectively. The utilization and realization of these deferred tax assets are dependant upon many complex factors including the future jurisdictional mix of our earnings as adjusted for the income sharing and cost reimbursement arrangements among the related entities. Historically, the differences between book income and taxable income have varied in both amount and type but have primarily been the result of timing differences and share-based compensation deductions. In addition,

we believe that we will realize our benefited deferred tax assets assuming continued profitability in the applicable jurisdictions at existing levels.

 

We have significant operations and generate a substantial portion of our taxable income in Ireland. In general, the tax rate in Ireland on trading income, which is 12.5%, is significantly lower than U.S. tax rates. Moreover, our Irish taxable income derived from software substantially developed in Ireland is taxed at a 10% effective tax rate through December 31, 2010. Therefore, our effective tax rate is affected by the percentage of revenue that qualifies for this favorable tax treatment. We anticipate that we will continue to benefit from this tax treatment, although the extent of the benefit could vary from period to period, and our tax treatment may change in the future. Any variation in the amount of our benefit from this tax treatment could have a material adverse effect on our business, financial condition and results of operations.

 

In addition, we operate within multiple worldwide taxing jurisdictions and may be subject to audits in these jurisdictions. These audits can involve complex issues that may require an extended period of time for resolution. We believe that adequate provisions for income taxes have been made.

 

Goodwill and Intangible Assets

 

At December 31, 2007, we have approximately $10.1 million of goodwill and intangible assets related to acquisitions, net of approximately $0.7 million of accumulated amortization. Goodwill and intangible assets with indefinite lives are tested at least annually for impairment in accordance with the provisions of SFAS No. 142, Goodwill and Other Intangible Assets . The goodwill and other intangible asset impairment test is a two-step process. The first step of the impairment analysis compares our fair value to its net book value to determine if there is an indicator of impairment. In determining fair value, SFAS No. 142 allows for the use of several valuation methodologies, although it states quoted market prices are the best evidence of fair value. Since we have one reporting unit, we calculate fair value using the average market price of our American Depositary Receipts over a seven-day period surrounding the annual impairment testing date (during the fourth fiscal quarter) and the number of our ordinary shares outstanding on the date of the annual impairment test. Step two of the analysis compares the implied fair value of goodwill and other intangible assets to its carrying amount in a manner similar to a purchase price allocation for a business combination. If the carrying amount of goodwill and other intangible assets exceeds its implied fair value, an impairment loss is recognized equal to that excess. We test our goodwill and other intangible assets for impairment annually during the fourth fiscal quarter and in interim periods if certain events occur indicating that the carrying value of goodwill or other intangible assets may be impaired. Indicators such as unexpected adverse business conditions, economic factors, unanticipated technological change or competitive activities, loss of key personnel, and acts by governments and courts, may signal that an asset has become impaired. As of December 31, 2007, we were not aware of any indicators or impairment that would impact the carrying value of goodwill and intangible assets.

 

Restructuring

 

Prior to 2007, we recorded restructuring charges and credits to align our cost structure with changing market conditions. Our restructuring plan resulted in a reduction in headcount and the closure and consolidation of excess facilities. In determining the charges to record, we made certain estimates and judgments surrounding the amounts ultimately to be paid for the actions we have taken. At December 31, 2007, there were various accruals recorded for the costs associated with certain excess facilities and lease obligations, which may be adjusted periodically for either resolution of certain contractual commitments or changes in estimates of sublease income or the period of time the facilities will be vacant and subleased. During 2007, we recorded a restructuring charge of $1.2 million related to a subtenant’s decision not to renew its sublease. Although we do not anticipate additional significant changes to our restructuring accruals for existing excess facilities, the actual costs may differ from those recorded in the event that the subleasing assumptions require adjustment due to changes in economic conditions surrounding the real estate market, actions of our subtenants or if we terminate our lease obligations prior to the scheduled termination dates.

In order to estimate the costs related to our restructuring efforts, we made our best estimates of the most likely expected outcomes of the significant actions to accomplish the restructuring. These estimates principally related to charges for excess facilities and included estimates of future sublease income, future net operating expenses of the facilities, brokerage commissions and other expenses. The charge was calculated by taking into consideration:

 

(1) the committed annual rental charge associated with the vacant square footage;

 

(2) an assessment of the sublet rents that could be achieved based on current market conditions, vacancy rates and future outlook following consultation with third party realtors;

 

(3) an assessment of the period of time the facility would remain vacant before being sublet;

 

(4) an assessment of the percentage increases in the primary lease rent at each review; and

 

(5) the application of a discount rate of 4% over the remaining period of the lease or termination clause.

