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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ___________ TO ______________
COMMISSION FILE NUMBER 000-30277
SERVICEWARE TECHNOLOGIES, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 25-1647861
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
333 ALLEGHENY AVENUE, SUITE 301 NORTH
OAKMONT, PA 15139
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (412) 826-1158
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [ X ] No [ ]
The number of shares of the registrant's common stock outstanding as of
the close of business on November 8, 2002 was 24,017,790.
SERVICEWARE TECHNOLOGIES, INC.
FORM 10-Q
SEPTEMBER 30, 2002
INDEX
PART I. FINANCIAL INFORMATION PAGE NO.
--------
ITEM 1. Consolidated Financial Statements (Unaudited)
. Consolidated Balance Sheets as of September 30, 2002 and December 31, 2001..... 2
. Consolidated Statements of Operations for the three and nine months
ended September 30, 2002 and 2001.............................................. 3
. Consolidated Statements of Stockholders' Equity for the six months ended
June 30, 2002 and the three months ended September 30, 2002.................... 4
. Consolidated Statements of Cash Flows for the nine months ended
September 30, 2002 and 2001.............................................. 5
. Notes to Consolidated Financial Statements..................................... 6
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................. 11
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk..................... 24
ITEM 4. Controls and Procedures........................................................ 25
PART II. OTHER INFORMATION
ITEM 6. Exhibits and Reports on Form 8-K.................................................... 26
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS
SEPTEMBER 30, DECEMBER 31,
2002 2001
-------- --------
(Unaudited)
ASSETS
Current assets
Cash and cash equivalents $ 1,379 $ 4,790
Short term investments 2,002 --
Accounts receivable, less allowance for doubtful accounts of $171 as of September 30,
2002 and $376 in 2001 1,572 1,981
Other current assets 712 998
-------- --------
Total current assets 5,665 7,769
Non current assets
Purchased technology, net of amortization of $1,786 as of September 30, 2002 and
$1,448 in 2001 96 333
Property and equipment
Office furniture, equipment, and leasehold improvements 1,945 2,189
Computer equipment 6,257 6,533
-------- --------
Total property and equipment 8,202 8,722
Less accumulated depreciation (6,597) (5,805)
-------- --------
Property and equipment, net 1,605 2,917
Intangible assets, net of accumulated amortization of $12,370 as of September 30, 2002
and $12,091 in 2001 2,538 2,817
Other non current assets 56 50
-------- --------
Total non current assets 4,295 6,117
-------- --------
Total assets $ 9,960 $ 13,886
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable 853 628
Accrued compensation and benefits 259 801
Deferred revenue - licenses 90 940
Deferred revenue - services 2,444 2,783
Restructuring reserve 174 1,052
Other current liabilities 590 929
-------- --------
Total current liabilities 4,410 7,133
Non current convertible debt, net of unamortized discount of $1,939 1,311 --
Non current deferred revenue - services 13 293
Other non current liabilities 106 150
-------- --------
Total liabilities 5,840 7,576
Stockholders' equity
Common stock, $0.01 par; 100,000 shares authorized, 24,685 and 24,655 shares issued
and 24,018 and 23,828 shares outstanding in 2002 and 2001, respectively 247 247
Additional paid in capital 74,070 71,774
Treasury stock, 667 and 827 shares in 2002 and 2001, respectively (248) (307)
Deferred compensation and other (17) (114)
Warrants 1,414 1,414
Accumulated other comprehensive loss:
Currency translation account (33) (24)
Deficit (71,313) (66,680)
-------- --------
Total stockholders' equity 4,120 6,310
-------- --------
Total liabilities and stockholders' equity $ 9,960 $ 13,886
======== ========
See accompanying notes to the financial statements.
2
CONSOLIDATED STATEMENTS OF OPERATIONS
AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS
(UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2002 2001 2002 2001
-------- -------- -------- --------
Revenues
Licenses $ 712 $ 707 $ 3,134 $ 3,204
Services 1,474 1,538 4,549 4,834
-------- -------- -------- --------
Total revenues 2,186 2,245 7,683 8,038
Cost of revenues
Cost of licenses 192 594 809 2,092
Cost of services 846 1,003 2,765 7,582
-------- -------- -------- --------
Total cost of revenues 1,038 1,597 3,574 9,674
-------- -------- -------- --------
Gross margin 1,148 648 4,109 (1,636)
Operating expenses
Sales and marketing 1,439 2,161 3,903 11,882
Research and development 800 1,568 1,974 5,614
General and administrative 679 756 2,386 2,867
Intangible assets amortization 79 1,166 279 3,695
Restructuring and other non-recurring charges (90) 2,929 (429) 5,186
-------- -------- -------- --------
Total operating expenses 2,907 8,580 8,113 29,244
-------- -------- -------- --------
Loss from operations (1,759) (7,932) (4,004) (30,880)
Other income (expense)
Interest expense (508) (30) (702) (73)
Other (net) 24 (39) 73 481
-------- -------- -------- --------
Other income (expense), net (484) (69) (629) 408
-------- -------- -------- --------
Net loss from continuing operations (2,243) (8,001) (4,633) (30,472)
Net income from discontinued operations -- 557 -- 1,240
Net gain from disposal of a business segment -- 532 -- 532
-------- -------- -------- --------
Net loss $ (2,243) $ (6,912) $ (4,633) $(28,700)
======== ======== ======== ========
Net (loss) income per common share, basic and diluted:
Continuing operations $ (0.09) $ (0.34) $ (0.19) $ (1.25)
Discontinued operations -- 0.05 -- 0.07
-------- -------- -------- --------
Net loss per share $ (0.09) $ (0.29) $ (0.19) $ (1.18)
======== ======== ======== ========
Shares used in computing per share amounts 24,018 23,871 23,928 24,220
======== ======== ======== ========
See accompanying notes to the financial statements.
3
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS
(UNAUDITED)
ADDITIONAL
COMMON STOCK PAID IN TREASURY STOCK
SHARES AMOUNT CAPITAL SHARES AMOUNT
-------- -------- -------- -------- --------
Balance at December 31, 2001 23,828 $ 247 $ 71,774 827 $ (307)
Exercise of stock options 160 -- (13) (160) 59
Issuance of stock for Employee Stock Purchase Plan 30 -- 6 -- --
Stock based compensation -- -- 78 -- --
Amortization of warrants -- -- -- -- --
Beneficial conversion feature of convertible notes -- -- 2,225 -- --
Comprehensive loss:
Currency translation adjustment -- -- -- -- --
Net loss -- -- -- -- --
Total comprehensive loss -- -- -- -- --
-------- -------- -------- -------- --------
Balance at June 30, 2002 24,018 $ 247 $ 74,070 667 $ (248)
Amortization of warrants -- -- -- -- --
Comprehensive loss:
Currency translation adjustment -- -- -- -- --
Net loss -- -- -- -- --
Total comprehensive loss -- -- -- -- --
-------- -------- -------- -------- --------
Balance at September 30, 2002 24,018 $ 247 $ 74,070 667 $ (248)
======== ======== ======== ======== ========
ACCUMULATED
DEFERRED OTHER TOTAL
COMPENSATION COMPREHENSIVE STOCKHOLDERS'
AND OTHER WARRANTS (LOSS) GAIN DEFICIT EQUITY
-------- -------- -------- -------- --------
Balance at December 31, 2001 $ (114) $ 1,414 $ (24) $(66,680) $ 6,310
Exercise of stock options -- -- -- -- 46
Issuance of stock for Employee Stock Purchase Plan -- -- -- -- 6
Stock based compensation -- -- -- -- 78
Amortization of warrants 88 -- -- -- 88
Beneficial conversion feature of convertible notes -- -- -- -- 2,225
Comprehensive loss:
Currency translation adjustment -- -- (4) -- (4)
Net loss -- -- -- (2,390) (2,390)
-------- -------- --------
Total comprehensive loss -- -- (4) (2,390) (2,394)
-------- -------- -------- -------- --------
Balance at June 30, 2002 $ (26) $ 1,414 $ (28) $(69,070) $ 6,359
Amortization of warrants 9 -- -- -- 9
Comprehensive loss:
Currency translation adjustment -- -- (5) -- (5)
Net loss -- -- -- (2,243) (2,243)
-------- -------- --------
Total comprehensive loss -- -- (5) (2,243) (2,248)
-------- -------- -------- -------- --------
Balance at September 30, 2002 $ (17) $ 1,414 $ (33) $(71,313) $ 4,120
======== ======== ======== ======== ========
See accompanying notes to the financial statements.
4
CONSOLIDATED STATEMENTS OF CASH FLOWS
AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
2002 2001
-------- --------
Cash flows from operating activities
Net loss $ (4,633) $(28,700)
Adjustments to reconcile net loss to net cash used in operations:
Non cash items:
Depreciation and amortization 2,020 6,013
Amortization of beneficial conversion feature related to convertible notes 543 --
Stock based compensation 78 1,834
Gain on disposal of a business segment -- (532)
Other non cash items (15) 8
Changes in operating assets and liabilities:
Decrease in accounts receivable 410 1,526
Decrease in other assets 279 1,998
Increase (decrease) in accounts payable 225 (1,870)
(Decrease) increase in accrued compensation (541) 332
Decrease in deferred revenue (954) (2,015)
(Decrease) increase in other liabilities (1,470) 574
Decrease in net current liability of discontinued operations -- (1,300)
-------- --------
Net cash used in operating activities (4,058) (22,132)
-------- --------
Cash flows from investing activities
Purchases of short term investments (2,002) (1,951)
Sales of short term investments -- 12,100
Payment for purchase of InfoImage assets (100) --
Property and equipment acquisitions (12) (769)
Proceeds from sale of assets 13 42
-------- --------
Net cash (used in) provided by investing activities (2,101) 9,422
-------- --------
Cash flows from financing activities
Repayments of principal of capital lease obligations (28) (44)
Repayments of principal of term loans (258) (129)
Proceeds from issuance of convertible notes, net of debt issuance costs 2,993 --
Proceeds from borrowing under revolving line of credit -- 1,000
Proceeds from stock option exercises 52 165
-------- --------
Net cash provided by financing activities 2,759 992
Effect of exchange rate changes on cash (11) (5)
Decrease in cash and cash equivalents (3,411) (11,723)
Cash and cash equivalents at beginning of period 4,790 12,048
-------- --------
Cash and cash equivalents at end of period $ 1,379 $ 325
======== ========
Supplemental disclosures of cash flow information:
Cash paid for interest $ 18 $ 55
======== ========
See accompanying notes to the financial statements.
