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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 JUNE 30, 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 (I.R.S. Employer
of 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 July 21, 2003 there were 34,547,817 shares of Common Stock outstanding,
exclusive of Treasury Stock.
1
QUARTERLY REPORT ON FORM 10-Q
QUARTER ENDED JUNE 30, 2003
TABLE OF CONTENTS
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 2003 and
December 31, 2002 (unaudited)................................................................. 3
Consolidated Statements of Operations for the three months ended June 30, 2003 and
2002 (unaudited).............................................................................. 4
Consolidated Statements of Operations for the six months ended June 30, 2003 and
2002 (unaudited).............................................................................. 5
Consolidated Statements of Cash Flows for the six months ended June 30, 2003 and
2002 (unaudited).............................................................................. 6
Notes to Consolidated Financial Statements.................................................... 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations......... 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk.................................... 29
Item 4. Controls and Procedures....................................................................... 29
PART II OTHER INFORMATION............................................................................. 30
Item 4. Submission of Matters to a Vote of Security Holders........................................... 30
Item 6. Exhibits and Reports on Form on 8-K........................................................... 30
SIGNATURES.............................................................................................. 31
2
PART I. - FINANCIAL INFORMATION
NETEGRITY, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS)
JUNE 30, DECEMBER 31,
2003 2002
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................................... $ 13,761 $ 25,707
Short-term available-for-sale securities.................................... 26,139 48,361
Accounts receivable--trade, net of allowances of $690 at
June 30, 2003 and $922 at December 31, 2002................................ 9,685 15,046
Prepaid expenses and other current assets................................... 2,399 2,949
Restricted cash............................................................. -- 281
------------ ------------
Total Current Assets..................................................... 51,984 92,344
Long-term available-for-sale securities..................................... 53,526 12,655
Property and equipment, net................................................. 6,029 6,837
Long-term restricted cash................................................... 764 790
Other intangible assets, net................................................ -- 5,398
Other assets................................................................ 334 338
------------ ------------
Total Assets.............................................................. $ 112,637 $ 118,362
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable--trade..................................................... $ 2,421 $ 1,906
Accrued compensation and benefits........................................... 3,276 4,293
Other accrued expenses...................................................... 6,499 6,530
Deferred revenue............................................................ 16,677 14,875
------------ ------------
Total Current Liabilities................................................. 28,873 27,604
------------ ------------
Commitments and Contingencies
STOCKHOLDERS' EQUITY:
Common stock, voting, $.01 par value; 135,000 shares authorized;
34,558 shares issued and 34,520 shares outstanding at June 30,
2003; 34,346 shares issued and 34,308 shares outstanding at
December 31, 2002......................................................... 345 343
Additional paid-in capital.................................................. 197,732 197,250
Accumulated other comprehensive income...................................... 18 106
Accumulated deficit......................................................... (114,131) (106,741)
Loan to officer............................................................. (116) (116)
------------ ------------
83,848 90,842
Less--Treasury stock, at cost: 38 shares.................................... (84) (84)
------------ ------------
Total Stockholders' Equity.................................................. 83,764 90,758
------------ ------------
Total Liabilities and Stockholders' Equity.................................. $ 112,637 $ 118,362
============ ============
The accompanying notes are an integral part of the consolidated
financial statements.
3
NETEGRITY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
FOR THE THREE MONTHS
ENDED JUNE 30,
-------------------------
2003 2002
---------- ----------
Revenues:
Software licenses............................. $ 10,714 $ 7,669
Services...................................... 7,500 7,493
Other......................................... 650 646
---------- ----------
Total revenues............................... 18,864 15,808
---------- ----------
Cost of Revenues:
Cost of software licenses..................... 376 409
Non-cash cost of software licenses............ 2,699 917
Cost of services.............................. 2,760 3,566
Cost of other................................. 390 388
---------- ----------
Total cost of revenues....................... 6,225 5,280
---------- ----------
Gross profit................................... 12,639 10,528
Selling, general and administrative expenses... 10,493 14,038
Research and development expenses.............. 5,036 6,478
Non-recurring charges.......................... -- 689
---------- ----------
Loss from operations........................... (2,890) (10,677)
Other income, net.............................. 417 724
---------- ----------
Loss before provision for income taxes......... (2,473) (9,953)
Provision for income taxes..................... 59 --
---------- ----------
Net loss....................................... $ (2,532) $ (9,953)
========== ==========
Net loss per share:
Basic and diluted............................. $ (0.07) $ (0.29)
Weighted average shares outstanding:
Basic and diluted............................. 34,416 34,001
The accompanying notes are an integral part of the financial statements.