 

These estimates are reviewed at the end of each period and would be revised if estimated future vacancy rates and sublease rates vary from our original estimates. Historically, our estimates and assumptions used to determine the liability for excess facilities have been consistent with actual results experienced. Revisions to our estimates of this liability could materially impact our operating results and financial position in future periods if anticipated events and assumptions, such as the timing and amounts of sublease rental income, either change or do not materialize.

 

Foreign Currency

 

The U.S. dollar is our functional currency. A percentage of our revenue, expenses, assets and liabilities are denominated in currencies other than our functional currency. Monetary assets and liabilities denominated in currencies other than the U.S. dollar are translated at year end exchange rates. Revenue and expenses denominated in currencies other than the U.S. dollar are translated at rates approximating those ruling at the dates of the related transactions. Resulting gains and losses are included in net (loss) income for the year. Fluctuations in exchange rates may have a material adverse effect on our results of operations, particularly on our operating margins, and could also result in exchange gains and losses. We cannot accurately predict the impact of future exchange rate fluctuations on our consolidated results of operations. We have in the past sought to hedge the risks associated with fluctuations in exchange rates of the Irish pound and the Euro to the dollar. However, we currently rely on offsetting assets and liabilities in the primary currencies in which we operate to mitigate our foreign exchange risk and we have had no derivative or hedging transactions in 2007, 2006 or 2005. In the future, we may undertake transactions to hedge the risks associated with fluctuations in exchange rates.

 

Recent Accounting Pronouncements

 

In September 2006, FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements, or SFAS 157, which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The provisions of SFAS 157 were effective as of January 1, 2008 and we do not expect its adoption to have a material impact on our Consolidated Financial Statements.

 

In February 2007, FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities Including an amendment of FASB Statement No. 115, or SFAS 159. SFAS 159 permits a company to choose, at specified election dates, to measure at fair value certain eligible financial assets and liabilities that are not currently required to be measured at fair value. The specified election dates include, but are not limited to, the date when an entity first recognizes the item, when an entity enters into a firm commitment, or when changes in the financial instrument causes it to no longer qualify for fair value accounting under a different accounting standard. An entity may elect the fair value option for eligible items that exist at the effective date. At that date, the difference between the carrying amounts and the fair values of eligible items for which the fair value option is elected should be recognized as a cumulative effect adjustment to the opening balance of retained earnings. The fair value option may be

elected for each entire financial instrument, but need not be applied to all similar instruments. Once the fair value option has been elected, it is irrevocable. Unrealized gains and losses on items for which the fair value option has been elected will be reported in earnings. The provisions of SFAS 159 were effective as of January 1, 2008 and we do not expect its adoption to have a material impact on our Consolidated Financial Statements.

 

In December 2007, the FASB issued Financial Accounting Standards No. 141R, Business Combinations , or SFAS 141R. SFAS 141R establishes principles and requirements for how an acquirer (a) recognizes and measures in its financial statements the identifiable assets acquired, liabilities assumed and any noncontrolling interest in the acquiree; (b) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and (c) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141R applies prospectively to all business combination transactions for which the acquisition date is on or after January 1, 2009.

 

In December 2007, the FASB issued Financial Accounting Standards No. 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of Accounting Research Bulletin (ARB) No. 51 , or SFAS 160. SFAS 160 requires (1) presentation of ownership interests in subsidiaries held by parties other than the parent within equity in the consolidated statements of financial position, but separately from the parent’s equity; (2) separate presentation of the consolidated net income attributable to the parent and to the minority interest on the face of the consolidated statements of income; (3) accounting for changes in a parent’s ownership interest where the parent retains its controlling financial interest in its subsidiary as equity transactions; (4) initial measurement of the noncontrolling interest retained for any deconsolidated subsidiaries at fair value with recognition of any resulting gains or losses through earnings; and (5) additional disclosures that identify and distinguish between the interests of the parent and noncontrolling owners. The provisions of SFAS 160 are effective for us beginning January 1, 2009. Adoption of SFAS 160 is not expected to have a material impact on our Consolidated Financial Statements.

