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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| Quarterly Report Pursuant to Section 13 or
15(d) of the Securities Exchange Act of 1934
for the quarterly period ended June 30, 2002.
|_| Transition Report Pursuant to Section 13 or
15(d) of the Securities Exchange Act of 1934 for
the transition period from _______ to _______.
Commission File Number: 0-22667
Mercator Software, Inc.
(Exact name of registrant as specified in its charter)
Delaware 06-1132156
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
45 Danbury Road, Wilton, CT 06897
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code:
203-761-8600
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.
|X| Yes |_| No
As of August 9, 2002, Registrant had 34,528,560 outstanding shares of Common
Stock $.01 par value.
MERCATOR SOFTWARE, INC.
Form 10-Q
For the Quarterly Period Ended June 30, 2002
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION Page
----
Item 1. Consolidated Condensed Financial Statements
Consolidated Balance Sheets as of June 30, 2002 (unaudited) and
December 31, 2001 ............................................................................ 3
Consolidated Statements of Operations for the Three and Six Months Ended
June 30, 2002 (unaudited) and 2001 (unaudited) ............................................... 4
Consolidated Statements of Cash Flows for the Six
Months Ended June 30, 2002 (unaudited) and 2001 (unaudited) .................................. 5
Notes to Consolidated Condensed Financial Statements ............................................ 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ........... 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk ...................................... 38
PART II OTHER INFORMATION
Item 1. Legal Proceedings ............................................................................... 39
Item 4. Submission of Matters to a Vote of Security Holders ............................................. 40
Item 6. Exhibits and Reports on Form 8-K ................................................................ 41
Signatures and certifications .................................................................................. 42
MERCATOR SOFTWARE, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
June 30, 2002
(unaudited) December 31, 2001
------------------ -----------------
ASSETS
Current assets:
Cash and cash equivalents ......................................................... $ 27,342 $ 28,236
Accounts receivable, less allowances of $2,221 and $3,884 ......................... 20,537 28,966
Prepaid expenses and other current assets ......................................... 5,359 3,021
------------------ -----------------
Total current assets .......................................................... 53,238 60,223
Furniture, fixtures and equipment, net ................................................. 8,808 9,230
Goodwill, net .......................................................................... 43,960 43,960
Intangible assets, net ................................................................. 7,745 10,172
Restricted collateral deposits and other assets ........................................ 616 3,393
------------------ -----------------
Total assets .................................................................. $ 114,367 $ 126,978
================== =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable .................................................................. $ 6,869 $ 7,632
Accrued expenses and other current liabilities .................................... 25,435 21,066
Current portion of deferred revenue ............................................... 20,284 22,280
------------------ -----------------
Total current liabilities ..................................................... 52,588 50,978
Deferred revenue, less current portion ................................................. 988 917
Long-term deferred tax liability ....................................................... 1,743 2,418
Other long-term liabilities ............................................................ 4,044 3,585
------------------ -----------------
Total liabilities ............................................................. 59,363 57,898
------------------ -----------------
Stockholders' equity:
Convertible preferred stock: $.01 par value; authorized 5,000,000 shares;
no shares issued and outstanding .................................................... -- --
Common Stock: $.01 par value; authorized 190,000,000 shares; issued and
outstanding 33,890,750 shares and 32,885,228 shares ................................. 339 329
Additional paid-in capital ............................................................. 249,547 249,090
Deferred compensation .................................................................. -- (82)
Accumulated deficit .................................................................... (192,607) (178,220)
Accumulated other comprehensive loss ................................................... (2,275) (2,037)
------------------ -----------------
Total stockholders' equity .................................................... 55,004 69,080
------------------ -----------------
Total liabilities and stockholders' equity .................................... $ 114,367 $ 126,978
================== =================
See accompanying notes to consolidated condensed financial statements.
3
MERCATOR SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- ---------------------------
2002 2001 2002 2001
------------- ----------- ----------- ------------
Revenues:
Software licensing ........................................... $ 10,890 $ 13,009 $ 20,439 $ 24,531
Services ..................................................... 6,901 8,182 14,865 17,454
Maintenance .................................................. 9,175 8,540 19,074 16,486
------------- ----------- ----------- ------------
Total revenues ........................................... 26,966 29,731 54,378 58,471
------------- ----------- ----------- ------------
Cost of revenues:
Software licensing ........................................... 153 364 277 601
Services (exclusive of non-cash stock option re-pricing
(benefits) of $(36), $0, $(246) and $0, respectively) ...... 6,065 7,074 13,720 15,053
Maintenance (exclusive of non-cash stock option re-pricing
(benefits) of $(11), $0, $(73) and $0, respectively) ....... 1,993 1,852 4,009 3,641
Stock option re-pricing (benefit) ............................ (47) -- (319) --
Amortization of intangibles .................................. 962 961 1,923 1,922
------------- ----------- ----------- ------------
Total cost of revenues ................................... 9,126 10,251 19,610 21,217
------------- ----------- ----------- ------------
Gross profit ............................................. 17,840 19,480 34,768 37,254
------------- ----------- ----------- ------------
Operating expenses:
Product development (exclusive of non-cash stock option
re-pricing (benefits) of $(33), $0, $(222) and $0,
respectively) .............................................. 5,237 5,324 9,746 10,570
Selling and marketing (exclusive of non-cash stock option
re-pricing (benefits) of $(52), $0, $(350) and $0,
respectively) .............................................. 11,893 17,143 23,844 33,951
General and administrative (exclusive of non-cash stock
option re-pricing (benefits) of $(24), $0, $(176) and $0,
respectively) .............................................. 6,986 7,933 13,809 16,529
Stock option re-pricing (benefit) ............................ (109) -- (748) --
Amortization of goodwill ..................................... -- 5,627 -- 11,253
Amortization of intangibles .................................. 200 357 505 714
Restructuring charges ........................................ 1,308 5,318 1,063 5,318
------------- ----------- ----------- ------------
Total operating expenses ................................. 25,515 41,702 48,219 78,335
------------- ----------- ----------- ------------
Operating loss ........................................... (7,675) (22,222) (13,451) (41,081)
Other income (expense), net ....................................... (75) 114 (142) 152
------------- ----------- ----------- ------------
Loss before income taxes .......................................... (7,750) (22,108) (13,593) (40,929)
Provision for income taxes ........................................ 524 555 794 2,422
------------- ----------- ----------- ------------
Net loss .......................................................... $ (8,274) $(22,663) $(14,387) $(43,351)
============= =========== =========== ============
Net loss per share:
Basic and fully diluted ...................................... $ (0.24) $ (0.75) $ (0.43) $ (1.44)
Weighted average shares outstanding:
Basic and fully diluted ...................................... 33,866 30,288 33,721 30,118
See accompanying notes to consolidated condensed financial statements.
4
MERCATOR SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
Six Months Ended
June 30,
-----------------------------------
2002 2001
--------------- ---------------
Cash flows from operating activities:
Net (loss) ..................................................................... $(14,387) $(43,351)
Adjustment to reconcile net (loss) to net cash (used) by
operating activities:
Depreciation and amortization .............................................. 4,701 16,349
Amortization of deferred compensation ...................................... 82 162
Compensation related to options associated with non-employees .............. (109) --
Employee stock option re-pricing (benefit) ................................. (1,067) --
Compensation related to modifications of fixed stock option awards ......... -- 250
Provisions for losses on accounts receivable ............................... 440 983
Disposals of furniture, fixtures and equipment ............................. 10 --
Deferred taxes ............................................................. -- 1,703
Changes in operating assets and liabilities:
Accounts receivable ................................................... 8,484 7,671
Prepaid expenses and other current assets ............................. (2,406) (974)
Other assets .......................................................... (109) (28)
Accounts payable ...................................................... (860) 1,497
Accrued expenses and other current liabilities ........................ 2,657 (1,000)
Deferred revenue ...................................................... (2,110) 3,577
--------------- ---------------
Net cash (used) by operating activities ........................... (4,674) (13,161)
--------------- ---------------
Cash flows from investing activities:
Purchase of furniture, fixtures and equipment .................................. (1,505) (2,897)
Net sales of marketable securities ............................................. -- 3,420
Restricted collateral deposits, net ............................................ 2,888 (1,480)
--------------- ---------------
Net cash provided (used) by investing activities .................. 1,383 (957)
--------------- ---------------
Cash flows from financing activities:
Private placement expenses ..................................................... (173) --
Net proceeds from Mitsui issuance .............................................. -- 1,635
Principal payments under capital leases ........................................ (292) (224)
Insurance premium financing proceeds ........................................... 1,523 686
Principal payments under insurance premium financing ........................... (88) --
Proceeds from exercise of stock options ........................................ 691 199
Proceeds from exercise of warrants ............................................. 63 167
Proceeds from employee stock plan .............................................. 1,062 1,374
--------------- ---------------
Net cash provided by financing activities ......................... 2,786 3,837
--------------- ---------------
Effect of exchange rate changes on cash ............................................. (389) (1,888)
--------------- ---------------
Net change in cash .................................................................. (894) (12,169)
Cash at beginning of period ......................................................... 28,236 18,327
--------------- ---------------
Cash at end of period ............................................................... $ 27,342 $ 6,158
=============== ===============
Supplemental information:
Cash paid for:
Interest ............................................................. $47 $112
Income taxes ......................................................... $90 $65
Non-cash investing and financing activities:
Acquisition of equipment under capital leases ........................ $159 $484
See accompanying notes to consolidated condensed financial statements.
5
MERCATOR SOFTWARE, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited)
(1) UNAUDITED INTERIM FINANCIAL STATEMENTS
The accompanying consolidated interim condensed financial statements
contained herein are unaudited, but, in the opinion of management, include all
adjustments (consisting of normal recurring adjustments) necessary for a fair
presentation of the financial position, results of operations and cash flows for
the periods presented. Results of operations for the periods presented herein
are not necessarily indicative of results of operations for the entire year.
Reference should be made to the Mercator Software, Inc. ("Mercator" or "the
Company") 2001 Annual Report on Form 10-K, which includes audited financial
statements for the year ended December 31, 2001.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to the Securities and Exchange
Commission's rules and regulations.
Certain reclassifications have been made to the prior years' financial
statements to conform to the 2002 presentation.
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements, and the reported amounts of revenue and
expenses during the reporting period. Actual results could differ from those
estimates.
(2) COMPREHENSIVE INCOME (LOSS)
The Company applies the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 130, "Reporting Comprehensive Income" which requires the
Company to report in its financial statements, in addition to its net income
(loss), comprehensive income (loss), which includes all changes in equity during
a period from non-owner sources. The Company's total comprehensive (loss)
consists of net (loss) and foreign currency translation adjustments. Total
comprehensive (loss) was ($8.2) million and ($23.6) million for the three months
ended June 30, 2002 and 2001, respectively, and ($14.6) million and ($44.7)
million for the six months ended June 30, 2002 and 2001, respectively.
(3) RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other
Intangible Assets". SFAS No. 141 requires that the purchase method of accounting
be used for all business combinations. SFAS No. 141 specifies criteria that
intangible assets acquired in a business combination must meet to be recognized
and reported separately from goodwill. SFAS No. 142 requires that goodwill and
intangible assets with indefinite useful lives no longer be amortized, but
instead be tested for impairment at least annually in accordance with the
provisions of SFAS No. 142. SFAS No. 142 also requires that intangible assets
with estimable useful lives be amortized over their respective estimated useful
lives to their estimated residual values, and reviewed for impairment in
accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long
Lived Assets".
The Company adopted the provisions of SFAS No. 141 as of July 1, 2001 and
the provisions of SFAS No. 142 as of January 1, 2002. Amortization of goodwill
and intangible assets with indefinite useful lives acquired in business
combinations completed before July 1, 2001 was discontinued as of January 1,
2002. Had SFAS No. 142 been in effect for the prior year, the net loss for the
three and six months ended June 30, 2001 would have been ($17.0) million and
($32.1), respectively, and net loss per share would have been ($0.56) and
($1.07), respectively (see Note 5).
In connection with SFAS No. 142's transitional goodwill impairment
evaluation, the Statement requires the Company to perform an assessment of
whether there is an indication that goodwill is impaired as of the date of
adoption. To accomplish this, the Company must identify its reporting units and
determine the carrying value of each reporting unit by assigning the assets and
liabilities, including the existing goodwill and intangible assets, to those
reporting units as of January 1, 2002. The Company has up to six months from
January 1, 2002 to determine the fair value of each reporting unit and compare
it to the carrying amount of the reporting unit. To the extent the carrying
amount of a reporting unit exceeds the fair value of the reporting unit, an
indication exists that the reporting unit goodwill may be impaired and the
Company must perform the
6
MERCATOR SOFTWARE, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)
(unaudited)
second step of the transitional impairment test. The second step is required to
be completed as soon as possible, but no later than the end of the year of
adoption. In the second step, the Company must compare the implied fair value of
the reporting unit goodwill with the carrying amount of the reporting unit
goodwill, both of which would be measured as of the date of adoption. The
implied fair value of goodwill is determined by allocating the fair value of the
reporting unit to all of the assets (recognized and unrecognized) and
liabilities of the reporting unit in a manner similar to a purchase price
allocation, in accordance with SFAS No. 141. The residual fair value after this
allocation is the implied fair value of the reporting unit goodwill. Any
transitional impairment loss would be recognized as the cumulative effect of a
change in accounting principle in the Company's Consolidated Statement of
Operations. The Company completed the transitional impairment test for its
goodwill in the second quarter of 2002 and determined that its goodwill was not
impaired and therefore did not require the recognition of any transitional
impairment losses.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". SFAS No. 143 requires the Company to record the fair
value of an asset retirement obligation as a liability in the period in which it
incurs a legal obligation associated with the retirement of tangible long-lived
assets that result from the acquisition, construction, development and/or normal
use of the assets. The Company also records a corresponding asset, which is
depreciated over the life of the asset. Subsequent to the initial measurement of
the asset retirement obligation, the obligation will be adjusted at the end of
each period to reflect the passage of time and changes in the estimated future
cash flows underlying the obligation. The Company is required to adopt SFAS
No. 143 on January 1, 2003. Management does not expect the adoption of SFAS
No. 143 to have a significant impact on the Company's financial position or
results of operations.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
This Statement requires that long-lived assets be reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to future net cash
flows expected to be generated by the asset. If the carrying amount of an asset
exceeds its estimated future cash flows, an impairment charge is recognized by
the amount by which the carrying amount of the asset exceeds the fair value of
the asset. SFAS No. 144 requires companies to separately report discontinued
operations and extends that reporting to a component of an entity that either
has been disposed of (by sale, abandonment, or in a distribution to owners) or
is classified as held for sale. Assets to be disposed of are reported at the
lower of the carrying amount or fair value less costs to sell. The Company
adopted SFAS No. 144 on January 1, 2002 and the adoption did not have a
significant impact on the Company's financial position or results of operations.
In November 2001, the Emerging Issues Task Force ("EITF") concluded that
reimbursements for out-of-pocket-expenses incurred should be included in revenue
in the income statement and subsequently issued EITF Issue No. 01-14, "Income
Statement Characterization of Reimbursements Received for `Out-of-Pocket'
Expenses Incurred" in January 2002. The Company adopted EITF Issue No. 01-14 on
January 1, 2002 and has presented these reimbursements as services revenues for
current year periods and has reclassified amounts in prior year periods to
conform to this presentation. These reimbursements are primarily for travel
related expenses incurred for services personnel and totaled approximately
$0.5 million and $0.6 million for the three months ended June 30, 2002 and 2001,
respectively, and $0.9 and $1.2 for the six months ended June 30, 2002 and 2001,
respectively. The adoption of Issue No. 01-14 did not impact the Company's
financial position, operating loss or net loss.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which supersedes EITF Issue
No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (Including Certain Costs Incurred in a
Restructuring)". This Statement requires that a liability for costs associated
with exit or disposal activities be recognized when the liability is incurred as
opposed to recognition on the date an entity commits to an exit plan as
previously required under EITF Issue No. 94-3. The Company is required to adopt
SFAS No. 146 for exit and disposal activities initiated after December 31, 2002.
Management has not yet determined the expected impact of SFAS No. 146 on the
Company's financial position or results of operations.
Other pronouncements issued by the FASB or other authoritative accounting
standard groups with future effective dates are either not applicable or are not
significant to the financial statements of Mercator.
(4) RESTRUCTURING CHARGES
During the second and third quarters of 2001, the Company restructured its
operations to strategically align its personnel with the markets it serves.
Consequently, the Company incurred restructuring charges of $5.3 million and
$2.8 million in
7
MERCATOR SOFTWARE, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)
(unaudited)
the three month periods ended June 30, 2001 and September 30, 2001,
respectively, which consisted of $5.2 million of accruals for lease payments
associated with leased space no longer required due to the reduction in the
workforce, and $2.9 million of severance-related costs. At December 31, 2001,
$5.0 million of these accruals remained which consisted of $4.7 million for
losses related to leased space and $0.3 million for severance benefits. During
the six months ended June 30, 2002, $0.2 million of severance benefits and $0.8
million of leased space related payments were paid and charged against the
restructuring liability. Additionally, during the six months ended June 30,
2002, the Company reversed approximately $0.1 million of remaining restructuring
accruals relating to severance payments and $0.2 million of remaining leased
space accruals as all payments had been finalized for those employees and
leases. In June 2002, due to the continued weakness in the economy and the
commercial real estate market, the Company increased its accrual for excess
office space by $1.4 million. Such increase represents an adjustment to
management's original estimate of the timing and amount of anticipated sublease
income, as well as subtenant allowances and estimated broker's fees. The Company
is currently seeking to sublease this idle space to third parties. At June 30,
2002, $3.5 million of the unpaid restructuring liability was included in accrued
expenses and other current liabilities and $1.5 million was included in other
long-term liabilities.
