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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934, FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002.
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934, FOR THE TRANSITION PERIOD FROM_______ TO_______
COMMISSION FILE NUMBER 1-10139
NETEGRITY, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 04-2911320
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
52 SECOND AVENUE WALTHAM, MA 02451
(Address of principal executive offices) (Zip Code)
(781) 890-1700
(Registrant's Telephone Number)
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 other 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 [ ]
As of July 31, 2002 there were 34,186,151 shares of Common Stock outstanding,
exclusive of Treasury Stock.
QUARTERLY REPORT ON FORM 10-Q
QUARTER ENDED JUNE 30, 2002
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Condensed Financial Statements
Consolidated Condensed Balance Sheets as of December 31,
2001 and June 30, 2002 (unaudited) 3
Consolidated Condensed Statements of Operations for the
three months ended June 30, 2001 and 2002 (unaudited) 4
Consolidated Condensed Statements of Operations for the
six months ended June 30, 2001 and 2002 (unaudited) 5
Consolidated Condensed Statements of Cash Flows for the six
months ended June 30, 2001 and 2002 (unaudited) 6
Notes to Consolidated Condensed Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk 20
PART II OTHER INFORMATION
Item 1. Legal Proceedings 22
Item 2. Changes in Securities 22
Item 3. Defaults upon Senior Securities 22
Item 4. Submission of Matters to a Vote of Security Holders 22
Item 5. Other Information 22
Item 6. Exhibits and Forms on 8-K 23
SIGNATURES 24
2
PART I. -- FINANCIAL INFORMATION
NETEGRITY, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(IN THOUSANDS)
DECEMBER 31, JUNE 30,
2001 2002
------------ -----------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents .................................... $ 26,332 $ 19,698
Short-term marketable securities ............................. 76,651 64,652
Accounts receivable--trade, net of allowances of $1,579 at
December 31, 2001; $1,414 at June 30, 2002 .................. 16,122 14,086
Prepaid expenses and other current assets .................... 3,418 3,639
--------- ---------
Total Current Assets ...................................... 122,523 102,075
Long-term marketable securities ................................ 6,083 11,898
Property and equipment, net .................................... 8,494 7,566
Restricted cash ................................................ 631 637
Goodwill ....................................................... 57,262 57,374
Other intangible assets, net ................................... 10,846 9,014
Other assets ................................................... 340 356
--------- ---------
Total Assets .............................................. $ 206,179 $ 188,920
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable--trade ...................................... $ 1,707 $ 519
Accrued compensation and benefits ............................ 5,152 4,868
Other accrued expenses ....................................... 9,956 6,099
Deferred revenue ............................................. 13,223 13,698
--------- ---------
Total Current Liabilities ................................. 30,038 25,184
--------- ---------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, voting, $.01 par value; 55,000 shares
authorized; 33,866 shares issued and 33,828 shares outstanding
at December 31, 2001; 34,042 issued and 34,004 outstanding
at June 30, 2002 ............................................. 339 340
Additional paid-in capital ..................................... 196,492 196,842
Accumulated other comprehensive loss ........................... (44) (98)
Accumulated deficit ............................................ (20,432) (33,134)
Loan to officer ................................................ (130) (130)
--------- ---------
176,225 163,820
Less--Treasury Stock, at cost: 38 shares ....................... (84) (84)
--------- ---------
Total Stockholders' Equity ..................................... 176,141 163,736
--------- ---------
Total Liabilities and Stockholders' Equity ..................... $ 206,179 $ 188,920
========= =========
The accompanying notes are an integral part of the consolidated condensed
financial statements.
3
NETEGRITY, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
FOR THE THREE MONTHS
ENDED JUNE 30,
---------------------
2001 2002
------- --------
Revenues:
Software licenses .............................. $16,054 $ 7,669
Services ....................................... 8,498 7,493
Other .......................................... 793 646
------- --------
Total revenues .............................. 25,345 15,808
------- --------
Cost of Revenues:
Cost of software licenses ...................... 482 1,326
Cost of services ............................... 4,352 3,566
Cost of other .................................. 447 388
------- --------
Total cost of revenues ...................... 5,281 5,280
------- --------
Gross profit ..................................... 20,064 10,528
Selling, general and administrative expenses ..... 13,893 14,038
Research and development costs ................... 4,053 6,478
Restructuring expenses ........................... -- 689
------- --------
Income (loss) from operations .................... 2,118 (10,677)
Other income, net ................................ 1,275 724
------- --------
Income (loss) before provision for income taxes .. 3,393 (9,953)
Provision for income taxes ....................... 292 --
------- --------
Net income (loss) ................................ $ 3,101 $ (9,953)
======= ========
Net income (loss) per share attributable to common
stockholders:
Basic ....................................... $ 0.10 $ (0.29)
Diluted ..................................... $ 0.09 $ (0.29)
Weighted average shares outstanding:
Basic ....................................... 30,914 34,001
Diluted ..................................... 32,962 34,001
The accompanying notes are an integral part of the consolidated condensed
financial statements.
4
NETEGRITY, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
FOR THE SIX MONTHS
ENDED JUNE 30,
---------------------
2001 2002
------- --------
Revenues:
Software licenses .............................. $34,826 $ 21,286
Services ....................................... 14,940 15,071
Other .......................................... 1,864 1,421
------- --------
Total revenues .............................. 51,630 37,778
------- --------
Cost of Revenues:
Cost of software licenses ...................... 1,367 2,798
Cost of services ............................... 8,482 7,432
Cost of other .................................. 1,148 841
------- --------
Total cost of revenues ...................... 10,997 11,071
------- --------
Gross profit ..................................... 40,633 26,707
Selling, general and administrative expenses ..... 28,342 27,528
Research and development costs ................... 8,008 12,536
Restructuring expenses ........................... -- 689
------- --------
Income (loss) from operations .................... 4,283 (14,046)
Other income, net ................................ 2,774 1,380
------- --------
Income (loss) before provision for income taxes .. 7,057 (12,666)
Provision for income taxes ....................... 607 40
------- --------
Net income (loss) ................................ $ 6,450 $(12,706)
======= ========
Net income (loss) per share attributable to common
stockholders:
Basic ....................................... $ 0.21 $ (0.37)
Diluted ..................................... $ 0.19 $ (0.37)
Weighted average shares outstanding:
Basic ....................................... 30,670 33,938
Diluted ..................................... 33,124 33,938
The accompanying notes are an integral part of the consolidated condensed
financial statements.
5
NETEGRITY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
FOR THE SIX MONTHS
ENDED JUNE 30,
---------------------
2001 2002
--------- ---------
OPERATING ACTIVITIES:
Net income (loss) ...................................... $ 6,450 $ (12,706)
Adjustments to reconcile net income (loss) to net cash
provided by (used for)
operating activities:
Depreciation and amortization ........................ 1,186 4,139
Provision for doubtful accounts receivable ........... 432 207
Non-cash interest income ............................. -- 25
Loss on sale of marketable securities ................ -- 11
Changes in operating assets and liabilities:
Accounts receivable -- trade ......................... (6,082) 1,828
Prepaid expenses and other current assets ............ (534) (699)
Other assets ......................................... (58) 464
Accounts payable -- trade ............................ (304) (1,188)
Accrued compensation and benefits .................... (1,667) (285)
Other accrued expenses ............................... 2,357 (3,970)
Deferred revenue ..................................... 2,764 474
--------- ---------
Net cash provided by (used for) operating activities ... 4,544 (11,700)
INVESTING ACTIVITIES:
Proceeds from sales of marketable securities ........... -- 121,261
Proceeds from maturities of marketable securities ...... -- 4,284
Purchases of marketable securities ..................... (10,640) (119,409)
Purchases of property and equipment .................... (3,987) (1,378)
Restricted cash ........................................ 322 (6)
--------- ---------
Net cash provided by (used for) investing activities ... (14,305) 4,752
--------- ---------
FINANCING ACTIVITY:
Proceeds from issuance of common stock under stock
plans .................................................. 6,252 351
--------- ---------
Net cash provided by financing activity ................ 6,252 351
--------- ---------
Effect of exchange rate changes on cash and cash
equivalents ............................................ 95 (37)
Net change in cash and cash equivalents ................ (3,414) (6,634)
Cash and cash equivalents at beginning of period ....... 115,747 26,332
--------- ---------
Cash and cash equivalents at end of period ............. $ 112,333 $ 19,698
========= =========
The accompanying notes are an integral part of the consolidated condensed
financial statements.
