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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

     (Mark One)

OR

ASCENTIAL SOFTWARE CORPORATION

(Exact name of registrant as specified in its charter)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES  þ    NO  o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

YES  þ    NO  o

At October 31, 2003, 59,400,547 shares of the registrant’s common stock were outstanding.

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ASCENTIAL SOFTWARE CORPORATION
FORM 10-Q
Quarterly Period Ended September 30, 2003
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FORWARD–LOOKING STATEMENTS

This report contains forward-looking statements that are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or anticipated results. These risks and uncertainties include, but are not limited to, those set forth under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Factors That May Affect Future Results” are included elsewhere in this report. Readers of this report should review carefully these factors as well as the description of risks and uncertainties, which, together with other detailed information about the Company, is contained in other documents and periodic reports that the Company files from time to time with the Securities and Exchange Commission. These forward-looking statements reflect management’s opinions only and only as of the date of this report, and the Company disclaims any obligation to update or revise these statements. Ascential, DataStage, MetaRecon, Mercator, and INTEGRITY are trademarks of Ascential Software Corporation or its affiliates and may be registered in the U.S. and other jurisdictions. Other marks are the property of the owners of those marks.

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Part I. FINANCIAL INFORMATION

ASCENTIAL SOFTWARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(In thousands, except per share data)

See Notes to Unaudited Condensed Consolidated Financial Statements.

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ASCENTIAL SOFTWARE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(In thousands)

See Notes to Unaudited Condensed Consolidated Financial Statements.

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ASCENTIAL SOFTWARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In thousands)

See Notes to Unaudited Condensed Consolidated Financial Statements.

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ASCENTIAL SOFTWARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(In thousands)

See Notes to Unaudited Condensed Consolidated Financial Statements.

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ASCENTIAL SOFTWARE CORPORATION
Notes to Unaudited Condensed Consolidated Financial Statements

Note A — Summary of Significant Accounting Policies

     Organization and Operations. Ascential Software Corporation (“Ascential” or the “Company”) was incorporated in Delaware in 1986 and, until the third quarter of 2001, operated under the name “Informix Corporation.” During the third quarter of 2001, the Company sold to International Business Machines Corporation (“IBM”) substantially all of the assets relating to its database management systems business, including the name “Informix,” for a purchase price of $1.0 billion in cash (the “IBM Transaction” — see Note F). In connection with the sale to IBM, the Company changed its name to Ascential Software Corporation.

     Ascential is a global provider of enterprise data integration software and services. Ascential designs, develops, markets and supports enterprise data integration software products and solutions to allow its worldwide customers, mid-sized and large organizations and governmental institutions, to turn vast amounts of disparate, unrefined data into reliable, reusable information assets. The Company also offers to its customers a variety of services such as consulting, including implementation assistance and project planning and deployment, software product enhancements and support, and education.

     The principal geographic markets for the Company’s products are North America, Europe and Asia/Pacific. Customers include businesses ranging from medium-sized corporations to Global 2000 companies, principally in the manufacturing, financial services, telecommunications, media, retail/wholesale, hospitality, and government services sectors.

     Basis of Presentation. The accompanying unaudited condensed consolidated financial statements have been prepared on the same basis as the audited financial statements for the year ended December 31, 2002 included in the Company’s most recent Annual Report on Form 10-K. In the opinion of management, all significant adjustments, which are normal, recurring in nature and necessary for a fair presentation of the financial position and results of the operations of the Company, have been consistently recorded. The operating results for the interim periods presented are not necessarily indicative of expected performance for the entire year. The unaudited information should be read in conjunction with the audited financial statements of the Company, and the notes thereto, for the year ended December 31, 2002 that are included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 27, 2003. Certain prior period amounts have been reclassified to conform to the current period presentation. On September 12, 2003, the Company completed the acquisition of Mercator Software, Inc. (“Mercator”) pursuant to the Agreement and Plan of Merger dated as of August 2, 2003 (“Merger Agreement”), (see Note K – Business Combinations). The acquisition has been accounted for under the purchase method of accounting, and accordingly, the results of operations of Mercator have been included in the Company’s unaudited condensed consolidated financial statements since the date of acquisition.

     Reverse Stock Split. On June 17, 2003, the Company effected a one-for-four reverse stock split. Accordingly, all share and earnings per share figures have been restated as though the reverse split had been in effect for all periods presented.

     Comprehensive Income. Through June 30, 2002, the Company did not record deferred tax expense related to unrealized gains in comprehensive income, as none were required due to the Company’s consolidated tax position.

