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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 1-10139
NETEGRITY, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 04-2911320
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
201 JONES ROAD
WALTHAM, MASSACHUSETTS 02451
(Address of principal executive offices) (Zip Code)
(781) 890-1700
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE
(Title of class)
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). [X] Yes No [ ]
The aggregate market value of the Common Stock held by non-affiliates of the
registrant was $187,994,119 based on the closing price of the registrant's
Common Stock on June 30, 2003 as reported by the NASDAQ National Market ($5.99
per share). As of February 23, 2004, there were 37,608,583 shares of Common
Stock outstanding.
DOCUMENT INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement for its 2004 Annual
Meeting of Stockholders, which will be filed with Securities and Exchange
Commission within 120 days after the end of the registrant's fiscal year, are
incorporated by reference into Part III hereof.
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ANNUAL REPORT ON FORM 10-K
YEAR ENDED DECEMBER 31, 2003
TABLE OF CONTENTS
PART I
Item 1. Business.......................................................... 4
Item 2. Properties........................................................ 11
Item 3. Legal Proceedings................................................. 11
Item 4. Submission of Matters to a Vote of Security Holders............... 11
Executive Officers of Registrant.............................................. 11
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities................. 13
Item 6. Selected Financial Data........................................... 13
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................... 15
Item 7A. Quantitative and Qualitative Disclosure About Market Risk......... 36
Item 8. Financial Statements and Supplementary Data....................... 37
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.......................................... 60
Item 9A. Controls and Procedures........................................... 60
PART III
Item 10. Directors and Executive Officers of the Registrant................ 61
Item 11. Executive Compensation............................................ 61
Item 12. Security Ownership of Certain Beneficial Owners and
Management........................................................ 61
Item 13. Certain Relationships and Related Transactions.................... 61
Item 14. Principal Accountant Fees and Services............................ 61
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form
8-K............................................................... 62
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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report and the documents incorporated in it by reference contain
forward-looking statements about our plans, objectives, expectations and
intentions. You can identify these statements by words such as "expect,"
"anticipate," "intend," "plan," "believe," "seek," "estimate," "may," "will" and
"continue" or similar words. You should read statements that contain these words
carefully. They discuss our future expectations, contain projections of our
future results of operations or our financial condition or state other
forward-looking information, and may involve known and unknown risks over which
we have no control. You should not place undue reliance on forward-looking
statements. We cannot guarantee any future results, levels of activity,
performance or achievements. Moreover, we assume no obligation to update
forward-looking statements or update the reasons actual results could differ
materially from those anticipated in forward-looking statements, except as
required by law. The factors discussed in the sections captioned "Business,"
"Certain Factors that May Affect Future Results," and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" in this report
and the documents incorporated in it by reference identify important factors
that may cause our actual results to differ materially from the expectations we
describe in our forward-looking statements.
PART I
ITEM 1. BUSINESS
Netegrity, Inc. and its wholly-owned subsidiaries are referred to throughout
this report as "Netegrity", "Company", "we", "us" and similar expressions. For
financial information, see our consolidated financial statements and the related
notes thereto found in Item 8 of this report. Netegrity, SiteMinder,
IdentityMinder Web Edition, IdentityMinder eProvision and TransactionMinder are
trademarks or registered trademarks of Netegrity, Inc. All other brand or
product names may be trademarks or registered trademarks of their respective
owners.
COMPANY OVERVIEW
Our objective is to be a leading provider of enterprise security software
solutions specifically for managing user identities and access. Our identity and
access management, or IAM, product line gives companies a secure way to make
corporate information assets and resources available online. We believe that
open, protected access is essential as companies seek to utilize the Web to grow
their businesses.
Identity is the authorized login/user name associated with an individual
such as a customer, employee or partner/supplier contact. Each identity is
assigned a level of access privileges based on their relationship with a
particular company. Managed together using Netegrity solutions, identity and
access are the keys that enable secure access to the informational and
enterprise resources that users need while online.
With Netegrity identity and access management products, companies are able
to securely use the Web -- Internet, Intranet or Extranet -- to meet the
information access needs of partners, suppliers, customers and employees. For
example, customers need access to banking accounts or to purchase items from an
online retailer. Suppliers need an automated way to know when new parts or
products need to be shipped. Employees need access to benefits administration.
Whatever the transaction, across a variety of applications, business systems and
computing architectures, Netegrity solutions enable businesses to ensure that
the right people have the right access to the right information. This enables
more business to be securely conducted online, providing opportunities to
improve customer service and productivity, increase sales of products and
services and create business partnership value chains.
Netegrity's headquarters are in Waltham, Massachusetts. We have sales and
service offices in North America, Europe, the Middle East, Asia and Australia.
We have systems integration partners across the world, international resellers,
24/7 customer support, a network of more than 1200 trained integration
consultants and over 200 technology partners.
Netegrity solutions are licensed to more than 300 million users at over 800
organizations worldwide. Our customer base includes more than half of the
Fortune 100 companies.
Netegrity was formed as a Delaware corporation in 1986. On December 30,
2003, the Company acquired Business Layers, Inc. This acquisition provides us
with a leading provisioning solution that complements our existing product
offerings and helps to position Netegrity as a leading, independent vendor
offering a comprehensive identity and access management solution available on
the market.
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INDUSTRY BACKGROUND
The Web provides the opportunity for many companies to increase revenue and
reduce their cost of doing business. However, with this opportunity comes many
security challenges. It is essential for companies to ensure that the right
people have the right access to the right corporate assets.
In addition, many companies manage user identities and information access
within individual applications or individual business divisions. Typically this
is ineffective and costly. This results in an overburdened staff and a strain on
technical resources. Customer satisfaction is compromised because users are
essentially required to manage their own identities, logging in numerous times
and using multiple passwords while conducting a transaction on a single Web site
or within a single corporation. We believe the better alternative is to
streamline and centralize identity and access management, ensuring that the
right users get the right degree of access to the right information at the right
time.
User populations grow and change continually. The online information users
need to access may change as their roles change. For example, an employee may
receive a promotion and need access to additional information, or a partner may
achieve preferred status and require a change in access privileges to new
business systems. Just as important is the ability to revoke access when an
employee leaves or a supplier relationship ends. In addition, government
regulations require some companies to determine and report who has access to
certain information.
To effectively manage this identity complexity, an IAM solution must
provide:
- A unified view of all users (customers, partners, suppliers and
employees) across internal and external enterprise applications. This
provides the appropriate privileges for each identity in each application.
- Single identities for users, enabling single sign-on across multiple
applications. This contributes to a positive user experience online.
- Centralized user identification, authentication and automated processes
for granting, changing or revoking access. This supports improved
productivity and reduced risk exposure.
- A mechanism for recording or auditing user privileges and access history
to meet reporting requirements. This supports regulatory compliance.
NETEGRITY STRATEGY
Our strategy is to provide the most open and comprehensive enterprise
security solution for identity and access management. We view enterprise
security software as a business enabler and a way to effectively and securely
allow more partners, suppliers and customers access to enterprise information.
Accordingly, we offer our customers solutions that provide opportunities to:
- - Increase revenue by forging new partnerships and moving new products and
services online;
- - Reduce operational costs by centralizing and automating access to resources
and information;
- - Support regulatory compliance and mitigate risk; and
- - Improve return on investment by leveraging existing investments in
applications and software.
We understand that every business has its own priorities, which is why our
products can be used separately to solve a single security challenge, such as
secure access, or integrate in a modular fashion to create a comprehensive
identity management solution.
Our business strategy is based on the following priorities:
- - Build on the proven success of Netegrity SiteMinder. A recognized leader in
Web access control and management, we continually seek to enhance SiteMinder
to meet changing market needs. We sell SiteMinder and the rest of our IAM
platform --IdentityMinder Web edition, IdentityMinder eProvision and
TransactionMinder - separately and as part of an integrated IAM solution to
our installed base of more than 800 customers and to new customers.
- - Accommodate growth of Web services. Web services, an increasingly popular
way to build and link business over the Web, gives business partners the
ability to jointly market products and services without having to
re-engineer their computing and business systems. For example, Bank X can
offer insurance products from Company Y or Retailer A can sell products from
Companies B to Z. With Netegrity TransactionMinder, our identity-based Web
services security solution, we are one of few vendors able to
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help companies securely incorporate and manage Web services. We believe that
the opportunity to gain revenue from TransactionMinder will increase along
with the rising demand for Web services.
- - Offer integrated solution and individual components. We are one of few
enterprise security vendors offering a single source solution for
integrated, centralized identity management, user access and administration
and account provisioning/de-provisioning. We remain committed to providing
individual products as customer needs dictate, while gaining revenue from
additional components in follow-on sales.
- - Establish leadership for integrated IAM and individual components. We are
working to establish leadership for our integrated solution and individual
products through active, competitive product development and expansion.
Additionally, we are working with industry analysts in an effort to
publicize a leading market position for our integrated and individual IAM
solutions.
- - Continue to support and incorporate new technologies and standards. Our
objective is to support key enterprise applications and new resources that
companies need for secure IAM. Also, we expect to support emerging and
established technologies and standards important to our customers.
- - Leverage and strengthen strategic relationships. We have established
significant relationships with major global system integrators, including
PricewaterhouseCoopers, Deloitte & Touche, Ernst & Young and Accenture.
Working closely with these firms, we are seeking to increase market
awareness and expand distribution capabilities and deployment and
integration services. We believe these relationships will help us to
increase market penetration and accelerate global deployment of our
solution.
- - Increase penetration in focused geographies. We continue to extend our
resale and integration capabilities to better serve customers outside the
U.S. We believe product localization and translation are keys to further
global market penetration.
- - Improve customer service. To provide a high level of customer service and
support, we continue to invest in improvements to our worldwide customer
service and support capabilities. We are also building relationships with
leading systems integration firms to further support the successful
deployment of our products.
- - Evaluate strategic acquisitions. We continue to evaluate strategic
opportunities and potential acquisitions. This may include companies or
technologies that broaden our market opportunity and enable us to expand
into adjacent areas, or that leverage our existing solutions to extend
further into our current markets.