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002
(UNAUDITED)
NOTE 1. ORGANIZATION OF THE COMPANY
ServiceWare is a leading provider of enterprise Knowledge Management (KM)
solutions that enable organizations to deliver superior service for customers,
employees and partners by transforming information into knowledge.
ServiceWare's Web-based eService Suite(TM) software, powered by MindSync(TM), a
patented self-learning search technology, enables organizations to first capture
intellectual capital and then manage this repository of corporate knowledge. The
knowledge base can then be easily accessed via a browser to effectively answer
inquiries made either over the Web, e-mail, chat, or through the telephone to a
customer contact center or help desk.
Customers use ServiceWare's Knowledge Management solutions to:
- Strengthen relationships with customers, partners, suppliers
and employees
- Decrease operating costs
- Improve creation, dissemination and sharing of enterprise
knowledge
- Integrate seamlessly with existing technology investments
eService Suite is a software solution that allows ServiceWare customers to
provide personalized, automated Web-based service tailored to the needs of their
users. eService Suite enables businesses to capture enterprise knowledge, solve
customer problems, reuse solutions and share captured knowledge throughout the
extended enterprise. It also enables the extended enterprise to access this
knowledge online. In addition, through the self-learning features of
ServiceWare's patented MindSync technology, the solutions generated by these
products are intelligent in that they have the capability to learn from each
interaction and automatically update themselves accordingly. eService Suite
includes the software products eService Site(TM) (Web-based self-service for
customers, partners and employees), eService Professional(TM) (for customer
service, sales and field service personnel) and eService Architect(TM) (for
knowledge managers, subject matter experts and system administrators).
Previously, the Company had two reportable business segments: Software and
Content. However, on July 20, 2001, the Company completed the sale of all of its
Content segment to RightAnswers LLC ("RightAnswers"). The Content segment is
reported as a discontinued operation, and all previously reported financial
information has been restated accordingly. See Note 7.
NOTE 2. UNAUDITED INTERIM FINANCIAL INFORMATION
The accompanying unaudited balance sheet as of September 30, 2002 and related
unaudited consolidated statements of operations for the three and nine months
ended September 30, 2002 and 2001, unaudited consolidated statements of cash
flows for the nine months ended September 30, 2002 and 2001 and the unaudited
consolidated statement of stockholders' equity for the six and three months
ended June 30 and September 30, 2002 have been prepared by the Company in
accordance with accounting principles generally accepted in the United States
for interim financial information and Article 10 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by U.S.
generally accepted accounting principles for complete financial statements.
Management believes that the interim financial statements include all
adjustments, consisting of normal recurring accruals, considered necessary for a
fair presentation of the results of interim periods. Operating results for the
three and nine months ended September 30, 2002 are not necessarily indicative of
the results that may be expected for the year ending December 31, 2002. These
unaudited consolidated financial statements should be read in conjunction with
the consolidated financial statements and notes thereto included in the
Company's 2001 Annual Report on Form 10-K filed with the Securities and Exchange
Commission.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries after elimination of all significant intercompany
accounts and transactions.
RECLASSIFICATION
Certain prior period amounts have been reclassified to conform to current year
presentation. Effective January 1, 2002, the Company adopted Emerging Issues
Task Force Number 01-14, "Income Statement Characterization of Reimbursements
Received for 'Out-of-Pocket' Expenses Incurred" (EITF 01-14), which requires
that reimbursements received for out-of-
6
pocket expenses be classified as revenues and not as cost reductions. Before the
effective date of EITF 01-14, the Company netted out-of-pocket reimbursements
from customers with the applicable costs. These items include primarily travel,
meals and certain telecommunication costs. EITF 01-14 requires restatement of
all periods presented in order to reflect reimbursed expenses as both revenues
and costs. During the three months ended September 30, 2002 and 2001, reimbursed
expenses totaled approximately $65,000 and $133,000, respectively. During the
nine months ended September 30, 2002 and 2001, reimbursed expenses totaled
approximately $207,000 and $375,000, respectively. Total reimbursed expenses for
the full-year 2001 totaled approximately $473,000. While the adoption of EITF
01-14 has no impact on income from operations or net income, it does reduce
total operating margins since both revenues and costs increase by the same
amount.
NOTE 3. NET LOSS PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share:
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2002 2001 2002 2001
-------- -------- -------- --------
(in thousands)
Numerator:
Net loss from continuing operations $ (2,243) $ (8,001) $ (4,633) $(30,472)
Net income from discontinued operations -- 557 -- 1,240
Net gain from disposal of a business segment -- 532 -- 532
-------- -------- -------- --------
Net loss (2,243) (6,912) (4,633) (28,700)
======== ======== ======== ========
Denominator:
Denominator for basic and diluted earnings per
share -weighted average shares 24,018 23,871 23,928 24,220
======== ======== ======== ========
Basic and diluted net (loss) income per share:
Continuing operations $ (0.09) $ (0.34) $ (0.19) $ (1.25)
Discontinued operations -- 0.05 -- 0.07
-------- -------- -------- --------
Net loss per share $ (0.09) $ (0.29) $ (0.19) $ (1.18)
======== ======== ======== ========
Dilutive securities include convertible notes, options and warrants as if
converted. Potentially dilutive securities totaling 17,183,204 and 5,437,004
shares as of September 30, 2002 and 2001, respectively, were excluded from
historical basic and diluted loss per share because of their antidilutive
effect.
NOTE 4. ADOPTION OF NEW ACCOUNTING STANDARD
Effective January 1, 2002, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
("SFAS 142"). This statement modifies the financial accounting and reporting for
goodwill and other intangible assets, including the requirement that goodwill
and certain intangible assets no longer be amortized. This new standard also
requires an annual impairment review to be performed. As a result of the
adoption of SFAS 142, amortization expense for the three and nine months ended
September 30, 2002 decreased by approximately $258,000 and $2,324,000,
respectively, compared to the three and nine months ended September 30, 2001 due
to the discontinuance of amortization expense related to goodwill. Aside from
this change in accounting for goodwill, no other change in accounting for
intangible assets was required as a result of the adoption of SFAS 142 based on
the nature of the Company's intangible assets. In accordance with SFAS 142, the
Company had six months from the initial date of adoption, or until June 30,
2002, to complete its transitional impairment review. This review was completed,
and it was determined that there is no impairment at this time.
The following table reflects the effect of the adoption of SFAS 142 on net
income and net income per share as if SFAS 142 had been in effect for the period
presented:
7
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2002 2001 2002 2001
---------- ---------- ---------- ----------
(in thousands)
Net income:
As reported $ (2,243) $ (6,912) $ (4,633) $ (28,700)
Goodwill amortization -- 1,033 -- 3,098
---------- ---------- ---------- ----------
As adjusted $ (2,243) $ (5,879) $ (4,633) $ (25,602)
========== ========== ========== ==========
Basic and diluted net income per share:
As reported $ (0.09) $ (0.34) $ (0.19) $ (1.25)
Goodwill amortization -- 0.04 -- 0.13
---------- ---------- ---------- ----------
As adjusted $ (0.09) $ (0.30) $ (0.19) $ (1.12)
========== ========== ========== ==========
Intangible assets resulted primarily from the acquisition of Molloy Group on
July 23, 1999 and consist of the following:
Amortization
Description Amount Period
- -----------------------------------------------------------------------------------------
(in thousands)
Value of employees $ 1,042 2 years
Customer list 1,043 4 years
Noncompetition agreement 345 3 years
Goodwill 12,394 3 years
--------
Total intangible assets resulting from the Molloy acquisition 14,824
Payment for rights to the "ServiceWare" name 75 3 years
Other 9 1 year
--------
Total intangible assets 14,908
Less accumulated amortization at September 30, 2002 (12,370)
--------
Intangible assets, net $ 2,538
========
Intangible assets are recorded at cost, net of accumulated amortization.
Amortization is computed using the straight-line method over the estimated
useful lives of the related assets (one to four years).
Future aggregate amortization expense related to intangible assets other than
goodwill is as follows:
Year Ending December 31, (in thousands)
------------------------
Remainder of 2002 $ 67
2003 147
--------------------
$ 214
====================
NOTE 5. RECEIVABLES
Receivables consist of the following:
SEPTEMBER 30, DECEMBER 31,
2002 2001
------- -------
(in thousands)
Billed receivables $ 1,731 $ 1,262
Unbilled receivables 12 1,095
------- -------
1,743 2,357
Allowance for doubtful accounts (171) (376)
------- -------
Net receivables $ 1,572 $ 1,981
======= =======
Unbilled receivables consist of non-cancelable, non-refundable amounts that are
billable by the Company at future dates based on contractual payment terms and
travel expenses to be billed to customers.
8
NOTE 6. DEBT
CREDIT FACILITIES
On October 16, 2002, the Company entered into a loan and security agreement with
Comerica Bank - California (see Note 9).
Previously, the Company had a secured credit facility with PNC Bank. In April
2002, the remaining outstanding loan of $200,820 was repaid in full. At December
31, 2001, $258,197 was outstanding and classified as other current liabilities
due to the uncertainty of the Company's ability to meet the new loan covenants.
CONVERTIBLE NOTES
On April 1, 2002, the Company signed a binding commitment letter for the sale of
Convertible Notes. The closing of the transaction took place in two tranches on
May 6 and June 19, 2002 with total proceeds of $2,975,000 being received, net of
transaction costs of $275,000.
Of the total amount of $3,250,000 of Convertible Notes issued, Convertible Notes
with an aggregate principal amount of $2,635,000 were acquired by a Director of
the Company and his affiliated entities, who collectively owned approximately
20% of the Company's stock prior to the acquisition of Convertible Notes.
The notes mature 18 months from the closing date, bear interest at 10% per
annum, and are convertible at any time at the option of the holder, into shares
of the Company's common stock at a conversion price of $0.30 per share. Interest
can be paid in cash or additional notes, at the option of the Company. The Notes
are senior unsecured obligations that will rank senior to all future
subordinated indebtedness, pari passu to all existing and future senior,
unsecured indebtedness and subordinated to all existing and future senior
secured indebtedness.
In accordance with EITF 00-27, the Company recognized a beneficial conversion
feature ("BCF") in the aggregate amount of $2,225,000 as the difference between
the market value of the Company's common stock on the commitment date and the
conversion price of the Notes, reduced for the investors' transaction costs. The
BCF was recorded as an increase in additional paid in capital and a discount on
debt on the accompanying balance sheet. Additionally, the Company incurred total
legal and other expenses of approximately $47,000 related to the transaction
which is also recorded as a discount on debt in the accompanying balance sheet.