     Stock-Based Compensation. In December 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure (“SFAS” and “SFAS No. 148,” respectively). SFAS No. 148 amends the disclosure requirements of Statement of Financial Accounting Standard No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), to require prominent disclosure in the Company’s annual and interim financial statements regarding the method used by the Company for stock-based compensation and the effect of the method used on reported results. As permitted by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and SFAS No. 123, the Company utilizes the intrinsic value method to account for awards to employees, directors, and officers under its plans. Under the intrinsic value method, the Company generally recognizes no compensation expense with respect to such awards granted under the terms of the Company’s various stock option plans as all options granted under those plans typically are for a fixed number of shares and have a fixed exercise price equal to the market value of the underlying common stock on the date of grant.

     Pro forma information regarding the net income (loss) and net income (loss) per share required by SFAS No. 123 and SFAS No. 148, as if the Company had accounted for its stock-based awards to employees under the fair value method, is presented below. The Company estimates the fair value of stock-based awards to employees using the Black-Scholes option-pricing model. For pro forma purposes, the estimated fair value of the Company’s stock-based awards is amortized over the award’s vesting period (for options) and the three-month purchase period (for stock purchases under the Company’s employee stock purchase plan). The following table illustrates the effect on net income (loss) and net income (loss) per share as if the Company had applied the fair value method to stock-based employee compensation (in thousands, except per share data):

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     Recent accounting pronouncements. The FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities,” (“FIN” and “FIN 46,” respectively) in January 2003. This interpretation of Accounting Research Bulletin No. 51 requires the consolidation of certain variable interest entities by the primary beneficiary. FIN 46 became effective immediately for all variable interest entities created after January 31, 2003, and applies in the first interim or annual period occurring subsequent to June 15, 2003 for variable interest entities created prior to February 1, 2003. Adoption of FIN 46 did not have a material effect on the Company’s operating results or financial position.

     In April 2003, FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities”, which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”. This statement is effective for contracts entered into or modified and, for hedging relationships, designated after June 30, 2003. The Company does not currently hold any derivative instruments, other than foreign currency forward exchange contracts, and the adoption of this statement did not have a material impact on its operating results or financial position.

     In May 2003, FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity”. The statement revises the accounting for three types of financial instruments that were previously accounted for as equity – mandatorily redeemable shares, instruments that may require the issuer to buy back shares and certain obligations that can be settled with shares. The statement requires that those instruments be accounted for as liabilities in the statement of financial position. The disclosure provisions of the statement are effective for all financial instruments entered into or modified after May 31, 2003, and otherwise are effective at the beginning of the first interim period beginning after June 15, 2003. Certain accounting provisions of this statement have been deferred indefinately. Adoption of this statement did not have a material impact on the Company’s operating results or financial position.

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Note B — Goodwill and Other Intangible Assets

     As of September 30, 2003 the Company had goodwill in the amount of $328.5 million. There was an increase of $165.8 million in the carrying value from December 31, 2002. This change consists of a $167.0 million increase associated with the acquisition of Mercator Software Inc. (see Note K), offset by a $1.2 million reduction related to the final valuation of the acquired assets and obligations of Vality Technology Incorporated (“Vality”). The Company previously determined, in accordance with SFAS No. 142 “Goodwill and Other Intangible Assets”, that it would assess the impairment of goodwill and other intangible assets with indefinite lives annually in the fourth quarter, or more frequently if other indicators of impairment arise. Other intangible assets amounted to $22.1 million (net of accumulated amortization of $11.0 million) and $11.1 million (net of accumulated amortization of $6.9 million) at September 30, 2003 and December 31, 2002, respectively. These intangible assets consist primarily of customer relationships, developed technology and agreements not to compete acquired through business combinations, including the value assigned to amortizable intangible assets in connection with the acquisition of Mercator during the third quarter of 2003 consisting of $7.0 million of developed technology, $7.0 million of customer relationships and $1.2 million associated with agreements not to compete executed by certain former Mercator executives. The Company is currently amortizing these assets over their estimated useful lives, generally one to seven years. There are no anticipated residual values related to these intangible assets. Amortization expense for the three and nine months ended September 30, 2003 was $1.5 million and $5.4 million, respectively. Amortization expense for the three and nine months ended September 30, 2002 was $1.3 million and $3.3 million, respectively. Not including the Mercator intangible assets, amortization expense for intangible assets, is anticipated to be $1.3 million for the remainder of 2003, and amortization expense for these intangibles for each of the years ended December 31, 2004, 2005 and 2006, is anticipated to be $4.8 million, $1.0 million and $0.1 million, respectively. In addition, based upon the preliminary purchase price allocation and appraisal of the acquired Mercator intangibles, the Company expects, barring unforeseen circumstances, amortization expense to increase approximately $3.0 million to $5.0 million in each of the years ended December 31, 2004, 2005, and 2006.