NETEGRITY SOLUTIONS AND SERVICES
Our products and services include the following:
NETEGRITY PRODUCTS
- - NETEGRITY SITEMINDER software provides a security and management foundation
for Web applications within the enterprise or across multiple partners,
providing single sign-on across multiple applications, databases, Internet
domains and computing architectures. Using SiteMinder, consumers, trading
partners and service providers can automatically link information in a
federated network. Seamless transactions across multiple companies increase
efficiencies, improve product and service offerings and enhance the user
experience.
- - NETEGRITY IDENTITYMINDER WEB EDITION software provides user administration
and access management for Web-based applications.
- - NETEGRITY IDENTITYMINDER EPROVISION software provides controlled access to
corporate information and resources and a way to modify or revoke access
rights when "identity relationships" change or end.
Both IdentityMinder Web Edition and eProvision products create automated and
dynamic workflows that synchronize business needs to information technology
activities according to business processes and security policies.
- - NETEGRITY TRANSACTIONMINDER software provides identity-based security access
and tracking (auditing) for Web services.
Using TransactionMinder, companies can establish consistent security
policies for Web services that can be consistently applied across the
enterprise.
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Individually, these products are recognized as best-of-breed software.
Together, they represent a comprehensive single-source IAM solution whose
key benefits may include:
- Reduced costs by reducing information technology complexity
- Increased revenue potential by improving customer service online
- Expanded business opportunities by creating real-time business networks
and
- Providing support for regulatory compliance and risk mitigation.
Among the key features of our integrated IAM solution are:
Automated, simplified management of users and their access privileges across
different applications and business systems
- Reduces the number of tasks required to administer users accounts and assign
and modify access
Centralized access and authentication management
- Confirms and enforces user identities and their rights to access sensitive
application data, and enables an audit of user access
Delegated administration
- Enables delegation of user administration to other business units or
business partners, as needed, while complying with corporate policies
Self-service capabilities
- Allows users to register for application access and modify their account
profile themselves, including their password. This reduces the quantity and
expense of calls to the IT help desk
Support for consistent security, audit trails
- Enables consistent security procedures across corporate environments,
ensuring that access rules are universally applied. Also records user
privileges to applications and resources, tracking identity-related security
events for regulatory compliance
Simplified application development
- Creates centralized access control and management services, reducing time
and labor to create new internal and/or external applications
NETEGRITY SERVICES AND SUPPORT
PROFESSIONAL SERVICES
Our professional services organization assists customers in installing our
products and operating these products to documented specifications. These
services include architecture design support, implementation, integration and
custom development of advanced or unique features. We also have relationships
with global systems integrators, such as PricewaterhouseCoopers, Deloitte &
Touche, Ernst & Young and Accenture, who play a major role in implementing and
promoting our products.
TRAINING
Our worldwide training organization teaches SiteMinder, IdentityMinder Web
Edition, IdentityMinder eProvision and TransactionMinder skills to customers,
partners and employees. We offer ongoing comprehensive training for our
products, offering new courses as new products are released. Our selection of
courses is varied and flexible, customized for our customers' instructional
objectives and time frame.
MAINTENANCE AND SUPPORT
We have technical support operations in Waltham, Massachusetts
(headquarters), Kuala Lumpur, Malaysia and Rannana Israel designed to ensure the
availability of customer service around the clock. We provide a range of support
and services for a variety customer environments. Our technical support centers
offer email, fax, Web-based and telephone access. Extended services such as
on-site
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training, installation and customized offerings are also available.
ADDITIONAL PRODUCTS AND SERVICES
In addition to selling and marketing our own product lines, we distribute,
on a non-exclusive basis, Check Point Software Technologies Ltd.'s FireWall-1
product. We sell this product directly to end users in the United States through
a small, dedicated sales organization.
SALES, MARKETING AND DISTRIBUTION
In North America, we directly market SiteMinder, IdentityMinder Web Edition,
IdentityMinder eProvision and TransactionMinder software and services through a
field sales organization supported by inside sales representatives. We also
indirectly market our products through strategic partnerships and third-party
relationships with vendors of Internet-related systems and application software,
resellers and systems integrators. Internationally, we market our products to
key accounts through our direct sales organization. We also indirectly market
our products through international resellers and system integrators in a number
of international markets.
Direct Sales Force. Our direct sales force covers three geographical
regions. Our field sales representatives find and qualify prospects with
identity and access management plans and requirements. Our field sale
representatives use a consultative, solution-oriented selling approach.
Representatives conduct on-site meetings with accounts that have substantial
product and service requirements. Inside sales representatives qualify, develop
and pursue leads generated through a variety of sources.
We market software and services to large, corporate customers in the major
vertical markets of the Global 2000 companies. We also target smaller firms that
need to protect access to mission-critical information while providing users
with personalized, seamless online experiences.
Indirect Distribution. We continue to work to further relationships with
systems integrators and technology partners to increase the leverage of our
partner channel. We classify our partners as follows:
- Systems Integrators. We have established significant relationships with
major global systems integrators who play a major role in deploying our
products and who may also recommend our products to prospective customers.
We are investing in training our systems integration partners to enhance
their effectiveness in integrating and selling our products. As of
December 31, 2003, we had trained over 1,200 consultants at partner
companies.
- Alliance Partners and Resellers. Alliance partners license our software
and bundle our products into their products. Resellers sell licenses to
Netegrity products and play a significant role in the expansion of our
distribution network, particularly in Europe and Asia.
- Technology Partners. Technology partners integrate their product offerings
to ensure that they interoperate with our software. They also bundle our
products into theirs. We provide technical integration support. In many
cases we work together with our partners on sales and marketing
initiatives. There were more than 200 active members in the Netegrity
Technology Partner Program as of December 31, 2003.
Product Marketing Programs. Netegrity's product marketing programs are aimed
at communicating the capabilities and benefits of our solutions and increasing
the demand for our solutions across major industry segments. We devote
significant resources to marketing our products and brand and will continue to
do so.
We sponsor seminars for prospective customers, exhibit at targeted
conferences for the technology and investment communities and use many
interactive lead generation programs.
We have an active public relations program and consistently issue press
releases to highlight major customer additions, strategic partnerships and new
product releases. We develop relationships with industry analysts and promote
coverage of the Company in the trade and business press.
Our Web site is consistently refreshed to provide the latest product and
Company information and customer profiles. Web site features are added
regularly, including online presentations, seminar content and customer
application success stories.
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CUSTOMERS
As of December 31, 2003, Netegrity software was licensed to more than 300
million users at over 800 customer sites worldwide. Our customer base spans
multiple industry segments, including financial services, government,
manufacturing, healthcare and telecommunications.
We operate in one business segment. Our total revenues for 2003, 2002 and
2001 by geographical region were $60.6 million, $54.5 million and $70.2 million,
respectively in the United States and $17.9 million, $14.8 million and $17.9
million, respectively, in countries outside the United States. Additionally, our
long-lived assets as of December 31, 2003, 2002 and 2001 by geographical region
were $46.4 million, $11.8 million and $14.8 million, respectively, in the United
States and $1.6 million, $768,000 and $726,000, respectively, in countries
outside the United States. No single customer, including direct end users or
resellers, accounted for more than 10 percent of our total revenues during the
years ended December 31, 2003, 2002 or 2001.
PURCHASING
We purchase the FireWall-1 product directly from Check Point Software
Technologies, Ltd. We also purchase firewall-related accessory products from
various third-party vendors. Additionally, we license various third party
software products to enhance, enable or provide additional functionality to our
products. We have not experienced any material difficulties or delays in
acquiring any products we distribute or license.
PRODUCT RESEARCH AND DEVELOPMENT
The identity and access management market is characterized by rapid
technological change, changes in customer requirements, new product
introductions and enhancements and emerging industry standards. We devote
significant time and resources to analyze and respond to industry changes, such
as those in operating systems, application software, security standards,
networking software and evolving customer requirements.
We have made, and expect to continue to make, a substantial investment in
research and development. In the years ended December 31, 2003, 2002 and 2001,
we spent approximately $24.1 million, $22.7 million, and $18.8 million,
respectively (which include approximately $3.8 million and $3.0 million of
acquired in-process research and development in connection with the acquisition
of Business Layers and DataChannel in the years ended December 31, 2003 and
2001, respectively) or 31 percent, 33 percent and 21 percent of total revenues,
respectively, on research and development. We plan on continuing our product
development efforts for our current products, as well as for next generation
products for new markets.
We believe our future success depends largely on our ability to enhance and
broaden our existing product lines to meet evolving market needs. There can be
no assurance that we will be able to respond effectively to technological
changes or new industry standards or developments. Our operating results and
business could be adversely affected if we incur significant delays, are
unsuccessful in developing new products or enhancing our existing products or if
any such enhancements or new products do not gain market acceptance. As a result
of our acquisition of Business Layers, we now have a team in Israel, which may
present product integration challenges and could impact our ability to deliver
products in a timely fashion. In addition, a number of factors, including the
timing of product introductions and enhancements by us or our competitors,
market acceptance of new products or customer order delay in anticipation of new
products may cause variations in our future operating results.
PROPRIETARY RIGHTS
Our success and ability to compete are dependent to a significant degree on
our ability to develop and maintain the proprietary aspects of our technology
and to operate without infringing on the proprietary rights of others. We rely
on a combination of patent, trademark, trade secret and copyright laws and
licenses and contractual restrictions to protect the proprietary aspects of our
technology. These legal protections afford only limited protection for our
technology. We seek to protect our source code for our software, documentation
and other written materials under trade secret and copyright laws. We license
our software pursuant to license agreements, which impose restrictions on the
licensee's ability to utilize the software. In addition, we seek to limit
disclosure of our intellectual property by requiring employees, consultants and
customers with access to our proprietary information to execute confidentiality
agreements with us. We also restrict access to our source code. Due to rapid
technological change, we believe that
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factors such as the technological and creative skills of our personnel, new
product developments and enhancements to existing products are more important to
establishing and maintaining a technology leadership position than the various
legal protections of our technology.
We have filed patent applications on three inventions embodied in our
software products that may be useful in the field of identity and access
management. There can be no assurance that any of these applications will result
in an issued patent.