6
NETEGRITY, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
The unaudited financial information furnished herein reflects all adjustments
(which are of a normal recurring nature), which in the opinion of management are
necessary to fairly state the Company's financial position, cash flows and
results of operations for the periods presented. Certain information and
footnote disclosure normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States
have been condensed or omitted. The consolidated financial statements of the
Company also include the accounts and operations of its wholly owned
subsidiaries. All significant intercompany accounts and transactions have been
eliminated in consolidation. The results of operations for the three and six
months ended June 30, 2002 are not necessarily indicative of the results to be
expected for the remainder of the year ending December 31, 2002. This
information should be read in conjunction with the Company's audited
consolidated financial statements for the fiscal year ended December 31, 2001,
included in Form 10-K filed on March 22, 2002.
(b) REVENUE RECOGNITION
The Company's revenues are primarily generated from the sale of perpetual
licenses to Netegrity's(R) proprietary SiteMinder(R), Delegated Management
Services(TM) and Netegrity Interaction Server(TM) products and services and from
licensing the rights to use software products developed by Checkpoint Software
Technologies, Ltd. to end users and resellers. (Such Checkpoint revenue is
included in "other" revenue in the accompanying consolidated condensed statement
of operations.) The Company generates its services revenue from consulting and
training services performed for customers and from maintenance and support for
the Company's products. Installation by Netegrity is not considered essential to
the functionality of our products as these services do not alter the product
capabilities, do not require specialized skills and may be performed by the
customers or other vendors. Revenues from software license agreements are
recognized when persuasive evidence of an arrangement exists, the product has
been delivered, fees are fixed or determinable and collection of the resulting
receivable is reasonably assured. The Company does not offer a right of return
on its products. Revenues may include multiple software products, maintenance
and other services sold together; these are allocated to each element based on
the residual method in accordance with Statement of Position No. 98-9, "Software
Revenue Recognition, with Respect to Certain Transactions". Under the residual
method, the fair value of the undelivered elements is deferred and subsequently
recognized when earned. The Company has established sufficient vendor specific
objective evidence for professional services, training and maintenance services
based on the price when these elements are sold separately. Accordingly,
software license revenue is recognized under the residual method upon delivery
in arrangements in which software is licensed with professional services,
training and maintenance services. Revenues for maintenance and support are
recognized ratably over the term of the support period. Revenues from consulting
and training services are recognized as the services are performed. Maintenance,
training and consulting services that have been billed but not recognized are
included in deferred revenue.
(c) CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash, money market investments and other
highly liquid investments with original maturities of three months or less at
the date of purchase.
(d) MARKETABLE SECURITIES
Investments with a maturity greater than three months, which primarily consist
of debt securities, are accounted for under Statement of Financial Accounting
Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity
Securities" issued by the Financial Accounting Standards Board (FASB). Pursuant
to the provisions of SFAS No. 115, the Company has classified its investment
portfolio as "trading", "available-for-sale" or "held to maturity". "Trading"
securities are bought and held principally for the purpose of selling them in
the near term and are recorded at fair value. Fair value is based upon quoted
market prices. Unrealized gains and losses on trading securities are included in
the determination of net earnings. "Available-for-sale" securities include debt
securities that are being held for an unspecified period of time and may be used
for liquidity or other corporate purposes and are recorded at fair value.
Unrealized gains and losses on available-for-sale securities are reported as a
separate component of
7
comprehensive income (loss) in stockholders' equity. "Held to maturity"
securities are debt securities that the Company intends to hold to maturity and
are recorded at amortized cost.
As of June 30, 2002, based on management's intentions, all marketable securities
have been classified as "available for sale". The change in the net unrealized
(loss) included in accumulated other comprehensive loss in stockholders' equity
was approximately $(17,000) for the six months ended June 30, 2002. Net realized
losses amounting to approximately $8,000 and $11,000 for the three and six
months ended June 30, 2002, respectively, are included in other income, net in
the consolidated condensed statements of operations.
(e) COMPREHENSIVE INCOME (LOSS)
Comprehensive income is defined as the change in equity of a business enterprise
during a period from transactions and other events and circumstances from
non-owner sources, including foreign currency translation adjustments and
unrealized gains and losses on marketable securities held as "available for
sale". For the three and six months ended June 30, 2001, comprehensive income
was $3.2 million and $6.5 million, respectively, compared to net income of $3.1
million and $6.5 million, respectively. The difference for the three months
ended June 30, 2001, is due to a favorable cumulative translation adjustment of
approximately $101,000. For the three and six months ended June 30, 2002,
comprehensive loss was $9.9 million and $12.7 million, respectively, compared to
net loss of $10.0 million and $12.7 million, respectively. The difference of
approximately $30,000 and ($54,000), in the three and six months ended June 30,
2002, respectively, is due to unrealized gains (losses) on marketable securities
of approximately $97,000 and ($17,000) offset by an unfavorable cumulative
translation adjustment of approximately ($67,000) and ($37,000), for the three
and six months ended June 30, 2002, respectively.
(f) NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share (EPS) is calculated by dividing net income
(loss) by the weighted average number of shares of common stock outstanding
during the period. Diluted EPS is calculated by dividing net income by the
weighted average number of shares outstanding plus the dilutive effect, if any,
of the outstanding stock options and warrants using the "treasury stock" method.
During periods of net loss, diluted net loss per share does not differ from
basic net loss per share since potential common shares from stock options and
warrants are anti-dilutive and therefore are excluded from the calculation.
The following table presents the calculation for both basic and diluted earnings
per share data for the periods presented (in thousands, except per share data):
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------------- ---------------------
2001 2002 2001 2002
------- -------- ------- --------
Net income (loss) ....................... $ 3,101 $ (9,953) $ 6,450 $(12,706)
------- -------- ------- --------
Basic weighted average shares outstanding 30,914 34,001 30,670 33,938
Dilutive effect of stock options and
warrants ................................ 2,048 -- 2,454 --
------- -------- ------- --------
Diluted shares outstanding .............. 32,962 34,001 33,124 33,938
------- -------- ------- --------
Basic net income (loss) per share ....... $ 0.10 $ (0.29) $ 0.21 $ (0.37)
======= ======== ======= ========
Diluted net income (loss) per share ..... $ 0.09 $ (0.29) $ 0.19 $ (0.37)
======= ======== ======= ========
Options to purchase a total of 3.3 million, 6.6 million, 1.6 million and 5.2
million weighted shares outstanding for the three and six months ended June 30,
2001 and 2002, respectively, were outstanding but were excluded in the
computation of diluted EPS because the options are anti-dilutive.
(g) RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, FASB issued SFAS No. 141, "Business Combinations", and SFAS No.
142, "Goodwill and Other Intangible Assets". SFAS No. 141 requires that all
business combinations initiated after June 30, 2001, be accounted for using the
purchase method of accounting. SFAS No. 142 discusses how intangible assets that
are acquired should be accounted for in financial statements upon their
acquisition. In addition, under SFAS No. 142, goodwill and other indefinite
lived intangible assets are no longer amortized but are reviewed at least
annually for impairment (or more frequently if impairment indicators arise).
Separable intangible assets that are not deemed to have indefinite lives will
continue to be amortized over their useful lives.
The acquisition discussed in Note 2 was accounted for in accordance with the
transition provisions of SFAS No. 141 and No. 142. In connection with the
adoption of SFAS No. 142, goodwill will be tested at least annually and also
whenever events or circumstances
8
occur indicating that goodwill might be impaired (or more frequently if
impairment indicators arise) See Note 2. We currently operate as a single
reporting unit and all of our goodwill is associated with the entire company. A
transitional impairment test was performed on January 1, 2002 and an annual
impairment test will be completed in the fourth quarter of each fiscal year.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets", which is effective for the Company on January 1,
2002. SFAS No. 144 addresses accounting and reporting of all long-lived assets,
except goodwill, that are either held and used or disposed of through sale or
other means.
The Company adopted SFAS No's. 141, 142 and No. 144 during the first quarter of
2002 without a material impact on its financial position or results of
operations. If the Company had accounted for goodwill and other intangibles in
accordance with SFAS 142 during the period ended June 30, 2001, the results of
operations would not be different from those previously reported.
