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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 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 MARCH 31, 2003.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________________ TO
________________
COMMISSION FILE NUMBER 1-10139
NETEGRITY, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 04-2911320
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
201 JONES ROAD
WALTHAM, MA 02451
(Address of principal executive offices) (Zip Code)
(781) 890-1700
(Registrant's Telephone Number, Including Area Code)
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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
As of April 21, 2003 there were 34,324,210 shares of Common Stock outstanding,
exclusive of Treasury Stock.
QUARTERLY REPORT ON FORM 10-Q
QUARTER ENDED MARCH 31, 2003
TABLE OF CONTENTS
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of March 31, 2003 and
December 31, 2002 (unaudited)............................................................... 3
Condensed Consolidated Statements of Operations for the three months ended
March 31, 2003 and 2002 (unaudited)......................................................... 4
Condensed Consolidated Statements of Cash Flows for the three months ended
March 31, 2003 and 2002 (unaudited)......................................................... 5
Notes to Condensed Consolidated Financial Statements........................................ 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....... 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk.................................. 27
Item 4. Controls and Procedures..................................................................... 27
PART II OTHER INFORMATION........................................................................... 28
Item 1. Legal Proceedings........................................................................... 28
Item 6. Exhibits and Forms on 8-K................................................................... 28
SIGNATURES............................................................................................. 29
CERTIFICATIONS......................................................................................... 30
2
PART I. - FINANCIAL INFORMATION
NETEGRITY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
MARCH 31, DECEMBER 31,
2003 2002
---- ----
ASSETS
CURRENT ASSETS:
Cash and cash equivalents............................................................... $ 23,309 $ 25,707
Short-term available-for-sale securities................................................ 56,180 48,361
Accounts receivable--trade, net of allowances of $857 at
March 31, 2003 and $922 at December 31, 2002........................................... 7,974 15,046
Prepaid expenses and other current assets............................................... 1,829 2,949
Restricted cash......................................................................... 310 281
--------- --------
Total Current Assets.................................................................. 89,602 92,344
Long-term available-for-sale securities.................................................. 11,216 12,655
Property and equipment, net.............................................................. 6,335 6,837
Restricted cash.......................................................................... 764 790
Other intangible assets, net............................................................. 2,699 5,398
Other assets............................................................................. 332 338
--------- --------
Total Assets........................................................................... $ 110,948 $118,362
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable--trade................................................................. $ 2,002 $ 1,906
Accrued compensation and benefits....................................................... 2,388 4,293
Other accrued expenses.................................................................. 5,139 6,530
Deferred revenue........................................................................ 15,474 14,875
--------- --------
Total Current Liabilities.............................................................. 25,003 27,604
--------- --------
Commitments and Contingencies
STOCKHOLDERS' EQUITY:
Common stock, voting, $.01 par value; 135,000 shares authorized;
34,362 shares issued and 34,324 shares outstanding at
March 31, 2003; 34,346 shares issued and 34,308 shares outstanding at
December 31, 2002....................................................................... 343 343
Additional paid-in capital............................................................... 197,297 197,250
Accumulated other comprehensive income................................................... 103 106
Accumulated deficit...................................................................... (111,598) (106,741)
Loan to officer.......................................................................... (116) (116)
--------- --------
86,029 90,842
Less--Treasury stock, at cost: 38 shares.................................................. (84) (84)
--------- --------
Total Stockholders' Equity................................................................. 85,945 90,758
--------- --------
Total Liabilities and Stockholders' Equity.................................................. $ 110,948 $118,362
========= ========
The accompanying notes are an integral part of the condensed
consolidated financial statements.
3
NETEGRITY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
FOR THE THREE MONTHS
ENDED MARCH 31,
---------------------
2003 2002
-------- --------
Revenues:
Software licenses......................................................................... $ 8,418 $ 13,617
Services.................................................................................. 7,630 7,578
Other..................................................................................... 631 775
-------- --------
Total revenues........................................................................... 16,679 21,970
-------- --------
Cost of Revenues:
Cost of software licenses................................................................. 491 555
Non-cash cost of software licenses........................................................ 2,699 917
Cost of services.......................................................................... 2,987 3,866
Cost of other............................................................................. 363 453
-------- --------
Total cost of revenues................................................................... 6,540 5,791
-------- --------
Gross profit............................................................................... 10,139 16,179
Selling, general and administrative expenses............................................... 10,496 13,490
Research and development expenses.......................................................... 4,874 6,058
-------- --------
Loss from operations....................................................................... (5,231) (3,369)
Other income, net.......................................................................... 374 656
-------- --------
Loss before provision for income taxes..................................................... (4,857) (2,713)
Provision for income taxes................................................................. -- 40
-------- --------
Net loss................................................................................... $ (4,857) $ (2,753)
======== ========
Net loss per share:
Basic and diluted......................................................................... $ (0.14) $ (0.08)
Weighted average shares outstanding:
Basic and diluted......................................................................... 34,318 33,875
The accompanying notes are an integral part of the condensed
consolidated financial statements.
4
NETEGRITY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
FOR THE THREE MONTHS
ENDED MARCH 31,
---------------------
2003 2002
-------- -------
OPERATING ACTIVITIES:
Net loss................................................................................... $ (4,857) $ (2,753)
Adjustments to reconcile net loss to net cash
provided by (used for) operating activities:
Depreciation and amortization............................................................. 3,826 2,056
Provision for doubtful accounts........................................................... 45 (110)
Non-cash interest (income) expense........................................................ 95 (65)
Loss on sale of marketable securities..................................................... -- (3)
Changes in operating assets and liabilities:
Accounts receivable - trade............................................................... 7,027 3,026
Prepaid expenses and other current assets................................................. 1,120 99
Other assets.............................................................................. 6 (19)
Accounts payable - trade.................................................................. 96 (358)
Accrued compensation and benefits......................................................... (1,905) (2,007)
Other accrued expenses.................................................................... (1,391) (1,385)
Deferred revenue.......................................................................... 599 (640)
-------- ---------
Net cash provided by (used for) operating activities....................................... 4,661 (2,159)
-------- ---------
INVESTING ACTIVITIES:
Proceeds from sales of marketable securities............................................... 8,035 9,391
Proceeds from maturities of marketable securities.......................................... 7,320 28,628
Purchases of marketable securities......................................................... (21,822) (48,184)
Purchases of property and equipment........................................................ (625) (869)
Payment of DataChannel acquisition costs................................................... -- (1,843)
Restricted cash............................................................................ (4) (4)
-------- ---------
Net cash used for investing activities..................................................... (7,096) (12,881)
-------- ---------
FINANCING ACTIVITY:
Proceeds from issuance of common stock under stock plans................................... 47 348
-------- ---------
Net cash provided by financing activity.................................................... 47 348
-------- ---------
Effect of exchange rate changes on cash and cash equivalents............................... (10) 16
Net change in cash and cash equivalents.................................................... (2,398) (14,676)
Cash and cash equivalents at beginning of period........................................... 25,707 29,332
-------- ---------
Cash and cash equivalents at end of period................................................. $ 23,309 $ 14,656
======== =========
The accompanying notes are an integral part of the condensed
consolidated financial statements
5
NETEGRITY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Basis of Presentation and Principles of Consolidation
The accompanying unaudited condensed consolidated financial statements
include the accounts of Netegrity, Inc. and its wholly owned subsidiaries
("Netegrity", "we" or "our") and have been prepared pursuant to the rules and
regulations of the Securities and Exchange Commission regarding interim
financial reporting. Accordingly, they do not include all of the information and
notes required by accounting principles generally accepted in the United States
of America for complete financial statements and should be read in conjunction
with the audited consolidated financial statements included in our Annual Report
on Form 10-K/A filed on March 6, 2003. The results of operations for the three
months ended March 31, 2003 are not necessarily indicative of the results
expected for the remainder of the year ending December 31, 2003.
