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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
10
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 satisfied once the system integrator receives consulting
revenues totaling approximately $3.9 million from our customers, or by April
2004, whichever occurs first. In the event that we recommend a competitor of the
system integrator to perform the integration work for a customer, we could
potentially owe a royalty to the system integrator based on the net license fee.
As of December 31, 2003 no royalties were due under this agreement to the system
integrator.
In August 2002, we entered into a five year non-cancelable operating lease
for an office building for our corporate headquarters. We moved into the new
facility in March 2003. In connection with the lease agreement, we delivered an
irrevocable, unconditional, negotiable letter of credit in the amount of
$767,000 as a security deposit. Additionally, we spent $1.0 million in leasehold
improvements to build out the new facility.
In December 2003, we acquired Business Layers, Inc. for 2,556,940 shares of
our common stock, cash payments of $15.0 million and estimated transaction costs
of $1.0 million. As of December 31, 2003, approximately $10.8 million of the
cash payment had been made. The remaining $4.2 million of the cash payment and
the $1.0 million of transaction costs are expected to be paid by March 31, 2004.
We enter into standard indemnification agreements with our business partners
or customers in our ordinary course of business. Pursuant to these agreements,
we agree to repair or replace the product, pay royalties for a right to use, or
reimburse the indemnified party for actual damages awarded by a court against
the indemnified party for a intellectual property infringement claim by a third
party with respect to our products. The term of these indemnification agreements
is generally perpetual. The maximum potential amount of future payments we could
be required to make under these indemnification agreements is unlimited. We have
never incurred costs to defend lawsuits or settle claims related to these
indemnification agreements. As a result, we believe the estimated fair value of
these agreements is minimal. Accordingly, we have no liabilities recorded for
these agreements as of December 31, 2003.
We enter into standard indemnification agreements with our customers whereby
we indemnify them for certain damages, such as personal property damage, which
may be caused in connection with consulting services performed at a customer
location by our employees or our subcontractors. The maximum potential amount of
future payments we could be required to make under these indemnification
agreements is unlimited. However, we have general and umbrella insurance
policies that enable us to recover a portion of any amounts paid. We have never
incurred costs to defend lawsuits or settle claims related to these
indemnification agreements. As a result, we believe the estimated fair value of
these agreements is minimal. Accordingly, we have no liabilities recorded for
these agreements as of December 31, 2003.
We generally warrant for ninety days from delivery to a customer that our
software products will perform free from material errors which prevent
performance in accordance with user documentation. Additionally, we warrant that
our consulting services will be performed consistent with generally accepted
industry standards. We have never incurred significant expense under our product
or service warranties. As a result, we believe the estimated fair value of these
agreements is minimal. Accordingly, we have no liabilities recorded for these
agreements as of December 31, 2003.
27
We have entered into employment and executive retention agreements with
certain employees and executive officers which, among other things, include
certain severance and change of control provisions. We have also entered into
agreements whereby we indemnify our officers and directors for certain events or
occurrences while the officer or director is, or was, serving at our request in
such capacity.
From time to time, we are involved in litigation relating to claims arising
out of our operations in the normal course of business. We are not presently a
party to any legal proceedings, the adverse outcome of which, in our opinion,
would have a material adverse effect on our results of operations or financial
position.
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CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
The Private Securities Litigation Reform Act of 1995 contains certain safe
harbors regarding forward-looking statements. In that context, the discussion in
this item and other portions of this report contain forward-looking statements
that involve certain degrees of risk and uncertainty, including statements
relating to our business, liquidity and capital resources. Except for the
historical information contained herein, the matters discussed in this section
are such forward-looking statements that involve risks and uncertainties,
including:
WE HAVE INCURRED SUBSTANTIAL LOSSES AND MAY NOT BE PROFITABLE IN THE FUTURE.
In recent years, we have incurred substantial operating losses. While we
recently returned to profitability on a quarterly basis, we cannot predict if we
will maintain profitability for any substantial period of time. To sustain
operating profitability on a quarterly and annual basis, we will need to
continue to increase our revenues, particularly our license revenues. Failure to
maintain levels of profitability as expected by investors may adversely affect
the market price of our common stock. We had a net loss of $4.2 million for the
year ended December 31, 2003 and an accumulated deficit of $111.0 million as of
December 31, 2003.
OUR QUARTERLY RESULTS MAY FLUCTUATE WIDELY.
