UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| Quarterly Report Pursuant to Section 13 or
15(d) of the Securities Exchange Act of 1934
for the quarterly period ended March 31, 2002.
|_| Transition Report Pursuant to Section 13 or
15(d) of the Securities Exchange Act of 1934 for
the transition period from _______ to _______.
Commission File Number: 0-22667
MERCATOR SOFTWARE, INC.
(Exact name of registrant as specified in its charter)
Delaware 06-1132156
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
45 Danbury Road, Wilton, CT 06897
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code:
203-761-8600
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.
|X| Yes |_| No
As of May 8, 2002, Registrant had 33,918,174 outstanding shares of Common Stock
$.01 par value.
MERCATOR SOFTWARE, INC.
Form 10-Q
For the Quarterly Period Ended March 31, 2002
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION Page
----
Item 1. Consolidated Condensed Financial Statements
Consolidated Balance Sheets as of March 31, 2002 (unaudited) and
December 31, 2001.............................................. 3
Consolidated Statements of Operations for the Three Months Ended
March 31, 2002 (unaudited) and 2001 (unaudited)................ 4
Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 2002 (unaudited) and 2001 (unaudited)................ 5
Notes to Consolidated Condensed Financial Statements.............. 6
Item 2. Managements' Discussion and Analysis of Financial
Condition and Results of Operations............................ 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk........ 31
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................. 33
Item 6. Exhibits and Reports on Form 8-K.................................. 34
Signatures................................................................. 35
2
MERCATOR SOFTWARE, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
March 31, December 31,
2002 2001
(unaudited)
----------- ------------
ASSETS
Current assets:
Cash and cash equivalents............................................... $ 28,120 $ 28,236
Accounts receivable, less allowances of $2,072 and $3,884............... 19,268 28,966
Prepaid expenses and other current assets............................... 3,822 3,021
----------- ------------
Total current assets................................................. 51,210 60,223
Furniture, fixtures and equipment, net..................................... 8,561 9,230
Goodwill, net.............................................................. 43,960 43,960
Intangible assets, net..................................................... 8,907 10,172
Restricted collateral deposits and other assets............................ 3,395 3,393
----------- ------------
Total assets......................................................... $ 116,033 $ 126,978
=========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable........................................................ $ 6,532 $ 7,632
Accrued expenses and other current liabilities.......................... 18,592 21,066
Current portion of deferred revenue..................................... 20,795 22,280
----------- ------------
Total current liabilities............................................ 45,919 50,978
Deferred revenue, less current portion..................................... 784 917
Long-term deferred tax liability........................................... 2,083 2,418
Other long-term liabilities................................................ 3,979 3,585
----------- ------------
Total liabilities.................................................... 52,765 57,898
----------- ------------
Stockholders' equity:
Convertible preferred stock: $.01 par value; authorized 5,000,000 shares;
no shares issued and outstanding........................................ -- --
Common Stock: $.01 par value; authorized 190,000,000 shares; issued and
outstanding 33,824,000 shares and 32,885,228 shares..................... 338 329
Additional paid-in capital................................................. 249,580 249,090
Deferred compensation...................................................... -- (82)
Accumulated deficit........................................................ (184,333) (178,220)
Accumulated other comprehensive income..................................... (2,317) (2,037)
----------- ------------
Total stockholders' equity........................................... 63,268 69,080
----------- ------------
Total liabilities and stockholders' equity........................... $ 116,033 $ 126,978
=========== ============
See accompanying notes to consolidated condensed financial statements.
3
MERCATOR SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(unaudited)
Three Months Ended
March 31,
------------------------------
2002 2001
---------- ---------
Revenues:
Software licensing................................................................ $ 9,549 $ 11,522
Services.......................................................................... 7,964 9,272
Maintenance....................................................................... 9,899 7,946
---------- ----------
Total revenues................................................................. 27,412 28,740
---------- ----------
Cost of revenues:
Software licensing................................................................ 124 237
Services (exclusive of non-cash stock option re-pricing
(benefit) of $(210) and $0, respectively)...................................... 7,655 7,979
Maintenance (exclusive of non-cash stock option re-pricing (benefit)
of $(62) and $0, respectively)................................................. 2,016 1,789
Stock option re-pricing (benefit)................................................. (272) --
Amortization of intangibles....................................................... 961 961
---------- ----------
Total cost of revenues......................................................... 10,484 10,966
---------- ----------
Gross profit................................................................... 16,928 17,774
---------- ----------
Operating expenses:
Product development (exclusive of non-cash stock option re-pricing
(benefit) of $(190) and $0, respectively)...................................... 4,509 5,246
Selling and marketing (exclusive of non-cash stock option re-pricing
(benefit) of $(298) and $0, respectively)...................................... 11,951 16,808
General and administration (exclusive of non-cash stock option re-pricing
(benefit) of $(151) and $0, respectively)...................................... 6,823 8,596
Stock option re-pricing (benefit)................................................. (639) --
Amortization of goodwill.......................................................... -- 5,626
Amortization of intangibles....................................................... 305 357
Restructuring (benefit)........................................................... (245) --
---------- ----------
Total operating expenses.................................................... 22,704 36,633
---------- ----------
Operating loss.............................................................. (5,776) (18,859)
Other income (expense), net.......................................................... (67) 38
---------- ----------
Loss before income taxes............................................................. (5,843) (18,821)
Provision for income taxes........................................................... 270 1,867
---------- ---------
Net loss............................................................................. $ (6,113) $(20,688)
========== ==========
Net loss per share:
Basic and fully diluted......................................................... $ (0.18) $ (0.69)
Weighted average shares outstanding:
Basic and fully diluted......................................................... 33,575 29,989
See accompanying notes to consolidated condensed financial statements.
4
MERCATOR SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
Three Months Ended
March 31,
-----------------------
2002 2001
--------- ---------
Cash flows from operating activities:
Net (loss) ........................................................... $ (6,113) $(20,688)
Adjustment to reconcile net (loss) to net cash (used) by
operating activities:
Depreciation and amortization .................................... 2,417 8,160
Amortization of deferred compensation ............................ 82 81
Compensation related to options associated with non-employees..... (109) --
Employee stock option re-pricing (benefit) ....................... (911) --
Compensation related to modifications of fixed stock option awards -- 175
Provisions for losses on accounts receivable ..................... 73 300
Disposals of furniture, fixtures and equipment ................... 15 --
Changes in operating assets and liabilities:
Accounts receivable ......................................... 9,642 5,054
Prepaid expenses and other current assets ................... (809) (207)
Other assets ................................................ 157 (406)
Accounts payable ............................................ (1,110) 2,541
Accrued expenses and other current liabilities .............. (2,363) (5,595)
Deferred revenue ............................................ (1,620) 2,502
-------- --------
Net cash (used) by operating activities ................. (649) (8,083)
-------- --------
Cash flows from investing activities:
Purchase of furniture, fixtures and equipment ........................ (380) (1,875)
Net sales of marketable securities ................................... -- 2,839
Restricted collateral deposits ....................................... (72) (1,554)
-------- --------
Net cash (used) by investing activities ................. (452) (590)
-------- --------
Cash flows from financing activities:
Private placement expenses ........................................... (229) --
Net proceeds from Mitsui issuance .................................... -- 2,000
Principal payments under capital leases .............................. (151) (113)
Proceeds from exercise of stock options .............................. 686 149
Proceeds from employee stock plan .................................... 1,062 1,375
-------- --------
Net cash provided by financing activities ............... 1,368 3,411
-------- --------
Effect of exchange rate changes on cash ................................... (383) (186)
-------- --------
Net change in cash ........................................................ (116) (5,448)
Cash at beginning of period ............................................... 28,236 18,327
-------- --------
Cash at end of period ..................................................... $ 28,120 $ 12,879
======== ========
Supplemental information:
Cash paid for:
Interest ......................................................... $ 54 $ 91
Income taxes ..................................................... $ 65 $ 36
Non-cash investing and financing activities:
Acquisition of equipment under capital leases .................... $ 159 --
See accompanying notes to consolidated condensed financial statements.
5
MERCATOR SOFTWARE, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited)
(1) UNAUDITED INTERIM FINANCIAL STATEMENTS
The accompanying consolidated interim condensed financial statements
contained herein are unaudited, but, in the opinion of management, include all
adjustments (consisting of normal recurring adjustments) necessary for a fair
presentation of the financial position, results of operations and cash flows for
the periods presented. Results of operations for the periods presented herein
are not necessarily indicative of results of operations for the entire year.
Reference should be made to the Mercator Software, Inc. ("Mercator" or "the
Company") 2001 Annual Report on Form 10-K, which includes audited financial
statements for the year ended December 31, 2001.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to the Securities and Exchange
Commission's rules and regulations.
Certain reclassifications have been made to the prior years' financial
statements to conform to the 2002 presentation.
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements, and the reported amounts of revenue and
expenses during the reporting period. Actual results could differ from those
estimates.
(2) COMPREHENSIVE INCOME (LOSS)
The Company applies the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 130, "Reporting Comprehensive Income" which requires the
Company to report in its financial statements, in addition to its net income
(loss), comprehensive income (loss), which includes all changes in equity during
a period from non-owner sources. The Company's total comprehensive (loss)
consists of net (loss) and foreign currency translation adjustments. Total
comprehensive (loss) was ($6.4) million and ($21.2) million for the three months
ended March 31, 2002 and 2001, respectively.
(3) RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other
Intangible Assets". SFAS No. 141 requires that the purchase method of accounting
be used for all business combinations. SFAS No. 141 specifies criteria that
intangible assets acquired in a business combination must meet to be recognized
and reported separately from goodwill. SFAS No. 142 requires that goodwill and
intangible assets with indefinite useful lives no longer be amortized, but
instead be tested for impairment at least annually in accordance with the
provisions of SFAS No. 142. SFAS No. 142 also requires that intangible assets
with estimable useful lives be amortized over their respective estimated useful
lives to their estimated residual values, and reviewed for impairment in
accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long
Lived Assets".
The Company adopted the provisions of SFAS No. 141 as of July 1, 2001 and
the provisions of SFAS No. 142 as of January 1, 2002. Amortization of goodwill
and intangible assets with indefinite useful lives acquired in business
combinations completed before July 1, 2001 was discontinued as of January 1,
2002. Had SFAS No. 142 been in effect for the prior year, the net loss for the
three months ended March 31, 2001 would have been ($15.1) million and net loss
per share would have been ($0.50).
In connection with SFAS No. 142's transitional goodwill impairment
evaluation, the Statement requires the Company to perform an assessment of
whether there is an indication that goodwill is impaired as of the date of
adoption. To accomplish this, the Company must identify its reporting units and
determine the carrying value of each reporting unit by assigning the assets and
liabilities, including the existing goodwill and intangible assets, to those
reporting units as of January 1, 2002. The Company has up to six months from
January 1, 2002 to determine the fair value of each reporting unit and compare
it to the carrying amount of the reporting unit. To the extent the carrying
amount of a reporting unit exceeds the fair value of the reporting unit, an
indication exists that the reporting unit goodwill may be impaired and the
Company must perform the second step of the transitional impairment test. The
second step is required to be completed as soon as possible, but no later than
the end of the year of adoption. In the second step, the Company must compare
the implied fair value of the reporting
6
MERCATOR SOFTWARE, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)
(unaudited)
unit goodwill with the carrying amount of the reporting unit goodwill, both of
which would be measured as of the date of adoption. The implied fair value of
goodwill is determined by allocating the fair value of the reporting unit to all
of the assets (recognized and unrecognized) and liabilities of the reporting
unit in a manner similar to a purchase price allocation, in accordance with SFAS
No. 141. The residual fair value after this allocation is the implied fair value
of the reporting unit goodwill. Any transitional impairment loss will be
recognized as the cumulative effect of a change in accounting principle in the
Company's Consolidated Statement of Operations. The Company will complete the
transitional impairment test for its goodwill by June 30, 2002. Because of the
extensive effort needed to comply with adopting SFAS No. 142, it is not
practicable to reasonably estimate the impact of adopting this Statement on the
Company's financial statements at the date of this report, including whether the
Company will be required to recognize any transitional impairment losses as the
cumulative effect of a change in accounting principle.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". SFAS No. 143 requires the Company to record the fair
value of an asset retirement obligation as a liability in the period in which it
incurs a legal obligation associated with the retirement of tangible long-lived
assets that result from the acquisition, construction, development and/or normal
use of the assets. The Company also records a corresponding asset, which is
depreciated over the life of the asset. Subsequent to the initial measurement of
the asset retirement obligation, the obligation will be adjusted at the end of
each period to reflect the passage of time and changes in the estimated future
cash flows underlying the obligation. The Company is required to adopt SFAS No.
143 on January 1, 2003. Management does not expect the adoption of SFAS No. 143
to have a significant impact on the Company's financial position or results of
operations.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
This Statement requires that long-lived assets be reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to future net cash
flows expected to be generated by the asset. If the carrying amount of an asset
exceeds its estimated future cash flows, an impairment charge is recognized by
the amount by which the carrying amount of the asset exceeds the fair value of
the asset. SFAS No. 144 requires companies to separately report discontinued
operations and extends that reporting to a component of an entity that either
has been disposed of (by sale, abandonment, or in a distribution to owners) or
is classified as held for sale. Assets to be disposed of are reported at the
lower of the carrying amount or fair value less costs to sell. The Company
adopted SFAS No. 144 on January 1, 2002 and the adoption did not have a
significant impact on the Company's financial position or results of operations.
In November 2001, the Emerging Issues Task Force ("EITF") concluded that
reimbursements for out-of-pocket-expenses incurred should be included in revenue
in the income statement and subsequently issued EITF Issue No. 01-14, "Income
Statement Characterization of Reimbursements Received for `Out-of-Pocket'
Expenses Incurred" in January 2002. The Company adopted EITF Issue No. 01-14 on
January 1, 2002 and as such, has presented these reimbursements in accordance
with EITF Issue No. 01-14 for the current period and all comparative prior
period financial statements presented herein, to provide consistent
presentation. These reimbursements represent costs paid directly to third
parties primarily for travel related expenses incurred for services personnel.