The condensed consolidated financial statements of Netegrity include
the accounts and operations of our wholly owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in consolidation.
(b) Revenue Recognition
Our revenues are primarily generated from the sale of perpetual
licenses for our proprietary SiteMinder (R), IdentityMinder (TM),
TransactionMinder (TM) and provisioning products and services. We generate our
services revenue from consulting and training services performed for customers
and from the maintenance and support of our products. 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 specific transactions, historical
experience, credit worthiness 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 generally 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. We do not offer a right of
return on our 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, 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 each component is either the price we
charge when the same component is sold separately or the price established by
the members of our management, who have the relevant authority to set prices,
for an element not yet sold separately.
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 generally 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
typically request collateral from our customers. If we determine that collection
of a fee is not reasonably assured, we defer the fee and recognize revenue at
the time collection becomes reasonably assured, which is generally upon receipt
of cash.
Installation by Netegrity is not considered essential to the
functionality of our products as these services do not alter the product
capabilities, do not require specialized skills and may be performed by the
customer or other vendors. Revenues for maintenance and support are recognized
ratably over the term of the support period. Revenues from consulting and
training services are recognized as the services are performed.
6
(c) Cash and Cash Equivalents and Restricted Cash
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. Restricted cash represents time deposits held at
financial institutions in connection with the lease of our office space. As of
March 31, 2003, restricted cash is security for outstanding letters of credit
expiring in April 2003 and August 2003. The letter of credit expiring in August
2003 has an automatic renewal clause.
(d) Marketable Securities
Investments, 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, we have classified our 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 comprehensive income (loss) in stockholders' equity. Held
to maturity securities are debt securities that we intend to hold to maturity
and are recorded at amortized cost.
As of March 31, 2003, based on management's intentions, all marketable
securities have been classified as available-for-sale. Net realized losses from
the sales and maturities of marketable securities amounting to $300 and $3,000
are included in other income, net in the condensed consolidated statements of
operations for the three months ended March 31, 2003 and 2002, respectively. The
unrealized holding gains of $7,600 and $177,000 have been included in
accumulated other comprehensive income in the condensed consolidated financial
statements as of March 31, 2003 and December 31, 2002, respectively.
(e) Intangible Assets and Other Long-Lived Assets
We review the valuation of long-lived assets, including property and
equipment and capitalized software, under the provisions 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". We are required to assess the recoverability of long-lived
assets and purchased software 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 interim impairment review include
the following:
- significant underperformance relative to expected historical or
projected future operating results;
- significant changes in the manner of our use of the acquired assets
or the strategy of our overall business;
- significant negative industry or economic trends;
- significant decline in our stock price for a sustained period; and
- our market capitalization relative to net book value.
In accordance with SFAS No. 144, when we determine that the carrying
value of applicable 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
certain other types of long-lived assets may not be recoverable 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 being evaluated.
Other intangible assets, net, consists of acquired technology that
resulted from the acquisition of DataChannel during 2001. We
7
account for these intangible assets in accordance with SFAS No. 86, "Accounting
for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed".
During the fourth quarter of 2002, we determined that there had been a change in
the estimated useful life of the acquired technology and therefore it was
appropriate that the acquired technology be amortized over a nine month period
starting at the beginning of the fourth quarter of 2002 (the period during which
the change in estimated life was identified). Prior to this change, the acquired
technology long-lived asset was being amortized on a straight line basis over
three years. As a result of this change, the quarterly amortization expense
related to the acquired technology increased from approximately $0.9 million in
the three months ended March 31, 2002 to approximately $2.7 million for the
three months ended March 31, 2003.
(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 months ended March 31, 2003, the comprehensive loss and the net
loss were essentially equal as the effect of an unrealized gain on marketable
securities of $7,600 was offset by an unfavorable cumulative translation
adjustment of $10,000. For the three months ended March 31, 2002, the difference
of approximately ($83,000) between the comprehensive loss of approximately $2.8
million and net loss of approximately $2.7 million was due to unrealized losses
on marketable securities of approximately ($113,000) offset by a favorable
cumulative translation adjustment of approximately $30,000. At March 31, 2003
and December 31, 2002, accumulated other comprehensive income consisted of
unrealized gains (losses) on marketable securities of $185,000 and $177,000,
offset by cumulative translation adjustments of ($82,000) and ($71,000),
respectively.
(g) Net Earnings (Loss) Per Share
Basic net earnings (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
(loss) 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 shares of common
stock from stock options and warrants are anti-dilutive and therefore are
excluded from the calculation.
Outstanding options to purchase a total of approximately 0.5 million
and 3.5 million shares of common stock for the three months ended March 31, 2003
and 2002, respectively, were excluded in the computation of diluted EPS because
the effect on EPS was anti-dilutive.
(h) Stock-Based Compensation
We account for our stock option plans under the recognition and
measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to
Employees, and Related Interpretations." No stock-based compensation cost is
reflected in net income (loss) for these plans, as all options granted under
these plans had an exercise price equal to the market value of the underlying
common stock on the date of grant. The following table illustrates the effect on
net loss and loss per share if we had applied the fair value recognition
provisions of FASB Statement No. 123, "Accounting for Stock Based Compensation",
to stock based compensation (in thousands, except per share data):
FOR THE THREE MONTHS
ENDED MARCH 31,
(UNAUDITED)
----------------------------
2003 2002
------------- ------------
Net loss, as reported..................................... $ (4,857) $ (2,753)
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of related tax effects................................ (2,876) (15,886)
------------- ------------
Net loss, as adjusted..................................... $ (7,733) $ (18,639)
============= ============
Loss per share:
Basic and diluted -- as reported........................ $ (0.14) $ (0.08)
Basic and diluted -- as adjusted........................ $ (0.23) $ (0.55)
8
The fair value of each stock option is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions:
FOR THE THREE
MONTHS ENDED
MARCH 31,
---------------------
2003 2002
---- ----
Risk-free interest rate.............. 2.78% 4.74%
Expected dividend yield.............. 0.0% 0.0%
Expected volatility.................. 138% 114%
Expected life (years)................ 5.0 5.0
Weighted average fair value of
options granted during the period.... $ 3.22 $ 12.77
(i) Recent Accounting Pronouncements
In November 2002, the FASB issued FIN No. 45 "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" an interpretation of SFAS No. 5, 57, and 107 and
rescission of FASB Interpretation No. 34. The Interpretation requires that a
guarantor recognize, at the inception of a guarantee, a liability for the fair
value of the obligation undertaken by issuing the guarantee. The Interpretation
also requires additional disclosures to be made by a guarantor in its interim
and annual financial statements about its obligations under certain guarantees
it has issued. The accounting requirements for the initial recognition of
guarantees are applicable on a prospective basis for guarantees issued or
modified after December 31, 2002. The disclosure requirements are effective
during the first quarter of 2003 for all guarantees outstanding, regardless of
when they were issued or modified. The adoption of FIN No. 45 did not have a
material effect on our condensed consolidated financial statements. The
following is a summary of our agreements that we have determined are within the
scope of FIN No. 45.