Our quarterly revenues and operating results are difficult to predict and
may continue to fluctuate significantly from quarter to quarter for several
reasons, including, but not limited to, the following:
- customers choosing to delay their purchase commitments or purchase
in smaller than expected quantities due to a general slowdown in
the economy or in anticipation of the introduction of new products
by us or our competitors;
- market acceptance of our SiteMinder, IdentityMinder Web Edition,
IdentityMinder eProvision and TransactionMinder products;
- our success in obtaining follow-on sales to existing customers;
- the long sales and deployment cycle of our products;
- our ability to hire and retain personnel, particularly in
development, services and sales and marketing;
- the loss of or changes in key management personnel;
- the timing of the release of new versions of our SiteMinder,
IdentityMinder Web Edition, IdentityMinder eProvision and
TransactionMinder or other products;
- pricing pressures that result in increased discounts or changes in
our or competitors' pricing policies;
- changes in our operating expenses;
- the development of our direct and indirect distribution channels;
- integration issues with acquired technology; and
- general economic conditions.
In addition, because our revenues from services, particularly maintenance
revenues, are largely correlated with our software revenues, a decline in
software revenues could also cause a decline in our services revenues in the
same quarter or in subsequent quarters. Other factors, many of which are outside
our control, could also cause variations in our quarterly revenues and operating
results.
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Most of our expenses, such as employee compensation and rent, are relatively
fixed. As a result, any shortfall in revenues in relation to our expectations
could cause significant changes in our operating results from quarter to quarter
and could result in future losses.
OUR SUCCESS WILL DEPEND ON OUR ABILITY TO MARKET OUR PRODUCTS AND RELATED
SERVICES SUCCESSFULLY.
Our revenues are primarily generated from the sale of perpetual licenses for
our proprietary SiteMinder, IdentityMinder Web Edition, IdentityMinder
eProvision, TransactionMinder and related services. Broad market acceptance of
our products will depend on the continued development of a market for identity
and access management, the education of our customers on the use of business
software applications in general and the relevance of our products specifically.
Market acceptance for our products, and customer demand for the services they
provide, may not develop.
We have released several new product offerings in the past 12 months. If we
fail to gain market acceptance for these products, our business, operating
results and financial position could be materially adversely affected.
Additionally, with the reduction in information technology spending in all
industries we will need to be successful in conveying the value of our products
to customers who may be hesitant to replace a "homegrown" system due to the
costs involved with switching to a purchased solution.
Our ability to succeed in the market for our products depends in part on our
ability to provide support services on a 24 hour per day, seven day per week
basis. Any damage or disruptions to our service centers, including our service
centers in Malaysia and Israel, whether as a result of employee attrition, acts
of terrorism or some other cause, or language barriers, could seriously impact
our ability to provide the necessary service to our customers and fulfill our
service contracts.
OUR SUCCESS IS DEPENDENT ON OUR ABILITY TO ENHANCE OUR PRODUCT LINES AND DEVELOP
NEW PRODUCTS.
We believe our success is dependent, in large part, on our ability to
enhance and broaden our product lines to meet the evolving needs of the business
market. We may not be able efficiently to integrate recently acquired
technologies into our products. We may be unable to respond effectively to
technological changes or new industry standards or developments. Product
development cycles are unpredictable and, in the past, we have delayed the
introduction of several new product versions due to delays in development.
We have arrangements with a third party located in India to perform certain
testing of our products, as well as internationalization and porting of our
products to new platforms, and with third party software vendors who provide
software which is embedded in our products. Any adverse change in our
relationship with these third parties could result in delays in the release of
our products. In the future, we could be adversely affected and be at a
competitive disadvantage if we incur significant delays or are unsuccessful in
enhancing our product lines or developing new products, or if any of our
enhancements or new products do not gain market acceptance.
As we continue to release new versions of our existing software we may be
required to assist customers in migrating to the latest version once a product
is announced to be at the end of its life. Additionally, we may be required to
assist Business Layers customers in migrating to more standardized versions of
the provisioning product. We could be adversely affected if there are
significant migration issues and a decline in customer satisfaction related to
such transitions.
OUR ACQUISITION OF BUSINESS LAYERS AND OTHER COMPANIES MAY INCREASE THE RISKS WE
FACE.