Despite our efforts to protect our proprietary rights, unauthorized parties
may attempt to copy aspects of our products or to obtain and use information
that we regard as proprietary. Policing unauthorized use of our products is
difficult and, while we are unable to determine the extent to which piracy of
our software exists, it can be expected to be a persistent problem. In addition,
the laws of many countries do not protect our proprietary rights to as great an
extent as do United States laws. Litigation may be necessary in the future to
enforce our intellectual property rights, protect our trade secrets, determine
the validity and scope of the proprietary rights of others or defend against
claims of infringement or invalidity. Any such litigation could result in
substantial costs and diversion of resources and could have a material adverse
effect on our business, operating results and financial condition. There can be
no assurance that our means of protecting our proprietary rights will be
adequate or that our competitors will not independently develop similar
technology. Any failure by us to meaningfully protect our intellectual property
could have a material adverse effect on our business, operating results and
financial condition.
There can be no assurance that other parties will not claim infringement
with respect to our current or future products. We expect that developers of
Web-based application software products increasingly will be subject to
infringement claims as the number of products and competitors in our industry
segment grows and as the functionality of products in different segments of the
software industry increasingly overlaps. Any such claims, with or without merit,
could be time consuming to defend, result in costly litigation, divert
management's attention and resources, cause product shipment delays or require
us to enter into terms marginally acceptable to us. A successful infringement
claim against us and our failure or inability to license the infringed rights or
develop or license technology with comparable functionality could have a
material adverse effect on our business, financial condition and operating
results.
We integrate third-party software into our products. This third-party
software may not continue to be available on commercially reasonable terms. We
believe there are alternative sources for such technology. However, if we are
unable to maintain licenses to the third-party software included in our
products, product distribution could be delayed until equivalent software could
be developed or licensed and integrated into our products. This delay could
materially adversely affect our business, operating results and financial
condition.
COMPETITION
The identity and access management market is relatively new, rapidly
evolving and highly competitive. We expect competition to continue to increase
both from existing competitors and new market entrants. We believe our ability
to compete depends on factors within and beyond our control, including: the
performance, reliability, features, price and ease of use of our products as
compared to those of our competitors; our ability to secure and maintain key
strategic relationships; our ability to expand domestic and international sales
operations; our ability to support our customers; and the timing and market
acceptance of new products and enhancements to existing products by us and our
competitors.
Our large installed base, partner network and strong customer service
capabilities provided advantages in the softer IT markets of 2002 and 2003. With
the introduction of IdentityMinder eProvision, we now offer a comprehensive IAM
solution, comprised of a set of individual products. IdentityMinder eProvision
complements and works in an integrated fashion with our other products including
SiteMinder, IdentityMinder Web Edition and TransactionMinder.
Our primary competitor in the IAM market is the Tivoli Division of IBM. We
also compete against traditional security and software companies, such as Oblix,
RSA and Novell, and stack vendors such as Sun MicroSystems. In addition, a
number of other security and software companies are beginning to offer products
that may compete with our identity and access management solution. Competition
may also develop as the market matures and other companies begin to offer
similar products, and as our product offerings expand to other market segments.
Current and potential competitors have established, or may in the future
establish, cooperative selling relationships with third parties to increase
market distribution of their products. Accordingly, it is possible that new
competitors may emerge and acquire significant market share.
Today, some of our competitors have shorter operating histories and fewer
financial and technical resources than we have. In
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addition, these smaller competitors have smaller customer bases. Several of our
competitors, however, are larger companies with significant financial resources,
well-established development and support teams and large customer bases. These
larger competitors may initiate pricing policies that would make it more
difficult for us to maintain our competitive position.
As new participants enter the IAM market, we will face increased
competition. Potential competitors may bundle their products in a way that
discourages users from purchasing our products. It is also possible that current
and potential competitors may be able to respond more quickly to new or emerging
technologies or customer requirements, resulting in increased market share for
these companies.
Our FireWall-1 reseller business competes with companies that offer products
competitive with Check Point Software Technologies' FireWall-1 product,
including Symantec Corporation, Cisco Systems and Secure Computing. We also
compete with other resellers of the FireWall-1 product.
EMPLOYEES
As of December 31, 2003, we had 400 full-time employees, 133 of whom were
involved in research and development, 187 in sales, marketing and customer
support, 37 in consulting and training and 43 in administration and finance.
None of our employees are represented by a labor union. We have not experienced
any work stoppages and believe that employee relationships are good. Our future
success will depend in part on our ability to attract, retain and motivate
highly qualified technical and management personnel in a highly competitive
market.
AVAILABLE INFORMATION
Our Internet address is www.netegrity.com. Our Annual Reports on Form 10-K,
Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to
these reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Exchange Act are available free of charge on our website, where they are posted
as soon as reasonably practicable after electronic filing with or furnishing to
the Securities and Exchange Commission.
ITEM 2. PROPERTIES
Our headquarters consist of a leased office suite located at 201 Jones Road
in Waltham, Massachusetts. We occupy 54,383 square feet of space at that
location under a lease expiring in June 2008. We also occupy 3,783 square feet
of office space in Rannana Israel under a lease expiring in June 2008. In
addition, we lease 4,127 square feet of space to house our technical service
center in Kuala Lumpur, Malaysia, under a lease expiring in March 2004.
In order to support our field sales and consulting staff, we lease office
space domestically in Los Angeles, San Jose and San Mateo, California; Maitland,
Florida; Chicago, Illinois; Cincinnati, Ohio; New York, New York; and Reston,
Virginia. Internationally, we lease office space in Sydney and Melbourne,
Australia; Toronto, Canada; Marlow, England; Paris, France; Munich, Germany;
Hong Kong, China; Milan, Italy; Tokyo, Japan; Seoul, Korea; and Ngee Ann City,
Singapore.
ITEM 3. LEGAL PROCEEDINGS
From time to time, we are involved in litigation relating to claims arising
out of our operations in the normal course of business. We are not presently a
party to any legal proceedings, the adverse outcome of which, in management's
opinion, would have a material adverse effect on our results of operations or
financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders, whether through the
solicitation of proxies or otherwise, during the quarter ended December 31,
2003.
EXECUTIVE OFFICERS OF THE REGISTRANT
Below are the name, age and principal occupations for at least the last five
years of our current executive officers. All such persons have been appointed to
serve until their successors are appointed or until their earlier resignation or
removal.
11
BARRY N. BYCOFF, 55 years old, was appointed President and Chief Executive
Officer and Director of the Company in April 1993. In November 1999, Mr. Bycoff
was also appointed Chairman of the Board.
REGINA O. SOMMER, 45 years old, joined the Company as Vice President, Chief
Financial Officer and Treasurer in December 2001. From 1999 to 2001, she was
Vice President and CFO for Revenio, Inc. a privately-held customer relationship
management software company. From 1995 to 1999, she served as Senior Vice
President and CFO for Open Market, Inc., an Internet infrastructure software
company.
WILLIAM C. BARTOW, 41 years old, joined the Company in October 1999 and
presently serves as Vice President of Engineering. From August 1998 to October
1999, he was Vice President of Marketing and Engineering at the Internet
division of Powersoft Corporation, a subsidiary of Sybase, Inc.
THOMAS THIMOT, 37 years old, joined the Company in September 2002 and
presently serves as Vice President Worldwide Sales and Services. From February
2001 to June 2002, he was President and Chief Operating Officer of Enigma, a
privately-held provider of support chain solutions. From November 1994 to
January 2001, he served in multiple sales and service leadership roles at Oracle
where he was most recently Vice President of Sales for the central U.S.
STEPHANIE FERADAY, 44 years old, joined the Company in November 2002 and
presently serves as Vice President of Marketing. From October 2001 to November
2002, she ran her own strategy consulting firm for emerging technology
companies. From September 2000 to October 2001, she served as Executive Vice
President of Virtusa, Inc., a privately-held advanced technology services firm.
From July 1992 to 1997, she was general manager at Symantec, where she launched
their Networking Business Unit, which was acquired by Hewlett Packard in 1997.
At Hewlett Packard, she was responsible for assisting in the development of HP
OpenView's business strategy until September 2000.
DEEPAK TANEJA, 43 years old, joined the Company in January 1998 and
presently serves as Chief Technology Officer. From January 1998 until November
2001, Mr. Taneja served as Vice President Engineering and Development of the
Company.
12
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is traded on the NASDAQ National Market under the symbol
"NETE." As of February 18, 2004, there were 231 holders of record of our common
stock, some of whom are nominee holders for the benefit of different
shareholders. The following table sets forth, for the periods indicated, the
range of high and low closing prices per share of our common stock, as reported
on the NASDAQ National Market during each of the quarters indicated.
PRICE RANGE OF
COMMON STOCK
----------------
HIGH LOW
------- -------
2002 YEAR
First Quarter..... $ 19.50 $ 11.90
Second Quarter.... $ 13.70 $ 5.24
Third Quarter..... $ 2.90 $ 1.99
Fourth Quarter.... $ 4.00 $ 1.52
2003 YEAR
First Quarter..... $ 4.76 $ 3.02
Second Quarter.... $ 6.55 $ 3.39
Third Quarter..... $ 11.49 $ 6.09
Fourth Quarter.... $ 13.30 $ 9.73
On December 30, 2003, we acquired Business Layers, Inc. pursuant to an
agreement and plan of merger under which Business Layers became a wholly-owned
subsidiary of us. In connection with the merger, we issued 2,556,940 shares of
our common stock, $0.01 par value per share, to holders of outstanding shares of
Business Layers capital stock. A total of 357,577 of these shares are being held
in escrow to secure the indemnification obligations of the Business Layers
stockholders and certain former employees. The shares were offered and issued
pursuant to Regulation D of the Securities Act of 1933, as amended, or the
Securities Act, based in part upon representations from the Business Layers
stockholders that they were accredited investors, as defined in Rule 501(a) of
the Securities Act.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth below should be read in conjunction
with our consolidated financial statements and related notes and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
appearing elsewhere herein.