Approximately $0.5 million and $0.6 million of out-of-pocket reimbursements have
been reclassified from a reduction in services expenses incurred to services
revenues for the three months ended March 31, 2002 and March 31, 2001,
respectively. The adoption of Issue No. 01-14 did not impact the Company's
financial position, operating loss or net loss.
Other pronouncements issued by the FASB or other authoritative accounting
standard groups with future effective dates are either not applicable or are not
significant to the financial statements of Mercator.
(4) RESTRUCTURING CHARGE (BENEFIT)
During the second and third quarters of 2001, the Company restructured its
operations to strategically align its personnel with the markets it serves.
Consequently, the Company incurred restructuring charges in 2001, which
consisted of accruals for lease payments associated with leased space no longer
required due to the reduction in the workforce and severance-related costs. At
December 31, 2001, $5.0 million of these accruals remained which consisted of
$4.7 million for losses related to leased space and $0.3 million for severance
related charges. During the three months ended March 31, 2002, $0.2 million of
severance benefits and $0.2 million of leased space related payments were paid
and charged against the restructuring liability. Additionally, the Company
reversed approximately $0.2 million of EMEA restructuring accruals as all
severance payments and leased space activities had been finalized. At March 31,
2002, $2.6 million of the unpaid restructuring liability was included in accrued
expenses and other current liabilities and $1.7 million was included in other
long-term liabilities.
7
MERCATOR SOFTWARE, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)
(unaudited)
Restructuring accruals established by the Company, and subsequent charges
related thereto, are summarized as follows (in thousands):
Balance Balance
January 1, 2002 Additions Cash Payments Reversals March 31, 2002
---------------- ------------- --------------- ------------- ----------------
Charges for leased space no longer required
(net of estimated sub-lease recoveries):
Americas.................................... $ 4,408 $ -- $ (205) $ -- $ 4,203
EMEA........................................ 223 -- (8) (215) --
Severance related charges:
Americas.................................... 297 -- (203) -- 94
EMEA........................................ 30 -- -- (30) --
---------------- ------------- --------------- ------------- ----------------
Totals........................................ $ 4,958 $ -- $ (416) $ (245) $ 4,297
================ ============= =============== ============= ================
(5) GOODWILL AND INTANGIBLE ASSETS
(a) Goodwill
The total carrying amount of goodwill (all related to the Braid
acquisition), which is the Company's only intangible asset not subject to
amortization, is $44.0 million at March 31, 2002 and December 31, 2001. This
amount is allocated to the Americas segment.
Effective January 1, 2002, the Company adopted SFAS No. 142. Under the
provisions of SFAS No. 142, goodwill is no longer amortized and is tested
annually for impairment using a fair value methodology (see Note 3). On a
comparable basis, the net (loss) and net (loss) per share as adjusted to exclude
goodwill amortization for the three months ended March 31, 2002 and 2001 are as
follows:
Three Months Ended
March 31,
------------------------------------------
2002 2001
------------------- -------------------
(In thousands, except share data)
Reported net (loss)............................ $ (6,113) $ (20,688)
Adjustment for goodwill amortization........... -- 5,626
------------------- -------------------
Net (loss), as adjusted........................ $ (6,113) $ (15,062)
=================== ===================
Net (loss) per share, as adjusted to exclude
amortization of goodwill.................. $ (0.18) $ (0.50)
Weighted average shares outstanding:
Basic and fully diluted................... 33,575 29,989
(b) Intangibles subject to amortization
The components of the Company's intangible assets are as follows:
At March 31, 2002 At December 31, 2001
----------------------------------------- ----------------------------------------
Gross Carrying Accumulated Gross Carrying Accumulated
Amount Amortization Amount Amortization
------------------- ------------------- ------------------ ------------------
(In thousands)
Purchased technology................ $ 19,226 $ (11,856) $ 19,226 $ (10,895)
Customer list....................... 4,008 (2,471) 4,008 (2,271)
Covenant not to compete............. 1,874 (1,874) 1,874 (1,770)
------------------- ------------------- ------------------ ------------------
Total........................... $ 25,108 $ (16,201) $ 25,108 $ (14,936)
=================== =================== ================== ==================
All of these intangibles were acquired in conjunction with the Braid
acquisition in March 1999.
8
MERCATOR SOFTWARE, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)
(unaudited)
The weighted-average amortization periods as of March 31, 2002 are as
follows: Purchased technology - 1.9 years; Customer list - 1.9 years; and in
total - 1.9 years.
Consolidated amortization expense related to the intangible assets and
excluding goodwill amortization was $1.3 million for the three months ended
March 31, 2002 and 2001, respectively. The estimated amortization expense is
expected to be $4.8 million, $4.6 million, and $0.8 million for the years ended
December 31, 2002, 2003 and 2004, respectively. These intangible assets are
expected to be fully amortized by February 29, 2004.
(6) ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Included in accrued expenses and other current liabilities are compensation
costs (regular payroll, commissions, bonuses, profit sharing, and other
withholdings) of $5.3 million and $6.9 million as of March 31, 2002 and
December 31, 2001, respectively. Also included are accrued legal fee and
settlement costs of $4.2 million and $4.0 million as of March 31, 2002 and
December 31, 2001, respectively. Additionally, restructuring charges of $2.6
million and $3.3 million are included as of March 31, 2002 and December 31,
2001, respectively (see Note (4) Restructuring Charge (Benefit)).
(7) STOCK ACTIVITIES
On January 17, 2002, the Company filed a Registration Statement on Form S-3
with the Securities and Exchange Commission ("SEC") relating to the offer and
sale from time to time of up to 3,577,883 shares of our Common Stock by certain
security holders. Of the shares, 2,228,412 shares were issued by the Company in
a private placement and 557,104 shares are issuable upon the exercise of related
warrants granted to those security holders who participated in the private
placement. Additionally, 229,342 shares of Common Stock were issued upon
exercise of warrants to certain selling stockholders and the remaining 563,025
shares are issuable upon the exercise of outstanding warrants granted to other
selling stockholders. On March 19, 2002 the SEC declared the Company's
Registration Statement on Form S-3 effective thereby registering an aggregate of
3,577,883 shares of Common Stock. All of the shares included in the Registration
Statement may be offered by certain security holders of the Company. The Company
will not receive any proceeds from the resale of these shares by the selling
security holders.
In January 2002 a warrant was exercised for 1,200 shares of Common Stock at
an exercise price of $1.00 per share for which the company received proceeds of
$1,200. At March 31, 2002, there are three similar warrants remaining, which are
exercisable into 62,610 shares at $1.00 per share, and expire in June 2002.
In June 2001, in connection with a secured credit facility, the Company
issued a warrant to Silicon Valley Bank to purchase 220,000 shares of Common
Stock at $4.00 per share expiring in June 2008. The fair value of this warrant
was determined to be approximately $0.3 million using the Black-Scholes pricing
model with the following assumptions: (i) a risk-free interest rate of 5.67%;
(ii) an expected contractual life of 7 years; (iii) expected volatility of 126%;
and (iv) an expected dividend yield of 0%. The fair value was charged to prepaid
expenses as a loan origination fee and credited to additional paid-in capital in
June 2001. This prepaid loan origination fee is being amortized to operations
over the term of the secured credit facility agreement. The warrant holder
subsequently assigned the warrant to an affiliate, and on January 3, 2002,
pursuant to the cashless exercise provisions of the warrant agreement, the
affiliate exercised the warrant for 123,296 shares of Common Stock, and as such,
the Company did not receive any proceeds.
In June, July and October of 2001, the Company granted warrants to purchase
a total of 179,404 shares of Common Stock to Morgan Howard Global International
Limited at exercise prices ranging from $2.62 to $5.60 per share for its
services in connection with executive search assignments. The number of warrants
issued was determined by dividing the amount owed to the vendor by the value of
a warrant, as determined under the Black-Scholes pricing model and based on
risk-free interest rates ranging from 3.06% to 4.48%, expected contractual lives
of 3 years, expected volatility of 80% and expected dividend yields of 0%. The
costs of these warrants based on the fair value of services received of $0.1
million were expensed to general and administrative expense when counterparty
performance was complete in 2001. On January 9, 2002, the warrant holder
exercised the warrants for 104,846 shares of Common Stock pursuant to cashless
exercise provisions in the warrant agreement, and as such, the Company did not
receive any proceeds from this exercise.
During November 2000, the Company's Board of Directors approved an offer to
exchange the first half of a September 2000 option grant, of which 615,465
options were exchanged for an equal amount of options priced at the market price
of $5.063 per option. The new options vest quarterly over a twelve-month period.
According to FASB Interpretation No. ("FIN") 44, "Accounting for Certain
Transactions Involving Stock Compensation", if the exercise price of a fixed
stock option award is reduced, the award shall be accounted for as variable from
the date of the modification to the date the award
9
MERCATOR SOFTWARE, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)
(unaudited)
is exercised, is forfeited, or expires unexercised. In accordance with FIN 44
and FIN 28, "Accounting for Stock Appreciation Rights and Other Variable Stock
Option or Award Plans", the Company recorded a variable non-cash compensation
charge of $1.2 million and $0.1 million for the years ended December 31, 2001
and 2000, respectively, relating to the re-priced options. During the three
months ended March 31, 2002, the Company recorded a benefit of ($0.9) million
relating to the re-priced options as a result of the reduction in the Company's
stock price from December 31, 2001 to March 31, 2002. There was no charge or
benefit in the period ended March 31, 2001. As of March 31, 2002, 320,842
re-priced options were outstanding.
During the three months ended March 31, 2002, the Company recorded a
non-cash compensation benefit of ($0.1) million related to consulting services
provided by a former employee. During the three months ended March 31, 2001, the
Company recorded a non-cash compensation charge of $0.2 million, as a result of
accelerated vesting and extension of option terms in connection with severance
agreements for certain officers (some of which are providing ongoing services).
The Company accounted for these charges in accordance with Accounting Principles
Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees", FIN
44, SFAS No. 123, "Accounting for Stock-Based Compensation" and EITF Issue No.
96-18, "Accounting for Equity Instruments That are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services".
On September 17, 2001, the Company announced a voluntary option exchange
program for its employees. This tender offer related to an offer to all eligible
individuals, which excluded all directors, executive vice presidents, senior
vice-presidents and corporate vice-presidents of the Company, to exchange all
outstanding options granted under the Mercator Software, Inc. 1997 Equity
Incentive Plan ("EIP") for new options to purchase shares of Common Stock under
the EIP. Under the exchange program, for every two options tendered and
cancelled, one new option will be issued. The offer expired on October 19, 2001
and the Company accepted for cancellation options to purchase an aggregate of
1,100,062 shares from 239 option holders who participated. On April 23, 2002,
447,597 options were granted at the exercise price of $2.90, which was the fair
market value of the Company's Common Stock on that date, to 211 option holders.
For the three months ended March 31, 2002 and 2001, the Company granted
1,685,850 and 1,423,850, respectively, of employee stock options. The exercise
prices of these employee stock options equaled the fair value of the underlying
Common Stock on the date of grant. (See Note 10.)
The Company established an Employee Stock Purchase Plan in 1997 (the
"ESPP"), which reserves a total of 1,500,000 shares of the Company's Common
Stock for issuance thereunder. The plan permits eligible employees to acquire
shares of the Company's Common Stock through payroll deductions subject to
certain limitations. The shares are acquired at 85% of the lower of the fair
market value on the offering date or the fair market value on the purchase date.
During the three months ended March 31, 2002, 536,283 shares were purchased
under the plan. As of March 31, 2002, 1,415,291 shares had been purchased on a
cumulative basis under the plan and 84,709 were remaining and available for
grant. (See Note 10.)
(8) COMMITMENTS AND CONTINGENCIES
In connection with a facility lease in Wilton, CT, the Company has
available a letter of credit with Fleet Bank for $2.5 million and a related
restricted collateral deposit of $3.0 million. As discussed in Note 4, the
Company has idle space and is currently seeking to sublease certain space to
third parties.
The Company has certain significant legal contingencies, discussed below,
and other litigation of a nature considered normal to its business which are
pending against the Company.
On or about February 1, 2000, Mercator was named as a defendant and served
with a complaint in an action entitled Carpet Co-Op of America Association,
Inc., and FloorLINK, L.L.C. v. TSI International Software, Ltd., Civil Action
No. 00CC- 0231, in the Circuit Court of St. Louis County, Missouri. The
complaint includes counts for breach of contract, fraud and negligent
misrepresentation in connection with certain software implementation work
provided under contract by Mercator. Mercator counter-sued in the United States
District Court for the District of Connecticut on March 30, 2000 for copyright
infringement, trademark infringement, unfair competition, misappropriation of
trade secrets, breach of contract, fraud, unjust enrichment and violation of the
Connecticut Unfair Trade Practices Act. As reported on the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 2001, on
January 30, 2002, Mercator entered into a settlement agreement with respect to
these actions, which resolves these actions in their entirety. Mercator paid
$0.5 million after insurance proceeds in January 2002 as a requirement of this
settlement agreement.
Between August 23, 2000 and September 21, 2000 a series of fourteen
purported securities class action lawsuits was filed in the United States
District Court for the District of Connecticut, naming as defendants Mercator,
Constance Galley and Ira Gerard. Kevin McKay was also named as a defendant in
nine of these complaints. On or about November 24, 2000, these lawsuits were
consolidated into one lawsuit captioned: In re Mercator Software, Inc.
Securities Litigation, Master File No.