4
NETEGRITY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
FOR THE SIX MONTHS
ENDED JUNE 30,
-------------------------
2003 2002
---------- ----------
Revenues:
Software licenses............................. $ 19,132 $ 21,286
Services...................................... 15,129 15,071
Other......................................... 1,281 1,421
---------- ----------
Total revenues............................... 35,542 37,778
---------- ----------
Cost of Revenues:
Cost of software licenses..................... 867 964
Non-cash cost of software licenses............ 5,398 1,834
Cost of services.............................. 5,748 7,432
Cost of other................................. 752 841
---------- ----------
Total cost of revenues....................... 12,765 11,071
---------- ----------
Gross profit................................... 22,777 26,707
Selling, general and administrative expenses... 20,989 27,528
Research and development expenses.............. 9,910 12,536
Non-recurring charges.......................... -- 689
---------- ----------
Loss from operations........................... (8,122) (14,046)
Other income, net.............................. 791 1,380
---------- ----------
Loss before provision for income taxes......... (7,331) (12,666)
Provision for income taxes..................... 59 40
---------- ----------
Net loss....................................... $ (7,390) $ (12,706)
========== ==========
Net loss per share:
Basic and diluted............................. $ (0.22) $ (0.37)
Weighted average shares outstanding:
Basic and diluted............................. 34,367 33,938
The accompanying notes are an integral part of the financial statements.
5
NETEGRITY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
FOR THE SIX MONTHS
ENDED JUNE 30,
-------------------------
2003 2002
---------- ----------
OPERATING ACTIVITIES:
Net loss......................................................... $ (7,390) $ (12,706)
Adjustments to reconcile net loss to net cash
provided by (used for) operating activities:
Depreciation and amortization................................... 7,650 4,139
Provision for doubtful accounts................................. 190 207
(Gain)/Loss on sale of marketable securities.................... (41) 11
Other........................................................... 238 25
Changes in operating assets and liabilities:
Accounts receivable - trade..................................... 5,171 1,828
Prepaid expenses and other current assets....................... 550 (699)
Other assets.................................................... 4 464
Accounts payable - trade........................................ 515 (1,188)
Accrued compensation and benefits............................... (1,017) (285)
Other accrued expenses.......................................... (31) (3,970)
Deferred revenue................................................ 1,802 474
---------- ----------
Net cash provided by (used for) operating activities............. 7,641 (11,700)
---------- ----------
INVESTING ACTIVITIES:
Proceeds from sales of marketable securities..................... 17,577 121,261
Proceeds from maturities of marketable securities................ 12,407 4,284
Purchases of marketable securities............................... (48,924) (119,409)
Purchases of property and equipment.............................. (1,444) (1,378)
Restricted cash.................................................. 307 (6)
---------- ----------
Net cash used for investing activities........................... (20,077) 4,752
---------- ----------
FINANCING ACTIVITY:
Proceeds from issuance of common stock under stock plans......... 484 351
---------- ----------
Net cash provided by financing activity.......................... 484 351
---------- ----------
Effect of exchange rate changes on cash and cash equivalents..... 6 (37)
Net change in cash and cash equivalents.......................... (11,946) (6,634)
Cash and cash equivalents at beginning of period................. 25,707 26,332
---------- ----------
Cash and cash equivalents at end of period....................... $ 13,761 $ 19,698
========== ==========
The accompanying notes are an integral part of the consolidated
financial statements
6
NETEGRITY, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Basis of Presentation and Principles of Consolidation
The accompanying unaudited 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 and six months
ended June 30, 2003 are not necessarily indicative of the results expected for
the remainder of the year ending December 31, 2003.
The 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) and
TransactionMinder(R) products and related services. We generate our services
revenues 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
revenues 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
revenues 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 revenues 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 a signed license agreement and/or a purchase
order with binding terms and conditions as evidence of an arrangement. For
arrangements with multiple obligations (for example, product, undelivered
maintenance and support, training and consulting), we allocate revenues 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 value 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 revenues 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 revenues 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 generally are recognized as the services are performed.
7
NETEGRITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(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
June 30, 2003, restricted cash is security for an outstanding letter of credit
which expires in August 2003, but 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 June 30, 2003, based on management's intentions, all marketable
securities have been classified as available-for-sale. Net realized gains
(losses) from the sales and maturities of marketable securities amounting to
$42,000 and ($8,000) for the three months ended June 30, 2003 and 2002,
respectively, and $41,000 and ($11,000) for the six months ended June 30, 2003
and 2002, respectively, are included in other income, net in the accompanying
consolidated statements of operations. The unrealized holding gains of $84,000
and $178,000 have been included in accumulated other comprehensive income in the
consolidated financial statements as of June 30, 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.
