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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004
OR
[ ] 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 000-30277
SERVICEWARE TECHNOLOGIES, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 25-1647861
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
ONE NORTH SHORE CENTRE, 12 FEDERAL STREET, SUITE 503
PITTSBURGH, PA 15212
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (412) 222-4450
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer as
defined in Rule 12b-2 of the Exchange Act. Yes [ ] No [X]
The number of shares of the registrant's common stock outstanding as of
the close of business on November 4, 2004 was 52,507,667.
SERVICEWARE TECHNOLOGIES, INC.
FORM 10-Q
SEPTEMBER 30, 2004
INDEX
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
ITEM 1. Consolidated Financial Statements
. Consolidated Balance Sheets as of September 30, 2004 (unaudited)
and December 31, 2003....................................................................... 3
. Consolidated Statements of Operations for the three and nine months
ended September 30, 2004 and 2003 (unaudited) .............................................. 4
. Consolidated Statements of Stockholders' Equity for the nine months
ended September 30, 2004 and 2003 (unaudited)............................................... 5
. Consolidated Statements of Cash Flows for the nine months ended
September 30, 2004 and 2003 (unaudited)..................................................... 6
. Notes to Consolidated Financial Statements (unaudited) ..................................... 7
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations... 12
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk.............................. 24
ITEM 4. Controls and Procedures................................................................. 24
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings........................................................................... 24
ITEM 6. Exhibits .................................................................................... 25
2
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------- ------------
ASSETS
Current assets
Cash and cash equivalents $ 2,739 $ 1,438
Short term investments 5,030 -
Accounts receivable, less allowance for doubtful accounts of $95 as of September
30, 2004 and $100 as of December 31, 2003 3,560 3,348
Other current assets 299 420
-------- --------
Total current assets 11,628 5,206
Non current assets
Property and equipment
Office furniture, equipment, and leasehold improvements 1,510 1,510
Computer equipment 4,785 5,013
-------- --------
Total property and equipment 6,295 6,523
Less accumulated depreciation (5,813) (6,002)
-------- --------
Property and equipment, net 482 521
Long term investments 997 -
Other non-current assets 61 33
Goodwill 2,324 2,324
-------- --------
Total long term assets 3,864 2,878
-------- --------
Total assets $ 15,492 $ 8,084
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Revolving line of credit - 250
Accounts payable 1,313 1,089
Accrued compensation and benefits 312 274
Deferred revenue 2,972 2,481
Other current liabilities 915 530
-------- --------
Total current liabilities 5,512 4,624
Convertible debt, net of unamortized discount of $980 as of December 31, 2003 - 2,753
Non current deferred revenue 363 546
Other non current liabilities 70 54
-------- --------
Total liabilities 5,945 7,977
Commitments and Contingencies
Stockholders' equity
Common stock, $0.01 par; 100,000 shares authorized, 52,690 and 24,684 shares issued
and 52,508 and 24,325 shares outstanding as of September 30, 2004 and December
31, 2003, respectively 526 247
Additional paid in capital 83,190 76,433
Treasury stock, 182 and 359 shares as of September 30, 2004 and December 31, 2003,
respectively (67) (134)
Deferred compensation (199) -
Warrants 4,936 46
Accumulated other comprehensive loss (8) -
Accumulated deficit (78,831) (76,485)
-------- --------
Total stockholders' equity 9,547 107
-------- --------
Total liabilities and stockholders' equity $ 15,492 $ 8,084
======== ========
See accompanying notes to the financial statements.
3
CONSOLIDATED STATEMENTS OF OPERATIONS
AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS
(UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2004 2003 2004 2003
-------- -------- -------- --------
Revenues
Licenses $ 1,605 $ 1,194 $ 4,144 $ 2,725
Services 2,368 1,537 5,553 5,205
-------- -------- -------- --------
Total revenues 3,973 2,731 9,697 7,930
-------- -------- -------- --------
Cost of revenues
Cost of licenses 116 72 260 183
Cost of services 1,493 750 3,192 2,295
-------- -------- -------- --------
Total cost of revenues 1,609 822 3,452 2,478
-------- -------- -------- --------
Gross margin 2,364 1,909 6,245 5,452
Operating expenses
Sales and marketing 1,137 1,068 3,678 3,657
Research and development 387 339 1,615 1,417
General and administrative 660 537 2,070 1,625
Intangible assets amortization - 16 - 147
Restructuring and other special (income) - - - (20)
-------- -------- -------- --------
Total operating expenses 2,184 1,960 7,363 6,826
-------- -------- -------- --------
Income (loss) from operations 180 (51) (1,118) (1,374)
Other income (expense)
Interest expense (2) (443) (1,276) (1,432)
Other (net) 23 - 48 -
-------- -------- -------- --------
Other income (expense), net 21 (443) (1,228) (1,432)
-------- -------- -------- --------
Net income (loss) $ 201 $ (494) $ (2,346) $ (2,806)
======== ======== ======== ========
Net income (loss) per common share, basic $ 0.00 $ (0.02) $ (0.05) $ (0.12)
Net income (loss) per common share, diluted $ 0.00 $ (0.02) $ (0.05) $ (0.12)
Shares used in computing per share amounts:
Basic 52,186 24,226 51,141 24,176
======== ======== ======== ========
Diluted 53,165 24,226 51,141 24,176
======== ======== ======== ========
See accompanying notes to the financial statements.
4
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS
(UNAUDITED)
ADDITIONAL DEFERRED
COMMON STOCK PAID IN TREASURY STOCK COMPENSATION
SHARES AMOUNT CAPITAL SHARES AMOUNT AND OTHER
------ ------- ---------- ------ ------ ------------
Balance at December 31, 2003 24,325 $ 247 $ 76,433 359 $ (134) $ -
Exercise of warrants and stock
options 185 - 32 (163) 61 -
Beneficial conversion feature
of convertible notes - - 233 - - -
Issuance of common stock and
warrants, net of $574 of
issuance costs 12,308 123 2,510 - - -
Issuance of warrants for
settlement of lawsuit - - - - - -
Issuance of common stock
related to note conversion 15,354 154 3,685 - - -
Stock based compensation 322 2 295 - - (199)
Issuance of stock under
Employee Stock Purchase Plan 14 - 2 (14) 6 -
Comprehensive loss:
Unrealized loss on short term
investments - - - - - -
Net loss - - - - - -
Total comprehensive loss
------ ------- -------- ------ ------ --------
Balance at September 30, 2004 52,508 $ 526 $ 83,190 182 $ (67) $ (199)
====== ======= ======== ====== ====== ========
ACCUMULATED
OTHER TOTAL
COMPREHENSIVE ACCUMULATED STOCKHOLDERS'
WARRANTS LOSS DEFICIT EQUITY
-------- ------------- ----------- -------------
Balance at December 31, 2003 $ 46 $ - $(76,485) $ 107
Exercise of warrants and stock
options - - - 93
Beneficial conversion feature
of convertible notes - - - 233
Issuance of common stock and
warrants, net of $574 of
issuance costs 4,785 - - 7,418
Issuance of warrants for
settlement of lawsuit 105 - - 105
Issuance of common stock
related to note conversion - - - 3,839
Stock based compensation - - - 98
Issuance of stock under
Employee Stock Purchase Plan - - - 8
Comprehensive loss:
Unrealized loss on short term
investments - (8) - (8)
Net loss - - (2,346) (2,346)
-------- -------- --------
Total comprehensive loss (8) (2,346) (2,354)
-------- -------- -------- --------
Balance at September 30, 2004 $ 4,936 $ (8) $(78,831) $ 9,547
======== ======== ======== ========
ADDITIONAL DEFERRED
COMMON STOCK PAID IN TREASURY STOCK COMPENSATION
SHARES AMOUNT CAPITAL SHARES AMOUNT AND OTHER
------ ------- ---------- ------ ------ ------------
Balance at December 31, 2002 24,083 $ 247 $ 74,184 601 $ (223) $ (9)
Exercise of stock options 63 - (8) (63) 23 -
Adjustment to Beneficial
Conversion Feature for
amendment to notes - - 587 - - -
Amortization of warrants - - - - - 9
Expiration of warrants - - 1,368 - - -
Issuance of stock under
Employee Stock Purchase Plan 80 - (10) (80) 30 -
Comprehensive income (loss):
Currency translation adjustment - - - - - -
Net loss - - - - - -
Total comprehensive income (loss) - - - - - -
------ ------- -------- ------ ------ --------
Balance at September 30, 2003 24,226 $ 247 $ 76,121 458 $ (170) $ -
====== ======= ======== ====== ====== ========
ACCUMULATED
OTHER TOTAL
COMPREHENSIVE ACCUMULATED STOCKHOLDERS'
WARRANTS INCOME (LOSS) DEFICIT EQUITY
-------- ------------- ----------- -------------
Balance at December 31, 2002 $ 1,414 $ (37) $(73,506) $ 2,070
Exercise of stock options - - - 15
Adjustment to Beneficial
Conversion Feature for
amendment to notes - - - 587
Amortization of warrants - - - 9
Expiration of warrants (1,368) - - -
Issuance of stock under
Employee Stock Purchase Plan - - - 20
Comprehensive income (loss):
Currency translation adjustment - 37 - 37
Net loss - - (2,806) (2,806)
-------- -------- --------
Total comprehensive income (loss) - 37 (2,806) (2,769)
-------- -------- -------- --------
Balance at September 30, 2003 $ 46 $ - $(76,312) $ (68)
======== ======== ======== ========
See accompanying notes to the financial statements
5
CONSOLIDATED STATEMENTS OF CASH FLOWS
AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
2004 2003
-------- --------
Cash flows from operating activities
Net loss $(2,346) $(2,806)
Adjustments to reconcile net loss to net cash provided in (used in) operations:
Non cash items:
Depreciation 240 650
Amortization of intangible assets and warrants 33 194
Cost of warrants in connection with settlement of lawsuit 105 -
Amortization of beneficial conversion feature related to convertible notes 1,162 1,037
Amortization of discount on convertible notes 50 92
Interest expense paid by issuing convertible notes - 169
Write-off cumulative translation adjustment - 37
Interest expense paid by issuing common stock 107 -
Stock based compensation 98 -
Gain on disposal of equipment (7) -
Other non cash items (8) 14
Changes in operating assets and liabilities:
Increase in accounts receivable (212) (1,177)
Decrease (increase) in other assets 121 (153)
Increase (decrease) in accounts payable 224 (399)
Increase in accrued compensation 38 48
Increase in deferred revenue 308 1,055
Increase in other liabilities 416 112
------- -------
Net cash provided by (used in) operating activities 329 (1,177)
------- -------
Cash flows from investing activities
Purchases of investments (6,027) -
Proceeds from sale of short term investments - 500
Proceeds from sale of assets 1 -
Increase in restricted cash (61) -
Property and equipment acquisitions (163) (49)
------- -------
Net cash (used in) provided by investing activities (6,250) 451
------- -------
Cash flows from financing activities
Repayments of principal of capital lease obligations (24) (28)
Repayments of principal of revolving line of credit (250) (800)
Proceeds from borrowings under revolving line of credit - 250
Proceeds from equity funding, net of issuance costs 7,418 -
Proceeds from stock option exercises 78 35
------- -------
Net cash provided by (used in) financing activities 7,222 (543)
------- -------
Increase (decrease) in cash and cash equivalents 1,301 (1,269)
Cash and cash equivalents at beginning of period 1,438 2,461
------- -------
Cash and cash equivalents at end of period $ 2,739 $ 1,192
======= =======
Supplemental disclosures of cash flow information:
Cash paid for interest $ 8 $ 10
======= =======
Supplemental disclosures of non-cash investing and financing activities:
Conversion of convertible debt and accrued interest to common stock $ 3,839 $ -
Adjustment to beneficial conversion feature for convertible notes 233 587
Expiration of warrants - 1,368
Exercise of warrants by bank 23 -
Issuance of warrants 5,134 -
Assets acquired under capital lease obligation 32 -
See accompanying notes to the financial statements.