We enter into standard indemnification agreements in our ordinary
course of business. Pursuant to these agreements, we indemnify, hold harmless,
and agree to reimburse the indemnified party for losses suffered or incurred by
the indemnified party, generally our business partners or customers, in
connection with any patent or any copyright or other intellectual property
infringement claim by any third party with respect to our products. The term of
these indemnification agreements is generally perpetual. The maximum potential
amount of future payments we could be required to make under these
indemnification agreements is unlimited. We have never incurred costs to defend
lawsuits or settle claims related to these indemnification agreements. As a
result, we believe the estimated fair value of these agreements is minimal.
Accordingly, we have no liabilities recorded for these agreements as of March
31, 2003.
We enter into arrangements with our business partners, whereby the
business partner agrees to provide services as a subcontractor for our
implementations. We may, at our discretion and in the ordinary course of
business, subcontract the performance of any of our services. Accordingly, we
enter into standard indemnification agreements with our customers, whereby we
indemnify them for other acts, such as personal property damage, of our
subcontractors. The maximum potential amount of future payments we could be
required to make under these indemnification agreements is unlimited; however,
we have general and umbrella insurance policies that enable us to recover a
portion of any amounts paid. We have never incurred costs to defend lawsuits or
settle claims related to these indemnification agreements. As a result, we
believe the estimated fair value of these agreements is minimal. Accordingly, we
have no liabilities recorded for these agreements as of March 31, 2003.
We warrant that our software products will perform in all material
respects in accordance with our standard published specifications in effect at
the time of delivery of the licensed products to the customer for ninety days.
Additionally, we warrant that our maintenance services will be performed
consistent with generally accepted industry standards through completion of the
agreed upon services. If necessary, we would provide for the estimated cost of
product and service warranties based on specific warranty claims and claim
history, however, we have never incurred significant expense under our product
or service warranties. As a result, we believe the estimated fair value of these
agreements is minimal. Accordingly, we have no liabilities recorded for these
agreements as of March 31, 2003.
As permitted under Delaware law, we have agreements whereby we
indemnify our officers and directors for certain events or occurrences while the
officer or director is, or was, serving at our request in such capacity. The
term of the indemnification period is for the later of six years after the date
that the officer or director ceases to serve at our request in such capacity or
the final termination
9
of proceedings against the officer or director as outlined in the
indemnification agreement. The maximum potential amount of future payments we
could be required to make under these indemnification agreements is unlimited;
however, we have a director and officer insurance policy that limits our
exposure and enables us to recover a portion of any future amounts paid. As a
result of our insurance policy coverage, we believe the estimated fair value of
these indemnification agreements is minimal. All of these indemnification
agreements were grandfathered under the provisions of FIN No. 45 as they were in
effect prior to December 31, 2002. Accordingly, we have no liabilities recorded
for these agreements as of March 31, 2003.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation -- Transition and Disclosure". SFAS No. 148 amends SFAS
No. 123, to provide alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation.
In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The transition guidance and
annual disclosure provisions of SFAS No. 148 are effective for fiscal years
ending after December 15, 2002. The interim disclosure provisions are effective
for financial reports containing financial statements for interim periods
beginning after December 15, 2002. As we did not make a voluntary change to the
fair value based method of accounting for stock-based employee compensation in
2002, the adoption of SFAS No. 148 did not have a material impact on our
financial position and results of operations.
NOTE 2: TENDER OFFER
On August 23, 2002, we 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, we offered to exchange certain employee options to purchase
shares of our common stock for new options to purchase shares of our common
stock. The Offer to Exchange, which excluded directors and non-employees of
Netegrity and which expired on September 23, 2002, provided for the grant of new
options on two different dates. We granted 50% of the new options on March 25,
2003 and 50% of the new options on April 25, 2003 to employees that were
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 Netegrity.
On March 25, and April 25, 2003, we granted options to purchase an
aggregate of 2,155,910 and 2,138,604 shares, respectively of our common stock at
fair market value in connection with the Offer to Exchange. In accordance with
FASB Interpretation No. 44, since the replacement options were granted more
than six months and one day after cancellation of the old options, the new
options were considered a fixed award and therefore did not result in any
compensation expense.
10
NOTE 3: OPERATING SEGMENTS AND GEOGRAPHICAL INFORMATION
Based on the information provided to our chief operating decision maker
for purposes of making decisions about allocating resources and assessing
performance, our continuing operations have been classified into a single
segment. We primarily operate in the United States, Europe and Asia Pacific.
Revenues (based on the location of the customer) and long-lived assets by
geographic region are as follows (in thousands):
FOR THE THREE MONTHS
ENDED MARCH 31,
----------------------
2003 2002
---------- ----------
Revenues:
United States of America........ $ 12,083 $ 18,671
Europe.......................... 3,469 2,368
Asia Pacific.................... 949 381
Other........................... 178 550
---------- ----------
Total........................... $ 16,679 $ 21,970
========== ==========
MARCH 31,
----------------------
2003 2002
---------- ----------
Long-Lived Assets:
United States of America........ $ 18,103 $ 18,211
Europe.......................... 395 272
Asia Pacific.................... 455 531
Other........................... 4 4
---------- ----------
Total........................... $ 18,957 $ 19,018
========== ==========
NOTE 4: RELATED PARTY TRANSACTIONS
LOAN TO OFFICER
The condensed consolidated balance sheets as of March 31, 2003 and
December 31, 2002 include $116,000 in loans to an officer of Netegrity issued in
connection with the exercise of stock options in 1996. The loan is reflected as
a reduction of stockholders' equity in the accompanying condensed consolidated
balance sheets. The loan is payable upon demand and bears interest at 7% per
annum. The loan was originally represented by a secured note; however, in May
2002, the note was amended such that it became a full recourse unsecured note.
MARKETING SERVICES
During the three months ended March 31, 2003 and 2002, we paid
approximately $5,300 and $20,700, respectively, to a company for marketing
services. The principal shareholder of such company is the son-in-law of one of
the members of our Board of Directors. We have similar arrangements with other
marketing services firms and believe the arrangement was entered into on
substantially the same terms and conditions as our arrangements with such other
firms.
NOTE 5: COMMITMENTS AND CONTINGENCIES
We have commitments that expire at various times through 2010.
Operating leases shown below are primarily for facility costs for our corporate
headquarters and world-wide sales offices. Other contractual obligations
primarily consist of minimum royalty fees payable by Netegrity in connection
with a software license and distribution agreement which we entered into in
January 2003.
