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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 SEPTEMBER 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 (I.R.S. Employer
jurisdiction of 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 October 21, 2002 there were 34,192,339 shares of Common Stock outstanding,
exclusive of Treasury Stock.
QUARTERLY REPORT ON FORM 10-Q
QUARTER ENDED SEPTEMBER 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 September 30, 2002 (unaudited) 3
Consolidated Condensed Statements of Operations for the
three months ended September 30, 2001 and 2002 (unaudited) 4
Consolidated Condensed Statements of Operations for the
nine months ended September 30, 2001 and 2002 (unaudited) 5
Consolidated Condensed Statements of Cash Flows for the
nine months ended September 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 13
Item 3. Quantitative and Qualitative Disclosures About Market 25
Risk
Item 4. Controls and Procedures 25
PART II OTHER INFORMATION 27
Item 1. Legal Proceedings 27
Item 2. Changes in Securities 27
Item 3. Defaults upon Senior Securities 27
Item 4. Submission of Matters to a Vote of Security Holders 27
Item 5. Other Information 27
Item 6. Exhibits and Forms on 8-K 27
SIGNATURES 29
CERTIFICATIONS 30
2
PART I. - FINANCIAL INFORMATION
NETEGRITY, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(IN THOUSANDS)
SEPTEMBER 30,
DECEMBER 31, 2002
2001 (UNAUDITED)
--------- ---------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ........................................ $ 26,332 $ 14,446
Short-term marketable securities ................................. 76,651 63,353
Accounts receivable--trade, net of allowances of $1,579 at
December 31, 2001; $1,367 at September 30, 2002 ................. 16,122 11,228
Prepaid expenses and other current assets ........................ 3,418 2,986
--------- ---------
Total Current Assets .......................................... 122,523 92,013
Long-term marketable securities .................................... 6,083 15,143
Property and equipment, net ........................................ 8,494 6,910
Restricted cash .................................................... 631 1,070
Goodwill ........................................................... 57,262 --
Other intangible assets, net ....................................... 10,846 8,097
Other assets ....................................................... 340 340
--------- ---------
Total Assets .................................................. $ 206,179 $ 123,573
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable---trade ......................................... $ 1,707 $ 1,906
Accrued compensation and benefits ................................ 5,152 4,490
Other accrued expenses ........................................... 9,956 6,713
Deferred revenue ................................................. 13,223 12,607
--------- ---------
Total Current Liabilities ..................................... 30,038 25,716
--------- ---------
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; 34,230 issued and 34,192 outstanding at
September 30, 2002 339 342
Additional paid-in capital ......................................... 196,492 197,053
Accumulated other comprehensive loss ............................... (44) (38)
Accumulated deficit ................................................ (20,432) (99,286)
Loan to officer .................................................... (130) (130)
--------- ---------
176,225 97,941
Less--Treasury stock, at cost: 38 shares .......................... (84) (84)
--------- ---------
Total Stockholders' Equity ......................................... 176,141 97,857
--------- ---------
Total Liabilities and Stockholders' Equity ......................... $ 206,179 $ 123,573
========= =========
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 SEPTEMBER 30,
-----------------------
2001 2002
-------- --------
Revenues:
Software licenses ........................ $ 9,016 $ 6,457
Services ................................. 7,260 7,885
Other .................................... 908 836
-------- --------
Total revenues ........................ 17,184 15,178
-------- --------
Cost of Revenues:
Cost of software licenses ................ 136 715
Non-cash cost of software licenses ....... -- 917
Cost of services ......................... 3,507 3,272
Cost of other ............................ 522 517
-------- --------
Total cost of revenues ................ 4,165 5,421
-------- --------
Gross profit ............................... 13,019 9,757
Selling, general and administrative expenses 12,275 13,262
Research and development expenses .......... 3,857 5,794
Impairment charge .......................... -- 57,374
Non-recurring charges ...................... 603 --
-------- --------
Loss from operations ....................... (3,716) (66,673)
Other income, net .......................... 1,324 521
-------- --------
Loss before provision for income taxes ..... (2,392) (66,152)
Provision for income taxes ................. -- --
-------- --------
Net loss ................................... $ (2,392) $(66,152)
======== ========
Net loss per share:
Basic ................................. $ (0.08) $ (1.94)
Diluted ............................... $ (0.08) $ (1.94)
Weighted average shares outstanding:
Basic ................................. 31,203 34,180
Diluted ............................... 31,203 34,180
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 NINE MONTHS
ENDED SEPTEMBER 30,
----------------------
2001 2002
-------- --------
Revenues:
Software licenses ........................... $ 43,842 $ 27,743
Services .................................... 22,203 22,957
Other ....................................... 2,772 2,257
-------- --------
Total revenues ........................... 68,817 52,957
-------- --------
Cost of Revenues:
Cost of software licenses ................... 1,503 1,680
Non-cash cost of software licenses .......... -- 2,750
Cost of services ............................ 11,991 10,704
Cost of other ............................... 1,671 1,359
-------- --------
Total cost of revenues ................... 15,165 16,493
-------- --------
Gross profit .................................. 53,652 36,464
Selling, general and administrative expenses .. 40,617 40,791
Research and development expenses ............. 11,865 18,330
Impairment charge ............................. -- 57,374
Non-recurring charges ......................... 603 689
-------- --------
Income (loss) from operations ................. 567 (80,720)
Other income, net ............................. 4,098 1,900
-------- --------
Income (loss) before provision for income taxes 4,665 (78,820)
Provision for income taxes .................... 607 40
-------- --------
Net income (loss) ............................. $ 4,058 $(78,860)
======== ========
Net income (loss) per share:
Basic .................................... $ 0.13 $ (2.32)
Diluted .................................. $ 0.12 $ (2.32)
Weighted average shares outstanding:
Basic .................................... 30,850 34,020
Diluted .................................. 32,962 34,020
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 NINE MONTHS
ENDED SEPTEMBER 30,
-------------------------
2001 2002
--------- ---------
OPERATING ACTIVITIES:
Net income (loss) ................................................ $ 4,058 $ (78,860)
Adjustments to reconcile net income (loss) to net cash provided by
(used for) operating activities:
Depreciation, amortization and impairment ...................... 1,936 63,640
Provision for doubtful accounts ................................ 902 45
Non-cash interest income ....................................... -- 154
Loss on sale of marketable securities .......................... -- (4)
Changes in operating assets and liabilities:
Accounts receivable trade ...................................... (1,128) 4,849
Prepaid expenses and other current assets ...................... (613) (380)
Other assets ................................................... (120) 812
Accounts payable trade ......................................... (488) 200
Accrued compensation and benefits .............................. (2,972) (662)
Other accrued expenses ......................................... 3,853 (3,356)
Deferred revenue ............................................... 2,711 (617)
--------- ---------
Net cash provided by (used for) operating activities ............. 8,139 (14,179)
--------- ---------
INVESTING ACTIVITIES:
Proceeds from sales of marketable securities ..................... -- 141,713
Proceeds from maturities of marketable securities ................ -- 6,665
Purchases of marketable securities ............................... (75,317) (144,253)
Purchases of property and equipment .............................. (4,223) (1,931)
Restricted cash .................................................. 316 (439)
--------- ---------
Net cash provided by (used for) investing activities ............. (79,224) 1,755
--------- ---------
FINANCING ACTIVITY:
Proceeds from issuance of common stock under stock plans ......... 6,566 564
--------- ---------
Net cash provided by financing activity .......................... 6,566 564
--------- ---------
Effect of exchange rate changes on cash and cash equivalents ..... (26) (26)
Net change in cash and cash equivalents .......................... (64,545) (11,886)
Cash and cash equivalents at beginning of period ................. 115,747 26,332
--------- ---------
Cash and cash equivalents at end of period ....................... $ 51,202 $ 14,446
========= =========
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 Netegrity, Inc.'s ("Netegrity" or "the Company")
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 nine months ended September 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 year ended December
31, 2001, included in Form 10-K filed on March 22, 2002.
(b) REVENUE RECOGNITION
The Company's revenues have primarily been generated from the sale of perpetual
licenses to the Company's proprietary SiteMinder(R), Delegated Management
Services(TM) and PortalMinder(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 September 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 $32,000 for the nine months ended
September 30, 2002. Net realized losses of approximately $14,000 and $4,000 for
the three and nine months ended September 30, 2002, respectively, are included
in other income, net in the consolidated condensed statements of operations.
(e) INTANGIBLE AND OTHER LONG-LIVED ASSETS
Other intangible assets, net consists of acquired technology that resulted from
the acquisition of DataChannel during 2001. The Company accounts for these
intangible assets in accordance with SFAS No. 86, "Accounting for the Costs of
Computer Software to Be Sold, Leased, or Otherwise Marketed". Acquired
technology is being amortized over a three-year period on a straight-line basis
and is required to be tested for impairment annually, or on an interim basis if
an event or circumstance indicates that it is more likely than not that an
impairment loss has been incurred, by comparing the unamortized costs of
capitalized software to the expected future net realizable value of the
products. If the unamortized costs exceed the expected future net realizable
value of the products, the excess amount is written off. See Note 2.
(f) 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 nine months ended September 30, 2001, comprehensive
income (loss) was $(2.5) million and $4.0 million, respectively, compared to net
income (loss) of $(2.4) million and $4.1 million, respectively. The difference
in the three and nine months ended September 30, 2001, is due to cumulative
translation adjustment of approximately $(121,000) and $(20,000), respectively.
For the three and nine months ended September 30, 2002, comprehensive loss was
$(66.1) million and $(78.9) million, respectively, compared to net loss of
$(66.2) million and $(78.9) million, respectively. The difference in the three
and nine months ended September 30, 2002, is due to unrealized gains on
marketable securities of approximately $48,000 and $32,000 and cumulative
translation adjustment of approximately $11,000 and $(26,000), respectively.
(g) 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 sets forth basic and diluted net income (loss) per share
computational data for the periods presented (in thousands, except per share
data):
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------- ----------------------
2001 2002 2001 2002
-------- -------- -------- --------
Net income (loss) ....................... $ (2,392) $(66,152) $ 4,058 $(78,860)
-------- -------- -------- --------
Basic weighted average shares outstanding 31,203 34,180 30,850 34,020
Dilutive effect of stock options and
warrants ........................... -- -- 2,112 --
-------- -------- -------- --------
Diluted shares outstanding .............. 31,203 34,180 32,962 34,020
======== ======== ======== ========
Basic net income (loss) per share ....... $ (0.08) $ (1.94) $ 0.13 $ (2.32)
======== ======== ======== ========
Diluted net income (loss) per share ..... $ (0.08) $ (1.94) $ 0.12 $ (2.32)
======== ======== ======== ========
Options to purchase a total of 3.7 million, 3.0 million, 6.4 million and 5.5
million weighted shares outstanding for the three and nine months ended
September 30, 2001 and 2002, respectively, were outstanding but were excluded in
the computation of diluted EPS because the options are anti-dilutive.
(h) RECENT ACCOUNTING PRONOUNCEMENTS
8
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 on an
interim basis if an event or circumstance indicates that it is more likely than
not that an impairment loss has been incurred. 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. See Note 2
regarding the impairment of goodwill recorded during the quarter ended September
30, 2002.
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 certain 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 September 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 $0.5 million and $1.3 million
have been reclassified as revenues from reduction of cost of revenues for the
three and nine months ended September 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. Accordingly the excess of the purchase price over
the fair value of the tangible net liabilities assumed of approximately $71.4
million was allocated to in-process research and development (IPRD), acquired
technology and goodwill in the amounts of approximately $3.0 million, $11.0
million and $57.4 million, respectively. Results of operations of DataChannel
from the Acquisition Date are included in the Company's consolidated results of
operations.
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
September 30, 2002, the technologies are 100% complete.
9
The Company is amortizing the acquired existing technology of approximately
$11.0 million over an estimated remaining useful life of three years.