We recently acquired Business Layers. In the future, we may pursue other
acquisitions to obtain complementary products, services and technologies. These
acquisitions may not produce the revenues, earnings or business synergies that
we anticipate, and an acquired product, service or technology might not perform
as we expect. In pursuing any acquisition, our management could spend a
significant amount of time and effort in identifying and completing the
acquisition. We will have to devote a significant amount of management resources
to integrate with our existing businesses the business we acquired from Business
Layers and any other business we might acquire. We might not be able to
successfully transfer the knowledge of the employees or integrate the operations
of acquired businesses, including Business Layers. As a result of acquisitions,
we might assume contracts and other agreements that subject us to burdensome
liabilities, including obligations to indemnify third parties, or impose
unfavorable terms on us, including significant royalty obligations and
termination fees. We may not be able to renegotiate these agreements. To pay for
an acquisition, we might use our stock or cash. Alternatively, we might borrow
money from a bank or other lender. If we use our stock, our stockholders would
experience dilution of their ownership interests. If we use cash or debt
financing, our financial liquidity will be reduced.
30
OUR PERFORMANCE DEPENDS ON OUR ABILITY TO WIN BUSINESS AND OBTAIN FOLLOW-ON
SALES IN PROFITABLE SEGMENTS.
Customers typically place small initial orders for our products to allow
them to evaluate our products' performance. A key element of our strategy is to
pursue more significant follow-on sales after these initial installations. Our
financial performance depends on successful initial deployments of our products
that, in turn, lead to follow-on sales. If the initial deployments of our
products are not successful or if our customers do not remain satisfied with our
products and services, we may be unable to obtain follow-on sales. In addition,
even if initial deployments are successful, we cannot assure you that customers
will choose to make follow-on purchases, which could have a material adverse
effect on our ability to generate revenues.
WE FACE SIGNIFICANT COMPETITION FROM OTHER TECHNOLOGY COMPANIES AND WE MAY NOT
BE ABLE TO COMPETE EFFECTIVELY.
The market for identity and access management is highly competitive. We
expect the level of competition to increase as a result of the anticipated
growth of the identity and access management market. Our primary competitor in
the identity and access management market is the Tivoli Division of IBM. We also
compete against traditional security and software companies, such as Oblix, RSA
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 segments of the
marketplace. We also face competition from Web development professional services
organizations. We expect that additional competitors will emerge in the future.
Current and potential competitors have established, or may in the future
establish, cooperative selling relationships with third parties to increase the
distribution of their products to the marketplace. Accordingly, it is possible
that new competitors may emerge and acquire significant market share. It is
possible that current and potential competitors may attempt to hire our
employees and although we have non-compete agreements in place with most of our
employees they may or may not be enforceable. It is possible that new
competitors or alliances may emerge and rapidly acquire significant market
share. Today, many of our competitors have shorter operating histories and fewer
financial and technical resources than we have. In addition, these smaller
competitors have smaller customer bases. Some of our other competitors, however,
are larger companies who have large financial resources, well-established
development and support teams, and large customer bases. These larger
competitors may initiate pricing policies that would make it more difficult for
us to maintain our competitive position against these companies. It is also
possible that current and potential competitors may be able to respond more
quickly to new or emerging technologies or customer requirements, resulting in
increased market share. If, in the future, a competitor chooses to bundle a
competing point product with other applications within a suite, the demand for
our products might be substantially reduced. Because of these factors, many of
which are out of our control, we may be unable to maintain or enhance our
competitive position against current and future competitors.
REGULATIONS OR CONSUMER CONCERNS REGARDING THE USE OF "COOKIES" ON THE INTERNET
COULD REDUCE THE EFFECTIVENESS OF OUR SOFTWARE PRODUCTS.
Certain of our products use cookies to support their single sign-on
functionality. A cookie is information keyed to a specific user that is stored
on the hard drive of the user's computer, typically without the user's
knowledge. Cookies are generally removable by the user, and can be refused by
the user at the point at which the information would not be stored on the user's
hard drive. A number of governmental bodies and commentators in the United
States and abroad have urged passage of laws limiting or abolishing the use of
cookies. The passage of laws limiting or abolishing the use of cookies, or the
widespread deletion or refusal of cookies by Web site users, could reduce or
eliminate the effectiveness of our single sign-on functionality and could reduce
market demand for our products.
WE MAY BE UNABLE TO HIRE AND RETAIN SKILLED PERSONNEL.
Qualified personnel are in great demand throughout the software industry.