LESS THAN 1 AFTER 5
TOTAL YEAR 1-3 YEARS 4-5 YEARS YEARS
---------- --------- ---------- ---------- -----------
(in thousands)
Operating Leases.................... $ 11,015 $ 3,747 $ 3,379 $ 2,833 $ 1,056
Other Contractual Obligations....... 3,775 1,125 2,650 -- --
---------- --------- ---------- ---------- -----------
Total............................... $ 14,790 $ 4,872 $ 6,029 $ 2,833 $ 1,056
========== ========= ========== ========== ===========
11
Included in the operating lease commitments above is approximately $0.9
million related to excess facilities which have been accrued in purchase
accounting and are payable through April 2004.
We incurred total operating lease expense, primarily related to certain
facilities and equipment under non-cancelable operating leases, of approximately
$1.1 million for the three months ended March 31, 2003.
In April 2002, we entered into an agreement with a system integrator to
assist us in the development and launch of one of our products. Under the terms
of the agreement, for consideration of the system integrator's time in assisting
with the development of the product, we agreed to promote the system integrator
as an integrator of the developed product. Our obligation under the agreement
will be considered satisfied once the system integrator receives consulting
revenues totaling approximately $3.9 million from our customers, or by April
2004, whichever occurs first. In the event that we recommend a competitor of the
system integrator to do the integration work for a customer, we could
potentially owe a royalty to the system integrator based on the net license fee.
As of March 31, 2003, no royalties were due to the system integrator.
In August 2002, we entered into a five year non-cancelable operating
lease for an office building for our corporate headquarters. We moved into the
new facility in March 2003. In connection with the lease agreement, we delivered
an irrevocable, unconditional, negotiable letter of credit in the amount of $0.8
million as a security deposit. At the time we signed the lease, we anticipated
that we would spend approximately $1.0 million in leasehold improvements to
build out the new facility. As of March 31, 2003, the leasehold improvements had
been substantially completed and approximately $0.9 million has been spent.
In January 2003, we entered into a software license and distribution
agreement, as amended in March 2003, under which we were granted the right to
sublicense the use of a provisioning application software program. In addition,
we were granted certain rights to integrate or combine the software into our
existing products. In exchange for these rights, we have agreed to pay a
quarterly royalty fee based on a percentage of the net license fees we charge
our customers for the software. The minimum royalty fees due in the first,
second and third years of the agreement are approximately $1.0 million, $1.4
million and $1.6 million. The initial term of this agreement is three years.
After the initial year of the agreement, we have the right to terminate the
agreement without cause. As of March 31, 2003, we had paid $0.2 million under
this agreement.
We have 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.
From time to time, we are involved in litigation relating to claims
arising out of our operations in the normal course of business. We are not
presently a party to any legal proceedings, the adverse outcome of which, in our
opinion, would have a material adverse effect on our results of operations or
financial position.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
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 "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Certain Factors that May Affect Future Results," 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.
CRITICAL ACCOUNTING POLICIES AND SIGNIFICANT JUDGMENTS AND ESTIMATES
The discussion and analysis of our financial condition and results of
operations are based on our condensed 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 as well as 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, accounts receivable reserves, marketable securities,
valuation of long-lived and intangible assets and goodwill, income taxes and
stock based compensation. 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
Our revenues are primarily generated from the sale of perpetual
licenses for our proprietary SiteMinder (R), IdentityMinder (TM),
TransactionMinder (TM) and provisioning products and services. We generate our
services revenue from consulting and training services performed for customers
and from maintenance and support of our products. 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, credit worthiness 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 generally 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. We do not offer a right of
return on our 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, 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 each component are either the price we
charge when the same component is sold separately or the price established by
the members of our management, who have the relevant authority to set prices,
for an element not yet sold separately.
13
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 generally 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
typically request collateral from our customers. If we determine that collection
of a fee is not reasonably assured, we defer the fee and recognize revenue at
the time collection becomes reasonably assured, which is generally upon receipt
of cash.
Installation by Netegrity is not considered essential to the
functionality of our products as these services do not alter the product
capabilities, do not require specialized skills and may be performed by the
customer or other vendors. Revenues for maintenance and support are recognized
ratably over the term of the support period. Revenues from consulting and
training services are recognized as the services are performed.
ACCOUNTS RECEIVABLE RESERVES
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 a general reserve based on the aging of receivables and historical
write-off experience. While management believes the allowance to be adequate, if
the financial condition of our 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.
MARKETABLE SECURITIES
Investments, which primarily consist of debt securities, are accounted
for under SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities" issued by FASB. Pursuant to the provisions of SFAS No. 115, we have
classified our 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 comprehensive income (loss)
in stockholders' equity. Held to maturity securities are debt securities that we
intend to hold to maturity and are recorded at amortized cost. As of March 31,
2003, all of our investments have been classified as available-for-sale.
VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS AND GOODWILL
We review the valuation of long-lived assets, including property and
equipment and capitalized software, under the provisions 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". We are required to assess the recoverability of long-lived
assets and purchased software 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 interim impairment review include
the following:
- significant underperformance relative to expected historical
or projected future operating results;
- significant changes in the manner of our use of the acquired
assets or the strategy of our overall business;
- significant negative industry or economic trends;
- significant decline in our stock price for a sustained period;
and
- our market capitalization relative to net book value.
In accordance with SFAS No. 144, when we determine that the carrying
value of applicable 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
14
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 certain other types of long-lived assets may not be recoverable 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 being evaluated.
ACCOUNTING FOR INCOME TAXES
The preparation of our condensed 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. We must then record a valuation allowance to reduce our 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. We have recorded a
full valuation allowance of $75.9 million as of March 31, 2003, 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.
STOCK BASED COMPENSATION
Our stock option program is a broad-based, long-term retention program
that is intended to contribute to the success of Netegrity by attracting,
retaining and motivating talented employees and to align employee interests with
the interests of our existing stockholders. Stock options are typically granted
to employees when they first join Netegrity and typically on an annual basis
thereafter. Stock options are also granted when there is a significant change in
an employee's responsibilities and, occasionally, to achieve equity within a
peer group. The Compensation Committee of the Board of Directors is responsible
for the review and approval of the granting of stock options to employees and
consultants. The Compensation Committee recommends the compensation of executive
management to the Board of Directors who has authority to approve stock option
grants. All members of the Compensation Committee are independent directors, as
defined in the applicable rules for issuers traded on The NASDAQ Stock Market.
See the "Report of the Compensation Committee" in our 2003 proxy statement for
further information regarding the policies and procedures of Netegrity and the
Compensation Committee regarding the grant of stock options.
Under the stock option plans, the participants may be granted options
to purchase shares of Netegrity stock and substantially all of our employees and
directors participate in at least one of our plans. Options issued under these
plans generally are granted at fair market value at the date of grant, become
exercisable at varying rates, generally over three or four years, and generally
expire seven to ten years from the date of grant.
We account for our stock option plans under the recognition and
measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to
Employees, and related Interpretations". No stock-based compensation cost is
reflected in net income (loss) for these plans, as all options granted under
these plans had an exercise price equal to the market value of the underlying
common stock on the date of grant.
During 2002, we 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,
we offered to exchange certain employee options to purchase shares of our common
stock for new options to purchase shares of our common stock. The Offer to
Exchange, which excluded directors and non-employees of Netegrity and which
expired on September 23, 2002, provided for the grant of new options on two
different dates. We granted 50% of the new options on March 25, 2003 and
50% of the new options on April 25, 2003 to employees that were 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
15
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 Netegrity.