Restructuring accruals established by the Company, and subsequent charges
related thereto, are summarized as follows (in thousands):
Balance Balance
January 1, 2002 Additions Cash Payments Reversals June 30, 2002
--------------- --------- ------------- --------- -------------
Charges for leased space no longer required
(net of estimated sub-lease recoveries):
Americas ..................................... $ 4,408 $ 1,362 $ (787) $ (2) $ 4,981
EMEA ......................................... 223 -- (8) (215) --
Severance related charges:
Americas ..................................... 297 -- (245) (52) --
EMEA ......................................... 30 -- -- (30) --
------- ------- -------- ------ -------
Totals .......................................... $ 4,958 $ 1,362 $ (1,040) $ (299) $ 4,981
======= ======= ======== ====== =======
(5) GOODWILL AND INTANGIBLE ASSETS
(a) Goodwill
The total carrying amount of goodwill (all related to the Braid
acquisition), which is the Company's only intangible asset not subject to
amortization, is $44.0 million at June 30, 2002 and December 31, 2001. This
amount is allocated to the Americas segment.
Effective January 1, 2002, the Company adopted SFAS No. 142. Under the
provisions of SFAS No. 142, goodwill is no longer amortized and is tested
annually for impairment using a fair value methodology (see Note 3). On a
comparable basis, the net (loss) and net (loss) per share as adjusted to exclude
goodwill amortization for the three and six months ended June 30, 2002 and 2001
are as follows:
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- --------------------------
2002 2001 2002 2001
-------- -------- -------- --------
(In thousands, except share data)
Reported net (loss) ............................. $ (8,274) $ (22,663) $ (14,387) $ (43,351)
Adjustment for goodwill amortization ............ -- 5,627 -- 11,253
-------- --------- --------- ---------
Net (loss), as adjusted ......................... $ (8,274) $ (17,036) $ (14,387) $ (32,098)
======== ========= ========= =========
Net (loss) per share, as adjusted
to exclude amortization of goodwill ............ $ (0.24) $ (0.56) $ (0.43) $ (1.07)
Weighted average shares outstanding:
Basic and fully diluted ..................... 33,866 30,288 33,721 30,118
8
MERCATOR SOFTWARE, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)
(unaudited)
(b) Intangibles subject to amortization
The components of the Company's intangible assets are as follows:
At June 30, 2002 At December 31, 2001
------------------------------------ ----------------------------------
Gross Carrying Accumulated Gross Carrying Accumulated
Amount Amortization Amount Amortization
--------------- ------------ -------------- ------------
(In thousands)
Purchased technology ..................... $ 19,226 $ (12,817) $ 19,226 $ (10,895)
Customer list ............................ 4,008 (2,672) 4,008 (2,271)
Covenant not to compete .................. 1,874 (1,874) 1,874 (1,770)
--------- ---------- --------- ----------
Total ................................ $ 25,108 $ (17,363) $ 25,108 $ (14,936)
========= ========== ========= ==========
All of these intangibles were acquired in conjunction with the Braid
acquisition in March 1999.
The weighted-average remaining amortization periods as of June 30, 2002 are
as follows: Purchased technology - 1.7 years; Customer list - 1.7 years; and in
total - 1.7 years.
Consolidated amortization expense related to the intangible assets and
excluding goodwill amortization was $1.2 million and $1.3 million for the three
months ended June 30, 2002 and 2001, respectively, and $2.4 million and
$2.6 million for the six months ended June 30, 2002 and 2001, respectively.
Amortization expense is expected to be $4.8 million, $4.6 million, and
$0.8 million for the years ended December 31, 2002, 2003 and 2004, respectively.
These intangible assets are expected to be fully amortized by February 29, 2004.
(6) ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Included in accrued expenses and other current liabilities are compensation
costs (regular payroll, commissions, bonuses, profit sharing, and other
withholdings) and related payroll taxes of $6.9 million and $8.0 million as of
June 30, 2002 and December 31, 2001, respectively. Also included are accrued
legal fee and settlement costs of $4.9 million and $4.0 million as of June 30,
2002 and December 31, 2001, respectively. Additionally, restructuring charges of
$3.5 million and $3.3 million are included as of June 30, 2002 and December 31,
2001, respectively (see Note 4).
In April and June 2002, in connection with the renewal of certain insurance
policies, the Company financed through two separate loans with separate lenders,
a portion of certain of its annual insurance premium amounts. The first loan was
for approximately $0.4 million with interest payable at an annual percentage
rate of 7.25% over a term of nine months. At June 30, 2002, approximately
$0.3 million remained outstanding on this loan. The second loan was for
approximately $1.1 million with interest payable at an annual percentage rate of
4.0% over a term of eight months and was outstanding in full at June 30, 2002.
At June 30, 2002, the total combined outstanding balance of the loans of
$1.4 million was included in accrued expenses and other current liabilities.
(7) STOCK ACTIVITIES
On January 17, 2002, the Company filed a Registration Statement on Form S-3
with the Securities and Exchange Commission ("SEC") relating to the offer and
sale from time to time of up to 3,577,883 shares of our Common Stock by certain
security holders. Of the shares, 2,228,412 shares were issued by the Company in
a private placement and 557,104 shares are issuable upon the exercise of related
warrants granted to those security holders who participated in the private
placement. Additionally, 229,342 shares of Common Stock were issued upon
exercise of warrants to certain selling stockholders and the remaining 563,025
shares are issuable upon the exercise of outstanding warrants granted to other
selling stockholders. On March 19, 2002 the SEC declared the Company's
Registration Statement on Form S-3 effective thereby registering an aggregate of
3,577,883 shares of Common Stock. All of the shares included in the Registration
Statement may be offered by certain security holders of the Company. The Company
will not receive any proceeds from the resale of these shares by the selling
security holders.
In January 2002, a warrant was exercised for 1,200 shares of Common Stock
at an exercise price of $1.00 per share for which the Company received proceeds
of $1,200. In May 2002, two similar warrants were exercised for a total of
62,010 shares of Common Stock at exercise prices of $1.00 per share for which
the Company received proceeds of $62,010.
9
MERCATOR SOFTWARE, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)
(unaudited)
In June 2002, a remaining similar warrant for 600 shares of Common Stock at an
exercise price of $1.00 per share expired unexercised.
In June 2001, in connection with a secured credit facility, the Company
issued a warrant to Silicon Valley Bank ("SVB") to purchase 220,000 shares of
Common Stock at $4.00 per share expiring in June 2008. The fair value of this
warrant was determined to be approximately $0.3 million using the Black-Scholes
pricing model with the following assumptions: (i) a risk-free interest rate of
5.67%; (ii) an expected contractual life of 7 years; (iii) expected volatility
of 126%; and (iv) an expected dividend yield of 0%. The fair value was charged
to prepaid expenses as a loan origination fee and credited to additional paid-in
capital in June 2001. This prepaid loan origination fee is being amortized to
operations over the term of the secured credit facility agreement. The warrant
holder subsequently assigned the warrant to an affiliate, and on January 3,
2002, pursuant to the cashless exercise provisions of the warrant agreement, the
affiliate exercised the warrant for 123,296 shares of Common Stock, and as such,
the Company did not receive any proceeds.
In June, July and October 2001, the Company granted warrants to purchase a
total of 179,404 shares of Common Stock to Morgan Howard Global International
Limited at exercise prices ranging from $2.62 to $5.60 per share for its
services in connection with executive search assignments. The number of warrants
issued was determined by dividing the amount owed to the vendor by the value of
a warrant, as determined under the Black-Scholes pricing model and based on
risk-free interest rates ranging from 3.06% to 4.48%, expected contractual lives
of 3 years, expected volatility of 80% and expected dividend yields of 0%. The
costs of these warrants based on the fair value of services received of
$0.1 million were expensed to general and administrative expense when
counterparty performance was complete in 2001. On January 9, 2002, the warrant
holder exercised the warrants for 104,846 shares of Common Stock pursuant to
cashless exercise provisions in the warrant agreement, and as such, the Company
did not receive any proceeds from this exercise.
During November 2000, the Company's Board of Directors approved an offer to
exchange a portion of the September 2000 option grant, of which 615,465 options
were exchanged for an equal amount of options priced at the market price of
$5.063 per option. The new options vested quarterly over a twelve-month period.
According to FASB Interpretation No. ("FIN") 44, "Accounting for Certain
Transactions Involving Stock Compensation", if the exercise price of a fixed
stock option award is reduced, the award shall be accounted for as variable from
the date of the modification to the date the award is exercised, is forfeited,
or expires unexercised. In accordance with FIN 44 and FIN 28, "Accounting for
Stock Appreciation Rights and Other Variable Stock Option or Award Plans", the
Company recorded a variable non-cash compensation charge of $1.2 million and
$0.1 million for the years ended December 31, 2001 and 2000, respectively,
relating to the re-priced options. During the three and six months ended June
30, 2002, the Company recorded benefits of ($0.2) million and ($1.1) million,
respectively, relating to the re-priced options as a result of the reduction in
the Company's stock price during the current year. There was no charge or
benefit for the three and six months ended June 30, 2001. As of June 30, 2002,
306,942 of these re-priced options were outstanding.
During the first quarter of 2002, the Company recorded non-cash
compensation benefits of ($0.1) million related to consulting services provided
by a former employee. No charge was recorded in the second quarter of 2002 as
the consulting agreement ended in the first quarter of 2002. There were no such
charges recorded in the first and second quarters of 2001. During the three and
six months ended June 30, 2001, the Company recorded non-cash compensation
charges of $0.2 million and $0.3 million, respectively, as a result of
accelerated vesting and extension of option terms in connection with severance
agreements for certain officers (some of which were providing ongoing services).
The Company accounted for these charges in accordance with Accounting Principles
Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees",
FIN 44, SFAS No. 123, "Accounting for Stock-Based Compensation" and EITF Issue
No. 96-18, "Accounting for Equity Instruments That are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services".
On September 17, 2001, the Company announced a voluntary option exchange
program for its employees. This tender offer related to an offer to all eligible
individuals, which excluded all directors, executive vice-presidents, senior
vice-presidents and corporate vice-presidents of the Company, to exchange all
outstanding options granted under the Mercator Software, Inc. 1997 Equity
Incentive Plan ("EIP") for new options to purchase shares of Common Stock under
the EIP. Under the exchange program, for every two options tendered and
cancelled, one new option was issued. The offer expired on October 19, 2001 and
the Company accepted for cancellation options to purchase an aggregate of
1,100,062 shares from 239 option holders who participated. On April 23, 2002,
447,597 options were granted at the exercise price of $2.90, which was the fair
market value of the Company's Common Stock on that date, to 211 option holders.
On May 14, 2002, the Company's shareholders approved an amendment to the
EIP to provide for increases in the number of shares of Common Stock reserved
for issuance under the EIP (i) on May 14, 2002 by 2,500,000 shares of
10
MERCATOR SOFTWARE, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)
(unaudited)
Common Stock and (ii) on January 1, 2003 by the lesser of (a) 7.5% of the number
of shares of Common Stock outstanding on the close of business immediately
preceding January 1, 2003, or (b) 3,000,000 shares. For the three months ended
June 30, 2002 and 2001, the Company granted 1,041,537 and 1,502,800,
respectively, of employee stock options. For the six months ended June 30, 2002
and 2001, the Company granted 2,727,387 and 2,926,650, respectively, of employee
stock options. The exercise prices of these employee stock options equaled the
fair value of the underlying Common Stock on the date of grant.
The Company established an Employee Stock Purchase Plan in 1997 (the
"ESPP"), which reserved a total of 1,500,000 shares of the Company's Common
Stock for issuance thereunder. The plan permits eligible employees to acquire
shares of the Company's Common Stock through payroll deductions subject to
certain limitations. The shares are acquired at 85% of the lower of the fair
market value on the offering date or the fair market value on the purchase date.
On May 14, 2002, the Company's shareholders approved an amendment to the ESPP
providing for an annual increase in the number of shares of Common Stock
reserved for issuance under the ESPP so that on May 14, 2002 and on each
January 1 thereafter there are 1,500,000 shares of Common Stock reserved for
issuance under the ESPP (or such lesser number of shares as may be determined by
the Board of Directors). During the six months ended June 30, 2002 and 2001,
536,283 and 163,636 shares were purchased under the plan, respectively. None of
these shares in 2002 and 2001 were purchased in the second quarter.
(8) INCOME TAXES
During the second quarter of 2001, the Company determined that taxable
income for the full year of 2001 was unlikely to be sufficient to support the
full value of the U.S. federal deferred tax assets. As a result, for the quarter
ended June 30, 2001, a full valuation allowance was established on the U.S.
federal deferred tax assets.
(9) COMMITMENTS AND CONTINGENCIES
In connection with a facility lease in Wilton, CT, the Company had
available a letter of credit with Fleet Bank for $2.5 million and a related
restricted collateral deposit of $3.0 million. On June 28, 2002, the Company
terminated its letter of credit and related restricted collateral deposit with
Fleet Bank and replaced it with a letter of credit with SVB using its existing
line of credit with SVB as collateral (see below). As discussed in Note 4, the
Company is currently seeking to sublease this idle space to third parties.
In June 2001, we finalized a credit facility with SVB. The maximum amount
available under the facility is $15.0 million, of which up to $4.0 million may
be used for letters of credit pursuant to an amendment in June 2002. As of June
30, 2002, a $2.5 million letter of credit was outstanding under the facility and
is secured by $4.0 million of domestic accounts receivable. In addition, as of
June 30, 2002, the maximum eligible accounts receivable for borrowings, which
exclude the aforementioned accounts receivable securing the letter of credit,
were approximately $14 million. Borrowings may not exceed 80% of eligible
accounts receivable, as defined in the credit facility agreement and are subject
to bank approval. Borrowings are also subject to the Company maintaining
compliance with the terms of the facility. The agreement, as amended in June
2002, requires that the Company maintain a ratio of eligible domestic accounts
receivable to outstanding letters of credit of 1.6 to 1.0. The Adjusted Quick
Ratio, as also amended in June 2002, requires the Company to maintain a ratio of
1.3 to 1.0 for June 2002, 1.25 to 1.0 for July 2002, and 1.5 to 1.0 thereafter
through the expiration date of the facility on November 27, 2002. The Company
was in compliance with both ratios as of June 30, 2002. The Company is seeking
to amend the Adjusted Quick Ratio for periods subsequent to July 2002.
Upon the expiration of the agreement relating to the facility, or upon a
default in the agreement, the Company will be required to place cash in a
restricted account for up to 105% of the amounts of outstanding letters of
credit, which would result in a reclassification of such amounts from cash into
long-term assets in the consolidated balance sheet. In addition, such default
could result in SVB terminating the credit facility and our being required to
pay a $0.2 million termination fee. Since inception, excluding the
aforementioned letter of credit, no borrowings have been made under this
facility. Prior to November 27, 2002, we expect to seek to renegotiate the
facility to extend it beyond its scheduled termination or, alternatively,
negotiate a similar facility with another party on no less favorable terms.
The Company has certain significant legal contingencies, discussed below,
and other litigation of a nature considered normal to its business which are
pending against the Company.
Between August 23, 2000 and September 21, 2000 a series of fourteen
purported securities class action lawsuits was filed in the United States
District Court for the District of Connecticut, naming as defendants Mercator,
Constance Galley and
11
MERCATOR SOFTWARE, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)
(unaudited)
Ira Gerard. Kevin McKay was also named as a defendant in nine of these
complaints. On or about November 24, 2000, these lawsuits were consolidated into
one lawsuit captioned: In re Mercator Software, Inc. Securities Litigation,
Master File No. 3:00-CV-1610 (GLG). The lead plaintiffs purport to represent a
class of all persons who purchased Mercator's Common Stock from April 20, 2000
through and including August 21, 2000. Each complaint in the consolidated action
alleges violations of Section 10(b) of the Securities Exchange Act of 1934 and
Rule 10b-5 thereunder, through alleged material misrepresentations and omissions
and seeks an unspecified award of damages. On January 26, 2001, the lead
plaintiffs filed an amended complaint in the consolidated matter with
substantially the same allegations. Named as defendants in the amended complaint
are Mercator, Constance Galley and Ira Gerard. The amended complaint in the
consolidated action alleges violations of Section 10(b) and Rule 10b-5 through
alleged material misrepresentations and omissions and seeks an unspecified award
of damages. Mercator filed a motion to dismiss the amended complaint on March
12, 2001. The lead plaintiffs filed an opposition to Mercator's motion to
dismiss on or about April 18, 2001, and Mercator filed its reply brief on May 7,
2001. The Court heard oral argument on the motion to dismiss on July 6, 2001. On
September 13, 2001, the Court denied Mercator's motion to dismiss. Mercator
believes that the allegations in the amended complaint are without merit and
intends to contest them vigorously. Management believes that this securities
class action lawsuit is covered by insurance. Mercator notified its directors'
and officers' liability insurance companies of this matter. The insurance
carriers have reserved their rights in this matter. There can be no guarantee as
to the ultimate outcome of this proceeding or whether the ultimate outcome,
after considering liabilities already accrued in the Company's June 30, 2002
consolidated balance sheet and insurance recoveries, may have a material adverse
effect on the Company's consolidated financial position or consolidated results
of operations.