Amortization expense on intangible assets other than goodwill was $0.9 million
and $2.8 million for the three and nine months ended September 30, 2002,
respectively, and has been classified as non-cash cost of software licenses in
the accompanying consolidated condensed statements of operations. Amortization
expense for the intangible assets other than goodwill is estimated to be
approximately $3.7 million for each of the years ended December 31, 2002, 2003
and 2004.
The total goodwill of approximately $57.4 million related to the Acquisition was
not amortized in accordance with SFAS No. 142. In lieu of being amortized,
goodwill is required to be tested for impairment annually or on an interim basis
if an event or circumstance indicates that it is more likely than not that an
impairment loss has been incurred. 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. During the third quarter of 2002, the
Company determined that the recent significant decline in our stock price as a
result of underperformance relative to recent and expected operating results and
the overall adverse change in the business climate had resulted in a triggering
event that warranted an impairment review in accordance with SFAS No. 142. As a
result, the Company tested for impairment based on a two-step approach. The
first step was to test for indicators of impairment of goodwill by comparing the
fair value of the Company with its carrying value. Since the Company operates as
an enterprise-wide reporting unit, it was determined that the market value of
the Company represents an approximation of its fair value as of September 30,
2002. Furthermore, it was determined that the fair value of the Company as of
September 30, 2002 was less than its carrying value and therefore, an indication
of impairment existed. The second step was to measure the amount of the
impairment of goodwill. As a result of the second step, we determined that the
implied fair value of the goodwill determined using the market capitalization of
the Company on September 30, 2002 was lower than its carrying value and
therefore, goodwill had been impaired. The Company has recorded a charge of
$57.4 million in the third quarter of 2002, classified as impairment charge in
the accompanying consolidated condensed statements of operations, to write down
goodwill to its implied fair value of zero.
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 $287,000 and $962,000 of
these costs were paid during the three and nine months ended September 30, 2002,
respectively.
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 NINE MONTHS
ENDED ENDED
SEPTEMBER 30, 2001 SEPTEMBER 30, 2001
------------------ ------------------
Revenues .................................. $ 18,593 $ 75,386
Net loss .................................. $ (8,811) $ (17,593)
Net loss per basic and fully diluted common $ (0.26) $ (0.53)
share
NOTE 3: TENDER OFFERS
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.
10
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.
On August 23, 2002, the Company filed a tender offer statement with the
Securities and Exchange Commission in connection with certain stock options
outstanding under non-director stock plans (the Offer to Exchange). Under the
Offer to Exchange, 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 Offer to Exchange, which excluded directors and
non-employees of the Company and which expired on September 23, 2002, provided
for the grant of new options on two different dates. The Company expects to
grant 50% of the new options on or about March 25, 2003 and the remaining 50% on
or about April 25, 2003 to employees that are continuously and actively employed
from the date the employee tendered eligible options for exchange to the date of
the grant of the new options. The number of shares underlying the new options
will be equal to the number of shares underlying the cancelled eligible options,
except that certain options granted to certain executive officers will be
exchanged at a rate of one share underlying a new option for each two shares
underlying the tendered options. The exercise price of the new options will be
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 schedule tied to the length of
time of an individual's employment with the Company.
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
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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------------------ ------------------------------------
2001 2002 2001 2002
------------ ------------ ------------ ------------
Revenues:
North America $ 12,871 $ 11,914 $ 56,812 $ 42,864
Europe ...... 3,265 2,403 8,626 7,851
Asia Pacific 1,048 861 3,379 2,242
------------ ------------ ------------ ------------
Total ....... $ 17,184 $ 15,178 $ 68,817 $ 52,957
============ ============ ============ ============
SEPTEMBER 30, SEPTEMBER 30,
2001 2002
------------ ------------
Long-Lived Assets:
North America $ 27,168 $ 30,731
Europe ...... 187 400
Asia Pacific 609 429
------------ ------------
Total ....... $ 27,964 $ 31,560
============ ============
NOTE 5: NON-RECURRING CHARGES
During the nine months ended September 30, 2002, the Company recorded net
restructuring expenses of $689,000 in accordance with Emerging Issues Task Force
Issue No. 94-3 and Staff Accounting Bulletin No. 100. These expenses are
classified as non-recurring charges in the accompanying condensed consolidated
statements of operations.
11
The Company's restructuring expenses related to severance charges associated
with a 10% reduction in workforce and the closing of several sales offices
during April 2002. Employees affected by the restructuring were notified both
through direct personal contact and by written notification. Approximately,
$223,000 and $642,000 of these costs were paid out during the three and nine
months ended September 30, 2002, respectively. The remainder is expected to be
paid prior to March 31, 2003.
During the nine months ended September 30, 2001, the Company recorded
non-recurring charges of approximately of $603,000 primarily related to
severance charges associated with an 8% reduction in workforce and a
contribution to the James Hayden Memorial Fund established in memory of the
Company's former Chief Financial Officer.
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 September
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
note was amended such that it became an unsecured note. The consolidated
condensed balance sheet at September 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.
NOTE 8: COMMITMENTS AND CONTINGENCIES
In August 2002, the Company entered into a five-year non-cancellable operating
lease for an office building for its Corporate headquarters. The Company
anticipates moving to the new facility in March 2003. In connection with the
lease agreement, the Company has paid a security deposit in the amount of
$760,000 in the form of an irrevocable, unconditional, negotiable letter of
credit. This letter of credit is reflected in restricted cash on the
accompanying consolidated condensed balance sheets. The Company anticipates that
it will expend approximately $913,000 for leasehold improvements to build out
the new facility.
The Company has entered into Indemnification Agreements with its non-executive
members of the Board of Directors. Additionally, the Company has entered into
employment and executive retention agreements with certain employees and
executive officers which, among other things, include certain severance and
change of control provisions.
NOTE 9: SUBSEQUENT EVENTS
Due to changing market dynamics and economic factors, during October 2002, the
Company announced its decision to focus its efforts and resources on expanding
its leadership position in the access control and identity management market. In
connection with this decision, the Company has decided not to continue
developing, marketing or selling the PortalMinder product on a stand-alone
basis. We will continue to use the PortalMinder technology in our other
strategic product initiatives. In addition to this strategic decision, the
Company also announced changes in its sales and services organization to better
leverage the Company's inside sales organization and partner channel.