The following consolidated data includes the results of operations from the
date of acquisition of Business Layers, Inc., which we acquired on December 30,
2003, and the results of operations from the date of acquisition of DataChannel,
Inc. which we acquired on December 14, 2001. Since the acquisition of Business
Layers occurred on December 30, 2003, the majority of the impact of this
acquisition in the 2003 results of operations was the $3.8 million charge
recorded for in-process research and development. See Note 3 to the Company's
consolidated financial statements for further information concerning these
acquisitions.
13
Prior to 2002, we had historically accounted for reimbursements received for
out-of-pocket expenses incurred as a reduction to the cost of service revenues
in the statement of operations to offset the costs incurred. We adopted EITF
01-14 effective January 1, 2002 and reclassified approximately $1.6 million,
$1.2 million and $200,000 into revenues from cost of revenues for the years
ended December 31, 2001, 2000 and 1999, respectively, to comply with this
guidance.
YEARS ENDED DECEMBER 31,
---------------------------------------------------------
2003 2002 2001 2000 1999
--------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Revenues:
Software licenses.......................... $ 44,030 $ 36,072 $ 55,314 $ 37,688 $ 7,527
Services................................... 31,536 30,158 29,199 13,902 2,407
Other...................................... 2,878 3,034 3,633 3,655 3,008
--------- --------- --------- --------- ---------
Total revenues.......................... 78,444 69,264 88,146 55,245 12,942
--------- --------- --------- --------- ---------
Cost of revenues:
Cost of software licenses.................. 1,926 2,071 1,931 2,549 631
Non-cash cost of software licenses......... 5,398 5,449 153 -- --
Cost of services........................... 11,385 13,664 15,113 8,624 1,423
Cost of other.............................. 1,841 1,827 2,221 2,169 1,620
--------- --------- --------- --------- ---------
Total cost of revenues.................. 20,550 23,011 19,418 13,342 3,674
--------- --------- --------- --------- ---------
Gross profit................................. 57,894 46,253 68,728 41,903 9,268
Selling, general and administrative
expenses................................... 43,947 52,755 51,989 36,094 16,294
Research and development expenses............ 20,297 22,701 15,791 9,103 3,744
Gain on sale of portal technology............ (4,959) -- -- -- --
Acquired in-process research and
development................................ 3,800 -- 3,000 -- --
Impairment charges........................... -- 57,374 -- -- --
Restructuring and other non-recurring
expenses................................... 459 2,080 529 -- --
--------- --------- --------- --------- ---------
Loss from operations......................... (5,650) (88,657) (2,581) (3,294) (10,770)
Other income, net............................ 1,791 2,418 4,831 6,103 824
--------- --------- --------- --------- ---------
Income (loss) before provision for income
taxes...................................... (3,859) (86,239) 2,250 2,809 (9,946)
Provision for income taxes................... 371 70 607 75 --
--------- --------- --------- --------- ---------
Net income (loss)............................ (4,230) (86,309) 1,643 2,734 (9,946)
Recognition of beneficial conversion
feature and accretion of preferred
stock...................................... -- -- -- -- 413
--------- --------- --------- --------- ---------
Net income (loss) attributable to common
stockholders............................... $ (4,230) $ (86,309) $ 1,643 $ 2,734 $ (10,359)
========= ========= ========= ========= =========
Earnings (loss) per
share:
Basic...................................... $ (0.12) $ (2.53) $ 0.05 $ 0.09 $ (0.59)
Diluted.................................... $ (0.12) $ (2.53) $ 0.05 $ 0.08 $ (0.59)
========= ========= ========= ========= =========
Weighted average shares outstanding:
Basic...................................... 34,559 34,078 31,076 29,010 17,472
Diluted.................................... 34,559 34,078 32,936 33,407 17,472
DECEMBER 31,
---------------------------------------------------------
2003 2002 2001 2000 1999
--------- --------- --------- --------- ---------
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash and cash equivalents.................... $ 20,123 $ 25,707 $ 29,332 $ 115,747 $ 102,879
Marketable securities........................ 70,958 61,016 79,734 -- --
Working capital.............................. 46,933 64,740 92,485 112,330 104,435
Goodwill..................................... 34,503 -- 57,262 -- --
Intangible assets, net....................... 7,500 5,398 10,846 -- --
Total assets................................. 157,224 118,362 206,179 138,379 110,970
Total stockholders' equity................... 115,086 90,758 176,141 117,899 106,434
14
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
The following discussion and analysis of our financial condition and results
of operations should be read in conjunction with "Selected Financial Data"
appearing in Item 6 of this report and our consolidated financial statements and
related notes appearing under Item 8 of this report. This discussion and
analysis contains forward-looking statements that involve risks and
uncertainties. Our actual results may differ materially from those anticipated
in these forward-looking statements, as described under "Special Note Regarding
Forward-Looking Statements" above Item 1 of this report.
OVERVIEW
Netegrity's objective is to be a leading provider of enterprise security
software solutions specifically for managing user identities and access. Our
identity and access management product line provides companies a secure way to
make corporate information assets and resources available online. We believe
open, protected access is essential as companies seek to leverage the Web to
grow their businesses.
With Netegrity identity and access management products, companies are able
to securely use the Web -- Internet, Intranet or Extranet -- to meet the
information access needs of partners, suppliers, customers and employees.
Netegrity solutions are designed to enable businesses to ensure that the right
people have the right access to the right information across a variety of
applications, business systems and computing architectures. This enables more
business to be more securely conducted online providing opportunities to improve
customer service and productivity, increase sales of products and services and
create business partnership value chains.
We derive our revenues primarily from our core products, SiteMinder,
IdentityMinder Web Edition, IdentityMinder eProvision and TransactionMinder,
which offer a single source solution for integrated, centralized identity
management, user access and administration and account
provisioning/de-provisioning. Our solution supports a broad range of technology
environments, and aims to ensure that companies optimize their existing
information technology investments while incorporating new technologies. We also
offer various levels of consulting and support services that enable our
customers to successfully implement our products in their organizations.
Our products are generally sold on a perpetual license basis. Customers
typically place an initial order for a limited number of users and purchase
additional users as their need for our products within their enterprise
increases. We believe that our product line synergies and the strength of our
customer base create opportunities to sell additional products to existing
customers. Customers also enter into an annual support agreement for their
software license at the time of initial purchase and typically renew this
support agreement annually. Our support agreement entitles customers to software
license updates and telephone support.
We believe sales of our products will be driven by customers' desires for a
comprehensive single-source IAM solution whose key benefits include reduced
costs by reducing information technology complexity, increased revenue potential
by improving customer service online, expanded business opportunities by
creating real-time business networks and support for regulatory compliance and
risk mitigation. As a result, we expect that companies will spend their
discretionary information technology dollars on technology that will help them
drive revenue and reduce costs while mitigating risk. The combined impact of a
broadened product portfolio as well as the focus of our direct sales resources
on larger companies in selected industries has enabled us to continue to drive
business through our installed base while at the same time adding new customers.
However, information technology spending has sharply decreased in the past two
years and information technology budgets remained constrained, which has had and
could continue to have a direct effect on the sale of our products. While we
believe that spending on technology will begin to modestly increase in 2004, we
believe that it will continue to be constrained in the first two or three
quarters of 2004.
Some of our products contain technology that is licensed from third parties.
Our cost of license revenue consists primarily of royalty fees that we pay for
the licensed technology. Cost of license revenue also includes amortization of
acquired software and product fulfillment costs. Cost of services includes
salaries and related expenses for our consulting, education and technical
support services organizations, and the associated cost of training facilities.
Our professional services group provides customers with project management,
architecture and design, custom develop services and training. Our customers
typically pay for professional services at an hourly rate for the time it takes
us to complete the project. We strive to maintain effective staffing levels and
to limit the amount of turnover of our professional services staff. If we are
not successful in maintaining effective staffing levels, our ability to achieve
our service revenue and profitability objectives may be adversely affected.
The majority of our sales are made directly with customers. Our direct sales
to customers in countries outside of the United States
15
are denominated in U.S. dollars and local currency, with the majority of our
sales denominated in U.S. dollars. Our sales through indirect distribution
channels are generally denominated in U.S. dollars. For countries outside of the
United States, we generally pay our operating expenses in local currency. Where
we do invoice customers in local currency, we are exposed to foreign exchange
rate fluctuations from the time the contract is signed until collection occurs.
We are also exposed to foreign currency fluctuations between the time we collect
in U.S. dollars and the time we pay our operating expenses in local currency.
Fluctuations in currency exchange rates could affect the profitability and cash
flows in U.S. dollars of our products sold in international markets. To date,
these fluctuations have not been material.
Our future revenues and operating results may also fluctuate from quarter to
quarter based on the number and size of license deals and the size and scope of
the professional service projects in which we are engaged. In addition, license
revenues from a large customer deal may constitute a significant portion of our
total revenues in a particular quarter. Any such deal may result in increased
royalty payments and commission expenses. Any decline in our revenues will have
a significant impact on our financial results, particularly because a
significant portion or our operating costs, such as personnel, rent and
depreciation, are fixed in advance of a particular quarter. As a result, despite
cost savings realized during 2003, our costs for services personnel, sales and
marketing and general and administrative could increase as a percentage of
revenue, thereby affecting our operating results.
CRITICAL ACCOUNTING POLICIES AND SIGNIFICANT JUDGMENTS AND ESTIMATES
Netegrity's discussion and analysis of its financial condition and results
of operations are based on the Company's consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States of America. The preparation of these financial
statements requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at the date of the financial statements as well as the
reported revenues and expenses during the reporting periods. On an ongoing
basis, management evaluates its estimates and judgments, including those related
to revenue recognition, accounts receivable reserves, valuation of long-lived
and intangible assets, goodwill, in-process research and development, and income
taxes.. Management bases its estimates on historical experience and on various
other factors that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying value of
assets and liabilities that are not readily apparent from other sources. Actual
results may differ from these estimates under different assumptions or
conditions.