Results of Operations

 

The following table sets forth certain operating data as a percentage of total revenue for the periods indicated:

 

 

The total number of revenue transactions over $250,000 decreased to 41 in 2007 from 54 in 2006. There was an increase in average transaction size to approximately $76,000 in 2007 from approximately $75,000 in 2006.

 

Sales to Boeing represented approximately 18% and 17%, respectively, of our revenue for the years ended December 31, 2007 and 2006. In addition, due in part to industry consolidation in the telecommunications market, sales to AT&T represented approximately 11% of our revenue for the years ended December 31, 2007 and 2006.

 

 

The decrease in product revenue was attributable to a continued decline in revenue from our Orbix family of products partially offset by increased revenue from our Artix family of products. We expect the dollar amount of product revenue for our Orbix product family to continue to decline, as the product family continues to age, and be offset by an increase in revenue for our Artix product family.

 

Service revenue includes revenues from maintenance, consulting and training. Maintenance revenue increased $2.3 million to $32.0 million during 2007, compared to $29.7 million during the same period of 2006. The increase in maintenance revenue is primarily related to an increase in Artix support contracts. Consulting and training revenue increased $0.7 million to $6.8 million during 2007 from $6.1 million during 2006. The increase in consulting and training revenue was primarily due to sales related to our FUSE open source product family.

 

 

Cost of product revenue consists primarily of product media and duplication, manuals, packaging materials, shipping and handling expenses, third-party royalties, amortization of purchased technology and, to a lesser extent, the salaries and benefits of certain personnel and related operating costs of computer equipment. The increase in cost of product revenue year-over-year is attributable to $0.5 million of intangible asset amortization related to the C24 acquisition that was completed in 2007. We recorded $2.4 million of developed technology which is being amortized on a straight-line basis to cost of product revenue over a four year period. This additional cost in the current year was partially offset by a decrease in third-party royalties.

 

 

Cost of service revenue consists primarily of personnel costs for consultancy, training, customer support, product configuration and implementation, and related operating costs of computer equipment and travel expenses. The increase in cost of service revenue expenses was primarily attributable to increased personnel costs related to foreign exchange, inflation and acquisition related costs. The average number of service personnel increased to 58 for the year ended December 31, 2007, compared to 56 for the year ended

December 31, 2006. We expect that the cost of service revenue expenses will increase in 2008 primarily as a result of our continued efforts to grow our consulting and training business.

 

 

Research and development expenses consist primarily of salaries and benefits of research and development personnel, costs of third-party contractors, personnel-related overhead allocation, depreciation expenses arising from the acquisition of computer equipment, software license fees and related indirect costs. The increase in research and development expense is primarily related to an increase in personnel costs attributable to acquisition, foreign exchange and inflation related costs. Primarily attributable to acquisitions, the average number of research and development personnel increased to 139 for the year ended December 31, 2007, compared to 130 for the year ended December 31, 2006. We expect research and development expenses will decrease in aggregate dollar amount in 2008 primarily as a result of restructuring actions executed in the first quarter of 2008.

 

 

Sales and marketing expenses consist primarily of salaries, sales commissions and benefits of sales and marketing personnel, personnel-related overhead allocation, travel, entertainment, advertising and promotional expenses, and related indirect costs. The decrease in sales and marketing expenses is primarily related to a decrease in volume related expenses. The average number of sales and marketing personnel increased to 109 for the year ended December 31, 2007, compared to 108 for the year ended December 31, 2006. We expect that sales and marketing expenses will remain at approximately the same level in 2008 as in 2007.

 

 

General and administrative expenses consist primarily of salaries and benefits of financial, administrative and management personnel, general office administration expenses (rent and occupancy, telephone and other office supply costs), and related indirect costs. General and administrative expenses also include professional fees, provisions for bad debt, liability insurance and depreciation. The increase in general and administrative expenses was primarily related to increased audit and compliance fees. The average number of general and administrative personnel increased to 56 for the year ended December 31, 2007, compared to 52 for the year ended December 31, 2006. We expect general and administrative expenses to increase in 2008 due to increased professional fees as compared to 2007.