8
NETEGRITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Other intangible assets, net, consists of acquired technology that
resulted from the acquisition of DataChannel during 2001. We account for these
intangible assets in accordance with SFAS No. 86. 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 $917,000 and $1.8 million in the three
and six months ended June 30, 2002, respectively, to approximately $2.7 million
and $5.4 million for the three and six months ended June 30, 2003, respectively.
As of June 30, 2003 the acquired technology was fully amortized.
(f) Comprehensive Income (Loss)
The components of comprehensive loss are as follows:
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
----------------------- ------------------------
2003 2002 2003 2002
-------- --------- --------- ---------
(in thousands)
Net loss................................................... $ (2,532) $ (9,953) $ (7,390) $ (12,706)
Net unrealized holding gain (loss) arising during
the period................................................. (60) 89 (53) (28)
Reclassification adjustment for net realized (gains)
losses included in net loss................................ (42) 8 (41) 11
-------- --------- --------- --------
(102) 97 (94) (17)
Net unrealized foreign currency translation
adjustment arising during the period....................... $ 16 $ (67) $ 5 $ (37)
-------- --------- --------- ---------
Comprehensive loss......................................... $ (2,618) $ (9,923) $ (7,479) $ (12,760)
======== ========= ========= =========
The components of accumulated other comprehensive loss as of June 30,
2003 and December 31, 2002 are as follows:
JUNE 30, DECEMBER 31,
2003 2002
-------- ------------
(in thousands)
Net unrealized holding gain................................ $ 84 $ 178
Net unrealized foreign currency translation adjustment..... (66) (72)
------ -------
Accumulated other comprehensive income.................... $ 18 $ 106
====== =======
(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 344,000 and
1.2 million shares of common stock for the three and six months ended June 30,
2003, respectively, and a total of 6.6 million and 5.2 million shares of common
stock for the three and six months ended June 30, 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
9
NETEGRITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
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 FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
(UNAUDITED) (UNAUDITED)
------------------------ ------------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Net loss, as reported.................................... $ (2,532) $ (9,953) $ (7,390) $ (12,706)
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all
awards, net of related tax effects................... (4,147) (7,737) (7,023) (23,623)
--------- --------- --------- ---------
Net loss, as adjusted.................................... $ (6,679) $ (17,690) $ (14,413) $ (36,329)
========= ========= ========= =========
Loss per share:
Basic and diluted -- as reported....................... $ (0.07) $ (0.29) $ (0.22) $ (0.37)
Basic and diluted -- as adjusted....................... $ (0.19) $ (0.52) $ (0.42) $ (1.07)
(i) Recent Accounting Pronouncements
In November 2002, the Emerging Issues Task Force (EITF) issued EITF No.
00-21, "Revenue Arrangements with Multiple Deliverables," which provides
guidance on the timing and method of revenue recognition for sales arrangements
that include the delivery of more than one product or service. EITF No. 00-21 is
effective prospectively for arrangements entered into in fiscal periods
beginning after June 15, 2003. We anticipate the adoption of EITF No. 00-21 will
not have significant impact on our consolidated financial statements.
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.
In May 2003, the FASB issued SFAS 150, "Accounting For Certain
Financial Instruments with Characteristics of Both Liabilities and Equity" which
establishes standards for how an issuer of financial instruments classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances) if, at
inception, the monetary value of the obligation is based solely or predominantly
on a fixed monetary amount known at inception, variations in something other
than the fair value of the issuer's equity shares or variations inversely
related to changes in the fair value of the issuer's equity shares. SFAS No. 150
is effective for financial instruments entered into or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. The adoption of SFAS 150 is not expected to have
a material impact on our financial position or 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 excluded directors and non-employees of Netegrity,
expired on September 23, 2002 and 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
10
NETEGRITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
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 was equal to
the number of shares underlying the cancelled eligible options, except that
certain options granted to certain executive officers were 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 was equal to the fair market
value of one share of common stock on the date of grant of the new options as
determined in accordance with the applicable option plans. Each new option will
vest in accordance with a 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.
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 FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
---------------------------- --------------------------
2003 2002 2003 2002
------------ ---------- ---------- ----------
Revenues:
United States of America... $ 15,163 $ 11,621 $ 27,243 $ 30,292
Europe..................... 1,256 3,081 4,726 5,448
Asia Pacific............... 2,416 999 3,365 1,381
Other...................... 29 107 208 657
------------ ---------- ---------- ----------
Total...................... $ 18,864 $ 15,808 $ 35,542 $ 37,778
============ ========== ========== ==========
JUNE 30,
----------------------------
2003 2002
------------ ----------
Long-Lived Assets:
United States of America... $ 6,412 $ 6,763
Europe..................... 324 398
Asia Pacific............... 387 641
Other...................... 4 --
------------ ----------
Total...................... $ 7,127 $ 7,802
============ ==========
NOTE 4: RELATED PARTY TRANSACTIONS
LOAN TO OFFICER
The consolidated balance sheets as of June 30, 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 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 and six months ended June 30, 2003 we paid
approximately $37,000 and $42,000, respectively, and during the three and six
months ended June 30, 2002 we paid approximately $48,000 and $63,000,
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.