Our success depends, in large part, upon our ability to attract, train, motivate
and retain highly skilled employees, particularly software engineers,
professional services personnel, sales and marketing personnel and other senior
personnel. Our failure to attract and retain the highly trained technical
personnel that are integral to our product development, professional services
and direct sales teams, particularly software engineers, may limit the rate at
which we can generate sales, develop new products or product enhancements or
transfer technical knowledge across our employee base. A change in key
management could result in transition and attrition in the affected department.
In addition, we may experience attrition by employees we acquire as a result of
acquisitions of other companies if those employees experience difficulties in
integrating with our existing employees and management. This could have a
material adverse effect on our business, operating results and financial
condition.
OUR SUCCESS DEPENDS ON OUR ABILITY TO OPTIMIZE OUR DIRECT SALES AND INDIRECT
DISTRIBUTION CHANNELS.
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To increase our revenues, we must optimize our direct sales force and
continue to enhance relationships with systems integrators, resellers and
technology partners to increase the leverage of our partners. There is intense
competition for sales personnel in our business, and we cannot be sure that we
will be successful in attracting, integrating, motivating and retaining sales
personnel. In addition, we must effectively leverage our relationships with our
strategic partners and other third-party system integrators, vendors of
Internet-related systems and application software and resellers in order to
reach a larger customer population than we could reach alone through our direct
sales and marketing efforts.
We may not be able to find appropriate strategic partners or may not be able
to enter into relationships on commercially favorable terms, particularly if
these partners decide to compete directly in the identity and access management
market. Furthermore, the relationships we do enter into may not be successful.
Our strategic relationships are generally non-exclusive, and therefore, our
strategic partners may decide to pursue alternative technologies or to develop
alternative products in addition to or instead of our products, either on their
own or in collaboration with our competitors.
WE RELY ON THIRD PARTY TECHNOLOGY TO ENHANCE OUR PRODUCTS.
We incorporate into our products software licensed from third party software
companies that enhances, enables or provides functionality for our products and,
therefore, we need to create relationships with third parties, including some of
our competitors, to ensure that our products will interoperate with the third
parties' products. Third party software may not continue to be available on
commercially reasonable terms or with acceptable levels of support or
functionality, or at all. Failure to maintain those license arrangements,
failure of the third party vendors to provide updates, modifications or future
versions of their software or defects and errors in or infringement claims
against those third party products could delay or impair our ability to develop
and sell our products and potentially cause us to incur additional cost. There
are also third party products incorporated into the provisioning products that
we recently acquired from Business Layers. We expect to renegotiate some of the
terms of those licensing arrangements. There can be no assurance that we will be
able to renegotiate those agreements on commercially favorable terms. In
addition, if we discover that third party products are no longer available as a
result of changes in the third party's operations or financial position, there
can be no assurance that we would be able to offer our product without
substantial reengineering, or at all.
Often these third party software companies require prepayment of royalties
on their products and, in the past, we have had to expense these prepaid
royalties to cost of sales when it was determined that they may not have future
realizable value.
OUR FAILURE TO EXPAND OUR RELATIONSHIP WITH GLOBAL SYSTEMS INTEGRATORS COULD
LIMIT OUR ABILITY TO SUPPORT OUR CUSTOMERS' DEPLOYMENT OF OUR PRODUCTS.
Our professional services organization and our relationship with global
systems integrators provide critical support to our customers' installation and
deployment of our products. If we fail to adequately develop our relationship
with global systems integrators, our ability to increase products sales may be
limited. In addition, if we or our partners cannot adequately support product
installations, our customers may not be able to use our products, which could
harm our reputation and hurt our business.
OUR LENGTHY SALES CYCLE MAKES IT DIFFICULT TO PREDICT OUR QUARTERLY OPERATING
RESULTS.
The length of our sales cycle varies depending on the size, type and
complexity of the customer contemplating a purchase, whether we have conducted
business with a potential customer in the past and the size of the deal. In
addition, some of our customers may also need to invest substantial resources
and modify their computer network infrastructures to take advantage of our
products. As a result, these potential customers frequently need to obtain
approvals from multiple decision makers prior to making purchase decisions, a
process that has been, at times, further lengthened as a result of the current
market conditions surrounding technology spending. Our long sales cycle, which
can range from several weeks to several months or more, makes it difficult to
predict the quarter in which sales will occur. Delays in sales could cause
significant variability in our revenues and operating results for any particular
quarterly period. Our sales cycle is subject to a number of uncertainties such
as:
- the need to educate potential customers regarding the benefits of
our products;
- customers' budgetary constraints;
- the timing of customers' budget cycles;
32
- customers' willingness to make changes in their network
infrastructures; and
- delays caused by customers' internal review processes.