 

Amortization of Intangible and Other Assets

 

In 2007, we recorded $3.3 million of intangible assets related to our acquisitions of C24 and LogicBlaze consisting of technology, customer relationships and covenants not to compete. Intangible assets of

approximately $2.4 million related to technology are amortized to cost of product revenue whereas approximately $0.9 million of intangible assets related to customer relationships and covenant not to compete are amortized to operating expenses. These assets are principally being amortized on a straight-line basis over a three to five year period. Amortization expense of $0.2 million in 2007 represents amortization of customer relationships and covenants not to compete.

 

Restructuring

 

In 2007, we recorded a $1.2 million restructuring charge related to a subtenant’s decision not to renew a sublease for our Dublin facility. Cash outlays associated with the restructuring plans initiated in previous periods totaled approximately $0.1 million during 2007 related to facility closure costs. During 2006, we recorded a $0.2 million charge related to a revision of lease estimates for previous restructurings and released $0.2 million of restructuring accruals related to the negotiation of a new sublease in the United Kingdom. Cash outlays associated with the restructuring plans initiated in previous periods totaled approximately $0.6 million during 2006 related to facility closure costs.

 

On January 11, 2008, we committed to a cost reduction plan focused on streamlining our operations and the elimination of certain fixed costs. This includes costs associated with a workforce reduction across the Company, costs associated with the consolidation of certain of our facilities, and other associated costs. We estimate a total of $1.5 million to $1.7 million for severance payments and related costs in connection with workforce reduction actions during the first half of 2008. We are currently exploring our options to mitigate our affected real estate lease obligations. At this time, we are unable to estimate the amount or range of costs and timing of charges associated with the consolidation of certain facilities and other associated costs.

 

Interest Income, Net

 

Interest income, net primarily represents interest earned on cash and investment balances net of investment related expenses. Interest income, net was $2.0 million in 2007 compared to $1.7 million in 2006. The increase in interest income, net was due primarily to an increase in interest rates.

 

Net Exchange Loss

 

Net exchange loss was $0.1 million in 2007 compared to $0.6 million in 2006. The net exchange loss in both periods was primarily due to the average strength of the Euro against the U.S. dollar, partially offset by the average strength of the Japanese Yen against the U.S. dollar.

 

(Benefit) Provision for Income Taxes

 

In 2007, we had an income tax benefit of $1.0 million compared to a provision for income taxes of $1.2 million in 2006. Included in the income tax benefit for 2007 are $2.0 million of deferred tax benefit related to the reversal of a portion of our deferred tax assets and related valuation allowance and $0.1 million of deferred tax expense related to deferred tax liabilities in Japan. Provision for incomes taxes for 2007, excluding the net deferred tax benefit of $1.9 million, was $0.9 million. The decrease in our income tax provision is primarily a result of lower taxable income.

 

Based upon our U.S. operating results and an assessment of our expected future results, we concluded that it was more likely than not that we would be able to realize a portion of our U.S. deferred tax assets, including a portion of our net operating loss carryforward tax assets prior to their expiration. As a result, we reduced our deferred tax asset valuation allowance in 2007, resulting in recognition of a deferred tax asset of $2.0 million. This has been partially offset by $0.1 million in deferred tax liabilities in Japan. We may record additional deferred tax benefits in future periods if we expect to utilize additional net operating losses. The reduction in our valuation allowance resulted in an income tax benefit during 2007 and could have a negative impact on our results in future periods as we would expect to begin recording an increase in the provision for income taxes.

At December 31, 2007, we had net operating loss carryforwards of approximately $71.9 million for U.S. federal income tax purposes, including approximately $64.3 million pre-acquisition losses from the acquisition of Netfish Technologies, Inc., or Netfish, in 2001, which will expire in tax years 2011 through 2025, if not previously utilized. At December 31, 2007, we also had net operating loss carryforwards of approximately $124.1 million and $3.5 million for Irish and Australian tax purposes, respectively, both of which carry forward indefinitely. However, as of December 31, 2006, we no longer had active operations in Australia.

 

 

The total number of revenue transactions over $250,000 increased to 54 in 2006 from 48 in 2005. There was an increase in average transaction size to approximately $75,000 in 2006 from $64,000 in 2005. Sales to Boeing represented approximately 17% of our revenue for the year ended December 31, 2006. In addition, due in part to industry consolidation in the telecommunications market, sales to AT&T represented approximately 11% of our revenue for the year ended December 31, 2006. No customer accounted for more than 10% of our revenue in 2005.