     The following table summarizes the balance of components of “Goodwill” at September 30, 2003 and December 31, 2002 (in millions):

Note C — Loss Per Share

     The following table sets forth the computation of basic and diluted net income (loss) per common share (in thousands, except per share data):

     During the three and nine months ended September 30, 2003 and 2002 shares have been excluded from the diluted calculation relating to options to purchase shares of the Company’s common stock (“Common Stock”) because the potential common shares associated with these options are anti-dilutive due to the net losses during those periods. During the three and nine months ended September 30, 2003, the number of potential common shares excluded totaled 1.8 million and 1.2 million, respectively. These options have exercise prices ranging from $0.19 to $17.00 and $0.19 to $14.52 for the three and nine months ended September 30, 2003, respectively. During the three and nine months ended September 30, 2002, the number of potential common shares totaled 0.5 million and 2.5 million, respectively. These options had exercise prices ranging from $0.20 to $9.28 and $0.20 to $13.12 for the three and nine months ended September 30, 2002, respectively.

     Additionally, the Company excluded other potential common shares for the three and nine months ended September 30, 2003 and 2002, from its diluted net loss per share computation because the exercise prices of these securities were equal to or exceeded the average market value of the Common Stock for the same periods and, therefore, these securities were anti-dilutive. The following is a summary of the excluded potential common shares and the related exercise/conversion features for the three and nine months ended September 30, 2003 and 2002 (in thousands):

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     The stock options had per share exercise prices ranging from $17.14 to $341.58 and from $14.68 to $341.58 per share in the three and nine months ended September 30, 2003, respectively. These stock options are exercisable at various dates through June 30, 2013. During the three and nine months ended September 30, 2002, the above stock options had exercise prices ranging from $9.56 to $112.40 per share and from $13.36 to $112.40 per share, respectively.

     The warrants to purchase shares of Common Stock (the “Series B Warrants”) were issued in connection with the conversion of certain shares of the Company’s Series B convertible preferred stock (“Series B Preferred”) into shares of Common Stock in July 2000. As of September 30, 2002, Series B Warrants exercisable for 0.6 million shares of Common Stock were outstanding and exercisable at a per share exercise price of $31.36. These warrants expired unexercised on November 19, 2002.

Note D — Comprehensive Loss

     Accumulated other comprehensive loss on the balance sheet is comprised of the following at September 30, 2003 and December 31, 2002 (in thousands):

Note E — Stockholders’ Equity

     The following table reconciles Common Stock shares issued and outstanding at September 30, 2003 and December 31, 2002 (in thousands):

     The Company had 8,392,779 and 8,492,779 shares of Common Stock in treasury at September 30, 2003 and December 31, 2002, respectively. As of September 30, 2003, the Company had repurchased an aggregate of approximately 15.1 million shares of Common Stock for an aggregate purchase price of approximately $217.2 million as part of its previously approved stock repurchase program that commenced in the second quarter of 2001. The Company is authorized to repurchase up to $350.0 million of Common Stock under this program.

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Note F — Sale of the Database Business Assets

     Holdback. On July 1, 2001, the Company completed the initial closing of the IBM Transaction, which consisted of the sale to IBM of substantially all of the assets and certain liabilities of the Company’s database business for $1.0 billion in cash. The IBM Transaction was completed on August 1, 2001, upon the closing of the sale of the assets related to the database business in the nine remaining countries that were not closed on July 1, 2001. As part of the IBM Transaction, IBM retained $100.0 million of the sale proceeds as a holdback (the “Holdback”) to satisfy the indemnification obligations that might arise under the IBM Transaction purchase agreement (the “MPA”). The MPA provided that the Company would indemnify IBM and its affiliates against any loss, claim, damage, liability or other expense incurred in connection with (i) any failure of any representation or warranty of the Company under the MPA to be true and correct in all respects; provided, however, that any such liability, in the aggregate, exceeds on a cumulative basis $10.0 million (and only to the extent of any such excess); (ii) any breach of any obligation of the Company under the MPA; (iii) any of the Excluded Liabilities, as defined in the MPA; or (iv) the operation or ownership of the Excluded Assets, as defined in the MPA. The MPA provided that IBM would retain the Holdback until January 1, 2003, except for any funds necessary to provide for any claims made prior to that date. The MPA also provided that the Company would receive interest from July 1, 2001 to the payment date of the Holdback. In January 2003, IBM released the full amount of the Holdback to the Company, in the amount of $109.3 million, which included accrued interest. Indemnification obligations of the Company with respect to certain representations and warranties under the MPA terminated on July 1, 2003.