These decisions resulted in a reduction in workforce of 90 people, representing
approximately 20% of the Company's worldwide workforce. These reductions were in
the development group associated with the PortalMinder product, as well as in
the sales and services departments, predominantly in Europe and Asia, where we
continue to experience a weakening economy.
In connection with these decisions, the Company anticipates recording a
non-recurring charge of approximately $1.0 million to $1.5 million during the
quarter ending December 31, 2002.
12
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.
RECENT EVENT
Due to changing market dynamics and economic factors, during October 2002, the
Company announced its decision to focus its efforts and resources on expanding
its leadership position in the access control and identity management market. In
connection with this decision, the Company has decided not to continue
developing, marketing or selling the PortalMinder product on a stand-alone
basis. We will continue to use the PortalMinder technology in our other
strategic product initiatives. In addition to this strategic decision, the
Company also announced changes in its sales and services organization to better
leverage the Company's inside sales organization and partner channel.
These decisions resulted in a reduction in workforce of 90 people, representing
approximately 20% of the Company's worldwide workforce. These reductions were in
the development group associated with the PortalMinder product, as well as in
the sales and services departments, predominantly in Europe and Asia, where we
continue to experience a weakening economy.
In connection with these decisions, the Company anticipates recording a
non-recurring charge of approximately $1.0 million to $1.5 million during the
quarter ending December 31, 2002.
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 nine months ended
September 30, 2002, we had a net loss of $78.9 million. As a result of
historical operating losses, as of September 30, 2002, we had an accumulated
deficit of approximately $99.3 million.
OUR QUARTERLY RESULTS MAY FLUCTUATE WIDELY.
Our quarterly revenues and operating results are difficult to predict and may
continue to fluctuate significantly from quarter to quarter 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;
13
- market acceptance of our SiteMinder, Delegated Management Services
("DMS"), TransactionMinder 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 loss of or changes in key management personnel;
- the release of new versions of SiteMinder, DMS, TransactionMinder or
other products;
- pricing pressures that result in increased discounts;
- 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. 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 SUCCESS WILL DEPEND ON OUR ABILITY TO MARKET OUR PRODUCTS AND RELATED
SERVICES SUCCESSFULLY.
We currently derive the 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, usage of our products for 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.
In addition, we have recently announced several new product offerings. If we
fail to gain market acceptance for these products, it could have a material
adverse effect on our business, operating results and financial position.
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.
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 and business-to-consumer markets. 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. Currently, due to industry and economic factors, we have
chosen to cease developing, marketing and selling our PortalMinder product on a
stand-alone basis. In the future, we could be adversely affected and be at a
competitive disadvantage 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.
14
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. In
addition, even if initial deployments are successful, there can be no assurances
that customers will choose to make follow-on purchases, which could have a
material adverse effect on our ability to generate revenues.
WE FACE SIGNIFICANT COMPETITION FROM OTHER TECHNOLOGY COMPANIES AND WE MAY NOT
BE ABLE TO COMPETE EFFECTIVELY.
The market for access control and identity management is highly competitive. We
expect the level of competition to increase as a result of the anticipated
growth of access control and identity management. Our primary competitors
include IBM, RSA/Securant, Entrust, OpenNetwork Technology, 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 current and potential competitors may
attempt to hire our highly skilled employees and although we have non-compete
agreements in place with most of our employees, they may or may not be
enforceable. 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 point product with other applications within a suite, 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 SOFTWARE PRODUCTS.
Certain of our 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 our single sign-on functionality and could reduce
market demand for our products.
WE MAY BE UNABLE TO HIRE AND RETAIN SKILLED PERSONNEL.
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. A
change in key management, such as the recent appointment of Thomas Thimot, Vice
President of Worldwide Sales and Services, could result in transition and
attrition in the affected department. Our failure 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.
15
We incorporate into our products software licensed from third-party software
companies that enhances and enables 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 or infringement claims against
those third-party products could delay or impair our ability to develop and sell
our products. In addition, often these third party software companies require
prepayment of royalties on their products and in the past, we have had to
write-off certain of these prepayments when there has been an adverse change in
forecasted sales volume.
OUR FAILURE TO EXPAND OUR PARTNER ENABLEMENT MODEL COULD LIMIT OUR ABILITY TO
INCREASE OUR PRODUCT SALES.
Our professional services organization and our partner enablement model provide
critical support to our customers' installation and deployment of our products.
If we fail to adequately develop our partner enablement model, 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, a process that
has been further lengthened as a result of the current market conditions
surrounding IT spending. 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. More recently, based
upon economic factors beyond our control, we implemented a reduction in
workforce of 48 positions during April 2002 and 90 positions during October
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, maintain our ability
to retain key personnel, 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.
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.
At the current time, we have no plans to expand beyond our current international
operations. However, if in the future we decide to expand our international
operations, the 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;
16
- 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;
- selling under contracts governed by local law;
- 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, 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 and the unauthorized use of our
source code could have an adverse effect on our business. 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 violate 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 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. Additionally, we provide technical support to our customers and if
17
customers were dissatisfied with product functionality or performance or
response times of our technical support staff, we could lose revenue or be
subject to liability for service or warranty costs and claims.
WE COULD INCUR SUBSTANTIAL COSTS RESULTING FROM PRODUCT LIABILITY CLAIMS
RELATING TO OUR CUSTOMERS' USE OF OUR PRODUCTS.
Many of the e-business 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, speculation in the press or investment community and overall economic
conditions are among the factors affecting our stock price.
In addition, the stock market in general and the market prices for technology
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.
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 September 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
18
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 have been primarily generated from the sale of perpetual
licenses for its proprietary SiteMinder, DMS and PortalMinder products and
services. In the future, the Company anticipates generating its revenue
primarily from the sale of perpetual licenses for SiteMinder, IdentityMinder,
TransactionMinder products and services as well as from new product offerings.