In November 2001, the Emerging Issues Task Force issued Topic No. D-103 (Topic
D-103) relating to the accounting for reimbursements received from customers for
the Company's out-of-pocket expenses for the delivery of services. In accordance
with Topic D-103, reimbursements received for out-of-pocket expenses incurred
should be characterized as revenue in the statement of operations. The Company
has historically accounted for reimbursements received for out-of-pocket
expenses incurred as a reduction to the cost of service revenues in the
statement of operations to offset the costs incurred. The Company adopted Topic
D-103 effective January 1, 2002 and approximately $585,000 and $834,000 have
been reclassified for the three and six months ended June 30, 2001,
respectively, to comply with this guidance.
In June 2002, The FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit of Disposal Activities". SFAS No. 146 requires companies to recognize
costs associated with exit or disposal activities when they are incurred rather
than at the date of a commitment to an exit or disposal plan. This statement is
effective for fiscal years beginning after December 31, 2002. We do not believe
that the impact of adopting SFAS No. 146 will have a material impact on the
consolidated financial statements.
NOTE 2: ACQUISITION
On December 14, 2001 (the Acquisition Date) the Company acquired, for aggregate
consideration of $70.2 million, all of the outstanding stock of DataChannel,
Inc., a Washington Corporation (DataChannel). On the Acquisition Date,
DataChannel, a provider of enterprise portal solutions, became a wholly-owned
subsidiary of the Company (the Acquisition). The aggregate consideration
included approximately $17.5 million in cash (including assumed debt of
approximately $1.4 million), $3.0 million in acquisition costs and 2,499,968
shares of the Company's Common Stock valued at approximately $49.7 million.
The Acquisition was accounted for using the purchase method of accounting in
accordance with SFAS No. 141, "Business Combinations." Accordingly the excess of
the purchase price over the fair value of the tangible net liabilities assumed
of approximately $71.3 million was allocated to acquired technology, in-process
research and development (IPRD), and goodwill in the amounts of approximately
$11.0 million, $3.0 million and $57.3 million, respectively. None of the
goodwill recorded is expected to be deductible for tax purposes. Results of
operations of DataChannel from the Acquisition Date are included in the
Company's consolidated results of operations.
In connection with the Acquisition, the Company initiated an overall integration
plan that included the elimination of redundant headcount and facilities. The
Company accrued approximately $2.2 million of cost related to the integration
plan consisting of approximately $1.8 million of facilities costs and $0.4
million for planned workforce reductions consisting primarily of duplicative
general and administrative functions. Approximately $294,000 and $675,000 of
these costs were paid during the three and six months ended June 30, 2002,
respectively.
The total goodwill of approximately $57.3 million related to the Acquisition is
not amortized in accordance with SFAS No. 142. During the first quarter of 2002,
the Company performed a transitional impairment test on goodwill and concluded
that there was no impairment as of January 1, 2002. The annual impairment test
will be completed in the fourth quarter of each fiscal year. The Company is
currently evaluating whether or not there has been a triggering event that
warrants an impairment review of its long-lived assets and goodwill based on the
recent significant decline in our stock price as a result of underperformance
relative to recent and expected operating results and overall adverse change in
the business climate. If the Company determines that a triggering event has
occurred, the Company will test for impairment based on a two-step approach.
The first step is to test for an impairment of long-lived assets other than
goodwill. The second step, to be done after completion of the first step, is to
determine if there has been an impairment of goodwill.
9
If the Company determines that the long-lived assets including goodwill are
impaired, the resulting impairment charge could have a material adverse effect
on the financial statements. The Company is amortizing the acquired existing
technology of approximately $11.0 million over an estimated remaining useful
life of three years. Excluding goodwill, amortization expense on intangible
assets was $0.9 million and $1.8 million for the three and six months ended June
30, 2002, respectively. The amount allocated to IPRD of $3.0 million was charged
to expense in the fourth quarter of fiscal year 2001. At the Acquisition Date,
DataChannel was conducting testing activities associated with the development of
next-generation technologies that were expected to address emerging market
demands for Enterprise Information Portal solutions. At the acquisition date,
the technologies under development were approximately 50% complete based on
project duration and costs. DataChannel had spent approximately $1.8 million on
the IPRD projects prior to the acquisition date, and expected to spend another
$1.9 million to complete these specific research and development activities. As
of June 30, 2002, the technologies are 100% complete. Amortization expense for
the intangible assets is estimated to be approximately $3.7 million for each of
the years ended December 31, 2002, 2003 and 2004.
The following unaudited pro forma financial information presents the combined
results of operations of the Company and DataChannel as if the Acquisition
occurred on January 1, 2001, after giving effect to certain adjustments,
including amortization expense. Due to the non-recurring nature of the IPRD
charge, the amount has not been included in the unaudited pro forma financial
information. The unaudited pro forma financial information does not necessarily
reflect the results of operations that would have occurred had the Acquisition
been completed as of the dates indicated or of the results that may be obtained
in the future (in thousands except per share information).
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, 2001 JUNE 30, 2001
------------- -------------
Revenues ............................................ $ 27,906 $ 56,793
Net loss ............................................ $ (4,145) $ (8,782)
Net loss per basic and fully diluted common share ... $ (0.12) $ (0.26)
NOTE 3: TENDER OFFER
On August 9, 2001 and as subsequently amended, the Company filed a tender offer
statement with the Securities and Exchange Commission in connection with certain
stock options issued after December 1, 1999 (the Option Offer). Under the Option
Offer, the Company offered to exchange certain employee options to purchase
shares of the Company's common stock for new options to purchase shares of its
common stock. The Option Offer, which excluded executive officers, directors and
non-employees of the Company and which expired on September 7, 2001, provided
for the grant of new options on or about March 11, 2002 to eligible employees
who were actively employed on the grant date. The number of shares underlying
the new options was equal to the number of shares underlying the cancelled
eligible options. The exercise price of the new options was equal to the fair
market value of one share of common stock on the date of grant of the new
options as determined in accordance with the applicable option plans. Each new
option will vest in accordance with a vesting schedule that is equivalent to
what would have been in place had the cancelled option remained in effect.
On March 11, 2002, the Company granted options to purchase an aggregate of
2,103,406 shares of its common stock at fair market value in connection with the
Option Offer. In accordance with FASB Interpretation No. 44, since the
replacement options were granted more than six months after cancellation of the
old options, the new options were considered a fixed award and therefore did not
result in any compensation expense.
NOTE 4: OPERATING SEGMENTS AND GEOGRAPHICAL INFORMATION
(a) OPERATING SEGMENTS
The Company has one operating segment that provides products which securely
manage e-business relationships. Operating segments are defined as components of
the enterprise about which separate financial information is available that is
reviewed regularly by the chief operating decision maker, or decision-making
group, in deciding how to allocate resources and in assessing their performance.
(b) GEOGRAPHIC INFORMATION
10
The Company operates in three geographic regions: North America, Europe and Asia
Pacific. Revenues (based on the location of the customer) and long-lived assets
(including marketable securities) by geographic region are as follows:
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------- --------------------
2001 2002 2001 2002
------- ------- ------- -------
Revenues:
North America ... $21,841 $11,728 $43,772 $30,949
Europe .......... 2,666 3,081 5,318 5,448
Asia Pacific .... 838 999 2,540 1,381
------- ------- ------- -------
Total ........... $25,345 $15,808 $51,630 $37,778
======= ======= ======= =======
JUNE 30, JUNE 30,
2001 2002
-------- --------
Long-Lived Assets:
North America ... $17,955 $19,418
Europe .......... 141 398
Asia Pacific .... 656 641
------- -------
Total ........... $18,752 $20,457
======= =======
NOTE 5: RESTRUCTURING EXPENSES
During April 2002, the Company recorded restructuring expenses of $689,000
related to severance charges associated with a 10% reduction in workforce and
the closing of several sales offices. Approximately, $419,000 of these costs was
paid out during the three months ended June 30, 2002. The remainder is expected
to be paid prior to March 31, 2003.
NOTE 6: EMPLOYEE STOCK PURCHASE PLAN
During May 2002, the Company held its Annual Meeting of Stockholders, at which
time the stockholders approved the 2002 Employee Stock Purchase Plan and
reserved 700,000 shares of common stock for issuance thereunder.