The Company was named as a defendant in an action filed on August 3, 2001
in the United States District Court for the Eastern District of Pennsylvania,
entitled Ulrich Neubert v. Mercator Software, Inc., f/k/a TSI International
Software, Ltd., Civil Action No. 01-CV-3961. The complaint alleges claims of
breach of contract, breach of the implied covenant of good faith and fair
dealing, breach of fiduciary duty, and fraud in connection with the Company's
acquisition of Software Consulting Partners ("SCP") in November 1998. Neubert,
who was the sole shareholder of SCP prior to November 1998, seeks purported
damages of up to approximately $7.5 million, plus punitive damages and
attorney's fees. The complaint was served on the Company on November 21, 2001.
The Company believes that the allegations in the complaint are without merit and
intends to contest the lawsuit vigorously. Mercator has notified its insurance
carrier of this matter, but has not yet received any coverage position from
them. The ultimate legal and financial liability of the Company in respect to
this claim cannot be estimated with any certainty. There can be no guarantee as
to the ultimate outcome of this proceeding or whether the ultimate outcome,
after considering liabilities already accrued in the Company's June 30, 2002
consolidated balance sheet, may have a material adverse effect on the Company's
consolidated financial position or consolidated results of operations.
In addition, the Company and a third party are currently disputing the
break-up fee provisions with respect to a proposed investment in the Company.
As of June 30, 2002 the Company has accrued approximately $4.4 million,
after considering any insurance recoveries, for the aggregate amount of the
contingencies described above.
(10) SEGMENT INFORMATION
The Company reports its segment information in accordance with SFAS
No. 131, "Disclosures about Segments of an Enterprise and Related Information".
SFAS No. 131 establishes standards for the way that public business enterprises
report information about operating segments. It also establishes standards for
related disclosures about products and services. Reportable segment information
is determined based on management defined operating segments used to make
operation decisions and assess financial performance.
The Company has three reportable segments: Americas (North America, Central
and South America) including Corporate, EMEA (Europe, Middle East & Africa) and
APAC (Asia Pacific). Information regarding the Company's operations in these
three segments is set forth below. For consolidated results, the accounting
policies of operating segments are the same as those described in Note 1. There
are no significant corporate overhead allocations or inter-segment sales or
transfers between the segments for the periods presented.
12
MERCATOR SOFTWARE, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- ------------------------
2002 2001 2002 2001
-------- -------- -------- --------
(In thousands)
Revenue:
Americas .................................................... $ 16,215 $ 20,078 $ 32,348 $ 36,567
EMEA ........................................................ 8,450 8,465 17,925 19,898
APAC ........................................................ 2,301 1,188 4,105 2,006
-------- --------- -------- ---------
Total $ 26,966 $ 29,731 $ 54,378 $ 58,471
======== ========= ======== =========
Operating loss before stock option re-pricing benefit,
amortization of goodwill and intangibles, and
restructuring charges:
Americas (including Corporate) .............................. $ (3,565) $ (6,249) $ (7,873) $ (16,285)
EMEA ........................................................ (2,678) (3,663) (4,073) (5,015)
APAC ........................................................ 882 (47) 919 (574)
-------- --------- -------- ---------
Total ............................................. (5,361) (9,959) (11,027) (21,874)
Stock option re-pricing benefit ................................ 156 -- 1,067 --
Amortization of goodwill ....................................... -- (5,627) -- (11,253)
Amortization of intangibles .................................... (1,162) (1,318) (2,428) (2,636)
Restructuring charges .......................................... (1,308) (5,318) (1,063) (5,318)
Other income (expense), net .................................... (75) 114 (142) 152
Provision for income taxes ..................................... (524) (555) (794) (2,422)
-------- --------- -------- ---------
Net loss ....................................................... $ (8,274) $ (22,663) $(14,387) $ (43,351)
======== ========= ======== =========
Capital expenditures:
Americas (including Corporate) .............................. $ 1,007 $ 344 $ 1,282 $ 1,322
EMEA ........................................................ $ 113 $ 246 $ 214 $ 915
APAC ........................................................ $ 5 $ 432 $ 9 $ 660
Depreciation expense:
Americas (including Corporate) .............................. $ 855 $ 956 $ 1,757 $ 1,846
EMEA ........................................................ $ 223 $ 237 $ 429 $ 542
APAC ........................................................ $ 44 $ 51 $ 87 $ 72
As of June 30,
------------------------
2002 2001
-------- --------
Total assets: (In thousands)
Americas (including Corporate) ................................................................. $ 85,727 $ 88,960
EMEA ........................................................................................... $ 23,683 $ 31,301
APAC ........................................................................................... $ 4,957 $ 2,998
Revenues primarily relate to sales of the Mercator product line and are
recorded in the country in which the sales office is located. The Company had no
sales to any one customer in excess of 10% of total net revenues for the
quarters ended June 30, 2002 and 2001.
(11) SUBSEQUENT EVENTS
On July 12, 2002, the Company announced a restructuring of operations to
provide greater focus on partnerships and industry integration solutions for
targeted vertical markets. As part of this restructuring, the Company announced
that it would reduce its workforce by approximately 15%, or 90 employees, by
December 31, 2002. As such, the Company expects to record a restructuring charge
of approximately $1.7 million in the three months ending September 30, 2002.
On July 31, 2002, eligible employees purchased 637,810 shares of the
Company's Common Stock under the ESPP. These shares were acquired through
payroll deductions at $1.19 per share, which represented 85% of the fair market
value of those shares at July 31, 2002.
13
MERCATOR SOFTWARE, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)
(unaudited)
Subsequent to June 30, 2002 and through August 9, 2002, the Company granted
options to employees to purchase an aggregate of 433,500 shares of the Company's
Common Stock under the EIP. The exercise prices of such options were equal to
fair market value at the date of grant.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
We make statements in Management's Discussion and Analysis of Financial
Condition and Results of Operations that are considered forward-looking within
the meaning of the Securities Act of 1933 and the Securities Exchange Act of
1934. Sometimes these statements will contain words such as "believes,"
"expects," "intends," "plans" and other similar words. We intend those
forward-looking statements to be covered by the safe harbor provisions for
forward-looking statements contained in the Private Securities Litigation Reform
Act of 1995 and are including this statement for purposes of complying with
these safe harbor provisions. These forward-looking statements reflect our
current views which are based on the information currently available to us and
on assumptions we have made. Although we believe that our plans, intentions and
expectations as reflected in or suggested by those forward-looking statements
are reasonable, we can give no assurance that the plans, intentions or
expectations will be achieved. We have listed below and have discussed elsewhere
in this report some important risks, uncertainties and contingencies which could
cause our actual results, performances or achievements to be materially
different from the forward-looking statements we make in this report. These
risks, uncertainties and contingencies include, but are not limited to, the
following:
o our inability to develop and release new products or product
enhancements;
o seasonal fluctuations in our revenues or results of operations;
o general economic conditions;
o competition from others;
o risks in expanding international operations; and
o other risk factors set forth under "Risk Factors."
We assume no obligation to update publicly any forward-looking statements,
whether as a result of new information, future events or otherwise. In
evaluating forward-looking statements, you should consider these risks and
uncertainties, together with the other risks described from time to time in our
reports and documents filed with the Securities and Exchange Commission, and you
should not rely on those statements.
Overview
The Company was incorporated in Connecticut in 1985 as TSI International
Software Ltd. and reincorporated in Delaware in September 1993. We completed our
initial public offering in July 1997 and a second public offering in June 1998.
We changed our name to Mercator Software, Inc. effective April 3, 2000.
Our revenues are derived principally from three sources: (i) license fees
for the use of our software products; (ii) fees for consulting services and
training; and (iii) fees for maintenance and technical support. We generally
recognize revenue from software license fees when a license agreement has been
signed by both parties, the fee is fixed or determinable, collection of the fee
is probable, delivery of our products has occurred and no other significant
obligations remain. Payments for licenses, services and maintenance received in
advance of revenue recognition are recorded as deferred revenue.
Revenues from services include fees for consulting services and training.
Revenues from services are recognized on either a time and materials or
percentage of completion basis as the services are performed and amounts due
from customers are deemed collectible and nonrefundable. Revenues from fixed
price service agreements are recognized on a percentage of completion basis in
direct proportion to the services provided.
Customers who license our products normally purchase maintenance contracts.
These contracts provide unspecified software upgrades and technical support over
a fixed term, and can range from one to four years. Maintenance contracts are
usually paid on an annual basis in advance, and revenues from these contracts
are recognized ratably over the term of the contract.
Our products can be used by information technology professionals, as well
as value added resellers, independent software vendors, systems integrator
partners or other third party technology partners who resell, embed or otherwise
bundle our products with their products. License fee revenues are derived from
direct licensing of software products through our direct sales force and
strategic partners, which include systems integrators and technology partners.
Sales through strategic partners accounted for 33% of license revenues for the
three months ended June 30, 2002 and 2001, and 27% and 26% of license revenues
for the six months ended June 30, 2002 and 2001, respectively. International
revenues accounted for 40% and 32% of total revenues for the three months ended
June 30, 2002 and 2001, respectively, and 41% and 37% of total revenues for the
six months ended June 30, 2002 and 2001, respectively.
The size of orders has typically ranged from $50,000 to over $3.0 million
per order. The loss or delay of large individual orders, therefore, can have a
significant impact on revenue and other quarterly results. In addition, due to
the buying habits of
15
our customers, we generally recognize a substantial portion of our quarterly
software licensing revenues in the last month of each quarter, and, as a result,
revenue for any particular quarter may be difficult to predict in advance.
Because operating expenses are relatively fixed, a delay in the recognition of
revenue from even a limited number of license transactions could cause
significant variations in operating results from quarter to quarter and could
result in significant losses. To the extent such expenses precede, or are not
subsequently followed by increased revenue, operating results would be
materially and adversely affected. As a result of these and other factors,
operating results for any quarter are subject to variation, and period-to-period
comparisons of results of operations may not necessarily be meaningful and
should not be relied upon as indications of future performance.
Critical Accounting Policies and Estimates
The policies discussed below are considered by us to be critical to an
understanding of our financial statements because they require us to apply the
most judgment and make estimates regarding matters that are inherently
uncertain. Specific risks for these critical accounting policies are described
in the following paragraphs. With respect to the policies discussed below, we
note that because of the uncertainties inherent in forecasting, the estimates
frequently require adjustment.
Our financial statements and related disclosures, which are prepared to
conform with accounting principles generally accepted in the United States of
America, require us to make estimates and assumptions that affect the reported
amounts of assets, liabilities, revenues and accounts receivable and expenses
during the period reported. We are also required to disclose amounts of
contingent assets and liabilities at the date of the financial statements. Our
actual results in future periods could differ from those estimates. Estimates
and assumptions are reviewed periodically, and the effects of revisions are
reflected in the Consolidated Financial Statements in the period they are
determined to be necessary.
We consider the most significant accounting policies and estimates in our
financial statements to be those surrounding: (1) revenues and accounts
receivable; (2) valuation of goodwill and long-lived assets; (3) valuation of
deferred tax assets; (4) legal contingencies; and (5) restructuring reserves.
The accounting policies, the basis for any estimates and potential impact to our
Consolidated Financial Statements, should any of the estimates change, are
further described as follows:
Revenues and Accounts Receivable. Our revenues are derived principally from
three sources: (i) license fees for the use of our software products; (ii) fees
for consulting services and training; and (iii) fees for maintenance and
technical support. We generally recognize revenue from software license fees
when a license agreement has been signed by both parties, the fee is fixed or
determinable, collection of the fee is probable, delivery of our products has
occurred and no other significant obligations remain. For multiple-element
arrangements, we apply the "residual method". According to the residual method,
revenue allocated to the undelivered elements is allocated based on vendor
specific objective evidence ("VSOE") of fair value of those elements. VSOE is
determined by reference to the price the customer would be required to pay when
the element is sold separately. Revenue applicable to the delivered elements is
deemed equal to the remainder of the contract price. The revenue recognition
rules pertaining to software arrangements are complicated and certain
assumptions are made in determining whether the fee is fixed and determinable
and whether collectability is probable. For instance, in our license
arrangements with resellers, estimates are made regarding the reseller's ability
and intent to pay the license fee. Our estimates may prove incorrect if, for
instance, subsequent sales by the reseller do not materialize. Should our actual
experience with respect to collections differ from our initial assessment, there
could be adjustments to future results. Another assumption made in the revenue
recognition process involves assessing whether the fee may be allocated to the
various elements of the arrangement. For instance, the literature on software
revenue recognition requires that the vendor have the ability to determine
whether VSOE of fair value of the undelivered element exists when recognizing
revenue on the delivered elements. The estimate of fair value of the undelivered
element is generally determined by reference to separate stand-alone sales of
the undelivered element. Should our actual experience with respect to VSOE
differ from our initial assessment, there could be adjustments to future
results.
Revenues from services include fees for consulting services and training.
Revenues from services are recognized on either a time and materials or
percentage of completion basis as the services are performed and amounts due
from customers are deemed collectible and non-refundable. Revenues from fixed
price service agreements are recognized on a percentage of completion basis in
direct proportion to the services provided. To the extent the actual time to
complete such services varies from the estimates made at any reporting date, our
revenue and the related gross margins may be impacted in the following period.
In addition to assessing the probability of collection in conjunction with
revenue arrangements, we continually assess the collectability of outstanding
invoices. Assumptions are made regarding the customer's ability and intent to
pay and are based on historical trends, general economic conditions, and current
customer data. Should our actual experience with respect to collections differ
from our initial assessment, there could be adjustments to bad debt expense.
Valuation of Goodwill and Long-Lived Assets. Under the provisions of SFAS
No. 142, which we adopted effective January 1, 2002, goodwill is no longer
amortized, but instead it is tested for impairment at least annually. In
connection with
16
SFAS No. 142's transitional goodwill impairment evaluation, companies are
required to perform an assessment of whether there is an indication that
goodwill is impaired as of the date of adoption. To accomplish this, companies
must identify their reporting units and determine the carrying value of each
reporting unit by assigning the assets and liabilities, including the existing
goodwill and intangible assets, to those reporting units as of January 1, 2002.
Companies have up to six months from January 1, 2002 to determine the fair value
of each reporting unit and compare it to the carrying amount of the reporting
unit. To the extent the carrying amount of a reporting unit exceeds the fair
value of the reporting unit, an indication exists that the reporting unit
goodwill may be impaired and the second step of the transitional impairment test
must be performed. The second step is required to be completed as soon as
possible, but no later than the end of the year of adoption. In the second step,
companies must compare the implied fair value of the reporting unit goodwill
with the carrying amount of the reporting unit goodwill, both of which would be
measured as of the date of adoption. The implied fair value of goodwill is
determined by allocating the fair value of the reporting unit to all of the
assets (recognized and unrecognized) and liabilities of the reporting unit in a
manner similar to a purchase price allocation, in accordance with SFAS No. 141.
The residual fair value after this allocation is the implied fair value of the
reporting unit goodwill. Any transitional impairment loss would be recognized as
the cumulative effect of a change in accounting principle in the Company's
Consolidated Statement of Operations. The Company completed the transitional
impairment test for its goodwill in the second quarter of 2002 and determined
that its goodwill was not impaired and therefore did not require the recognition
of any transitional impairment losses. At June 30, 2002, we had goodwill on our
consolidated balance sheet, net of accumulated amortization, totaling $44.0
million. Should we experience reductions in revenues and cash flows because our
business or market conditions vary from our current expectations, we may not be
able to realize the carrying value of goodwill and would be required to record a
charge for impairment.
Under the provisions of SFAS No. 144, which we adopted effective January 1,
2002, we review long-lived assets and certain identifiable intangible assets for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. When factors indicate that
an intangible or long-lived asset should be evaluated for possible impairment,
an estimate of the related asset's undiscounted future cash flows over the
remaining life of the asset will be made to measure whether the carrying value
is recoverable. Any impairment is measured based upon the excess of the carrying
value of the asset over its estimated fair value which is generally based on an
estimate of future discounted cash flows. At June 30, 2002, we had long-lived
assets consisting of furniture, fixtures and equipment and intangibles on our
consolidated balance sheet net of accumulated amortization and depreciation,
totaling $16.6 million. Should we experience reductions in revenues and cash
flows because our business or market conditions vary from our current
expectations, we may not be able to realize the carrying value of these assets
and will record an impairment charge at that time.
Valuation of Deferred Tax Assets. Income taxes are accounted for under the
asset and liability method. Deferred tax assets and liabilities are recognized
for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases and operating loss and tax credit carry forwards.
Deferred income tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred
income tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date. A valuation allowance is
established to the extent that it is more likely than not, that we will be
unable to utilize deferred income tax assets in the future.
Legal Contingencies. Our policy is to accrue for an estimated loss from a
legal contingency if both of the following conditions are met: (1) information
available prior to issuance of the financial statements indicates that it is
probable that a liability had been incurred or an asset had been impaired at the
date of the financial statements; and (2) the amount of loss can be reasonably
estimated. When there is no best point estimate of the loss and only a range of
loss is available, we accrue to the low end of the range. We have certain
significant legal and other contingencies as well as other litigation of a
nature considered normal to our business which are pending against us. As of
June 30, 2002, we have accrued approximately $4.4 million after considering any
insurance recoveries for the aggregate amount of such contingencies. Should our
actual payments resulting from the resolution of these contingencies differ from
amounts accrued, we could incur additional expense in future periods. (See Note
9 of Notes to Consolidated Condensed Financial Statements.)