OUR FAILURE TO EFFECTIVELY MANAGE CHANGES IN THE BUSINESS ENVIRONMENT IN WHICH
WE OPERATE COULD HARM OUR BUSINESS.
Our failure to effectively manage changes in the business environment in
which we operate could have a material adverse effect on the quality of our
products, our ability to retain key personnel and our business, operating
results and financial condition. In the past, we have experienced both periods
of rapid growth as well as periods of economic slowdown which have resulted in
reductions in workforce Both of these situations have placed a significant
strain on all of our resources. We may experience similar changes in the future.
Additionally, we may experience disruptions as a result of attacks from
electronic viruses which could result in reduced productivity. To effectively
manage changes in the business environment in which we operate we must maintain
and enhance our financial and accounting systems and controls, maintain the
security of our infrastructure, maintain our ability to retain key personnel,
integrate new personnel and manage operations.
IF WE LOSE THE SERVICES OF BARRY BYCOFF OR ANY OTHER MEMBER OF OUR MANAGEMENT
TEAM, OUR BUSINESS COULD SUFFER.
Our future success depends, to a significant degree, on the skill,
experience and efforts of Barry Bycoff, our chief executive officer, and the
rest of our management team. A change in our management team or the inability of
our officers and key employees to work effectively as a team could have a
material adverse effect on our business, operating results and financial
condition.
AS WE CONTINUE TO OPERATE IN INTERNATIONAL MARKETS, WE WILL FACE CONTINUED RISKS
TO OUR SUCCESS.
We operate in several international markets, including Israel as a result of
our recent acquisition of Business Layers. Our international operations are
subject to increased regulatory, economic and political risks. We have limited
experience in international markets and we cannot be sure that our continued
expansion into global markets will be successful. In addition, we will face
increased risks in conducting business internationally, including the ability to
develop, market and distribute localized versions of our products in a timely
manner or at all. These risks could reduce demand for our products and services,
increase the prices at which we can sell our products and services, or otherwise
have an adverse effect on our operating results. Among the risks related to
international operations we believe are most likely to affect us are:
- longer decision making cycles;
- longer payment cycles and problems in collecting accounts
receivable;
- adverse changes in trade and tax regulations, including
restrictions on the import and export of sensitive technologies,
such as encryption technologies, that we use or may wish to use in
our software products;
- the absence or significant lack of legal protection for
intellectual property rights;
- selling under contracts governed by local law;
- difficulties in managing an organization spread over multiple
countries, including complications arising from cultural, language
and time differences that may lengthen development, sales and
implementation cycles and delay the resolution of customer support
issues;
- currency risks, including fluctuations in exchange rates;
- political and economic instability;
- localization of technology, including delays in localizing the
most recent versions of our products;
- increased use of contractors on a global basis for both
professional services and development, that may result in
increased cost of services and less direct control; and
33
- disruption caused by terrorist activities in various regions
around the world.
OUR SUCCESS DEPENDS ON OUR ABILITY TO PROTECT OUR PROPRIETARY RIGHTS.
Our success depends to a significant degree upon the protection of our
software and other proprietary technology. The unauthorized reproduction or
other misappropriation of our proprietary technology would enable third parties
to benefit from our technology without paying us for it. This could have a
material adverse effect on our business, operating results and financial
condition. We depend upon a combination of patent, trademark, trade secret and
copyright laws, license agreements and non-disclosure and other contractual
provisions to protect proprietary and distribution rights in our products. In
addition, we attempt to protect our proprietary information and the proprietary
information of our vendors and partners through confidentiality and/or license
agreements with our employees and others. Although we have taken steps to
protect our proprietary technology, they may be inadequate and the unauthorized
use of our source code could have an adverse effect on our business. Existing
trade secret, copyright and trademark laws offer only limited protection.
Moreover, the laws of other countries in which we market our products may afford
little or no effective protection of our intellectual property. If we resort to
legal proceedings to enforce our intellectual property rights, the proceedings
could be burdensome and expensive, even if we were to prevail.
CLAIMS BY OTHER COMPANIES THAT WE INFRINGE THEIR PROPRIETARY TECHNOLOGY COULD
HURT OUR FINANCIAL CONDITION.