RESULTS OF OPERATIONS
The following table presents statement of operations data as percentages of
total revenues for the periods indicated:
THREE MONTHS
ENDED
MARCH 31,
--------------
2003 2002
---- ----
STATEMENT OF OPERATIONS DATA:
Revenues:
Software licenses.............................................................. 50% 62%
Services....................................................................... 46 34
Other.......................................................................... 4 4
--- ---
Total revenues.............................................................. 100 100
Cost of revenues:
Cost of software licenses...................................................... 3 2
Non-cash cost of software licenses............................................. 16 4
Cost of services............................................................... 18 18
Cost of other.................................................................. 2 2
--- ---
Total cost of revenues...................................................... 39 26
--- ---
Gross profit..................................................................... 61 74
Selling, general and administrative expenses..................................... 63 61
Research and development expenses................................................ 29 28
--- ---
Loss from operations............................................................. (31) (15)
Other income, net................................................................ 2 3
--- ---
Loss before provision for income taxes........................................... (29) (12)
Provision for income taxes....................................................... -- --
--- ---
Net loss......................................................................... (29)% (12)%
--- ---
THE THREE MONTHS ENDED MARCH 31, 2003 COMPARED TO THE THREE MONTHS ENDED MARCH
31, 2002
The following discussion reviews the results of operations for the
three months ended March 31, 2003 (the "2003 Quarter") compared to the three
months ended March 31, 2002 (the "2002 Quarter").
Revenues. Total revenues decreased by $5.3 million or 24%, to $16.7
million in the 2003 Quarter, from $22.0 million in the 2002 Quarter. The
decrease was primarily due to decreases in software license revenues and
decreases in consulting and training revenue, partially offset by an increase in
maintenance and support revenue. The decrease in total revenue in the 2003
Quarter as compared to the 2002 Quarter was primarily due to the continued
decline in information technology spending by our existing and prospective
customers based primarily on the uncertainty of the economy. Overall, we believe
that revenue growth will be modest over the next couple of quarters as
constraints on technology spending continue. However, we believe that if and
when information technology spending increases from the current amounts that we
will benefit with increased revenue. We also believe that the continued
build-out of the leveraged model with our partners and our focus on expanding
our leadership position in the identity and access management market with our
new product offerings will enable us to acquire new customers and generate
additional revenue by selling additional products to our existing customers.
Software license revenues decreased by $5.2 million or 38%, to $8.4
million in the 2003 Quarter, from $13.6 million in the 2002 Quarter. The
decrease is due to broad based economic weakness and reduced technology spending
which resulted in deals being delayed or reduced in size. While the number of
new name deals decreased from 43 in the 2002 Quarter to 23 in the 2003 Quarter,
the average size of new name deals increased from approximately $118,000 in the
2002 Quarter to approximately $141,000 in the 2003
16
Quarter. The increase in the average deal size was primarily related to the
introduction of two new products in late 2002 and an increase in the number of
user licenses purchased by customers. In slight contrast, the number of follow
on deals remained consistent at 43 in both the 2002 Quarter and the 2003 Quarter
but the average size of follow on deals decreased from approximately $232,000 in
the 2002 Quarter to approximately $162,000 in the 2003 Quarter. The primary
reason for the decrease in follow-on deal size was that the 2002 Quarter
included two deals over $2 million that led to an increase in the average deal
size in that quarter.
Services revenues remained flat at $7.6 million in both the 2003
Quarter and the 2002 Quarter. Consulting and training revenues decreased by $1.3
million and $0.2 million, respectively, in the 2003 Quarter as compared to 2002
Quarter as a result of both broad based economic weakness and reduced technology
spending that resulted in a reduction in our customers' need for installation
and integration services as well as our decision to leverage our partners to
provide integration services directly to our customers. In connection with this
leveraged model, the cumulative number of third party consultants we had trained
increased from approximately 650 in the 2002 Quarter to over 1,100 in the 2003
Quarter. These decreases were offset by an increase in maintenance and support
revenue resulting from an increase in maintenance renewals by our existing
customer base.
Other revenues decreased by $0.2 million or 25%, to $0.6 million in the
2003 Quarter, from $0.8 million in the 2002 Quarter. Other revenues are derived
from the Firewall legacy business. This business has declined over the past
several quarters and is not expected to have a significant impact in future
periods.
Cost of revenues. Total cost of revenues increased by $0.7 million or
12%, to $6.5 million in the 2003 Quarter, from $5.8 million in the 2002 Quarter.
Overall, we believe that the cost of revenues may 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. These increases are expected to be offset by a decrease in
non-cash cost of software licenses beginning in the third quarter of 2003 as the
purchased software acquired in the DataChannel acquisition becomes fully
amortized at the end of the second quarter of 2003.
Cost of software license revenue increased by $1.7 million or 113%, to
$3.2 million in the 2003 Quarter from $1.5 million in the 2002 Quarter. This
increase is primarily due to a change in the amortization period of purchased
software recorded in connection with the acquisition of DataChannel. During the
fourth quarter of 2002, we determined that there had been a change in the
estimated useful life of the acquired technology and therefore it was
appropriate to amortize the acquired technology over a nine month period
starting at the beginning of the fourth quarter of 2002 (the period during which
the change in estimated life was identified). Prior to this change, the acquired
technology long-lived asset was being amortized on a straight line basis over
three years. As a result of this change, the quarterly amortization expense
related to the acquired technology increased from approximately $0.9 million for
the three months ended March 31, 2002 to approximately $2.7 million for the
three months ended March 31, 2003.
Cost of services decreased by $0.9 million or 23%, to $3.0 million in
the 2003 Quarter, from $3.9 million in the 2002 Quarter. The decrease is
primarily due to the leveraging of our system integrator partner relationships.
The cumulative number of billable consultants we have trained at our affiliated
partners increased from approximately 650 through the end of the 2002 Quarter to
over 1,100 through the end of the 2003 Quarter. This leveraging allowed us to
reduce the headcount in our professional services organization by approximately
68% from March 31, 2002 to March 31, 2003. This decrease was partially offset by
increased investment in both personnel and customer support systems within the
technical support organization during the second half of 2002 and the first
quarter of 2003 in order to enhance overall customer satisfaction.
Cost of other revenues decreased by $0.1 million or 20%, to $0.4
million in the 2003 Quarter, from $0.5 million in the 2002 Quarter. The decrease
in the 2003 Quarter 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 decreased by $3.0 million, or 22%, to $10.5 million in
the 2003 Quarter, from $13.5 million in the 2002 Quarter. The decrease is
attributable to (i) a decrease in salaries and related expenses due to the
reductions in force implemented in April and October of 2002, which reduced
headcount by 31%, (ii) a decrease in commission expenses as a result of a
decrease in license revenue, and (iii) reduced marketing and travel related
expenses. As we realize the savings from the consolidations of office space and
continue to scrutinize all discretionary expenses and evaluate reductions in
non-strategic programs, we anticipate selling, general and administration
expenses will remain flat or decrease in future periods.