The aggregate discount is being amortized as interest expense over the 18 month
term of the Notes.
NOTE 7. DISCONTINUED OPERATIONS
On July 20, 2001, the Company completed the sale of its Content business segment
to RightAnswers. The sale was completed in accordance with the terms of a
Purchase and Sale Agreement (the "Agreement"), dated July 20, 2001, between the
Company and RightAnswers.
RightAnswers is a limited liability company that was formed to acquire the
Company's Content business. The Chief Executive Officer of RightAnswers, Mark
Finkel, was the Company's Chief Financial Officer from January 2000 to July
2001. In addition, Mr. Finkel owns an equity interest in RightAnswers.
The consideration for the business consisted of the assumption of approximately
$0.5 million of net liabilities associated with the business. Revenues for the
Content segment were $0.2 million and $2.9 million for the three and nine months
ended September 30, 2001, respectively.
NOTE 8. RESTRUCTURING AND OTHER NON-RECURRING CHARGES
In February 2001, the Company announced a strategic restructuring to reduce its
cost structure and focus on revenue growth opportunities in the Knowledge
Management software market. The plan of restructuring approved by the Board of
Directors required a charge to operations of approximately $1,856,000. Costs of
the plan included severance and other benefit costs of $471,000, costs for
reduction and relocation of facilities of $1,231,000, termination costs for
certain service contracts of $115,000 and an equipment write off of $39,000. As
part of the restructuring plan, 55 employees were laid off on February 28, 2001.
In July 2001, the Company announced a revision to its organizational structure
and a workforce reduction of 75 employees, or approximately 40% of its workforce
at that time. As a result, the Company recognized a charge of approximately
$550,000 in the third quarter of 2001. In October 2001, the Company announced a
workforce reduction of approximately 50 people to further reduce its cost
structure. As a result, the Company recognized a charge of approximately
$390,000 in the fourth quarter of 2001.
As of September 30, 2002, $1,985,000 of costs related to the restructuring plans
had been paid of which $477,000 was paid during the first nine months of 2002.
9
A portion of the restructuring charge related to potential costs for terminating
certain real estate leases at the Company's corporate headquarters, in addition
to amounts related to unused capacity within the building. The Company has been
successful in sub-leasing much of the unused capacity and consequently reduced
its reserve for excess capacity by $231,000 and $99,000 in the fourth quarter of
2001 and second quarter of 2002, respectively. Additionally, management has
decided not to terminate the lease on the property as anticipated and
accordingly has reversed approximately $302,000 in exit reserves in the second
quarter of 2002. Furthermore, a change in the estimate of the termination costs
for certain service contracts was recorded as a reduction to the restructuring
expense in third quarter 2002.
The remaining restructuring liability of $174,000, related to reduction of
facilities and certain contracts, is expected to be fully amortized by June
2003.
Other non-recurring charges consist of severance costs for senior executives,
forgiveness of loans in connection with repurchases of common stock, and income
tax gross-ups related to the loan forgiveness. The restructuring and other
non-recurring charges of separated executives consist of the following amounts:
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2002 2001 2002 2001
------ ------ ------ ------
(in thousands)
Restructuring costs $ (90) $ 550 $ (492) $2,406
Other severance costs -- 392 -- 579
Executive loan forgiveness and related tax
costs -- 1,987 63 2,201
------ ------ ------ ------
Total restructuring and other non-recurring charges $ (90) $2,929 $ (429) $5,186
====== ====== ====== ======
NOTE 9. SUBSEQUENT EVENTS
On October 16, 2002, the Company entered into a $2.5 million loan and security
agreement with Comerica Bank - California (the "Bank"). The agreement allows for
a revolving line of credit and a term loan. Borrowings on the revolving line can
be in amounts up to the lesser of $2.0 million or 75% of eligible receivables
and mature October 1, 2003. Such amounts will bear interest at a rate of 1.5%
above the Bank's prime rate. Advances of up to $0.5 million on the term loan can
be taken until October 16, 2003, and the term loan will mature one year from the
date of the advance. Such amounts are to be repaid in 12 monthly installments
and will bear interest at the Bank's prime rate. In conjunction with this loan
agreement, a Warrant was issued to the Bank to purchase 50,000 shares of the
Company's Common Stock at an exercise price of $0.46 per share, with a 10-year
maturity. The Warrant includes assignability to Bank's affiliates, antidilution
protection and a net exercise provision. In addition, the Bank can require the
Company to repurchase the Warrant for $69,000 after a change of control.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our consolidated financial
statements and related notes contained in this Quarterly Report on Form 10-Q
("Form 10-Q").
Certain statements contained in this Form 10-Q that are not historical facts,
including those statements that refer to our plans, prospects, expectations,
strategies, intentions, hopes and beliefs, constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. You should not place undue reliance on these forward-looking
statements. These statements involve known and unknown risks, uncertainties and
other factors that may cause our actual results, levels of activity, performance
or achievements to be materially different from any expressed or implied by
these forward-looking statements. We assume no obligation to update these
forward-looking statements as circumstances change in the future. In some cases,
you can identify forward-looking statements by terminology such as "may",
"will", "should", "expects", "plans", "anticipates", "believes", "estimates",
"predicts", "potential", "continue", or the negative of these terms or other
comparable terminology. For a description of some of the risk factors that could
cause our results to differ materially from our forward looking statements,
please refer to the risk factors set forth in the section entitled "Additional
Factors that May Affect Future Results" on page 18 of this Form 10-Q, as well as
to our other filings with the Securities and Exchange Commission and to other
factors discussed elsewhere in this Form 10-Q.
OVERVIEW
ServiceWare is a leading provider of enterprise Knowledge Management (KM)
solutions that enable organizations to deliver superior service for customers,
employees and partners by transforming information into knowledge. Founded in
1991 in Oakmont, Pennsylvania, we sell our products throughout the United States
and have a European subsidiary based in the United Kingdom.
ServiceWare's Web-based eService Suite(TM) software, powered by MindSync(TM), a
patented self-learning search technology, enables organizations to first capture
intellectual capital and then manage this repository of corporate knowledge. The
knowledge base can then be easily accessed via a browser to effectively answer
inquiries made either over the Web, e-mail, chat, or through the telephone to a
customer contact center or help desk.
Customers use ServiceWare's Knowledge Management solutions to:
- Strengthen relationships with customers, partners, suppliers
and employees
- Decrease operating costs
- Improve creation, dissemination and sharing of enterprise
knowledge
- Integrate seamlessly with existing technology investments
eService Suite is a software solution that allows ServiceWare customers to
provide personalized, automated Web-based service tailored to the needs of their
users. eService Suite enables businesses to capture enterprise knowledge, solve
customer problems, reuse solutions and share captured knowledge throughout the
extended enterprise. It also enables the extended enterprise to access this
knowledge online. In addition, through the self-learning features of
ServiceWare's patented MindSync technology, the solutions generated by these
products are intelligent in that they have the capability to learn from each
interaction and automatically update themselves accordingly. eService Suite
includes the software products eService Site(TM) (Web-based self-service for
customers, partners and employees), eService Professional(TM) (for customer
service, sales and field service personnel) and eService Architect(TM) (for
knowledge managers, subject matter experts and system administrators).
Previously, we had two reportable business segments: Software and Content.
However, on July 20, 2001, we completed the sale of all of our Content segment
to RightAnswers LLC ("RightAnswers"). The Content segment is reported as a
discontinued operation, and all previously reported financial information has
been restated accordingly. See Note 7 to our consolidated financial statements.
In response to poor financial performance and the economic downturn, during 2001
we announced strategic corporate restructuring programs pursuant to which we
have significantly reduced costs and we have focused our business exclusively on
revenue growth opportunities in our Software business. As part of the
restructuring plans, approximately 55, 75 and 50 employees were laid off in
February, July and October 2001, respectively. As a result, our net loss for
first nine months of 2002 decreased to $4.6 million, or $0.19 per share,
compared to a loss of $28.7 million, or $1.18 per share for the first nine
months of 2001.
On February 14, 2002, we received a compliance notice from The Nasdaq Stock
Market. In this letter, Nasdaq informed us that our common stock had failed to
maintain a minimum bid price per share of $1.00 over the last 30 consecutive
trading days, as required by The Nasdaq National Market under Marketplace Rule
4450(a)(5).
11
In response to the letter from Nasdaq, we submitted an application to transfer
the listing of our common stock to The Nasdaq SmallCap Market. This application
was granted and our common stock has been trading on the Nasdaq SmallCap Market
since April 24, 2002. As a result, the grace period for the delisting
determination was extended until August 13, 2002. As we continued to meet the
initial listing criteria for the SmallCap Market under Marketplace Rule
4310(c)(2)(A), we were afforded an additional 180-day grace period which has now
extended our grace period until February 2003. However, there can be no
assurance that we will remain compliant with the applicable continued listing
requirements.
If our common stock is unable to meet the minimum maintenance requirements
during the extended grace periods, then we would be subject to delisting from
the Nasdaq SmallCap Market. In that event, we would be notified of any Nasdaq
staff determination to this effect and we would then have the right to appeal
such a delisting determination to the Nasdaq Listings Qualifications Panel. We
allowed this authority to expire since we continue to qualify for extensions. As
necessary, we intend to consider implementing a reverse stock split if we
believe it would increase the probability that we would be able to continue to
meet the Nasdaq SmallCap Market listing requirements.
On August 21, 2002, we acquired all existing technology assets, certain customer
and vendor contracts of InfoImage, Inc., a privately held enterprise portal
company which filed for bankruptcy protection prior to our agreement to acquire
these assets. We paid initial consideration of $100,000 and will pay contingent
consideration not to exceed a total of $1.5 million to be predominantly based on
future sales of InfoImage products and services. InfoImage's feature product,
Decision Portal, provides companies with an enterprise portal framework that
consolidates key information from disparate data sources and provides
collaboration tools in one unified view.
FACTORS AFFECTING FUTURE OPERATIONS
Our operating losses, as well as our negative operating cash flow, have been
significant to date. We expect to have positive operating margins over time by
increasing our customer base without significantly increasing related capital
expenditures and other operating costs. We do not know if we will be able to
achieve these objectives.