10
MERCATOR SOFTWARE, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)
(unaudited)
3:00-CV-1610 (GLG). The lead plaintiffs purport to represent a class of all
persons who purchased Mercator's Common Stock from April 20, 2000 through and
including August 21, 2000. Each complaint in the consolidated action alleges
violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule
10b-5 thereunder, through alleged material misrepresentations and omissions and
seeks an unspecified award of damages. On January 26, 2001, the lead plaintiffs
filed an amended complaint in the consolidated matter with substantially the
same allegations. Named as defendants in the amended complaint are Mercator,
Constance Galley and Ira Gerard. The amended complaint in the consolidated
action alleges violations of Section 10(b) and Rule 10b-5 through alleged
material misrepresentations and omissions and seeks an unspecified award of
damages. Mercator filed a motion to dismiss the amended complaint on
March 12, 2001. The lead plaintiffs filed an opposition to Mercator's motion to
dismiss on or about April 18, 2001, and Mercator filed its reply brief on
May 7, 2001. The Court heard oral argument on the motion to dismiss on
July 6, 2001. On September 13, 2001, the Court denied Mercator's motion to
dismiss. Mercator believes that the allegations in the amended complaint are
without merit and intends to contest them vigorously. Management believes that
this securities class action lawsuit is covered by insurance. Mercator notified
its directors' and officers' liability insurance companies of this matter. The
insurance carriers have reserved their rights in this matter. There can be no
guarantee as to the ultimate outcome of this proceeding or whether the ultimate
outcome, after considering liabilities already accrued in the Company's
March 31, 2002 consolidated balance sheet and insurance recoveries, may have a
material adverse effect on the Company's consolidated financial position or
consolidated results of operations.
The Company has been named as a defendant in an action filed on August 3,
2001 in the United States District Court for the Eastern District of
Pennsylvania, entitled Ulrich Neubert v. Mercator Software, Inc., f/k/a TSI
International Software, Ltd., Civil Action No. 01-CV-3961. The complaint alleges
claims of breach of contract, breach of the implied covenant of good faith and
fair dealing, breach of fiduciary duty, and fraud in connection with the
Company's acquisition of Software Consulting Partners ("SCP") in November 1998.
Neubert, who was the sole shareholder of SCP prior to November 1998, seeks
purported damages of up to approximately $7.5 million, plus punitive damages and
attorney's fees. The complaint was served on the Company on November 21, 2001.
The Company filed a motion to dismiss the complaint on January 10, 2002, which
is still pending. The Company believes that the allegations in the complaint are
without merit and intends to contest the lawsuit vigorously. Mercator has
notified its insurance carrier of this matter, but has not yet received any
coverage position from them. The ultimate legal and financial liability of the
Company in respect to this claim cannot be estimated with any certainty.
However, the ultimate outcome of this proceeding, after considering liabilities
already accrued in the Company's March 31, 2002 consolidated balance sheet, is
not expected to have a material adverse effect on its consolidated financial
position, but could possibly be material to the consolidated results of
operations of any quarter.
In addition, the Company and a third party are currently disputing the
break-up fee provisions with respect to a proposed investment in the Company.
As of March 31, 2002 the Company has accrued approximately $3.9 million,
after considering any insurance recoveries, for the aggregate amount of the
contingencies described above.
(9) SEGMENT INFORMATION
The Company reports its segment information in accordance with SFAS No.
131, "Disclosures about Segments of an Enterprise and Related Information". SFAS
No. 131 establishes standards for the way that public business enterprises
report information about operating segments. It also establishes standards for
related disclosures about products and services. Reportable segment information
is determined based on management defined operating segments used to make
operation decisions and assess financial performance.
The Company has three reportable segments: Americas (North America, Central
and South America) including Corporate, EMEA (Europe, Middle East & Africa) and
APAC (Asia Pacific). Information regarding the Company's operations in these
three segments is set forth below. For consolidated results, the accounting
policies of operating segments are the same as those described in Note 1. There
are no significant corporate overhead allocations or inter-segment sales or
transfers between the segments for the periods presented.
11
MERCATOR SOFTWARE, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)
(unaudited)
Three Months Ended
March 31,
----------------------
2002 2001
--------- ---------
Revenue: (In thousands)
Americas ............................................................. $ 16,133 $ 16,489
EMEA ................................................................. 9,475 11,433
APAC ................................................................. 1,804 818
--------- ---------
Total .............................................................. $ 27,412 $ 28,740
========= =========
Operating loss before stock option re-pricing benefit, amortization of
goodwill and intangibles, and restructuring benefit:
Americas (including Corporate) ....................................... $ (4,308) $ (10,034)
EMEA ................................................................. (1,395) (1,353)
APAC ................................................................. 37 (528)
--------- ---------
Total ...................................................... (5,666) (11,915)
Stock option re-pricing benefit ......................................... 911 --
Amortization of goodwill ................................................ -- (5,626)
Amortization of intangibles ............................................. (1,266) (1,318)
Restructuring benefit ................................................... 245 --
Other income (expense), net ............................................. (67) 38
Provision for income taxes .............................................. (270) (1,867)
--------- ---------
Net loss ................................................................ $ (6,113) $ (20,688)
========= =========
Capital expenditures:
Americas (including Corporate) ....................................... $ 275 $ 978
EMEA ................................................................. $ 101 $ 669
APAC ................................................................. $ 4 $ 228
Depreciation expense:
Americas (including Corporate) ....................................... $ 902 $ 890
EMEA ................................................................. $ 206 $ 305
APAC ................................................................. $ 43 $ 21
Total assets:
Americas (including Corporate) ....................................... $ 86,587 $ 102,930
EMEA ................................................................. $ 24,887 $ 36,583
APAC ................................................................. $ 4,559 $ 3,414
Revenues primarily relate to sales of the Mercator product line and are
recorded in the country in which the sales office is located. The Company had no
sales to any one customer in excess of 10% of total net revenues for the
quarters ended March 31, 2002 and 2001.
(10) SUBSEQUENT EVENTS
Including the options issued on April 23, 2002 as discussed in Note 7,
subsequent to March 31, 2002 and through May 8, 2002, the Company granted
options to employees to purchase an aggregate of 987,537 shares of the Company's
Common Stock under the EIP. The exercise prices of such options were equal to
fair market value at the date of grant.
In May 2002, two warrants were exercised for a total of 62,010 shares at
exercise prices of $1.00 per share, for which the Company received proceeds of
$62,010. At May 8, 2002, there is one similar warrant remaining, which is
exercisable into 600 shares at $1.00 per share, and expires in June 2002.
On May 14, 2002, the Company's shareholders approved an amendment to the
EIP to provide for increases in the number of shares of Common Stock reserved
for issuance under the EIP (i) on May 14, 2002 by 2,500,000 shares of Common
Stock and (ii) on January 1, 2003 by the lesser of (a) 7.5% of the number of
shares of Common Stock outstanding on the close of business immediately
preceding January 1, 2003, or (b) 3,000,000 shares.
On May 14, 2002, the Company's shareholders also approved an amendment to
the ESPP providing for an annual increase in the number of shares of Common
Stock reserved for issuance under the ESPP so that on May 14, 2002 and on each
January 1 thereafter there are 1,500,000 shares of Common Stock reserved for
issuance under the ESPP (or such lesser number of shares as may be determined by
the Board of Directors).
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
We make statements in Management's Discussion and Analysis of Financial
Condition and Results of Operations that are considered forward-looking within
the meaning of the Securities Act of 1933 and the Securities Exchange Act of
1934. Sometimes these statements will contain words such as "believes,"
"expects," "intends," "plans" and other similar words. We intend those
forward-looking statements to be covered by the safe harbor provisions for
forward-looking statements contained in the Private Securities Litigation Reform
Act of 1995 and are including this statement for purposes of complying with
these safe harbor provisions. These forward-looking statements reflect our
current views which are based on the information currently available to us and
on assumptions we have made. Although we believe that our plans, intentions and
expectations as reflected in or suggested by those forward-looking statements
are reasonable, we can give no assurance that the plans, intentions or
expectations will be achieved. We have listed below and have discussed elsewhere
in this report some important risks, uncertainties and contingencies which could
cause our actual results, performances or achievements to be materially
different from the forward-looking statements we make in this report. These
risks, uncertainties and contingencies include, but are not limited to, the
following:
o our inability to develop and release new products or product
enhancements;
o seasonal fluctuations in our revenues or results of operations;
o general economic conditions;
o competition from others;
o risks in expanding international operations; and
o other risk factors set forth under "Risk Factors."
We assume no obligation to update publicly any forward-looking statements,
whether as a result of new information, future events or otherwise. In
evaluating forward-looking statements, you should consider these risks and
uncertainties, together with the other risks described from time to time in our
reports and documents filed with the Securities and Exchange Commission, and you
should not rely on those statements.
Overview
The Company was incorporated in Connecticut in 1985 as TSI International
Software Ltd. and reincorporated in Delaware in September 1993. We completed our
initial public offering in July 1997 and a second public offering in June 1998.
We changed our name to Mercator Software, Inc. effective April 3, 2000.
Our revenues are derived principally from three sources: (i) license fees
for the use of our software products; (ii) fees for consulting services and
training; and (iii) fees for maintenance and technical support. We generally
recognize revenue from software license fees when a license agreement has been
signed by both parties, the fee is fixed or determinable, collection of the fee
is probable, delivery of our products has occurred and no other significant
obligations remain. Payments for licenses, services and maintenance received in
advance of revenue recognition are recorded as deferred revenue. We intend to
continue to increase the scope of service offerings insofar as it supports the
licensing of our software products. Although it was not the case for 2001 and
for the three months ended March 31, 2002, we believe that software licensing
revenue will continue to account for a larger portion of total revenues than
services and maintenance revenues.
Revenues from services include fees for consulting services and training.
Revenues from services are recognized on either a time and materials or
percentage of completion basis as the services are performed and amounts due
from customers are deemed collectible and nonrefundable. Revenues from fixed
price service agreements are recognized on a percentage of completion basis in
direct proportion to the services provided.
Customers who license our products normally purchase maintenance contracts.
These contracts provide unspecified software upgrades and technical support over
a fixed term, and can range from one to four years. Maintenance contracts are
usually paid on an annual basis in advance, and revenues from these contracts
are recognized ratably over the term of the contract.
Our products can be used by information technology professionals, as well
as value added resellers, independent software vendors, software integrators or
other third parties who resell, embed or otherwise bundle our products with
their products. License fee revenues are derived from direct licensing of
software products through our direct sales force and strategic partners. Sales
through strategic partners accounted for 20% and 18% of license revenues for the
three months ended March 31, 2002 and 2001, respectively. International revenues
accounted for 41% and 43% of total revenues for the three months ended
March 31, 2002 and 2001, respectively.
The size of orders typically range from $50,000 to over $3.0 million per
order. The loss or delay of large individual
13
orders, therefore, can have a significant impact on revenue and other quarterly
results. In addition, we generally recognize a substantial portion of our
quarterly software licensing revenues in the last month of each quarter due to
the buying habits of our customers, and, as a result, revenue for any particular
quarter may be difficult to predict in advance. Because operating expenses are
relatively fixed, a delay in the recognition of revenue from a limited number of
license transactions could cause significant variations in operating results
from quarter to quarter and could result in significant losses. To the extent
such expenses precede, or are not subsequently followed by increased revenue,
operating results would be materially and adversely affected. As a result of
these and other factors, operating results for any quarter are subject to
variation, and period-to-period comparisons of results of operations are not
necessarily meaningful and should not be relied upon as indications of future
performance.
Critical Accounting Policies and Estimates
The policies discussed below are considered by us to be critical to an
understanding of our financial statements because they require us to apply the
most judgment and make estimates regarding matters that are inherently
uncertain. Specific risks for these critical accounting policies are described
in the following paragraphs. With respect to the policies discussed below, we
note that because of the uncertainties inherent in forecasting, the estimates
frequently require adjustment.
Our financial statements and related disclosures, which are prepared to
conform with accounting principles generally accepted in the United States of
America, require us to make estimates and assumptions that affect the reported
amounts of assets, liabilities, revenues and accounts receivable and expenses
during the period reported. We are also required to disclose amounts of
contingent assets and liabilities at the date of the financial statements. Our
actual results in future periods could differ from those estimates. Estimates
and assumptions are reviewed periodically, and the effects of revisions are
reflected in the Consolidated Financial Statements in the period they are
determined to be necessary.
We consider the most significant accounting policies and estimates in our
financial statements to be those surrounding: (1) revenues and accounts
receivable; (2) valuation of goodwill and long-lived assets; (3) valuation of
deferred tax assets; (4) legal contingencies; and (5) restructuring reserves.
The accounting policies, the basis for any estimates and potential impact to our
Consolidated Financial Statements, should any of the estimates change, are
further described as follows:
Revenues and Accounts Receivable. Our revenues are derived principally from
three sources: (i) license fees for the use of our software products; (ii) fees
for consulting services and training; and (iii) fees for maintenance and
technical support. We generally recognize revenue from software license fees
when a license agreement has been signed by both parties, the fee is fixed or
determinable, collection of the fee is probable, delivery of our products has
occurred and no other significant obligations remain. For multiple-element
arrangements, we apply the "residual method". According to the residual method,
revenue allocated to the undelivered elements is allocated based on vendor
specific objective evidence ("VSOE") of fair value of those elements. VSOE is
determined by reference to the price the customer would be required to pay when
the element is sold separately. Revenue applicable to the delivered elements is
deemed equal to the remainder of the contract price. The revenue recognition
rules pertaining to software arrangements are complicated and certain
assumptions are made in determining whether the fee is fixed and determinable
and whether collectability is probable. For instance, in our license
arrangements with resellers, estimates are made regarding the reseller's ability
and intent to pay the license fee. Our estimates may prove incorrect if, for
instance, subsequent sales by the reseller do not materialize. Should our actual
experience with respect to collections differ from our initial assessment, there
could be adjustments to future results. Another assumption made in the revenue
recognition process involves assessing whether the fee may be allocated to the
various elements of the arrangement. For instance, the literature on software
revenue recognition requires that the vendor have the ability to determine
whether VSOE of fair value of the undelivered element exists when recognizing
revenue on the delivered elements. The estimate of fair value of the undelivered
element is generally determined by reference to separate stand-alone sales of
the undelivered element. Should our actual experience with respect to VSOE
differ from our initial assessment, there could be adjustments to future
results.