Research and development costs. Research and development costs
decreased by $1.2 million or 20%, to $4.9 million in the 2003 Quarter, from $6.1
million in the 2002 Quarter. The decrease was primarily due to a decrease in
salaries and related expenses due to
17
the reductions in force implemented in April and October of 2002, which reduced
headcount by 28% in these departments. These reductions were primarily related
to the decision not to continue developing, marketing or selling the
PortalMinder product on a stand-alone basis. We recognize that our investment in
research and development is required to remain competitive and therefore our
research and development expenses may increase in future periods due to the
continued development of our products and services.
Other income, net. Other income, net, which is comprised primarily of
interest income earned on our cash and marketable securities, decreased by
approximately $0.3 million or 43%, to $0.4 million in the 2003 Quarter, from
$0.7 million in the 2002 Quarter. 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. The provision for income taxes decreased
by $40,000 or 100%, to $0 in the 2003 Quarter, from $40,000 in the 2002
Quarter. This decrease was attributable to the net loss position in the quarter
ended March 31, 2003 and larger state and foreign taxes in the same period of
the prior year.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities in the 2003 Quarter was $4.7
million, primarily due to a decrease in accounts receivable as the result of
strong collections in the 2003 Quarter partially offset by the net loss for the
quarter and a decrease in accrued expenses primarily resulting from the payment
during the 2003 Quarter of commissions earned during 2002.
Cash used in investing activities was $7.1 million in the 2003
Quarter. Investing activities for the period consisted primarily of the
purchases of marketable securities of approximately $21.8 million, and the
purchase of $0.6 million of property and equipment, primarily computer related
equipment and software, offset by the proceeds from sales and maturities of
marketable securities of approximately $15.3 million.
Cash provided by financing activities in the 2003 Quarter was
approximately $47,000, which related to the exercise of employee stock options.
COMMITMENTS
We have commitments that expire at various times through 2010.
Operating leases shown below are primarily for facility costs for our corporate
headquarters and world-wide sales offices. Other contractual obligations
primarily consist of minimum royalty fees payable by Netegrity in connection
with a software license and distribution agreement which we entered into in
January 2003.
LESS THAN 1 AFTER 5
TOTAL YEAR 1-3 YEARS 4-5 YEARS YEARS
-------- ----------- --------- --------- -------
(in thousands)
Operating Leases.................... $ 11,015 $ 3,747 $ 3,379 $ 2,833 $ 1,056
Other Contractual Obligations....... 3,775 1,125 2,650 -- --
-------- -------- -------- --------- --------
Total............................... $ 14,790 $ 4,872 $ 6,029 $ 2,833 $ 1,056
======== ======== ======== ========= ========
Included in the operating lease commitments above is approximately $0.9
million related to excess facilities which have been accrued in purchase
accounting and are payable through April 2004.
We incurred total operating lease expense, primarily related to certain
facilities and equipment under non-cancelable operating leases, of approximately
$1.1 million for the three months ended March 31, 2003.
In April 2002, we entered into an agreement with a system integrator to
assist us in the development and launch of one of our products. Under the terms
of the agreement, for consideration of the system integrator's time in assisting
with the development of the product, we agreed to promote the system integrator
as an integrator of the developed product. Our obligation under the agreement
will be considered satisfied once the system integrator receives consulting
revenues totaling approximately $3.9 million from our customers, or by April
2004, whichever occurs first. In the event that we recommend a competitor of the
system integrator to do the integration work for a customer, we could
potentially owe a royalty to the system integrator based on the net license fee.
As of March
18
31, 2003, no royalties were due to the system integrator.
In August 2002, we entered into a five year non-cancelable operating
lease for an office building for our corporate headquarters. We moved into the
new facility in March 2003. In connection with the lease agreement, we delivered
an irrevocable, unconditional, negotiable letter of credit in the amount of $0.8
million as a security deposit. At the time we signed the lease, we anticipated
that we would spend approximately $1.0 million in leasehold improvements to
build out the new facility. As of March 31, 2003 the leasehold improvements had
been substantially completed and approximately $0.9 million has been spent.
In January 2003, we entered into a software license and distribution
agreement, as amended in March 2003, under which we were granted the right to
sublicense the use of a provisioning application software program. In addition,
we were granted certain rights to integrate or combine the software into our
existing products. In exchange for these rights, we have agreed to pay a
quarterly royalty fee based on a percentage of the net license fees we charge
our customers for the software. The minimum royalty fees due in the first,
second and third years of the agreement are approximately $1.0 million, $1.4
million and $1.6 million. The initial term of this agreement is three years.
After the initial year of the agreement we have the right to terminate the
agreement without cause. As of March 31, 2003, we had paid $0.2 million under
this agreement.
We have 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.
From time to time, we are involved in litigation relating to claims
arising out of our operations in the normal course of business. We are not
presently a party to any legal proceedings, the adverse outcome of which, in our
opinion, would have a material adverse effect on our results of operations or
financial position.
We enter into standard indemnification agreements in our ordinary
course of business. Pursuant to these agreements, we indemnify, hold harmless,
and agree to reimburse the indemnified party for losses suffered or incurred by
the indemnified party, generally our business partners or customers, in
connection with any patent or any copyright or other intellectual property
infringement claim by any third party with respect to our products. The term of
these indemnification agreements is generally perpetual. The maximum potential
amount of future payments we could be required to make under these
indemnification agreements is unlimited. We have never incurred costs to defend
lawsuits or settle claims related to these indemnification agreements. As a
result, we believe the estimated fair value of these agreements is minimal.
Accordingly, we have no liabilities recorded for these agreements as of March
31, 2003.
We enter into arrangements with our business partners, whereby the
business partner agrees to provide services as a subcontractor for our
implementations. We may, at our discretion and in the ordinary course of
business, subcontract the performance of any of our services. Accordingly, we
enter into standard indemnification agreements with our customers, whereby we
indemnify them for other acts, such as personal property damage, of our
subcontractors. The maximum potential amount of future payments we could be
required to make under these indemnification agreements is unlimited; however,
we have general and umbrella insurance policies that enable us to recover a
portion of any amounts paid. We have never incurred costs to defend lawsuits or
settle claims related to these indemnification agreements. As a result, we
believe the estimated fair value of these agreements is minimal. Accordingly, we
have no liabilities recorded for these agreements as of March 31, 2003.
We warrant that our software products will perform in all material
respects in accordance with our standard published specifications in effect at
the time of delivery of the licensed products to the customer for ninety days.
Additionally, we warrant that our maintenance services will be performed
consistent with generally accepted industry standards through completion of the
agreed upon services. If necessary, we would provide for the estimated cost of
product and service warranties based on specific warranty claims and claim
history, however, we have never incurred significant expense under our product
or service warranties. As a result, we believe the estimated fair value of these
agreements is minimal. Accordingly, we have no liabilities recorded for these
agreements as of March 31, 2003.
As permitted under Delaware law, we have agreements whereby we
indemnify our officers and directors for certain events or occurrences while the
officer or director is, or was, serving at our request in such capacity. The
term of the indemnification period is for the later of six years after the date
that the officer or director ceases to serve at our request in such capacity or
the final termination of proceedings against the officer or director as outlined
in the indemnification agreement. The maximum potential amount of future
payments we could be required to make under these indemnification agreements is
unlimited; however, we have a director and officer insurance policy that limits
our exposure and enables us to recover a portion of any future amounts paid. As
a result of our insurance policy coverage, we believe the estimated fair value
of these indemnification agreements is minimal. All of these indemnification
19
agreements were grandfathered under the provisions of FIN No. 45 as they were in
effect prior to December 31, 2002. Accordingly, we have no liabilities recorded
for these agreements as of March 31, 2003.