DESCRIPTION OF STATEMENT OF OPERATIONS
Revenues
We market and sell our products primarily in North America through our direct
sales force. Internationally, we market our products through value-added
resellers, software vendors and system integrators as well as our direct sales
force. International revenues were 7% and 8% of total revenues in the first nine
months of 2002 and fiscal 2001. We derive our revenues from licenses for
software products and from providing related services, including installation,
training, consulting, customer support and maintenance contracts. License
revenues primarily represent fees for perpetual licenses. Service revenues
contain variable fees for installation, training and consulting, reimbursements
for travel expenses that are billed to customers, as well as fixed fees for
customer support and maintenance contracts. We recognize revenues on license
fees after a non-cancelable license agreement is signed, the product is
delivered, the fee is fixed, determinable and collectable, and there is
vendor-specific objective evidence to support the allocation of the total fee to
elements of a multiple-element arrangement using the residual method. We
recognize revenues on installation, training and consulting on a
time-and-material basis. Customer support and maintenance contracts are
recognized over the life of the contract.
Cost of Revenues
Cost of license revenues consists primarily of the expenses related to
royalties, the cost of media on which our product is delivered, product
fulfillment costs, amortization of purchased technology, and salaries, benefits,
direct expenses and allocated overhead costs related to product fulfillment.
Cost of service revenues consists of the salaries, benefits, direct expenses and
allocated overhead costs of customer support and services personnel,
reimbursable expenses for travel that are billed to customers, fees for
sub-contractors, and the costs associated with maintaining our customer support
site.
Operating Costs
We classify our core operating costs into four general categories: sales and
marketing, research and development, general and administrative, and intangible
assets amortization based upon the nature of the costs. Special one time
charges, including restructuring costs, are presented separately as
restructuring and other non-recurring charges to enable the reader to determine
core operating costs. We allocate the total costs for overhead and facilities,
based upon headcount, to each of the functional areas that benefit from these
services. Allocated charges include general overhead items such as building
rent, equipment-leasing costs, telecommunications charges and depreciation
expense. Sales and marketing expenses consist primarily of
12
employee compensation for direct sales and marketing personnel, travel, public
relations, sales and other promotional materials, trade shows, advertising and
other sales and marketing programs. Research and development expenses consist
primarily of expenses related to the development and upgrade of our proprietary
software and other technologies. These expenses include employee compensation
for software developers and quality assurance personnel and third-party contract
development costs. General and administrative expenses consist primarily of
compensation for personnel and fees for outside professional advisors.
Intangible assets amortization expense consists primarily of the amortization of
intangible assets acquired through our acquisition of the Molloy Group in 1999.
These assets (other than goodwill) are amortized on a straight line basis over
their respective estimated useful lives. Restructuring and other non-recurring
charges consist of costs incurred for restructuring plans and other costs
related to the separation of senior executives.
Restructuring and Other Non-recurring Charges
In 2001, we announced strategic restructurings to reduce our cost structure and
focus on revenue growth opportunities in the Knowledge Management software
market. The plans of restructurings approved by our Board of Directors included
severance and other benefit costs, costs for reduction and relocation of
facilities, termination costs for certain service contracts and an equipment
write off.
A portion of the restructuring charges related to potential costs for
terminating certain real estate leases at its corporate headquarters, in
addition to amounts related to unused capacity within the building. We have been
successful in sub-leasing much of the unused capacity and consequently we
reduced our reserve for excess capacity. Additionally, we decided not to
terminate our lease on the property as anticipated and accordingly have reversed
exit reserves. The remaining restructuring liability related to reduction of
facilities and certain contracts, is expected to be fully amortized through June
2003.
Other non-recurring charges consist of severance costs for senior executives,
forgiveness of loans in connection with repurchases of common stock, and income
tax gross-ups related to the loan forgiveness.
Discontinued Operations
We sold our Content business segment in July 2001. As a result, all financial
data for the Content business has been presented separately as discontinued
operations. Financial information for prior periods has been restated
accordingly.
Net income from discontinued operations represents the net results of operations
of the Content business through July 20, 2001, the date of sale.
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of operations
is based upon our consolidated financial statements, which have been prepared in
accordance with generally accepted accounting principles. The preparation of
these financial statements requires us to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenues and expenses, and
related disclosure of contingent assets and liabilities. On an on-going basis,
we evaluate our estimates, including those related to allowance for doubtful
accounts and intangible assets. We base our estimates on historical experience
and on various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions. We believe the following critical accounting policies
affect our more significant judgments and estimates used in the preparation of
our consolidated financial statements.
Accounts Receivable
We perform a quarterly analysis to determine the appropriate allowance for
doubtful accounts. This analysis includes a review of specific individual
balances in our accounts receivable, our history of collections, as well as the
overall economic environment.
Intangible Assets
Since adoption of SFAS No. 142, goodwill is no longer amortized but instead is
assessed for impairment at least as often as annually and as triggering events
occur. In making this assessment, we rely on a number of factors including
operating results, business plans, economic projections, anticipated future cash
flows, and transactions and market place data. There are inherent uncertainties
related to these factors and management's judgement in applying them to the
analysis of goodwill impairment. Since our judgement is involved in performing
goodwill valuation analyses, there is risk that the carrying value of our
goodwill may be overstated or understated. We have determined that there is no
impact of adopting this new standard under the transition provisions of SFAS No.
142.
13
RESULTS OF OPERATIONS
The following table sets forth the consolidated statement of operations data as
a percentage of total revenues for each of the periods indicated:
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2002 2001 2002 2001
----- ----- ----- -----
Revenues
Licenses 32.6% 31.5% 40.8% 39.9%
Services 67.4 68.5 59.2 60.1
----- ----- ----- -----
Total revenues 100.0 100.0 100.0 100.0
Cost of revenues
Cost of licenses 8.8 26.5 10.5 26.0
Cost of services 38.7 44.7 36.0 94.3
----- ----- ----- -----
Total cost of revenues 47.5 71.2 46.5 120.4
----- ----- ----- -----
Gross margin 52.5 28.8 53.5 (20.4)
Operating expenses
Sales and marketing 65.8 96.3 50.8 147.8
Research and development 36.6 69.8 25.7 69.8
General and administrative 31.0 33.7 31.1 35.7
Intangible assets amortization 3.6 51.9 3.6 46.0
Restructuring and other non-recurring charges (4.1) 130.4 (5.6) 64.5
----- ----- ----- -----
Total operating expenses 133.0 382.1 105.6 363.8
----- ----- ----- -----
Loss from operations (80.5) (353.3) (52.1) (384.2)
Other income (expense), net (22.2) (3.1) (8.2) 5.1
----- ----- ----- -----
Net loss from continuing operations (102.6) (356.4) (60.3) (379.1)
Net income from discontinued operations -- 24.8 -- 15.4
Gain from disposal of a business segment -- 23.7 -- 6.6
----- ----- ----- -----
Net loss (102.6)% (307.8)% (60.3)% (357.1)%
===== ===== ===== =====
THREE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
REVENUES
Total revenues remained steady at $2.2 million in third quarter 2002 and third
quarter 2001. License revenues were $0.7 million in third quarter 2002 and third
quarter 2001. The average license revenue recognized from sales to new customers
was $89,000 down 6.0% from $95,000 in third quarter 2001, and the average from
existing customers was $35,000 in third quarter 2002 down 58.3% from $84,000 in
third quarter 2001. However, the number of new license sales to customers
increased 50.0% to 6 in third quarter 2002 from 3 in third quarter 2001, and the
number of sales of additional licenses and services to existing customers stayed
the same at 5 in third quarter 2002 and third quarter 2001. The combination of
these factors resulted in constant license revenues.
Service revenues remained steady at $1.5 million in third quarter 2002 and third
quarter 2001. The components of services revenues, primarily billable hours and
maintenance revenues, were also constant.
COST OF REVENUES
Cost of revenues decreased to $1.0 million in third quarter 2002 from $1.6
million in third quarter 2001. Cost of revenues as a percentage of revenues
decreased to 47.5% from 71.2%, resulting in gross margin of 52.5% for the third
quarter 2002 compared to 28.8% for third quarter 2001.
Cost of license revenues decreased to $0.2 million in third quarter 2002 from
$0.6 million in third quarter 2001. Cost of license revenues as a percentage of
revenues decreased to 8.8% from 26.5%. The decrease in the cost of license
revenues was primarily attributable to decreases in product royalties payable to
third parties and amortization of purchased technology, which was fully
amortized in July 2002.
Cost of service revenues decreased to $0.8 million in third quarter 2002 from
$1.0 million in third quarter 2001, and as a percentage of revenues decreased to
38.7% from 44.7%. The decrease in the cost of service revenues was principally
the result of a 20.0% decrease in staff to 20 in third quarter 2002 from 25 in
third quarter 2001 primarily attributable to the 2001 restructurings.
14
OPERATING EXPENSES
Sales and Marketing. Sales and marketing expenses decreased to $1.4 million, or
65.8% of revenues, in third quarter 2002 from $2.2 million, or 96.3% of
revenues, in third quarter 2001. The decrease is attributable to a reduction in
sales and marketing staff of 9.7% to 28 in third quarter 2002 from 31 in third
quarter 2001 primarily attributable to the 2001 restructurings and a decrease in
expenses for marketing programs of 75.8% to $0.1 million in third quarter 2002
from $0.4 million in third quarter 2001.
Research and Development. Research and development expenses decreased to $0.8
million, or 36.6% of revenues, in third quarter 2002 from $1.6 million, or 69.8%
of revenues, in third quarter 2001. The decrease is principally the result of a
75.9% reduction in software development staffing levels to 7 in third quarter
2002 from 29 in third quarter 2001 primarily attributable to the 2001
restructurings. This reduction was slightly offset by an increase in the use of
third parties to perform development work in 2002.
General and Administrative. General and administrative expenses decreased to
$0.7 million, or 31.0% of revenues in third quarter 2002 from $0.8 million, or
33.7% of revenues in third quarter 2001. The decrease is primarily the result of
a decrease in stock based compensation expense related to stock options.
Intangible Assets Amortization. Intangible assets amortization decreased to $0.1
million, or 3.6% of revenues in third quarter 2002 from $1.2 million, or 51.9%
of revenues in third quarter 2001. Intangible assets amortization consists of
the amortization expense in respect of the consideration in excess of the fair
value of assets acquired and liabilities assumed in our acquisition of the
Molloy Group in July 1999. The decrease is primarily the result of the
implementation of new accounting rules that discontinue the amortization of
goodwill and provide for write off of the goodwill value should it become
impaired.
Restructuring and other non-recurring charges. Restructuring and other
non-recurring charges decreased to $(0.1) million in third quarter 2002, from
$2.9 million in third quarter 2001. In third quarter 2002, the credit to
restructuring expense represents a change in the estimate of termination costs
for certain service contracts. In third quarter 2001, we incurred a
restructuring charge of $0.6 million representing severance benefits and costs
resulting from the lay off of 75 employees on July 10, 2001. Other non-recurring
charges in third quarter 2001 consisted of severance charges for senior
executives of $0.4 million, as well as costs associated with forgiveness of
stockholder loans and related tax gross-up of $2.0 million.