Restructuring Reserves. As mentioned in Note 4 of our Consolidated Condensed
Financial Statements, we incurred restructuring charges during fiscal 2001.
Additionally, during the second quarter of 2002, it was also determined that we
would incur additional restructuring charges of approximately $1.4 million
relating to certain leased space as a result of revised estimates regarding the
timing of future possible sublease activities. At June 30, 2002, the
restructuring liabilities that remain total $5.0 million on our consolidated
balance sheets, all of which is for estimated future payments for rent in excess
of anticipated sublease income. Certain assumptions went into this estimate
including sublease income expected to be derived from these facilities. Should
we negotiate more favorable subleases or reach a settlement with our landlords
to be released from our existing obligations, we could realize a favorable
benefit to our results of future operations. Should future lease costs, in
excess of sublease income, if any, related to these facilities exceed our
estimates, we could incur additional expense in future periods.
17
As mentioned in Note 11 of our Consolidated Condensed Financial Statements,
in July 2002, the Company announced a restructuring of operations to provide
greater focus on partnerships and industry integration solutions for targeted
vertical markets. As part of this restructuring, the Company announced that it
would reduce its workforce by approximately 15%, or 90 employees, by December
31, 2002. As such, the Company expects to record a restructuring charge of
approximately $1.7 million in the three months ending September 30, 2002.
Restatement of the Quarter Ended March 31, 2000
In August 2000, the audit committee of our Board of Directors became aware
of questions concerning the accounting for certain expense items. The audit
committee initiated a review of these items and performed certain additional
procedures. As a result of these procedures, it was determined that certain
expenses were not properly recorded in the first and second quarters of 2000
and, accordingly, it was determined that the financial statements for the
quarter ended March 31, 2000 should be restated (the "Restatement"). The impact
of this Restatement on our results of operations for the three months ended
March 31, 2000 was to increase cost of revenues by $0.1 million, increase
operating expenses by $1.2 million, and increase the net loss by $1.6 million
from $9.9 million to $11.5 million. Mercator's fully diluted net loss per share
increased by ($0.06) from ($0.35) to ($0.41). In addition to restating earnings
for the quarter ended March 31, 2000, it was determined that the financial
results announced on July 20, 2000 for the quarter ended June 30, 2000 were
incorrect. As a result, the financial results included in the June 30, 2000 Form
10-Q are different from the results initially announced on July 20, 2000.
During the third and fourth quarters of 2000, we incurred certain expenses
either connected with the Restatement or to mitigate the effects of the
Restatement on our continuing operations. These expenses were incremental to
those expenses required to maintain normal levels of operations and we believe
such expenses would not have been incurred had the Restatement not occurred. The
incremental Selling and Marketing and General and Administrative costs were
approximately $1.6 million and $4.7 million, respectively, during the third and
fourth quarters of 2000. The Selling and Marketing costs relate to a special
commission incentive plan. The General and Administrative costs consisted
primarily of severance costs for the former CEO and CFO, the cost of
accelerating the vesting of options granted to our former CEO, legal costs
associated with securities litigation, and search fees to replace departed
executives. Incremental General and Administrative costs relating to the
Restatement were approximately $2.0 million during 2001, representing legal
costs associated with securities litigation and search fees to replace several
executives.
18
Results of Operations
The following table sets forth, for the periods indicated, the percentage
of total revenues represented by certain items from our statements of
operations:
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------- --------------------------------
2002 2001 2002 2001
-------------- -------------- -------------- --------------
Revenues:
Software licensing ........................... 40.4% 43.8% 37.6% 42.0%
Services ..................................... 25.6 27.5 27.3 29.8
Maintenance .................................. 34.0 28.7 35.1 28.2
-------------- -------------- -------------- --------------
Total revenues ........................... 100.0 100.0 100.0 100.0
-------------- -------------- -------------- --------------
Cost of revenues:
Software licensing ........................... 0.6 1.2 0.5 1.0
Services ..................................... 22.5 23.8 25.2 25.8
Maintenance .................................. 7.4 6.2 7.4 6.2
Stock option re-pricing (benefit) ............ (0.2) -- (0.6) --
Amortization of intangibles .................. 3.5 3.3 3.6 3.3
-------------- -------------- -------------- --------------
Total cost of revenues ................... 33.8 34.5 36.1 36.3
-------------- -------------- -------------- --------------
Gross profit ...................................... 66.2 65.5 63.9 63.7
-------------- -------------- -------------- --------------
Operating expenses:
Product development .......................... 19.4 17.9 17.9 18.1
Selling and marketing ........................ 44.1 57.6 43.9 58.1
General and administrative ................... 25.9 26.7 25.4 28.3
Stock option re-pricing (benefit) ............ (0.4) -- (1.4) --
Amortization of goodwill ..................... -- 18.9 -- 19.2
Amortization of intangibles .................. 0.7 1.2 0.9 1.2
Restructuring charges ........................ 4.9 17.9 1.9 9.1
-------------- -------------- -------------- --------------
Total operating expenses ................. 94.6 140.2 88.6 134.0
-------------- -------------- -------------- --------------
Operating loss .................................... (28.4) (74.7) (24.7) (70.3)
Other income (expense), net ....................... (0.3) 0.4 (0.3) 0.3
-------------- -------------- -------------- --------------
Loss before income taxes .......................... (28.7) (74.3) (25.0) (70.0)
Provision for income taxes ........................ 2.0 1.9 1.5 4.1
-------------- -------------- -------------- --------------
Net loss .......................................... (30.7)% (76.2)% (26.5)% (74.1)%
============== ============== ============== ==============
Gross profit exclusive of stock option re-
pricing (benefit) and amortization of intangibles:
Software licensing ........................... 98.6% 97.2% 98.6% 97.6%
Services ..................................... 12.1% 13.5% 7.7% 13.8%
Maintenance .................................. 78.3% 78.3% 79.0% 77.9%
Total .................................... 69.6% 68.8% 66.9% 67.0%
19
The Quarter Ended June 30, 2002 Compared with The Quarter Ended June 30, 2001
During the second quarter of 2002 we incurred a net (loss) of ($8.3)
million compared to a net (loss) of ($22.7) million in the second quarter of
2001. Effective January 1, 2002, the Company adopted SFAS No. 142 and
discontinued amortization of goodwill. On a comparable basis, the net (loss) as
adjusted to exclude goodwill amortization for the three-month periods ended June
30, 2002 and 2001 are as follows:
Three Months Ended
June 30,
------------------------------------------
2002 2001
------------------- -------------------
(In thousands)
Reported net (loss) .................... $ (8,274) $ (22,663)
Adjustment for goodwill amortization ... -- 5,627
------------ ------------
Net (loss), as adjusted ................ $ (8,274) $ (17,036)
============ ============
Our second quarter 2002 operating (loss) excluding non-cash stock option
re-pricing benefits, amortization of intangibles, and restructuring charges was
($5.4) million versus ($10.0) million in the second quarter of 2001. Gross
profit excluding non-cash stock option re-pricing benefits and amortization of
intangibles decreased from $20.4 million in the second quarter of 2001 to $18.8
million in the second quarter of 2002. Product development expenses decreased by
$0.1 million, selling and marketing expenses decreased by $5.3 million and
general and administrative expenses decreased by $0.9 million from the second
quarter of 2001 to 2002.
Revenues
Total Revenues. Our revenues are derived principally from three sources:
(i) license fees for the use of our software products; (ii) fees for consulting
services and training; and (iii) fees for maintenance and technical support.
Total revenues decreased 9% from $29.7 million for the three months ended June
30, 2001 to $27.0 million for the three months ended June 30, 2002. This
decrease resulted from decreased license and services revenues partially offset
by increased revenues for maintenance.
Software Licensing. Total software licensing revenues decreased 16% from
$13.0 million for the three months ended June 30, 2001 to $10.9 million for the
three months ended June 30, 2002 as a result of continued weak economic
conditions, delayed purchasing decisions by customers, and phased purchasing by
customers choosing to buy software in strategic increments rather than large
one-time purchases. From the second quarter of 2001 to 2002 we noted a 17%
increase in the number of license contracts exceeding $100,000, offset by a 25%
decrease in the average size of such contracts. Americas' software licensing
revenues decreased 26% from $9.9 million to $7.3 million, EMEA software
licensing revenues decreased 13% from $2.5 million to $2.1 million and APAC
software licensing revenues increased 109% from $0.7 million to $1.4 million.
Services. Total services revenues decreased 16% from $8.2 million for the
three months ended June 30, 2001 to $6.9 million for the three months ended June
30, 2002 due to a decrease in Americas services revenues primarily as a result
of the economic slowdown causing decreases in billable hours, average billing
rates, and reduced training revenues. We believe that these decreases are
related to earlier declines in license revenues beginning in January 2002. Lower
license revenues generally translate into reduced service opportunities.
Americas' services revenues decreased 31% from $4.7 million to $3.3 million,
EMEA services revenue increased 1% from $3.2 million to $3.3 million and APAC
services revenue increased 70% from $0.2 million to $0.4 million. As discussed
in Note 3 of the Notes to Consolidated Condensed Financial Statements, as a
result of our adoption of EITF Issue No. 01-14 effective January 1, 2002,
approximately $0.5 million and $0.6 million of out-of-pocket reimbursements are
included as services revenues for the three months ended June 30, 2002 and June
30, 2001, respectively.
Maintenance. Total maintenance revenues increased 7% from $8.5 million for
the three months ended June 30, 2001 to $9.2 million for the three months ended
June 30, 2002 primarily due to growth in the worldwide customer base, partially
offset by a decline in renewal rates of annual maintenance contracts as
customers reduce their technology spend. Lower license revenues produce both
lower initial and renewal maintenance revenues to be recognized in future
periods. Americas' maintenance revenues increased 2% from $5.5 million to $5.6
million, EMEA maintenance revenues increased 11% from $2.7 million to $3.0
million and APAC maintenance revenues increased 77% from $0.3 million to $0.5
million.
20
Cost of Revenues
Total Cost of Revenues. Cost of software licensing revenues consists
primarily of CD-ROMs, manuals, distribution costs and the royalty costs of
third-party software that we resell. Cost of services consists primarily of
personnel-related and travel costs in providing consulting and training to
customers, and occupancy costs. Cost of maintenance revenues consists primarily
of personnel-related and occupancy costs in providing maintenance and technical
support to customers. The non-cash stock option re-pricing benefit relates to
the November 2000 re-pricing of certain options previously granted to certain
service and maintenance personnel as described below. The intangibles
amortization expense relates to certain purchased intangible technology assets
in connection with the Braid acquisition in 1999 as described below. Total costs
of revenues decreased 11% from $10.3 million for the three months ended June 30,
2001 to $9.1 million for the three months ended June 30, 2002 primarily due to
the redeployment of idle services personnel to assist in sales activities and
product development projects in the Americas, partially offset by an increase in
EMEA compensation costs as a result of expansion into new markets.
Gross margin on software licensing revenues is higher than gross margins on
services and maintenance revenues reflecting the low materials, packaging and
other costs of software products compared with the relatively high personnel
costs associated with providing consulting and training services, maintenance
and technical support. Cost of services also varies based upon the mix of
consulting and training services. Total gross margins remained essentially flat
at 66% for the three months ended June 30, 2002 and 2001. Total gross margins,
excluding the impact of the non-cash stock option re-pricing benefit and
intangibles amortization, were $18.8 million (70%) for the three months ended
June 30, 2002 compared to $20.4 million (69%) for the three months ended June
30, 2001.
Cost of Software Licensing. Total software licensing costs decreased 58%
from $0.4 million for the three months ended June 30, 2001 to $0.2 million for
the three months ended June 30, 2002 due to the decrease in software licensing
revenues and related royalty expenses. Software licensing gross margin increased
from 97% to 99% for the three months ended June 30, 2001 and 2002, respectively.
Cost of Services exclusive of Non-Cash Stock Option Re-Pricing Benefits.
Total services costs decreased 14% from $7.1 million for the three months ended
June 30, 2001 to $6.1 million for the three months ended June 30, 2002 as a
result of decreases in compensation and travel costs in Americas due to
headcount reductions and the redeployment of idle services personnel to assist
in product development projects, partially offset by increases in EMEA
compensation costs as a result of the expansion of staff to service new markets
in the latter half of 2001 and beginning of 2002. Total services gross margin
decreased from 14% for the three months ended June 30, 2001 to 12% for the three
months ended June 30, 2002 as a result of the 16% decrease in services revenues
in conjunction with an increase in EMEA services costs, partially offset by
decreases in Americas' services costs. Americas' services costs decreased 40%
from $4.4 million for the three months ended June 30, 2001 to $2.7 million for
the three months ended June 30, 2002, resulting in an increase in services gross
margin from 6% for the three months ended June 30, 2001 to 18% for the three
months ended June 30, 2002. EMEA services costs increased 32% from $2.4 million
for the three months ended June 30, 2001 to $3.1 million for the three months
ended June 30, 2002. EMEA services gross margin decreased from 28% for the three
months ended June 30, 2001 to 5% for the three months ended June 30, 2002. APAC
services costs remained constant at $0.3 million for the three months ended June
30, 2002 and 2001.
Cost of Maintenance exclusive of Non-Cash Stock Option Re-Pricing Benefits.
Total maintenance costs increased marginally by $0.1 million from $1.9 million
for the three months ended June 30, 2001 to $2.0 million for the three months
ended June 30, 2002. Total maintenance gross margin remained constant at 78% for
the three months ended June 30, 2002 and 2001. Americas' maintenance costs
increased 17% from $1.1 million for the three months ended June 30, 2001 to $1.3
million for the three months ended June 30, 2002 due to severance costs in 2002.
America's maintenance gross margins decreased from 80% for the three months
ended June 30, 2001 to 77% for the three months ended June 30, 2002. EMEA
maintenance costs decreased 4% from $0.7 million for the three months ended June
30, 2001 to $0.6 million for the three months ended June 30, 2002, and
maintenance gross margins increased from 76% for the three months ended June 30,
2001 to 79% for the three months ended June 30, 2002. APAC maintenance costs
remained constant at $0.1 million for the three months ended June 30, 2002 and
2001.
Stock Option Re-Pricing Benefit. In November 2000, our Board of Directors
approved the exchange of 615,465 options granted in September 2000 for an equal
amount of options (the replacement options) priced at the then current market
price of $5.06 per share. As this was a reduction in the exercise prices of
fixed stock option awards, the replacement options are subject to variable
accounting from the date of modification to the date on which the awards are
exercised, forfeited, or expire unexercised in accordance with FASB
Interpretation No. ("FIN") 44 "Accounting for Certain Transactions Involving
Stock Compensation" and FIN 28 "Accounting for Stock Appreciation Rights and
Other Variable Stock Option or Award Plans". At June 30, 2002, 306,942 re-priced
options were outstanding. We recorded a small variable non-cash compensation
benefit for the three months ended June 30, 2002 for such re-priced options
granted to personnel generating services and maintenance revenues. We also
recorded a variable non-cash compensation benefit of $0.1 million for the three
months
21
ended June 30, 2002 for the re-priced options related to operating personnel
(see below). There was no stock option re-pricing charge or benefit for the
three months ended June 30, 2001.
Amortization of Intangibles. Amortization of intangible assets remained
constant at $1.0 million for the three months ended June 30, 2002 and 2001. The
expense is related to the Braid business combination completed in 1999, which
was accounted for using the purchase method of accounting. We had net purchased
technology intangibles of $6.4 million and $10.3 million at June 30, 2002 and
2001, respectively.
In accordance with Statement of Financial Accounting Standards ("SFAS") No.
86, "Accounting for the Costs of Computer Software to Be Sold", amortization
relating to capitalized software costs has been charged to cost of revenues, and
amortization relating to other intangible assets is being classified as a
component of operating expenses.
Operating Expenses
Total Operating Expenses. Total operating expenses decreased 39% from $41.7
million for the three months ended June 30, 2001 to $25.5 million for the three
months ended June 30, 2002. This decrease is attributable to (i) a $5.6 million
decrease in goodwill amortization due to our adoption of SFAS No. 142 effective
January 1, 2002, which requires us to discontinue amortization of goodwill;
(ii) a net $5.2 million decrease in sales and marketing expenses primarily
representing reductions in staff and related expenses in the Americas and EMEA
initiated as part of our fiscal year 2001 restructuring activities; (iii) a
decrease in restructuring charges as we recorded a charge of $5.3 million for
both personnel and leased space reductions in the three months ended June 30,
2001 as compared to a charge of $1.4 million for unoccupied leased space offset
by a $0.1 million severance reversal in the three months ended June 30, 2002
(See Note 4 of Notes to Consolidated Condensed Financial Statements); and
(iv) a net $0.9 million reduction in general and administrative expenses.
Product Development exclusive of Non-Cash Stock Option Re-Pricing Benefits.
Product development expenses include expenses associated with the development of
new products and enhancements to existing products. These expenses consist
primarily of salaries, recruiting, and other personnel-related costs,
depreciation of development equipment, supplies, travel, allocated facilities
and allocated communication costs.
Product development expenses decreased slightly from $5.3 million for the
three months ended June 30, 2001 to $5.2 million for the three months ended June
30, 2002. A 7% decrease due to a reduction in the use of subcontractors, and
decreases in various other expense categories was mostly offset by increased
compensation costs relating to the redeployment of certain idle services
personnel to work on various product development projects. We believe that a
significant level of research and development expenditures is required to remain
competitive. Accordingly, we expect to continue to devote substantial resources
to research and development. To date, all research and development expenditures
have been expensed as incurred.