 

 

The increase in both product and service revenue was attributable to increased demand for our Artix family of products. More specifically, consulting and training revenue increased by $2.6 million, or 75.1%, to $6.1 million in 2006 from $3.5 million in 2005. The increase in consulting and training revenue is primarily attributable to consulting engagements relating to our Artix product family. Maintenance revenue remained flat at $29.7 million in both 2006 and 2005. In 2006, the increase in Artix support contracts was partially offset by the expiration of Orbix support contracts from prior years.

 

 

The improvement in product gross margin year-over-year is primarily attributable to a decrease in amortization of certain other assets in 2006, when compared to the prior period.

 

The decrease in service gross margin was primarily attributable to share-based compensation costs of approximately $0.5 million incurred in 2006 upon adoption of SFAS 123R, as well as an increase in external contract labor used to service consulting revenue. The average number of service personnel increased to 56 in 2006 from 55 in 2005.

 

 

The increase in research and development expenses in dollar amount was primarily the result of share-based compensation costs of approximately $0.9 million incurred in 2006 upon adoption of SFAS 123R. This additional expense in 2006 was partially offset by reductions related to consolidation of development infrastructure, the movement towards lower cost geographies, and an expense of approximately $0.3 million incurred in the prior year related to a first time accrual for vacation expense. The average number of research and development personnel increased to 130 in 2006 from 129 in 2005.

 

 

The increase in sales and marketing expenses in dollar amount was primarily the result of approximately $1.6 million of share-based compensation costs incurred in 2006 upon adoption of SFAS 123R. Additionally, payments made to two customers in the Asia-Pacific Rim region to resolve a consumption tax issue related to previous years and a settlement to resolve a foreign payroll tax liability arising out of the 2001 termination of employees of an acquired company contributed to the increase in sales and marketing expenses in 2006. The average number of sales and marketing personnel was 108 in both 2006 and 2005.

 

 

The increase in general and administrative expenses was primarily the result of approximately $1.6 million of share-based compensation costs incurred in the current period upon adoption of SFAS 123R. The remaining increase was primarily the result of increased audit, legal and compliance fees, compensation expenses and an increase in provisions for bad debt. The average number of general and administrative personnel was 52 in both 2006 and 2005.

Amortization of Intangible and Other Assets

 

Amortization of intangible and other assets in 2005 consists of the amortization of purchased technologies acquired by us, which have reached technological feasibility. Amortization of intangible and other assets was zero in 2006, compared to $0.1 million, or 0.1% of total revenue in 2005. The decrease in amortization of intangible and other assets is primarily attributable to the full amortization of certain intangible assets.

 

Restructuring

 

Cash outlays associated with the restructuring plans initiated in previous periods totaled approximately $0.6 million during 2006 related to facility closure costs. During 2006, we recorded a $0.2 million charge related to a revision of lease estimates for previous restructurings and released $0.2 million of restructuring accruals related to the negotiation of a new sublease in the United Kingdom. In 2005, we released $0.2 million of restructuring accruals of which $0.1 million was related to severance and benefit costs from previous restructurings and $0.1 million was related to facilities costs for our Dublin, Ireland and Reading, UK offices. Cash outlays associated with the restructuring plans initiated in previous periods totaled approximately $5.8 million during 2005, including approximately $0.3 million in severance and related benefits paid to employees worldwide and $5.5 million in facility closure costs.

 

Interest Income, Net

 

Interest income, net primarily represents interest earned on cash and investment balances net of investment related expenses. Interest income, net was $1.7 million in 2006 compared to $0.8 million in 2005. The increase in interest income, net was due primarily to an increase in interest rates.

 

Net Exchange (Loss) Gain

 

Net exchange loss was $0.6 million in 2006 compared to a net exchange gain of $0.1 million in 2005. The net exchange loss in 2006 was primarily due to the average strength of the Euro against the U.S. dollar. The net exchange gain for 2005 was primarily due to the strengthening of the U.S. dollar against the Euro partially offset by the strengthening of the U.S. dollar against the Japanese Yen.

 

Provision for Income Taxes

 

Income taxes were $1.2 million in 2006 compared to $0.9 million in 2005. The increase in the charge for income taxes in 2006 compared to 2005 arises as a result of an increase in taxes payable in foreign jurisdictions.