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2004
(UNAUDITED)
NOTE 1. ORGANIZATION OF THE COMPANY
ServiceWare, Technologies, Inc. (the "Company") is a provider of
knowledge-powered support solutions that enable organizations to deliver
superior service for customers, employees and partners by transforming
information into knowledge. Founded in 1991 in Pennsylvania, the Company sells
its products throughout the United States and Europe.
ServiceWare Enterprise(TM), powered by the Cognitive Processor(R), a
patented self-learning search technology, enables organizations to capture and
manage intellectual capital. This repository of corporate knowledge, known as a
knowledge base, can then be easily accessed by way of a browser to effectively
answer inquiries made either over the Web or through the telephone to a customer
contact center or help desk.
Customers use ServiceWare's knowledge management solutions to:
- Strengthen relationships with customers, partners, suppliers
and employees
- Decrease operating costs
- Improve creation, dissemination and sharing of enterprise
knowledge
- Integrate seamlessly with existing technology investments
ServiceWare Enterprise(TM) is a software solution that allows the
Company's customers to provide personalized, automated Web-based service
tailored to the needs of their users. ServiceWare Enterprise enables businesses
to capture enterprise knowledge, solve customer problems, reuse solutions and
share captured knowledge throughout the extended enterprise. It also enables the
extended enterprise to access this knowledge online. In addition, through the
self-learning features of ServiceWare's patented Cognitive Processor technology,
the solutions generated by these products are intelligent in that they have the
capability to learn from each interaction and automatically update themselves
accordingly. ServiceWare Enterprise includes the software products ServiceWare
Self-Service(TM) (Web-based self-service for customers, partners and employees),
ServiceWare Professional(TM) (for customer service, sales and field service
personnel) and ServiceWare Architect(TM) (for quality assurance managers and
system administrators).
The accompanying financial statements have been prepared on a basis that
assumes that the Company will continue as a going concern, which contemplates
the realization of assets and the satisfaction of liabilities and commitments in
the normal course of business. The Company has an accumulated deficit of
approximately $78,831,000 at September 30, 2004, incurred a net loss of
approximately $2,346,000 and had positive cash flows from operations of
approximately $329,000 for the nine months ended September 30, 2004,
respectively. The ability of the Company to continue in its present form is
largely dependent on its ability to generate additional revenues, achieve
profitability and positive cash flows or to obtain additional debt or equity
financing. Management believes that the Company has the ability to do so and
plans to fund the remainder of 2004 and 2005 operations through cash the Company
expects to generate from operations and cash balances. There is no assurance
that the Company will be successful in obtaining sufficient license and service
fees from its products or alternatively, to obtain additional financing on terms
acceptable to the Company.
NOTE 2. UNAUDITED INTERIM FINANCIAL INFORMATION
The accompanying unaudited balance sheet as of September 30, 2004 and
related unaudited consolidated statements of operations for the three and nine
months ended September 30, 2004 and 2003, unaudited consolidated statements of
cash flows for the nine months ended September 30, 2004 and 2003 and the
unaudited consolidated statements of stockholders' equity for the nine months
ended September 30, 2004 and 2003 have been prepared by the Company in
accordance with accounting principles generally accepted in the United States of
America for interim financial information and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by U.S. generally accepted accounting principles for complete financial
statements. Management believes that the interim financial statements include
all adjustments, consisting of normal recurring accruals, considered necessary
for a fair presentation of the results of interim periods. Operating results for
the three and nine months ended September 30, 2004 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2004. These unaudited consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's 2003 Annual Report on Form 10-K filed with the
Securities and Exchange Commission.
NOTE 3. SIGNIFICANT ACCOUNTING POLICIES
7
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries after elimination of all significant
intercompany accounts and transactions.
RESTRICTED CASH
The Company has included $61,000 of restricted cash in other non-current
assets.
INVESTMENTS
The Company considers all investments as available-for-sale. Accordingly,
these investments are carried at fair value and unrealized holding gains and
losses, net of the related tax effect, are excluded from earnings and are
reported as a separate component of other comprehensive income (loss) until
realized. Realized gains and losses from the sale of available-for-sale
securities are determined on a specific identification basis.
The Company classifies investments as short term or long term based upon
the maturity date of the investment.
The short and long-term investments are held in an account with an
investment firm that is related to a director of the Company and his affiliated
entities and consist of commercial notes.
STOCK BASED COMPENSATION
The Company has adopted the disclosure only provisions of Statement of
Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation
("SFAS No. 123"), as amended by SFAS No. 148. SFAS No. 123 permits the Company
to continue accounting for stock-based compensation as set forth in Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB
Opinion No. 25"), provided the Company discloses the proforma effect on net
income and earnings per share of adopting the full provisions of SFAS No. 123.
Accordingly, the Company continues to account for stock-based compensation under
APB Opinion No. 25.
The following proforma disclosure presents the Company's net income (loss)
and net income (loss) per share had compensation cost for the Company's stock
option plans been determined based upon the fair value at the grant date for
awards under these plans consistent with the methodology prescribed under SFAS
No. 123.
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2004 2003 2004 2003
-------- -------- -------- --------
(in thousands)
Net income (loss) from continuing operations, $ 201 $ (494) $ (2,346) $ (2,806)
as reported
Add back stock based compensation expense 37 - 204 9
included in net income (loss)
Deduct total stock based compensation expense (213) (450) (802) (1,322)
under SFAS No. 123
-------- -------- -------- --------
Adjusted net income (loss) $ 25 $ (944) $ (2,944) $ (4,119)
======== ======== ======== ========
Net income (loss) per common share, basic $ 0.00 $ (0.04) $ (0.06) $ (0.17)
Net income (loss) per common share, diluted $ 0.00 $ (0.04) $ (0.06) $ (0.17)
Shares used in computing per share amounts:
Basic 52,186 24,226 51,141 24,176
Diluted 53,165 24,226 51,141 24,176
The average fair value of the options granted was $0.58 during the first
nine months of 2004 and $0.36 during first nine months of 2003, on the date of
grant using the Black-Scholes pricing model.
The effects of applying SFAS 123 in this proforma disclosure are not
likely to be representative of the effects on reported net income for future
years.
RECLASSIFICATIONS
Certain reclassifications have been made for comparative purposes.
8
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
Effective May 1, 2003, the FASB issued SFAS No. 150, Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity ("SFAS 150"). This statement establishes standards for how an issuer
classifies and measures certain financial instruments with characteristics of
both liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances). Many of those instruments were previously classified as equity.
This statement was effective for the Company after May 31, 2003. In November
2003, the FASB issued FASB Staff Position No. 150-3 which deferred the effective
dates for applying certain provisions of SFAS 150 related to mandatorily
redeemable financial instruments of certain non-public entities and certain
mandatorily redeemable non-controlling interests for public and non-public
companies. For public entities, SFAS 150 is effective for mandatorily redeemable
financial instruments entered into or modified after May 31, 2003 and is
effective for all other financial instruments as of the first interim period
beginning after June 15, 2003. For mandatorily redeemable non-controlling
interests that would not have to be classified as liabilities by a subsidiary
under the exception in paragraph 9 of SFAS 150, but would be classified as
liabilities by the parent, the classification and measurement provisions of SFAS
150 are deferred indefinitely. The measurement provisions of SFAS 150 are also
deferred indefinitely for other mandatorily redeemable non- controlling
interests that were issued before November 4, 2003. For those instruments, the
measurement guidance for redeemable shares and non-controlling interests in
other literature shall apply during the deferral period. The Company adopted the
provisions of SFAS 150 effective June 30, 2003, and such adoption had no impact
on its consolidated financial statements.
In December 2003, the FASB issued FASB Interpretation ("FIN") No. 46-R,
Consolidation of Variable Interest Entities. FIN No. 46-R, which modifies
certain provisions and effective dates of FIN No. 46, sets forth criteria to be
used in determining whether an investment in a variable interest entity should
be consolidated, and is based on the general premise that companies that control
another entity through interests other than voting interests should consolidate
the controlled entity. The Company does not have any variable interest entities.
The Emerging Issues Task Force ("EITF") reached final consensuses on Issue
03-6 Participating Securities and the Two-Class Method Under FASB Statement No.
128, Earnings Per Share at its March 17-18, 2004 meeting. Issue 03-6 addresses a
number of questions regarding the computation of earnings per share ("EPS") by
companies that have issued securities other than common stock that contractually
entitle the holder to participate in dividends and earnings of the company when,
and if, it declares dividends on its common stock. The issue also provides
further guidance in applying the two-class method of calculating EPS. It
clarifies what constitutes a participating security and how to apply the
two-class method of computing EPS once it is determined that a security is
participating, including how to allocate undistributed earnings to such a
security. The Company adopted EITF 03-6 during the six month period ended June
30, 2004. The adoption of EITF 03-6 has had no impact on the Company's results
of operations.