11
NETEGRITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
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 worldwide 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............... $ 10,245 $ 3,575 $ 2,781 $ 2,833 $ 1,056
Other Contractual Obligations.. 3,550 1,250 2,300 -- --
-------- ------- ------- ------- -------
Total.......................... $ 13,795 $ 4,825 $ 5,081 $ 2,833 $ 1,056
======== ======= ======= ======= =======
Included in the operating lease commitments above is approximately $0.7
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
$1.0 million and $2.0 million for the three and six months ended June 30, 2003,
respectively.
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 perform the integration work for a customer, we could
potentially owe a royalty to the system integrator based on the net license fee.
As of June 30, 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. Additionally, we spent approximately $1.0 million
in leasehold improvements to build out the new facility in the six months ended
June 30, 2003.
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, respectively. The initial term of this agreement is
three years. After the first year of the agreement, we have the right to
terminate the agreement without cause. As of June 30, 2003, we became obligated
to pay $0.5 million in royalties under this agreement, of which $0.2 million had
been paid and $0.3 million was accrued.
We enter into standard indemnification agreements in our ordinary
course of business. Pursuant to these agreements, we indemnify, hold harmless,
and agree to repair or replace the product or 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 June 30, 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 certain damages, such as personal property damage, caused by
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
12
NETEGRITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
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 June 30, 2003.
We generally warrant for ninety days from delivery 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. 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 June 30, 2003.
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. We have also entered into
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.
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.
13
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.
OVERVIEW
Netegrity is a leading provider of security software solutions that
securely manage identities and their access to enterprise information assets.
Our flexible, standards-based offerings increase security, reduce administrative
costs and enable revenue enhancement. Our products help companies ensure that
only the people or business processes that are entitled to access corporate
resources and applications access them. Our products also enable customers to
manage the user population that needs to access those resources and
applications. In addition, our products provide a more automated way to grant,
modify or revoke account access to applications and resources.
We primarily derive our revenues from our core products, SiteMinder
(R), IdentityMinder(TM), and TransactionMinder(R), which are integrated into an
identity and access management solution to provide Web access control and
management, user administration, provisioning and de-provisioning of account
access. Our solution supports a broad range of technology environments, and aims
to ensure that companies optimize their existing information technology
investments while incorporating new technologies. We also offer various levels
of consulting and support services that enable our customers to successfully
implement our products in their organizations.
We believe sales of our products will be driven by the customers'
desire for increased security, reduced costs, and regulatory compliance across
large, heterogeneous environments. We are beginning to see customers' interest
shifting away from network security and towards enterprise security, as their
objective changes from keeping people out to letting them in -- and securely
managing their access to corporate information assets. As a result, we expect
that companies will spend their discretionary IT dollars on technology that will
help them drive revenue and reduce costs while mitigating risk. We have seen an
upwards trend in deal sizes in both new name and follow-on accounts. This
movement reflects the combined impact of a broadened product portfolio as well
as the focus of our direct sales resources on the largest companies in the
world. However, information technology spending has sharply decreased in the
past two years and information technology budgets remained constrained, which
has had and could continue to have a direct affect on the sale of our products.
Our software products are typically sold on a perpetual license basis
and customers enter into an annual customer support agreement for their software
license at the time of initial purchase and renew this support agreement
annually. Our support agreement entitles our customers to software license
upgrades and support.
Our professional services group provides customers with project
management, architecture and design, custom development and training.
CRITICAL ACCOUNTING POLICIES AND SIGNIFICANT JUDGMENTS AND ESTIMATES
The discussion and analysis of our financial condition and results of
operations are based on our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
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
14
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) and
TransactionMinder(R) products and related services. We generate our services
revenues 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
revenues 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 revenues 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 revenues 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 a signed license agreement and/or a purchase
order with binding terms and conditions as evidence of an arrangement. For
arrangements with multiple obligations (for example, product, undelivered
maintenance and support, training and consulting), we allocate revenues 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.
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 revenues 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 revenues 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 generally 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.
15
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 June 30, 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 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 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 estimating our actual current exposure together with
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 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 against our net deferred tax assets as of June 30,
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
16
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 current 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 four to five 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.
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 excluded directors and non-employees of Netegrity,
expired on September 23, 2002 and 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 was equal to the number of shares underlying the
cancelled eligible options, except that certain options granted to certain
executive officers were 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 was equal to the fair market value of one share of common stock on
the date of grant of the new options as determined in accordance with the
applicable option plans. Each new option will vest in accordance with a 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.