Selling and Marketing exclusive of Non-Cash Stock Option Re-Pricing
Benefits. Selling and marketing expenses consist of third party marketing
agreement commissions, sales and marketing personnel costs, including sales
commissions, recruiting, travel, advertising, public relations, seminars, trade
shows, product literature, and allocated facilities and communications costs.
Selling and marketing expenses decreased 31% from $17.1 million for the
three months ended June 30, 2001 to $11.9 million for the three months ended
June 30, 2002 primarily due to sales staff reductions in the Americas and EMEA
from June 30, 2001 to June 30, 2002. These reductions are the result of a shift
in our sales strategy from increasing the number of sales personnel to relying
more heavily on systems integrators and technology partners who resell, embed or
bundle our software and industry integration solutions. This decrease is
partially offset by increases in APAC selling and marketing expenses due to
market expansion activities. Americas' selling and marketing expenses decreased
22% from $9.9 million for the three months ended June 30, 2001 to $7.7 million
for the three months ended June 30, 2002 due to sales staff reductions resulting
in a $0.8 million decrease in compensation costs and related reductions in
occupancy, travel and training costs of $1.1 million, a decrease of $0.7 million
in marketing events due to expense management, partially offset by an increase
of $0.5 million in third party sales commissions. EMEA selling and marketing
expenses decreased 48% from $6.9 million for the three months ended June 30,
2001 to $3.6 million for the three months ended June 30, 2002 due to sales staff
reductions resulting in decreases in compensation of $2.0 million and related
reductions in occupancy, travel and training. APAC selling and marketing
expenses increased 80% from $0.3 million for the three months ended June 30,
2001 to $0.6 million for the three months ended June 30, 2002 primarily due to
market expansion activities.
General and Administrative exclusive of Non-Cash Stock Option Re-Pricing
Benefits. General and administrative expenses consist primarily of salaries,
recruiting, and other personnel related expenses for our administrative,
executive, and finance personnel as well as outside legal, consulting, tax
services and audit fees.
22
General and administrative expenses decreased 12% from $7.9 million for the
three months ended June 30, 2001 to $7.0 million for the three months ended
June 30, 2002 primarily due to improved expense management. Americas' general
and administrative expenses decreased 39% from $6.8 million for the three months
ended June 30, 2001 to $4.1 million for the three months ended June 30, 2002
primarily due to lower consulting fees of $0.8 million, lower legal and
recruiting expenses, and lower personnel costs as a result of second and third
quarter 2001 restructuring activities. EMEA general and administrative expenses
increased by $1.7 million from $0.7 million for the three months ended June 30,
2001 to $2.4 million for the three months ended June 30, 2002 due primarily to
the expansion of EMEA's management and infrastructure to support the sales
offices. APAC general and administrative expenses were unchanged at $0.4 million
for both the three months ended June 30, 2002 and 2001, respectively.
Amortization of Goodwill and Intangibles. Amortization of intangible assets
and goodwill decreased by $5.8 million from $6.0 million for the three months
ended June 30, 2001 to $0.2 million for the three months ended June 30, 2002. As
noted above, this decrease over prior year quarter is primarily due to our
adoption of SFAS No. 142 effective January 1, 2002, which requires us to
discontinue goodwill amortization.
Stock Option Re-Pricing Benefit. As discussed above, we recorded a variable
non-cash compensation benefit of $0.1 million during the second quarter of 2002
related to the re-pricing of certain fixed stock option awards previously
granted to certain product development, sales and marketing and general and
administrative employees in November of 2000. There was no stock option
re-pricing charge or benefit in the second quarter of 2001.
Restructuring Charges. The restructuring charge of $1.3 million for the
three months ended June 30, 2002 consists of a $1.4 million increase in our
Americas restructuring accrual for unoccupied lease space based on revised
estimates for the commencement of future possible sublease activities, offset by
a $0.1 million reversal of Americas restructuring reserve accruals for severance
recorded in 2001. At June 30, 2002, $3.5 million of the unpaid restructuring
liability was included in accrued expenses and other current liabilities and
$1.5 million was included in other long-term liabilities. There was a $5.3
million restructuring charge in the second quarter of 2001 consisting of a $2.4
million charge for severance and a $2.9 million charge for unoccupied lease
space. (See Note 4 of Notes to Consolidated Condensed Financial Statements.)
Other Income (Expense), Net
Net other income (expense) represents interest income earned on cash and
marketable securities balances and term license contracts, offset by borrowing
costs related to certain contractual obligations.
Net other income (expense) was ($0.1) million for the three months ended
June 30, 2002 as compared to income of $0.1 million for the three months ended
June 30, 2001 primarily due to fees incurred in connection with our credit
facility with Silicon Valley Bank ("SVB").
Income Taxes
The provision for income taxes was $0.5 million for the three months ended
June 30, 2002 as compared to $0.6 million for the three months ended June 30,
2001. The provision for income taxes is based on the anticipated effective tax
rates and taxable income for the full year taking into account each jurisdiction
in which we operate. During the second quarter of 2001 we determined that
taxable income for the full year of 2001 was unlikely to be sufficient to
support the full value of the federal deferred tax asset. Consequently, our tax
provision includes a full valuation reserve for that asset.
The Six Months Ended June 30, 2002 Compared with The Six Months Ended June 30,
2001
During the six months ended June 30, 2002 we incurred a net (loss) of
($14.4) million compared to a net (loss) of ($43.4) million during the six
months ended June 30, 2001. Effective January 1, 2002, the Company adopted SFAS
No. 142 and discontinued amortization of goodwill. On a comparable basis, the
net (loss) as adjusted to exclude goodwill amortization for the six-month
periods ended June 30, 2002 and 2001 are as follows:
Six Months Ended
June 30,
-----------------------------------------
2002 2001
------------------- ------------------
(In thousands)
Reported net (loss) ............................ $ (14,387) $ (43,351)
Adjustment for goodwill amortization ........... -- 11,253
------------------- -------------------
Net (loss), as adjusted ........................ $ (14,387) $ (32,098)
=================== ===================
23
For the six months ended June 30, 2002, our operating (loss) excluding
non-cash stock option re-pricing benefits, amortization of intangibles, and
restructuring charges was ($11.0) million versus ($21.9) million for the six
months ended June 30, 2001. Gross profit excluding non-cash stock option
re-pricing benefits and amortization of intangibles decreased from $39.2 million
for the six months ended June 30, 2001 to $36.4 million for the six months ended
June 30, 2002. Product development expenses decreased by $0.8 million, selling
and marketing expenses decreased by $10.1 million and general and administrative
expenses decreased by $2.7 million from the first half of 2001 to the first half
of 2002.
Revenues
Total Revenues. Total revenues decreased 7% from $58.5 million for the six
months ended June 30, 2001 to $54.4 million for the six months ended June 30,
2002. This decrease resulted from decreased license and services revenues
partially offset by increased revenues for maintenance.
Software Licensing. Total software licensing revenues decreased 17% from
$24.5 million for the six months ended June 30, 2001 to $20.4 million for the
six months ended June 30, 2002 as a result of continued weak economic
conditions, delayed purchasing decisions by customers, and phased purchasing by
customers choosing to buy software in strategic increments rather than large
one-time purchases. From the first half of 2001 to 2002 we noted a 10% increase
in the number of license contracts exceeding $100,000, offset by a 17% decrease
in the average size of such contracts. Americas' software licensing revenues
decreased 25% from $16.5 million to $12.3 million, EMEA software licensing
revenues decreased 21% from $7.1 million to $5.6 million and APAC software
licensing revenues increased by $1.6 million from $0.9 million to $2.5 million.
Services. Total services revenues decreased 15% from $17.5 million for the
six months ended June 30, 2001 to $14.9 million for the six months ended June
30, 2002 due to decreases in Americas and EMEA services revenues primarily as a
result of the economic slowdown causing decreases in both billable hours and
reduced training revenues. We believe that these decreases are related to
earlier declines in license revenues beginning in January 2002. Lower license
revenues generally translate into reduced service opportunities. Americas'
services revenues decreased 16% from $9.5 million to $8.0 million, EMEA services
revenue decreased 16% from $7.4 million to $6.2 million and APAC services
revenue increased $0.1 million from $0.5 million to $0.6 million. As discussed
in Note 3 of the Notes to Consolidated Condensed Financial Statements, as a
result of our adoption of EITF Issue No. 01-14 effective January 1, 2002,
approximately $0.9 million and $1.2 million of out-of-pocket reimbursements are
included as services revenues for the six months ended June 30, 2002 and June
30, 2001, respectively.
Maintenance. Total maintenance revenues increased 16% from $16.5 million
for the six months ended June 30, 2001 to $19.1 million for the six months ended
June 30, 2002 primarily due to growth in the worldwide customer base, partially
offset by a decline in renewal rates of annual maintenance contracts as
customers reduce their technology spend. Lower license revenues produce both
lower initial and renewal maintenance revenues to be recognized in future
periods. Americas' maintenance revenues increased 14% from $10.6 million to
$12.0 million, EMEA maintenance revenues increased 14% from $5.3 million to $6.1
million and APAC maintenance revenues increased 67% from $0.6 million to $0.9
million.
Cost of Revenues
Total Cost of Revenues. Total costs of revenues decreased 8% from $21.2
million for the six months ended June 30, 2001 to $19.6 million for the six
months ended June 30, 2002 due to decreased costs associated with lower license
revenues, reductions in services personnel and consulting, and a non-cash stock
option re-pricing benefit, partially offset by increases in the costs associated
with higher maintenance revenues.
Total gross margins remained constant at 64% for the six months ended June
30, 2002 and 2001. Total gross margins, excluding the impact of the non-cash
stock option re-pricing benefit and intangibles amortization, were $36.4 million
(67%) for the six months ended June 30, 2002 compared to $39.2 million (67%) in
2001.
Cost of Software Licensing. Total software licensing costs decreased 54%
from $0.6 million for the six months ended June 30, 2001 to $0.3 million for the
six months ended June 30, 2002 due to the decrease in software licensing
revenues and related royalty expenses. Software licensing gross margin increased
slightly from 98% to 99% for the six months ended June 30, 2001 and 2002,
respectively.
Cost of Services exclusive of Non-Cash Stock Option Re-Pricing Benefits.
Total services costs decreased 9% from $15.1 million for the six months ended
June 30, 2001 to $13.7 million for the six months ended June 30, 2002 as a
result of decreases in compensation and travel costs in Americas due to
headcount reductions and the redeployment of idle services personnel to assist
in product development projects, partially offset by increases in EMEA
compensation costs. Total services gross margin decreased from 14% for the six
months ended June 30, 2001 to 8% for the six months ended June 30, 2002 as a
result of the 15% decrease in services revenues in conjunction with an increase
in EMEA services costs, partially offset by decreases in Americas' services
costs. Americas' services costs decreased 19%
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from $9.1 million for the six months ended June 30, 2001 to $7.3 million for the
six months ended June 30, 2002. Americas' services gross margin increased
slightly from 5% for the six months ended June 30, 2001 to 8% for the six months
ended June 30, 2002. EMEA services costs increased 9% from $5.3 million for the
six months ended June 30, 2001 to $5.8 million for the six months ended June 30,
2002 as a result of the expansion of staff to service new markets in the latter
half of 2001 and beginning of 2002. EMEA services gross margin decreased from
29% for the six months ended June 30, 2001 to 7% for the six months ended June
30, 2002 as a result of the decrease in services revenues and increase in
services costs. APAC services costs decreased 13% from $0.7 million for the six
months ended June 30, 2001 to $0.6 million for the six months ended June 30,
2002.
Cost of Maintenance exclusive of Non-Cash Stock Option Re-Pricing Benefits.
Total maintenance costs increased 10% from $3.6 million for the six months ended
June 30, 2001 to $4.0 million for the six months ended June 30, 2002 to support
the increase in the worldwide customer base. Total maintenance gross margin
increased from 78% for the six months ended June 30, 2001 to 79% for the six
months ended June 30, 2002. Americas' maintenance costs increased 15% from $2.2
million for the six months ended June 30, 2001 to $2.5 million for the six
months ended June 30, 2002. America's maintenance gross margins decreased
slightly from 80% for the six months ended June 30, 2001 to 79% for the six
months ended June 30, 2002. EMEA maintenance costs remained unchanged at $1.3
million for the six months ended June 30, 2001 and 2002, and maintenance gross
margins increased from 75% for the six months ended June 30, 2001 to 78% for the
six months ended June 30, 2002. APAC maintenance costs remained constant at $0.2
million for the six months ended June 30, 2002 and 2001 with maintenance gross
margins increasing from 73% for the six months ended June 30, 2001 to 78% for
the six months ended June 30, 2002.
Stock Option Re-Pricing Benefit. We recorded a $0.3 million variable
non-cash compensation benefit for the six months ended June 30, 2002 for
re-priced options granted to personnel generating services and maintenance
revenues. We also recorded a variable non-cash compensation benefit of $0.7
million for the six months ended June 30, 2002 for the re-priced options related
to operating personnel (see below). There was no stock option re-pricing charge
or benefit for the six months ended June 30, 2001.
Amortization of Intangibles. Amortization of intangible assets remained
constant at $1.9 million for the six months ended June 30, 2002 and 2001.
Operating Expenses
Total Operating Expenses. Total operating expenses decreased 38% from $78.3
million for the six months ended June 30, 2001 to $48.2 million for the six
months ended June 30, 2002. This decrease is attributable to (i) an $11.3
million decrease in goodwill amortization due to our adoption of SFAS No. 142
effective January 1, 2002, which requires us to discontinue amortization of
goodwill; (ii) a net $10.1 million decrease in sales and marketing expenses
primarily representing reductions in staff and related expenses in the Americas
and EMEA initiated as part of our fiscal year 2001 restructuring activities;
(iii) a decrease in restructuring charges as we recorded a charge of $5.3
million for both personnel and leased space reductions in the six months ended
June 30, 2001, as compared to a net charge of $1.1 million for the six months
ended June 30, 2002 which is comprised of certain additional unoccupied leased
space accruals, partially offset by reversals of severance and certain other
leased space accruals recorded in 2001 (See Note 4 of Notes to Consolidated
Condensed Financial Statements); and (iv) a net $2.7 million reduction in
general and administrative expenses.
Product Development exclusive of Non-Cash Stock Option Re-Pricing Benefits.
Product development expenses decreased 8% from $10.6 million for the six months
ended June 30, 2001 to $9.7 million for the six months ended June 30, 2002 due
to reductions in the use of subcontractors and decreased occupancy costs,
partially offset by increased compensation costs relating to the redeployment of
certain idle services personnel to work on various product development projects.
Selling and Marketing exclusive of Non-Cash Stock Option Re-Pricing
Benefits. Selling and marketing expenses decreased 30% from $34.0 million for
the six months ended June 30, 2001 to $23.8 million for the six months ended
June 30, 2002. This was primarily due to sales staff reductions in the Americas
and EMEA from June 30, 2001 to June 30, 2002, as a result of the shift in our
sales strategy from increasing the number of sales personnel to relying more
heavily on systems integrators and technology partners who resell, embed or
bundle our software and industry integration solutions. This decrease is
partially offset by an increase in APAC selling and marketing expenses due to
geographical market expansion activities. Americas' selling and marketing
expenses decreased 31% from $20.3 million for the six months ended June 30, 2001
to $14.0 million for the six months ended June 30, 2002 due to sales staff
reductions resulting in a $2.8 million decrease in compensation costs and
related reductions in occupancy, travel, training and recruiting costs of
$2.6 million, a decrease of $0.7 million in marketing events due to expense
management, partially offset by an increase of $0.5 million in third party sales
commissions. EMEA selling and marketing expenses decreased 35% from
$12.9 million for the six months ended June 30, 2001 to $8.4 million for the six
months ended June 30, 2002 due to sales staff reductions resulting in decreases
in a number of categories, including
25
compensation and related occupancy, travel, and recruiting costs. APAC selling
and marketing expenses increased 80% from $0.8 million for the six months ended
June 30, 2001 to $1.4 million for the six months ended June 30, 2002 primarily
due to market expansion activities.
General and Administrative exclusive of Non-Cash Stock Option Re-Pricing
Benefits. General and administrative expenses decreased 16% from $16.5 million
for the six months ended June 30, 2001 to $13.8 million for the six months ended
June 30, 2002 primarily due to improved expense management. Americas' general
and administrative expenses decreased 32% from $13.4 million for the six months
ended June 30, 2001 to $9.2 million for the six months ended June 30, 2002
primarily due to lower personnel costs of $1.1 million as a result of second and
third quarter 2001 restructuring activities, reductions in consulting fees of
$1.5 million due to expense management actions, and lower recruiting costs as
the new management team was in place as of January 1, 2002. EMEA general and
administrative expenses increased 73% from $2.2 million for the six months ended
June 30, 2001 to $3.8 million for the six months ended June 30, 2002 primarily
due to the expansion of EMEA's management and infrastructure to support the
sales offices. APAC general and administrative expenses decreased slightly from
$0.9 million for the six months ended June 30, 2001 to $0.8 million for the six
months ended June 30, 2002.
Amortization of Goodwill and Intangibles. Amortization of intangible assets
and goodwill decreased by $11.5 million from $12.0 million for the six months
ended June 30, 2001 to $0.5 million for the six months ended June 30, 2002. As
noted above, this decrease over prior year quarter is primarily due to our
adoption of SFAS No. 142 effective January 1, 2002, which requires us to
discontinue goodwill amortization.