NOTE 4. DEBT
CREDIT FACILITIES
In October 2002, the Company entered into a $2.5 million loan and security
agreement with Comerica Bank - California (the "Bank"). The agreement provided
for a revolving line of credit and a term loan. The term loan expired on October
16, 2003. Borrowings under the line of credit accrued interest at the Bank's
prime rate plus 1.5%, which was 5.5% at December 31, 2003. Borrowings under the
loan agreement were collateralized by essentially all of the Company's tangible
and intangible assets. At December 31, 2003, the Company had outstanding
borrowings of $250,000 under the revolving line of credit, which were repaid in
January 2004, at which time, the agreement terminated. The Company has not
pursued obtaining any further credit facility at this time. In conjunction with
this agreement, a warrant was issued to the Bank to purchase 50,000 shares of
the Company's Common Stock at an exercise price of $0.46 per share with a
10-year term. The warrant included assignability to the Bank's affiliates,
anti-dilution protection and a net exercise provision. In addition, the Bank had
the right to require the Company to repurchase the warrant for $69,000 after a
change of control. The warrant was treated as consideration for the loan
agreement and was valued at $22,990 on the date of the issuance using the Black
Scholes option valuation model. As such, the warrant value was recorded as a
debt issue cost and was amortized to interest expense over the life of the
agreement. As the warrant contained a put option, the warrant value was accrued
as a liability and not recorded as equity. The Bank exercised the warrant on a
cashless, net value basis in March 2004 and was issued 21,250 shares of common
stock.
CONVERTIBLE NOTES
On April 1, 2002, the Company signed a binding commitment letter for the
sale of convertible notes. The closing of the transaction took place in two
tranches on May 6 and June 19, 2002 with total proceeds of $2,975,000 being
received, net of transaction costs of $275,000.
9
Of the total amount of $3,250,000 of convertible notes issued, convertible
notes with an aggregate principal amount of $2,635,000 were acquired by a
director of the Company and his affiliated entities, who collectively owned
approximately 20% of the Company's stock prior to the acquisition of convertible
notes.
The convertible notes were originally to mature 18 months from the closing
date, bore interest at 10% per annum, and were originally convertible at any
time at the option of the holder into shares of the Company's common stock at a
conversion price of $0.30 per share. Interest was to be paid in cash or
additional convertible notes, at the option of the Company. The convertible
notes were senior unsecured obligations that ranked senior to all future
subordinated indebtedness, pari passu to all existing and future senior,
unsecured indebtedness and subordinate to all existing and future senior secured
indebtedness. While the notes were outstanding, the Company was restricted from
paying or declaring dividends on common stock, making any other distribution on
common stock, or repurchasing or redeeming any shares of common stock.
In accordance with EITF 00-27, Application of EITF Issue No. 98-5,
Accounting for Convertible Securities with Beneficial Conversion Features or
Contingently Adjustable Conversion Ratios, to Certain Convertible Instruments,
the Company recognized in 2002 a beneficial conversion feature ("BCF") in the
aggregate amount of $2,225,000 as the difference between the market value of the
Company's common stock on the commitment date and the conversion price of the
convertible notes, reduced for the investors' transaction costs. The BCF was
recorded as an increase in additional paid in capital and a discount on debt in
the 2002 consolidated balance sheet. Additionally, the Company incurred total
legal and other expenses of approximately $54,000 related to the transaction,
which was also recorded as a discount on debt in the 2002 consolidated balance
sheet. The aggregate discount was being amortized as interest expense over the
18 month term of the convertible notes.
On March 31, 2003, the noteholders agreed to an amendment to the original
notes. The amendment reduced the conversion price from $0.30 per share to $0.25
per share and extended the term of the notes until July 15, 2004.
On October 31, 2003, April 30, 2003 and October 31, 2002, interest
payments were due on the convertible notes and were paid by issuing additional
convertible notes in the amounts of $177,748, $169,284 and $135,681,
respectively. These additional convertible notes had the same terms as the
amended convertible notes. The Company recognized additional BCF of $232,672 and
$906,799 in 2004 and 2003, respectively, as a result of the amendment of the
notes and payment of interest with additional convertible notes.
On February 10, 2004, all of the notes were converted into common stock as
part of the terms of an equity funding. Additional interest of $105,760 was paid
in shares of stock in connection with the conversion.
NOTE 5. NET INCOME (LOSS) PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share:
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2004 2003 2004 2003
-------- -------- -------- --------
(in thousands)
Numerator:
Net income (loss) $ 201 $ (494) $ (2,346) $ (2,806)
Denominator:
Denominator for basic earnings per
share-weighted average shares 52,186 24,226 51,141 24,176
Denominator for dilutive earnings per 53,165 24,226 51,141 24,176
share-weighted average shares
Basic net income (loss) per share: $ 0.00 $ (0.02) $ (0.05) $ (0.12)
Dilutive net income (loss) per share: $ 0.00 $ (0.02) $ (0.05) $ (0.12)
Dilutive securities include options and warrants, if converted.
Potentially dilutive securities totaling 15,679,826 and 19,996,127 shares as of
September 30, 2004 and 2003, respectively, were excluded from historical basic
and diluted loss per share because of their anti-dilutive effect, for the nine
months ended September 30, 2004 and 2003, and the three months ended September
30, 2003.
NOTE 6. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) consists of net income (loss) adjusted for
other increases and decreases affecting stockholders' equity that is excluded
from the determination of net income (loss). The calculation of comprehensive
income (loss) follows (in thousands):
10
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
------- ------- ------- -------
Net income (loss) $ 201 $ (494) $(2,346) $(2,806)
Unrealized loss on short term investments (8) - (8) -
Foreign currency translation gain - 41 - 37
------- ------- ------- -------
Comprehensive income (loss) $ 193 $ (453) $(2,354) $(2,769)
======= ======= ======= =======
NOTE 7. SEGMENT INFORMATION
The Company has one business segment. The following chart indicates the
percentage of the Company's business in the United States and internationally
for the periods indicated.
THREE MONTHS ENDED
SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2004 2003 2004 2003
------ ------ ------ ------
Revenue (a)
United States $3,307 $2,672 $8,713 $7,308
International 666 59 984 622
------ ------ ------ ------
Total $3,973 $2,731 $9,697 $7,930
====== ====== ====== ======
(a) Revenues are attributed to the United States and International based on
customer location.
NOTE 8. CAPITAL STOCK
On January 30, 2004, the Company secured an additional $7.4 million, net
of expenses, in funding to finance its operations and the development of its
business. The funding was raised through a private placement of equity
securities consisting of 12,307,692 shares of common stock and five-year
warrants to purchase 6,153,846 shares of common stock at $0.72 per share.
NOTE 9. CONTINGENCIES
On January 16, 2004, the Company entered into a release agreement with its
prior landlord, Sibro Enterprises, LP ("Sibro"), pursuant to which the Company
settled all outstanding disputes under the lawsuit Sibro had filed in the Court
of Common Pleas of Allegheny County, Pennsylvania. Pursuant to the release
agreement, the Company paid Sibro Enterprises an agreed upon amount representing
rent due through December 31, 2003, which was recorded in its 2003 consolidated
financial statements and issued Sibro Enterprises a warrant to purchase 125,000
shares of common stock at a purchase price of $0.84 per share. The warrant was
valued at $104,925 on the date of the issuance using the Black Scholes option
valuation model. In exchange, the parties mutually agreed to terminate the lease
as of December 31, 2003, dismiss the lawsuit with prejudice, and release each
other from any and all claims as of the date of the release agreement.
NOTE 10. SUBSEQUENT EVENTS
In October 2003, the Company filed suit against Primus Knowledge
Solutions, Inc. ("Primus") in the United States District Court for the Western
District of Pennsylvania, alleging that Primus had infringed certain United
States patents owned by the Company. Primus filed an answer denying liability
and asserting counterclaims against the Company, including allegations of
interference, defamation and unfair competition. The Company subsequently
asserted certain reply counterclaims against Primus. This action, including the
related counterclaims and reply claims, is referred to as the "Lawsuit".
On August 10, 2004, Primus announced that it had entered into a definitive
agreement and plan of merger whereby Primus would be acquired by Art Technology
Group, Inc. or ATG.
As of November 1, 2004, the Company entered into a settlement
agreement with Primus and ATG in which:
- Without any admission of liability by either party, the Company and
Primus agreed to dismiss with prejudice all the claims,
11
counterclaims and reply claims in the Lawsuit, and to deliver to
each other mutual general releases.
- The Company agreed to grant to Primus and its affiliates, including
ATG, a fully paid, irrevocable, nonexclusive, nontransferable (with
certain exceptions specified in the agreement), worldwide,
perpetual limited license under the patents at issue in the Lawsuit
and a covenant not to sue under those patents.
- Primus agreed to pay the Company the sum of $800,000 in cash, of
which $500,000 is payable within five business days following the
closing of ATG's acquisition of Primus, and the balance is due on
January 3, 2005.
- Primus agreed to issue to the Company, immediately prior to the
closing of ATG's acquisition of Primus, shares of Primus common
stock having a value, determined in the manner specified in the
settlement, equal to $850,000.
- ATG agreed to guarantee the obligation of Primus to make the
specified cash payment.
- The Company agreed to certain restrictions on its transfer of the
shares of ATG common stock issued in connection with the acquisition
by ATG of Primus, which restrictions will expire not later than May
15, 2005.
On November 1, 2004, the acquisition of Primus by ATG was completed and
the transactions contemplated by the settlement agreement were consummated.
In addition to the amounts payable to the Company under the foregoing
agreement with Primus and ATG, the Company's insurance carrier, Chubb Group,
agreed to pay the sum of $575,000 towards the Company's out-of-pocket costs and
expenses associated with the Lawsuit resulting in total cash and stock
settlement proceeds of $2,225,000. In connection with the Lawsuit the Company
incurred approximately $1.0 million in attorneys' fees and other out-of-pocket
expenses. The Company's net settlement proceeds after taking into consideration
the out-of-pocket expenses will be approximately $1.2 million.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of our financial condition and
results of operations should be read in conjunction with our consolidated
financial statements and related notes contained in this Quarterly Report on
Form 10-Q ("Form 10-Q").