 

At December 31, 2006, we had net operating loss carryforwards of approximately $116.0 million for U.S. federal income tax purposes, including approximately $64.3 million pre-acquisition losses from the acquisition of Netfish Technologies, Inc., or Netfish, in 2001, which will expire in tax years 2011 through 2025, if not previously utilized. At December 31, 2006, we also had net operating loss carryforwards of approximately $121.9 million and $2.9 million for Irish and Australian tax purposes, respectively, both of which carry forward indefinitely. However, as of December 31, 2006, we no longer had active operations in Australia.

 

Exposure to Currency Fluctuations

 

Our Consolidated Financial Statements are prepared in U.S. dollars, our functional currency. A percentage of our revenue, expenses, assets and liabilities are denominated in currencies other than our functional currency. Fluctuations in exchange rates may have a material adverse effect on our results of operations, particularly our operating margins, and could also result in exchange gains and losses. As a result of currency fluctuations, we recognized an exchange loss of $0.1 million in 2007 compared to $0.6 million in 2006. We cannot accurately predict the impact of future exchange rate fluctuations on our results of operations. We have in the past sought to hedge the risks associated with fluctuations in exchange rates of the Irish pound and the Euro to the U.S. dollar. However, we currently rely on offsetting assets and liabilities in the primary currencies

in which we operate to mitigate our foreign exchange risk and we had no derivative or hedging transactions in 2007, 2006 or 2005. In the future, we may undertake transactions to hedge the risks associated with fluctuations in exchange rates. See also Item 7A “Quantitative and Qualitative Disclosure About Market Risk.”

 

March 10, 2008 $18.0 million of our auction rate securities failed to settle. See Note 19 of our Notes to Consolidated Financial Statement.

 

Net cash provided by financing activities was $1.8 million, $1.4 million and $1.1 million in 2007, 2006 and 2005 respectively. In 2007, 2006 and 2005, net cash provided by financing activities resulted primarily from the proceeds from the exercise of share options and the sale of shares under our 1999 Employee Stock Purchase Plan.

 

We anticipate our operating costs will remain relatively stable or be reduced for the foreseeable future, and as a result, we anticipate we will fund our operating expenses through cash flows from operations. We expect to use our cash resources to fund capital expenditures as well as acquisitions or investments in complementary businesses, technologies or product lines. We believe that our current cash, cash equivalents, marketable securities and cash flows from operations will be sufficient to meet our anticipated cash requirements for working capital and capital expenditures for at least the next twelve months.

 

It is possible that, when needed, adequate funding may not be available to us or, if available, may not be available on terms favorable to us. In addition, we may decide to issue additional equity or debt securities for such funding, which could dilute the ownership of existing shareholders. Any shortfall in our capital resources could result in our limiting the introduction or marketing of new products and services, which could have a material adverse effect on our business, financial condition and results of operation.

 

We lease office space under non-cancelable operating leases with various expiration or termination clause dates through 2013. Future minimum lease payments under all operating leases as of December 31, 2007 are as follows:

 

 

The lease commitments shown include amounts related to certain exited facilities which have been reserved for as a result of our restructuring plans, which, net of estimated sublease income, results in a restructuring balance of approximately $2.4 million at December 31, 2007. Our software license agreements generally include language indemnifying customers against liabilities if our proprietary software products infringe a third party’s intellectual property rights. To date, we have not incurred any significant or material costs as a result of such indemnifications and have not accrued any liabilities related to such obligations in our consolidated financial statements. Our software license agreements also generally include a warranty that our proprietary software products will substantially operate as described in the applicable program documentation for a period of 180 days after delivery. Our subscription agreements relating to our open source support offerings generally include “open source assurance” which provides the customer with a limited remedy in the event that our branded distribution of open source software products infringe a third party’s intellectual property rights. This remedy typically includes (i) obtaining the rights necessary for the customer to continue to use the software, (ii) modifying the software so that it is non-infringing and (iii) replacing the infringing portion of the code with non-infringing code. We also generally warrant that the services we perform will be provided in a professional and workman-like manner. To date, we have not incurred any material costs associated with these warranties.

 

In connection with certain facility leases, we have indemnified our lessors for claims arising from our use of the facility or our breach of the lease. We also indemnify our directors and officers to the maximum extent permitted by law. The duration of the indemnities varies, and in many cases is indefinite. We have not recorded any liability for these indemnities in the accompanying consolidated balance sheets.

 

operations and financial condition. In the normal course of business, we employ established policies and procedures to manage these risks.