NOTE 7: RELATED PARTY TRANSACTIONS
The consolidated condensed balance sheets as of December 31, 2001 and June 30,
2002, include $130,000 in loans to an officer of the Company issued in
connection with the exercise of stock options in 1996. The loan is reflected as
a reduction of stockholders' equity in the accompanying consolidated condensed
financial statements. The loan is represented by a full recourse note, is
payable upon demand and bears interest at 7% per annum. Prior to May 2002, the
loan was secured by 300,000 shares of common stock of the Company. During May
2002, the note was amended such that it became an unsecured note. The
consolidated condensed balance sheet as of June 30, 2002 also includes an
advance of approximately $17,000 to this officer. The advance is reflected in
prepaid and other current assets in the accompanying consolidated condensed
financial statements.
ITEM 2. MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
FORWARD-LOOKING STATEMENTS AND INDUSTRY DATA
This report contains forward-looking statements about our plans, objectives,
expectations and intentions. You can identify these statements by words such as
"expect," "anticipate," "intend," "plan," "believe," "seek," "estimate," "may,"
"will" and "continue" or similar words. You should read statements that contain
these words carefully. They discuss our future expectations, contain projections
of our future results of operations or our financial condition or state other
forward-looking information, and may involve known and unknown risks over which
we have no control. You should not place undue reliance on forward-looking
statements. We cannot guarantee any future results, levels of activity,
performance or achievements. Moreover, we assume no obligation to update
forward-looking statements or update the reasons actual results could differ
materially from those anticipated in forward-looking statements, except as
required by law. The factors discussed in the sections captioned "Risk Factors,"
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations" in this report identify important factors that may cause our actual
results to differ materially from the expectations we describe in our
forward-looking statements.
11
RISK FACTORS
The Private Securities Litigation Reform Act of 1995 contains certain safe
harbors regarding forward-looking statements. In that context, the discussion in
this item contains forward-looking statements that involve certain degrees of
risk and uncertainty, including statements relating to liquidity and capital
resources. Except for the historical information contained herein, the matters
discussed in this section are such forward-looking statements that involve risks
and uncertainties, including:
WE HAVE INCURRED SUBSTANTIAL LOSSES AND MAY NOT BE PROFITABLE IN THE FUTURE.
In recent years, we have incurred substantial operating losses. We cannot
predict if we will achieve profitability for any substantial period of time.
Failure to maintain levels of profitability as expected by investors may
adversely affect the market price of our common stock. In the six months ended
June 30, 2002, we had a net loss of $12.7 million. As a result of historical
operating losses, including during the last two quarters of the year ended
December 31, 2001, as of June 30, 2002, we had an accumulated deficit of
approximately $33.1 million.
DISAPPOINTING QUARTERLY RESULTS COULD CAUSE THE MARKET PRICE OF OUR COMMON STOCK
TO FALL SUBSTANTIALLY.
Our quarterly revenues and operating results are difficult to predict and may
continue to fluctuate significantly from quarter to quarter. If our quarterly
revenues or operating results fall below the expectations of investors, the
price of our common stock could fall substantially. Our quarterly revenues may
fluctuate for several reasons, including, but not limited to, the following:
- customers choosing to delay their purchase commitments or purchase in
smaller than expected quantities due to a general slowdown in the
economy;
- market acceptance of our SiteMinder, Delegated Management Services
("DMS"), Netegrity Interaction Server ("NIS") and related products;
- our success in obtaining follow-on sales to existing customers;
- the long sales and deployment cycle of our products;
- our ability to hire and retain personnel, particularly in development,
services and sales and marketing;
- the release of new versions of SiteMinder, DMS, NIS or other products;
- the development of our direct and indirect sales channels; and
- Integration issues with acquired technology.
In addition, because our revenues from services are largely correlated with our
software revenues, a decline in software revenues could also cause a decline in
our services revenues in the same quarter or in subsequent quarters. Other
factors, many of which are outside our control, could also cause variations in
our quarterly revenues and operating results.
Most of our expenses, such as employee compensation and rent, are relatively
fixed. Moreover, our expense levels are based, in part, on our expectations
regarding future revenue increases. We expect to continue to invest in all
areas, particularly in research and development and sales and marketing, in
order to execute our business plan. As a result, any shortfall in revenues in
relation to our expectations could cause significant changes in our operating
results from quarter to quarter and could result in future losses.
OUR FUTURE SUCCESS WILL DEPEND ON OUR ABILITY TO MARKET OUR PRODUCTS AND RELATED
SERVICES SUCCESSFULLY.
We currently derive a substantial majority of our total revenues from the sale
of SiteMinder software licenses and related products and services. Commercial
deployments of SiteMinder products have grown to include not only
business-to-business and e-business applications, but large intranet and
multi-million user business-to-consumer deployments, as well. Broad market
acceptance of our products will depend on the development of a market for access
control and identity management, including usage of our products for
12
software business-to-consumer applications, and customer demand for the specific
functionality of our products. Market acceptance for our products, and customer
demand for the services they provide, may not develop.
Our ability to develop the market for our products depends in part on our
ability to provide support services on a 24 hour per day, seven-day per week
basis. Any damage or disruptions to our service centers, including the service
center in Malaysia, whether as a result of terrorism or some other cause, could
seriously impact our ability to provide the necessary service to our customers
and fulfill our service contracts.
There are currently 41 commercial deployments of our NIS product. Broad market
acceptance of the NIS product and related services will depend on continued
development of the enterprise portal market, and consequent customer demand for
the specific functionality of the NIS product. If we fail in marketing our
products and services, for whatever reason, our business will be harmed.
OUR SUCCESS IS DEPENDENT ON OUR ABILITY TO ENHANCE OUR PRODUCT LINES AND DEVELOP
NEW PRODUCTS.
We believe our success is dependent, in large part, on our ability to enhance
and broaden our product lines to meet the evolving needs of both the
business-to-business internet and business-to-consumer market. We may be unable
to respond effectively to technological changes or new industry standards or
developments. In the past, we have been forced to delay introduction of several
new product versions. In the future, we could be adversely affected if we incur
significant delays or are unsuccessful in enhancing our product lines or
developing new products, or if any of our enhancements or new products do not
gain market acceptance.
OUR PERFORMANCE DEPENDS ON OUR ABILITY TO OBTAIN FOLLOW-ON SALES.
Customers typically place small initial orders for a Netegrity product
installation to allow them to evaluate its performance. Our strategy is to
pursue more significant follow-on sales after these initial installations. Our
financial performance depends on successful initial deployments of our products
that, in turn, lead to follow-on sales. If the initial deployments of our
products are not successful, we may be unable to obtain follow-on sales.
WE FACE SIGNIFICANT COMPETITION FROM OTHER TECHNOLOGY COMPANIES AND WE MAY NOT
BE ABLE TO COMPETE EFFECTIVELY.
The market for access control, identity management and portal products and
services is highly competitive. We expect the level of competition to increase
as a result of the anticipated growth of e-business. Our primary competitors
include IBM, RSA/Securant, Entrust, OpenNetwork Technology, Plumtree,
Epicentric, BEA, Oblix and many early-stage companies. In addition, a number of
other software companies have indicated that they offer products, which may
compete with ours. We also face competition from web development professional
services organizations. We expect that additional competitors will emerge in the
future. Current and potential competitors have established, or may in the future
establish, cooperative relationships with third parties to increase the
availability of their products to the marketplace. It is possible that new
competitors or alliances may emerge and rapidly acquire significant market
share. Potential competitors may have significantly greater financial,
marketing, technical and other competitive resources than we have. If, in the
future, a competitor chooses to bundle a competing secure user management
product with other e-commerce applications, the demand for our products might be
substantially reduced. Because of these factors, many of which are out of our
control, we may be unable to maintain or enhance our competitive position
against current and future competitors.
REGULATIONS OR CONSUMER CONCERNS REGARDING THE USE OF "COOKIES" ON THE INTERNET
COULD REDUCE THE EFFECTIVENESS OF OUR SITEMINDER SOFTWARE PRODUCTS.
Our SiteMinder products use cookies to support their single sign-on
functionality. A cookie is information keyed to a specific user that is stored
on the hard drive of the user's computer, typically without the user's
knowledge. Cookies are generally removable by the user, and can be refused by
the user at the point at which the information would be stored on the user's
hard drive. A number of governmental bodies and commentators in the United
States and abroad have urged passage of laws limiting or abolishing the use of
cookies. The passage of laws limiting or abolishing the use of cookies, or the
widespread deletion or refusal of cookies by web site users, could reduce or
eliminate the effectiveness of SiteMinder's single sign-on functionality and
could reduce market demand for our SiteMinder products.