Certain statements contained in this Form 10-Q that are not historical
facts, including those statements that refer to our plans, prospects,
expectations, strategies, intentions, hopes and beliefs, constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. These statements involve known and unknown risks,
uncertainties and other factors that may cause our actual results, levels of
activity, performance or achievements to be materially different from any
expressed or implied by these forward-looking statements. We assume no
obligation to update these forward-looking statements as circumstances change in
the future. In some cases, you can identify forward-looking statements by
terminology such as "may", "will", "should", "expects", "plans", "anticipates",
"believes", "estimates", "predicts", "potential", "continue", or the negative of
these terms or other comparable terminology. For a description of some of the
risk factors that could cause our results to differ materially from our forward
looking statements, please refer to the risk factors set forth in the section
entitled "Additional Factors that May Affect Future Results" beginning on page
17 of this Form 10-Q, as well as to our other filings with the Securities and
Exchange Commission and to other factors discussed elsewhere in this Form 10-Q.
OVERVIEW
We are a provider of knowledge-powered support solutions that enable
organizations to deliver superior service for customers, employees and partners
by transforming information into knowledge. Our solutions allow customers to
capture enterprise knowledge, solve customer problems, reuse solutions and share
captured knowledge throughout the extended enterprise. Customers use our
knowledge-powered support solutions to achieve some or all of the following
benefits:
- Strengthen relationships with customers, partners, suppliers
and employees
- Decrease operating costs
- Improve creation, dissemination and sharing of enterprise
knowledge
- Provide easy access to knowledge online on an enterprise-wide
basis
- Integrate seamlessly with existing technology investments
With ServiceWare Enterprise(TM), our core software product line, our
customers can provide personalized, automated Web-based service tailored to the
needs of their applicable users. ServiceWare Enterprise is based on our patented
self-learning search technology called the Cognitive Processor(R). This
technology enables organizations to capture and manage repositories of
intellectual capital, or corporate knowledge, in a manner that can be easily
accessed by way of a browser to effectively answer inquiries made either over
the Web or through the telephone to a customer contact center or help desk.
Through the self-learning features of the Cognitive Processor, our ServiceWare
Enterprise products provide our customers an intelligent solution in that the
solutions have the capability to learn from each interaction and automatically
update themselves accordingly.
The ServiceWare Enterprise suite is comprised of the following software
products:
ServiceWare Self-Service(TM): This product is a Web-based, self-service
product designed for use by an organization's
customers, partners and employees.
ServiceWare Agent(TM): This product is designed for use by Level-1
agents or for any company that needs to
provide a complete agent workstation knowledge
management center.
12
ServiceWare Professional(TM): This product is designed for use by customer
service, sales and field service personnel.
ServiceWare Architect(TM): This product is designed for quality
assurance managers and system administrators.
FACTORS AFFECTING FUTURE OPERATIONS
Our operating losses, as well as our negative operating cash flow, have
been significant to date. We expect to have positive operating margins over time
by increasing our customer base without significantly increasing related capital
expenditures and other operating costs. We do not know if we will be able to
achieve these objectives.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of our financial condition and results of
operations is based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
us to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an on-going basis, we evaluate our estimates. We base our
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions. We believe the
following critical accounting policies affect our more significant judgments and
estimates used in the preparation of our consolidated financial statements: (i)
revenue recognition on license fees, (ii) estimates of doubtful accounts
receivable, and (iii) the valuation of intangible assets and goodwill. For
additional discussion of our critical accounting estimates, see our
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in our annual report on Form 10-K for the year ended December 31,
2003.
DESCRIPTION OF STATEMENT OF OPERATIONS
REVENUES
We market and sell our products primarily in North America through our
direct sales force. Internationally, we market our products through value-added
resellers, software vendors and system integrators as well as our direct sales
force. International revenues were 10% of total revenues in the first nine
months of 2004 and 8% in the first nine months of 2003. We derive our revenues
from licenses for software products and from providing related services,
including installation, training, consulting, customer support and maintenance
contracts. License revenues primarily represent fees for perpetual licenses.
Service revenues contain fixed and variable fees for installation, training and
consulting, reimbursements for travel expenses that are billed to customers, as
well as fixed fees for customer support and maintenance contracts.
COST OF REVENUES
Cost of license revenues consists primarily of the expenses related to
royalties, the cost of the media on which our product is delivered, product
fulfillment costs and amortization of purchased technology. Cost of service
revenues consists of the salaries, benefits, direct expenses and allocated
overhead costs of customer support and services personnel, reimbursable expenses
for travel that are billed to customers, fees for sub-contractors, and the costs
associated with maintaining our customer support site.
OPERATING COSTS
We classify our core operating costs into four general categories: sales
and marketing, research and development, general and administrative, and
intangible assets amortization based upon the nature of the costs. Special
one-time charges, including restructuring costs, are presented separately as
restructuring and other special charges to enable the reader to determine core
operating costs. We allocate the total costs for overhead and facilities, based
upon headcount, to each of the functional areas that benefit from these
services. Allocated charges include general overhead items such as building
rent, equipment leasing costs, telecommunications charges and depreciation
expense. Sales and marketing expenses consist primarily of employee compensation
for direct sales and marketing personnel, travel, public relations, sales and
other promotional materials, trade shows, advertising and other sales and
marketing programs. Research and development expenses consist primarily of
expenses related to the development and upgrade of our proprietary software and
other technologies. These expenses include employee compensation for software
developers and quality assurance personnel and third-party contract development
costs. General and administrative expenses consist primarily of compensation for
personnel and fees for outside professional advisors. Intangible assets
amortization expense consists primarily of the amortization of intangible assets
acquired through our acquisition of the Molloy Group in 1999. These assets
(other than goodwill) are amortized on a straight line basis over their
respective estimated useful lives. Restructuring and other special
13
charges consist of costs incurred in connection with prior restructurings.
RESULTS OF OPERATIONS
The following table sets forth the consolidated statement of operations data as
a percentage of total revenues for each of the periods indicated:
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2004 2003 2004 2003
------ ------ ------ ------
Revenues
Licenses 40.4% 43.7% 42.7% 34.4%
Services 59.6 56.3 57.3 65.6
----- ----- ----- -----
Total revenues 100.0 100.0 100.0 100.0
Cost of revenues
Cost of licenses 2.9 2.6 2.7 2.3
Cost of services 37.6 27.5 32.9 28.9
----- ----- ----- -----
Total cost of revenues 40.5 30.1 35.6 31.2
----- ----- ----- -----
Gross margin 59.5 69.9 64.4 68.8
Operating expenses
Sales and marketing 28.6 39.2 37.9 46.1
Research and development 9.8 12.4 16.7 17.9
General and administrative 16.6 19.6 21.3 20.5
Intangible assets amortization - 0.6 - 1.9
Restructuring and other special charges - - - (0.3)
----- ----- ----- -----
Total operating expenses 55.0 71.8 75.9 86.1
----- ----- ----- -----
Income (loss) from operations 4.5 (1.9) (11.5) (17.3)
Other income (expense), net 0.5 (16.2) (12.7) (18.1)
----- ----- ----- -----
Net income (loss) 5.0% (18.1)% (24.2)% (35.4)%
===== ===== ===== =====
THREE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
REVENUES
Total revenues increased 45.5% to $4.0 million in third quarter 2004 from
$2.7 million in third quarter 2003. License revenues increased 34.4% to $1.6
million in third quarter 2004 from $1.2 million in third quarter 2003; the
increase resulted primarily from an increase in the number of sales to existing
customers and an increase in average revenue per sale to new customers. The
average license revenue recognized from sales to new customers was $254,000 up
85.4% from $137,000 in third quarter 2003, and the average license revenue from
existing customers was $66,000 in third quarter 2004 down 18.5% from $81,000 in
third quarter 2003. There were four license sales to new customers, including
two license sales by resellers, in third quarter 2004 compared to five in third
quarter 2003, and the number of sales of additional licenses to existing
customers increased to nine in third quarter 2004 from five in third quarter
2003.
Service revenues increased 54.1% to $2.4 million in third quarter 2004 from $1.5
million in third quarter 2003. The increase was primarily due to the fact that
there were three large services efforts in third quarter 2004, which consisted
of 66% of the services revenue for the quarter.
COST OF REVENUES
Cost of revenues increased 95.7% to $1.6 million in third quarter 2004
from $0.8 million in third quarter 2003. The increase is primarily attributable
to a 52.9% increase in headcount and an increase in the use of third party
contractors hired in 2004 for special services projects booked with existing
customers. Cost of revenues as a percentage of revenues increased to 40.5% from
30.1% for the same reasons, resulting in a gross margin of 59.5% for the third
quarter 2004 compared to 69.9% for third quarter 2003.
Cost of license revenues increased to $116,000 in third quarter 2004 from
$72,000 in third quarter 2003. Cost of license revenues as a percentage of
revenues increased to 2.9% from 2.6%. The increase in the cost of license
revenues was primarily attributable to royalty payments payable with respect to
license sales.
Cost of service revenues increased 99.1% in third quarter 2004 from third
quarter 2003. The increase was primarily attributable to a 52.9% increase in
headcount and an increase in the use of third party contractors hired in 2004
for special services projects booked with existing customers. Cost of service
revenues as a percentage of revenues increased to 37.6% from 27.5% for the same
reasons.
14
OPERATING EXPENSES
Sales and Marketing. Sales and marketing expenses increased 6.5% in third
quarter 2004, which was 28.6% of revenues, compared to 39.2% of revenues in
third quarter 2003. Increases of commissions paid on higher revenues, travel and
tradeshow expenses in 2004 were partially offset by reductions in allocated
facility costs due to expense control in 2004. Sales and marketing expenses as a
percentage of revenue declined due to our higher revenues.
Research and Development. Research and development expenses increased 14.2% to
$0.4 million in third quarter 2004 from $0.3 million in third quarter 2003. The
increase is primarily attributable to an increase in the number of third party
development resources used.
General and Administrative. General and administrative expenses increased 22.9%
to $0.7 million, or 16.6% of revenues in third quarter 2004 from $0.5 million,
or 19.6% of revenues in third quarter 2003. Increases resulted from stock based
compensation recorded upon the issuance of restricted stock to executives and an
increase in legal expense due to out of pocket costs related to the lawsuit
mentioned in "Legal Proceedings".
Intangible Assets Amortization. There was no intangible assets amortization
recorded in third quarter 2004 compared to $16,000 in third quarter 2003 as a
result of components of our intangible assets becoming fully amortized.
Restructuring and other special charges. There were no special charges recorded
in third quarters 2004 or 2003.