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 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
19
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
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 for impairment 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 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.
Intangible assets other than goodwill 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 nine months
ended September 30, 2001, the results of operations would not be different from
those previously reported.
During the third quarter of 2002, the Company determined that the recent
significant decline in our stock price as a result of underperformance relative
to recent and expected operating results and the overall adverse change in the
business climate had resulted in a triggering event that warranted an impairment
review in accordance with SFAS No. 142. As a result, the Company tested for
impairment based on a two-step approach. The first step was to test for
indicators of impairment of goodwill by comparing the fair value of the Company
with its carrying value. Since the Company operates as an enterprise-wide
reporting unit, it was determined that the market value of the Company
represents an approximation of its fair value as of September 30, 2002.
Furthermore, it was determined that the fair value of the Company as of
September 30, 2002 was less than its carrying value and therefore, an indication
of impairment existed. The second step was to measure the amount of the
impairment of goodwill. As a result of the second step, we determined that the
implied fair value of the goodwill determined using the market capitalization of
the Company on September 30, 2002 was lower than its carrying value and
therefore, goodwill had been impaired. The Company has recorded a charge of
$57.4 million in the third quarter of fiscal 2002, classified as impairment
charge in the accompanying consolidated condensed statements of operations, to
write down goodwill to its implied fair value of zero.
The Company reviews the valuation of 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" and SFAS No.
86, "Accounting for the Costs of Computer Software to Be Sold, Leased, or
Otherwise Marketed". The Company is required to assess the impairment of
long-lived assets and certain identifiable intangible assets annually, or on an
interim basis 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
20
- our market capitalization relative to net book value.
In accordance with SFAS No. 144, 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 to the extent the carrying amount of
the particular long-lived asset or group exceeds 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. In accordance with SFAS No. 86, when we
determine that the carrying value of long-lived assets may not be recoverable
based on the existence of one or more of the above indicators of impairment, we
evaluate whether the unamortized cost exceeds the expected future net realizable
value of the products. If the unamortized costs exceed the expected future net
realizable value of the products, the excess amount is written off. Changes in
judgments on any of these factors could impact the value of the asset.
The Company adopted SFAS No. 144, which addresses accounting and reporting of
certain 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 its financial position or results of
operations.
At September 30, 2002, in conjunction with the impairment review of goodwill, we
evaluated the carrying amount of the capitalized software acquired in the
DataChannel acquisition in accordance with SFAS No. 86 by comparing the
unamortized costs of capitalized software to the expected future net realizable
value of the products. We determined that no impairment existed as of September
30, 2002.
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 September 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.
21
RESULTS OF OPERATIONS
The following table presents statement of operations data as percentages of
total revenues for the periods indicated:
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------------ -----------------------------
2001 2002 2001 2002
-------- -------- -------- --------
STATEMENT OF OPERATIONS DATA:
Revenues:
Software licenses ..................... 53% 43% 64% 53%
Services .............................. 42 52 32 43
Other ................................. 5 5 4 4
-------- -------- -------- --------
Total revenues ..................... 100 100 100 100
Cost of revenues:
Cost of software licenses ............. 1 5 2 3
Non-cash cost of software licenses .... -- 6 -- 5
Cost of services ...................... 20 22 17 20
Cost of other ......................... 3 3 2 3
-------- -------- -------- --------
Total cost of revenues ............. 24 36 21 31
-------- -------- -------- --------
Gross profit ............................ 76 64 79 69
-------- -------- -------- --------
Selling, general and administrative
expenses............................... 71 87 59 77
Research and development expenses ....... 22 38 17 35
Impairment charges ...................... -- 378 -- 108
Non-recurring charges ................... 4 -- 1 1
-------- -------- -------- --------
Income (loss) from operations ........... (21) (439) 2 (152)
Other income, net ....................... 8 3 6 4
-------- -------- -------- --------
Income (loss) before provision for income (13) (436) 8 (148)
taxes
Provision for income taxes .............. -- -- 1 --
-------- -------- -------- --------
Net income (loss) ....................... (13)% (436)% 7% (148)%
-------- -------- -------- --------
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO THE THREE AND
NINE MONTHS ENDED SEPTEMBER 30, 2001
The following discussion reviews the results of operations for the three and
nine months ended September 30, 2002 (the "2002 Quarter" and "2002 Period",
respectively) compared to the three and nine months ended September 30, 2001
(the "2001 Quarter" and "2001 Period", respectively).
Revenues. Total revenues decreased by $2.0 million or 12%, to $15.2 million in
the 2002 Quarter, from $17.2 million in the 2001 Quarter, and by $15.8 million
or 23%, to $53.0 million in the 2002 Period, from $68.8 million in the 2001
Period. The decrease was primarily due to decreases in software license revenues
for the SiteMinder product, partially offset by an increase in service revenues
and the impact of the acquisition of DataChannel in December 2001, which
contributed approximately 6% and 7% of total revenues in the 2002 Quarter and
2002 Period, respectively. Additionally, revenues in both Europe and Asia have
continued to decline throughout the current year. Overall, we believe that
revenue growth will be modest over the next couple of quarters as constraints on
IT spending continue. However, we believe that the continued build-out of the
leveraged model with our partners and our focus on expanding our leadership
position in the access control and identity management market with our new
product offerings will help to drive new account acquisition and increase deal
size in the future.
Software license revenues decreased by $2.5 million or 28%, to $6.5 million in
the 2002 Quarter, from $9.0 million in the 2001 Quarter, and by $16.1 million or
37%, to $27.7 million in the 2002 Period, from $43.8 million in the 2001 Period.
The decrease is due to broad based economic weakness, specifically in Europe,
and reduced technology spending which resulted in deals being delayed or reduced
in size. While the number of new name deals decreased from 50 in the 2001
Quarter to 33 in the 2002 Quarter, the average size of new name deals increased
from approximately $102,000 in the 2001 Quarter to approximately $111,000 in the
2002 Quarter. In slight contrast, the number of follow on deals increased from
45 in the 2001 Quarter to 54 in the 2002 Quarter and the average size of follow
on deals decreased from approximately $96,000 in the 2001 Quarter to
approximately $70,000 in the 2002 Quarter. The primary reason for the decrease
in deal size was that customers continue to buy licenses for a smaller number of
users.