WE MAY BE UNABLE TO HIRE AND RETAIN SKILLED PERSONNEL.
13
Qualified personnel are in great demand throughout the software industry. Our
success depends, in large part, upon our ability to attract, train, motivate and
retain highly skilled employees, particularly software engineers, professional
services personnel, sales and marketing personnel and other senior personnel.
Our failures to attract and retain the highly trained technical personnel that
are integral to our product development, professional services and direct sales
teams may limit the rate at which we can generate sales and develop new products
or product enhancements. This could have a material adverse effect on our
business, operating results and financial condition.
OUR SUCCESS DEPENDS ON OUR ABILITY TO DEVELOP OUR DIRECT SALES AND INDIRECT
DISTRIBUTION CHANNELS.
To increase our revenues, we must develop our direct sales channel and increase
the number of our indirect channel partners. There is intense competition for
sales personnel in our business, and we cannot be sure that we will be
successful in attracting, integrating, motivating and retaining sales personnel.
In addition, we must increase the number of strategic partnerships and other
third-party relationships with system integrators, vendors of Internet-related
systems and application software and resellers. Our existing, or future, channel
partners may choose to devote greater resources to marketing and supporting the
products of other companies or conflicts may develop among our sales force and
channel partners. If we fail to develop these relationships or these
relationships do not result in successful partnerships, our revenue could
suffer.
WE RELY ON THIRD PARTY TECHNOLOGY TO ENHANCE OUR PRODUCTS.
We incorporate into our products software licensed from third-party software
developers that enhance and enable the functionality of our product. Third-party
software may not continue to be available on commercially reasonable terms or
with acceptable levels of support, or at all. Failure to maintain those license
arrangements or defects and errors in those third-party products could delay or
impair our ability to develop and sell our products.
OUR FAILURE TO EXPAND OUR PROFESSIONAL SERVICES RESOURCES COULD LIMIT OUR
ABILITY TO INCREASE OUR PRODUCT SALES.
Our professional services organization and our system integrators provide
critical support to our customers' installation and deployment of our products.
If we fail to expand our professional services resources and/or adequately
develop our system integrator relationships, our ability to increase products
sales may be limited. In addition, if we cannot adequately support product
installations, our customers' use of our products may fail which could harm our
reputation and hurt our business.
OUR LENGTHY SALES CYCLE MAKES IT DIFFICULT TO PREDICT OUR QUARTERLY OPERATING
RESULTS.
We have a long sales cycle because we generally need to educate potential
customers regarding the use and benefits of our products. The length of our
sales cycle varies depending on the size and type of customer contemplating a
purchase and whether we have conducted business with a potential customer in the
past. In addition, these potential customers frequently need to obtain approvals
from multiple decision makers prior to making purchase decisions. Our long sales
cycle, which can range from several weeks to several months or more, makes it
difficult to predict the quarter in which sales will occur. Delays in sales
could cause significant variability in our revenues and operating results for
any particular period.
OUR FAILURE TO EFFECTIVELY MANAGE CHANGES IN THE BUSINESS ENVIRONMENT IN WHICH
WE OPERATE, COULD HURT OUR BUSINESS.
Our failure to effectively manage changes in the business environment in which
we operate could have a material adverse effect on the quality of our products,
our ability to retain key personnel and our business, operating results and
financial condition. Historically, we had experienced a period of rapid growth
that placed a significant strain on all of our resources. From December 31, 2000
to June 30, 2002, we increased the number of our employees from 292 to 450
(including 95 from our acquisition of DataChannel on December 14, 2001). Based
upon economic factors beyond our control, we implemented a reduction in force of
48 positions during April 2002. We may experience similar changes in the future.
To effectively manage changes in the business environment in which we operate we
must maintain and enhance our financial and accounting systems and controls,
integrate new personnel and manage operations.
IF WE LOSE THE SERVICES OF BARRY BYCOFF OR ANY OTHER MEMBER OF OUR MANAGEMENT
TEAM, OUR BUSINESS COULD SUFFER.
14
Our future success depends, to a significant degree, on the skill, experience
and efforts of Barry Bycoff, our chief executive officer, and the rest of our
management team. The loss of any member of our management team or the inability
of our officers and key employees to work effectively as a team could have a
material adverse effect on our business, operating results and financial
condition.
AS WE CONTINUE TO OPERATE IN INTERNATIONAL MARKETS, WE WILL FACE CONTINUED RISKS
TO OUR SUCCESS.
We intend to continue to expand our international operations in the future. This
expansion will require additional resources and management attention, and will
subject us to increased regulatory, economic and political risks. We have
limited experience in international markets and we cannot be sure that our
continued expansion into global markets will be successful. In addition, we will
face increased risks in conducting business internationally. These risks could
reduce demand for our products and services, increase the prices at which we can
sell our products and services, or otherwise have an adverse effect on our
operating results. Among the risks we believe are most likely to affect us are:
- longer decision making cycles;
- longer payment cycles and problems in collecting accounts receivable;
- adverse changes in trade and tax regulations, including restrictions
on the import and export of sensitive technologies, such as encryption
technologies, that we use or may wish to use in our software products;
- the absence or significant lack of legal protection for intellectual
property rights;
- difficulties in managing an organization spread over several
countries, including complications arising from cultural, language and
time differences that may lengthen sales and implementation cycles;
- currency risks, including fluctuations in exchange rates;
- political and economic instability;
- increased use of contractors on a global basis for both professional
services and development works, as business requirements dictate that
may result in increased cost of services and/or less direct control;
and
- disruption caused by terrorist activities in various regions around
the world.
OUR SUCCESS DEPENDS ON OUR ABILITY TO PROTECT OUR PROPRIETARY RIGHTS.
Our success depends to a significant degree upon the protection of our software
and other proprietary technology. The unauthorized reproduction or other
misappropriation of our proprietary technology could enable third parties to
benefit from our technology without paying us for it. This could have a material
adverse effect on our business, operating results and financial condition. We
depend upon a combination of patent, trademark, trade secret and copyright laws,
license agreements and non-disclosure and other contractual provisions to
protect proprietary and distribution rights in our products. In addition, we
attempt to protect our proprietary information and the proprietary information
of our vendors and partners through confidentiality and/or license agreements
with our employees and others. Although we have taken steps to protect our
proprietary technology, they may be inadequate. Existing trade secret, copyright
and trademark laws offer only limited protection. Moreover, the laws of other
countries in which we market our products may afford little or no effective
protection of our intellectual property. If we resort to legal proceedings to
enforce our intellectual property rights, the proceedings could be burdensome
and expensive, even if we were to prevail.
CLAIMS BY OTHER COMPANIES THAT WE INFRINGE THEIR PROPRIETARY TECHNOLOGY COULD
HURT OUR FINANCIAL CONDITION.
If we discover that any of our products violated third-party proprietary rights,
there can be no assurance that we would be able to reengineer our product or to
obtain a license on commercially reasonable terms to continue offering the
product without substantial reengineering. We do not conduct comprehensive
patent searches to determine whether the technology used in our products
infringes
15
patents held by third parties. In addition, product development is inherently
uncertain in a rapidly evolving technology environment in which there may be
numerous patent applications pending for similar technologies, many of which are
confidential when filed. Any claim of infringement, even if invalid, could cause
us to incur substantial costs defending against the claim and could distract our
management from our business. Furthermore, a party making such a claim could
secure a judgment that requires us to pay substantial damages. A judgment could
also include an injunction or other court order that could prevent us from
selling our products. Any of these events could have a material adverse effect
on our business, operating results and financial condition.
OUR BUSINESS COULD BE ADVERSELY AFFECTED IF OUR PRODUCTS CONTAIN ERRORS.
Software products as complex as ours may contain undetected errors or "bugs"
that result in product failures. The occurrence of errors could result in loss
of, or delay in, revenues, loss of market share, failure to achieve market
acceptance, diversion of development resources, injury to our reputation, or
damage to our efforts to build brand awareness, any of which could have a
material adverse effect on our business, operating results and financial
condition.
WE COULD INCUR SUBSTANTIAL COSTS RESULTING FROM PRODUCT LIABILITY CLAIMS
RELATING TO OUR CUSTOMERS' USE OF OUR PRODUCTS.