OTHER INCOME (EXPENSE), NET
Other income (expense), net consists primarily of interest income on
short-term investments, offset by interest expense and other fees related to our
bank borrowings. Third quarter 2004 results reflect net other income of $21,000
or 0.5% of revenues compared to a net expense of $0.4 million or 16.2% of
revenues in third quarter 2003. The interest expense primarily represents
amortization of the beneficial conversion feature recognized in conjunction with
the issuance and amendment of the convertible notes, in addition to the 10%
interest, amortization of the debt discount, and debt issue costs on the
convertible notes. The beneficial conversion feature was fully amortized in
first quarter 2004 as a result of the conversion of all of the notes into common
stock as a part of the equity funding in first quarter 2004.
NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
REVENUES
Total revenues increased 22.3% to $9.7 million in the first nine months of
2004 from $7.9 million in the first nine months of 2003. License revenues
increased 52.1% to $4.1 million in the first nine months of 2004 from $2.7
million in the first nine months of 2003; the increase resulted primarily from
an increase in the number of total deals sold. The average license revenue
recognized from sales to new customers was $163,000 up 26.4% from $129,000 in
the first nine months of 2003, and the average license revenue from existing
customers was $82,000 in the first nine months of 2004 up 22.4% from $67,000 in
the first nine months of 2003. There were 20 license sales to new customers,
including ten license sales by resellers and outsourcers, in the first nine
months of 2004 compared to 13 in the first nine months of 2003.
Service revenues increased 6.7% to $5.6 million in the first nine months of 2004
from $5.2 million in the first nine months of 2003. The increase was primarily
due to the fact that there were three large services efforts in the first nine
months of 2004, which resulted in 45% of the services revenue.
COST OF REVENUES
Cost of revenues increased 39.3% to $3.5 million in the first nine months
of 2004 from $2.5 million in the first nine months of 2003. The increase is
primarily attributable to a 52.9% increase in headcount and third party
contractors hired in 2004 for special services projects booked with existing
customers. Cost of revenues as a percentage of revenues increased to 35.6% from
31.2%, resulting in a gross margin of 64.4% for the first nine months of 2004
compared to 68.8% for the first nine months of 2003.
Cost of license revenues increased to $0.3 million in the first nine
months of 2004 from $0.2 million in the first nine months of 2003. The increase
in the cost of license revenues was primarily attributable to royalty payments
payable with respect to license sales.
Cost of service revenues increased 39.1% to $3.2 million in the first nine
months of 2004 from $2.3 million in the first nine months of 2003. The increase
was primarily attributable to a 62.5% increase in headcount from 16 to 26. The
increase of
15
headcount was necessary due to 2004 bookings of substantial fixed fee services
projects. Cost of service revenues as a percentage of revenues increased to
32.9% from 28.9%.
OPERATING EXPENSES
Sales and Marketing. Sales and marketing expenses remained constant at $3.7
million, which was 37.9% of revenues in the first nine months of 2004 compared
to 46.1% of revenues in the first nine months of 2003. Increases of commissions
paid on higher revenues, travel and tradeshow expenses in 2004 were offset by
reductions in allocated facility costs due to expense control in 2004. Sales and
marketing expenses as a percentage of revenue declined due to higher revenues.
Research and Development. Research and development expenses increased 14.0% to
$1.6 million in the first nine months of 2004 from $1.4 million in the first
nine months of 2003. The increase is primarily attributable to an increase in
the number of third party development resources used.
General and Administrative. General and administrative expenses increased 27.4%
to $2.1 million, or 21.3% of revenues in the first nine months of 2004 from $1.6
million, or 20.5% of revenues in the first nine months of 2003. The increase is
primarily attributable to stock based compensation recorded for the issuance of
restricted stock to executives, bonuses paid to executives, and the hiring of an
investor relations firm.
Intangible Assets Amortization. There was no intangible assets amortization
recorded in the first nine months of 2004 compared to $0.1 million or 1.9% of
revenues in the first nine months of 2003 as a result of components of our
intangible assets becoming fully amortized.
Restructuring and other special charges. There were no special charges recorded
in the first nine months of 2004. The $20,000 credit recorded in the first nine
months of 2003 represents a change in estimate to the restructuring charge
recorded in 2001.
OTHER INCOME (EXPENSE), NET
Other income (expense), net consists primarily of interest income on
short-term investments, offset by interest expense and other fees related to our
bank borrowings. Results for the first nine months of 2004 reflect a net expense
of $1.2 million or 12.7% of revenues compared to a net expense of $1.4 million
or 18.1% of revenues in the first nine months of 2003. The interest expense
primarily represents amortization of the beneficial conversion feature
recognized in conjunction with the issuance and amendment of the convertible
notes, in addition to the 10% interest, amortization of the debt discount, and
debt issue costs on the convertible notes. The beneficial conversion feature was
fully amortized in first quarter 2004 as a result of the conversion of all of
the notes into common stock as a part of the equity funding in first quarter
2004. With no current debt, we do not expect any significant amount of interest
expense in the near future.
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have satisfied our cash requirements primarily through
private placements of preferred stock and common stock, our initial public
offering, and incurrence of debt.
We incurred a net loss of $2.3 million in the first nine months of 2004,
but have achieved profitability in each of the last two quarters.
Net cash provided by operating activities in the first nine months of 2004
is principally the result of our net loss reduced by non-cash expense items. The
net cash provided by operating activities was $0.3 million in the first nine
months of 2004 compared to $1.2 million used in operating activities in the
first nine months of 2003.
Net cash of $6.2 million used in investing activities in the first nine
months of 2004 is primarily due to the purchase of short and long term
investments. Net cash provided by investing activities was $0.5 million in the
first nine months of 2003, primarily due to the sale of short term investments.
Net cash provided by financing activities was $7.2 million in the first
nine months of 2004, which is primarily due to the proceeds from the equity
funding reduced by the repayment of a borrowing under our revolving line of
credit, which is now terminated. Net cash used in financing activities was $0.5
million in the first nine months of 2003, which was primarily the result of
repayments offset by borrowings against our revolving line of credit.
As of September 30, 2004, we had $8.8 million in cash, cash equivalents
and investments. In January 2004, we received proceeds of $7.4 million, net of
expenses, to finance our operations and the development of our business. The
additional funding was raised through a private placement of equity securities
consisting of 12,307,692 shares of common stock and five-year warrants to
16
purchase 6,153,846 shares of common stock at $0.72 per share. In February 2004,
our convertible notes were converted into common stock as part of terms of the
equity funding.
Our ability to continue as a business in our present form is largely
dependent on our ability to continue to achieve profitability and positive cash
flows. We believe that we have the ability to do so and plan to fund our
operations through operating revenue and cash balances.
If we require additional financing, there can be no assurance that
additional capital will be available to us on reasonable terms, if at all, when
needed or desired. If we raise additional funds through the issuance of equity,
equity-related or debt securities, such securities may have rights, preferences
or privileges senior to those of the rights of our common stock. Furthermore,
because of the low trading price of our common stock, the number of shares of
new equity or equity-related securities that we may be required to issue may be
greater than it otherwise would be. Under those circumstances, our stockholders
may suffer significant additional dilution. Further, the issuance of debt
securities could increase the risk or perceived risk of our company.
RELATED PARTY TRANSACTIONS
Our short-term investments are held in an account with an investment firm
that is related to one of our directors and his affiliated entities, who
collectively own more than 40% of our stock. At September 30, 2004, cash and
investments totaling $7,143,000 are with this investment firm.
RECENT ACCOUNTING PRONOUNCEMENTS
Effective May 1, 2003, the FASB issued SFAS No. 150 Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity ("SFAS
150"). This statement establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). Many of
those instruments were previously classified as equity. This statement was
effective for us after May 31, 2003. In November 2003, the FASB issued FASB
Staff Position No. 150-3 which deferred the effective dates for applying certain
provisions of SFAS 150 related to mandatorily redeemable financial instruments
of certain non-public entities and certain mandatorily redeemable
non-controlling interests for public and non-public companies. For public
entities, SFAS 150 is effective for mandatorily redeemable financial instruments
entered into or modified after May 31, 2003 and is effective for all other
financial instruments as of the first interim period beginning after June 15,
2003. For mandatorily redeemable non-controlling interests that would not have
to be classified as liabilities by a subsidiary under the exception in paragraph
9 of SFAS 150, but would be classified as liabilities by the parent, the
classification and measurement provisions of SFAS 150 are deferred indefinitely.
The measurement provisions of SFAS 150 are also deferred indefinitely for other
mandatorily redeemable non- controlling interests that were issued before
November 4, 2003. For those instruments, the measurement guidance for redeemable
shares and non-controlling interests in other literature shall apply during the
deferral period. We adopted the provisions of SFAS 150 effective June 30, 2003,
and such adoption had no impact on our consolidated financial statements.
In December 2003, the FASB issued FASB Interpretation ("FIN") No. 46-R,
Consolidation of Variable Interest Entities. FIN No. 46-R, which modifies
certain provisions and effective dates of FIN No. 46, sets forth criteria to be
used in determining whether an investment in a variable interest entity should
be consolidated, and is based on the general premise that companies that control
another entity through interests other than voting interests should consolidate
the controlled entity. We do not have any variable interest entities.
The Emerging Issues Task Force ("EITF") reached final consensuses on Issue
03-6 Participating Securities and the Two-Class Method Under FASB Statement No.
128, Earnings Per Share at its March 17-18, 2004 meeting. Issue 03-6 addresses a
number of questions regarding the computation of earnings per share ("EPS") by
companies that have issued securities other than common stock that contractually
entitle the holder to participate in dividends and earnings of the company when,
and if, it declares dividends on its common stock. The issue also provides
further guidance in applying the two-class method of calculating EPS. It
clarifies what constitutes a participating security and how to apply the
two-class method of computing EPS once it is determined that a security is
participating, including how to allocate undistributed earnings to such a
security. We adopted EITF 03-6 during the six month period ended June 30, 2004.
The adoption of EITF 03-6 has had no impact on our results of operations.
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
Set forth below and elsewhere in this Form 10-Q and in other documents we
file with the Securities and Exchange Commission are risks and uncertainties
that could cause actual results to differ materially from the results
contemplated by any forward-looking statements contained in this Form 10-Q or
the results indicated or projected by our historical results.
WE HAVE A HISTORY OF LOSSES.
17
As of September 30, 2004, we had an accumulated deficit of $78.8 million.
We achieved profitability on a quarterly basis for the first time in second
quarter 2004, but have incurred a net loss of $2.3 million in the first nine
months of 2004. If we cannot maintain our revenues and expenses at or above
current levels, our losses may continue. In addition, our history of losses may
cause some of our potential customers to question our viability, which might
hamper our ability to make sales.