Services revenues increased by $0.6 million or 8%, to $7.9 million in the 2002
Quarter, from $7.3 million in the 2001 Quarter, and by $0.8 million or 4%, to
$23.0 million in the 2002 Period, from $22.2 million in the 2001 Period. The
increase is primarily attributable to an increase of $1.8 million and $4.9
million in the 2002 Quarter and the 2002 Period, respectively, in maintenance
and support revenue resulting from maintenance renewals by our existing customer
base and, to a lesser extent, the impact of the acquisition of DataChannel,
which contributed approximately 12% and 2% of services revenues in the 2002
Quarter and 2002 Period, respectively. The increase was partially offset by a
decrease of $0.8 million and $4.2 million in the 2002 Quarter and the 2002
Period, respectively,
22
in consulting and training revenue as a result of broad based economic weakness
and reduced technology spending. The number of trained billable third party
consultants increased from 420 in the 2001 Quarter to 850 in the 2002 Quarter.
Other revenues decreased by $0.1 million or 11%, to $0.8 million in the 2002
Quarter, from $0.9 million in the 2001 Quarter, and by $0.5 million or 18%, to
$2.3 million in the 2002 Period, from $2.8 million in the 2001 Period. Other
revenues are derived from the Firewall legacy business. This business has
declined during the 2002 Period and is not expected to have a significant impact
in future periods.
Cost of revenues. Total cost of revenues increased by $1.2 million or 29%, to
$5.4 million in the 2002 Quarter, from $4.2 million in the 2001 Quarter, and by
$1.3 million or 9%, to $16.5 million in the 2002 Period, from $15.2 million in
the 2001 Period. Overall, we believe that the cost of revenues, and particularly
the cost of services, will increase over the short term primarily as a result
of, (i) the cost of third party software products that enhance and enable our
products, and (ii) increased investment in our technical support organization.
Cost of software license revenue increased by $1.5 million or 1,100%, to $1.6
million in the 2002 Quarter from $0.1 million in the 2001 Quarter, and by $2.9
million or 193%, to $4.4 million in the 2002 Period, from $1.5 million in the
2001 Period. This increase is primarily due to the amortization of purchased
software recorded in connection with the acquisition of DataChannel of
approximately $0.9 million per quarter and a $0.3 million write-off of a prepaid
third party royalty arrangement which was entered into during the first quarter
of 2002. The write off was recorded because the latest release of the product
was no longer dependent on the third party technology.
Cost of services decreased by $0.2 million or 6%, to $3.3 million in the 2002
Quarter, from $3.5 million in the 2001 Quarter, and by $1.3 million or 11%, to
$10.7 million in the 2002 Period, from $12.0 million in the 2001 Period. The
decrease is primarily due to the leveraging of our system integrator partner
relationships. The number of fully trained billable consultants at our
affiliated partners increased from 420 in the 2001 Quarter to 850 in the 2002
Quarter. This leveraging allowed us to reduce the headcount in our professional
services organization by approximately 20% from September 30, 2001 to September
30, 2002. This decrease was partially offset by increased investment in the
technical support organization during the quarter in order to enhance overall
customer satisfaction.
Cost of other revenues remained flat at $0.5 million in the 2002 Quarter as
compared to the 2001 Quarter, and decreased by $0.3 million or 18%, to $1.4
million in the 2002 Period, from $1.7 million in the 2001 Period. The decrease
in the 2002 Period is in relative proportion to the decrease in revenue. Cost of
other revenues are not expected to have a significant impact in future periods.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased by $1.0 million, or 8%, to $13.3 million in
the 2002 Quarter, from $12.3 million in the 2001 Quarter, and by $0.2 million or
1%, to $40.8 million in the 2002 Period, from $40.6 million in the 2001 Period.
The increase is primarily attributable to increased salaries and wages
associated with a full quarter effect of increasing headcount throughout 2001,
increased legal, accounting, facility rent, marketing program and insurance
expenses (primarily Directors and Officers insurance premiums) partially offset
by reduced commission expenses in connection with decreased license revenue. We
will continue to scrutinize all discretionary expenses and evaluate investment
reductions in non-strategic programs. In the immediate future, we anticipate
selling, general and administration expenses will decrease in future periods as
we realize the economic impact of the restructuring initiatives completed in
April 2002 and October 2002.
Research and development costs. Research and development costs increased by $1.9
million or 49%, to $5.8 million in the 2002 Quarter, from $3.9 million in the
2001 Quarter, and by $6.4 million or 54%, to $18.3 million in the 2002 Quarter,
from $11.9 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) and to the increased usage of
approximately 50 contractors in India between the 2001 Quarter and the 2002
Quarter and other incremental expenses associated with the research and
development of our new product offerings. We recognize that our investment in
research and development is required to remain competitive and therefore, expect
that research and development expenses may increase in future periods due to the
continued development of our products and services.
Impairment charges. Impairment charges increased by $57.4 million or 100%, to
$57.4 million in both the 2002 Quarter and the 2002 Period. There were no
impairment charges recorded in the 2001 Quarter or 2001 Period. In the 2002
Quarter, we determined that the recent significant decline in our stock price as
a result of underperformance relative to recent and expected operating results
and the overall adverse change in the business climate had resulted in a
triggering event that warranted an impairment review in accordance with SFAS No.
142. As a result, the Company tested for impairment based on a two-step
approach. The first step was to test for indicators of impairment of goodwill by
comparing the fair value of the Company with its carrying value. Since the
Company operates as an enterprise-wide reporting unit, it was determined that
the market value of the Company represents an approximation of
23
its fair value as of September 30, 2002. Furthermore, it was determined that the
fair value of the Company as of September 30, 2002 was less than its carrying
value and therefore, an indication of impairment existed. The second step was to
measure the amount of the impairment of goodwill. As a result of the second
step, we determined that the implied fair value of the goodwill determined using
the market capitalization of the Company on September 30, 2002 was lower than
its carrying value and therefore, goodwill had been impaired. The Company has
recorded a charge of $57.4 million in the third quarter of fiscal 2002,
classified as impairment charge in the accompanying consolidated condensed
statements of operations, to write down goodwill to its implied fair value of
zero.