As of March 31, 2003, we had cash and cash equivalents totaling $23.3
million, short-term marketable securities of approximately $56.2 million and
working capital of $64.6 million.
Any increase or decrease in our accounts receivable balance and
accounts receivable days outstanding (calculated as net accounts receivable
divided by revenue per day) will affect our cash flow from operations and
liquidity. Our accounts receivable and accounts receivable days outstanding may
increase due to changes in factors such as the timing of when sales are invoiced
and length of customer's payment cycle. We also record deferred maintenance
billings as accounts receivable, and the timing of these billings affects the
accounts receivable days outstanding. Historically, international and indirect
customers pay at a slower rate than domestic and direct customers. An increase
in revenue generated from international and indirect customers may increase our
accounts receivable days outstanding and accounts receivable balance. Due to the
current economic climate, we may observe an increase in the length of our
customers' payment cycle and as a result our days sales outstanding may increase
in future periods. To the extent that our accounts receivable balance increases,
we may incur increased bad debt expense and will be subject to greater general
credit risks.
In the past, we experienced a period of rapid growth, which resulted in
significant increases in our operating expenses. More recently, due to economic
conditions beyond our control, we have made considerable efforts to reduce our
operating expenses through constrained spending, reductions in workforce and
better alignment of our cost structure to our revenue. While we anticipate that
our operating expenses and capital expenditures will constitute a material use
of our cash resources, we may also 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
equivalent balances together with our marketable securities will be sufficient
to meet our anticipated cash requirements for working capital and capital
expenditures for at least the next twelve months.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
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. To achieve and sustain operating profitability on a quarterly and annual
basis, we will need to increase our revenues, particularly our license revenues.
Failure to maintain levels of profitability as expected by investors may
adversely affect the market price of our common stock. In the three months ended
March 31, 2003, we had a net loss of $4.9 million and an accumulated deficit of
approximately $111.6 million as of March 31, 2003.
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 or in anticipation of the introduction
of new products by us or our competitors;
- market acceptance of our SiteMinder, IdentityMinder,
TransactionMinder, provisioning products 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 timing of the release of new versions of SiteMinder,
IdentityMinder, TransactionMinder, provisioning products or
other products;
20
- pricing pressures that result in increased discounts or
changes in competitors' pricing policies;
- changes in our operating expenses;
- the development of our direct and indirect sales channels;
- integration issues with acquired technology; and
- general economic conditions.
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. 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.
Our revenues are primarily generated from the sale of perpetual licenses for
our proprietary SiteMinder (R), IdentityMinder (TM), TransactionMinder (TM) and
provisioning products and services. Broad market acceptance of our products will
depend on the development of a market for identity and access management, usage
of our products for software business-to-consumer, business-to-business and
e-business 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.
We have recently released 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. Additionally, with the
reduction in information technology spending in all industries we will need to
be successful in conveying the value our products provide to customers who may
be hesitant to replace a "homegrown" system due to the costs involved with
switching to a purchased solution.
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 employee attrition, language
barriers, acts 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. Although we recently released two new products on time, product
development cycles are unpredictable and in the past, we have delayed the
introduction of several new product versions due to delays in development of
these versions. In addition, we have arrangements with a third party located in
India to perform certain development and testing of our products and with third
party software vendors who provide software which is embedded in our products.
Any adverse change in our relationship with these third parties could result in
delays in the release of our products. 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 WIN BUSINESS AND OBTAIN FOLLOW-ON
SALES IN PROFITABLE SEGMENTS.
21
Customers typically place small initial orders for our products to
allow them to evaluate our products' performance. A key element of 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 or if our customers do not remain satisfied with
our products and services, 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 identity and access management is highly competitive. We
expect the level of competition to increase as a result of the anticipated
growth of the identity and access management markets. Our primary competitor in
the identity and access management market is the Tivoli Division of IBM. We also
compete against traditional security and software companies such as Oblix, RSA,
Novell, Waveset, Sun MicroSystems and Open Network Technology. In addition, a
number of other security and software companies have indicated that they plan to
offer products that may compete with our identity and access management solution
in the future. Competition may also develop as the market matures and other
companies begin to offer similar products, and as our product offerings expand
to other segments of the marketplace. 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 selling relationships
with third parties to increase the distribution of their products to the
marketplace. Accordingly, it is possible that new competitors may emerge and
acquire significant market share. It is possible that current and potential
competitors may attempt to hire our 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. Today, many of our competitors have
shorter operating histories and fewer financial and technical resources than we
have. In addition, these smaller competitors have smaller customer bases. Some
of our other competitors, however, are larger companies who have large financial
resources, well-established development and support teams, and large customer
bases. These larger competitors may initiate pricing policies that would make it
more difficult for us to maintain our competitive position against these
companies. It is also possible that current and potential competitors may be
able to respond more quickly to new or emerging technologies or customer
requirements, resulting in increased market share. 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. 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. A change in key
management could result in transition and attrition in the affected department.
This could have a material adverse effect on our business, operating results and
financial condition.
22
OUR SUCCESS DEPENDS ON OUR ABILITY TO OPTIMIZE OUR DIRECT SALES AND INDIRECT
DISTRIBUTION CHANNELS.
To increase our revenues, we must optimize our direct sales force and
continue to enhance relationships with systems integrators, resellers and
technology partners to increase the leverage of our partner channel. 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 effectively leverage our relationships
with our strategic partners and other third-party system integrators, vendors of
Internet-related systems and application software and resellers in order to
reach a larger customer population than we could reach alone through our direct
sales and marketing efforts.
We may not be able to find appropriate strategic partners or may not be
able to enter into relationships on commercially favorable terms. Furthermore,
the relationships we do enter into may not be successful. Since our strategic
relationships are generally non-exclusive, our strategic partners may decide to
pursue alternative technologies or to develop alternative products in addition
to or instead of our product, either on their own or in collaboration with our
competitors.
WE RELY ON THIRD PARTY TECHNOLOGY TO ENHANCE OUR PRODUCTS.
We incorporate into our products software licensed from third party
software companies that enhances, enables or provides functionality for our
products and therefore we need to create relationships with third parties,
including some of our competitors, to ensure that our products will interoperate
with the third parties' products. Third party software may not continue to be
available on commercially reasonable terms or with acceptable levels of support
or functionality, or at all. Failure to maintain those license arrangements,
failure of the third party vendors to provide updates, modifications or future
versions of their software 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 and potentially cause us to incur additional cost. In
addition, if we discover that third party products are no longer available as a
result of changes in the third party's operations, there can be no assurance
that we would be able to offer our product without substantial reengineering, or
at all.
Often these third party software companies require prepayment of
royalties on their products and in the past, we have had to expense to cost of
sales these prepaid royalties when it was determined that they may not have
future realizable value.
OUR FAILURE TO EXPAND OUR RELATIONSHIP WITH GLOBAL SYSTEMS INTEGRATORS COULD
LIMIT OUR ABILITY TO INCREASE OUR PRODUCT SALES.