WE MAY NEED ADDITIONAL CAPITAL TO FUND CONTINUED BUSINESS OPERATIONS AND WE
CANNOT BE SURE THAT ADDITIONAL FINANCING WILL BE AVAILABLE WHEN AND IF NEEDED.
Although we presently have adequate cash resources for our near term
needs, our ability to continue as a business in our present form will ultimately
depend on our ability to generate sufficient revenues or to obtain additional
debt or equity financing. From time to time, we consider and discuss various
financing alternatives and expect to continue such efforts to raise additional
funds to support our operational plan as needed. However, we cannot be certain
that additional financing will be available to us on favorable terms when
required, or at all.
IF WE ARE NOT ABLE TO OBTAIN CAPITAL WHEN NEEDED, WE MAY NEED TO DRAMATICALLY
CHANGE OUR BUSINESS STRATEGY AND DIRECTION, INCLUDING PURSUING OPTIONS TO SELL
OR MERGE OUR BUSINESS, OR LIQUIDATE.
In the past, we have funded our operating losses and capital expenditures
through proceeds from equity offerings and debt. Changes in equity markets in
the recent past have adversely affected our ability to raise equity financing
and have adversely affected the markets for debt financing for companies with a
history of losses such as ours. If we raise additional funds through the
issuance of equity, equity-linked or debt securities, those securities may have
rights, preferences or privileges senior to those of the rights of our common
stock and, in light of our current market capitalization, our stockholders may
experience substantial dilution. Further, the issuance of debt securities could
increase the risk or perceived risk of our company. If we are not able to obtain
necessary capital, we may need to dramatically change our business strategy and
direction, including pursuing options to sell or merge our business, or
liquidate.
OUR CASH FLOW MAY NOT BE SUFFICIENT TO PERMIT REPAYMENT OF ANY FUTURE DEBT WHEN
DUE.
Although we do not have any outstanding debt other than trade debt
incurred in the ordinary course of business, we may need to, in the future,
raise additional money through bank financing or debt instruments. Our ability
to retire or to refinance any future indebtedness will depend on our ability to
generate cash flow in the future. Our cash flow from operations may be
insufficient to repay this indebtedness at scheduled maturity and some or all of
our indebtedness may have to be refinanced. If we are unable to refinance our
debt or if additional financing is not available on acceptable terms, or at all,
we could be forced to dispose of assets under circumstances that might not be
favorable to realizing the highest price for the assets or to default on our
obligations with respect to this indebtedness.
WE MAY NOT SUCCEED IN ATTRACTING AND RETAINING THE PERSONNEL WE NEED FOR OUR
BUSINESS AND WE HAVE A SMALL SENIOR MANAGEMENT TEAM.
Our business requires the employment of highly skilled personnel,
especially experienced software developers. The inability to recruit and retain
experienced software developers in the future could result in delays in
developing new versions of our software products or could result in the release
of deficient software products. Any such delays or defective products would
likely result in lower sales. We may also experience difficulty in hiring and
retaining sales personnel, product managers and professional services employees.
Our senior management team consists of only three individuals. The loss of any
of these officers could have an adverse effect on our operations, business, and
prospects and our ability to carry out our business plan. We do not maintain key
man life insurance on our officers.
A SIGNIFICANT PERCENTAGE OF OUR PRODUCT DEVELOPMENT IS PERFORMED BY A THIRD
PARTY INTERNATIONALLY, THE LOSS OF WHICH COULD SUBSTANTIALLY HARM OUR PRODUCT
DEVELOPMENT EFFORTS.
A significant percentage of our product development work, and some of our
implementation services, is performed by a third-party development organization
located in Minsk, Belarus. Unpredictable developments in the political, economic
and social conditions in Belarus, or our failure to maintain or renew our
business relationship with this organization on terms similar to those which
exist currently, could reduce or eliminate product development and
implementation services. If access to these services were to be unexpectedly
eliminated or significantly reduced, our ability to meet development objectives
vital to our ongoing strategy would be hindered, and our business could be
seriously harmed.
IT IS DIFFICULT TO DRAW CONCLUSIONS ABOUT OUR FUTURE PERFORMANCE BASED ON OUR
PAST PERFORMANCE DUE TO SIGNIFICANT FLUCTUATIONS IN OUR QUARTERLY OPERATING
RESULTS.
We manage our expense levels based on our expectations regarding future
revenues and our expenses are relatively fixed in the
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short term. Therefore, if revenue levels are below expectations in a particular
quarter, operating results and net income are likely to be disproportionately
adversely affected because our expenses are relatively fixed. In addition, a
significant percentage of our revenues is typically derived from large orders
from a limited number of customers, so it is difficult to estimate accurately
the timing of future revenues. Our revenues are unpredictable and in our last
eight quarters have fluctuated up and down between a low of $1.8 million in
first quarter 2004 and a high of $4.0 million in third quarter 2004.
Our quarterly results are also impacted by our revenue recognition
policies. Because we generally recognize license revenues upon installation and
training, sales orders from new customers in a quarter might not be recognized
during that quarter. Delays in the implementation and installation of our
software near the end of a quarter could also cause recognized quarterly
revenues and, to a greater degree, results of operations to fall substantially
short of anticipated levels. We often recognize revenues for existing customers
in a shorter time frame because installation and training can generally be
completed in significantly less time than for new customers. However, we may not
be able to recognize expected revenues at the end of a quarter due to delays in
the receipt of expected orders from existing customers.
Revenues in any given quarter are not indicative of revenues in any future
period because of these and other factors and, accordingly, we believe that
certain period-to-period comparisons of our results of operations are not
necessarily meaningful and should not be relied upon as indicators of future
performance.
THE KNOWLEDGE MANAGEMENT MARKET IS EVOLVING AND, IF IT DOES NOT GROW RAPIDLY,
OUR BUSINESS WILL BE ADVERSELY AFFECTED.
The knowledge management solutions market is an emerging industry, and it
is difficult to predict how large or how quickly it will grow, if at all.
Customer service historically has been provided primarily in person or over the
telephone with limited reference materials available for the customer service
representative. Our business model assumes that companies which provide customer
service over the telephone will find value in aggregating institutional
knowledge by using our software and will be willing to access our content over
the Internet. Our business model also assumes that companies will find value in
providing some of their customer service over the Internet rather than by
telephone. Our success will depend on the broad commercial acceptance of, and
demand for, these knowledge management solutions.
WE CURRENTLY HAVE ONE CORE PRODUCT FAMILY. IF THE DEMAND FOR THIS LINE OF
PRODUCTS DECLINES, OUR BUSINESS WILL BE ADVERSELY AFFECTED.
Our knowledge management solution, ServiceWare Enterprise, includes our
ServiceWare Self-Service, ServiceWare Professional, ServiceWare Agent and
ServiceWare Architect software products. Our past and expected future revenues
consist primarily of license fees for these software solutions and fees for
related services. Factors adversely affecting the demand for these products and
our products in general, such as competition, pricing or technological change,
could materially adversely affect our business, financial condition, operating
results and the value of our stock price. Our future financial performance will
substantially depend on our ability to sell current versions of our entire suite
of products and our ability to develop and sell enhanced versions of our
products.
DUE TO THE LENGTHY SALES CYCLES OF OUR PRODUCTS AND SERVICES, THE TIMING OF OUR
SALES IS DIFFICULT TO PREDICT AND MAY CAUSE US TO MISS OUR REVENUE EXPECTATIONS.
Our products and services are typically intended for use in applications
that may be critical to a customer's business. In certain instances, the
purchase of our products and services involves a significant commitment of
resources by prospective customers. As a result, our sales process is often
subject to delays associated with lengthy approval processes that accompany the
commitment of significant resources. For these and other reasons, the sales
cycle associated with the licensing of our products and subscription for our
services typically ranges between six and eighteen months and is subject to a
number of significant delays over which we have little or no control. While our
customers are evaluating whether our products and services suit their needs, we
may incur substantial sales and marketing expenses and expend significant
management effort. We may not realize forecasted revenues from a specific
customer in the quarter in which we expend these significant resources, or at
all, because of the lengthy sales cycle for our products and services.
WE MAY NOT BE ABLE TO EXPAND OUR BUSINESS INTERNATIONALLY, AND, IF WE DO, WE
FACE RISKS RELATING TO INTERNATIONAL OPERATIONS.
Our business strategy includes efforts to attract more international
customers. By doing business in international markets we face risks, such as
unexpected changes in tariffs and other trade barriers, fluctuations in currency
exchange rates, political instability, reduced protection for intellectual
property rights in some countries, seasonal reductions in business activity
during the summer months in Europe and certain other parts of the world, and
potentially adverse tax consequences, any of which could adversely impact our
international operations.
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IF WE ARE NOT ABLE TO KEEP PACE WITH RAPID TECHNOLOGICAL CHANGE, SALES OF OUR
PRODUCTS MAY DECREASE.
The software industry is characterized by rapid technological change,
including changes in customer requirements, frequent new product and service
introductions and enhancements and evolving industry standards. If we fail to
keep pace with the technological progress of our competitors, sales of our
products may decrease.
WE DEPEND ON TECHNOLOGY LICENSED TO US BY THIRD PARTIES, AND THE LOSS OF THIS
TECHNOLOGY COULD DELAY IMPLEMENTATION OF OUR PRODUCTS, INJURE OUR REPUTATION OR
FORCE US TO PAY HIGHER ROYALTIES.
We rely, in part, on technology that we license from a small number of
software providers for use with our products. After the expiration of these
licenses, this technology may not continue to be available on commercially
reasonable terms, if at all, and may be difficult to replace. The loss of any of
these technology licenses could result in delays in introducing or maintaining
our products until equivalent technology, if available, is identified, licensed
and integrated. In addition, any defects in the technology we may license in the
future could prevent the implementation or impair the functionality of our
products, delay new product introductions or injure our reputation. If we are
required to enter into license agreements with third parties for replacement
technology, we could be subject to higher royalty payments.
PROBLEMS ARISING FROM THE USE OF OUR PRODUCTS WITH OTHER VENDORS' PRODUCTS COULD
CAUSE US TO INCUR SIGNIFICANT COSTS, DIVERT ATTENTION FROM OUR PRODUCT
DEVELOPMENT EFFORTS AND CAUSE CUSTOMER RELATIONS PROBLEMS.
Our customers generally use our products together with products from other
companies. As a result, when problems occur in a customer's systems, it may be
difficult to identify the source of the problem. Even when our products do not
cause these problems, they may cause us to incur significant warranty and repair
costs, divert the attention of our technical personnel from our product
development efforts and cause significant customer relations problems.