The significant accounting policies that management believes are most
critical to aid in fully understanding and evaluating our reported financial
results include the following:
REVENUE RECOGNITION
Our revenues are generated primarily from the sale of perpetual licenses for
our proprietary SiteMinder, IdentityMinder eProvision, IdentityMinder Web
Edition and TransactionMinder products and related services. We generate our
services revenues from consulting and training services performed for customers
and from the maintenance and support of our products. As described below,
significant management judgments and estimates must be made and used in
connection with the revenues recognized in any accounting period. Management
analyzes various factors, including specific terms and conditions of a
transaction, historical experience, credit worthiness of customers and current
market and economic conditions. Changes in judgments based upon these factors
could impact the timing and amount of revenues and cost recognized.
We generally license our software products on a perpetual basis. We apply
the provisions of Statement of Position No. 97-2, "Software Revenue
Recognition," as amended by Statement of Position No. 98-9, "Software Revenue
Recognition, with Respect to Certain Transactions," to all transactions
involving the sale of software products. We recognize revenues from the sale of
software licenses when persuasive evidence of an arrangement exists, the product
has been delivered, the fees are fixed or determinable and collection of the
resulting receivable is reasonably assured. This policy is applicable to all
sales, including sales to resellers and end users. We do not offer a right of
return on our products.
For all sales, we use a license agreement signed by both parties and/or a
purchase order with binding terms and conditions as evidence of an arrangement.
For arrangements with multiple obligations, such as, software license,
undelivered maintenance and support, training and consulting, we allocate
revenues to each component of the arrangement using the residual value method
based on the fair value of the undelivered elements. We defer revenue from the
arrangement equivalent to the fair value of the undelivered elements. Fair value
for each component is either the price we charge when the same component is sold
separately or the price established by the members of our management who have
the relevant authority to set prices for an element not yet sold separately.
16
At the time of the transaction, we assess whether the fee associated with
the transaction is fixed or determinable based on the payment terms associated
with the transaction. If a significant portion of the fee is due after our
normal payment terms, which are generally 30 to 90 days from invoice date, we
account for the fee as not being fixed or determinable. In those cases, we
recognize revenues as the fees become due. In addition, we assess whether
collection is probable based on the credit worthiness of the customer. Initial
credit worthiness is assessed through Dun & Bradstreet or similar credit rating
agencies. Credit worthiness for follow-on transactions is assessed through a
review of the transaction history with the customer. We do not typically request
collateral from our customers. If we determine that collection of a fee is not
reasonably assured, we defer the fee and recognize revenues at the time
collection becomes reasonably assured, which is generally upon receipt of cash.
Installation by Netegrity is not considered essential to the functionality
of our products as these services do not alter the product capabilities, do not
require specialized skills and may be performed by the customer or other
vendors. Revenues for maintenance and support are recognized ratably over the
term of the support period. Revenues from consulting and training services
generally are recognized as the services are performed. A number of the
professional services contracts acquired from Business Layers have either a
fixed fee or a fixed hourly rate that is below our cost to provide these
services. As a result, we anticipate realizing losses on these contracts and
therefore have accrued approximately $1.2 million for these losses as of
December 31, 2003 related to these acquired professional services contracts. The
losses were estimated based on our estimate of the projected revenue and the
estimated time to complete the services for each contract.
ACCOUNTS RECEIVABLE RESERVES
We maintain allowances for doubtful accounts for estimated losses resulting
from the inability of our customers to make required payments. We base our
estimates on our historical collection and write-off experience, current trends,
credit policy, detailed analysis of specific customer situations and percentage
of our accounts receivable by aging category. While such losses have
historically been within our expectations and the allowances we established, we
cannot guarantee that we will continue to experience the same credit loss rates
that we have in the past. If the financial condition of our customers
deteriorates, resulting in an impairment of their ability to make payment,
additional allowances may be required. Our failure to accurately estimate the
losses for doubtful accounts and ensure that payments are received on a timely
basis could result in lower than anticipated profitability or losses and
decreased cash flow.
VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS, GOODWILL AND IN-PROCESS RESEARCH
AND DEVELOPMENT
We review the valuation of goodwill in accordance with SFAS No. 142
"Goodwill and Other Intangible Assets." Under the provisions of SFAS No. 142,
goodwill is required to be tested for impairment annually in lieu of being
amortized. This testing is done in the fourth quarter of each year. Furthermore,
goodwill is required to be tested for impairment on an interim basis if an event
or circumstance indicates that it is more likely than not that an impairment
loss has been incurred. An impairment loss shall be recognized to the extent
that the carrying amount of goodwill exceeds its implied fair value. Impairment
losses shall be recognized in operations. The Company's valuation methodology
for assessing impairment requires management to make judgments and assumptions
based on historical experience and projections of future operating performance.
Management predominantly uses third party valuation reports to assist in its
determination of the fair value. If these assumptions differ materially from
future results, the Company may record impairment charges in the future.
We review the valuation of long-lived assets, including property and
equipment and capitalized software, under the provisions of SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" and SFAS No.
86, "Accounting for the Costs of Computer Software to Be Sold, Leased, or
Otherwise Marketed." We are required to assess the recoverability of long-lived
assets and purchased software on an interim basis whenever events and
circumstances indicate that the carrying value may not be recoverable. Factors
we consider important that could trigger an interim impairment review include
the following:
- significant underperformance relative to expected historical or projected
future operating results;
- significant changes in the manner of our use of the acquired assets or the
strategy of our overall business;
- significant negative industry or economic trends;
- significant decline in our stock price for a sustained period; and
- our market capitalization relative to net book value.
17
In accordance with SFAS No. 144, when we determine that the carrying value
of applicable long-lived assets may not be recoverable based upon the existence
of one or more of the above indicators of impairment, we evaluate whether the
carrying amount of the asset exceeds the sum of the undiscounted cash flows
expected to result from the use and eventual disposition of that asset. If such
a circumstance exists, we would measure an impairment loss to the extent the
carrying amount of the particular long-lived asset or group exceeds its fair
value. We would determine the fair value based on a projected discounted cash
flow method using a discount rate determined by our management to be
commensurate with the risk inherent in our current business model. In accordance
with SFAS No. 86, when we determine that the carrying value of certain other
types of long-lived assets may not be recoverable we evaluate whether the
unamortized cost exceeds the expected future net realizable value of the
products. If the unamortized costs exceed the expected future net realizable
value of the products, the excess amount is written off. Changes in judgments on
any of these factors could impact the value of the asset being evaluated.
The valuation of in-process research and development is typically determined
using the income method. Revenue and expense projections for the in-process
research and development project are based on estimates prepared by management.
The value is determined using the present value of the cash flows from the
projections using a discount rate based on the uncertainty associated with
completing the project. The value is also based on an estimate of the percentage
of completion of the technologies under development based on the projects
remaining duration and costs. Management also assumed that in the event that the
project is not completed and technological feasibility is not achieved, there is
no alternative future use for the in-process technology. Changes in judgments on
any of these factors could impact the value of the in-process research and
development and the results of operations.
ACCOUNTING FOR INCOME TAXES
The preparation of our consolidated financial statements require us to
estimate our income taxes in each of the jurisdictions in which we operate,
including those outside the United States which may be subject to certain risks
that ordinarily would not be expected in the United States. The income tax
accounting process involves our estimating our actual current exposure together
with assessing temporary differences resulting from differing treatment of
items, such as deferred revenue, for tax and accounting purposes. These
differences result in the recognition of deferred tax assets and liabilities.
The Company must then record a valuation allowance to reduce its deferred tax
assets to the amount that is more likely than not to be realized.
Significant management judgment is required in determining our provision for
income taxes, our deferred tax assets and liabilities and any valuation
allowance recorded against deferred tax assets. The Company has recorded a
valuation allowance of $78.9 million as of December 31, 2003, due to
uncertainties related to our ability to utilize our deferred tax assets,
primarily consisting of certain net operating losses carried forward before they
expire. The valuation allowance is based on our estimates of taxable income by
jurisdiction in which we operate and the period over which our deferred tax
assets will be recoverable. In the event that actual results differ from these
estimates or we adjust these estimates in future periods we may need to adjust
our valuation allowance, which could materially impact our financial position
and results of operations.
18
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002
REVENUES ($ IN MILLIONS)
2003 2002
------------------------- ---------------------------
% OF TOTAL % OF TOTAL $ CHANGE % CHANGE
$ REVENUES $ REVENUES 2003 TO 2002 2003 TO 2002
----------- ---------- ----------- ---------- ------------ ------------
Software licenses $ 44.0 56% $ 36.1 52% $ 7.9 22%
Services 31.5 40% 30.2 44% 1.3 4%
Other 2.9 4% 3.0 4% (0.1) (3%)
----------- --- ----------- --- -------------
Total revenues $ 78.4 100% $ 69.3 100% $ 9.1 13%
=========== === =========== === ============= ==
The increase in total revenues in the year ended December 31, 2003 from the
year ended December 31, 2002 was primarily due to increases in software license
revenues from the sale of our SiteMinder product, as well as sales generated by
our new product offerings, IdentityMinder Web Edition, IdentityMinder eProvision
and TransactionMinder in the year ended December 31, 2003. In addition, in the
year ended December 31, 2003, we also experienced increased revenues from the
sale of our service offerings which include consulting, training and maintenance
and support. Overall, while we believe that information technology spending will
begin to modestly increase in 2004, we believe that revenue growth will continue
to be constrained over the next two to three quarters. However, we believe that
as information technology spending increases from current levels our revenues
will increase. We expect to continue to generate revenue from our SiteMinder
product as we continue to enhance SiteMinder to meet changing market needs. We
also believe that our focus on expanding our leadership position in the identity
and access management market with our new IdentityMinder Web Edition,
IdentityMinder eProvision and TransactionMinder product offerings and continuing
to leverage the relationships we have built with our partners to provide
integration services directly to our customers will enable us to acquire new
customers and sell additional products to our existing customers.