Stock Option Re-Pricing Benefit. As discussed above, we recorded a variable
non-cash compensation benefit of $0.7 million during the first half of 2002
related to the re-pricing of certain fixed stock option awards previously
granted to certain product development, sales and marketing and general and
administrative employees in November of 2000. There was no stock option
re-pricing charge or benefit in the first half of 2001.
Restructuring Charges. The restructuring charge of $1.1 million for the six
months ended June 30, 2002 consists of a $1.4 million increase in our Americas
restructuring accrual for unoccupied lease space based on revised estimates for
the commencement of future possible sublease activities, offset by a $0.1
million reversal of Americas restructuring reserve accruals related to severance
and a $0.2 million reversal of EMEA restructuring reserve accruals related to
leased space. There was a $5.3 million restructuring charge in the first half of
2001 consisting of a $2.4 million charge for severance and a $2.9 million charge
for unoccupied lease space. (See Note 4 of Notes to Consolidated Condensed
Financial Statements.)
Other Income (Expense), Net
Net other income (expense) was ($0.1) million for the six months ended June
30, 2002 as compared to income of $0.2 million for the six months ended June 30,
2001 primarily due to fees incurred in connection with our credit facility with
SVB.
Income Taxes
The provision for income taxes was $0.8 million for the six months ended
June 30, 2002 as compared to $2.4 million for the six months ended June 30,
2001. The provision for income taxes is based on the anticipated effective tax
rates and taxable income for the full year taking into account each jurisdiction
in which we operate. During the second quarter of 2001 we determined that
taxable income for the full year of 2001 was unlikely to be sufficient to
support the full value of the federal deferred tax asset. Consequently, our tax
provision includes a full valuation reserve for that asset.
Liquidity and Capital Resources
Our cash and cash equivalents decreased by $0.9 million to $27.3 million at
June 30, 2002 from $28.2 at December 31, 2001 primarily due to cash flow used in
operations of $4.7 million and purchases of software and computer equipment of
$1.5 million, offset by (i) $3.0 million reclassified from restricted
non-current assets as a result of an amended credit agreement (See Note 9 of
Notes to Consolidated Condensed Financial Statements); (ii) $1.8 million in
proceeds from the exercise of employee stock options, warrants and purchases of
stock under the ESPP; and (iii) $1.5 million from financing of certain fiscal
2002 annual insurance premiums. As compared with June 30, 2001, our cash and
cash equivalents increased $21.2 million from $6.2 million at June 30, 2001
primarily as a result of proceeds realized from the sale of Common Stock through
a private placement completed in December of 2001, which resulted in net
proceeds of approximately $14.5 million.
Operating Activities
Operating activities consumed cash of $4.7 million during the six months
ended June 30, 2002 compared to consuming
26
cash of $13.2 million during the six months ended June 30, 2001. We were able to
reduce substantially our operating cash burn in 2002 as compared to 2001
through: (i) restructuring activities which began in the second quarter of 2001
that included an approximate 29% reduction in the consolidated workforce and a
reorganization of our sales efforts; (ii) expense management efforts; and (iii)
continued improvements in accounts receivable collections resulting in a
decrease in the number of days sales outstanding in net accounts receivable from
93 days at June 30, 2001 to 69 days at June 30, 2002. However, cash flow used in
operations for the three months ended June 30, 2002 increased to $4.0 million
from $649,000 in the three months ended March 31, 2002 primarily due to (i) an
increase in our quarterly net loss from $6.1 million in the first quarter to
$8.3 million in the second quarter; and (ii) a $1.3 million increase in our net
accounts receivable at June 30, 2002 as compared to March 31, 2002, as revenues
were flat sequentially in 2002 at $27.4 million and $27.0 million for the three
months ended March 31, 2002 and June 30, 2002, respectively, as compared to a
level of $34.0 million for the three months ended December 31, 2001, and
therefore significant benefits from receivables collections in the first quarter
of 2002 were non-recurring in the second quarter of 2002. These changes were
partially offset by increases in our accrued expenses and other current
liabilities.
Net accounts receivable decreased 29% from $29.0 million at December 31,
2001 to $20.5 million at June 30, 2002 as a result of the decrease in revenues
discussed above, as well as improved collections. The number of days sales in
net accounts receivable decreased from 75 days at December 31, 2001 to 69 days
at June 30, 2002 as we continued to improve our collection efforts. The
allowance for doubtful accounts decreased from $3.9 million at December 31, 2001
to $2.2 million at June 30, 2002 due primarily to a $1.9 million dollar
write-off against the allowance related to the settlement of a legal matter in
the first quarter of 2002.
Current liabilities increased 3% from $51.0 million at December 31, 2001 to
$52.6 million at June 30, 2002. Accounts payable decreased 10% from $7.6 million
to $6.9 million due to the timing of payments. Accrued expenses and other
current liabilities increased 21% from $21.1 million to $25.4 million due
primarily to the financing of certain insurance premiums resulting in current
notes payable balances of $1.4 million at June 30, 2002, a $0.9 million increase
in legal accruals, and to a lesser extent, increases in accruals relating to
rent, software purchases, and third party commissions. These increases were
partially offset by a $1.1 million decrease in accrued compensation costs.
Current portion of deferred revenue decreased 9% from $22.3 million to $20.3
million due primarily to the recognition of approximately $1.3 million in
license revenue, which was deferred at year-end 2001.
Our short-term operating commitments include operating lease payments over
the next twelve months of approximately $7 million, including approximately $2
million for certain office space in Wilton, CT, which we do not occupy. Should
we negotiate an early termination of this lease, our quarterly cash flows may be
impacted. While the Company is seeking to enter into a sublease agreement
relating to this facility, if we are unable to enter into a sublease agreement
for this space by June 30, 2003, we may need to record an additional charge for
estimated future rent payments required to be made by the Company until such
time as the space is sublet.
As of June 30, 2002, we have accruals of $4.4 million, after considering
insurance recoveries, related to costs associated with outstanding legal
contingencies. A significant increase in the estimate of the cost of settlement
of these contingencies could have a material adverse effect on our consolidated
financial position or results of operations. In addition, we may be required to
make cash payments, which would decrease our cash and cash equivalents.
As discussed above, we used cash flow of $4.7 million in our operations in
the six months ended June 30, 2002. As a result of our lower than anticipated
revenues and our decision to supplement our direct sales force with greater
reliance on third parties' sales forces, we determined in July 2002 to reduce
our global workforce by approximately 15% (approximately 90 positions) by the
end of 2002, primarily in the areas of sales and professional services. The cost
savings from these workforce reductions will be partially offset by greater
partner referral commissions in connection with our reliance on third party
sales forces. We expect to record a charge of approximately $1.7 million in the
third quarter of 2002 for severance payments. We anticipate that if a recovery
in information technology integration spending does not occur by the end of the
fourth quarter of 2002, and we are unable to grow our revenues on a sequential
basis, we may continue to utilize cash in our operations, excluding the impact
of potential cash payments for the contingencies discussed in Note 9 of the
Notes to the Consolidated Condensed Financial Statements.
Investing Activities
Investing activities provided cash of $1.4 million during the six months
ended June 30, 2002 compared to consuming cash of $1.0 million during the six
months ended June 30, 2001. Investing activities for the first half of 2002
included a $1.5 million net investment in furniture, fixtures, software and
equipment, offset by a net $2.9 million decrease in restricted collateral
deposits as discussed below. Investing activities in the first half of 2001
included a $2.9 million net investment in furniture, fixtures and equipment, a
$1.5 million increase in the restricted collateral deposit in connection with a
facility lease, partially offset by a $3.4 million liquidation of investments in
marketable securities.
Our expenditures for furniture, fixtures, software and equipment are
expected to be approximately $5 million for the next twelve months, including
approximately $1 million to implement a new enterprise relationship management
system. In
27
addition, notes payable and capital lease commitments over the next twelve
months are approximately $2 million.
Financing Activities
Financing activities generated cash of $2.8 million during the six months
ended June 30, 2002 compared to $3.8 million during the six months ended June
30, 2001. Financing activities for the first half of 2002 included $1.5 million
of borrowings related to the financing of certain insurance premiums, $1.1
million of proceeds from employee stock plan purchases, $0.7 million of proceeds
from the exercise of employee stock options and $0.1 million of proceeds from
the exercise of stock purchase warrants, partially offset by $0.1 million of
financed insurance premium principal payments, $0.3 million of capital lease
principal payments and $0.2 million of expenses relating to our December 2001
private placement issuance of stock to certain investors. Financing activities
for the first half of 2001 included $1.6 million in net proceeds from the
private placement issuance of stock to Mitsui and Co., Ltd., $1.4 million of
proceeds from employee stock plan purchases, $0.7 million of borrowings related
to the financing of certain insurance premiums, $0.2 million of proceeds from
the exercise of employee stock options and $0.2 million of proceeds from the
exercise of stock purchase warrants, partially offset by $0.2 million of capital
lease principal payments.
In June 2000, we obtained a $1.2 million letter of credit from Fleet Bank
in connection with a new headquarters office lease. At Fleet Bank's request we
provided a $1.5 million restricted collateral deposit as security for the
outstanding letter of credit. In January 2001, we increased the letter of credit
to $2.5 million and the related restricted collateral deposit to $3.0 million.
This letter of credit was terminated in June 2002 and replaced with a letter of
credit for a similar amount with SVB as discussed below.
In June 2001, we finalized a credit facility with SVB. The maximum amount
available under the facility is $15.0 million, of which up to $4.0 million may
be used for letters of credit pursuant to an amendment in June 2002. As of June
30, 2002, a $2.5 million letter of credit was outstanding under the facility and
is secured by $4.0 million of domestic accounts receivable. In addition, as of
June 30, 2002, the maximum eligible accounts receivable for borrowings, which
exclude the aforementioned accounts receivable securing the letter of credit,
were approximately $14 million. Borrowings may not exceed 80% of eligible
accounts receivable, as defined in the credit facility agreement and are subject
to bank approval. Borrowings are also subject to the Company maintaining
compliance with the terms of the facility. The agreement, as amended in June
2002, requires that the Company maintain a ratio of eligible domestic accounts
receivable to outstanding letters of credit of 1.6 to 1.0. The Adjusted Quick
Ratio, as also amended in June 2002, requires the Company to maintain a ratio of
1.3 to 1.0 for June 2002, 1.25 to 1.0 for July 2002, and 1.5 to 1.0 thereafter
through the expiration date of the facility on November 27, 2002. The Company
was in compliance with both ratios as of June 30, 2002. The Company is seeking
to amend the Adjusted Quick Ratio for periods subsequent to July 2002.
Upon the expiration of the agreement relating to the facility, or upon a
default in the agreement, the Company will be required to place cash in a
restricted account for up to 105% of the amounts of outstanding letters of
credit, which would result in a reclassification of such amounts from cash into
long-term assets in the consolidated balance sheet. In addition, such default
could result in SVB terminating the credit facility and our being required to
pay a $0.2 million termination fee. Since inception, excluding the
aforementioned letter of credit, no borrowings have been made under this
facility. Prior to November 27, 2002, we expect to seek to renegotiate the
facility to extend it beyond its scheduled termination or, alternatively, seek
to negotiate a similar facility with another party on no less favorable terms.
Cash Flow and Funding Requirements
We believe that current cash and cash equivalent balances ($27.3 million at
June 30, 2002), without regard to our SVB credit facility, will be sufficient to
meet our needs associated with cash shortfalls in any one quarter and are
sufficient to meet anticipated needs for working capital, capital expenditures
of approximately $5 million, and notes payable and capital lease commitments of
approximately $2 million through June 30, 2003. However, any projections of
future cash needs and cash flows are subject to uncertainty. A significant
increase in the cost of satisfying legal contingencies in excess of amounts
accrued and insurance coverages could have a material adverse impact on our
consolidated financial position or consolidated results of operations. Our
long-term capital needs will depend on numerous factors, including the rate at
which we are able to obtain new business from clients and expand our personnel
and infrastructure to accommodate such growth, as well as the rate at which we
choose to invest in new technologies. (See "Factors that May Affect Future
Results" below.)
If current cash, cash equivalents, cash that may be generated from
operations and any then available credit facility are deemed to be insufficient
to satisfy our liquidity requirements, we will likely seek to sell additional
equity securities and/or debt securities. Moreover, we may determine to sell
additional equity for the purpose of enhancing our cash resources. The sale of
additional equity or equity-related securities, if achieved, would result in
additional dilution to our stockholders. In addition, we will, from time to
time, consider the acquisition of or investment in complementary businesses,
products, services and technologies, which might impact our liquidity
requirements or cause us to issue debt or additional equity securities. There
can be no assurance that financing will be available in amounts or on terms
acceptable to us, or at all. A
28
failure to obtain such financing may adversely impact our business. In addition,
if we are unable to generate substantial improvements in cash flows, our
goodwill or our purchased technology intangible assets may become impaired and
we would have to record a charge for impairment, which may be material to our
financial position and results of operations.
Recently Issued Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other
Intangible Assets". SFAS No. 141 requires that the purchase method of accounting
be used for all business combinations. SFAS No. 141 specifies criteria that
intangible assets acquired in a business combination must meet to be recognized
and reported separately from goodwill. SFAS No. 142 requires that goodwill and
intangible assets with indefinite useful lives no longer be amortized, but
instead be tested for impairment at least annually in accordance with the
provisions of SFAS No. 142. SFAS No. 142 also requires that intangible assets
with estimable useful lives be amortized over their respective estimated useful
lives to their estimated residual values, and reviewed for impairment in
accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long
Lived Assets".
The Company adopted the provisions of SFAS No. 141 as of July 1, 2001 and
the provisions of SFAS No. 142 as of January 1, 2002. Amortization of goodwill
and intangible assets with indefinite useful lives acquired in business
combinations completed before July 1, 2001 was discontinued as of January 1,
2002. Had SFAS No. 142 been in effect for the prior year, the net loss for the
three and six months ended June 30, 2001 would have been ($17.0) million and
($32.1) million, respectively, and net loss per share would have been ($0.56)
and ($1.07), respectively.
In connection with SFAS No. 142's transitional goodwill impairment
evaluation, the Statement requires companies to perform an assessment of whether
there is an indication that goodwill is impaired as of the date of adoption. To
accomplish this, companies must identify its reporting units and determine the
carrying value of each reporting unit by assigning the assets and liabilities,
including the existing goodwill and intangible assets, to those reporting units
as of January 1, 2002. Companies have up to six months from January 1, 2002 to
determine the fair value of each reporting unit and compare it to the carrying
amount of the reporting unit. To the extent the carrying amount of a reporting
unit exceeds the fair value of the reporting unit, an indication exists that the
reporting unit goodwill may be impaired and companies must perform the second
step of the transitional impairment test. The second step is required to be
completed as soon as possible, but no later than the end of the year of
adoption. In the second step, companies must compare the implied fair value of
the reporting unit goodwill with the carrying amount of the reporting unit
goodwill, both of which would be measured as of the date of adoption. The
implied fair value of goodwill is determined by allocating the fair value of the
reporting unit to all of the assets (recognized and unrecognized) and
liabilities of the reporting unit in a manner similar to a purchase price
allocation, in accordance with SFAS No. 141. The residual fair value after this
allocation is the implied fair value of the reporting unit goodwill. Any
transitional impairment loss will be recognized as the cumulative effect of a
change in accounting principle in the companies Consolidated Statement of
Operations. The Company completed the transitional impairment test for its
goodwill in the second quarter of 2002 and determined that its goodwill was not
impaired and therefore did not require the recognition of any transitional
impairment losses.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". SFAS No. 143 requires the Company to record the fair
value of an asset retirement obligation as a liability in the period in which it
incurs a legal obligation associated with the retirement of tangible long-lived
assets that result from the acquisition, construction, development and/or normal
use of the assets. The Company also records a corresponding asset, which is
depreciated over the life of the asset. Subsequent to the initial measurement of
the asset retirement obligation, the obligation will be adjusted at the end of
each period to reflect the passage of time and changes in the estimated future
cash flows underlying the obligation. The Company is required to adopt SFAS No.
143 on January 1, 2003. Management does not expect the adoption of SFAS No. 143
to have a significant impact on the Company's financial position or results of
operations.
In August 2001, the FASB issued SFAS No. 144. SFAS No. 144 addresses
financial accounting and reporting for the impairment or disposal of long-lived
assets. This Statement requires that long-lived assets be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset
to future net cash flows expected to be generated by the asset. If the carrying
amount of an asset exceeds its estimated future cash flows, an impairment charge
is recognized by the amount by which the carrying amount of the asset exceeds
the fair value of the asset. SFAS No. 144 requires companies to separately
report discontinued operations and extends that reporting to a component of an
entity that either has been disposed of (by sale, abandonment, or in a
distribution to owners) or is classified as held for sale. Assets to be disposed
of are reported at the lower of the carrying amount or fair value less costs to
sell. The Company adopted SFAS No. 144 on January 1, 2002 and the adoption did
not have a significant impact on the Company's financial position or results of
operations.
In November 2001, the Emerging Issues Task Force ("EITF") concluded that
reimbursements for out-of-pocket-expenses incurred should be included in revenue
in the income statement and subsequently issued EITF Issue No. 01-14, "Income
29
Statement Characterization of Reimbursements Received for `Out-of-Pocket'
Expenses Incurred" in January 2002. The Company adopted EITF Issue No. 01-14 on
January 1, 2002 and has presented these reimbursements as services revenues for
current year periods and has reclassified amounts in prior year periods to
conform to this presentation. These reimbursements are primarily for travel
related expenses incurred for services personnel and totaled approximately $0.5
million and $0.6 million for the three months ended June 30, 2002 and 2001,
respectively, and $0.9 and $1.2 for the six months ended June 30, 2002 and 2001,
respectively. The adoption of Issue No. 01-14 did not impact the Company's
financial position, operating loss or net loss.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which supersedes EITF Issue No.