 

Our cash and cash equivalents are not subject to significant interest rate risk due to the short maturities of these instruments. As of December 31, 2007, the carrying value of our cash and cash equivalents approximated fair value. Our short term investments primarily consist of student loan auction rate securities, corporate bonds and U.S. government agency fixed income securities. Our auction rate securities have long-term underlying maturities (ranging from 20 to 40 years) with interest rates that typically reset every 28 to 31 days. The market for auction rate securities has historically been highly liquid. Our intent is not to hold these securities to maturity, but rather to use the interest rate reset feature to sell these securities to provide liquidity as needed. Our practice is to invest in these securities for higher yields compared to cash equivalents. Such short-term investments are carried at fair value, unrealized gains and losses are reflected in other comprehensive income and gains and losses are included in investment income in the period they are realized. Due to their inherent structure, auction rate securities carry higher market risk than commercial paper investments. At December 31, 2007 and March 10, 2008, we held $20.0 million and $18.0 million of these student loan auction rate securities, respectively, all of which had a successful interest rate auction reset between January 1, 2008 and February 9, 2008. As of March 10, 2008, $18.0 million of our holdings had insufficient demand at auction (also known as failure to settle). If an auction fails to settle for securities in which we have invested, our investment will not be liquid until a future auction on these investments is successful or the bond matures. If the issuer is unable to successfully close future auctions and their credit worthiness deteriorates, we may be required to adjust the carrying value of the investment through an impairment charge. If we were to sell the auction rate securities outside of an auction reset date, we could recognize a loss on some portion of the principal amount of these holdings. See Note 19 of our Notes to Consolidated Financial Statements.

 

We also currently have no debt, and therefore, we have no direct exposure to movements in interest rates. Based on our overall evaluation of our market risk exposures from all of our financial instruments at December 31, 2007, a near-term change in interest rates would not materially affect our consolidated financial position, results of operations or cash flows.

 

We, do, however, face exposure to adverse movements in foreign currency exchange rates. These exposures may change over time as our business practices evolve and could have a material adverse impact on our financial results. Our primary exposures to fluctuations in foreign currency exchange rates relate to sales and operating expenses denominated in currencies other than the US dollar. The majority of our sales are denominated in US dollars, however when we do invoice customers in a non U.S. dollar currency, we are exposed to foreign exchange fluctuations from the time of invoice until collection occurs. In Europe, where we primarily invoice our customers in U.S. dollars, we pay our operating expenses in local currencies. Accordingly, fluctuations in the Euro relative to the U.S. dollar are reflected directly in our consolidated statement of operations. We are also exposed to foreign currency rate fluctuations between the time we collect in U.S. dollars and the time we pay our operating expenses in local currency. Fluctuations in foreign currency exchange rates could affect the profitability and cash flows in U.S. dollars of our products sold in international markets.

 

For further discussion of our market risk, please see Item 7 “Operating Results — Exposure to Currency Fluctuations.”

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

To the Board of Directors and Shareholders of

IONA Technologies PLC

 

We have audited the accompanying consolidated balance sheets of IONA Technologies PLC (the “Company”) as of December 31, 2007 and 2006 and the related consolidated statements of operations, changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2007. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of IONA Technologies PLC as of December 31, 2007 and 2006, and the consolidated results of its operations and its consolidated cash flows for each of the three years in the period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), IONA Technologies PLC’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 14, 2008, expressed an unqualified opinion thereon.

 

As discussed in Note 1 to the consolidated financial statements, on January 1, 2006, IONA Technologies PLC changed its method of accounting for share-based compensation in accordance with guidance provided in Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment”. As discussed in Note 13 to the consolidated financial statements, IONA Technologies PLC adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” effective January 1, 2007.

 

 

Dublin, Ireland

March 14, 2008

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

The Board of Directors and Shareholders of

IONA Technologies PLC

 

We have audited IONA Technologies PLC (“the Company”)’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). IONA Technologies PLC’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in Management’s Annual Report on Internal Control over Financial Reporting at Item 9A (b). Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, IONA Technologies PLC maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on the COSO criteria.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of IONA Technologies PLC as of December 31, 2007 and 2006 and the related consolidated statements of operations, changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2007 of IONA Technologies PLC and our report dated March 14, 2008, expressed an unqualified opinion thereon.

 

 

Dublin, Ireland

March 14, 2008