Revenues from services include fees for consulting services and training.
Revenues from services are recognized on either a time and materials or
percentage of completion basis as the services are performed and amounts due
from customers are deemed collectible and non-refundable. Revenues from fixed
price service agreements are recognized on a percentage of completion basis in
direct proportion to the services provided. To the extent the actual time to
complete such services varies from the estimates made at any reporting date, our
revenue and the related gross margins may be impacted in the following period.
In addition to assessing the probability of collection in conjunction with
revenue arrangements, we continually assess the collectability of outstanding
invoices. Assumptions are made regarding the customer's ability and intent to
pay and are based on historical trends, general economic conditions, and current
customer data. Should our actual experience with respect to collections differ
from our initial assessment, there could be adjustments to bad debt expense.
Valuation of Goodwill and Long-Lived Assets. Under the provisions of SFAS No.
142, which we adopted effective January 1, 2002, goodwill is no longer
amortized, but instead it is tested for impairment at least annually. In
connection with
14
SFAS No. 142's transitional goodwill impairment evaluation, we are required to
perform an assessment of whether there is an indication that goodwill is
impaired as of the date of adoption. To accomplish this, we must identify our
reporting units and determine the carrying value of each reporting unit by
assigning the assets and liabilities, including the existing goodwill and
intangible assets, to those reporting units as of January 1, 2002. We have up to
six months from January 1, 2002 to determine the fair value of each reporting
unit and compare it to the carrying amount of the reporting unit. To the extent
the carrying amount of a reporting unit exceeds the fair value of the reporting
unit, an indication exists that the reporting unit goodwill may be impaired and
we must perform the second step of the transitional impairment test. The second
step is required to be completed as soon as possible, but no later than the end
of the year of adoption. In the second step, we must compare the implied fair
value of the reporting unit goodwill with the carrying amount of the reporting
unit goodwill, both of which would be measured as of the date of adoption. The
implied fair value of goodwill is determined by allocating the fair value of the
reporting unit to all of the assets (recognized and unrecognized) and
liabilities of the reporting unit in a manner similar to a purchase price
allocation, in accordance with SFAS No. 141. The residual fair value after this
allocation is the implied fair value of the reporting unit goodwill. Any
transitional impairment loss will be recognized as the cumulative effect of a
change in accounting principle in the Company's Consolidated Statement of
Operations. At March 31, 2002, we had goodwill on our consolidated balance sheet
net of accumulated amortization, totaling $44.0 million. Should we experience
reductions in revenues and cash flows because our business or market conditions
vary from our current expectations, we may not be able to realize the carrying
value of goodwill and will be required to record a transitional impairment
charge and possible impairment charges in future periods.
Under the provisions of SFAS No. 144, which we adopted effective
January 1, 2002, we review long-lived assets and certain identifiable intangible
assets for impairment whenever events or changes in circumstances indicate that
the carrying amount of an asset may not be recoverable. When factors indicate
that an intangible or long-lived asset should be evaluated for possible
impairment, an estimate of the related asset's undiscounted future cash flows
over the remaining life of the asset will be made to measure whether the
carrying value is recoverable. Any impairment is measured based upon the excess
of the carrying value of the asset over its estimated fair value which is
generally based on an estimate of future discounted cash flows. At
March 31, 2002, we had long-lived assets consisting of furniture, fixtures and
equipment and intangibles on our consolidated balance sheet net of accumulated
amortization and depreciation, totaling $17.5 million. Should we experience
reductions in revenues and cash flows because our business or market conditions
vary from our current expectations, we may not be able to realize the carrying
value of these assets and will record an impairment charge at that time.
Valuation of Deferred Tax Assets. Income taxes are accounted for under the
asset and liability method. Deferred tax assets and liabilities are recognized
for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases and operating loss and tax credit carry forwards.
Deferred income tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred
income tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date. A valuation allowance is
established to the extent that it is more likely than not, that we will be
unable to utilize deferred income tax assets in the future.
Legal Contingencies. Our policy is to accrue for an estimated loss from a
legal contingency if both of the following conditions are met: (1) information
available prior to issuance of the financial statements indicates that it is
probable that an asset had been impaired or a liability had been incurred at the
date of the financial statements; and (2) the amount of loss can be reasonably
estimated. When there is no best point estimate of the loss and only a range of
loss is available, we accrue to the low end of the range. We have certain
significant legal and other contingencies as well as other litigation of a
nature considered normal to our business which are pending against us. As of
March 31, 2002, we have accrued approximately $3.9 million after considering any
insurance recoveries for the aggregate amount of such contingencies. Should our
actual payments resulting from the resolution of these contingencies differ from
amounts accrued, we could incur additional expense in future periods. (See Note
8 of Notes to Consolidated Condensed Financial Statements.)
Restructuring Reserves. As mentioned in Note 4 of our Consolidated Condensed
Financial Statements, we incurred restructuring charges during fiscal 2001. At
March 31, 2002 the restructuring liabilities that remain totaled $4.3 million on
our consolidated balance sheets. Of this amount, $0.1 million is related to
employee termination benefits that we expect to be paid in the second quarter of
2002. The remaining $4.2 is for estimated future payments, primarily for rent in
excess of anticipated sublease income. Certain assumptions went into this
estimate including sublease income expected to be derived from these facilities.
Should we negotiate more favorable subleases or reach a settlement with our
landlords to be released from our existing obligations, we could realize a
favorable benefit to our results of future operations. Should future lease
costs, in excess of sublease income, if any, related to these facilities exceed
our estimates, we could incur additional expense in future periods.
Restatement of the Quarter Ended March 31, 2000
In August 2000, the audit committee of our Board of Directors became aware
of questions concerning the accounting for
15
certain expense items. The audit committee initiated a review of these items and
performed certain additional procedures. As a result of these procedures, it was
determined that certain expenses were not properly recorded in the first and
second quarters of 2000 and, accordingly, it was determined that the financial
statements for the quarter ended March 31, 2000 should be restated (the
"Restatement"). The impact of this Restatement on our results of operations for
the three months ended March 31, 2000 was to increase cost of revenues by $0.1
million, increase operating expenses by $1.2 million, and increase the net loss
by $1.6 million from $9.9 million to $11.5 million. Mercator's fully diluted net
loss per share increased by ($0.06) from ($0.35) to ($0.41). In addition to
restating earnings for the quarter ended March 31, 2000, it was determined that
the financial results announced on July 20, 2000 for the quarter ended
June 30, 2000 were incorrect. As a result, the financial results included in the
June 30, 2000 Form 10-Q are different from the results initially announced on
July 20, 2000.
During the third and fourth quarters of 2000, we incurred certain expenses
either connected with the Restatement or to mitigate the effects of the
Restatement on our continuing operations. These expenses were incremental to
those expenses required to maintain normal levels of operations and we believe
such expenses would not have been incurred had the Restatement not occurred. The
incremental Selling and Marketing and General and Administrative costs were
approximately $1.6 million and $4.7 million, respectively, during the third and
fourth quarters of 2000. The Selling and Marketing costs relate to a special
commission incentive plan. The General and Administrative costs consisted
primarily of severance costs for the former CEO and CFO, the cost of
accelerating the vesting of options granted to our former CEO, legal costs
associated with securities litigation, and search fees to replace departed
executives. Incremental General and Administrative costs relating to the
Restatement were approximately $2.0 million during 2001, representing legal
costs associated with securities litigation and search fees to replace several
executives.
16
Results of Operations
The following table sets forth, for the periods indicated, the percentage
of total revenues represented by certain items from our statements of
operations:
Three Months Ended
March 31,
------------------
2002 2001
-------- --------
Revenues:
Software licensing ....................................... 34.8% 40.1%
Services ................................................. 29.1 32.3
Maintenance .............................................. 36.1 27.6
------- -------
Total revenues ....................................... 100.0 100.0
------- -------
Cost of revenues:
Software licensing ....................................... 0.5 0.8
Services ................................................. 27.9 27.8
Maintenance .............................................. 7.4 6.2
Stock option re-pricing (benefit) ........................ (1.0) --
Amortization of intangibles .............................. 3.5 3.4
------- -------
Total cost of revenues ............................... 38.3 38.2
------- -------
Gross profit .................................................. 61.7 61.8
------- -------
Operating expenses:
Product development ...................................... 16.4 18.2
Selling and marketing .................................... 43.6 58.5
General and administration ............................... 24.9 29.9
Stock option re-pricing (benefit) ........................ (2.3) --
Amortization of goodwill ................................. -- 19.6
Amortization of intangibles .............................. 1.1 1.2
Restructuring (benefit) .................................. (0.9) --
------- -------
Total operating expenses ............................. 82.8 127.4
------- -------
Operating loss ................................................ (21.1) (65.6)
Other income (expense), net ................................... (0.2) 0.1
------- -------
Loss before income taxes ...................................... (21.3) (65.5)
Provision for income taxes .................................... (1.0) (6.5)
------- -------
Net loss ...................................................... (22.3)% (72.0)%
======= =======
Gross profit exclusive of stock option re-pricing (benefit) and
amortization of intangibles:
Software licensing ....................................... 98.7% 97.9%
Services ................................................. 3.9% 13.9%
Maintenance .............................................. 79.6% 77.5%
Total ................................................ 64.3% 65.2%
17
The Quarter Ended March 31, 2002 Compared with The Quarter Ended March 31, 2001
During the first quarter of 2002 we incurred a net (loss) of ($6.1) million
compared to a net (loss) of ($20.7) million in the first quarter of 2001.
Effective January 1, 2002, the Company adopted SFAS No. 142 and discontinued
amortization of goodwill. On a comparable basis, the net (loss) as adjusted to
exclude goodwill amortization for the periods ended March 31, 2002 and
March 31, 2001 are as follows:
Three Months Ended
March 31,
----------------------------------
2002 2001
---------------- ----------------
(In thousands)
Reported net (loss) ...................... $ (6,113) $ (20,688)
Adjustment for goodwill amortization ..... -- 5,626
--------- ----------
Net (loss), as adjusted .................. $ (6,113) $ (15,062)
========= ==========
Our first quarter 2002 operating (loss) excluding non-cash stock option
re-pricing benefits, amortization of intangibles, and a restructuring benefit
was ($5.7) million versus ($11.9) million in the first quarter of 2001. Gross
profit excluding non-cash stock option re-pricing benefits and amortization of
intangibles decreased from $18.7 million in the first quarter of 2001 to $17.6
million in the first quarter of 2002. Product development expenses decreased by
$0.7 million, selling and marketing expenses decreased by $4.9 million and
general and administrative expenses decreased by $1.8 million from the first
quarter of 2001 to 2002.
Revenues
Total Revenues. Our revenues are derived principally from three sources:
(i) license fees for the use of our software products; (ii) fees for consulting
services and training; and (iii) fees for maintenance and technical support.
Total revenues decreased 5% from $28.7 million for the three months ended March
31, 2001 to $27.4 million for the three months ended March 31, 2002. This
decrease resulted from decreased license and services revenues partially offset
by increased revenues for maintenance.
Software Licensing. Total software licensing revenues decreased 17% from
$11.5 million for the three months ended March 31, 2001 to $9.5 million for the
three months ended March 31, 2002 as a result of continued weak economic
conditions and delayed purchasing decisions by customers. From first quarter of
2001 to 2002 we noted a 3% increase in the number of license contracts exceeding
$100,000, offset by a 7% decrease in the average size of such contracts.
Americas' software licensing revenues decreased 25% from $6.6 million to $5.0
million, EMEA software licensing revenues decreased 26% from $4.7 million to
$3.5 million and APAC software licensing revenues increased by $0.8 million from
$0.3 million to $1.1 million.
Services. Total services revenues decreased 14% from $9.3 million for the
three months ended March 31, 2001 to $8.0 million for the three months ended
March 31, 2002 due to a decrease in EMEA services revenues. Americas' services
revenues decreased 1% from $4.8 million to $4.7 million, EMEA services revenue
decreased 30% from $4.2 million to $2.9 million and APAC services revenue
remained level at $0.3 million. As discussed in Note 3 of the Notes to
Consolidated Condensed Financial Statements, as a result of our adoption of EITF
Issue No. 01-14 effective January 1, 2002, approximately $0.5 million and $0.6
million of out-of-pocket reimbursements have been reclassified from a reduction
in services expenses incurred to services revenues for the three months ended
March 31, 2002 and March 31, 2001, respectively.
Maintenance. Total maintenance revenues increased 25% from $7.9 million for
the three months ended March 31, 2001 to $9.9 million for the three months ended
March 31, 2002 primarily due to growth in the worldwide customer base and the
related renewals of annual maintenance contracts. Americas' maintenance revenues
increased 26% from $5.1 million to $6.4 million, EMEA maintenance revenues
increased 18% from $2.6 million to $3.1 million and APAC maintenance revenues
increased from $0.3 million to $0.4 million.
Cost of Revenues
Total Cost of Revenues. Cost of software licensing revenues consists
primarily of CD-ROMs, manuals, distribution costs and the royalty costs of
third-party software that we resell. Cost of services consists primarily of
personnel-related and travel costs in providing consulting and training to
customers, and occupancy costs. Cost of maintenance revenues consists primarily
of personnel-related and occupancy costs in providing maintenance and technical
support to customers. The non-cash stock option re-pricing benefit relates to
the November 2000 re-pricing of certain options previously granted to certain
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service and maintenance personnel as described below. The intangibles
amortization expense relates to certain purchased intangible technology assets
in connection with the Braid acquisition in 1999 as described below. Total costs
of revenues decreased 4% from $11.0 million for the three months ended
March 31, 2001 to $10.5 million for the three months ended March 31, 2002 due to
the non-cash stock option re-pricing benefit in the first quarter of 2002 and
decreased costs associated with lower license and services revenues, partially
offset by increases in the costs associated with higher maintenance revenues.