OTHER INCOME (EXPENSE), NET
Other income (expense), net consists primarily of non-cash interest expense
related to our convertible notes slightly offset by interest income on
short-term investments. Third quarter 2002 results reflect a net expense of
$484,000 or 22.2% of revenues compared to a net expense of $69,000 or 3.1% of
revenues in third quarter 2001. The increase was primarily the result of an
increased interest expense related to the convertible notes issued in second
quarter 2002, including a non-cash charge of approximately $371,000 relating to
the amortization of beneficial conversion feature, and a decrease in interest
earned on investments.
NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
REVENUES
Total revenues decreased 4.4% to $7.7 million in the first nine months of 2002
from $8.0 million in the first nine months of 2001. License revenues decreased
2.2% to $3.1 million in the first nine months of 2002 from $3.2 million in the
first nine months of 2001. We recognized license revenue from 17 new customers
averaging $114,000 in the first nine months of 2002 compared to 12 new customers
averaging $190,000 in the first nine months of 2001. The average license revenue
recognized from sales to existing customers increased to $47,000 for 24 deals in
the first nine months of 2002 from $37,000 for 25 deals in the first nine months
of 2001.
Service revenues in total decreased 5.9% to $4.5 million in the first nine
months of 2002 from $4.8 million in the first nine months of 2001. The net
decrease is a result of decreased billable hours and reimbursable expenses
partially offset by an increase in maintenance revenue.
15
COST OF REVENUES
Cost of revenues decreased to $3.6 million in the first nine months of 2002 from
$9.7 million in the first nine months of 2001. Cost of revenues as a percentage
of revenues decreased to 46.5% from 120.4%, resulting in gross margin of 53.5%
for the first nine months of 2002 compared to negative 20.4% for the first nine
months of 2001.
Cost of license revenues decreased to $0.8 million in the first nine months of
2002 from $2.1 million in the first nine months of 2001. Cost of license
revenues as a percentage of revenues decreased to 10.5% from 26.0%. The decrease
in the cost of license revenues was primarily attributable to a decrease in
product royalties payable to third parties, costs incurred only in 2001 for
equipment for specific implementations, and a decrease in amortization of
purchased technology, which was fully amortized in July 2002.
Cost of service revenues decreased to $2.8 million in the first nine months of
2002 from $7.6 million in the first nine months of 2001, and as a percentage of
revenues decreased to 36.0% from 94.3%. The decrease in the cost of service
revenues was principally the result of a 48.6% decrease in staff to an average
of 19 in the first nine months of 2002 from an average of 37 in the first nine
months of 2001 primarily attributable to the 2001 restructurings, a decrease in
the use of third parties to perform services, and a decrease in travel expenses.
OPERATING EXPENSES
Sales and Marketing. Sales and marketing expenses decreased to $3.9 million, or
50.8% of revenues, in the first nine months of 2002 from $11.9 million, or
147.8% of revenues, in the first nine months of 2001. The decrease is
attributable to a reduction in sales and marketing staff of 60.3% to an average
of 23 in the first nine months of 2002 from an average of 58 in the first nine
months of 2001 primarily attributable to the 2001 restructurings and a decrease
in expenses for marketing programs of 90.6% to $0.2 million in the first nine
months of 2002 from $2.4 million in the first nine months of 2001. Additionally,
significant decreases in travel costs, commission expense, and recruiting costs
contributed to the decrease in sales and marketing expenses.
Research and Development. Research and development expenses decreased to $2.0
million, or 25.7% of revenues, in the first nine months of 2002 from $5.6
million, or 69.8% of revenues, in the first nine months of 2001. The decrease is
principally the result of a 75.9% reduction in software development staffing
levels to an average of 7 in the first nine months of 2002 from an average of 29
in the first nine months of 2001 primarily attributable to the 2001
restructurings.
General and Administrative. General and administrative expenses decreased to
$2.4 million, or 31.1% of revenues in the first nine months of 2002 from $2.9
million, or 35.7% of revenues in the first nine months of 2001. The decrease was
primarily attributable to reductions of bad debt and legal and accounting
expenses.
Intangible Assets Amortization. Intangible assets amortization decreased to $0.3
million, or 3.6% of revenues in the first nine months of 2002 from $3.7 million,
or 46.0% of revenues in the first nine months of 2001. Intangible assets
amortization consists of the amortization expense in respect of the
consideration in excess of the fair value of assets acquired and liabilities
assumed in our acquisition of the Molloy Group in July 1999. The decrease is
primarily the result of the implementation of new accounting rules that
discontinue the amortization of goodwill and provide for write off of the
goodwill value should it become impaired.
Restructuring and other non-recurring charges. In the first nine months of 2001,
we incurred restructuring charges of $2.4 million primarily representing excess
facilities costs and severance benefits and costs resulting from the lay off of
55 employees in February 2001 and an additional 75 employees in July 2001. A
portion of these restructuring charges related to potential costs for
terminating certain real estate leases. However, we have been able to sublease a
significant portion of our unused space and have decided not to terminate the
lease. Consequently, we have reduced this accrual by $0.4 million in the second
quarter 2002 to reflect changes in assumptions made for the initial charge.
Additionally, in third quarter 2002, a credit of $0.1 million to restructuring
expense was recorded representing a change in the estimate of termination costs
for certain service contracts.
Other non-recurring charges in the first nine months of 2002 of $38,000
consisted of a tax gross-up related to forgiveness of stockholder loans. Other
non-recurring charges in the first nine months of 2001 consisted of severance
charges for senior executives of $0.6 million, as well as costs recognized in
conjunction with forgiveness of stockholder loans and related tax gross-up of
$2.2 million.
OTHER INCOME (EXPENSE), NET
Other income (expense), net consists primarily of interest income on short-term
investments, offset by interest expense and other fees related to our bank
borrowings. The results for the first nine months of 2002 reflect a net other
expense of $629,000 or 8.2% of revenues compared to a net other income of
$408,000 or 5.1% of revenues in the first nine months of
16
2001. The decrease was primarily the result of an increased interest expense
related to the convertible notes issued in second quarter 2002, including a
non-cash charge of approximately $497,000 for the amortization of beneficial
conversion feature, and a decrease in interest earned on investments.
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have satisfied our cash requirements primarily through
private placements of convertible preferred stock and common stock, our initial
public offering, and borrowings.
On April 1, 2002, we signed a binding commitment letter to sell a total of
$3,000,000 of Convertible Notes. A note purchase agreement was signed on May 6,
2002, and we received $1,425,000 less transaction costs of approximately
$165,000 from the closing of the first tranche of Convertible Notes in May 2002.
In accordance with their terms, the Notes did not become convertible until
Shareholder approval of the transaction was obtained. Following Shareholder
approval on June 11, 2002, the size of the transaction was increased to
$3,250,000 and on June 19, 2002, the second tranche of Convertible Notes were
issued with an aggregate principal amount of $1,825,000. At that time, we
received $1,825,000 less transaction costs of approximately $125,000. Of the
total amount of $3,250,000 of Convertible Notes issued, Convertible Notes with
an aggregate principal amount of $2,635,000 were acquired by a Director of ours
and his affiliated entities, who collectively owned approximately 20% of our
stock prior to the acquisition of Convertible Notes. The notes mature 18 months
from the closing date, bear interest at 10% per annum, and are convertible at
any time at the option of the holder, into shares of our common stock at a
conversion price of $0.30 per share. Interest can be paid in cash or additional
notes, at our option. The Notes are senior unsecured obligations that will rank
senior to all future subordinated indebtedness, pari passu to all existing and
future senior, unsecured indebtedness and subordinated to all existing and
future senior secured indebtedness.
On October 16, 2002, we entered into a loan and security agreement with
Comerica Bank - California (the "Bank"). The agreement allows for a revolving
line of credit and a term loan. Borrowings on the revolving line can be in
amounts up to the lesser of $2.0 million or 75% of eligible receivables and
mature October 1, 2003. Such amounts will bear interest at a rate of 1.5% above
the Bank's prime rate. Advances of up to $0.5 million on the term loan can be
taken until October 16, 2003, and mature one year from the date of the advance.
Such amounts are to be repaid in 12 monthly installments and will bear interest
at the Bank's prime rate. In conjunction with this agreement, a Warrant was
issued to the Bank to purchase 50,000 shares of our Common Stock at an exercise
price of $0.46 per share, with a 10-year maturity. The Warrant includes
assignability to Bank's affiliates, antidilution protection and a net exercise
provision. In addition, the Bank can require us to repurchase the Warrant for
$69,000 after a change of control.
We have incurred a net loss of $2,243,000 in the third quarter 2002. We
have taken substantial measures to reduce our costs and improve our chances to
achieve profitability within the next year, however we may continue to incur net
losses for the foreseeable future.
We continue to use cash for operating activities as a result of our net
losses. The amount of cash used by current operations has been substantially
lower during 2002 due to lower personnel and office costs as a result of our
restructuring activities during 2001.
Decreases in accrued compensation and other liabilities in the first nine
months of 2002 are primarily the result of severance payments made. The
significant decrease in deferred revenue in the first nine months of 2002 is
primarily the result of revenue recognized in 2002 for contracts deferred at
December 31, 2001 and for new contracts in 2002. The significant increase in
other liabilities in the first nine months of 2001 is the result of the accrual
for restructuring charges.
Net cash used in investing activities was primarily attributable to
purchases of short-term investments. Consistent with our overall cost cutting,
our need for capital spending for new equipment has declined. Net cash provided
by financing activities was primarily from the proceeds received upon issuance
of our convertible notes.
As of September 30, 2002, we had $3.4 million in cash and cash equivalents
and short term investments. We believe that our existing cash balances which
include the proceeds of the Convertible Notes should be sufficient to meet
anticipated cash requirements for at least the next 12 months. We have taken
steps to reduce our recurring costs to approximate our anticipated levels of
revenue which included lay offs in February, July and October 2001 of
approximately 55, 75, and 50 employees, respectively. As of October 2002, we
have up to $2.5 million available as a result of our loan agreement with
Comerica Bank - California.