If we discover that any of our products or third party products embedded in
our products violates third party proprietary rights, there can be no assurance
that we would be able to reengineer our product or to obtain a license on
commercially reasonable terms to continue offering the product without
substantial reengineering. We do not conduct comprehensive patent searches to
determine whether the technology used in our products infringes patents held by
third parties. In addition, product development is inherently uncertain in a
rapidly evolving technology environment in which there may be numerous patent
applications pending for similar technologies, many of which are confidential
when filed. Any claim of infringement, even if invalid, could cause us to incur
substantial costs defending against the claim and could distract our management
from our business. Furthermore, a party making such a claim could secure a
judgment that requires us to pay substantial damages. A judgment could also
include an injunction or other court order that could prevent us from selling
our products. Any of these events could have a material adverse effect on our
business, operating results and financial condition.
OUR BUSINESS COULD BE ADVERSELY AFFECTED IF OUR PRODUCTS CONTAIN ERRORS OR
FLAWS.
Software products as complex as ours may contain undetected errors or "bugs"
that result in product failures. The occurrence of errors could result in loss
of, or delay in, revenues, loss of market share, failure to achieve market
acceptance, diversion of development resources, injury to our reputation, or
damage to our efforts to build brand awareness, any of which could have a
material adverse effect on our business, operating results and financial
condition. Additionally, the security features included in our products to
prevent unauthorized access to the application may not meet all of our
customers' requirements.
WE COULD INCUR SUBSTANTIAL COSTS RESULTING FROM PRODUCT LIABILITY CLAIMS
RELATING TO OUR CUSTOMERS' USE OF OUR PRODUCTS.
Many of the business applications supported by our products are critical to
the operations of our customers' businesses. Any failure in a customer's Web
site or application caused or allegedly caused by our products could result in a
claim for substantial damages against us, regardless of our responsibility for
the failure. Although we maintain general liability insurance, including
coverage for errors and omissions, and contractually attempt to limit liability,
we cannot be sure that our existing coverage will continue to be available on
reasonable terms or will be available in amounts sufficient to cover one or more
large claims, or that the insurer will not disclaim coverage as to any future
claim.
OUR FORMER INDEPENDENT PUBLIC ACCOUNTANT, ARTHUR ANDERSEN LLP, HAS BEEN FOUND
GUILTY OF A FEDERAL OBSTRUCTION OF JUSTICE CHARGE, AND YOU MAY BE UNABLE TO
EXERCISE EFFECTIVE REMEDIES AGAINST ARTHUR ANDERSEN IN ANY LEGAL ACTION.
Our former independent public accountant, Arthur Andersen LLP, provided us
with auditing services during the year ended December 31, 2001, including
issuing an audit report with respect to our audited consolidated financial
statements as of and for the year ended December 31, 2001. On June 15, 2002, a
jury in Houston, Texas found Arthur Andersen guilty of a federal obstruction of
justice charge arising from the federal government's investigation of Enron
Corp. On August 31, 2002, Arthur Andersen ceased practicing before the SEC.
34
We were unable to obtain Arthur Andersen's consent to include its report
with respect to our audited consolidated financial statements as of and for the
year ended December 31, 2001 in this Annual Report on Form 10-K or our Annual
Report on Form 10-K for the year ended December 31, 2002 and Rule 437a under the
Securities Act of 1933, or the Securities Act, permits us to dispense with the
requirement to file Arthur Andersen's consent. As a result, you may not have an
effective remedy against Arthur Andersen in connection with a material
misstatement or omission with respect to our audited consolidated financial
statements. In addition, even if you were able to assert such a claim, as a
result of its conviction and other lawsuits, Arthur Andersen may fail or
otherwise have insufficient assets to satisfy claims made by investors or by us
that might arise under federal securities laws or otherwise relating to any
alleged material misstatement or omission with respect to our audited
consolidated financial statements.
INCREASED UTILIZATION AND COSTS OF OUR TECHNICAL SUPPORT SERVICES AND INCREASED
DEMANDS ON OUR OTHER TECHNICAL RESOURCES MAY ADVERSELY AFFECT OUR FINANCIAL
RESULTS.
Our products involve very complex technology and the failure or inability of
our technical support staff to meet customer expectations in a timely manner or
customer dissatisfaction with our product functionality or performance could
result in loss of revenues, loss of market share, failure to achieve market
acceptance, injury to our reputation, liability for service or warranty costs
and claims and other increased costs. We may be unable to respond to
fluctuations in customer demand for support services as well as resolve customer
issues in a manner that is timely and satisfactory to them. We also may be
unable to modify the format of our support services to compete with changes in
support services provided by competitors.