Gross margin on software licensing revenues is higher than gross margins on
services and maintenance revenues reflecting the low materials, packaging and
other costs of software products compared with the relatively high personnel
costs associated with providing consulting and training services, maintenance
and technical support. Cost of services also varies based upon the mix of
consulting and training services. Total gross margins remained constant at 62%
for the three months ended March 31, 2002 and 2001. Total gross margins,
excluding the impact of the non-cash stock option re-pricing benefit and
intangibles amortization, were $17.6 million (64%) for the three months ended
March 31, 2002 compared to $18.7 million (65%) in 2001.
Cost of Software Licensing. Total software licensing costs decreased 48%
from $0.2 million for the three months ended March 31, 2001 to $0.1 million for
the three months ended March 31, 2002 due to the decrease in software licensing
revenues. Software licensing gross margin increased slightly from 98% to 99% for
the three months ended March 31, 2001 and 2002, respectively.
Cost of Services exclusive of Non-Cash Stock Option Re-Pricing Benefits.
Total services costs decreased 4% from $8.0 million for the three months ended
March 31, 2001 to $7.7 million for the three months ended March 31, 2002 as a
result of decreases in compensation and recruiting costs in Americas and EMEA
due to headcount reductions, partially offset by marginal increases in other
various expenses. Total services gross margin decreased from 14% for the three
months ended March 31, 2001 to 4% for the three months ended March 31, 2002.
Americas' services costs were flat at approximately $4.6 million for the three
months ended March 31, 2002 and 2001, resulting in a slight decrease in services
gross margin from 3% for the three months ended March 31, 2001 to 2% for the
three months ended March 31, 2002. EMEA services costs decreased marginally from
$2.9 million for the three months ended March 31, 2001 to $2.7 million for the
three months ended March 31, 2002. EMEA services gross margin decreased from 30%
for the three months ended March 31, 2001 to 9% for the three months ended
March 31, 2002 as a result of the decrease in services revenues. APAC services
costs decreased from $0.4 million for the three months ended March 31, 2001 to
$0.3 million for the three months ended March 31, 2002.
Cost of Maintenance exclusive of Non-Cash Stock Option Re-Pricing Benefits.
Total maintenance costs increased 13% from $1.8 million for the three months
ended March 31, 2001 to $2.0 million for the three months ended March 31, 2002
to support the increase in the worldwide customer base. Total maintenance gross
margin increased from 78% for the three months ended March 31, 2001 to 80% for
the three months ended March 31, 2002. Americas' maintenance costs increased
$0.1 million from $1.1 million for the three months ended March 31, 2001 to $1.2
million for the three months ended March 31, 2002. Americas maintenance gross
margins increased from 79% for the three months ended March 31, 2001 to 81% for
the three months ended March 31, 2002. EMEA maintenance costs remained unchanged
at $0.7 million for the three months ended March 31, 2001 and 2002, and
maintenance gross margins increased from 74% for the three months ended
March 31, 2001 to 77% for the three months ended March 31, 2002. APAC
maintenance costs increased modestly to $0.1 million for the three months ended
March 31, 2002.
Stock Option Re-Pricing Benefit. In November 2000, our Board of Directors
approved the exchange of 615,465 options granted in September 2000 for an equal
amount of options (the replacement options) priced at the then current market
price of $5.06 per share. As this was a reduction in the exercise prices of
fixed stock option awards, the replacement options are subject to variable
accounting from the date of modification to the date on which the awards are
exercised, forfeited, or expire unexercised in accordance with FASB
Interpretation No. ("FIN") 44 "Accounting for Certain Transactions Involving
Stock Compensation" and FIN 28 "Accounting for Stock Appreciation Rights and
Other Variable Stock Option or Award Plans". At March 31, 2002, 320,842
re-priced options were outstanding. We recorded a variable non-cash compensation
benefit of $0.3 million for the three months ended March 31, 2002 for such
re-priced options granted to personnel generating services and maintenance
revenues. We also recorded a variable non-cash compensation benefit of $0.6
million for the three months ended March 31, 2002 for the re-priced options
related to operating personnel (see below). There was no stock option re-pricing
charge or benefit for the three months ended March 31, 2001.
Amortization of Intangibles. Amortization of intangible assets remained
constant at $1.0 million for the three months ended March 31, 2002 and 2001. The
expense is related to the Braid business combination completed in 1999, which
was accounted for using the purchase method of accounting. We had net purchased
technology intangibles of $7.4 million and $11.2 million at March 31, 2002 and
2001, respectively.
In accordance with Statement of Financial Accounting Standards ("SFAS") No.
86, "Accounting for the Costs of Computer Software to Be Sold", amortization
relating to capitalized software costs has been charged to cost of revenues, and
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amortization relating to other intangible assets is being classified as a
component of operating expenses.
Operating Expenses
Total Operating Expenses. Total operating expenses decreased 38% from $36.6
million for the three months ended March 31, 2001 to $22.7 million for the three
months ended March 31, 2002. This decrease is primarily attributable to expense
management actions initiated as part of our fiscal year 2001 restructuring
activities as well as a $5.7 million decrease in goodwill amortization due to
our adoption of SFAS No. 142 effective January 1, 2002, which requires us to
discontinue amortization of goodwill. This decrease is also partially due to a
$0.6 million increase in a non-cash stock option re-pricing benefit, and the
reversal of a $0.2 million restructuring accrual.
Product Development exclusive of Non-Cash Stock Option Re-Pricing Benefits.
Product development expenses include expenses associated with the development of
new products and enhancements to existing products. These expenses consist
primarily of salaries, recruiting, and other personnel-related costs,
depreciation of development equipment, supplies, travel, allocated facilities
and allocated communication costs.
Product development expenses decreased 14% from $5.2 million for the three
months ended March 31, 2001 to $4.5 million for the three months ended March 31,
2002 primarily due to an 11% decrease in employee and consultant headcount
quarter over quarter as we focused our efforts on specific products as well as
enhanced productivity and product management.
We believe that a significant level of research and development
expenditures is required to remain competitive. Accordingly, we expect to
continue to devote substantial resources to research and development. We expect
that the dollar amount of research and development expenses will increase
modestly in 2002 as compared to 2001 as we continue to enhance our core
integration products and further develop industry solutions for our targeted
vertical markets. To date, all research and development expenditures have been
expensed as incurred.
Selling and Marketing exclusive of Non-Cash Stock Option Re-Pricing
Benefits. Selling and marketing expenses consist of sales and marketing
personnel costs, including sales commissions, recruiting, travel, advertising,
public relations, seminars, trade shows, product literature, and allocated
facilities and communications costs.
Selling and marketing expenses decreased 29% from $16.8 million for the
three months ended March 31, 2001 to $12.0 million for the three months ended
March 31, 2002 primarily due to staff reductions as a result of our shift in our
sales strategy from increasing the number of sales personnel to strategically
targeting certain vertical markets where our products have particular and proven
value. This decrease is partially offset by slight increases in APAC selling and
marketing expenses due to geographical market expansion activities. Americas'
selling and marketing expenses decreased 39% from $10.4 million for the three
months ended March 31, 2001 to $6.3 million for the three months ended
March 31, 2002 due to the elimination of 57 personnel in the second and third
quarters of 2001 resulting in a $2.0 million decrease in compensation costs and
related reductions in occupancy, travel, training and recruiting costs of $1.5
million. EMEA selling and marketing expenses decreased 19% from $6.0 million for
the three months ended March 31, 2001 to $4.8 million for the three months ended
March 31, 2002 due to decreases in a number of categories, including incentives
related to shortfalls in revenues, marketing, travel and occupancy. APAC selling
and marketing expenses increased 80% from $0.4 million for the three months
ended March 31, 2001 to $0.8 million for the three months ended March 31, 2002
primarily due to market expansion activities.
General and Administrative exclusive of Non-Cash Stock Option Re-Pricing
Benefits. General and administrative expenses consist primarily of salaries,
recruiting, and other personnel related expenses for our administrative,
executive, and finance personnel as well as outside legal, consulting, tax
services and audit fees.
General and administrative expenses decreased 21% from $8.6 million for the
three months ended March 31, 2001 to $6.8 million for the three months ended
March 31, 2002 primarily due to a 13% decrease in personnel quarter over quarter
and improved expense management. Total general and administrative expenses,
excluding the reserves for litigation, have declined sequentially throughout
2001 and 2002 as the restructuring announced in May 2001 took effect. Americas'
general and administrative expenses decreased 24% from $6.6 million for the
three months ended March 31, 2001 to $5.0 million for the three months ended
March 31, 2002 primarily due to lower personnel costs as a result of second and
third quarter 2001 restructuring activities, lower consulting fees, lower
recruiting costs as the new management team was in place as of January 1, 2002,
and improved expense management. Legal expenses incurred in the first quarter of
2001 related to the 2000 Restatement declined sharply, but were offset by costs
associated with other legal matters in the first quarter of 2002. EMEA general
and administrative expenses decreased $0.1 million from $1.5 million for the
three months ended March 31, 2001 to $1.4 million for the three months ended
March 31, 2002. APAC general and administrative expenses were unchanged at $0.4
million for both the three months ended March 31, 2002 and 2001, respectively.
20
Amortization of Goodwill and Intangibles. Amortization of intangible assets
and goodwill decreased 95% from $6.0 million for the three months ended March
31, 2001 to $0.3 million for the three months ended March 31, 2002. As noted
above, this decrease over prior year quarter is directly due to both our
adoption of SFAS No. 142 effective January 1, 2002, which requires us to
discontinue goodwill amortization, and to the effect of goodwill amortization
for the Software Consulting Partners acquisition, as such goodwill was fully
amortized in 2001.
Stock Option Re-Pricing Benefit. As discussed above, we recorded a variable
non-cash compensation benefit of $0.6 million during the first quarter of 2002
related to the re-pricing of certain fixed stock option awards previously
granted to certain product development, sales and marketing and general and
administrative employees in November of 2000. There was no stock option
re-pricing charge or benefit in the first quarter of 2001.
Restructuring Benefit. The restructuring benefit of $0.2 million for the
three months ended March 31, 2002 consists of reversals of EMEA restructuring
reserve accruals as all severance and leased space activities had been finalized
for that segment. At March 31, 2002, $2.6 million of the unpaid restructuring
liability was included in accrued expenses and other current liabilities and
$1.7 million was included in other long-term liabilities. There was no
restructuring charge or benefit in the first quarter of 2001.
Other Income (Expense), Net
Net other income (expense) represents interest income earned on cash and
marketable securities balances and term license contracts, offset by borrowing
costs related to certain contractual obligations.
Net other income (expense) was ($0.1) million for the three months ended
March 31, 2002 as compared to slight income for the three months ended
March 31, 2001 primarily due to fees incurred in connection with our credit
facility with Silicon Valley Bank.
Income Taxes
The provision for income taxes was $0.3 million for the three months ended
March 31, 2002 as compared to $1.9 million for the three months ended
March 31, 2001. The provision for income taxes is based on the anticipated
effective tax rates and taxable income for the full year taking into account
each jurisdiction in which we operate.
Liquidity and Capital Resources
Our cash position has improved at March 31, 2002 as compared to
March 31, 2001 primarily as a result of proceeds realized from the sale of
Common Stock through a private placement completed in December of 2001, which
resulted in net proceeds of $14.4 million.
Operating Activities
Operating activities consumed cash of $0.6 million during the three months
ended March 31, 2002 compared to consuming cash of $8.1 million during the three
months ended March 31, 2001. We were able to substantially eliminate our
operating cash burn through: (i) restructuring activities which began in the
second quarter of 2001 that included an approximate 29% reduction in the
consolidated workforce and a reorganization of our sales efforts; (ii) expense
management efforts; and (iii) continued improvements in accounts receivable
collections resulting in a decrease in the number of days sales outstanding in
net accounts receivable from 105 days at March 31, 2001 to 63 days at March 31,
2002.
Net accounts receivable decreased 33% from $29.0 million at December 31,
2001 to $19.3 million at March 31, 2002 due primarily to a $7.3 million decline
in first quarter revenues in 2002 as compared to fourth quarter revenues in
2001, as well as improved collections. The number of days sales in net accounts
receivable decreased from 75 days at December 31, 2001 to 63 days at March 31,
2002 as we continued to improve our collection efforts. The allowance for
doubtful accounts decreased from $3.9 million at December 31, 2001 to $2.1
million at March 31, 2002 due primarily to a $1.9 million dollar write-off
against the allowance related to the settlement of the Carpet Co-op matter as
discussed elsewhere in this report.
Current liabilities decreased 10% from $51.0 million at December 31, 2001
to $45.9 million at March 31, 2002. Accounts payable decreased 14% from $7.6
million to $6.5 million due to the timing of payments. Accrued expenses
decreased 12% from $20.7 million to $18.2 million due primarily to the payment
of approximately $1.4 million of 2001 bonuses, a $1.3 million decrease in
accruals for commissions and sales related incentives due to the decline in
revenues from the fourth quarter of 2001 to the first quarter of 2002 and $0.7
million of charges and reversals of restructuring reserve accruals. Current
portion of deferred revenue decreased 7% from $22.3 million to $20.8 million due
primarily to the
21
recognition of approximately $1.3 million in license revenue, which was deferred
at year-end 2001.
Our short-term operating commitments include operating lease payments over
the next twelve months of approximately $5.8 million, including approximately
$1.8 million for our new office space in Wilton, CT, which we do not occupy.