Our professional services organization and our relationship with global
systems integrators provide critical support to our customers' installation and
deployment of our products. If we fail to adequately develop our relationship
with global systems integrators, our ability to increase products sales may be
limited. In addition, if we or our partners cannot adequately support product
installations, our customers may not be able to use our products, which could
harm our reputation and hurt our business.
OUR LENGTHY SALES CYCLE MAKES IT DIFFICULT TO PREDICT OUR QUARTERLY OPERATING
RESULTS.
The length of our sales cycle varies depending on the size and type and
complexity of the customer contemplating a purchase, whether we have conducted
business with a potential customer in the past and the size of the deal. In
addition, some of our customers may also need to invest substantial resources
and modify their computer network infrastructures to take advantage of our
products. As a result, 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 technology 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
quarterly period. Our sales cycle is subject to a number of uncertainties such
as:
- the need to educate potential customers regarding the benefits
of our products;
- customers' budgetary constraints;
- the timing of customers' budget cycles;
- customers' willingness to make changes in their network
infrastructures; and
- delays caused by the customers internal review process.
23
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 experienced a period of rapid
growth that placed a significant strain on all of our resources. During 2002,
based upon economic factors beyond our control, we implemented two separate
reductions in workforce. 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. A change in 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 significantly 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, including the ability to develop, market and
distribute localized versions of our products in a timely manner or at all.
These risks could reduce demand for our products and services, increase the
prices at which we can sell our products and services, or otherwise have an
adverse effect on our operating results. Among the risks we believe are most
likely to affect us are:
- longer decision making cycles;
- longer payment cycles and problems in collecting accounts
receivable;
- adverse changes in trade and tax regulations, including
restrictions on the import and export of sensitive
technologies, such as encryption technologies, that we use or
may wish to use in our software products;
- the absence or significant lack of legal protection for
intellectual property rights;
- selling under contracts governed by local law;
- difficulties in managing an organization spread over multiple
countries, including complications arising from cultural,
language and time differences that may lengthen sales and
implementation cycles, and delay the resolution of customer
support issues;
- currency risks, including fluctuations in exchange rates;
- political and economic instability;
- localization of technology, including delays in localizing the
most recent versions of our products;
- 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.
24
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 or third party products
embedded in our products violates 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.
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, and contractually
attempt to limit liability, 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.
INCREASED UTILIZATION AND COSTS OF OUR TECHNICAL SUPPORT SERVICES AND INCREASED
DEMANDS ON OUR OTHER TECHNICAL RESOURCES MAY ADVERSELY AFFECT OUR FINANCIAL
RESULTS.
Our products involve very complex technology and the failure or
inability of our technical support staff to meet customer expectations in a
timely manner or customer dissatisfaction with our product functionality or
performance could result in loss of revenues, loss of market share, failure to
achieve market acceptance, injury to our reputation, liability for service or
warranty costs and claims and other increased costs. We may be unable to respond
to fluctuations in customer demand for support services as well as resolve
customer issues in a manner that is timely and satisfactory to them. We also may
be unable to modify the format of our support services to compete with changes
in support services provided by competitors.
Additionally, as we continue to win business from larger, more complex
customers there may be an increased demand on our resources, particularly
product management and support, which may affect the allocation of our
resources.
25
OUR ACQUISITION OF OTHER COMPANIES MAY INCREASE THE RISKS WE FACE.
In the future, we may pursue acquisitions to obtain complementary
products, services and technologies. Any 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, customers 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.
Although the majority of our services are performed on a time and
material basis, we have in the past, performed services under fixed price
contracts at the request of a customer. In the future, it is possible that an
increased portion of our services revenues could 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 affected.
CONTINUED WEAKNESS IN THE GLOBAL ECONOMY MAY ADVERSELY AFFECT OUR BUSINESS
The global economy, especially the technology sector, is still weak and
may continue to be weak in the foreseeable future. The general economic slowdown
has had and may continue to have negative consequences for our business and
operating results. We believe the current economic slowdown has caused some
potential or current customers to defer purchases. In response to the current
economic conditions, many companies have reduced their spending budgets for
information technology products and services, which could reduce or eliminate
potential sales of our products and services.
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 or delay a change in the control of Netegrity or a change in
our management. These provisions could also discourage proxy contests and make
it more difficult for you and other stockholders to elect directors and take
other corporate actions. The existence of these provisions could limit the price
that investors might be willing to pay in the future for shares of our common
stock. 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.
26
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Currency
In the quarter ended March 31, 2003, we generated approximately 28% of
our revenues outside of the United States. 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 (which
were $82,000 as of March 31, 2003) are deferred and accumulated as a separate
component of stockholders' equity (accumulated other comprehensive loss). Net
gains and losses resulting from foreign exchange transactions, which were $500
for the quarter ended March 31, 2003, are included in other income, net in the
accompanying condensed consolidated statements of operations. A 10% change in
the valuation of the functional currencies relative to the U.S. dollar as of
March 31, 2003 would not have a material impact on our results of operations for
the quarter ended March 31, 2003.
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 our 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 quarter ended March 31, 2003 would have
decreased by less than $100,000. This estimate assumes that the decrease
occurred on the first day of the year 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
(a) Evaluation of disclosure controls and procedures. Based on their
evaluation of our disclosure controls and procedures (as defined in Rules
13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934) as of a date
within 90 days of the filing date of this Quarterly Report on Form 10-Q, our
Chief Executive Officer and Chief Financial Officer have concluded that our
disclosure controls and procedures are designed to ensure that information
required to be disclosed by us in the reports that we file or submit under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms and are operating in an effective
manner.
(b) Changes in internal controls. There were no significant changes in
our internal controls or in other factors that could significantly affect these
controls subsequent to the date of their most recent evaluation.
27
PART II. - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, we are involved in litigation relating to claims arising out
of our operations in the normal course of business. We are not presently a party
to any legal proceedings, the adverse outcome of which, in our opinion, would
have a material adverse effect on our results of operations or financial
position.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT
ITEM NO. ITEM AND REFERENCE
- --------
10.01 Form of Executive Retention Agreement entered into by and between Netegrity, Inc., and Xristos Silaidis dated
January 13, 2003; Netegrity, Inc. and Richard Welch dated February 3, 2003; and Netegrity, Inc. and Roy Strand
dated February 24, 2003.
10.02 + Software License and Distribution Agreement by and between Netegrity, Inc. and Business Layers, Inc. dated
January 18, 2003, as amended on March 26, 2003.
99.1 Certification of President and Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
+ Confidential treatment requested as to certain portions, which portions have
been omitted and filed separately with the Securities and Exchange Commission
pursuant to a Confidential Treatment Request.
(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, thereunto duly authorized.
NETEGRITY, INC.
Date: April 28, 2003 By: /s/ Barry N. Bycoff
-------------------------------------
Barry N. Bycoff
President, Chief Executive Officer,
Director and Chairman of the Board
Date: April 28, 2003 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 we 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 function):
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 or not 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: April 28, 2003 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 we 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 function):
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 or not 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: April 28, 2003 By: /s/ Regina O. Sommer
-------------------------------------
Regina O. Sommer
Chief Financial Officer and Treasurer
(Principal Financial Officer and
Principal Accounting Officer)
31