94-3, "Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (Including Certain Costs Incurred in a
Restructuring)". This Statement requires that a liability for costs associated
with exit or disposal activities be recognized when the liability is incurred as
opposed to recognition on the date an entity commits to an exit plan as
previously required under EITF Issue No. 94-3. The Company is required to adopt
SFAS No. 146 for exit and disposal activities initiated after December 31, 2002.
Management has not yet determined the expected impact of SFAS No. 146 on the
Company's financial position or results of operations.
Other pronouncements issued by the FASB or other authoritative accounting
standard groups with future effective dates are either not applicable or are not
significant to the financial statements of Mercator.
Conversion to a Single European Currency
We generate revenues in a number of foreign countries. The conversion to a
single European currency (the "Euro") did not have a material impact on our
financial results.
Factors That May Affect Future Results
You should consider the following risks factors carefully before making an
investment decision. Our business, results of operations, and financial
condition could be adversely affected by any of the following factors. The
market price of our Common Stock could decline due to any of these risks, and
you could lose all or part of your investment.
Our quarterly and annual operating results are volatile and difficult to
predict and may cause our stock price to fluctuate
Our quarterly and annual operating results have varied significantly in the
past and may continue to do so in the future. We had operating losses for the
six months ended June 30, 2002 and for the year ended December 31, 2001 and may
continue to have losses in the future. In the past, our operating results were
below the expectations of public market analysts and investors. This may occur
in the future and if our revenues and operating results do not meet
expectations, our stock price could decline which may result in potential
customers choosing other vendors.
In 2001 and July 2002, we announced restructuring plans to reduce our cost
structure. These plans consisted of certain work force reductions across the
Company, closing some office facilities and reducing some other space. We also
announced a strategic plan to provide greater focus on partnerships and industry
integration solutions for targeted vertical markets. Our restructuring plans
that have been and will be put in place remain somewhat unproven, and could
result in increased volatility in and have an adverse effect on our stock price.
Our focus on partnerships and industry integration solutions for targeted
vertical markets may result in longer sales cycles and any delay in obtaining
larger contracts may have an adverse impact on quarterly operating results. We
believe that investors should not rely on period-to-period comparisons of our
results of operations, as they are not necessarily indications of our future
performance.
An adverse reaction by customers and vendors to changes in our Company may
result in a revenue decline and adverse impact to cash position
Our success depends in large part on the support of key customers and
vendors who may react adversely to changes in our Company. Many members of our
senior management have joined us during the past year. It will take time and
resources for these individuals to effect change within our organization and
during this period our vendors and customers may re-examine their willingness to
do business with us. If we are unable to retain and attract our existing and new
customers and vendors, our revenues could decline and our cash position could be
materially adversely affected.
30
Our future success depends on retaining our key personnel and attracting and
retaining additional highly qualified employees
Other than Roy King, our Chairman, Chief Executive Officer and President,
all of our employees are employed at-will and we have no fixed-term employment
agreements with our employees. The loss of the services of any of our key
employees could harm our business.
Our future success also depends on our ability to attract, train and retain
highly qualified sales, research and development, professional services and
managerial personnel, particularly sales and professional services personnel.
Competition for these personnel is intense. We may not be able to attract,
assimilate or retain qualified personnel. We have at times experienced, and we
continue to experience, difficulty in recruiting qualified sales and research
and development personnel, and we anticipate these difficulties may continue in
the future. Furthermore, we have in the past experienced, and in the future
expect to continue to experience, a significant time lag between the date sales,
research and development and professional services personnel are hired and the
date these employees become fully productive.
It would be difficult for us to materially or immediately adjust our spending
if we experience any revenue shortfalls
Our revenues have been and will continue to be difficult to predict and we
have in the past failed and may continue to fail to achieve our revenue
expectations. Our expense levels are based, in part, on our expectation of
future revenues, and expense levels are, to a large extent, fixed in the short
term. We may be unable to materially adjust spending in a timely manner to
compensate for any unexpected revenue shortfall. If revenue levels are below
expectations for any reason, our operating results and cash flows are likely to
be harmed. Net income may be disproportionately affected by a reduction in
revenue because large portions of our expenses are related to headcount that may
not be easily reduced without harming our business. If cash flows are negatively
impacted, there can be no assurance that our existing cash and accounts
receivable financing arrangement will be sufficient to meet cash needs or will
be available in the future, as there is no assurance that we will be able to
draw down upon our existing line of credit.
We may experience seasonal fluctuations in our revenues or results of
operations
It is not uncommon for software companies to experience strong calendar
year ends followed by weaker subsequent quarters, in some cases with sequential
declines in revenues or operating profit. We believe that many software
companies exhibit this pattern in their sales cycles primarily due to customers'
buying patterns and budget cycles. We have displayed this pattern in the past
and may display this pattern in future years.
We have been and may continue to be impacted by the overall economy and the
events of September 11, 2001
As a result of recent unfavorable economic conditions including the impact
of the events of September 11, 2001, on certain of our vertical markets, we have
seen reduced capital spending, and software licensing revenues have declined in
the six months ended June 30, 2002 and fiscal year 2001 in total and as a
percentage of our total revenues as compared to the prior year. In particular,
sales to e-commerce and internet businesses, value-added resellers and
independent software vendors were impacted during the first and second quarters
of 2002 and during the year 2001. Sales to financial institutions have been
impacted in the first and second fiscal quarters of 2002 and the fourth fiscal
quarter of 2001. If the economic conditions in the United States worsen, or if a
wider global economic slowdown occurs, we may experience a material adverse
impact on our revenues and collections of our accounts receivable.
We depend on the sales of our existing Mercator products and related services
We first introduced our Mercator products in 1993. In recent years, a
significant portion of our revenue has been attributable to licenses of Mercator
products and related services, and we expect that revenue attributable to our
Mercator products and related services will continue to represent a significant
portion of our total revenue for the foreseeable future. Accordingly, our future
operating results significantly depend on the market acceptance and growth of
our existing Mercator product line and enhancements of these products and
services. Market acceptance of our Mercator product line may not increase or
remain at current levels, and we may not be able to market successfully our
Mercator product line or develop extensions and enhancements to this product
line on a long-term basis. In the event that our current or future competitors
release new products that provide, or are perceived as providing, more advanced
features, greater functionality, better performance, better compatibility with
other systems or lower prices than our Mercator product line, demand for our
products and services would likely decline. A decline in demand for, or market
acceptance of, the Mercator product line would harm our business.
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We may face significant risks in expanding our international operations
International revenues accounted for approximately 41% of our total
revenues for the six months ended June 30, 2002 and 37% of our total revenues
for 2001. Continued expansion of our international sales and marketing efforts
will require significant management attention and financial resources. We also
expect to commit additional time and development resources to customizing our
products for selected international markets and to developing international
sales and support channels. International operations involve a number of
additional risks, including the following:
o difficulties in staffing and managing foreign operations;
o impact of possible recessionary environments in economies outside the
United States;
o longer receivables collection periods and greater difficulty in
accounts receivable collection;
o unexpected changes in regulatory requirements;
o dependence on independent resellers;
o reduced protection for intellectual property rights in some countries;
o tariffs and other trade barriers;
o foreign currency exchange rate fluctuations;
o the burdens of complying with a variety of foreign laws;
o potentially adverse tax consequences; and
o political instability.
To the extent that our international operations expand, we expect that an
increasing portion of our international license and service and other revenues
will be denominated in foreign currencies. We do not currently engage in foreign
currency hedging transactions. However, as we continue to expand our
international operations, exposures to gains and losses on foreign currency
transactions may increase. We may choose to limit our exposure by the purchase
of forward foreign exchange contracts or similar hedging strategies. The
currency exchange strategy that we adopt may not be successful in avoiding
exchange-related losses. In addition, the above-listed factors may cause a
decline in our future international revenue and, consequently, may harm our
business. We may not be able to sustain or increase revenue that we derive from
international sources.
We may experience difficulties in developing and introducing new or enhanced
products necessitated by technological changes
Our future success will depend, in part, upon our ability to anticipate
changes, to enhance our current products and to develop and introduce new
products that keep pace with technological advancements and address the
increasingly sophisticated needs of our customers. Development of enhancements
to existing products and new products depend, in part, on a number of factors,
including the following:
o the timing of releases of new versions of applications systems by
vendors;
o the introduction of new applications, systems or computing platforms;
o the timing of changes in platforms;
o the release of new standards or changes to existing standards;
o changing customer requirements; and
o the availability of cash to fund development.
32
Our product enhancements or new products may not adequately meet the
requirements of the marketplace or achieve any significant degree of market
acceptance. We have in the past experienced delays in the introduction of
product enhancements and new products and we may experience delays in the
future. Furthermore, as the number of applications, systems and platforms
supported by our products increases, we could experience difficulties in
developing, on a timely basis, product enhancements which address the increased
number of new versions of applications, systems or platforms served by our
existing products. If we fail, for technological or other reasons, to develop
and introduce product enhancements or new products in a timely and
cost-effective manner or if we experience any significant delays in product
development or introduction, our customers may delay or decide against purchases
of our products as our products may be rendered obsolete.
The success of our products will also depend upon the success of the platforms
we target
We may, in the future, seek to develop and market enhancements to existing
products or new products, which are targeted for applications, systems or
platforms that we believe will achieve commercial acceptance. This could require
us to devote significant development, sales and marketing personnel, as well as
other resources, to these efforts, which would otherwise be available for other
purposes. We may not be able to successfully identify these applications,
systems or platforms, and even if we do so, we may not achieve commercial
acceptance or we may not realize a sufficient return on our investment. Failure
of these targeted applications, systems or platforms to achieve commercial
acceptance or our failure to achieve a sufficient return on our investment could
harm our business.
We may not successfully expand our sales and distribution channels
An integral part of our strategy is to expand our indirect sales channels,
including strategic partners, value-added resellers, independent software
vendors, systems integrators and distributors. However, while we believe this is
a profitable and incremental strategy, such sales will be at lower unit prices,
may limit our contact with customers (potentially inhibiting future follow-up
sales) and places us in a position of depending upon the reseller to achieve
customer satisfaction, and could result in these resellers selling to customers
we may have sold to. We are increasing resources dedicated to developing and
expanding these indirect distribution channels. In the six months ended June 30,
2002 and for the year ended December 31, 2001, 27% of our total license revenues
came from those sources. We may not be successful in expanding the number of
indirect distribution channels for our products. If we are successful in
increasing our sales through indirect sales channels, we expect that those sales
will be at lower per unit prices than sales through direct channels, and revenue
we receive for each sale will be less than if we had licensed the same product
to the customer directly. As a result, our ability to accurately forecast sales,
evaluate customer satisfaction and recognize emerging customer requirements may
be hindered.
Even if we successfully expand our indirect distribution channels, any new
strategic partners, value-added resellers, independent software vendors, system
integrators or distributors may offer competing products, or have no minimum
purchase requirements of our products. These third parties may also not have the
technical expertise required to market and support our products successfully. If
the third parties do not provide adequate levels of services and technical
support, our customers could become dissatisfied, and we may have to devote
additional resources for customer support. Our brand name and reputation could
be harmed. Selling products through indirect sales channels could cause
conflicts with the selling efforts of our direct sales force.
Our strategy of marketing products directly to end-users and indirectly
through value-added resellers, independent software vendors, systems integrators
and distributors may result in distribution channel conflicts. Our direct sales
efforts may compete with those of our indirect channels and, to the extent
different resellers target the same customers, resellers may also come into
conflict with each other. Although we have attempted to manage our distribution
channels to avoid potential conflicts, channel conflicts may harm our
relationships with existing value-added resellers, independent software vendors,
systems integrators or distributors or impair our ability to attract new value
added resellers, independent software vendors, systems integrators and
distributors.
We face significant competition in the market for integration software
The markets for our products and services are extremely competitive and
subject to rapid change. Because there are relatively low barriers to entry in
the software market, we expect additional competition from other established and
emerging companies.
In the integration market, our products and related services compete
primarily against solutions developed internally by individual businesses to
meet their specific integration needs. In addition, we face increasing
competition in the integration market from other third-party software vendors.
33
Many of our current and potential competitors have longer operating
histories, significantly greater financial, technical, product development and
marketing resources, greater name recognition and larger customer bases than we
do. Our present or future competitors may be able to develop products that are
comparable or superior to those we offer, adapt more quickly than we do to new
technologies, evolving industry trends or customer requirements, or devote
greater resources than we do to the development, promotion and sale of their
products. Accordingly, we may not be able to compete effectively in our target
markets against these competitors.
We expect that we will face increasing pricing pressures from our current
competitors and new market entrants. Our competitors may engage in pricing
practices that may reduce the average selling prices of our products and related
services. To offset declining average selling prices, we believe that we must
successfully introduce and sell enhancements to existing products and new
products on a timely basis. We must also develop enhancements to existing
products and new products that incorporate features that can be sold at higher
average selling prices. To the extent that enhancements to existing products and
new products are not developed in a timely manner, do not achieve customer
acceptance or do not generate higher average selling prices, our operating
margins may decline.
Government regulation and legal uncertainties relating to the internet could
adversely affect our business
Congress has passed legislation and several more bills have been sponsored
in both the House and Senate that are designed to regulate various aspects of
the internet, including, for example, on-line content, copyright infringement,
user privacy, and taxation. In addition, federal, state, local and foreign
governmental organizations are considering other legislative and regulatory
proposals that would regulate aspects of the internet, including libel, pricing,
quality of products and services, and intellectual property ownership. The laws
governing the use of the internet, in general, remain largely unsettled, even in
areas where there has been some legislative action. It may take years to
determine whether and how existing laws apply to the internet. In addition, the
growth and development of the market for online commerce may prompt calls for
more stringent consumer protection laws, both in the United States and abroad,
which may impose additional burdens on companies conducting business on-line by
limiting the type and flow of information over the internet. The adoption or
modification of laws or regulations relating to the internet could adversely
affect our business.
It is not known how courts will interpret both existing and new laws.
Therefore, we are uncertain as to how new laws or the application of existing
laws will affect our business or our clients' business, which may have an
indirect affect on our business. Increased regulation of the internet may
decrease the growth in the use of the internet, which could decrease the demand
for our services, increase our cost of doing business or otherwise have a
material adverse effect on our business, or results of operations and financial
condition.
The United States Omnibus Appropriations Act of 1998 places a moratorium on
taxes levied on internet access from October 1998 to November 2003. However,
states may place taxes on internet access if taxes had already been generally
imposed and actually enforced prior to October 1998. States which can show they
enforced internet access taxes prior to October 1998 and states after November
2003 may be able to levy taxes on internet access resulting in increased cost to
access the internet, which may result in a material adverse effect to our
business.
We have only limited protection for our proprietary technology
Our success is dependent upon our proprietary software technology. We
protect our technology as described herein but this may not prevent
misappropriation or development by third parties of similar products. We do not
have any patents and we rely principally on trade secret, copyright and
trademark laws, nondisclosure and other contractual agreements and technical
measures to protect our technology. We enter into confidentiality and/or license
agreements with our employees, distributors and customers, and we limit access
to and distribution of our software, documentation and other proprietary
information by employees, distributors and customers. The steps taken by us may
not be sufficient to prevent misappropriation of our technology, and such
protections do not preclude competitors from developing products with
functionality or features similar to our products. Furthermore, it is possible
that third parties will independently develop competing technologies that are
substantially equivalent or superior to our technologies. In addition, effective
copyright and trade secret protection may be unavailable or limited in certain
foreign countries, which could pose additional risks of infringement as we
continue to expand internationally. Our failure or inability to protect our
proprietary technology could have a material adverse effect on our business.
Although we do not believe that our products infringe the proprietary
rights of any third parties, infringement claims could be asserted against us or
our customers in the future. Furthermore, we may initiate claims or litigation
against third parties for infringement of our proprietary rights, or for
purposes of establishing the validity of our proprietary rights.
34
Litigation, either as plaintiff or defendant, would cause us to incur
substantial costs and divert management resources from productive tasks whether
or not such litigation is resolved in our favor, which could have a material
adverse effect on our business. Parties making claims against us or customers
for which we are subject to payment of indemnification could recover substantial
damages, as well as injunctive or other equitable relief, which could
effectively block our ability to license our products in the United States or
abroad. Such a judgment could have a material adverse effect on our business. If
it appears necessary or desirable, we may seek licenses to intellectual property
that we are allegedly infringing. Licenses may not be obtainable on commercially
reasonable terms, if at all. The failure to obtain necessary licenses or other
rights could have a material adverse effect on our business. As the number of
software products in the industry increases and the functionality of these
products further overlaps, we believe that software developers may become
increasingly subject to infringement claims. Any such claims, with or without
merit, can be time-consuming and expensive to defend and could adversely affect
our business. We are not aware of any currently pending claims that our
products, trademarks or other proprietary rights infringe upon the proprietary
rights of third parties.
We may become subject to product liability claims
Our license agreements with our customers typically contain provisions
designed to limit our exposure to potential product liability claims. It is
possible, however, that the limitation of liability provisions contained in our
license agreements, especially unsigned shrink-wrap licenses, may not be
effective under the laws of certain jurisdictions. Consequently, the sale and
support of our software entails the risk of product liability claims in the
future and any liability insurance may not be sufficient to cover the product
liability claims.