Many of the e-commerce applications supported by our products are critical to
the operations of our customers' businesses. Any failure in a customer's web
site or application caused or allegedly caused by our products could result in a
claim for substantial damages against us, regardless of our responsibility for
the failure. Although we maintain general liability insurance, including
coverage for errors and omissions, we cannot be sure that our existing coverage
will continue to be available on reasonable terms or will be available in
amounts sufficient to cover one or more large claims, or that the insurer will
not disclaim coverage as to any future claim.
OUR ACQUISITION OF OTHER COMPANIES MAY INCREASE THE RISKS WE FACE.
On December 14, 2001, we acquired the capital stock of DataChannel, Inc., a
privately held Washington corporation. In the future, we may pursue other
acquisitions to obtain complementary products, services and technologies.
DataChannel and any other such acquisition may not produce the revenues,
earnings or business synergies that we anticipated, and an acquired product,
service or technology might not perform as we expected. In pursuing any
acquisition, our management could spend a significant amount of time and effort
in identifying and completing the acquisition. If we complete an acquisition, we
would probably have to devote a significant amount of management resources to
integrate the acquired business with our existing business. To pay for an
acquisition, we might use our stock or cash. Alternatively, we might borrow
money from a bank or other lender. If we use our stock, our stockholders would
experience dilution of their ownership interests. If we use cash or debt
financing, our financial liquidity will be reduced.
THE MARKET PRICE OF OUR COMMON STOCK HAS BEEN AND MAY CONTINUE TO BE VOLATILE.
Our stock price, like that of other technology companies, has been extremely
volatile. The announcement of new products, services, technological innovations
or distribution partners by us or our competitors, quarterly variations in our
operating results, changes in revenues or earnings estimates by securities
analysts and speculation in the press or investment community are among the
factors affecting our stock price.
The stock market in general and the market prices for Internet-related companies
in particular, have experienced extreme volatility that often has been unrelated
to the operating performance of these companies. These broad market and industry
fluctuations may adversely affect the market price of our common stock,
regardless of our operating performance. Recently, when the market price of a
stock has been volatile, holders of that stock have often instituted securities
class action litigation against the company that issued the stock. If any of our
stockholders brought a lawsuit against us, we could incur substantial costs
defending the lawsuit. The lawsuit could also divert the time and attention of
our management.
The general economic uncertainties in the United States and abroad continue to
cause significant volatility in the stock markets. The continued threat of
terrorism in the United States and abroad, the ongoing military action and
heightened security measures undertaken in response to that threat can be
expected to cause continued volatility in securities markets. In addition,
foreign political unrest may continue to adversely affect the economy.
WE MAY LOSE MONEY ON FIXED-PRICE CONSULTING CONTRACTS.
16
In the future, an increased portion of our services revenues may be derived from
fixed-price contracts. We work with complex technologies in compressed time
frames and it can be difficult to judge the time and resources necessary to
complete a project. If we miscalculate the resources or time we need to complete
work under fixed-price contracts, our operating results could be materially
harmed. As of June 30, 2002, the Company had no fixed-price contracts.
CERTAIN PROVISIONS OF OUR CHARTER AND OF DELAWARE LAW MAKE A TAKEOVER OF OUR
COMPANY MORE DIFFICULT.
Our corporate documents and Delaware law contain provisions that might enable
our management to resist a takeover of our company. These provisions might
discourage, delay or prevent a change in the control of Netegrity or a change in
our management. These provisions could also discourage proxy contests and make
it more difficult for you and other stockholders to elect directors and take
other corporate actions. The existence of these provisions could limit the price
that investors might be willing to pay in the future for shares of our common
stock.
CRITICAL ACCOUNTING POLICIES AND SIGNIFICANT JUDGMENTS AND ESTIMATES
Netegrity's discussion and analysis of its financial condition and results of
operations are based on the Company's 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 management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements and the reported revenues
and expenses during the reporting periods. On an ongoing basis, management
evaluates its estimates and judgments, including those related to revenue
recognition, bad debts, valuation of long-lived and intangible assets and
goodwill, and income taxes. Management bases its estimates on historical
experience and on various other factors that are believed to be reasonable under
the circumstances, the results of which form the basis for making judgments
about the carrying value of assets and liabilities that are not readily apparent
from other sources. Actual results may differ from these estimates under
different assumptions or conditions.
The significant accounting policies that management believes are most critical
to aid in fully understanding and evaluating our reported financial results
include the following:
Revenue Recognition
The Company's revenues are primarily generated from the sale of perpetual
licenses for its proprietary SiteMinder, DMS and NIS products and services. The
Company generates its services revenue from consulting and training services
performed for customers and from maintenance and support. As described below,
significant management judgments and estimates must be made and used in
connection with the revenue recognized in any accounting period. Management
analyzes various factors, including a review of specific transactions,
historical experience, creditworthiness of customers and current market and
economic conditions. Changes in judgments based upon these factors could impact
the timing and amount of revenue and cost recognized.
We license our software products on a perpetual basis. We apply the provisions
of Statement of Position No. 97-2, "Software Revenue Recognition," as amended by
Statement of Position No. 98-9, "Software Revenue Recognition, with Respect to
Certain Transactions," to all transactions involving the sale of software
products. We recognize revenue from the sale of software licenses when
persuasive evidence of an arrangement exists, the product has been delivered,
the fees are fixed or determinable and collection of the resulting receivable is
reasonably assured. This policy is applicable to all sales, including sales to
resellers and end users. The Company does not offer a right of return on its
products.
For all sales, we use either a binding purchase order or signed license
agreement as evidence of an arrangement. For arrangements with multiple
obligations (for example, product, undelivered maintenance and support, and
training and consulting), we allocate revenue to each component of the
arrangement using the residual value method based on the fair value of the
undelivered elements. We defer revenue from the arrangement equivalent to the
fair value of the undelivered elements. Fair values for the ongoing maintenance
and support obligations are based upon separate sales of renewals to other
customers. Fair value of services, such as training or consulting, is based upon
separate sales of these services to other customers.
At the time of the transaction, we assess whether the fee associated with the
transaction is fixed or determinable based on the payment terms associated with
the transaction. If a significant portion of the fee is due after our normal
payment terms, which are 30 to 90 days from invoice date, we account for the fee
as not being fixed or determinable. In these cases, we recognize revenue as the
fees become
17
due. In addition, we assess whether collection is probable or not based on the
credit worthiness of the customer. Initial credit worthiness is assessed through
Dun & Bradstreet or similar credit rating agencies. Credit worthiness for
follow-on transactions is assessed through a review of the transaction history
with the customer. We do not request collateral from our customers. If we
determine that collection of a fee is not reasonably assured, we defer the fee
and recognize revenue at the time collection becomes reasonably assured, which
is generally upon receipt of cash.
Installation by Netegrity is not considered essential to the functionality of
our products as these services do not alter the product capabilities, do not
require specialized skills and may be performed by the customer or other
vendors. Revenues for maintenance and support are recognized ratably over the
term of the support period. Revenues from consulting and training services are
recognized as the services are performed.
Accounts Receivable
Accounts receivable are reduced by an allowance for amounts that may become
uncollectible in the future. The estimated allowance for uncollectible amounts
is based primarily on a specific analysis of accounts in the receivable
portfolio and historical write-off experience. While management believes the
allowance to be adequate, if the financial condition of the Company's customers
were to deteriorate, resulting in impairment of their ability to make payments,
additional allowances may be required and could materially impact our financial
position and results of operations.
Valuation of Long-Lived Assets and Goodwill
Valuation of long-lived assets includes assessing the recorded value of certain
long-lived assets, including property and equipment and capitalized software
under the provision of SFAS No. 144, Accounting for the Impairment or Disposal
of Long-Lived Assets. The Company is required to assess the impairment of
long-lived assets and identifiable intangibles, whenever events and
circumstances indicate that the carrying value may not be recoverable. Factors
we consider important that could trigger an impairment review include the
following:
- significant underperformance relative to expected historical or
projected future operating results;
- significant changes in the manner of our use of the acquired assets or
the strategy of our overall business;
- significant negative industry or economic trends;
- significant decline in our stock price for a sustained period; and
- our market capitalization relative to net book value.