IF THIRD PARTIES CEASE TO PROVIDE OPEN PROGRAM INTERFACES FOR THEIR CUSTOMER
RELATIONSHIP MANAGEMENT SOFTWARE, IT WILL BE DIFFICULT TO INTEGRATE OUR SOFTWARE
WITH THEIRS. THIS MAY DECREASE THE ATTRACTIVENESS OF OUR PRODUCTS.
Our ability to compete successfully also depends on the continued
compatibility and interoperability of our products with products and systems
sold by various third parties, specifically including CRM software sold by
Clarify/Amdocs, Remedy, Peregrine, and Siebel Systems. Currently, these vendors
have open applications program interfaces, which facilitate our ability to
integrate with their systems. If any one of them should close their programs'
interface or if they should acquire one of our competitors, our ability to
provide a close integration of our products could become more difficult, or
impossible, and could delay or prevent our products' integration with future
systems. Inadequate integration with other vendors' products could make our
products less desirable and could lead to lower sales.
WE FACE INTENSE COMPETITION FROM BOTH ESTABLISHED AND RECENTLY FORMED ENTITIES,
AND THIS COMPETITION MAY ADVERSELY AFFECT OUR REVENUES AND PROFITABILITY BECAUSE
WE COMPETE IN THE EMERGING MARKET FOR KNOWLEDGE MANAGEMENT SOLUTIONS.
We compete in the emerging market for knowledge management solutions and
changes in the knowledge management solutions market could adversely affect our
revenues and profitability. We face competition from many firms offering a
variety of products and services. In the future, because there are relatively
low barriers to entry in the software industry, we expect to experience
additional competition from new entrants into the knowledge management solutions
market. It is also possible that alliances or mergers may occur among our
competitors and that these newly consolidated companies could rapidly acquire
significant market share. Greater competition may result in price erosion for
our products and services, which may significantly affect our future operating
margins.
IF OUR SOFTWARE PRODUCTS CONTAIN ERRORS OR FAILURES, SALES OF THESE PRODUCTS
COULD DECREASE.
Software products frequently contain errors or failures, especially when
first introduced or when new versions are released. In the past, we have
released products that contained defects, including software errors in certain
new versions of existing products and in new products after their introduction.
In the event that the information contained in our products is inaccurate or
perceived to be incomplete or out-of-date, our customers could purchase our
competitors' products or decide they do not need knowledge management solutions
at all. In either case, our sales would decrease. Our products are typically
intended for use in applications that may be critical to a customer's business.
As a result, we believe that our customers and potential customers have a great
sensitivity to product defects.
WE COULD INCUR SUBSTANTIAL COSTS AS A RESULT OF PRODUCT LIABILITY CLAIMS BECAUSE
OUR PRODUCTS ARE CRITICAL TO THE OPERATIONS OF OUR CUSTOMERS' BUSINESSES.
Our products are critical to the operations of our customers' businesses.
Any defects or alleged defects in our products entail the risk of product
liability claims for substantial damages, regardless of our responsibility for
the failure. Although our license
20
agreements with our customers typically contain provisions designed to limit our
exposure to potential product liability claims, these provisions may not be
effective under the laws of some jurisdictions. In addition, product liability
claims, even if unsuccessful, may be costly and divert management's attention
from our operations. Software defects and product liability claims may result in
a loss of future revenue, a delay in market acceptance, the diversion of
development resources, damage to our reputation or increased service and
warranty costs.
IF OUR CUSTOMERS' SYSTEM SECURITY IS BREACHED AND CONFIDENTIAL INFORMATION IS
STOLEN, OUR BUSINESS AND REPUTATION COULD SUFFER.
Users of our products transmit their and their customers' confidential
information, such as names, addresses, social security numbers and credit card
information, over the Internet. In our license agreements with our customers, we
typically disclaim responsibility for the security of confidential data and have
contractual indemnities for any damages claimed against us. However, if
unauthorized third parties are successful in illegally obtaining confidential
information from users of our products, our reputation and business may be
damaged, and if our contractual disclaimers and indemnities are not enforceable,
we may be subject to liability.
WE MAY ACQUIRE OR MAKE INVESTMENTS IN COMPANIES OR TECHNOLOGIES THAT COULD CAUSE
DISRUPTIONS TO OUR BUSINESS.
We intend to explore opportunities to acquire companies or technologies in
the future. Entering into an acquisition entails many risks, any of which could
adversely affect our business, including:
- - failure to integrate the acquired assets and/or companies with our current
business
- - the price we pay may exceed the value we eventually realize
- - potential loss of share value to our existing stockholders as a result of
issuing equity securities as part or all of the purchase price
- - potential loss of key employees from either our current business or the
acquired business
- - entering into markets in which we have little or no prior experience
- - diversion of management's attention from other business concerns
- - assumption of unanticipated liabilities related to the acquired assets
- - the business or technologies we acquire or in which we invest may have
limited operating histories and may be subject to many of the same risks
we are.
WE MAY NOT BE ABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, WHICH MAY CAUSE
US TO INCUR SIGNIFICANT COSTS IN LITIGATION AND AN EROSION IN THE VALUE OF OUR
BRANDS AND PRODUCTS.
Our business is dependent on proprietary technology and the value of our
brands. We rely primarily on patent, copyright, trade secret and trademark laws
to protect our technology and brands. Our patents may not survive a legal
challenge to their validity or provide meaningful protection to us. Litigation
to protect our patents could be expensive and the loss of our patents would
decrease the value of our products. Defending against claims of patent
infringement would also be expensive and, if successful, we could be forced to
redesign our products, pay royalties, or cease selling them. In addition,
effective trademark protection may not be available for our trademarks. The use
by other parties of our trademarks would dilute the value of our brands.
Notwithstanding the precautions we have taken, a third party may copy or
otherwise obtain and use our software or other proprietary information without
authorization or may develop similar software independently. Policing
unauthorized use of our technology is difficult, particularly because the global
nature of the Internet makes it difficult to control the ultimate destination or
security of software or other transmitted data. Further, we have granted certain
third parties limited contractual rights to use proprietary information, which
they may improperly use or disclose. The laws of other countries may afford us
little or no effective protection of our intellectual property. The steps we
have taken may not prevent misappropriation of our technology, and the
agreements entered into for that purpose may not be enforceable. The
unauthorized use of our proprietary technologies could also decrease the value
of our products.
WE MAY INITIATE LAWSUITS TO PROTECT OR ENFORCE OUR PATENTS. LAWSUITS MAY BE
EXPENSIVE AND, DEPENDING ON THE VERDICT, WE MAY LOSE SOME, IF NOT ALL, OF OUR
INTELLECTUAL PROPERTY RIGHTS, AND THIS MAY IMPAIR OUR ABILITY TO COMPETE IN THE
MARKET.
We believe that some companies, including direct and indirect competitors,
may be infringing our patents. In order to protect or enforce our patent rights,
we may initiate patent litigation suits against third parties, such as
infringement suits or interference proceedings. Lawsuits that we may file are
likely to be expensive, may take significant time and could divert management's
attention from other business concerns. Litigation also places our patents at
risk of being invalidated or interpreted narrowly. Lawsuits may also provoke
these third parties to assert claims against us. Patent law relating to the
scope of claims in the technology fields in which we operate is still evolving
and, consequently, patent positions in our industry are generally uncertain. We
may not prevail in any of these suits, the damages or other remedies that may be
awarded to us may not be commercially valuable and we could be held
21
liable for damages as a result of counterclaims.
THE SUCCESS OF OUR SOFTWARE PRODUCTS DEPENDS ON ITS ADOPTION BY OUR CUSTOMERS'
EMPLOYEES. IF THESE EMPLOYEES DO NOT ACCEPT THE IMPLEMENTATION OF OUR PRODUCTS,
OUR CUSTOMERS MAY FAIL TO RENEW THEIR SERVICE CONTRACTS AND WE MAY HAVE
DIFFICULTY ATTRACTING NEW CUSTOMERS.
The effectiveness of ServiceWare Enterprise depends in part on widespread
adoption and use of our software by our customers' customer service personnel
and on the quality of the solutions they generate. Resistance to our software by
customer service personnel and an inadequate development of the knowledge base
may make it more difficult to attract new customers and retain old ones.
Some of our customers have found that customer service personnel
productivity initially drops while customer service personnel become accustomed
to using our software. If an enterprise deploying our software has not
adequately planned for and communicated its expectations regarding that initial
productivity decline, customer service personnel may resist adoption of our
software.
The knowledge base depends in part on solutions generated by customer
service personnel and, sometimes, on the importation of our customers' legacy
solutions. If customer service personnel do not adopt and use our products
effectively, necessary solutions will not be added to the knowledge base, and
the knowledge base will not adequately address service needs. In addition, if
less-than-adequate solutions are created and left uncorrected by a user's
quality-assurance processes or if the legacy solutions are inadequate, the
knowledge base will similarly be inadequate, and the value of our solutions to
end-users will be impaired. Thus, successful deployment and broad acceptance of
ServiceWare Enterprise will depend in part on whether our customers effectively
roll-out and use our software products and the quality of the customers'
existing knowledge base of solutions.
WE DEPEND ON INCREASED BUSINESS FROM OUR NEW CUSTOMERS AND, IF WE FAIL TO GROW
OUR CLIENT BASE OR GENERATE REPEAT BUSINESS, OUR OPERATING RESULTS COULD BE
ADVERSELY AFFECTED.
Some of our customers initially make a limited purchase of our products
and services for pilot programs. If these customers do not successfully develop
and deploy such initial applications, they may choose not to purchase complete
deployment or development licenses. Some of our customers who have made initial
purchases of our software have deferred or suspended implementation of our
products due to slower than expected rates of internal adoption by customer
service personnel. If more customers decide to defer or suspend implementation
of our products in the future, we will be unable to increase our revenue from
these customers from additional licenses or maintenance agreements, and our
financial position will be seriously harmed.
In addition, as we introduce new versions of our products or new products,
our current customers may not need our new products and may not ultimately
license these products. Any downturn in our software licenses revenues would
negatively impact our future service revenues because the total amount of
maintenance and service fees we receive in any period depends in large part on
the size and number of licenses that we have previously sold. In addition, if
customers elect not to renew their maintenance agreements, our service revenues
could be significantly adversely affected.
A DECLINE IN INFORMATION TECHNOLOGY SPENDING COULD REDUCE THE SALE OF OUR
PRODUCTS.