There can be no assurance that additional capital will be available to us
on reasonable terms, if at all, when needed or desired. If we raise additional
funds through the issuance of equity, equity-related or debt securities, such
securities may have rights, preferences or privileges senior to those of the
rights of our common stock. Furthermore, because of the low trading price of our
common stock, the number of shares of new equity or equity-related securities
that we may be required to issue may be greater than it otherwise would be. As a
result, our stockholders may suffer significant additional dilution. Further,
the issuance of debt securities could increase the risk or perceived risk of our
company.
17
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2002, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities", effective for fiscal years beginning after
December 15, 2002. Under the new rules, a liability for a cost associated with
an exit or disposal activity must only be recognized when the liability is
incurred. Under the previous guidance of EITF 94-3, a liability for exit costs
was recognized at the date of an entity's commitment to an exit plan. In the
past, we have been subject to the provisions of EITF 94-3 when adopting plans to
exit activities and therefore, if we were to commit to further exit plans
subsequent to the effective date, we would be subject to the new rules regarding
expense recognition.
Effective January 1, 2002, we adopted Emerging Issues Task Force Number
01-14, "Income Statement Characterization of Reimbursements Received for
'Out-of-Pocket' Expenses Incurred" (EITF 01-14), which requires that
reimbursements received for out-of-pocket expenses be classified as revenues and
not as cost reductions. Before the effective date of EITF 01-14, we netted
out-of-pocket reimbursements from customers with the applicable costs. These
items include primarily travel, meals and certain telecommunication costs. EITF
01-14 requires restatement of all periods presented in order to reflect
reimbursed expenses as both revenues and costs. During the nine months ended
September 30, 2002 and 2001, reimbursed expenses totaled approximately $207,000
and $375,000, respectively. Total reimbursed expenses for the full-year 2001
totaled approximately $473,000. While the adoption of EITF 01-14 has no impact
on income from operations or net income, it does reduce total operating margins
since both revenues and costs increase by the same amount.
In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 141, "Business Combinations", and No. 142
"Goodwill and Other Intangible Assets" effective for fiscal years beginning
after December 15, 2001. Under the new rules, goodwill will no longer be
amortized but will be subject to annual impairment tests in accordance with the
Statements. Other intangible assets will continue to be amortized over their
useful lives. As a result, expense of $2.3 million was not recognized during the
first nine months of 2002 that would have otherwise fully amortized the balance
of goodwill. During 2002, we performed the new required impairment tests of
goodwill and indefinite lived intangible assets as of January 1, 2002 and did
not have an impairment loss.
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
Set forth below and elsewhere in this Form 10-Q and in other documents we
file with the Securities and Exchange Commission are risks and uncertainties
that could cause actual results to differ materially from the results
contemplated by the forward-looking statements contained in this Form 10-Q or
the results indicated or projected by our historical results.
WE MAY NEED ADDITIONAL CAPITAL TO FUND CONTINUED BUSINESS OPERATIONS AND WE
CANNOT BE SURE THAT ADDITIONAL FINANCING WILL BE AVAILABLE.
We have historically required substantial amounts of capital to fund our
business operations. Despite efforts to reduce our cost structure, we may
continue to experience negative cash flow from operations for the next few
quarters. We cannot, however, assure investors that we will attain break-even
cash flow from operations at any particular time in the future, or at all.
We continue to evaluate alternative means of financing to meet our needs on
terms that are attractive to us. We currently anticipate that our available
funds will be sufficient to meet our projected needs to fund operations in the
next 12 months. However, we may pursue additional financing to fund operations.
From time to time, we have considered and discussed various financing
alternatives and expect to continue such efforts to raise additional funds to
support our operational plan. However, we cannot be certain that additional
financing will be available to us on favorable terms when required, or at all.
IF WE ARE NOT ABLE TO OBTAIN SUCH CAPITAL, WE MAY NEED TO DRAMATICALLY CHANGE
OUR BUSINESS STRATEGY AND DIRECTION, INCLUDING PURSUING OPTIONS TO SELL OR MERGE
OUR BUSINESS, OR LIQUIDATE.
In the past, we have funded our operating losses and capital expenditures
through proceeds from equity offerings. Changes in equity markets in the past
year have adversely affected our ability to raise equity financing and have
adversely affected the markets for debt financing for companies with a history
of losses such as ours. If we raise additional funds through the issuance of
equity, equity-linked or debt securities, those securities may have rights,
preferences or privileges senior to those of the rights of our common stock and,
in light of our current market capitalization, our stockholders may experience
substantial dilution. Further, the issuance of debt securities could increase
the risk or perceived risk of our company.
18
WE HAVE A HISTORY OF LOSSES, ANTICIPATE THAT WE WILL CONTINUE TO INCUR LOSSES
FOR THE NEXT SEVERAL QUARTERS AND MAY NEVER ACHIEVE PROFITABILITY.
Our limited operating history in our current line of business and the
uncertain nature of the markets in which we compete make it difficult or
impossible to predict future results of operations. As of September 30, 2002, we
had an accumulated deficit of $71.3 million. We have not achieved profitability
on a quarterly or annual basis to date. In the first nine months of 2002, we
incurred net losses of $4.6 million and in fiscal 2001, we incurred net losses
of $29.7 million. We expect to have decreased operating expenses as a result of
our restructuring activities. However, if revenues do not significantly
increase, our losses will continue.
OUR CASH FLOW MAY NOT BE SUFFICIENT TO PERMIT REPAYMENT OF OUR DEBT WHEN DUE.
The convertible notes we issued in May 2002 and in June 2002 will be due in
fourth quarter 2003. To the extent the note purchasers do not elect to convert
the notes into common stock, we will be required to retire or refinance that
debt at that time. In addition, any borrowings that we make under our revolving
debt facility will be due in fourth quarter 2003. Our ability to retire or to
refinance our indebtedness will depend on our ability to generate cash flow in
the future. We cannot give assurance that our business will generate sufficient
cash flow from operations to meet these repayment requirements. Our cash flow
from operations may be insufficient to repay this indebtedness at scheduled
maturity and some or all of such indebtedness may have to be refinanced. If we
are unable to refinance our debt or if additional financing is not available on
acceptable terms, or at all, we could be forced to dispose of assets under
circumstances that might not be favorable to realizing the highest price for the
assets or to default on our obligations with respect to this indebtedness.
WE MAY NOT SUCCEED IN ATTRACTING AND RETAINING THE PERSONNEL WE NEED FOR OUR
BUSINESS AND THE INTEGRATION OF NEW MANAGEMENT AND PERSONNEL MAY STRAIN OUR
RESOURCES.
Our business requires the employment of highly skilled personnel,
especially experienced software developers. The inability to recruit and retain
experienced software developers in the future could result in delays in
developing new versions of our software products or could result in the release
of deficient software products. Any such delays or defective products would
likely result in lower sales. We may also experience difficulty in hiring and
retaining sales personnel, product managers and professional services employees.
The average tenure of our current employees is 2.3 years. Additionally, we have
experienced a high turn-over rate in some of our senior management positions in
the past few years. Continued high turn-over in management positions could have
an adverse effect on our operations, business, and prospects.
A SIGNIFICANT PERCENTAGE OF OUR PRODUCT DEVELOPMENT IS PERFORMED BY A THIRD
PARTY INTERNATIONALLY, THE LOSS OF WHICH COULD SUBSTANTIALLY HARM OUR PRODUCT
DEVELOPMENT EFFORTS.
A significant percentage of our product development work, and some of our
implementation services, are performed by a third-party development organization
in Minsk, Belarus. Unpredictable developments in the political, economic and
social conditions in Belarus, or our failure to maintain or renew our business
relationship with this organization on terms similar to those which exist
currently, could reduce or eliminate product development and implementation
services. If access to these services were to be unexpectedly eliminated or
significantly reduced, our ability to meet development objectives vital to our
ongoing strategy would be hindered, and our business could be seriously harmed.
OUR HISTORICAL FINANCIAL RESULTS MAY NOT BE HELPFUL IN EVALUATING OUR PROSPECTS
BECAUSE OUR CURRENT LINE OF PRODUCTS IS RELATIVELY NEW.
We have undergone a number of changes in our business model. We began in
1991 as a provider of consulting services, and later developed and sold content
relating to technology products for use by customer service operations. In July
1999, we acquired the Molloy Group and its complementary software product suite.
Last year we integrated our product offerings with those of the Molloy Group and
launched a suite of software and content products intended to form the basis of
businesses' Knowledge Management solutions.
Since the announcement of our corporate restructuring in February 2001, we
have reallocated our resources to the ongoing enhancement of our eService Suite
software product and in July 2001 sold our Content business. Because our current
line of software products is relatively new, our historical financial results
may not be helpful in evaluating our prospects.
19
IT IS DIFFICULT TO DRAW CONCLUSIONS ABOUT OUR FUTURE PERFORMANCE BASED ON OUR
PAST PERFORMANCE DUE TO SIGNIFICANT FLUCTUATIONS IN OUR QUARTERLY OPERATING
RESULTS.
Our projected expense levels are based on our expectations regarding future
revenues and are relatively fixed in the short term. Therefore, if revenue
levels are below expectations in a particular quarter, operating results and net
income are likely to be disproportionately adversely affected because our
expenses are relatively fixed. In addition, a significant percentage of our
revenues is typically derived from non-recurring sales to a limited number of
customers, so it is difficult to estimate accurately future revenues.
Our quarterly results are also impacted by our revenue recognition
policies. Our revenues are unpredictable and in our last six quarters have
fluctuated from $3.5 million to $2.2 million to $4.4 million to $2.6 million to
$2.9 million to $2.2 million. Because we generally recognize license revenues
upon installation and training, sales orders from new customers in a quarter
might not be recognized during that quarter. Delays in the implementation and
installation of our software near the end of a quarter could also cause
recognized quarterly revenues and, to a greater degree, results of operations to
fall substantially short of anticipated levels. We often recognize revenues for
existing customers in a shorter time frame because installation and training can
generally be completed in significantly less time than for new customers.
However, we may not be able to recognize expected revenues at the end of a
quarter due to delays in the receipt of expected orders from existing customers.
Revenues in any one quarter are not indicative of revenues in any future
period because of these and other factors and, accordingly, we believe that
certain period-to-period comparisons of our results of operations are not
necessarily meaningful and should not be relied upon as indicators of future
performance.
THE KNOWLEDGE MANAGEMENT MARKET IS EVOLVING AND, IF IT DOES NOT GROW RAPIDLY,
OUR BUSINESS WILL BE ADVERSELY AFFECTED.
The Knowledge Management solutions market is an emerging industry, and it
is difficult to predict how large or how quickly it will grow, if at all.