When we determine that the carrying value of long-lived assets may not be
recoverable based upon the existence of one or more of the above indicators of
impairment, we evaluate whether the carrying amount of the asset exceeds the sum
of the undiscounted cash flows expected to result from the use and eventual
disposition of that asset. If such a circumstance exists, we would measure an
impairment loss as the excess of the carrying amount of the particular
long-lived asset or group over its fair value. We would determine the fair value
based on a projected discounted cash flow method using a discount rate
determined by our management to be commensurate with the risk inherent in our
current business model. Changes in judgments on any of these factors could
impact the value of the asset.
Effective January 1, 2002, the Company adopted the provisions of SFAS No. 142,
Goodwill and Other Intangible Assets. Under SFAS No. 142, goodwill is required
to be tested annually in lieu of being amortized. Furthermore, we are required
to test for impairment of goodwill on an interim basis if an event or
circumstance indicates that it is more likely than not that an impairment loss
has been incurred.
The Company will recognize an impairment loss to the extent that the carrying
amount of goodwill exceeds its implied fair value. The impairment loss will be
recognized in operations.
The Company is currently evaluating whether or not there has been a triggering
event for an impairment review of its long-lived assets and goodwill based on
the recent significant decline in our stock price as a result of
underperformance relative to recent and expected operating results and overall
adverse change in the business climate. If the Company determines that a
triggering event has occurred, the Company will
18
test for impairment based on a two-step approach. The first step is to test for
an impairment of long-lived assets other than goodwill. The second step, to be
done after completion of the first step, is to determine if there has been an
impairment of goodwill. If the Company determines that the long-lived assets
including goodwill are impaired, the resulting impairment charge could have a
material adverse effect on the financial statements.
The acquisition of DataChannel, Inc. on December 14, 2001 was accounted for in
accordance with the transition provisions of SFAS No. 141 and No. 142. The
Company adopted SFAS No. 142 during the first quarter of 2002 without a material
impact on its financial position or results of operations. Under SFAS No. 142,
goodwill is not amortized but is reviewed at least annually for impairment.
Separable intangible assets that are not deemed to have indefinite lives are
amortized over their useful lives. The annual impairment test will be completed
in the fourth quarter of each fiscal year (or more frequently if impairment
indicators arise). If the Company had accounted for goodwill and other
intangibles in accordance with SFAS 142 during the three and six months ended
June 30, 2001, the results of operations would not be different from those
previously reported.
The Company adopted SFAS No. 144, which addresses accounting and reporting of
all long-lived assets, except goodwill, that are either held and used or
disposed of through sale or other means, during the first quarter of fiscal year
2002 without a material impact on it's financial position or results of
operations.
Accounting for Income Taxes
The preparation of our consolidated financial statements require us to estimate
our income taxes in each of the jurisdictions in which we operate, including
those outside the United States which may be subject to certain risks that
ordinarily would not be expected in the United States. The income tax accounting
process involves our estimating our actual current exposure together with
assessing temporary differences resulting from differing treatment of items,
such as deferred revenue, for tax and accounting purposes. These differences
result in the recognition of deferred tax assets and liabilities. The Company
must then record a valuation allowance to reduce its deferred tax assets to the
amount that is more likely than not to be realized.
Significant management judgment is required in determining our provision for
income taxes, our deferred tax assets and liabilities and any valuation
allowance recorded against deferred tax assets. The Company has recorded a
valuation allowance of $65.8 million as of June 30, 2002, due to uncertainties
related to our ability to utilize some of our deferred tax assets, primarily
consisting of certain net operating losses carried forward before they expire.
The valuation allowance is based on our estimates of taxable income by
jurisdiction in which we operate and the period over which our deferred tax
assets will be recoverable. In the event that actual results differ from these
estimates or we adjust these estimates in future periods we may need to adjust
our valuation allowance which could materially impact our financial position and
results of operations.
RESULTS OF OPERATIONS
The following table presents statement of operations data as percentages of
total revenues for the periods indicated:
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------- --------------
2001 2002 2001 2002
---- ---- ---- ----
STATEMENT OF OPERATIONS DATA:
Revenues:
Software licenses .......................... 63% 49% 67% 56%
Services ................................... 34 47 29 40
Other ...................................... 3 4 4 4
--- ---- --- ----
Total revenues ....................... 100 100 100 100
Cost of revenues:
Cost of software licenses .................. 2 8 3 7
Cost of services ........................... 17 23 16 20
Cost of other .............................. 2 2 2 2
--- ---- --- ----
Total cost of revenues ............... 21 33 21 29
--- ---- --- ----
Gross profit .................................. 79 67 79 71
--- ---- --- ----
Selling, general and administrative expenses .. 55 89 55 73
Research and development expenses ............. 16 42 16 33
Restructuring expenses ........................ -- 4 -- 2
--- ---- --- ----
Income (loss) from operations ................. 8 (68) 8 (37)
Other income, net ............................. 5 5 5 3
--- ---- --- ----
Income (loss) before provision for income taxes 13 (63) 13 (34)
Provision for income taxes .................... 1 -- 1 --
--- ---- --- ----
Net income (loss) ............................. 12% (63)% 12% (34)%
=== ==== === ====
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THE THREE AND SIX MONTHS ENDED JUNE 30, 2002 COMPARED TO THE THREE AND SIX
MONTHS ENDED JUNE 30, 2001
The following discussion reviews the results of operations for the three and six
months ended June 30, 2002 (the "2002 Quarter" and "2002 Period"), respectively,
compared to the three and six months ended June 30, 2001 (the "2001 Quarter" and
"2001 Period"), respectively.
Revenues. Total revenues decreased by $9.5 million or 38%, to $15.8 million in
the 2002 Quarter, from $25.3 million in the 2001 Quarter, and by $13.8 or 27%,
to $37.8 million in the 2002 Period, from $51.6 million in the 2001 Period.
Software license revenues decreased by $8.4 million or 52%, to $7.7 million in
the 2002 Quarter, from $16.1 million in the 2001 Quarter, and by $13.5 million
or 39%, to $21.3 million in the 2002 Period, from $34.8 million in the 2001
Period. This decrease is due to broad based economic weakness and reduced
technology spending which resulted in deals being delayed or reduced in size.
Services revenues decreased by $1.0 million or 12%, to $7.5 million in the 2002
Quarter, from $8.5 million in the 2001 Quarter, and increased by $131,000 or 1%,
to $15.1 million in the 2002 Period, from $15.0 million in the 2001 Period. The
decrease during the 2002 Quarter is primarily attributable to a $2.3 million
decline in consulting and training revenue as a result of broad based economic
weakness and reduced technology spending partially offset by an increase of $1.3
million in maintenance and support revenue primarily attributable to maintenance
renewals from our existing customer base. The increase of $131,000 during the
2002 Period is primarily attributable to a $2.9 million decline in consulting
and training revenue offset by an increase of $3.0 million in maintenance and
support revenue.
Other revenues decreased by $147,000 or 19%, to $0.6 million in the 2002
Quarter, from $0.8 million in the 2001 Quarter, and by $0.4 million or 24%, to
$1.4 million in the 2002 Period, from $1.8 million in the 2001 Period. Other
revenues are not expected to have a significant impact in future periods.
Cost of revenues. Total cost of revenues remained flat at $5.3 million for the
2002 and 2001 Quarters, and at $11 million for the 2002 and 2001 Periods.
Cost of software license revenue increased by $0.8 million or 175%, to $1.3
million in the 2002 Quarter from $0.5 million in the 2001 Quarter, and by $1.4
million or 105%, to $2.8 million in the 2002 Period, from $1.4 million in the
2001 Period. This increase is primarily due to the amortization of purchased
software in connection with the acquisition of DataChannel of approximately $0.9
million per quarter offset by proportional decreases in software revenues.
Cost of services decreased by $0.8 million or 18%, to $3.6 million in the 2002
Quarter, from $4.4 million in the 2001 Quarter, and by $1.1 million or 12%, to
$7.4 million in the 2002 Period, from $8.5 million in the 2001 Period. This
decrease is primarily due to the leveraging of our system integrator partner
relationships. This leveraging allowed us to reduce the headcount in our
professional services organization by 27% from June 30, 2001 to June 30, 2002.