Should we negotiate an early termination of this lease, our quarterly cash flows
may be impacted. While the Company expects to enter into a sublease agreement
relating to this facility, if we are unable to enter into a sublease agreement
for this space by September 30, 2002, we may need to record an additional charge
for estimated future rent payments required to be made by the Company until such
time as the space is sublet.
We believe that our expenditures for product development efforts over the
next twelve months will increase modestly as we continue to enhance our
integration products and further develop industry solutions for our targeted
vertical markets.
As of March 31, 2002, we have accruals of $3.9 million, after considering
insurance recoveries, related to settlements associated with outstanding legal
contingencies. A significant increase in the estimate of the cost of settlement
of these contingencies could have a material adverse effect on our consolidated
financial position or results of operations.
As a result of the decline in revenues, we used cash flow of $0.6 million
in our operations in the three months ended March 31, 2002. We anticipate that
if a recovery in information technology integration spending does not occur
until late 2002, we will continue to utilize cash in our operations, excluding
the impact of potential cash payments for the contingencies discussed in Note 8
of the Notes to the Consolidated Condensed Financial Statements. We believe
current cash on-hand as well as cash available from our Silicon Valley Bank
facility (see further discussions below) will be sufficient to meet our needs
associated with cash shortfalls in any one quarter.
Investing Activities
Investing activities consumed cash of $0.5 million during the quarter ended
March 31, 2002 compared to $0.6 million during the quarter ended March 31, 2001.
Investing activities for the first quarter of 2002 included a $0.4 million net
investment in furniture, fixtures and equipment and a $0.1 million increase in
restricted collateral deposits in connection with facility leases. Investing
activities in the first quarter of 2001 included a $1.9 million net investment
in furniture, fixtures and equipment, a $1.6 million increase in the restricted
collateral deposit in connection with a facility lease, partially offset by a
$2.8 million liquidation of investments in marketable securities.
Our expenditures for furniture, fixtures and equipment are expected to be
approximately $3.2 million for the next twelve months. In addition, capital
lease commitments over the next twelve months are approximately $0.6 million.
Financing Activities
Financing activities generated cash of $1.4 million during the quarter
ended March 31, 2002 compared to $3.4 million during the quarter ended
March 31, 2001. Financing activities for the first quarter of 2002 included $1.1
million of proceeds from employee stock plan purchases and $0.7 million of
proceeds from the exercise of employee stock options, partially offset by $0.2
million of capital lease principal payments and $0.2 million of expenses
relating to our December 2001 private placement issuance of stock to certain
investors. Financing activities for the first quarter of 2001 included $2.0
million in proceeds from the private placement issuance of stock to Mitsui and
Co., Ltd., $1.4 million of proceeds from employee stock plan purchases and $0.1
million of proceeds from the exercise of employee stock options, partially
offset by $0.1 million of capital lease principal payments.
In June 2000, we drew a $1.2 million letter of credit with Fleet Bank in
connection with a new headquarters office lease. At Fleet Bank's request we
provided a $1.5 million restricted collateral deposit as security for the
outstanding letter of credit. In January 2001, we increased the letter of credit
to $2.5 million and the related restricted collateral deposit to $3.0 million.
The letter of credit agreement with Fleet Bank remains in effect.
In June 2001, we finalized a credit facility with Silicon Valley Bank. The
maximum amount available under the facility at March 31, 2002 and in subsequent
quarters is $15 million, as a result of our achieving positive EBITDA in the
fourth quarter of 2001. This facility is secured by certain receivables, and
borrowings under the facility may not exceed 80% of eligible accounts
receivable, as defined in the facility agreement and subject to bank approval.
Borrowings are also subject to the Company maintaining compliance with the terms
of the facility agreement, including the level of the Adjusted Quick Ratio
covenant, as discussed below. As of March 31, 2002, the maximum eligible
accounts receivable were approximately $17 million. Since inception, no amounts
have been borrowed under this facility.
In September and November 2001, Silicon Valley Bank agreed to waive and
modified certain terms of the credit facility, including eliminating the
requirement for a capitalization event and relaxing the level of the Adjusted
Quick Ratio covenant. The Bank also extended the expiration date of the facility
to November 27, 2002. Specifically, the agreement, as amended, requires us to
maintain an Adjusted Quick Ratio, as defined, of at least 1.5 to 1.0 for each
month subsequent to December 1, 2001. We were in compliance with the Adjusted
Quick Ratio covenant under the agreement, as amended, at March 31, 2002. If the
Company were in default, such default, if uncured, could result in our being
required to pay a $0.2 million termination fee. Prior to November 27, 2002, we
expect to seek to renegotiate the facility to extend it beyond its scheduled
termination or,
22
alternatively, negotiate a similar facility with another party on no less
favorable terms.
Cash Flow and Funding Requirements
We believe that current cash and cash equivalent balances ($28.1 million at
March 31, 2002) are sufficient to meet anticipated needs for working capital,
capital expenditures of $3.2 million and capital leases of $0.6 million, through
March 31, 2003. However, any projections of future cash needs and cash flows are
subject to uncertainty. Additionally, a significant increase in the cost of
settlement of legal contingencies in excess of amounts accrued and insurance
coverages could have a material adverse impact on our consolidated financial
position or consolidated results of operations. Our long-term capital needs will
depend on numerous factors, including the rate at which we are able to obtain
new business from clients and expand our personnel and infrastructure to
accommodate such growth, as well as the rate at which we choose to invest in new
technologies. (See "Factors that May Affect Future Results" below.)
If current cash, cash equivalents and cash that may be generated from
operations and the credit facility are deemed to be insufficient to satisfy our
liquidity requirements, we will likely seek to sell additional equity securities
and/or debt securities. Moreover, we may determine to sell additional equity for
the purpose of further enhancing our cash resources. The sale of additional
equity or equity-related securities, if achieved, would result in additional
dilution to our stockholders. In addition, we will, from time to time, consider
the acquisition of or investment in complementary businesses, products, services
and technologies, which might impact our liquidity requirements or cause us to
issue debt or additional equity securities. There can be no assurance that
financing will be available in amounts or on terms acceptable to us, or at all.
A failure to obtain such financing may adversely impact our business. In
addition, if our cash flows were to substantially decrease, our goodwill or our
purchased technology intangible assets may become impaired and we would have to
record a charge for impairment, which may be material to our financial position
and results of operations.
Recently Issued Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other
Intangible Assets". SFAS No. 141 requires that the purchase method of accounting
be used for all business combinations. SFAS No. 141 specifies criteria that
intangible assets acquired in a business combination must meet to be recognized
and reported separately from goodwill. SFAS No. 142 requires that goodwill and
intangible assets with indefinite useful lives no longer be amortized, but
instead be tested for impairment at least annually in accordance with the
provisions of SFAS No. 142. SFAS No. 142 also requires that intangible assets
with estimable useful lives be amortized over their respective estimated useful
lives to their estimated residual values, and reviewed for impairment in
accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long
Lived Assets".
The Company adopted the provisions of SFAS No. 141 as of July 1, 2001 and
the provisions of SFAS No. 142 as of January 1, 2002. Amortization of goodwill
and intangible assets with indefinite useful lives acquired in business
combinations completed before July 1, 2001 was discontinued as of
January 1, 2002. Had SFAS No. 142 been in effect for the prior year, the net
loss for the three months ended March 31, 2001 would have been ($15.1) million
and net loss per share would have been ($0.50).
In connection with SFAS No. 142's transitional goodwill impairment
evaluation, the Statement requires the Company to perform an assessment of
whether there is an indication that goodwill is impaired as of the date of
adoption. To accomplish this, the Company must identify its reporting units and
determine the carrying value of each reporting unit by assigning the assets and
liabilities, including the existing goodwill and intangible assets, to those
reporting units as of January 1, 2002. The Company has up to six months from
January 1, 2002 to determine the fair value of each reporting unit and compare
it to the carrying amount of the reporting unit. To the extent the carrying
amount of a reporting unit exceeds the fair value of the reporting unit, an
indication exists that the reporting unit goodwill may be impaired and the
Company must perform the second step of the transitional impairment test. The
second step is required to be completed as soon as possible, but no later than
the end of the year of adoption. In the second step, the Company must compare
the implied fair value of the reporting unit goodwill with the carrying amount
of the reporting unit goodwill, both of which would be measured as of the date
of adoption. The implied fair value of goodwill is determined by allocating the
fair value of the reporting unit to all of the assets (recognized and
unrecognized) and liabilities of the reporting unit in a manner similar to a
purchase price allocation, in accordance with SFAS No. 141. The residual fair
value after this allocation is the implied fair value of the reporting unit
goodwill. Any transitional impairment loss will be recognized as the cumulative
effect of a change in accounting principle in the Company's Consolidated
Statement of Operations. The Company will complete the transitional impairment
test for its goodwill by June 30, 2002. Because of the extensive effort needed
to comply with adopting SFAS No. 142, it is not practicable to reasonably
estimate the impact of adopting this Statement on the Company's financial
statements at the date of this report, including whether it will be required to
recognize any transitional impairment losses as the cumulative effect of a
change in accounting principle.
23
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". SFAS No. 143 requires the Company to record the fair
value of an asset retirement obligation as a liability in the period in which it
incurs a legal obligation associated with the retirement of tangible long-lived
assets that result from the acquisition, construction, development and/or normal
use of the assets. The Company also records a corresponding asset, which is
depreciated over the life of the asset. Subsequent to the initial measurement of
the asset retirement obligation, the obligation will be adjusted at the end of
each period to reflect the passage of time and changes in the estimated future
cash flows underlying the obligation. The Company is required to adopt SFAS No.
143 on January 1, 2003. Management does not expect the adoption of SFAS No. 143
to have a significant impact on the Company's financial position or results of
operations.
In August 2001, the FASB issued SFAS No. 144. SFAS No. 144 addresses
financial accounting and reporting for the impairment or disposal of long-lived
assets. This Statement requires that long-lived assets be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset
to future net cash flows expected to be generated by the asset. If the carrying
amount of an asset exceeds its estimated future cash flows, an impairment charge
is recognized by the amount by which the carrying amount of the asset exceeds
the fair value of the asset. SFAS No. 144 requires companies to separately
report discontinued operations and extends that reporting to a component of an
entity that either has been disposed of (by sale, abandonment, or in a
distribution to owners) or is classified as held for sale. Assets to be disposed
of are reported at the lower of the carrying amount or fair value less costs to
sell. The Company adopted SFAS No. 144 on January 1, 2002 and the adoption did
not have a significant impact on the Company's financial position or results of
operations.
In November 2001, the Emerging Issues Task Force ("EITF") concluded that
reimbursements for out-of-pocket-expenses incurred should be included in revenue
in the income statement and subsequently issued EITF Issue No. 01-14, "Income
Statement Characterization of Reimbursements Received for `Out-of-Pocket'
Expenses Incurred" in January 2002. The Company adopted EITF Issue No. 01-14 on
January 1, 2002 and as such, has presented these reimbursements in accordance
with EITF Issue No. 01-14 for the current period and all comparative prior
period financial statements presented herein, to provide consistent
presentation. These reimbursements represent costs paid directly to third
parties primarily for travel related expenses incurred for services personnel.
Approximately $0.5 million and $0.6 million of out-of-pocket reimbursements have
been reclassified from a reduction in services expenses incurred to services
revenues for the three months ended March 31, 2002 and March 31, 2001,
respectively. The adoption of Issue No. 01-14 did not impact the Company's
financial position, operating loss or net loss.
Other pronouncements issued by the FASB or other authoritative accounting
standard groups with future effective dates are either not applicable or are not
significant to the financial statements of Mercator.
Conversion to a Single European Currency
We generate revenues in a number of foreign countries. The conversion to a
single European currency (the "Euro") did not have a material impact on our
financial results.
Factors That May Affect Future Results
You should carefully consider the following risks factors before making an
investment decision. Our business, results of operations, and financial
condition could be adversely affected by any of the following factors. The
market price of our Common Stock could decline due to any of these risks, and
you could lose all or part of your investment.
Our quarterly and annual operating results are volatile and difficult to
predict and may cause our stock price to fluctuate
Our quarterly and annual operating results have varied significantly in the
past and may continue to do so in the future. We had operating losses in the
quarter ended March 31, 2002 and for the year ended December 31, 2001 and may
continue to have losses in the future. In the first quarter of 2002 and certain
quarters of 2001, our operating results were below the expectations of public
market analysts and investors, and were followed by a decline in the price of
our stock. This may occur in the future and if our revenues and operating
results do not meet expectations, our stock price could decline which may result
in potential customers choosing other vendors.
24
In 2001, we announced a restructuring plan to reduce our cost structure. As
of March 31, 2002, this plan consisted of certain work force reductions across
the Company, closing some office facilities and reducing some other space. We
also announced a strategic plan to focus our resources on the largest vertical
market opportunities where we have significant experience including financial
services, manufacturing, retail and distribution, and healthcare. Our
restructuring plan that has been put in place remains somewhat unproven, and
could result in increased volatility in and have an adverse effect on our stock
price. Our focus on large vertical market opportunities may result in longer
sales cycles and any delay in obtaining larger contracts may have an adverse
impact on quarterly operating results. We believe that investors should not rely
on period-to-period comparisons of our results of operations, as they are not
necessarily indications of our future performance.
An adverse reaction by customers and vendors to changes in our company may
result in a revenue decline and adverse impact to cash position
Our success depends in large part on the support of key customers and
vendors who may react adversely to changes in our company. Many members of our
senior management have joined us during the past year. It will take time and
resources for these individuals to effect change within our organization and
during this period our vendors and customers may re-examine their willingness to
do business with us. If we are unable to retain and attract our existing and new
customers and vendors, our revenues could decline and our cash position could be
materially adversely affected.