17
RESULTS OF OPERATIONS
The following table presents statement of operations data as percentages of
total revenues for the periods indicated:
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
--------------- --------------
2003 2002 2003 2002
---- ---- ---- ----
STATEMENT OF OPERATIONS DATA:
Revenues:
Software licenses............................ 57% 49% 54% 56%
Services..................................... 40 47 43 40
Other........................................ 3 4 3 4
---- ---- ---- ----
Total revenues............................ 100 100 100 100
Cost of revenues:
Cost of software licenses.................... 2 2 3 2
Non-cash cost of software licenses........... 14 6 15 5
Cost of services............................. 15 23 16 20
Cost of other................................ 2 2 2 2
---- ---- ---- ----
Total cost of revenues.................... 33 33 36 29
---- ---- ---- ----
Gross profit................................... 67 67 64 71
Selling, general and administrative expenses... 55 89 59 73
Research and development expenses.............. 27 42 28 33
Non-recurring charges.......................... -- 4 -- 2
---- ---- ---- ----
Loss from operations........................... (15) (68) (23) (37)
Other income, net.............................. 2 5 2 3
---- ---- ---- ----
Loss before provision for income taxes......... (13) (63) (21) (34)
Provision for income taxes..................... -- -- -- --
---- ---- ---- ----
Net loss....................................... (13)% (63)% (21)% (34)%
---- ---- ---- ----
THE THREE AND SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO THE THREE AND SIX
MONTHS ENDED JUNE 30, 2002
The following discussion reviews the results of operations for the
three and six months ended June 30, 2003 (the "2003 Quarter" and "2003 Period",
respectively) compared to the three and six months ended June 30, 2002 (the
"2002 Quarter" and "2002 Period", respectively).
Revenues. Total revenues increased by $3.1 million or 20%, to $18.9
million in the 2003 Quarter, from $15.8 million in the 2002 Quarter, and
decreased by $2.3 million or 6%, to $35.5 million in the 2003 Period, from $37.8
million in the 2002 Period. The increase in the 2003 Quarter as compared to the
2002 Quarter was primarily due to an increase in software license revenues and
an increase in maintenance and support revenues, partially offset by a decrease
in consulting and training revenues. The decrease in total revenues in the 2003
Period as compared to the 2002 Period was primarily due to a decrease in
software license revenues and a decrease in consulting and training revenues,
partially offset by an increase in maintenance and support revenues. 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 as
information technology spending increases from the current levels our revenues
will increase. We also believe that our focus on expanding our leadership
position in the identity and access management market with our new product
offerings and the continued build-out of the leveraged model with our partners
has enabled us to acquire new customers and generate additional revenues by
selling additional products to our existing customers.
Software license revenues increased by $3.0 million or 39%, to $10.7
million in the 2003 Quarter, from $7.7 million in the 2002 Quarter. The increase
was primarily due to the sale of our new product offerings, as well as to
improved sales execution. These increases continue to be slightly offset by weak
international market conditions, particularly in Europe. While the number of new
name deals decreased from 52 in the 2002 Quarter to 28 in the 2003 Quarter, the
average size of new name deals increased from approximately $104,000 in the 2002
Quarter to approximately $148,000 in the 2003 Quarter. The number of follow on
deals increased from 47 in the 2002 Quarter to 60 in the 2003 Quarter and the
average size of follow on deals increased from approximately $81,000 in the 2002
Quarter to approximately $143,000 in the 2003 Quarter. The number of new name
deals decreased from 95 in the 2002 Period to 51 in the 2003 Period, however the
average size of new name deals increased from approximately $110,000 in the 2002
Period to approximately $145,000 in the 2003 Period. The number of follow on
deals increased from 90 in the 2002 Period to 103 in
18
the 2003 Period and the average size of follow on deals decreased from
approximately $153,000 in the 2002 Period to approximately $151,000 in the 2003
Period. The increase in the average deal size in the 2003 Quarter was primarily
related to increased sales of our IdentityMinder (TM) and TransactionMinder (R)
products, which were introduced in late 2002, as well as two deals over $1
million that led to an increase in the average deal size in the 2003 Quarter.
Services revenues remained flat at $7.5 million in both the 2003
Quarter and the 2002 Quarter. Services revenues also remained flat at $15.1
million in both the 2003 Period and the 2002 Period primarily as a result of a
$3.0 million decline in consulting and training revenues offset by an increase
of $3.1 million in maintenance and support revenues. Consulting and training
revenues decreased by $1.3 million in the 2003 Quarter as compared to 2002
Quarter and by $200,000 in the 2003 Period as compared to the 2002 Period as a
result of both broad based economic weakness and reduced technology spending
that resulted in a reduction in our customers' requests 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 710 in the 2002 Quarter to over 1,150 in the 2003
Quarter. The decreases in consulting and training revenues were offset by an
increase in maintenance and support revenues resulting from an increase in
maintenance renewals by our existing customer base.