Customer service historically has been provided primarily in person or over the
telephone with limited reference materials available for the customer service
representative. Our business model assumes that companies which provide customer
service over the telephone will find value in aggregating institutional
knowledge by using our eService Suite and will be willing to access our content
over the Internet. Our business model also assumes that companies will find
value in providing some of their customer service over the Internet rather than
by telephone. Our success will depend on the broad commercial acceptance of, and
demand for, these Knowledge Management solutions.
DUE TO THE LENGTHY SALES CYCLES OF OUR PRODUCTS AND SERVICES, THE TIMING OF OUR
SALES ARE DIFFICULT TO PREDICT AND MAY CAUSE US TO MISS OUR REVENUE
EXPECTATIONS.
Our products and services are typically intended for use in applications
that may be critical to a customer's business. In certain instances, the
purchase of our products and services involves a significant commitment of
resources by prospective customers. As a result, our sales process is often
subject to delays associated with lengthy approval processes that accompany the
commitment of significant resources. These delays may worsen in the future as a
greater proportion of our total revenues will be derived from our eService
Suite, for which contracts have a higher average dollar value. For these and
other reasons, the sales cycle associated with the licensing of our products and
subscription for our services typically ranges between six and eighteen months
and is subject to a number of significant delays over which we have little or no
control. While our customers are evaluating whether our products and services
suit their needs, we may incur substantial sales and marketing expenses and
expend significant management effort. We may not realize forecasted revenues
from a specific customer in the quarter in which we expend these significant
resources because of the lengthy sales cycle for our products and services.
WE MAY NOT BE ABLE TO EXPAND OUR BUSINESS INTERNATIONALLY, AND, IF WE DO, WE
FACE RISKS RELATING TO INTERNATIONAL OPERATIONS.
Our business strategy includes efforts to attract more international
customers. We are currently exploring business opportunities in the United
Kingdom and continental Europe. To date, we have only limited experience in
providing our products and services internationally. If we are not able to
market our products and services successfully in international markets, our
expenses may exceed our revenues. By doing business in international markets we
face risks, such as unexpected changes in tariffs and other trade barriers,
fluctuations in currency exchange rates, difficulties in staffing and managing
foreign operations, political instability, reduced protection for intellectual
property rights in some countries, seasonal reductions in business activity
during the summer months in Europe and certain other parts of the world, and
potentially adverse tax consequences, any of which could adversely impact our
international operations and may contribute further to our net losses.
20
IF WE ARE NOT ABLE TO KEEP PACE WITH RAPID TECHNOLOGICAL CHANGE, SALES OF OUR
PRODUCTS MAY DECREASE.
The software industry is characterized by rapid technological change,
including changes in customer requirements, frequent new product and service
introductions and enhancements and evolving industry standards. If we fail to
keep pace with the technological progress of our competitors, sales of our
products may decrease.
WE DEPEND ON TECHNOLOGY LICENSED TO US BY THIRD PARTIES, AND THE LOSS OF THIS
TECHNOLOGY COULD DELAY IMPLEMENTATION OF OUR PRODUCTS, INJURE OUR REPUTATION OR
FORCE US TO PAY HIGHER ROYALTIES.
We rely, in part, on technology that we license from a small number of
software providers for use with our products. After the expiration of these
licenses, this technology may not continue to be available on commercially
reasonable terms, if at all, and may be difficult to replace. The loss of any of
these technology licenses could result in delays in introducing or maintaining
our products until equivalent technology, if available, is identified, licensed
and integrated. In addition, any defects in the technology we may license in the
future could prevent the implementation or impair the functionality of our
products, delay new product introductions or injure our reputation. If we are
required to enter into license agreements with third parties for replacement
technology, we could be subject to higher royalty payments.
PROBLEMS ARISING FROM THE USE OF OUR PRODUCTS WITH OTHER VENDORS' PRODUCTS COULD
CAUSE US TO INCUR SIGNIFICANT COSTS, DIVERT ATTENTION FROM OUR PRODUCT
DEVELOPMENT EFFORTS AND CAUSE CUSTOMER RELATIONS PROBLEMS.
Our customers generally use our products together with products from other
companies. As a result, when problems occur in a customer's systems, it may be
difficult to identify the source of the problem. Even when these problems are
not caused by our products, they may cause us to incur significant warranty and
repair costs, divert the attention of our technical personnel from our product
development efforts and cause significant customer relations problems.
IF CERTAIN COMPANIES CEASE TO PROVIDE OPEN PROGRAM INTERFACES FOR THEIR CUSTOMER
RELATIONSHIP MANAGEMENT SOFTWARE, IT WILL BE DIFFICULT TO INTEGRATE OUR SOFTWARE
WITH THEIRS. THIS WILL DECREASE THE ATTRACTIVENESS OF OUR PRODUCTS.
Our ability to compete successfully also depends on the continued
compatibility and interoperability of our products with products and systems
sold by various third parties, specifically including CRM software sold by
Clarify, Oracle, Peregrine Systems, and Siebel Systems. Currently, these vendors
have open applications program interfaces, which facilitate our ability to
integrate with their systems. If any one of them should close their programs'
interface or if they should acquire one of our competitors, our ability to
provide a close integration of our products could become more difficult, or
impossible, and could delay or prevent our products' integration with future
systems. Inadequate integration with other vendors' products would make our
products less desirable and could lead to lower sales.
WE FACE INTENSE COMPETITION FROM BOTH ESTABLISHED AND RECENTLY FORMED ENTITIES,
AND THIS COMPETITION MAY ADVERSELY AFFECT OUR REVENUES AND PROFITABILITY BECAUSE
WE COMPETE IN THE EMERGING MARKET FOR KNOWLEDGE MANAGEMENT SOLUTIONS.
We compete in the emerging market for Knowledge Management solutions and
changes in the Knowledge Management solutions market could adversely affect our
revenues and profitability. We face competition from many firms offering a
variety of products and services. In the future, because there are relatively
low barriers to entry in the software industry, we expect to experience
additional competition from new entrants into the Knowledge Management solutions
market. It is also possible that alliances or mergers may occur among our
competitors and that these newly consolidated companies could rapidly acquire
significant market share. Greater competition may result in price erosion for
our products and services, which may significantly affect our future operating
margins.
IF OUR SOFTWARE PRODUCTS CONTAIN ERRORS OR FAILURES, SALES OF THESE PRODUCTS
COULD DECREASE.
Software products frequently contain errors or failures, especially when
first introduced or when new versions are released. In the past, we have
released products that contained defects, including software errors in certain
new versions of existing products and in new products after their introduction.
In the event that the information contained in our products is inaccurate or
perceived to be incomplete or out-of-date, our customers could purchase our
competitors' products or decide they do not need Knowledge Management solutions
at all. In either case, our sales would decrease. Our products are typically
intended for use in applications that may be critical to a customer's business.
As a result, we believe that our customers and potential customers have a great
sensitivity to product defects.
WE COULD INCUR SUBSTANTIAL COSTS AS A RESULT OF PRODUCT LIABILITY CLAIMS BECAUSE
OUR PRODUCTS ARE CRITICAL TO THE OPERATIONS OF OUR CUSTOMERS' BUSINESSES.
Our products are critical to the operations of our customers' businesses.
Any defects or alleged defects in our products entail the risk of product
liability claims for substantial damages, regardless of our responsibility for
the failure. Although our license agreements with our customers typically
contain provisions designed to limit our exposure to potential product
21
liability claims, these provisions may not be effective under the laws of
certain jurisdictions. In addition, product liability claims, even if
unsuccessful, may be costly and divert management's attention from our
operations. Software defects and product liability claims may result in a loss
of future revenue, a delay in market acceptance, the diversion of development
resources, damage to our reputation or increased service and warranty costs.
IF OUR CUSTOMERS' SYSTEM SECURITY IS BREACHED AND CONFIDENTIAL INFORMATION IS
STOLEN, OUR BUSINESS AND REPUTATION COULD SUFFER.
Users of our products transmit their and their customers' confidential
information, such as names, addresses, social security numbers and credit card
information, over the Internet. In our license agreements with our customers, we
typically disclaim responsibility for the security of confidential data and have
contractual indemnities for any damages claimed against us. However, if
unauthorized third parties are successful in illegally obtaining confidential
information from users of our products, our reputation and business may be
damaged, and if our contractual disclaimers and indemnities are not enforceable,
we may be subject to liability.
WE MAY ACQUIRE OR MAKE INVESTMENTS IN COMPANIES OR TECHNOLOGIES THAT COULD CAUSE
DISRUPTIONS TO OUR BUSINESS.
We intend to explore opportunities to acquire companies or technologies in
the future. Entering into an acquisition entails many risks, any of which could
adversely affect our business, including:
- - failure to integrate the acquired assets and/or companies with our
current business;
- - the price we pay may exceed the value we eventually realize;
- - potential loss of share value to our existing stockholders as a result
of issuing equity securities as part or all of the purchase price;
- - potential loss of key employees from either our current business or the
acquired business;
- - entering into markets in which we have little or no prior experience;
- - diversion of management's attention from other business concerns;
- - assumption of unanticipated liabilities related to the acquired assets;
and
- - the business or technologies we acquire or in which we invest may have
limited operating histories and may be subject to many of the same
risks we are.
WE MAY NOT BE ABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, WHICH MAY CAUSE
US TO INCUR SIGNIFICANT COSTS IN LITIGATION AND AN EROSION IN THE VALUE OF OUR
BRANDS AND PRODUCTS.
Our business is dependent on proprietary technology and the value of our
brands. We rely primarily on patent, copyright, trade secret and trademark laws
to protect our technology and brands. We currently have two patents. One of
these patents pertains to certain proprietary data structures and the other
pertains to our Cognitive Processor, now known as MindSync technology. Our
patents may not survive a legal challenge to their validity or provide
meaningful protection to us. Litigation to protect our patents would be
expensive and the loss of our patents would decrease the value of our products.
Defending against claims of patent infringement would also be expensive and, if
successful, we could be forced to redesign our products, pay royalties, or cease
selling them. In addition, effective trademark protection may not be available
for our trademarks. The use by other parties of our trademarks would dilute the
value of our brands.
Notwithstanding the precautions we have taken, a third party may copy or
otherwise obtain and use our software or other proprietary information without
authorization or may develop similar software independently. Policing
unauthorized use of our technology is difficult, particularly because the global
nature of the Internet makes it difficult to control the ultimate destination or
security of software or other transmitted data. Further, we have granted certain
third parties limited contractual rights to use proprietary information which
they may improperly use or disclose. The laws of other countries may afford us
little or no effective protection of our intellectual property. The steps we
have taken may not prevent misappropriation of our technology, and the
agreements entered into for that purpose may not be enforceable. The
unauthorized use of our proprietary technologies could also decrease the value
of our products.