The increase in software license revenue in the year ended December 31, 2003
from the year ended December 31, 2002 was primarily due to the sale of our
SiteMinder product, sales of our new product offerings, which typically result
in larger average deal sizes, increased sales to our existing customers and
improved sales execution in the year ended December 31, 2003. Additionally,
although the European economy continued to be weak in 2003, in the year ended
December 31, 2003 we saw an increase in European sales activity within certain
market segments on which we have been focusing our selling and marketing
resources during 2003. Average deal size and the type of customer (new name
versus follow-on) are important metrics of our business as these metrics assist
us in measuring our market penetration as well as our penetration into our
existing customer base. Although the number of new name deals decreased to 103
in 2003 from 163 in 2002, the average size of new name deals increased to
approximately $150,000 in 2003 from approximately $107,000 in 2002. This
indicates that while we added fewer new customers during 2003, we were able to
sell these customers more of our new products. The number of follow-on deals
increased to 253 in 2003 from 191 in 2002, however the average size of follow-on
deals decreased to approximately $144,000 in 2003 from approximately $191,000 in
2002. The increase in the number of follow-on deals indicates that our focus on
selling to our existing customers resulted in these customers buying additional
user licenses of our SiteMinder product as well as licenses for our new
products. However, during 2003 the average size of follow-on deals greater than
$500,000 decreased as compared to 2002 primarily due to a deal in excess of $3.0
million being included in the 2002 average deal size.
The increase in services revenues in the year ended December 31, 2003 from
the year ended December 31, 2002 was primarily attributable to an increase of
$5.2 million in maintenance and support revenue during 2003 resulting from the
increased maintenance associated with increasing license revenue and maintenance
renewals by our existing customer base. The increase was offset by a decrease in
consulting and training revenue of $3.8 million as a result of (i) broad based
economic weakness and decreased technology spending that resulted in a reduction
in our customers' need for installation and integration services and (ii) the
Company's decision to leverage its partners to provide integration services
directly to our customers. In connection with this leveraged model, the
cumulative number of third party consultants the Company had trained increased
from approximately over 1,000 in 2002 to over 1,200 in 2003.
Other revenues are derived from the Firewall legacy business. This business
remained relatively flat in 2003 and is not expected to significantly increase
in future periods.
19
GROSS PROFIT ($ IN MILLIONS)
2003 2002
------------------------ ------------------------
GROSS GROSS $ CHANGE % CHANGE
$ PROFIT % $ PROFIT % 2003 TO 2002 2003 TO 2002
---------- ---------- ---------- ---------- ------------ ------------
Gross profit - software
licenses $ 36.7 83% $ 28.6 79% $ 8.1 28%
Gross profit - services 20.2 64% 16.5 55% 3.7 22%
Gross profit - other 1.0 34% 1.2 40% (0.2) (17%)
---------- -- ---------- -- ----------
Total Gross Profit $ 57.9 74% $ 46.3 67% $ 11.6 25%
========== == ========== == ========== ===
Gross profit is calculated as revenues less cost of revenues. Cost of
revenues includes, among other things, royalties due to third parties for
technology included in our products, amortization of capitalized software,
product fulfillment costs, salaries and related expenses for our consulting,
education and technical support services organizations, and the associated cost
of training facilities. Historically, we have realized overall gross profit
percentages of between 65% and 70%, with gross profit percentages on license
revenue typically in excess of 80% and gross profit percentages on services
revenue typically in excess of 50%. Overall, we believe that the cost of
revenues in dollars will remain relatively flat in 2004 with the cost of
software licenses decreasing slightly due to a decrease in non-cash cost of
software licenses, offset by an increase in the cost of third party software
products that enhance and enable additional functionality in our products, and
increased investment in our technical support organization. Overall, we
anticipate gross margin percentages to increase in 2004 to approximately 75% to
78% as a result of an increase in our total revenue.
The increase in gross profit on software licenses is due to an increase in
license revenue and as a result of the cost of software licenses, which includes
non-cash cost of software amortization, remaining relatively flat in the year
ended December 31, 2003 to the year ended December 31, 2002. The non-cash cost
of software licenses represents the amortization of purchased software recorded
in connection with the acquisition of DataChannel. During the fourth quarter of
2002, the Company accounted for a change in accounting estimates to reflect a
change in the useful economic life of certain technology acquired in the
DataChannel acquisition in December 2001. Prior to this change, the acquired
technology long-lived asset was amortized on a straight line basis over three
years. As a result of this change, beginning in the fourth quarter of 2002, the
acquired technology was amortized over its revised estimated useful life of nine
months. As a result, the quarterly amortization increased from approximately
$916,000 in each of the first three quarters of 2002 to approximately $2.7
million in each of the fourth quarter of 2002 and the first and second quarter
of 2003. This acquired technology was fully amortized as of June 30, 2003. On
December 30, 2003, we acquired Business Layers, Inc., and as a result of the
transaction we recorded assets related to the capitalized software acquired.
These capitalized software assets will be amortized over their estimated useful
lives of two to five years. As a result, we expect amortization expense to
decrease to approximately $2.0 million in 2004 from approximately $5.4 million
in 2003. Overall, we expect that gross profits on software licenses will
increase in 2004 to over 90% due to the decrease in amortization expense,
coupled with anticipated increases in software license revenue.
The increase in gross profit on services is due to a slight increase in
service revenue and a decrease in cost of services in the year ended December
31, 2003 from the year ended December 31, 2002. The decrease in cost of services
in the year ended December 31, 2003 from the year ended December 31, 2002 was
primarily due to the leveraging of our system integrator partner relationships.
The cumulative number of consultants we have trained at our affiliated partners
increased to over 1,200 in 2003 from over 1,000 in 2002. This leveraging allowed
us to reduce the headcount in our professional services organization by over 50%
in December 31, 2003 from December 31, 2002. This decrease was partially offset
by increased investment in the technical support organization during 2003 in
order to enhance overall customer satisfaction. Gross profits on our services
revenue are primarily driven by gross profits on maintenance revenue partially
offset by gross profits on our professional services revenue. We anticipate an
increase in the investment in the technical support organization as a result of
the acquisition of Business Layers, but also anticipate maintaining our
historical gross profit percentage due to an increase in maintenance revenue.
This increase will be partially offset by a decrease in the gross profit
percentage of our professional services organization due to anticipated
increases in staff levels over 2003.
Gross profit on other is derived from the Firewall legacy business. This
business remained flat in 2003 and is not expected to significantly increase in
future periods.
20
OPERATING EXPENSES ($ IN MILLIONS)
2003 2002
------------------------ ------------------------
% OF TOTAL % OF TOTAL $ CHANGE % CHANGE
$ REVENUES $ REVENUES 2003 TO 2002 2003 TO 2002
---------- ---------- ---------- ---------- ------------ ------------
Selling, general and
administrative expenses $ 43.9 56% $ 52.7 76% $ (8.8) (17%)
Research and development
expenses 20.3 26% 22.7 33% (2.4) (11%)
Impairment charge -- -- 57.4 83% (57.4) (100%)
Gain on sale of portal
technology (5.0) (6%) -- -- (5.0) (100%)
Acquired in-process
research and
development charges 3.8 5% -- -- 3.8 100%
Restructuring and other
non-recurring charges 0.5 1% 2.1 3% (1.6) (76%)
---------- -- ---------- --- ----------
Total operating expenses $ 63.5 81% $ 134.9 195% $ (71.4) (53%)
========== == ========== === ========== ===
Selling, general and administrative expenses consist primarily of salaries
and other related costs for selling, administrative and marketing personnel,
sales commissions, travel, legal and accounting services, public relations,
marketing materials, trade shows and certain facilities-related expenses. The
decrease in selling, general and administrative expenses in the year ended
December 31, 2003 from the year ended December 31, 2002 was primarily
attributable to decreased salaries and related expenses as a result of a
reduction in headcount of 7% in 2003 as compared to 2002 (including reductions
in force implemented in April and October of 2002 and January 2003), reduced
marketing and travel related expenses, reduced legal fees, and reduced
facility-related expenses, including office rent, depreciation and utilities
primarily resulting from the consolidation of field offices and the move of our
corporate headquarters to a new facility. As we continue to realize the savings
from the consolidations of office space and continue to scrutinize all
discretionary expenses and evaluate reductions in non-strategic programs, we
anticipate selling, general and administrative expenses as a percentage of total
revenues will remain flat or decrease in future periods. We do not anticipate
significant increases in selling, general and administrative expenses as a
result of the acquisition of Business Layers because these functions have been
consolidated with our existing operations and duplicate positions were
eliminated.
Research and development expenses consist primarily of personnel and outside
contractor costs to support product development. The decrease in research and
development expenses in the year ended December 31, 2003 from the year ended
December 31, 2002 was primarily due to a decrease in salaries and related
expenses due to the reductions in force implemented in April and October 2002
and the sale of our portal technology in October 2003, which, in the aggregate,
reduced headcount by 14% in 2003 from 2002. These reductions were primarily
related to the decision not to continue developing, marketing or selling the
PortalMinder product. The decrease in research and development expenses was
primarily related to a reduction in salaries and related costs which was
partially offset by an increase in consulting expenses related to the continued
leverage of offshore third-party contractors used to perform certain testing and
porting of our products. We recognize that our investment in research and
development is required to remain competitive and, therefore, we expect that our
research and development expenses may increase in future periods due to the
continued development of our products and services. Additionally, we expect our
research and development expenses to increase by 23% to 28% over 2003 expense
levels in future periods due to the acquisition of Business Layers on December
30, 2003, which will result in increased salary and related expenses due to the
addition of 35 research and development employees and increased facility charges
related to the office in Israel.
The impairment charge recorded in the year ended December 31, 2002 resulted
from our determination that a significant decline in our stock price as a result
of underperformance relative to recent and expected operating results and the
overall adverse change in the business climate had resulted in a triggering
event that warranted an interim impairment review in accordance with SFAS No.
142. As a result, we tested for impairment based on a two-step approach. The
first step was to test for indicators of impairment of goodwill by comparing the
fair value of the Company with its carrying value. The second step was to
measure the amount of the impairment of goodwill. As a result of this test, we
determined that the implied fair value of the goodwill determined using the
market capitalization
21
of the Company on September 30, 2002 was lower than its carrying value and
therefore, goodwill had been impaired. We recorded a charge of $57.4 million in
the third quarter of 2002, classified as impairment charge in our consolidated
statements of operations, to write down goodwill to its implied fair value of
zero.