Non-recurring charges. Non-recurring charges of $0.7 million during the 2002
Period primarily represent severance charges associated with a 10% reduction in
workforce and the closing of several sales offices during April 2002.
Non-recurring expenses of $0.6 million during the 2001 Period primarily
represent severance charges associated with an 8% reduction in workforce in
September 2001 and a contribution to the James Hayden Memorial Fund established
in memory of the Company's former Chief Financial Officer. In connection with
the decision not to continue developing, marketing or selling the PortalMinder
product on a stand-alone basis and changes made in its sales and services
organization to better leverage the Company's inside sales organization and
partner channel, the Company anticipates recording a non-recurring charge of
approximately $1.0 million to $1.5 million during the quarter ending December
31, 2002.
Other income, net. Other income, net which is comprised primarily of interest
income earned on the company's cash and marketable securities, decreased by
approximately $0.8 million or 62%, to $0.5 million in the 2002 Quarter, from
$1.3 million in the 2001 Quarter, and by $2.2 million or 54%, to $1.9 million in
the 2002 Period, from $4.1 million in the 2001 Period. The 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. For the 2002 and 2001 Quarters, there was no
provision for income taxes due to the Company's loss position for the periods.
There was no provision for income taxes in the 2002 Period due to the Company's
loss position. In the 2001 Period, the Company recorded a provision for income
taxes of approximately $0.6 million. The provision is lower than the statutory
rate due to a reduction in the valuation allowance related to federal net
operating loss carryforwards.
LIQUIDITY AND CAPITAL RESOURCES
Cash used for operating activities in the 2002 Period was $14.2 million,
primarily due to the net loss for the period, decreases in accrued expenses
(including approximately $1.9 million in fees paid in connection with the
December 2001 acquisition of DataChannel), and decreases in deferred revenue as
a result of lower license sales and maintenance commitments in the third quarter
of 2001 coupled with longer approval cycles for maintenance contract renewals in
2002, all of which was partially offset by a decrease in accounts receivable.
Cash provided by investing activities was $1.8 million in the 2002 Period.
Investing activities for the period consisted primarily of net sales and
maturities of marketable securities of approximately $148.4 million, offset by
the purchases of marketable securities of approximately $144.3 million, and the
purchase of $1.9 million of equipment, primarily computer related.
Cash provided by financing activities in the 2002 Period was approximately $0.6
million, which primarily related to the exercise of employee stock options.
As of September 30, 2002, our primary financial commitments consisted of
obligations outstanding under operating leases. In August 2002, the Company
entered into a five year non-cancellable operating lease for an office building
for its Corporate headquarters. The Company anticipates moving to the new
facility in March 2003. In connection with the lease agreement, the Company has
paid a security deposit in the amount of $760,000 in the form of an irrevocable,
unconditional, negotiable letter of credit. The Company anticipates that it will
expend approximately $913,000 in leasehold improvements to build out the new
facility. The Company has entered into Indemnification Agreements with the
non-executive members of its Board of Directors. Additionally, the Company has
entered into employment and executive retention agreements with certain
employees and executive officers which, among other things, include certain
severance and change of control provisions.
As of September 30, 2002, we had cash and cash equivalents totaling $14.4
million, short-term marketable securities of $63.4 million and long-term
marketable securities of $15.1 million.
In the past, we had experienced a period of rapid growth which resulted in
significantly increases our operating expenses. More recently, due to economic
conditions beyond our control, we have made considerable efforts to reduce our
operating expenses through
24
constrained spending and reductions in workforce. Due to changing market
dynamics and economic factors, during October 2002, the Company announced its
decision to focus its efforts and resources on expanding its leadership position
in the access control and identity management market. In connection with this
decision, the Company has decided not to continue developing, marketing or
selling the PortalMinder product on a stand-alone basis. We will continue to use
the PortalMinder technology in our other strategic product initiatives. In
addition to this strategic decision, the Company also announced changes in its
sales and services organization to better leverage the Company's inside sales
organization and partner channel. These decisions resulted in a reduction in
workforce of 90 people, representing approximately 20% of the Company's
worldwide workforce. These reductions were in the development group associated
with the PortalMinder product, as well as in the sales and services departments,
predominantly in Europe and Asia, where we continue to experience a weakening
economy. In connection with these decisions, the Company anticipates recording a
non-recurring charge of approximately $1.0 million to $1.5 million during the
quarter ending December 31, 2002.
We anticipate that we will continue to scrutinize all discretionary expenses
and evaluate investment reductions in non-strategic programs 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 nine months ended September 30, 2002, the Company generated
approximately 22% and 19%, 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
$70,000 as of September 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 loss of approximately $37,000 for the three months ended
September 30, 2002 and a loss of approximately $11,500 for the nine months ended
September 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 September 30,
2002 would not have a material impact on the Company's results of operations for
the three and nine month periods.
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 nine months ended September 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.
ITEM 4. CONTROLS AND PROCEDURES
Within the ninety day period prior to the date of this report, the Company
conducted an evaluation under the supervision and with the participation of the
Company's management, including the Company's Chief Executive Officer and Chief
Financial Officer (its principal Executive Officer and principal Financial
Officer, respectively) regarding the effectiveness of the design and operation
of the Company's disclosure controls and procedures as defined in Rule 13a-14 of
the Securities Exchange Act of 1934 (the "Exchange
25
Act"). Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that the Company's disclosure controls and
procedures are effective to ensure that material information relating to the
Company, including its consolidated subsidiaries, is made known to them by
others within those entities.
There were no significant changes in the Company's internal controls or in other
factors that could significantly affect internal controls subsequent to the date
the Company carried out its evaluation.