The license fees for our products often represent a significant
expenditure of information technology ("IT") capital for our customers. Due to
the slowdown in the national and global economy and the uncertainties resulting
from recent acts of terrorism and the war in Iraq, we believe that many existing
and potential customers are reducing or reassessing their planned IT
expenditures. Such reductions in or eliminations of IT spending could cause us
to be unable to maintain or increase our sales volumes, and therefore, have a
material adverse effect on our revenues, operating results, ability to generate
positive cash flow and stock price.
INCREASING GOVERNMENT REGULATION OF THE INTERNET COULD HARM OUR BUSINESS.
As knowledge management and the Internet continue to evolve, we expect
that federal, state and foreign governments will adopt laws and regulations
tailored to the Internet addressing issues like user privacy, taxation of goods
and services provided over the Internet, pricing, content and quality of
products and services. If enacted, these laws and regulations could limit the
market for knowledge management services and, therefore, the market for our
products and services. Additionally, Internet security issues could deter
customers from using the Internet for certain transactions or from implementing
customer support websites.
The Telecommunications Act of 1996 prohibits certain types of information
and content from being transmitted over the Internet. The prohibition's scope
and the liability associated with a violation of the Telecommunications Act's
information and content provisions are currently unsettled. The imposition of
potential liability upon us and other software and service providers for
information carried on or disseminated through our applications could require us
to implement measures to reduce our exposure to this liability. These measures
could require us to expend substantial resources or discontinue certain
services. In addition, although
22
substantial portions of the Communications Decency Act, the act through which
the Telecommunications Act of 1996 imposes criminal penalties, were held to be
unconstitutional, similar legislation may be enacted and upheld in the future.
It is possible that this new legislation and the Communications Decency Act
could expose companies involved in Internet liability, which could limit the
growth of Internet usage and, therefore, the demand for knowledge management
solutions. In addition, similar or more restrictive laws in other countries
could have a similar effect and hamper our plans to expand overseas.
WE MAY BECOME INVOLVED IN SECURITIES CLASS ACTION LITIGATION, WHICH COULD DIVERT
MANAGEMENT'S ATTENTION AND HARM OUR BUSINESS.
In recent years, the common stocks of technology companies have
experienced significant price and volume fluctuations. These broad market
fluctuations may cause the market price of our common stock to decline. In the
past, following periods of volatility in the market price of a particular
company's securities, securities class action litigation has often been brought
against that company. We may become involved in that type of litigation in the
future. Litigation is often expensive and diverts management's attention and
resources, which could harm our business and operating results.
OUR COMMON STOCK HAS BEEN DELISTED FROM THE NASDAQ STOCK MARKET.
As of May 5, 2003, our common stock was delisted from The Nasdaq Stock
Market and began trading on the OTC Bulletin Board maintained by the National
Association of Securities Dealers.
As a result of our trading on the OTC Bulletin Board, investors may find
it more difficult to dispose of or obtain accurate quotations as to the market
value of the securities. In addition, we are subject to a rule promulgated by
the Securities and Exchange Commission that, if we fail to meet criteria set
forth in such rule, various practice requirements are imposed on broker-dealers
who sell securities governed by the rule to persons other than established
customers and accredited investors. For these types of transactions, the
broker-dealer must make a special suitability determination for the purchaser
and have received the purchaser's written consent to the transactions prior to
sale. Consequently, the rule may deter broker-dealers from recommending or
selling our common stock, which may further affect the liquidity of our common
stock.
Delisting from Nasdaq makes trading our shares more difficult for
investors, potentially leading to further declines in our share price. It may
also make it more difficult for us to raise additional capital. Further, we may
also incur additional costs under state blue sky laws in connection with any
sales of our securities.
SHARES AVAILABLE FOR FUTURE SALE COULD ADVERSELY AFFECT OUR STOCK PRICE.
Future sales of a substantial number of shares of our common stock in the
public market, or the perception that such sales may occur, could adversely
affect trading prices of our common stock from time to time. As of the time of
this filing, 52,507,667 shares of our common stock are outstanding. Virtually
all of these shares will be freely tradable without restriction or further
registration under the Securities Act, except for any shares which are owned by
an affiliate of ours as that term is defined in Rule 144 under the Securities
Act and that are not registered for resale under our currently effective
prospectus. The shares of our common stock owned by our affiliates and not
registered for resale under our currently effective prospectus are restricted
securities, as that term is defined in Rule 144, and may in the future be sold
under the Securities Act to the extent permitted by Rule 144 or any applicable
exemption under the Securities Act.
OUR MANAGEMENT OWNS A SIGNIFICANT PERCENTAGE OF OUR COMPANY AND WILL BE ABLE TO
EXERCISE SIGNIFICANT INFLUENCE OVER OUR ACTIONS.
Our officers and directors, who in the aggregate directly or indirectly
control more than 40% of our outstanding common stock and voting power, control
us. These stockholders collectively will likely be able to control our
management policy, decide all fundamental corporate actions, including mergers,
substantial acquisitions and dispositions, and elect our board of directors.
TERRORIST ATTACKS SUCH AS THE ATTACKS THAT OCCURRED IN NEW YORK AND WASHINGTON,
D.C. ON SEPTEMBER 11, 2001 AND OTHER ATTACKS OR ACTS OF WAR MAY ADVERSELY AFFECT
THE MARKETS ON WHICH OUR COMMON STOCK TRADES, OUR FINANCIAL CONDITION AND OUR
RESULTS OF OPERATIONS.
On September 11, 2001, the United States was the target of terrorist
attacks of unprecedented scope. In March 2003, the United States and allied
nations commenced a war in Iraq. These attacks and the war in Iraq have caused
major instability in the United States and other financial markets. There could
be further acts of terrorism in the United States or elsewhere that could have a
similar impact. Armed hostilities or further acts of terrorism could cause
further instability in financial markets and could directly impact our financial
condition and our results of operations.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Nearly all of our revenues recognized to date have been denominated in
United States dollars and are primarily from customers in the United States. We
have a European distributor located in London, England. Revenues from
international clients were 10% in the first nine months of 2004 and 7% in fiscal
2003, and all of these revenues have been denominated in United States dollars.
In the future, a portion of the revenues we derive from international operations
may be denominated in foreign currencies. Furthermore, to the extent that we
engage in international sales denominated in United States dollars, an increase
in the value of the United States dollar relative to foreign currencies could
make our services less competitive in international markets. Although currency
fluctuations are currently not a material risk to our operating results, we will
continue to monitor our exposure to currency fluctuations and when appropriate,
consider the use of financial hedging techniques to minimize the effect of these
fluctuations in the future. Exchange rate fluctuations may harm our business in
the future. We do not currently utilize any derivative financial instruments or
derivative commodity instruments.
Our interest income is sensitive to changes in the general level of United
States interest rates, particularly because the majority of our investments are
in short-term instruments. Since we no longer have any debt, we are not
currently subject to material interest rate risk.
ITEM 4. CONTROLS AND PROCEDURES
a. Evaluation of disclosure controls and procedures. As of the end of
the period covered by this report, under the supervision and with
the participation of our management, including our chief executive
officer (CEO) and chief financial officer (CFO), an evaluation of
the effectiveness of our disclosure controls and procedures was
performed. Based on this evaluation, the CEO and CFO have concluded
that our disclosure controls and procedures are effective to ensure
that material information is recorded, processed, summarized and
reported by our management on a timely basis in order to comply with
our disclosure obligations under the Securities Exchange Act of 1934
and the SEC rules thereunder.
b. Changes in internal control. There were no changes in our internal
control over financial reporting that occurred during our quarter
ended September 30, 2004, that have materially affected, or are
reasonably likely to materially affect, our internal control over
financial reporting.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In October 2003, we filed suit against Primus Knowledge Solutions, Inc.
("Primus") in the United States District Court for the Western District of
Pennsylvania, alleging that Primus had infringed certain United States patents
owned by us. Primus filed an answer denying liability and asserting
counterclaims against us, including allegations of interference, defamation and
unfair competition. We subsequently asserted certain reply counterclaims against
Primus. We refer to this action, including the related counterclaims and reply
claims, as the Lawsuit.
On August 10, 2004, Primus announced that it had entered into a
definitive agreement and plan of merger whereby Primus would be acquired by Art
Technology Group, Inc. or ATG.
As of November 1, 2004, we entered into a settlement agreement with
Primus and ATG in which:
- Without any admission of liability by either party, we and Primus
agreed to dismiss with prejudice all the claims, counterclaims and
reply claims in the Lawsuit, and to deliver to each other mutual
general releases.
- We agreed to grant to Primus and its affiliates, including ATG, a
fully paid, irrevocable, nonexclusive, nontransferable (with certain
exceptions specified in the agreement), worldwide, perpetual limited
license under the patents at issue in the Lawsuit and a covenant not
to sue under those patents.
- Primus agreed to pay us the sum of $800,000 in cash, of which
$500,000 is payable within five business days following the closing
of ATG's acquisition of Primus, and the balance is due on January 3,
2005.
- Primus agreed to issue to us, immediately prior to the closing of
ATG's acquisition of Primus, shares of Primus common stock having a
value, determined in the manner specified in the settlement, equal
to $850,000.
- ATG agreed to guarantee the obligation of Primus to make the
specified cash payment.
- We agreed to certain restrictions on transfer by us of the shares of
ATG common stock issued to us in connection with the acquisition by
ATG of Primus, which restrictions will expire not later than May 15,
2005.
On November 1, 2004, the acquisition of Primus by ATG was completed
and the transactions contemplated by the settlement agreement were consummated.
In addition to the amounts payable to us under the foregoing agreement
with Primus and ATG, our insurance carrier, Chubb Group, agreed to pay the sum
of $575,000 towards our out-of-pocket costs and expenses associated with the
Lawsuit resulting in total cash and stock settlement proceeds of $2,225,000. In
connection with the Lawsuit we incurred approximately $1.0 million in attorneys'
fees and other out-of-pocket expenses. Our net settlement proceeds after taking
into consideration the out-of-pocket expenses will be approximately $1.2
million.
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ITEM 6. EXHIBITS
Exhibits
31.1 Rule 13a - 14(a) / 15d - 14(a) Certification of Principal Executive
Officer
31.2 Rule 13a - 14(a) / 15d - 14(a) Certification of Principal Financial
Officer
32. Section 1350 Certifications
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SERVICEWARE TECHNOLOGIES, INC.
Date: November 8, 2004 By: /s/ SCOTT SCHWARTZMAN
---------------------------
Scott Schwartzman
Principal Financial Officer
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