     Working Capital Adjustment. Under the terms of the MPA, the Company was obligated to transfer $124.0 million in net working capital to IBM from the database business operations (the “Working Capital Adjustment”) as of July 1, 2001. Working Capital was defined in the MPA as the sum of (i) net accounts receivable and (ii) prepaid expenses, minus (a) ordinary course trade payables and (b) accrued ordinary course expenses (other than any such expenses incurred in connection with former employees, officers, directors, or independent contractors). These items were a subset of the various assets and liabilities of the database business that were transferred to IBM upon the closing of the IBM Transaction.

     On March 29, 2002, the Company was paid $11.0 million by IBM in final settlement of the net working capital adjustment. If the net working capital transferred to IBM on the closing date exceeded $124.0 million, IBM would pay the Company 50% of the excess over $124.0 million. If the net working capital transferred to IBM was less than $124.0 million, the Company would pay IBM an amount equal to the shortfall. As of December 31, 2001, the Company expected to be reimbursed at least $3.7 million from IBM, which it estimated to be the minimum net working capital adjustment. Accordingly, the Company had previously recognized the minimum net working capital adjustment of $3.7 million as an increase to the gain resulting from the IBM Transaction. As a result, the Company recorded the incremental $7.3 million received in “Gain on sale of database business, net of adjustments” during the first quarter of 2002.

     Gain Adjustment. During 2002, the Company also recorded a gain adjustment of $0.3 million, primarily to decrease the long-term assets sold to IBM and a $1.4 million loss to “Gain on sale of database business, net”. The $1.4 million loss consists of $0.9 million of accrued professional and administrative fees required to dissolve subsidiaries rendered inactive as a consequence of the IBM Transaction and $0.5 million to adjust the segmentation of accounts receivable sold to IBM as part of the sale of the database business assets.

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     Accrued IBM Transaction Costs. As a result of the IBM Transaction, the Company recorded a $41.9 million charge during 2001 to accrue for costs associated with the sale of the database business assets. The following table sets forth the components of the accrued transaction costs and related cash payments made during the nine months ended September 30, 2003 (in millions):

     Professional fees primarily consist of fees for investment bankers, attorneys and accountants for services provided related to the IBM Transaction. Severance and employment-related charges primarily consist of (i) severance payments and related taxes for approximately 30 sales and marketing employees and 70 general and administrative employees of the database business who did not join IBM after the IBM Transaction, and (ii) a $4.7 million charge that related to the modification of vesting and exercise terms of stock options for certain terminated executives and for database employees who joined IBM. As discussed above, during the third quarter of 2002, the Company accrued $0.9 million of professional and administrative fees required to dissolve subsidiaries rendered inactive as a consequence of the IBM Transaction. During 2002, the Company reversed $0.9 million of accrued severance and related costs, as certain employees terminated employment voluntarily, reversed $0.3 million of accrued transfer taxes as the Company was ultimately required to pay less than what was originally estimated, and accrued $1.2 million of professional fees to reflect an increase in estimated costs to reorganize the Company as a consequence of the IBM Transaction. As of September 30, 2003, severance payments and related taxes had been paid in connection with the termination of substantially all of these employees. The accrual balance of $4.4 million, for severance and related costs, is expected to be paid on various dates extending through 2007. The accrual balance of $0.6 million for professional fees is anticipated, barring unforeseen circumstances, to be paid by December 31, 2003.

Note G — Accrued Merger, Realignment and Other Charges

     The following table summarizes the balance of components of the “Accrued merger, realignment and other charges” at September 30, 2003 and December 31, 2002 (in millions):

     The components of the Company’s net merger, realignment and other charges are outlined below.

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Facility and Equipment Charges resulting from IBM Transaction

     As a result of the IBM Transaction (see Note F) the Company no longer required as much facility space and, accordingly, recorded charges and adjustments during 2002 and 2001 for facilities and equipment costs related to the Company’s vacant, or partially vacant, facilities. The accumulated charges were comprised of reserves for residual lease obligations and restoration costs and write-offs related to leasehold improvements and other fixed assets at these vacated, and partially vacated, facilities. The following table summarizes the accrual activity for the nine months ended September 30, 2003 (in millions):