Other revenues remained flat at $650,000 in both the 2003 Quarter and
the 2003 Quarter and decreased by $140,000 or 10%, to $1.3 million in the 2003
Period, from $1.4 million in the 2002 Period. 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 $0.9 million or
17%, to $6.2 million in the 2003 Quarter, from $5.3 million in the 2002 Quarter
and by $1.7 million or 15%, to $12.8 million in the 2003 Period, from $11.1
million in the 2002 Period. We believe that the cost of revenues will decrease
over the short term primarily as a result of the decrease in non-cash cost of
software licenses beginning in the third quarter of 2003 as the purchased
software acquired in the DataChannel acquisition was fully amortized at the end
of the second quarter of 2003. This decrease will be slightly offset by (i) the
cost of third party software products that enhance and enable our products and
(ii) increased investment in our technical support organization. Overall, we
believe that gross profit will increase in future periods as we increase our
software license revenues, which typically have higher gross profits than our
service offerings, and as a result of the capitalized software becoming fully
amortized as of June 30, 2003.
Cost of software license revenues increased by $1.8 or 138%, to $3.1
million in the 2003 Quarter, from $1.3 million in the 2002 Quarter and by $3.5
million or 125%, to $6.3 in the 2003 Period from $2.8 million in the 2002
Period. This increase is primarily due to a change in the amortization period of
purchased software recorded in connection with the DataChannel acquisition.
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 amortization expense related to the
acquired technology increased from approximately $0.9 million and $1.8 million
for the three months and six months ended June 30, 2002, respectively, to
approximately $2.7 million and $5.4 million for the three and six months ended
June 30, 2003, respectively. Overall, we believe that the cost of software
license revenues will decrease over the short term primarily as a result of the
decrease in non-cash cost of software licenses beginning in the third quarter of
2003 as the purchased software acquired in the DataChannel acquisition became
fully amortized at the end of the second quarter of 2003. This decrease will be
slightly offset by the cost of third party software products that enhance and
enable our products.
Cost of services decreased by $0.8 million or 22%, to $2.8 million in
the 2003 Quarter, from $3.6 million in the 2002 Quarter and by $1.7 million or
23%, to $5.7 million in the 2003 Period, from $7.4 million in the 2002 Period.
The decrease is primarily due to the leveraging of our system integrator partner
relationships which allowed us to reduce headcount by 61% from June 30, 2002 to
June 30, 2003 in our professional services organization resulting in a decrease
in salaries and related expenses. The cumulative number of billable consultants
we have trained at our affiliated partners increased from approximately 710 at
the end of the 2002 Quarter to over 1,150 at the end of the 2003 Quarter. The
decrease in cost of services 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 remained flat at $0.4 million in both the 2003
Quarter and the 2002 Quarter and decreased by $89,000 or 11%, to $752,000 in the
2003 Period, from $841,000 in the 2002 Period. The decrease in the 2003 Period
is in relative proportion to the decrease in revenues. Cost of other revenues
are not expected to have a significant impact in future periods.
19
Selling, general and administrative expenses. Selling, general and
administrative expenses decreased by $3.5 million or 25%, to $10.5 million in
the 2003 Quarter, from $14.0 million in the 2002 Quarter and by $6.5 million or
24%, to $21.0 million in the 2003 Period, from $27.5 million in the 2002 Period.
The decrease in both the 2003 Quarter and 2003 Period is attributable to (i) a
decrease in salaries and related expenses due to reduced headcount of 25% from
the 2002 Quarter to the 2003 Quarter (including reductions in force implemented
in April and October of 2002 and January 2003), (ii) reduced marketing and
travel related expenses, (iii) reduced legal fees, and (iv) reduced facility
related expenses, including office rent, depreciation and utilities primarily
resulting from the consolidation of field offices and the move of the corporate
headquarters to a new facility. As we continue to 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 as a percentage of total revenues
will remain flat or decrease in future periods.