In the year ended December 31, 2003, we recorded a charge of $3.8 million
for acquired in-process research and development resulting from the acquisition
of Business Layers. This amount was expensed on the date of acquisition because
the acquired technology had not yet reached technological feasibility and had no
future alternative uses. There can be no assurance that acquisitions of
businesses, products or technologies by us in the future will not result in
substantial charges for acquired in-process research and development. Such
charges may cause fluctuations in our quarterly and annual operating results.
During 2003, we sold our portal technology. As a result we recorded a gain
on the sale of the technology of $5.0 million and a restructuring charge of
approximately $500,000 in connection with the closing of certain facilities, the
write-off of property and equipment and the termination of certain employees.
During 2002, as a result of changing market dynamics and economic factors, we
reduced our workforce through restructurings by approximately 138 positions, or
32%. The reductions in workforce were primarily in the research and development
group as well as in the sales and services departments, both domestically and
internationally. The majority of the reductions in the research and development
group were related to our decision to stop developing, marketing or selling our
portal product. We continued to support existing customers through the date of
the sale. As a result of the restructurings, we recorded restructuring charges,
which related primarily to severance payments and the closing of several sales
offices, of approximately $2.1 million during the year ended December 31, 2002.
OTHER INCOME, NET
Other income, net decreased by approximately $0.6 million, or 26%, to $1.8
million in the year ended December 31, 2003, from $2.4 million in the year ended
December 31, 2002. This decrease was primarily attributable to lower average
cash, cash equivalents and marketable securities balances in 2003 and declines
in interest rates earned on such assets. Our portfolio is generally comprised of
highly liquid, high quality investments, and therefore we do not expect
significant fluctuations in other income as a result of changes in investment
yields.
PROVISION FOR INCOME TAXES
The provision for income taxes for the year ended December 31, 2003 was
approximately $371,000 compared with a provision of approximately $70,000 for
the year ended December 31, 2002. This increase relates to federal alternative
minimum taxes, and larger state taxes and foreign taxes in 2003. The provision
for the year ended December 31, 2003 differs from the expected tax rate due to
nondeductible in-process research and development and an increase in the
Company's valuation allowance. As of December 31, 2003, we had a deferred tax
asset related to net operating loss carryforwards of approximately $72.2
million, against which a full valuation allowance has been provided, available
for federal, state and foreign income tax purposes to reduce future taxable
income expiring on various dates through 2023. Of the $183.0 million of net
operating loss carryforwards, $98.7 million is attributable to tax deductions
relating to stock options, $10.7 million is related to the acquisition of
DataChannel, and $49.7 million is related to the acquisition of Business Layers.
The benefit of the stock option deductions included in the net operating loss
carryforward will be credited to additional paid-in capital when realized or
recognized. The benefit of the acquired net operating loss carryforward will
first reduce non-current intangible assets and the remaining will be recorded to
reduce income tax expense. Under the Tax Reform Act of 1986, the utilization of
a corporation's net operating loss carryforward is limited following a greater
than 50% change in ownership over a three-year period. As of December 31, 2003,
the Company believes that a portion of its net operating loss carryforward will
be subject to limitation.
Shares Outstanding
As part of the consideration for the acquisition of Business Layers, we
issued 2,556,940 shares of the Company's common stock on December 30, 2003.
22
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
REVENUES ($ IN MILLIONS)
2002 2001
------------------------ ------------------------
% OF TOTAL % OF TOTAL $ CHANGE % CHANGE
$ REVENUES $ REVENUES 2002 TO 2001 2002 TO 2001
---------- ---------- ---------- ---------- ------------ ------------
Software licenses $ 36.1 52% $ 55.3 63% $ (19.2) (35%)
Services 30.2 44% 29.2 33% 1.0 3%
Other 3.0 4% 3.6 4% (0.6) (17%)
---------- --- ---------- --- ----------
Total revenues $ 69.3 100% $ 88.1 100% $ (18.8) (21%)
========== === ========== === ========== ===
The decrease in total revenues in the year ended December 31, 2002 from the
year ended December 31, 2001 was primarily due to decreases in software license
revenues for the SiteMinder product, partially offset by an increase in service
revenues and the impact of the acquisition of DataChannel in December 2001,
which contributed approximately 6% of total revenues in 2002. Additionally,
revenues in both Europe and Asia declined throughout 2002.
The decrease in software license revenue in the year ended December 31, 2002
from the year ended December 31, 2001 was due to broad based economic weakness
in all geographic regions and reduced technology spending, which resulted in
deals being delayed or reduced in size. The number of new name deals decreased
to 163 in 2002 from 220 in 2001 and the average size of new name deals decreased
to approximately $107,000 in 2002 from approximately $148,000 in 2001. The
number of follow-on deals also decreased to 191 in 2002 from 204 in 2001 and the
average size of follow-on deals decreased to approximately $191,000 in 2002 from
approximately $204,000 in 2001. The primary reason for the decrease in deal size
in 2002 was that customers bought licenses for a smaller number of users.
The increase in services revenues in the year ended December 31, 2002 from
the year ended December 31, 2001 was primarily attributable to an increase of
$6.4 million in 2002 in maintenance and support revenue resulting from
maintenance renewals by our existing customer base and, to a lesser extent, the
impact of the acquisition of DataChannel in December 2001, which contributed
approximately 9% of services revenues in 2002. The increase was partially offset
by a decrease of $5.5 million in 2002 in consulting and training revenue as a
result of (1) broad based economic weakness and decreased technology spending
that resulted in a reduction in our customers' need for installation and
integration services and (2) the Company's decision to leverage its partners to
provide integration services directly to our customers. In connection with this
leveraged model, the cumulative number of third party consultants the Company
had trained increased to approximately 1,000 in 2002 from over 590 in 2001.
Other revenues are derived from the Firewall legacy business. This business
declined in 2002 and is not expected to have a significant impact in future
periods.
GROSS PROFIT ($ IN MILLIONS)
2002 2001
------------------------ ------------------------
GROSS GROSS $ CHANGE % CHANGE
$ PROFIT % $ PROFIT % 2002 TO 2001 2002 TO 2001
---------- ---------- ---------- ---------- ------------ ------------
Gross profit - software
licenses $ 28.6 79% $ 53.2 96% $ (24.6) (46%)
Gross profit - services 16.5 55% 14.1 48% 2.4 17%
Gross profit - other 1.2 40% 1.4 39% (0.2) (14%)
---------- -- ---------- -- ----------
Total gross profit $ 46.3 67% $ 68.7 78% $ 22.4 33%
========== == ========== == ========== ==
23
Gross profit is calculated as revenues less cost of revenues. Cost of
revenues includes, among other things, royalties due to third parties for
technology included in our products, amortization of acquired software, product
fulfillment costs, salaries and related expenses for our consulting, education
and technical support services organizations, and the associated cost of
training facilities.
The decrease in gross profit on software licenses was due to a decrease in
license revenue and as a result of an increase in cost of software license
revenue in the year ended December 31, 2002 from the year ended December 31,
2001. The increase in cost of software licenses, which includes non-cash cost of
software licenses, was primarily due to the amortization of purchased software
recorded in connection with the acquisition of DataChannel of approximately $5.4
million, partially offset by a decrease in cost of license software in 2002 that
is in relative proportion to the decrease in software license revenue. During
the fourth quarter of 2002, we accounted for a change in accounting estimates to
reflect a change in the useful economic life of certain technology acquired in
the DataChannel acquisition in December 2001. Prior to this change, the acquired
technology long-lived asset was being amortized on a straight line basis over
three years. As a result of this change, beginning in the fourth quarter of
2002, the acquired technology is being amortized over its current estimated
useful life of nine months starting at the beginning of the quarter in which the
change in estimated useful life was identified. Therefore, the quarterly
amortization increased from approximately $916,000 in each of the first three
quarters of 2002 to approximately $2.7 million in the fourth quarter of 2002.
The increase in gross profit on services was due to a slight increase in
service revenue and as a result of a decrease in cost of services in the year
ended December 31, 2002 from the year ended December 31, 2001. This decrease in
cost of services was primarily due to the leveraging of our system integrator
partner relationships. The cumulative number of consultants we have trained at
our affiliated partners increased to approximately 1,000 in 2002 from over 590
in 2001. This leveraging allowed us to reduce the headcount in our professional
services organization by over 50% from December 31, 2001 to December 31, 2002.
This decrease was partially offset by increased investment in the technical
support organization during 2002 in order to enhance overall customer
satisfaction.
Gross profit on Other is derived from the Firewall legacy business. This
business remained flat in 2002 and is not expected to significantly increase in
future periods.
OPERATING EXPENSES ($ IN MILLIONS)
2002 2001
------------------------ ------------------------
% OF TOTAL % OF TOTAL $ CHANGE % CHANGE
$ REVENUES $ REVENUES 2002 TO 2001 2002 TO 2001
---------- ---------- ---------- ---------- ------------ ------------
Selling, general and
administrative expenses $ 52.7 76% $ 52.0 59% $ 0.7 1%
Research and development
expenses 22.7 33% 15.8 18% 6.9 44%
Impairment charge 57.4 83% -- -- 57.4 100%
Acquired in-process
research and
development charges -- -- 3.0 3% (3.0) (100%)
Restructuring and other
non-recurring charges 2.1 3% 0.5 1% 1.6 320%
---------- --- ---------- -- ----------
Total operating expenses $ 134.9 195% $ 71.3 81% $ 63.6 89%
========== === ========== == ========== ==
Selling, general and administrative expenses consist primarily of salaries
and other related costs for selling, administrative and marketing personnel,
sales commissions, travel, legal and accounting services, public relations,
marketing materials, trade shows and certain facilities-related expenses. The
increase in selling, general and administrative expenses in the year ended
December 31, 2002 from the year ended December 31, 2001 was primarily
attributable to increased salaries and wages associated with the DataChannel
acquisition, increased legal expenses, consulting and accounting fees, marketing
program costs and insurance expenses (primarily directors and officer's
insurance premiums) and facility rent and depreciation expense primarily related
to office space and fixed assets acquired from DataChannel. These increases were
partially offset by reduced compensation and bonus expenses and as a result of
24
recording reduced bad debt expense in 2002. The reduction in bad debt expense
was primarily due to improved credit reviews, strong cash collections and fewer
write-offs than anticipated.