26
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
Not Applicable
ITEM 5. OTHER INFORMATION
Not Applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 10.1 Lease Agreement by and between Netegrity, Inc., and
Stonybrook Associates, LLC dated August 2002.
Exhibit 10.2 Offer letter from Netegrity, Inc., to Thomas
Thimot, dated September 6, 2002.
Exhibit 10.3 Indemnification Agreement by and between Netegrity,
Inc., a Delaware corporation, and Eric P. Giler, a
director of the Corporation.
Exhibit 10.4 Indemnification Agreement by and between Netegrity,
Inc., a Delaware corporation, and Lawrence D.
Lenihan, Jr., a director of the Corporation.
Exhibit 10.5 Indemnification Agreement by and between Netegrity,
Inc., a Delaware corporation, and Michael L. Mark, a
director of the Corporation.
Exhibit 10.6 Indemnification Agreement by and between Netegrity,
Inc., a Delaware corporation, and Ralph B. Wagner, a
director of the Corporation.
Exhibit 10.7 Consulting Agreement by and between Netegrity, Inc.
and Thomas M. Palka.
Exhibit 10.8 Transition Agreement by and between Netegrity, Inc.
and Thomas M. Palka.
Exhibit 10.9 Executive Retention Agreement by and between
Netegrity, Inc. and Barry N. Bycoff
Exhibit 10.10 Executive Retention Agreement by and between
Netegrity, Inc. and Regina O. Sommer
Exhibit 10.11 Executive Retention Agreement by and between
Netegrity, Inc. and Deepak Taneja
Exhibit 10.12 Executive Retention Agreement by and between
Netegrity, Inc. and James Rosen
Exhibit 10.13 Executive Retention Agreement by and between
Netegrity, Inc. and William Bartow
Exhibit 10.14 Executive Retention Agreement by and between
Netegrity, Inc. and Thomas Thimot
Exhibit 10.15 Executive Retention Agreement by and between
Netegrity, Inc. and Scott Sullivan
27
Exhibit 10.16 Executive Retention Agreement by and between
Netegrity, Inc. and Carmen Parisi
Exhibit 10.17 Executive Retention Agreement by and between
Netegrity, Inc. and Bradley Nelson
Exhibit 10.18 Executive Retention Agreement by and between
Netegrity, Inc. and Mary Jefts
Exhibit 10.19 Executive Retention Agreement by and between
Netegrity, Inc. and Vadim Lander
Exhibit 10.20 Executive Retention Agreement by and between
Netegrity, Inc. and Amit Jasuja
Exhibit 10.21 Executive Retention Agreement by and between
Netegrity, Inc. and Thomas Locke
Exhibit 10.22 Executive Retention Agreement by and between
Netegrity, Inc. and Mary Colette Cooke
Exhibit 10.23 Executive Retention Agreement by and between
Netegrity, Inc. and Geoffrey Charron
Exhibit 10.24 Executive Retention Agreement by and between
Netegrity, Inc. and Michael Hyman
Exhibit 10.25 Executive Retention Agreement by and between
Netegrity, Inc. and Jill Maunder
(b) Reports on Form 8-K
None
28
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.
NETEGRITY, INC.
Date: October 24, 2002 By: /s/ Barry N. Bycoff
----------------------------------
Barry N. Bycoff
President, Chief Executive Officer,
Director and Chairman of the Board
Date: October 24, 2002 By: /s/ Regina O. Sommer
----------------------------------
Regina O. Sommer
Chief Financial Officer and Treasurer
(Principal Financial Officer and Principal Accounting
Officer)
29
CERTIFICATIONS
I, Barry N. Bycoff, President and Chief Executive Officer, certify that
1. I have reviewed this quarterly report on Form 10-Q of Netegrity, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role
in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: October 24, 2002 By: /s/ Barry N. Bycoff
--------------------------------
Barry N. Bycoff
President and Chief Executive Officer
(Principal Executive Officer)
30
CERTIFICATIONS
I, Regina O. Sommer, Chief Financial Officer and Treasurer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Netegrity,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior
to the filing date of this quarterly report (the
"Evaluation Date"); and
c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and
the audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role
in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: October 24, 2002 By: /s/ Regina O. Sommer
--------------------------------------------
Regina O. Sommer
Chief Financial Officer and Treasurer
(Principal Financial Officer and Principal
Accounting Officer)
31
Netegrity, Inc.
Certification Pursuant To
18 U.S.C. Section 1350,
As Adopted Pursuant To
Section 906 of the Sarbanes/Oxley Act of 2002
In connection with the Quarterly Report of Netegrity, Inc. (the
"Company") on Form 10-Q for the period ended September 30, 2002 as filed with
the Securities and Exchange Commission (the "Report"), I, Barry N. Bycoff,
President and Chief Executive Officer of the Company, certify, pursuant to
Section 1350 of Chapter 63 of Title 18, United States Code, that this Report
fully complies with the requirements of Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 and that the information contained in this Report fairly
presents, in all material respects, the financial condition and results of
operations of the Company.
Date: October 24, 2002 By: /s/ Barry N. Bycoff
---------------------------------------
Barry N. Bycoff
President and Chief Executive Officer
(Principal Executive Officer)
32
Netegrity, Inc.
Certification Pursuant To
18 U.S.C. Section 1350,
As Adopted Pursuant To
Section 906 of the Sarbanes/Oxley Act of 2002
In connection with the Quarterly Report of Netegrity, Inc. (the
"Company") on Form 10-Q for the period ended September 30, 2002 as filed with
the Securities and Exchange Commission (the "Report"), I, Regina O. Sommer,
Chief Financial Officer and Treasurer of the Company, certify, pursuant to
Section 1350 of Chapter 63 of Title 18, United States Code, that this Report
fully complies with the requirements of Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 and that the information contained in this Report fairly
presents, in all material respects, the financial condition and results of
operations of the Company.
Date: October 24, 2002 By: /s/ Regina O. Sommer
-------------------------------------------------
Regina O. Sommer
Chief Financial Officer and Treasurer
(Principal Financial Officer and Principal
Accounting Officer)
33