Research and development costs. Research and development costs
decreased by $1.5 million or 23%, to $5.0 million in the 2003 Quarter, from $6.5
million in the 2002 Quarter and by $2.6 million or 21%, to $9.9 million in the
2003 Period, from $12.5 million in the 2002 Period. The decrease in both the
2003 Quarter and 2003 Period was primarily due to a decrease in salaries and
related expenses due to the reductions in force implemented in April and October
of 2002, which reduced headcount by 26% in these departments from the 2002
Quarter to the 2003 Quarter. These reductions were primarily related to the
decision not to continue developing, marketing or selling the PortalMinder
product on a stand-alone basis and to the continued leverage of offshore third
party contractors. 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 $0.3
million or 43%, to $0.4 million in the 2003 Quarter, from $0.7 million in the
2002 Quarter and by $0.6 million or 43%, to $0.8 million in the 2003 Period,
from $1.4 million in the 2002 Period. The decrease in both the 2003 Quarter and
2003 Period was attributable primarily to a decline in the average interest
rates earned on our marketable securities balances coupled with slightly lower
average cash and marketable securities balances as compared to the prior year.
Provision for income taxes. The provision for income taxes increased by
$59,000 or 100%, to $59,000 in the 2003 Quarter as compared to the 2002 Quarter
and by $19,000 or 48%, to $59,000 in the 2003 Period from $40,000 in the 2002
Period. The increase in both the 2003 Quarter and 2003 Period was attributable
to an increase in state and foreign taxes in the current period over the same
periods of the prior year.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities in the 2003 Period was $7.6
million, primarily due to a decrease in accounts receivable as the result of
strong cash collections in the 2003 Period and an increase in deferred revenue
as a result of an increase in maintenance renewals, partially offset by the net
loss for the period and a decrease in accrued compensation and benefits
primarily resulting from the payment during the first quarter of 2003 of
commissions earned during 2002.
Cash used in investing activities was $20.1 million in the 2003 Period.
Investing activities for the period consisted primarily of the purchases of
marketable securities of approximately $48.9 million, and the purchase of $1.4
million of property and equipment, primarily computer related equipment and
software, offset by the proceeds from sales and maturities of marketable
securities of approximately $30.0 million.
Cash provided by financing activities in the 2003 Period was
approximately $484,000, which related to the exercise of employee stock options
and stock purchased by employees as part of the employee stock purchase plan.
As of June 30, 2003, we had cash and cash equivalents totaling $13.8
million, short-term marketable securities of approximately $26.1 million and
working capital of $23.1 million. In addition, we had long-term marketable
securities totaling $53.5 million as of June 30, 2003.
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 as lower rate than domestic and direct customers. An increase
in revenues generated from international and indirect customers may increase our
accounts receivable
20
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 the
effects of general economic conditions, 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 revenues. 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.
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 worldwide 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.................. $ 10,245 $ 3,575 $ 2,781 $ 2,833 $ 1,056
Other Contractual Obligations..... 3,550 1,250 2,300 -- --
-------- ------- ------- ------- -------
Total............................. $ 13,795 $ 4,825 $ 5,081 $ 2,833 $ 1,056
======== ======= ======= ======= =======
Included in the operating lease commitments above is approximately $0.7
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
$1.0 million and $2.0 million for the three and six months ended June 30, 2003,
respectively.
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 perform the integration work for a customer, we could
potentially owe a royalty to the system integrator based on the net license fee.
As of June 30, 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. Additionally, we spent approximately $1.0 million
in leasehold improvements to build out the new facility in the six months ended
June 30, 2003.
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, respectively. The initial term of this agreement is
three years. After the first year of the agreement we have the right to
terminate the agreement without cause. As of June 30, 2003, we became obligated
to pay $0.5 million in royalties under this agreement, of which $0.2 million has
been paid and $0.3 million was accrued.
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.
21
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 repair or replace the product or 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 June 30, 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 certain damages, such as personal property damage, caused by
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 June 30, 2003.
We generally warrant for ninety days from date of delivery 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. 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 June 30, 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
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 June 30, 2003.
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 six months ended
June 30, 2003, we had a net loss of $7.4 million and an accumulated deficit of
$114.1 million as of June 30, 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
22
slowdown in the economy or in anticipation of the introduction
of new products by us or our competitors;
- market acceptance of our SiteMinder(R), IdentityMinder(TM)and
TransactionMinder(R)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 and TransactionMinder products or other
products;
- 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 distribution
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) and
TransactionMinder(R) products and related services. Broad market acceptance of
our products will depend on the continued development of a market for identity
and access management, the education of our customers on the use of business
software applications in general and the relevance of our products specifically.
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 succeed in 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 our
service center in Malaysia, whether as a result of employee attrition, acts of
terrorism or some other cause, or language barriers, 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 the business
market. We may be unable to respond effectively to technological changes or new
industry standards or
23
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.
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.
Additionally, as we continue to release new versions of our existing
software we may be required to assist customers in migrating to the latest
version once a product is announced to be at the end of its life. We could be
adversely affected if there are significant migration issues and a decline in
customer satisfaction related to such transitions.
OUR PERFORMANCE DEPENDS ON OUR ABILITY TO WIN BUSINESS AND OBTAIN FOLLOW-ON
SALES IN PROFITABLE SEGMENTS.