Our future success depends on retaining our key personnel and attracting and
retaining additional highly qualified employees
Other than Roy King, our Chairman, Chief Executive Officer and President,
all of our employees are employed at-will and we have no fixed-term employment
agreements with our employees. The loss of the services of any of our key
employees could harm our business.
Our future success also depends on our ability to attract, train and retain
highly qualified sales, research and development, professional services and
managerial personnel, particularly sales and professional services personnel.
Competition for these personnel is intense. We may not be able to attract,
assimilate or retain qualified personnel. We have at times experienced, and we
continue to experience, difficulty in recruiting qualified sales and research
and development personnel, and we anticipate these difficulties may continue in
the future. Furthermore, we have in the past experienced, and in the future
expect to continue to experience, a significant time lag between the date sales,
research and development and professional services personnel are hired and the
date these employees become fully productive.
It would be difficult for us to materially or immediately adjust our spending
if we experience any revenue shortfalls
Our future revenues will be difficult to predict and we could fail to
achieve our revenue expectations. Our expense levels are based, in part, on our
expectation of future revenues, and expense levels are, to a large extent, fixed
in the short term. We may be unable to materially adjust spending in a timely
manner to compensate for any unexpected revenue shortfall. If revenue levels are
below expectations for any reason, our operating results and cash flows are
likely to be harmed. Net income may be disproportionately affected by a
reduction in revenue because large portions of our expenses are related to
headcount that may not be easily reduced without harming our business. If cash
flows are negatively impacted, there can be no assurance that our existing cash
and accounts receivable financing arrangement will be sufficient to meet cash
needs or will be available in the future, as there is no assurance that we will
be able to draw down upon our existing line of credit.
We may experience seasonal fluctuations in our revenues or results of
operations
It is not uncommon for software companies to experience strong calendar
year ends followed by weaker subsequent quarters, in some cases with sequential
declines in revenues or operating profit. We believe that many software
companies exhibit this pattern in their sales cycles primarily due to customers'
buying patterns and budget cycles. We have displayed this pattern in the past
and may display this pattern in future years.
We have been and may continue to be impacted by the overall economy and the
events of September 11th
As a result of recent unfavorable economic conditions including the impact
of the events of September 11th on certain of our vertical markets, we have seen
reduced capital spending, and software licensing revenues have declined in the
first quarter of 2002 and fiscal year 2001 in total and as a percentage of our
total revenues as compared to the prior year. In particular, sales to e-commerce
and internet businesses, value-added resellers and independent software vendors
were impacted during the first quarter of 2002 and during the year 2001. Sales
to financial institutions have been impacted in the
25
first fiscal quarter of 2002 and the fourth fiscal quarter of 2001. If the
economic conditions in the United States worsen, or if a wider global economic
slowdown occurs, we may experience a material adverse impact on our revenues and
collections of our accounts receivable.
We depend on the sales of our existing Mercator products and related services
We first introduced our Mercator products in 1993. In recent years, a
significant portion of our revenue has been attributable to licenses of Mercator
products and related services, and we expect that revenue attributable to our
Mercator products and related services will continue to represent a significant
portion of our total revenue for the foreseeable future. Accordingly, our future
operating results significantly depend on the market acceptance and growth of
our existing Mercator product line and enhancements of these products and
services. Market acceptance of our Mercator product line may not increase or
remain at current levels, and we may not be able to market successfully our
Mercator product line or develop extensions and enhancements to this product
line on a long-term basis. In the event that our current or future competitors
release new products that provide, or are perceived as providing, more advanced
features, greater functionality, better performance, better compatibility with
other systems or lower prices than our Mercator product line, demand for our
products and services would likely decline. A decline in demand for, or market
acceptance of, the Mercator product line would harm our business.
We may face significant risks in expanding our international operations
International revenues accounted for approximately 41% of our total
revenues in the first quarter of 2002 and 37% of our total revenues for 2001.
Continued expansion of our international sales and marketing efforts will
require significant management attention and financial resources. We also expect
to commit additional time and development resources to customizing our products
for selected international markets and to developing international sales and
support channels. International operations involve a number of additional risks,
including the following:
o difficulties in staffing and managing foreign operations;
o impact of possible recessionary environments in economies outside the
United States;
o longer receivables collection periods and greater difficulty in
accounts receivable collection;
o unexpected changes in regulatory requirements;
o dependence on independent resellers;
o reduced protection for intellectual property rights in some countries;
o tariffs and other trade barriers;
o foreign currency exchange rate fluctuations;
o the burdens of complying with a variety of foreign laws;
o potentially adverse tax consequences; and
o political instability.
To the extent that our international operations expand, we expect that an
increasing portion of our international license and service and other revenues
will be denominated in foreign currencies. We do not currently engage in foreign
currency hedging transactions. However, as we continue to expand our
international operations, exposures to gains and losses on foreign currency
transactions may increase. We may choose to limit our exposure by the purchase
of forward foreign exchange contracts or similar hedging strategies. The
currency exchange strategy that we adopt may not be successful in avoiding
exchange-related losses. In addition, the above-listed factors may cause a
decline in our future international revenue and, consequently, may harm our
business. We may not be able to sustain or increase revenue that we derive from
international sources.
26
We may experience difficulties in developing and introducing new or enhanced
products necessitated by technological changes
Our future success will depend, in part, upon our ability to anticipate
changes, to enhance our current products and to develop and introduce new
products that keep pace with technological advancements and address the
increasingly sophisticated needs of our customers. Development of enhancements
to existing products and new products depend, in part, on a number of factors,
including the following:
o the timing of releases of new versions of applications systems by
vendors;
o the introduction of new applications, systems or computing platforms;
o the timing of changes in platforms;
o the release of new standards or changes to existing standards;
o changing customer requirements; and
o the availability of cash to fund development.
Our product enhancements or new products may not adequately meet the
requirements of the marketplace or achieve any significant degree of market
acceptance. We have in the past experienced delays in the introduction of
product enhancements and new products and we may experience delays in the
future. Furthermore, as the number of applications, systems and platforms
supported by our products increases, we could experience difficulties in
developing, on a timely basis, product enhancements which address the increased
number of new versions of applications, systems or platforms served by our
existing products. If we fail, for technological or other reasons, to develop
and introduce product enhancements or new products in a timely and
cost-effective manner or if we experience any significant delays in product
development or introduction, our customers may delay or decide against purchases
of our products as our products may be rendered obsolete.
The success of our products will also depend upon the success of the platforms
we target
We may, in the future, seek to develop and market enhancements to existing
products or new products, which are targeted for applications, systems or
platforms that we believe will achieve commercial acceptance. This could require
us to devote significant development, sales and marketing personnel, as well as
other resources, to these efforts, which would otherwise be available for other
purposes. We may not be able to successfully identify these applications,
systems or platforms, and even if we do so, we may not achieve commercial
acceptance or we may not realize a sufficient return on our investment. Failure
of these targeted applications, systems or platforms to achieve commercial
acceptance or our failure to achieve a sufficient return on our investment could
harm our business.
We may not successfully expand our sales and distribution channels
An integral part of our strategy is to expand our indirect sales channels,
including strategic partners, value-added resellers, independent software
vendors, systems integrators and distributors. However, while we believe this is
a profitable and incremental strategy, such sales will be at lower unit prices,
may limit our contact with customers (potentially inhibiting future follow-up
sales) and places us in a position of depending upon the reseller to achieve
customer satisfaction, and could result in these resellers selling to customers
we may have sold to. We are increasing resources dedicated to developing and
expanding these indirect distribution channels. In the first quarter of 2002,
20% of our total license revenues came from those sources and for the full year
2001, 27% of our total license revenues came from those sources. We may not be
successful in expanding the number of indirect distribution channels for our
products. If we are successful in increasing our sales through indirect sales
channels, we expect that those sales will be at lower per unit prices than sales
through direct channels, and revenue we receive for each sale will be less than
if we had licensed the same product to the customer directly. As a result, our
ability to accurately forecast sales, evaluate customer satisfaction and
recognize emerging customer requirements may be hindered.
Even if we successfully expand our indirect distribution channels, any new
strategic partners, value-added resellers, independent software vendors, system
integrators or distributors may offer competing products, or have no minimum
purchase requirements of our products. These third parties may also not have the
technical expertise required to market and support our products successfully. If
the third parties do not provide adequate levels of services and technical
support, our customers could become dissatisfied, and we may have to devote
additional resources for customer support. Our brand name
27
and reputation could be harmed. Selling products through indirect sales channels
could cause conflicts with the selling efforts of our direct sales force.
Our strategy of marketing products directly to end-users and indirectly
through value-added resellers, independent software vendors, systems integrators
and distributors may result in distribution channel conflicts. Our direct sales
efforts may compete with those of our indirect channels and, to the extent
different resellers target the same customers, resellers may also come into
conflict with each other. Although we have attempted to manage our distribution
channels to avoid potential conflicts, channel conflicts may harm our
relationships with existing value-added resellers, independent software vendors,
systems integrators or distributors or impair our ability to attract new value
added resellers, independent software vendors, systems integrators and
distributors.
We may encounter difficulties in managing our long-term growth
The long-term growth of our business has placed, and is expected to
continue to place, a strain on our administrative, financial, sales and
operational resources and increased demands on our internal systems and
controls.
To address this growth, we have recently implemented, or are in the process
of implementing and will implement in the future, a variety of new and upgraded
operational and financial systems, procedures and controls. We may not be able
to complete successfully the implementation and integration of these systems,
procedures and controls, or hire additional personnel, in a timely manner. Our
inability to manage our growth amid changing business conditions, or to adapt
our operational, management and financial control systems to accommodate our
growth, could harm our business.
We face significant competition in the market for integration software
The markets for our products and services are extremely competitive and
subject to rapid change. Because there are relatively low barriers to entry in
the software market, we expect additional competition from other established and
emerging companies.
In the integration market, our products and related services compete
primarily against solutions developed internally by individual businesses to
meet their specific integration needs. In addition, we face increasing
competition in the integration market from other third-party software vendors.
Many of our current and potential competitors have longer operating
histories, significantly greater financial, technical, product development and
marketing resources, greater name recognition and larger customer bases than we
do. Our present or future competitors may be able to develop products that are
comparable or superior to those we offer, adapt more quickly than we do to new
technologies, evolving industry trends or customer requirements, or devote
greater resources than we do to the development, promotion and sale of their
products. Accordingly, we may not be able to compete effectively in our target
markets against these competitors.
We expect that we will face increasing pricing pressures from our current
competitors and new market entrants. Our competitors may engage in pricing
practices that may reduce the average selling prices of our products and related
services. To offset declining average selling prices, we believe that we must
successfully introduce and sell enhancements to existing products and new
products on a timely basis. We must also develop enhancements to existing
products and new products that incorporate features that can be sold at higher
average selling prices. To the extent that enhancements to existing products and
new products are not developed in a timely manner, do not achieve customer
acceptance or do not generate higher average selling prices, our operating
margins may decline.
Government regulation and legal uncertainties relating to the internet could
adversely affect our business
Congress has passed legislation and several more bills have been sponsored
in both the House and Senate that are designed to regulate various aspects of
the internet, including, for example, on-line content, copyright infringement,
user privacy, and taxation. In addition, federal, state, local and foreign
governmental organizations are considering other legislative and regulatory
proposals that would regulate aspects of the internet, including libel, pricing,
quality of products and services, and intellectual property ownership. The laws
governing the use of the internet, in general, remain largely unsettled, even in
areas where there has been some legislative action. It may take years to
determine whether and how existing laws apply to the internet. In addition, the
growth and development of the market for online commerce may prompt calls for
more stringent consumer protection laws, both in the United States and abroad,
which may impose additional burdens on companies conducting business on-line by
limiting the type and flow of information over the internet. The adoption or
modification of laws or regulations relating to the internet could adversely
affect our business.
28
It is not known how courts will interpret both existing and new laws.
Therefore, we are uncertain as to how new laws or the application of existing
laws will affect our business or our clients' business, which may have an
indirect affect on our business. Increased regulation of the internet may
decrease the growth in the use of the internet, which could decrease the demand
for our services, increase our cost of doing business or otherwise have a
material adverse effect on our business, or results of operations and financial
condition.
The United States Omnibus Appropriations Act of 1998 places a moratorium on
taxes levied on internet access from October 1998 to November 2003. However,
states may place taxes on internet access if taxes had already been generally
imposed and actually enforced prior to October 1998. States which can show they
enforced internet access taxes prior to October 1998 and states after November
2003 may be able to levy taxes on internet access resulting in increased cost to
access the internet, which may result in a material adverse effect to our
business.
We have only limited protection for our proprietary technology
Our success is dependent upon our proprietary software technology. We
protect our technology as described herein but this may not prevent
misappropriation or development by third parties of similar products. We do not
have any patents and we rely principally on trade secret, copyright and
trademark laws, nondisclosure and other contractual agreements and technical
measures to protect our technology. We enter into confidentiality and/or license
agreements with our employees, distributors and customers, and we limit access
to and distribution of our software, documentation and other proprietary
information by employees, distributors and customers. The steps taken by us may
not be sufficient to prevent misappropriation of our technology, and such
protections do not preclude competitors from developing products with
functionality or features similar to our products. Furthermore, it is possible
that third parties will independently develop competing technologies that are
substantially equivalent or superior to our technologies. In addition, effective
copyright and trade secret protection may be unavailable or limited in certain
foreign countries, which could pose additional risks of infringement as we
continue to expand internationally. Our failure or inability to protect our
proprietary technology could have a material adverse effect on our business.