Research and development expenses consist primarily of personnel and outside
contractor costs to support product development. The increase in research and
development expenses in the year ended December 31, 2002 from the year ended
December 31, 2001 was primarily due to the addition of approximately 65
employees (including 40 from the acquisition of DataChannel in the fourth
quarter of 2001), the increased use of approximately 22 contractors in India
between 2001 and 2002 and other incremental expenses associated with the
research and development of our new product offerings which were released for
general availability during the fourth quarter of 2002. The increase was
partially offset by the reduction of approximately 35 employees during 2002,
primarily as a result of our decision in the fourth quarter to stop developing,
marketing or selling our portal product.
The impairment charge recorded in the year ended December 31, 2002 resulted
from our determination that a significant decline in our stock price as a result
of underperformance relative to recent and expected operating results and the
overall adverse change in the business climate had resulted in a triggering
event that warranted an interim impairment review in accordance with SFAS No.
142. As a result, we tested for impairment based on a two-step approach. The
first step was to test for indicators of impairment of goodwill by comparing the
fair value of the Company with its carrying value. Since we operate as an
enterprise-wide reporting unit, it was determined that the market value of the
Company represents an approximation of its fair value as of September 30, 2002.
Furthermore, it was determined that the fair value of the Company as of
September 30, 2002 was less than its carrying value and therefore, an indication
of impairment existed. The second step was to measure the amount of the
impairment of goodwill. As a result of the second step, we determined that the
implied fair value of the goodwill determined using the market capitalization of
the Company on September 30, 2002 was lower than its carrying value and
therefore, goodwill had been impaired. We recorded a charge of $57.4 million in
the third quarter of fiscal 2002, classified as impairment charge in our
consolidated statements of operations, to write down goodwill to its implied
fair value of zero.
In the year ended December 31, 2001, we recorded a charge of $3.0 million
for acquired in-process research and development resulting from the acquisition
of DataChannel. This amount was expensed on the date of acquisition because the
acquired technology had not yet reached technological feasibility and had no
future alternative uses.
We recorded restructuring and non-recurring charges in the year ended
December 31, 2002. As a result of changing market dynamics and economic factors,
we reduced our workforce through restructurings by approximately 138 positions,
or 32%. The reductions in workforce were primarily in the development group as
well as in the sales and services departments, both domestically and
internationally. The majority of the reductions in the development group were
concurrent with our decision to stop developing, marketing or selling its portal
product. As a result of the reduction in force, we recorded restructuring
charges, which related primarily to severance payments and the closing of
several sales offices, of approximately $2.1 million during the year ended
December 31, 2002. During 2001, the Company reduced its workforce by
approximately 8% in order to reduce expenses and realign its cost structure. The
reductions in workforce were primarily in the sales, development and general and
administrative groups. The Company recorded a charge of $303,000 during the year
ended December 31, 2001, for severance payments and the consolidation of excess
facilities. Additionally, the Company recorded non-recurring charges of $226,000
during the year ended December 31, 2001 primarily attributable to a contribution
to the James Hayden Memorial Fund, established in the memory of the Company's
former Chief Financial Officer, and the acceleration of 15,300 of his options
that would have vested by December 31, 2001.
OTHER INCOME
Other income decreased by approximately $2.4 million, or 50%, to $2.4
million in the year ended December 31, 2002, from $4.8 million in the year ended
December 31, 2001. This decrease was primarily attributable to declines in the
both the balances of, and interest rates for, cash and cash equivalents and
marketable securities.
PROVISION FOR INCOME TAXES
Provision for income taxes for the year ended December 31, 2002 was
approximately $70,000 compared with a provision of approximately $607,000 for
the year ended December 31, 2001. This decrease relates to federal alternative
minimum taxes, and larger state taxes and foreign taxes in 2001. The provision
for the year ended December 31, 2002 differs from the expected tax rate due to
nondeductible goodwill impairment and an increase in the Company's valuation
allowance. As of December 31, 2002, we had a deferred tax asset related to net
operating loss carryforwards of approximately $70.8 million, against which a
full valuation allowance has been provided, available for federal purposes to
reduce future taxable income expiring on various dates through 2022. Of the
$177.0 million of net operating loss carryforwards, $98.2 million is
attributable to tax deductions relating to stock options and $53.5
25
million is related to the acquisition of DataChannel. The benefit of the stock
option deductions included in the net operating loss carryforward will be
credited to additional paid-in capital when realized or recognized. The benefit
of the acquired net operating loss carryforward will first reduce non-current
intangible assets and the remaining portion of the net operating loss
carryforward will be recorded to reduce income tax expense. The acquired loss
carryforwards are subject to an annual limitation under Internal Revenue Code
Section 382 of approximately $3.1 million. Under the Tax Reform Act of 1986, the
utilization of a corporation's net operating loss carryforward is limited
following a greater than 50% change in ownership over a three-year period. As of
December 31, 2002, the Company believes that a portion of its net operating loss
carryforward will be subject to limitation.
LIQUIDITY AND CAPITAL RESOURCES
We have primarily funded our operations with cash flows generated from
operations in the current and prior years and the proceeds of our equity
issuances. We invest our cash primarily in instruments that are highly liquid,
investment grade securities. As of December 31, 2003, we had cash and cash
equivalents totaling $20.1 million, short-term marketable securities of $51.6
million and working capital of $46.9 million compared to cash and cash
equivalents totaling $25.7 million, short-term marketable securities of $48.4
million and working capital of $64.7 million as of December 31, 2002. In
addition, we had long-term marketable securities totaling $19.4 million and
$12.7 million as of December 31, 2003 and 2002, respectively.
Cash provided by operating activities for the year ended December 31, 2003
was $10.3 million. This resulted primarily from a net loss of $4.2 million and
decreases in accounts payable, and accrued expenses, offset by a decrease in
accounts receivable and increases in deferred revenue and accrued compensation
and benefits. The net loss included non-cash charges for depreciation and
amortization of $9.7 million, acquired in-process research and development
charges of $3.8 million, and the gain on the sale of our portal technology of
$5.0 million. Overall, cash provided by operating activities was primarily a
result of increased revenues and cost reductions during 2003. Also, our days
sales outstanding for accounts receivable decreased throughout 2003 from a high
of 85 days for the quarter ended December 31, 2002 to 53 days for the quarter
ended December 31, 2003. This decrease was primarily due to improved collection
efforts throughout 2003.
Cash used for investing activities was $18.2 million for the year ended
December 31, 2003. Investing activities for the year consisted primarily of net
sales and maturities of marketable securities of approximately $67.4 million and
cash proceeds from the sale of our portal technology of $4.9 million, offset by
the purchases of marketable securities of approximately $78.5 million, net cash
used in the acquisition of Business Layers of $9.9 million as of December 31,
2003 and the purchase of approximately $2.4 million of property and equipment,
primarily computer related, and leasehold improvements for the new corporate
headquarters.
Cash provided by financing activities in the year ended December 31, 2003
was $2.2 million, primarily related to proceeds received from the exercise of
stock options and issuance of shares in connection with the employee stock
purchase plan.
Any increase or decrease in our accounts receivable balance and accounts
receivable days outstanding (calculated as net accounts receivable divided by
revenue per day) affects our cash flow from operations and liquidity. Our
accounts receivable and accounts receivable days outstanding may increase due to
changes in factors such as the timing of when sales are invoiced and the length
of our customers' payment cycles. We also record deferred maintenance billings
as accounts receivable, and the timing of these billings affects the accounts
receivable days outstanding. Historically, international and indirect customers
pay at a slower rate than domestic and direct customers. An increase in revenues
generated from international and indirect customers may increase our accounts
receivable balance and accounts receivable days outstanding. Due to the current
economic climate, we may observe an increase in the length of our customers'
payment cycles and as a result our days sales outstanding may increase in future
periods. To the extent that our accounts receivable balance increases, we may
incur increased bad debt expense and will be subject to greater general credit
risks.
In the past, we experienced a period of rapid growth, which resulted in
significant increases in our operating expenses. Over the past two years, due to
the effects of general economic conditions, we have made considerable efforts to
reduce our operating expenses through constrained spending, reductions in
workforce and better alignment of our cost structure to our revenues. We
anticipate our short-term cash requirements to primarily include the continued
funding of our operating expenses and, to a lesser extent, the funding of
capital expenditures. Additionally, as of December 31, 2003 we were obligated to
pay the remaining $4.2 million of the purchase consideration and $1.0 million of
transaction costs associated with the acquisition of Business Layers. We believe
that our existing cash and cash equivalent balances together with our marketable
securities will be sufficient to meet these requirements over the next twelve
months. We anticipate our long-term cash requirements to primarily include the
funding of acquisitions or investments in businesses, technologies, products or
services that are complementary to our business. Other than those mentioned, we
are not aware of any other known material trends or uncertainties related to
cash flow, capital resources, capital requirements or
26
liquidity as of December 31, 2003.
COMMITMENTS, CONTRACTUAL OBLIGATIONS, AND OFF-BALANCE SHEET ARRANGEMENTS
We have commitments that expire at various times through 2010. Operating
leases shown below are primarily for facility costs for our corporate
headquarters, customer service, research and development and world-wide sales
offices (in thousands).
LESS THAN AFTER 5
TOTAL 1 YEAR 1-3 YEARS 4-5 YEARS YEARS
----- ------ --------- --------- -----
Operating leases........... 9,257 $ 2,421 $ 3,716 $ 2,857 $ 263
---------- --------- --------- --------- -------
$ 9,257 $ 2,421 $ 3,716 $ 2,857 $ 263
========== ========= ========= ========= =======
Included in the operating lease commitments above is approximately $670,000
related to excess facilities which have been accrued in purchase accounting
related to our acquisitions.
We incurred total operating lease expense, primarily related to certain
facilities and equipment under non-cancelable operating leases, of $3.9 million
for the year ended December 31, 2003.
In April 2002, we entered into an agreement with a system integrator to
assist us in the development and launch of one of our products. Under the terms
of the agreement, for consideration of the system integrator's time in assisting
with the development of the product, we agreed to promote the system integrator
as an integrator of the developed product. Our obligation under the agreement
will be considered s