Cost of other revenues decreased by $59,000 or 13%, to $0.3 million in the 2002
Quarter, from $0.4 million in the 2001 Quarter, and by $0.3 million or 27%, to
$0.8 million in the 2002 Period, from $1.1 million in the 2001 Period. This
decrease is in relative proportion to the decrease in revenue.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased by $145,000, or 1%, to $14.0 million in the
2002 Quarter, from $13.9 million in the 2001 Quarter. Selling, general and
administrative expenses decreased by $0.8 million or 3%, to $27.5 million in the
2002 Period, from $28.3 million in the 2001 Period. The increase in the 2002
Quarter is primarily attributable to increased salaries and wages associated
with a full quarter effect of increasing headcount throughout 2001 and increased
legal, accounting and insurance expenses which were not completely offset by
reduced commission expenses in connection with decreased license revenue. For
the 2002 Period, reduced commission expense and reduced recruiting expenses more
than offset the increases in salaries and wages, legal, accounting and insurance
expenses.
Research and development costs. Research and development costs increased by $2.4
million or 60%, to $6.5 million in the 2002 Quarter, from $4.1 million in the
2001 Quarter, and by $4.5 million or 57%, to $12.5 million in the 2002 Quarter,
from $8.0 million in the 2001 Period. The increase was primarily due to the
addition of approximately 65 employees (including 40 from the acquisition of
DataChannel in the fourth quarter of 2001) engaged in research and development
activities between the second quarter of 2001 and the
20
second quarter of 2002. We expect to continue to increase the amount spent on
research and development in the foreseeable future as we continue to develop and
enhance our product line to address the evolving needs of customers deploying
large scale and transaction-based e-business applications.
Restructuring expenses. Restructuring expenses of $0.7 million during the 2002
Quarter and the 2002 Period primarily represent severance charges associated
with a 10% reduction in workforce and the closing of several sales offices
during April 2002.
Other income, net. Other income, net which is composed primarily of interest
income earned on the company's cash and marketable securities, decreased by
approximately $0.6 million or 43%, to $0.7 million in the 2002 Quarter, from
$1.3 million in the 2001 Quarter, and by $1.4 million or 50%, to $1.4 million in
the 2002 Period, from $2.8 million in the 2001 Period. This decrease was
attributable primarily to a decline in the average cash and marketable
securities balances combined with lower average interest rates on such
investment balances.
Provision for income taxes. The provision for income taxes decreased by
approximately $0.3 million or 100%, to $0 in the 2002 Quarter, from
approximately $0.3 million in the 2001 Quarter, and by $0.6 million or 93%, to
$40,000 in the 2002 Period, from $0.6 million in the 2001 Period. This decrease
was attributable to the net loss position in the 2002 Quarter and the 2002
Period compared to net income in the 2001 Quarter and the 2001 Period.
LIQUIDITY AND CAPITAL RESOURCES
Cash used for operating activities in the 2002 Period was $11.7 million,
primarily due to the net loss for the period, decreases in accounts payable and
accrued expenses (including approximately $1.9 million in fees associated with
the December 2001 acquisition of DataChannel), which was partially offset by a
decrease in accounts receivable.
Cash provided by investing activities was $4.8 million in the 2002 Period.
Investing activities for the period consisted primarily of net sales of
marketable securities of approximately $6.1 million offset by the purchases of
approximately $1.3 million of equipment, primarily computer related.
Cash provided by financing activities in the 2002 Period was approximately $0.4
million, which primarily related to the exercise of employee stock options.
As of June 30, 2002, our primary financial commitments consisted of obligations
outstanding under operating leases.
As of June 30, 2002, we had cash and cash equivalents totaling $19.7 million,
short-term marketable securities of $64.7 million and long-term marketable
securities of $11.9 million.
In recent years, we have significantly increased our operating expenses. We
anticipate that we will continue to experience significant growth in our
operating expenses for the foreseeable future and that our operating expenses
and capital expenditures will constitute a material use of our cash resources.
In addition, we may utilize cash resources to fund acquisitions or investments
in businesses, technologies, products or services that are complementary to our
business. We believe that our existing cash and cash equivalents together with
our short-term marketable securities will be sufficient to meet our anticipated
cash requirements for working capital and capital expenditures for at least the
next twelve months.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Currency
In the three and six months ended June 30, 2002, the Company generated
approximately 26% and 18%, respectively, of its revenues outside of North
America. International sales are typically denominated in U.S. dollars. Our
foreign subsidiaries incur most of their expenses in the local currency.
Accordingly, all foreign subsidiaries use the local currency as their functional
currency. Translation gains and losses (amounting to a loss of approximately
$81,000 as of June 30, 2002) are deferred and accumulated as a separate
component of stockholders' equity (accumulated other comprehensive income
(loss)). Net gains and losses resulting from foreign exchange transactions,
amounting to a gain of approximately $55,000 for the three months ended June 30,
2002 and a loss of approximately $21,000 for the six months ended June 30, 2002
are included in other income, net in the accompanying consolidated condensed
statements of operations. A 10% change in the valuation of the functional
currencies relative to the U.S. dollar as of June 30, 2002 would not have a
material impact on the Company's results of operations for the three and six
month periods.
21
Interest Rates
We invest our cash in a variety of financial instruments including floating rate
bonds, municipal bonds, asset-backed securities and money market instruments in
accordance with an investment policy approved by the Company's Board of
Directors. These investments are denominated in U.S. dollars. Cash balances in
foreign currencies overseas are operating balances and are only invested in
short-term deposits of the local operating bank.
Investments in both fixed rate and floating rate interest earning instruments
carry a degree of interest rate risk. However, due to the conservative nature of
our investment portfolio, a sudden change in interest rates would not have a
material effect on the value of the portfolio. We estimate that if the average
yield of our investments had decreased by 100 basis points, our interest income
for the three and six months ended June 30, 2002 would have decreased by less
than $0.1 million. This estimate assumes that the decrease occurred on the first
day of the quarter and reduced the yield of each investment instrument by 100
basis points. The same 100 basis point change in interest rates would not have a
material impact on the fair value of the investment portfolio. The impact on our
future interest income and future changes in investment yields will depend
largely on the gross amount of our investment portfolio.
PART II. -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, the Company is involved in litigation relating to claims
arising out of its operations in the normal course of business. The Company is
not presently a party to any legal proceedings, the adverse outcome of which, in
management's opinion would have a material adverse effect on the Company's
results of operations or financial position.
ITEM 2. CHANGES IN SECURITIES
Not Applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 22, 2002, the Company held its Annual Meeting of Stockholders. At the
meeting, Barry N. Bycoff, Paul F. Deninger, Eric R. Giler, Lawrence D. Lenihan,
Jr., Michael L. Mark and Ralph B. Wagner were re-elected as Directors to serve
in accordance with the bylaws and until their successors are duly chosen and
qualify. The voting results were as follows:
For Withhold
--- --------
Barry N. Bycoff 25,727,929 157,053
Paul F. Deninger 25,801,757 83,225
Eric R. Giler 25,804,710 80,272
Lawrence D. Lenihan, Jr. 25,804,148 80,834
Michael L. Mark 25,804,948 80,034
Ralph B. Wagner 25,804,162 80,820
At the meeting, the stockholders approved the 2002 Employee Stock Purchase Plan
and reserved 700,000 shares of common stock for issuance hereunder. The vote was
as follows:
For Against Abstain
--- ------- -------
25,713,504 151,479 19,999
ITEM 5. OTHER INFORMATION
22
Not Applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 10.1 Executive Employment Agreement dated May 22, 2002
by and between Netegrity, Inc., and Barry N. Bycoff.
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K on June 21, 2002 with the
Securities and Exchange Commission reporting under Item 4 a change in the
Company's certifying accountant.
23
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, Barry N. Bycoff, President, Chief Executive Officer, Director and
Chairman of the Board, and Regina O. Sommer, Chief Financial Officer and
Treasurer (Principal Financial Officer and Principal Accounting Officer),
thereunto duly authorized. Pursuant to Section 1350 of Chapter 63 of Title 18,
United States Code, the undersigned hereby certify that this report fully
complies with the requirements of Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 and that information contained in this report fairly
presents, in all material respects, the financial condition and results of
operations of the Registrant.
NETEGRITY, INC.
Date: August 14, 2002 By: /s/ Barry N. Bycoff
-----------------------------------
Barry N. Bycoff
President, Chief Executive Officer,
Director and Chairman of the Board
Date: August 14, 2002 By: /s/ Regina O. Sommer
-----------------------------------
Regina O. Sommer
Chief Financial Officer and
Treasurer (Principal Financial
Officer and Principal Accounting
Officer)
24