The ultimate outcome of pending securities litigation is uncertain
After the restatement of our first quarter 2000 earnings and the adjustment
to previously disclosed second quarter 2000 results, we were named in a series
of similar purported securities class action lawsuits. These lawsuits have now
been consolidated into one matter. The amended complaint in the consolidated
matter alleges violations of United States securities law through alleged
material misrepresentations and omissions and seeks an unspecified award of
damages. We believe that the allegations in the amended complaint are without
merit, and we intend to contest them vigorously. There can be no guarantee as to
the ultimate outcome of this pending litigation or whether the ultimate outcome
may have a material adverse effect on our financial position or results of our
operations. Our insurance company has reserved its rights with respect to this
matter.
Our stock price has fluctuated and could continue to fluctuate
The trading price of our Common Stock has fluctuated widely in the past and
may be significantly affected by a number of factors, including the following:
o actual or anticipated fluctuations in our operating results;
o announcements of technological innovations or new products by us or our
competitors;
o developments with respect to patents, copyrights or proprietary rights;
o conditions and trends in the software or other industries; and
o general market conditions.
35
In addition, the stock market has, from time to time, experienced
significant price and volume fluctuations that have particularly affected the
market prices for the stock of technology companies. These broad market
fluctuations may cause the market price of our Common Stock to decline. The
following table shows the high and low sale prices of our Common Stock as
reported on the Nasdaq National Market System for the past three years and for
the first and second quarters of 2002:
Reported Sale Price
------------------------------
High Low
------------- ------------
1999
First Quarter .................................. 32.00 20.50
Second Quarter ................................. 28.875 14.00
Third Quarter .................................. 28.00 16.875
Fourth Quarter ................................. 66.75 22.00
2000
First Quarter .................................. 149.875 47.00
Second Quarter ................................. 84.00 26.75
Third Quarter .................................. 70.375 13.438
Fourth Quarter ................................. 16.188 2.81
2001
First Quarter .................................. 12.188 3.25
Second Quarter ................................. 3.75 1.40
Third Quarter .................................. 2.47 0.95
Fourth Quarter ................................. 9.44 1.09
2002
First Quarter .................................. 10.15 3.91
Second Quarter ................................. 5.65 1.38
Our stockholder rights plan, corporate governance structure and governing law
may delay or prevent our acquisition by another company
Our corporate governing documents as well as Delaware law contain
provisions that could make it more difficult for a third party to attempt to
acquire or gain control of our Company. These provisions include:
o our Board of Directors can issue shares of preferred stock without any
vote or action by the stockholders and this stock could have rights
superior to those of existing stockholders and could impede the success
of any acquisition attempt by another company;
o we adopted a stockholders rights plan which permits existing
stockholders to purchase a substantial number of shares at a
substantial discount to the market price if a third party attempts to
gain control on a large equity position in our Company;
o a stockholder must give our Board of Directors prior notice of a
proposal to take action by written consent;
o a stockholder must give advance notice to the Board of Directors before
stockholder-sponsored proposals may receive consideration at annual
meetings and before a stockholder may make nominations for the election
of directors;
o vacancies on the Board of Directors may be filled until the next annual
meeting of stockholders only by majority vote of the directors then in
office; and
o stockholders cannot call special meetings of stockholders.
We are also governed by Section 203 of the Delaware General Corporation
Law, which restricts certain business combinations with any interested
stockholder, as defined by that statute. Our stockholder rights plan, our
charter, bylaws and the provisions of Section 203 could make it more difficult
for a third party to acquire control of our outstanding voting stock and could
delay or prevent a change in our control.
36
In addition, we have arrangements with certain officers and other option
holders, which provide for benefits upon a change in control, which could also
delay or impede an acquisition.
Future sales of our common stock by our stockholders could cause our stock
price to decline
As of August 9, 2002, we have outstanding warrants to purchase an aggregate
of 1,058,119 shares of Common Stock and also options to purchase an aggregate of
9,290,519 shares of Common Stock granted under our directors' and employee
benefit plans. The number of shares issuable upon exercise of warrants are
subject to adjustment pursuant to anti-dilution provisions. Holders of such
warrants and options are likely to exercise them when, in all likelihood, we
could obtain additional capital on terms more favorable than those provided in
such warrants and options. Further, while these warrants and options are
outstanding, our ability to obtain additional financing on favorable terms could
be affected. Exercise of warrants and options may result in dilution to existing
stockholders.
Sales of a significant amount of Common Stock in the public market by
existing shareholders, including holders of warrants and options, could
adversely affect the market price of the Common Stock, and it may make it more
difficult for us to sell our Common Stock in the future at times and for prices
that we deem appropriate. Several of our stock and warrant holders are parties
to registration rights agreements with us under which we are required to
register their stock for sale to the public. In January 2002, we filed a
Registration Statement covering resale of an aggregate of 3,577,883 shares,
which was declared effective in March of 2002. Sale of the shares of Common
Stock covered by such Registration Statement, or even the availability of such
shares for sale, may have an adverse effect on the market price of our stock
from time to time.
Our industry is experiencing consolidation that may intensify competition
The software industries are undergoing substantial change which has
resulted in increasing consolidation and a proliferation of strategic
transactions. Many companies in these industries have been going out of business
or are being acquired by competitors. As a result, we are increasingly competing
with larger competitors that have substantially greater resources than we do. We
expect this consolidation and strategic partnering to continue. Acquisitions or
strategic relationships could harm us in a number of ways. For example:
o competitors could acquire or enter into relationships with companies
with which we have strategic relationships and discontinue our
relationship, resulting in the loss of distribution opportunities for
our products and services or the loss of certain enhancements or
value-added features to our products and services;
o suppliers of important or emerging technologies could be acquired by a
competitor or other company which could prevent us from being able to
utilize such technologies in our offerings, and disadvantage our
offerings relative to those of competitors;
o a competitor could be acquired by a party with significant resources
and experience that could increase the ability of the competitor to
compete with our products and services; and
o other companies with related interests could combine to form new,
formidable competition, which could preclude us from obtaining access
to certain markets or content, or which could dramatically change the
market for our products and services.
Any of these events could put us at a competitive disadvantage, which could
cause us to lose customers, revenue and market share. They could also force us
to expend greater resources to meet new or additional competitive threats, which
could also harm our operating results.
We could lose strategic relationships that are essential to our business
The loss of certain current strategic relationships or key licensing
arrangements, the inability to find other strategic partners or the failure of
our existing relationships to achieve meaningful positive results for us could
harm our business. We rely in part on strategic relationships to help us:
o increase adoption of our products through distribution arrangements;
o acquire desirable or necessary technology components and intellectual
property rights;
37
o enhance our brand; and
o increase the performance and utility of our products and services.
We would be unable to accomplish many of these goals without the assistance
of third parties. For example, we may become more reliant on strategic partners
to provide more secure and easy-to-use electronic commerce solutions. We may not
be successful in forming or managing strategic relationships, and, in
particular, we meet resistance in forging such relationships if our potential
strategic partners desire to minimize their dependency on any one technology
provider.
Because market participants in some markets have adopted industry specific
technologies, we may need to expend significant resources in order to address
specific markets.
Our strategy is to continue developing our integration software to be
broadly applicable to many industries. However, in some markets, market
participants have adopted core technologies that are specific to their markets.
For example, many companies in the healthcare and financial services industries
have adopted industry-specific protocols for the interchange of information. In
order to successfully sell our software to companies in these markets, we may
need to expand or enhance our software to adapt to these industry-specific
technologies, which could be costly and require the diversion of engineering
resources.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the ordinary course of operations, our financial position and cash flows
are subject to a variety of risks, which include market risks associated with
changes in foreign currency exchange rates and movement in interest rates. We do
not, in the normal course of business, use derivative financial instruments for
trading or speculative purposes. Uncertainties that are either non-financial or
non-quantifiable, such as political, economic, tax, other regulatory or credit
risks are not included in the following assessment of our market risks.
Foreign Currency Exchange Rates
Operations outside of the U.S. expose us to foreign currency exchange rate
changes and could impact translations of foreign denominated assets and
liabilities into U.S. dollars and future earnings and cash flows from
transactions denominated in different currencies. During the six months ended
June 30, 2002, 41% of our total revenue was generated from international sources
and the net assets of our foreign subsidiaries totaled approximately 25% of
consolidated net assets as of June 30, 2002. Our exposure to currency exchange
rate changes is diversified due to the number of different countries in which we
conduct business. We operate outside the U.S. primarily through wholly owned
subsidiaries in the United Kingdom, France, Germany, Netherlands, Sweden,
Switzerland, Spain, Singapore, Hong Kong, Australia and Japan. These foreign
subsidiaries use local currencies as their functional currency, as certain sales
are generated and expenses are incurred in such currencies. Foreign currency
gains and losses will continue to result from fluctuations in the value of the
currencies in which we conduct our operations as compared to the U.S. dollar. We
continue to evaluate different hedging strategies and at this time, we do not
believe that possible near-term changes in exchange rates will result in a
material effect on our future earnings or cash flows and, therefore, have chosen
not to enter into foreign currency hedging instruments. There can be no
assurance that this approach will be successful, especially in the event of a
sudden and significant decline in the value of foreign currencies relative to
the United States dollar.
Interest Rates
We invest our cash in a variety of financial instruments, consisting
principally of investments in commercial paper, interest-bearing demand deposit
accounts with financial institutions, money market funds and highly liquid debt
securities of corporations, municipalities and the U.S. Government. The majority
of our investments are denominated in U.S. dollars. Cash balances in foreign
currencies overseas are operating balances and are only invested in short-term
deposits of the local operating bank.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company has certain significant legal contingencies, discussed below,
and other litigation of a nature considered normal to its business which are
pending against the Company.
Between August 23, 2000 and September 21, 2000 a series of fourteen
purported securities class action lawsuits was filed in the United States
District Court for the District of Connecticut, naming as defendants Mercator,
Constance Galley and Ira Gerard. Kevin McKay was also named as a defendant in
nine of these complaints. On or about November 24, 2000, these lawsuits were
consolidated into one lawsuit captioned: In re Mercator Software, Inc.
Securities Litigation, Master File No. 3:00-CV-1610 (GLG). The lead plaintiffs
purport to represent a class of all persons who purchased Mercator's Common
Stock from April 20, 2000 through and including August 21, 2000. Each complaint
in the consolidated action alleges violations of Section 10(b) of the Securities
Exchange Act of 1934 and Rule 10b-5 thereunder, through alleged material
misrepresentations and omissions and seeks an unspecified award of damages. On
January 26, 2001, the lead plaintiffs filed an amended complaint in the
consolidated matter with substantially the same allegations. Named as defendants
in the amended complaint are Mercator, Constance Galley and Ira Gerard. The
amended complaint in the consolidated action alleges violations of Section 10(b)
and Rule 10b-5 through alleged material misrepresentations and omissions and
seeks an unspecified award of damages. Mercator filed a motion to dismiss the
amended complaint on March 12, 2001. The lead plaintiffs filed an opposition to
Mercator's motion to dismiss on or about April 18, 2001, and Mercator filed its
reply brief on May 7, 2001. The Court heard oral argument on the motion to
dismiss on July 6, 2001. On September 13, 2001, the Court denied Mercator's
motion to dismiss. Mercator believes that the allegations in the amended
complaint are without merit and intends to contest them vigorously. We believe
that this securities class action lawsuit is covered by insurance. Mercator
notified its directors' and officers' liability insurance companies of this
matter. The insurance carriers have reserved their rights in this matter. There
can be no guarantee as to the ultimate outcome of this proceeding or whether the
ultimate outcome, after considering liabilities already accrued in the Company's
June 30, 2002 consolidated balance sheet and insurance recoveries, may have a
material adverse effect on the Company's consolidated financial position or
consolidated results of operations.
The Company was named as a defendant in an action filed on August 3, 2001
in the United States District Court for the Eastern District of Pennsylvania,
entitled Ulrich Neubert v. Mercator Software, Inc., f/k/a TSI International
Software, Ltd., Civil Action No. 01-CV-3961. The complaint alleges claims of
breach of contract, breach of the implied covenant of good faith and fair
dealing, breach of fiduciary duty, and fraud in connection with the Company's
acquisition of Software Consulting Partners ("SCP") in November 1998. Neubert,
who was the sole shareholder of SCP prior to November 1998, seeks purported
damages of up to approximately $7.5 million, plus punitive damages and
attorney's fees. The complaint was served on the Company on November 21, 2001.
The Company believes that the allegations in the complaint are without merit and
intends to contest the lawsuit vigorously. Mercator has notified its insurance
carrier of this matter, but has not yet received any coverage position from
them. The ultimate legal and financial liability of the Company in respect to
this claim cannot be estimated with any certainty. There can be no guarantee as
to the ultimate outcome of this proceeding or whether the ultimate outcome,
after considering liabilities already accrued in the Company's June 30, 2002
consolidated balance sheet, may have a material adverse effect on the Company's
consolidated financial position or consolidated results of operations.
In addition, the Company and a third party are currently disputing the
break-up fee provisions with respect to a proposed investment in the Company.
As of June 30, 2002, the Company has accrued approximately $4.4 million,
after considering any insurance recoveries, for the aggregate amount of the
contingencies described above.
39
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 14, 2002, at Mercator's Annual Meeting of Stockholders, the
stockholders approved the proposals listed below. Proxies were solicited by
Mercator pursuant to Regulation 14A under the Securities Exchange Act of 1934,
as amended.
As of April 8, 2002 the record date for the Annual Meeting, there were
33,824,000 total shares of Mercator Common Stock outstanding and entitled to
vote, of which 30,317,469 were present in person by proxy and voted at the
meeting.
1. Proposal to elect seven directors of the Company, each to serve until
the next Annual Meeting of Stockholders and until his or her successor has
been elected and qualified or until his or her earlier resignation, death
or removal.
Constance F. Galley Ernest E. Keet Roy C. King Michael E. Lehman
James P. Schadt Dennis G. Sisco Mark C. Stevens
For Withheld
--- --------
Constance F. Galley 29,763,089 554,380
Ernest E. Keet 29,920,992 396,477
Roy C. King 28,820,358 1,497,111
Michael E. Lehman 29,923,784 393,685
James P. Schadt 29,900,941 416,528
Dennis G. Sisco 29,925,484 391,985
Mark C. Stevens 29,928,026 389,443
2. Proposal to amend the Company's 1997 Equity Incentive Plan to increase
the number of shares of Common Stock reserved for issuance under such Plan
(i) on May 14, 2002 by 2,500,000 shares and (ii) on January 1, 2003 by the
lesser of (a) 7.5% of the number of shares of Common Stock outstanding on
the close of business immediately preceding January 1, 2003, or (b)
3,000,000 shares.
For 8,747,505
Against/Withheld 3,284,884
Abstain 42,340
3. Proposal to amend the Company's 1997 Employee Stock Purchase Plan to
annually increase the number of shares of Common Stock reserved for
issuance under such Plan so that on (i) May 14, 2002 and (ii) on each
January 1 thereafter there are 1,500,000 shares of Common Stock reserved
for issuance under such Plan (or such lesser number of shares as may be
determined by the Board of Directors).
For 10,811,986
Against/Withheld 1,224,263
Abstain 38,480
4. Proposal to ratify the selection of KPMG LLP as the Company's
independent accountants for the fiscal year ending December 31, 2002.
For 30,216,507
Against/Withheld 82,832
Abstain 18,130
40
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit No. Exhibit Title
- ----------- -------------
10.36 Third Loan Modification Agreement dated as of June 28, 2002
between the Registrant and Silicon Valley Bank
10.37 Registrant's 1997 Equity Incentive Plan, as amended
10.38 Registrant's 1997 Employee Stock Purchase Plan, as amended
10.39 English Summary of Lease Agreement dated as of April 23, 2002
between a Subsidiary of the Registrant and KASA GbR/Atricom
GmbH (original in German)
(b) Reports on Form 8-K
Mercator Software, Inc. filed no current reports on Form 8-K in the second
quarter of 2002.
41
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act or 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Mercator Software, Inc.
Dated: August 14, 2002
By: /s/ Roy C. King
-----------------------------------
Roy C. King
Chairman of the Board of Directors,
Chief Executive Officer and President
(Principal Executive Officer)
By: /s/ Kenneth J. Hall
-----------------------------------
Kenneth J. Hall
Executive Vice President,
Chief Financial Officer and Treasurer
(Principal Financial and Accounting
Officer)
SECTION 906 CERTIFICATION
I, Roy C. King, Chairman of the Board of Directors, Chief Executive Officer
and President of Mercator Software, Inc. (the "Company"), and I, Kenneth J.
Hall, Executive Vice President, Chief Financial Officer and Treasurer of the
Company, each do hereby certify in accordance with 18 U.S.C. 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
o The Quarterly Report on Form 10-Q of the Company for the period ending
June 30, 2002 (the "Periodic Report") fully complies with the
requirements of section 13(a) or 15(d) of the Securities Exchange Act
of 1934 (15 U.S.C. 78m or 78o(d)), and
o The information contained in the Periodic Report fairly presents, in
all material respects, the financial condition and results of
operations of the Company.
Dated: August 14, 2002
By: /s/ Roy C. King By: /s/ Kenneth J. Hall
------------------------------------- --------------------------------
Roy C. King Kenneth J. Hall
Chairman of the Board of Directors, Executive Vice President, Chief
Chief Executive Officer and President Financial Officer and Treasurer
(Principal Executive Officer) (Principal Financial and
Accounting Officer)
42