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 market. 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 and Sun MicroSystems. In addition, a number of other security
and software companies are beginning to offer products that may compete with our
identity and access management solution. 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 not 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
24
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.
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, particularly
if these partners decide to compete directly in the identity and access
management market. Furthermore, the relationships we do enter into may not be
successful. Our strategic relationships are generally non-exclusive, and
therefore, 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 SUPPORT OUR CUSTOMERS' DEPLOYMENT OF OUR PRODUCTS.
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
25
decisions, a process that has been, at times, 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 customer's internal review processes.
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
26
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.
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 OR
FLAWS.
Software products as complex as ours may contain undetected errors or
"bugs" that result in product failures. The occurrence of errors could result in
loss of, or delay in, revenues, loss of market share, failure to achieve market
acceptance, diversion of development resources, injury to our reputation, or
damage to our efforts to build brand awareness, any of which could have a
material adverse effect on our business, operating results and financial
condition. Additionally, the security features included in our products to
prevent unauthorized access to the application may not meet all of our
customers' requirements.
WE COULD INCUR SUBSTANTIAL COSTS RESULTING FROM PRODUCT LIABILITY CLAIMS
RELATING TO OUR CUSTOMERS' USE OF OUR PRODUCTS.
Many of the 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
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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.
As we 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. Additionally, as we continue
to sell our new products to existing customers our customers will expect us to
provide the same level of product support on the new products as we do on the
old products. This may put increased demand on our product support resources.
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
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The global economy is still weak and may continue to be weak in the
foreseeable future. In addition, the United States' continued involvement in
Iraq, as well as the political unrest in other parts of the world, have
contributed to global economic uncertainty. 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 us 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, 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 that may have similar
effects.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
FOREIGN CURRENCY
In the three and six months ended June 30, 2003, we generated
approximately 20% and 23%, respectively, 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 losses (which were $66,000 as of June 30, 2003) are
deferred and accumulated as a separate component of stockholders' equity
(accumulated other comprehensive income). Net gains and losses resulting from
foreign exchange transactions, which were $16,000 and $5,000, respectively, for
the three and six months ended June 30, 2003, are included in other income, net,
in the accompanying consolidated statements of operations. A 10% change in the
valuation of the functional currencies relative to the U.S. dollar as of June
30, 2003 would not have a material impact on our results of operations for the
three and six months ended June 30, 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 three and six months ended June 30, 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
Our management evaluated, with the participation of our Chief Executive
Officer and Chief Financial Officer, the effectiveness of our disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934) as of June 30, 2003. Based on such evaluation,
our Chief Executive Officer and Chief Financial Officer have concluded that, as
of such date, 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 regulations and are operating
in an effective manner.
No change in our internal control over financial reporting (as defined
in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act) occurred
during the fiscal quarter ended June 30, 2003 that has materially affected , or
is reasonably likely to materially affect, our internal control over financial
reporting.
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PART II. - OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 16, 2003, we held our 2003 Annual Meeting of Stockholders. At
the meeting, the votes cast for the election of directors, the sole matter
presented to our stockholders, were as follows:
Director Votes For Votes Withheld
-------- --------- --------------
Barry N. Bycoff 29,383,332 374,986
Paul F. Deninger 28,432,890 1,325,428
Eric R. Giler 28,255,805 1,502,513
Lawrence D. Lenihan, Jr. 29,235,094 523,224
Michael L. Mark 29,233,064 525,249
Ralph B. Wagner 29,411,074 347,244
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT
ITEM NO. ITEM AND REFERENCE
- -------- ----------------------------------------------------------------------------------
31.1 Rule 13a-14(a)/15(d)-14(a) Certification of President and Chief Executive Officer.
31.2 Rule 13a-14(a)/15(d)-14(a) Certification of Chief Financial Officer and Treasurer.
32.1 Section 1350 Certification of President and Chief Executive Officer.
32.2 Section 1350 Certification of Chief Financial Officer and Treasurer.
(b) Reports on Form 8-K
On April 21, 2003, we furnished a Current Report on Form 8-K dated
April 21, 2003 under Item 9 containing a copy of our earnings release for the
period ended March 31, 2003 pursuant to Item 12 (Results of Operations and
Financial Condition).
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
NETEGRITY, INC.
Date: July 28, 2003 By: /s/ Barry N. Bycoff
--------------------------------------------
Barry N. Bycoff
President, Chief Executive Officer,
Director and Chairman of the Board
Date: July 28, 2003 By: /s/ Regina O. Sommer
--------------------------------------------
Regina O. Sommer
Chief Financial Officer and Treasurer
(Principal Financial Officer and Principal
Accounting Officer)
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