As we win business from larger, more complex customers there may be an
increased demand on our resources, particularly product management and support,
which may affect the allocation of our resources. Additionally, as we continue
to sell our new products to existing customers, our customers might expect us to
provide the same level of product support on the new products as we do on the
old products. This would increase demand on our product support resources beyond
levels we could provide.
THE MARKET PRICE OF OUR COMMON STOCK HAS BEEN AND MAY CONTINUE TO BE VOLATILE.
Our stock price, like that of other technology companies, has been extremely
volatile. The announcement of new products, services, technological innovations,
customers or distribution partners by us or our competitors, quarterly
variations in our operating results, changes in coverage by securities analysts,
changes in revenues or earnings estimates by securities analysts, speculation in
the press or investment community and overall economic conditions are among the
factors affecting our stock price.
In addition, the stock market in general and the market prices for
technology companies in particular have experienced extreme volatility that
often has been unrelated to the operating performance of these companies. These
broad market and industry fluctuations may adversely affect the market price of
our common stock, regardless of our operating performance. Recently, when the
market price of a stock has been volatile, holders of that stock have often
instituted securities class action litigation against the company that issued
the stock. If any of our stockholders brought a lawsuit against us, we could
incur substantial costs defending the lawsuit. The lawsuit could also divert the
time and attention of our management.
The general economic uncertainties in the United States and abroad continue
to cause significant volatility in the stock markets. The continued threat of
terrorism in the United States and abroad and the ongoing military action and
heightened security measures undertaken in response to that threat can be
expected to cause continued volatility in securities markets. In addition,
foreign political unrest may continue to adversely affect the economy.
WE MAY LOSE MONEY ON FIXED-PRICE CONSULTING CONTRACTS.
Although the majority of our services have historically been performed on a
time and material basis, we have in the past performed services under fixed
price contracts at the request of a customer. In the future, it is possible that
an increased portion of our services revenues could be derived from fixed-price
contracts, particularly since we assumed several fixed-price contract
obligations as a result of the Business Layers acquisition. We work with complex
technologies in compressed time frames and it can be difficult to judge the time
and resources necessary to complete a project. If we miscalculate the resources
or time we need to complete work under fixed-price contracts, we may suffer
losses, and our operating results could be materially adversely affected.
CONTINUED WEAKNESS IN THE GLOBAL ECONOMY MAY ADVERSELY AFFECT OUR BUSINESS.
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The global economy is still weak and may continue to be weak in the
foreseeable future. In addition, the United States' continued involvement in
Iraq, as well as the political unrest in other parts of the world, have
contributed to global economic uncertainty. We believe the current economic
slowdown has caused some potential or current customers to defer purchases. In
response to the current economic conditions, many companies have reduced their
spending budgets for information technology products and services, which could
reduce or eliminate potential sales of our products and services.
CERTAIN PROVISIONS OF OUR CHARTER AND OF DELAWARE LAW MAKE A TAKEOVER OF OUR
COMPANY MORE DIFFICULT.
Our corporate documents and Delaware law contain provisions that might
enable us to resist a takeover of our company. These provisions might discourage
or delay a change in the control of Netegrity or a change in our management.
These provisions could also discourage proxy contests and make it more difficult
for you and other stockholders to elect directors and take other corporate
actions. The existence of these provisions could limit the price that investors
might be willing to pay in the future for shares of our common stock.
Additionally, we have entered into employment and executive retention agreements
with certain employees and executive officers which, among other things, include
certain severance and change of control provisions that may have similar
effects.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
FOREIGN CURRENCY
In the year ended December 31, 2003, we generated approximately 23% of our
revenues outside of the United States. International sales are typically
denominated in U.S. dollars. Our foreign subsidiaries incur most of their
expenses in the local currency. Accordingly, all foreign subsidiaries use the
local currency as their functional currency. Translation gains and losses
(amounting to a loss of approximately $(49,000) as of December 31, 2003) are
deferred and accumulated as a separate component of stockholders' equity
(accumulated other comprehensive income (loss)). Net gains and losses resulting
from foreign exchange transactions, amounting to a gain of approximately
$341,000 for the year ended December 31, 2003, are included in other income, net
in the accompanying consolidated statements of operations. A 10% change in the
valuation of the functional currencies relative to the U.S. dollar as of
December 31, 2003 would not have a material impact on our results of operations
for the year ended December 31, 2003.