Although we do not believe that our products infringe the proprietary
rights of any third parties, infringement claims could be asserted against us or
our customers in the future. Furthermore, we may initiate claims or litigation
against third parties for infringement of our proprietary rights, or for
purposes of establishing the validity of our proprietary rights. Litigation,
either as plaintiff or defendant, would cause us to incur substantial costs and
divert management resources from productive tasks whether or not such litigation
is resolved in our favor, which could have a material adverse effect on our
business. Parties making claims against us or customers for which we are subject
to payment of indemnification could recover substantial damages, as well as
injunctive or other equitable relief, which could effectively block our ability
to license our products in the United States or abroad. Such a judgment could
have a material adverse effect on our business. If it appears necessary or
desirable, we may seek licenses to intellectual property that we are allegedly
infringing. Licenses may not be obtainable on commercially reasonable terms, if
at all. The failure to obtain necessary licenses or other rights could have a
material adverse effect on our business. As the number of software products in
the industry increases and the functionality of these products further overlaps,
we believe that software developers may become increasingly subject to
infringement claims. Any such claims, with or without merit, can be
time-consuming and expensive to defend and could adversely affect our business.
We are not aware of any currently pending claims that our products, trademarks
or other proprietary rights infringe upon the proprietary rights of third
parties.
We may become subject to product liability claims
Our license agreements with our customers typically contain provisions
designed to limit our exposure to potential product liability claims. It is
possible, however, that the limitation of liability provisions contained in our
license agreements, especially unsigned shrink-wrap licenses, may not be
effective under the laws of certain jurisdictions. Consequently, the sale and
support of our software entails the risk of product liability claims in the
future and any liability insurance may not be sufficient to cover the product
liability claims.
The ultimate outcome of pending securities litigation is uncertain
After the restatement of our first quarter 2000 earnings and the adjustment
to previously disclosed second quarter 2000 results, we were named in a series
of similar purported securities class action lawsuits. These lawsuits have now
been consolidated into one matter. The amended complaint in the consolidated
matter alleges violations of United States securities law through alleged
material misrepresentations and omissions and seeks an unspecified award of
damages. We believe that the allegations in the amended complaint are without
merit, and we intend to contest them vigorously. There can be no
29
guarantee as to the ultimate outcome of this pending litigation or whether the
ultimate outcome may have a material adverse effect on our financial position or
results of our operations. Our insurance company has reserved its rights with
respect to this matter.
Our stock price has fluctuated and could continue to fluctuate
The trading price of our Common Stock has fluctuated widely in the past and
may be significantly affected by a number of factors, including the following:
o actual or anticipated fluctuations in our operating results;
o announcements of technological innovations or new products by us or
our competitors;
o developments with respect to patents, copyrights or proprietary
rights;
o conditions and trends in the software or other industries; and
o general market conditions.
In addition, the stock market has, from time to time, experienced
significant price and volume fluctuations that have particularly affected the
market prices for the stock of technology companies. These broad market
fluctuations may cause the market price of our Common Stock to decline. The
following table shows the high and low sale prices of our Common Stock as
reported on the Nasdaq National Market System for the past three years and for
the first quarter of 2002:
Reported Sale Price
------------------------------
High Low
------------- ------------
1999
First Quarter............................... 32.00 20.50
Second Quarter.............................. 28.875 14.00
Third Quarter............................... 28.00 16.875
Fourth Quarter.............................. 66.75 22.00
2000
First Quarter............................... 149.875 47.00
Second Quarter.............................. 84.00 26.75
Third Quarter............................... 70.375 13.438
Fourth Quarter.............................. 16.188 2.81
2001
First Quarter............................... 12.188 3.25
Second Quarter.............................. 3.75 1.40
Third Quarter............................... 2.47 0.95
Fourth Quarter.............................. 9.44 1.09
2002
First Quarter............................... 10.15 3.91
Our stockholder rights plan, corporate governance structure and governing law
may delay or prevent our acquisition by another company
Our corporate governing documents as well as Delaware law contain
provisions that could make it more difficult for a third party to attempt to
acquire or gain control of our company. These provisions include:
o our Board of Directors can issue shares of preferred stock without any
vote or action by the stockholders and this stock could have rights
superior to those of existing stockholders and could impede the
success of any acquisition attempt by another company;
30
o we adopted a stockholders rights plan which permits existing
stockholders to purchase a substantial number of shares at a
substantial discount to the market price if a third party attempts to
gain control on a large equity position in our company;
o a stockholder must give our Board of Directors prior notice of a
proposal to take action by written consent;
o a stockholder must give advance notice to the Board of Directors
before stockholder-sponsored proposals may receive consideration at
annual meetings and before a stockholder may make nominations for the
election of directors;
o vacancies on the Board of Directors may be filled until the next
annual meeting of stockholders only by majority vote of the directors
then in office; and
o stockholders cannot call special meetings of stockholders.
We are also governed by Section 203 of the Delaware General Corporation
Law, which restricts certain business combinations with any interested
stockholder, as defined by that statute. Our stockholder rights plan, our
charter, bylaws and the provisions of Section 203 could make it more difficult
for a third party to acquire control of our outstanding voting stock and could
delay or prevent a change in our control.
In addition, we have arrangements with certain officers and other option
holders, which provide for benefits upon a change in control, which could also
delay or impede an acquisition.
Future sales of our common stock by our stockholders could cause our stock
price to decline
As of May 8, 2002, we have outstanding warrants to purchase an aggregate of
1,058,719 shares of Common Stock and also options to purchase an aggregate of
9,285,388 shares of Common Stock granted under our directors' and employee
benefit plans. The number of shares issuable upon exercise of warrants are
subject to adjustment pursuant to anti-dilution provisions. Holders of such
warrants and options are likely to exercise them when, in all likelihood, we
could obtain additional capital on terms more favorable than those provided in
such warrants and options. Further, while these warrants and options are
outstanding, our ability to obtain additional financing on favorable terms could
be affected. Exercise of warrants and options may result in dilution to existing
stockholders.
Sales of a significant amount of Common Stock in the public market by
existing shareholders, including holders of warrants and options, could
adversely affect the market price of the Common Stock, and it may make it more
difficult for us to sell our Common Stock in the future at times and for prices
that we deem appropriate. Several of our stock and warrant holders are parties
to registration rights agreements with us under which we are required to
register their stock for sale to the public. In January 2002, we filed a
Registration Statement covering resale of an aggregate of 3,577,883 shares,
which was declared effective in March of 2002. Sale of the shares of Common
Stock covered by such Registration Statement, or even the availability of such
shares for sale, may have an adverse effect on the market price of our stock
from time to time.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the ordinary course of operations, our financial position and cash flows
are subject to a variety of risks, which include market risks associated with
changes in foreign currency exchange rates and movement in interest rates. We do
not, in the normal course of business, use derivative financial instruments for
trading or speculative purposes. Uncertainties that are either non-financial or
non-quantifiable, such as political, economic, tax, other regulatory or credit
risks are not included in the following assessment of our market risks.
Foreign Currency Exchange Rates
Operations outside of the U.S. expose us to foreign currency exchange rate
changes and could impact translations of foreign denominated assets and
liabilities into U.S. dollars and future earnings and cash flows from
transactions denominated in different currencies. During the quarter ended
March 31, 2002, 41% of our total revenue was generated from international
sources and the net assets of our foreign subsidiaries totaled approximately 25%
of consolidated net assets as of March 31, 2002. Our exposure to currency
exchange rate changes is diversified due to the number of different countries in
which we conduct business. We operate outside the U.S. primarily through wholly
owned subsidiaries in the United Kingdom, France, Germany, Netherlands, Sweden,
Switzerland, Spain, Singapore, Hong Kong, Australia and Japan. These foreign
subsidiaries use local currencies as their functional currency, as certain sales
are generated and expenses are incurred in such currencies.
31
Foreign currency gains and losses will continue to result from fluctuations in
the value of the currencies in which we conduct our operations as compared to
the U.S. dollar. We continue to evaluate different hedging strategies and at
this time, we do not believe that possible near-term changes in exchange rates
will result in a material effect on our future earnings or cash flows and,
therefore, have chosen not to enter into foreign currency hedging instruments.
There can be no assurance that this approach will be successful, especially in
the event of a sudden and significant decline in the value of foreign currencies
relative to the United States dollar.
Interest Rates
We invest our cash in a variety of financial instruments, consisting
principally of investments in commercial paper, interest-bearing demand deposit
accounts with financial institutions, money market funds and highly liquid debt
securities of corporations, municipalities and the U.S. Government. The majority
of our investments are denominated in U.S. dollars. Cash balances in foreign
currencies overseas are operating balances and are only invested in short-term
deposits of the local operating bank.
32
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company has certain significant legal contingencies, discussed below,
and other litigation of a nature considered normal to its business which are
pending against the Company.
On or about February 1, 2000, Mercator was named as a defendant and served
with a complaint in an action entitled Carpet Co-Op of America Association,
Inc., and FloorLINK, L.L.C. v. TSI International Software, Ltd., Civil Action
No. 00CC- 0231, in the Circuit Court of St. Louis County, Missouri. The
complaint includes counts for breach of contract, fraud and negligent
misrepresentation in connection with certain software implementation work
provided under contract by Mercator. Mercator counter-sued in the United States
District Court for the District of Connecticut on March 30, 2000 for copyright
infringement, trademark infringement, unfair competition, misappropriation of
trade secrets, breach of contract, fraud, unjust enrichment and violation of the
Connecticut Unfair Trade Practices Act. As reported in the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 2001, on
January 30, 2002, Mercator entered into a settlement agreement with respect to
these actions, which resolves these actions in their entirety. Mercator paid
$0.5 million after insurance proceeds in January 2002 as a requirement of this
settlement agreement.
Between August 23, 2000 and September 21, 2000 a series of fourteen
purported securities class action lawsuits was filed in the United States
District Court for the District of Connecticut, naming as defendants Mercator,
Constance Galley and Ira Gerard. Kevin McKay was also named as a defendant in
nine of these complaints. On or about November 24, 2000, these lawsuits were
consolidated into one lawsuit captioned: In re Mercator Software, Inc.
Securities Litigation, Master File No. 3:00-CV-1610 (GLG). The lead plaintiffs
purport to represent a class of all persons who purchased Mercator's Common
Stock from April 20, 2000 through and including August 21, 2000. Each complaint
in the consolidated action alleges violations of Section 10(b) of the Securities
Exchange Act of 1934 and Rule 10b-5 thereunder, through alleged material
misrepresentations and omissions and seeks an unspecified award of damages. On
January 26, 2001, the lead plaintiffs filed an amended complaint in the
consolidated matter with substantially the same allegations. Named as defendants
in the amended complaint are Mercator, Constance Galley and Ira Gerard. The
amended complaint in the consolidated action alleges violations of Section 10(b)
and Rule 10b-5 through alleged material misrepresentations and omissions and
seeks an unspecified award of damages. Mercator filed a motion to dismiss the
amended complaint on March 12, 2001. The lead plaintiffs filed an opposition to
Mercator's motion to dismiss on or about April 18, 2001, and Mercator filed its
reply brief on May 7, 2001. The Court heard oral argument on the motion to
dismiss on July 6, 2001. On September 13, 2001, the Court denied Mercator's
motion to dismiss. Mercator believes that the allegations in the amended
complaint are without merit and intends to contest them vigorously. We believe
that this securities class action lawsuit is covered by insurance. Mercator
notified its directors' and officers' liability insurance companies of this
matter. The insurance carriers have reserved their rights in this matter. There
can be no guarantee as to the ultimate outcome of this proceeding or whether the
ultimate outcome, after considering liabilities already accrued in the Company's
March 31, 2002 consolidated balance sheet and insurance recoveries, may have a
material adverse effect on the Company's consolidated financial position or
consolidated results of operations.
The Company has been named as a defendant in an action filed on
August 3, 2001 in the United States District Court for the Eastern District of
Pennsylvania, entitled Ulrich Neubert v. Mercator Software, Inc., f/k/a TSI
International Software, Ltd., Civil Action No. 01-CV-3961. The complaint alleges
claims of breach of contract, breach of the implied covenant of good faith and
fair dealing, breach of fiduciary duty, and fraud in connection with the
Company's acquisition of Software Consulting Partners ("SCP") in November 1998.
Neubert, who was the sole shareholder of SCP prior to November 1998, seeks
purported damages of up to approximately $7.5 million, plus punitive damages and
attorney's fees. The complaint was served on the Company on November 21, 2001.
The Company filed a motion to dismiss the complaint on January 10, 2002, which
is still pending. The Company believes that the allegations in the complaint are
without merit and intends to contest the lawsuit vigorously. Mercator has
notified its insurance carrier of this matter, but has not yet received any
coverage position from them. The ultimate legal and financial liability of the
Company in respect to this claim cannot be estimated with any certainty.
However, the ultimate outcome of this proceeding, after considering liabilities
already accrued in the Company's March 31, 2002 consolidated balance sheet, is
not expected to have a material adverse effect on its consolidated financial
position, but could possibly be material to the consolidated results of
operations of any quarter.
In addition, the Company and a third party are currently disputing the
break-up fee provisions with respect to a proposed investment in the Company.
33
As of March 31, 2002, the Company has accrued approximately $3.9 million,
after considering any insurance recoveries, for the aggregate amount of the
contingencies described above.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit No. Exhibit Title
----------- -------------
10.35 Deed of Office Lease dated February 22, 2002 between 11720 Sunrise Corp.,
L.L.C. and the Registrant (previously filed as an exhibit to our Annual
Report on Form 10-K for the fiscal year ended December 31, 2001 and
incorporated herein by reference).
(b) Reports on Form 8-K
Mercator Software, Inc. filed no current reports on Form 8-K in the first
quarter of 2002.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act or 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Date: May 15, 2002 Mercator Software, Inc.
By: /s/ Roy C. King
-------------------------------------------------
Roy C. King
Chairman of the Board of Directors,
Chief Executive Officer and President
(Principal Executive Officer)
By: /s/ Kenneth J. Hall
-------------------------------------------------
Kenneth J. Hall
Executive Vice President, Chief Financial
Officer and Treasurer
(Principal Financial and Accounting Officer)
35