THE SUCCESS OF OUR SOFTWARE PRODUCTS DEPENDS ON ITS ADOPTION BY OUR CUSTOMERS'
EMPLOYEES. IF THESE EMPLOYEES DO NOT ACCEPT THE IMPLEMENTATION OF OUR PRODUCTS,
OUR CUSTOMERS MAY FAIL TO RENEW THEIR SERVICE CONTRACTS AND WE MAY HAVE
DIFFICULTY ATTRACTING NEW CUSTOMERS.
The effectiveness of our eService Suite depends in part on widespread
adoption and use of our software by our customers' customer service personnel
and on the quality of the solutions they generate. Resistance to our software by
customer service personnel and an inadequate development of the knowledge base
may make it more difficult to attract new customers and retain old ones.
22
Some of our customers have found that customer service personnel
productivity initially drops while customer service personnel become accustomed
to using our software. If an enterprise deploying our software has not
adequately planned for and communicated its expectations regarding that initial
productivity decline, customer service personnel may resist adoption of our
software.
The knowledge base depends in part on solutions generated by customer
service personnel and, sometimes, on the importation of our customers' legacy
solutions. If customer service personnel do not adopt and use our products
effectively, necessary solutions will not be added to the knowledge base, and
the knowledge base will not adequately address service needs. In addition, if
less-than-adequate solutions are created and left uncorrected by a user's
quality-assurance processes or if the legacy solutions are inadequate, the
knowledge base will similarly be inadequate, and the value of our eService Suite
to end-users will be impaired. Thus, successful deployment and broad acceptance
of our eService Suite will depend in part on whether our customers effectively
roll-out and use our software products and the quality of the customers'
existing knowledge base of solutions.
WE DEPEND ON INCREASED BUSINESS FROM OUR NEW CUSTOMERS AND, IF WE FAIL TO GROW
OUR CLIENT BASE OR GENERATE REPEAT BUSINESS, OUR OPERATING RESULTS COULD BE
ADVERSELY AFFECTED.
If we fail to grow our customer base or generate repeat and expanded
business from our current and future customers, our business and operating
results will be seriously harmed. Some of our customers initially make a limited
purchase of our products and services for pilot programs. If these customers do
not successfully develop and deploy such initial applications, they may choose
not to purchase complete deployment or development licenses. Some of our
customers who have made initial purchases of our software have deferred or
suspended implementation of our products due to slower than expected rates of
internal adoption by customer service personnel. If more customers decide to
defer or suspend implementation of our products in the future, we will be unable
to increase our revenue from these customers from additional licenses or
maintenance agreements, and our financial position will be seriously harmed.
In addition, as we introduce new versions of our products or new products,
our current customers may not need our new products and may not ultimately
license these products. Any downturn in our software licenses revenues would
negatively impact our future service revenues because the total amount of
maintenance and service fees we receive in any period depends in large part on
the size and number of licenses that we have previously sold. In addition, if
customers elect not to renew their maintenance agreements, our service revenues
could be significantly adversely affected.
A DECLINE IN INFORMATION TECHNOLOGY SPENDING COULD REDUCE THE SALE OF OUR
PRODUCTS.
The license fees for our products typically range from approximately
several hundred thousand to several million dollars. These fees often represent
a significant expenditure of Information Technology ("IT") capital for our
customers. It is possible for our customers' and potential customers' IT
spending to decline as a result of a weakened economy, or due to other factors.
Such a decline could cause us to be unable to maintain or increase our sales
volumes and achieve revenue growth.
INCREASING GOVERNMENT REGULATION OF THE INTERNET COULD HARM OUR BUSINESS.
As e-business, Knowledge Management and the Internet continue to evolve, we
expect that federal, state and foreign governments will adopt laws and
regulations tailored to the Internet covering issues like user privacy, taxation
of goods and services provided over the Internet, pricing, content and quality
of products and services. If enacted, these laws and regulations could limit the
market for e-business and Knowledge Management and, therefore, the market for
our products and services.
The Telecommunications Act of 1996 prohibits certain types of information
and content from being transmitted over the Internet. The prohibition's scope
and the liability associated with a violation of the Telecommunications Act's
information and content provisions are currently unsettled. The imposition upon
us and other software and service providers of potential liability for
information carried on or disseminated through our applications could require us
to implement measures to reduce our exposure to this liability. These measures
could require us to expend substantial resources or discontinue certain
services. In addition, although substantial portions of the Communications
Decency Act, the act through which the Telecommunications Act of 1996 imposes
criminal penalties, were held to be unconstitutional, similar legislation may be
enacted and upheld in the future. It is possible that this new legislation and
the Communications Decency Act could expose companies involved in e-business to
liability, which could limit the growth of Internet usage and e-business
generally and, therefore, the demand for Knowledge Management solutions. In
addition, similar or more restrictive laws in other countries could have a
similar effect and hamper our plans to expand overseas.
23
WE MAY BECOME INVOLVED IN SECURITIES CLASS ACTION LITIGATION WHICH COULD DIVERT
MANAGEMENT'S ATTENTION AND HARM OUR BUSINESS.
The stock market is currently experiencing significant price and volume
fluctuations that have affected the market price for the common stocks of
technology companies. These broad market fluctuations may cause the market price
of our common stock to decline. In the past, following periods of volatility in
the market price of a particular company's securities, securities class action
litigation has often been brought against that company. We may become involved
in that type of litigation in the future. Litigation is often expensive and
diverts management's attention and resources, which could harm our business and
operating results.
THE LOW PRICE OF OUR COMMON STOCK AND THE LOW MARKET VALUE OF PUBLIC FLOAT COULD
RESULT IN THE DELISTING OF OUR COMMON STOCK.
If our common stock is delisted by Nasdaq and our securities begin to trade
on the OTC Bulletin Board maintained by Nasdaq, another over-the-counter
quotation system, or on the pink sheets, investors may find it more difficult to
dispose of or obtain accurate quotations as to the market value of the
securities. In addition, we would be subject to a Rule promulgated by the
Securities and Exchange Commission that, if we fail to meet criteria set forth
in such Rule, imposes various practice requirements on broker-dealers who sell
securities governed by the Rule to persons other than established customers and
accredited investors. For these types of transactions, the broker-dealer must
make a special suitability determination for the purchaser and have received the
purchaser's written consent to the transactions prior to sale. Consequently, the
Rule may deter broker-dealers from recommending or selling our common stock,
which may further affect the liquidity of our common stock.
Delisting from Nasdaq would make trading our shares more difficult for
investors, potentially leading to further declines in our share price. It would
also make it more difficult for us to raise additional capital. Further, if we
are delisted we could also incur additional costs under state blue sky laws in
connection with any sales of our securities.
OUR MANAGEMENT OWNS A SIGNIFICANT PERCENTAGE OF OUR COMPANY AND WILL BE ABLE TO
EXERCISE SIGNIFICANT INFLUENCE OVER OUR ACTIONS.
We are controlled by our officers and directors, who in the aggregate
directly or indirectly could control more than 50% of our outstanding common
stock and voting power, assuming conversion of all of our Convertible Notes.
These stockholders collectively will likely be able to control our management
policy, decide all fundamental corporate actions, including mergers, substantial
acquisitions and dispositions, and elect our board of directors.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Nearly all of our revenues recognized to date have been denominated in United
States dollars and are primarily from customers in the United States. We have a
European subsidiary located in London, England, and might establish other
foreign subsidiaries. Revenues from international clients were 7% in the first
nine months of 2002 and 8% in fiscal 2001, but historically have not been
substantial, and nearly all of these revenues have been denominated in United
States dollars. In the future, a portion of the revenues we derive from
international operations may be denominated in foreign currencies. We incur
costs for our overseas office in the local currency of that office for staffing,
rent, telecommunications and other services. As a result, our operating results
could become subject to significant fluctuations based upon changes in the
exchange rates of those currencies in relation to the United States dollar.
Furthermore, to the extent that we engage in international sales denominated in
United States dollars, an increase in the value of the United States dollar
relative to foreign currencies could make our services less competitive in
international markets. Although currency fluctuations are currently not a
material risk to our operating results, we will continue to monitor our exposure
to currency fluctuations and when appropriate, consider the use of financial
hedging techniques to minimize the effect of these fluctuations in the future.
We cannot assure you that exchange rate fluctuations will not harm our business
in the future. We do not currently utilize any derivative financial instruments
or derivative commodity instruments.
Our interest income is sensitive to changes in the general level of United
States interest rates, particularly because the majority of our investments are
in short-term instruments. Our convertible notes bear interest at a fixed rate.
We believe that we are currently not subject to material interest rate risk.
24
ITEM 4. CONTROLS AND PROCEDURES
(a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. Our principal executive
officer and our principal financial officer, after evaluating the effectiveness
of our disclosure controls and procedures (as defined in Exchange Act Rules
13a-14(c) and 15d-14(c)) on November 12, 2002, have concluded that, as of such
date, our disclosure controls and procedures were adequate and effective to
ensure that material information relating to our company and our consolidated
subsidiaries would be made known to them by others within those entities.
(b) CHANGES IN INTERNAL CONTROLS. There were no significant changes in our
internal controls or in other factors that could significantly affect our
disclosure controls and procedures subsequent to the date of their evaluation,
nor were there any significant deficiencies or material weaknesses in our
internal controls. As a result, no corrective actions were required or
undertaken.
25
PART II -- OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 Asset Purchase and Sale Agreement dated August 21, 2002, between
Maureen R. Gaughan as Trustee of the Chapter 7 Bankruptcy Estate of
InfoImage, Inc. and ServiceWare Technologies, Inc.
99.1 Certification Pursuant to 18 U.S.C.ss.1350, as adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for
Kent Heyman, President and Chief Executive Officer and Richard Liebman,
Chief Financial Officer
(b) Reports on Form 8-K
None.
26
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SERVICEWARE TECHNOLOGIES, INC.
Date: November 13, 2002 By: /s/ Richard Liebman
----------------------------- .
Richard Liebman
Chief Financial Officer
27
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Kent Heyman, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ServiceWare
Technologies, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
(a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date November 13, 2002
/s/ KENT HEYMAN
----------------------------
Kent Heyman
President and Chief Executive Officer
28
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Richard Liebman, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ServiceWare
Technologies, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
(a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date November 13, 2002
/s/ RICHARD LIEBMAN
----------------------------
Richard Liebman
Chief Financial Officer
29