INTEREST RATES
We invest our cash in a variety of financial instruments including floating
rate bonds, municipal bonds, asset-backed securities and money market
instruments in accordance with an investment policy approved by our Board of
Directors. These investments are denominated in U.S. dollars. Cash balances in
foreign currencies overseas are operating balances and are only invested in
short-term deposits of the local operating bank.
Investments in both fixed rate and floating rate interest earning
instruments carry a degree of interest rate risk. However, due to the
conservative nature of our investment portfolio, a sudden change in interest
rates would not have a material effect on the value of the portfolio. We
estimate that if the average yield of our investments had decreased by 100 basis
points, our interest income for the year ended December 31, 2003 would have
decreased by less than $1.0 million. This estimate assumes that the decrease
occurred on the first day of the year and reduced the yield of each investment
instrument by 100 basis points. The same 100 basis point change in interest
rates would not have a material impact on the fair value of the investment
portfolio. The impact on our future interest income and future changes in
investment yields will depend largely on the gross amount of our investment
portfolio.
36
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's consolidated financial statements and the related auditors'
reports are presented in the following pages. The consolidated financial
statements filed in this Item 8 are as follows:
Reports of Independent Accountants
Consolidated Balance Sheets -- December 31, 2003 and 2002
Consolidated Statements of Operations for the years ended December 31, 2003,
2002 and 2001
Consolidated Statements of Stockholders' Equity for the years ended December
31, 2003, 2002 and 2001
Consolidated Statements of Cash Flows for the years ended December 31, 2003,
2002 and 2001
Notes to Consolidated Financial Statements
37
Independent Auditors' Report
The Board of Directors and Stockholders
Netegrity, Inc.:
We have audited the accompanying consolidated balance sheets of Netegrity, Inc.
and subsidiaries as of December 31, 2003 and 2002, and the related consolidated
statements of operations, stockholders' equity and cash flows for the years then
ended. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits. The 2001 financial
statements were audited by other auditors who have ceased operations. Those
auditors expressed an unqualified opinion on those consolidated financial
statements, before the restatement described in Note 1 to the consolidated
financial statements, in their report dated January 30, 2002.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Netegrity, Inc. and
subsidiaries as of December 31, 2003 and 2002, and the results of their
operations and their cash flows for the years then ended in conformity with
accounting principles generally accepted in the United States of America.
As discussed above, the consolidated financial statements of Netegrity, Inc. and
subsidiaries as of December 31, 2001 and for the year then ended were audited by
other auditors who have ceased operations. As described in Note 1, those
financial statements have been restated. In our opinion, the adjustments are
appropriate and have been properly applied. However, we were not engaged to
audit, review or apply any procedures to the 2001 consolidated financial
statements of Netegrity, Inc. and subsidiaries other than with respect to such
adjustments and, accordingly, we do not express an opinion or any form of
assurance on the 2001 consolidated financial statements taken as a whole.
KPMG LLP
Boston, Massachusetts
January 26, 2004
38
THE FOLLOWING REPORT OF ARTHUR ANDERSEN LLP (ANDERSEN) IS A COPY OF THE REPORT
PREVIOUSLY ISSUED BY ANDERSEN ON JANUARY 30, 2002. THE REPORT OF ANDERSEN IS
INCLUDED IN THIS ANNUAL REPORT ON FORM 10-K PURSUANT TO RULE 2-02(E) OF
REGULATION S-X. AFTER REASONABLE EFFORTS THE COMPANY HAS NOT BEEN ABLE TO OBTAIN
A REISSUED REPORT FROM ANDERSEN. ANDERSEN HAS NOT CONSENTED TO THE INCLUSION OF
ITS REPORT IN THIS ANNUAL REPORT ON FORM 10-K. BECAUSE ANDERSEN HAS NOT
CONSENTED TO THE INCLUSION OF ITS REPORT IN THIS ANNUAL REPORT, IT MAY BE
DIFFICULT TO SEEK REMEDIES AGAINST ANDERSEN AND THE ABILITY TO SEEK RELIEF
AGAINST ANDERSEN MAY BE IMPAIRED.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
and Stockholders of Netegrity, Inc.:
We have audited the accompanying consolidated balance sheet of Netegrity,
Inc. (a Delaware corporation) and subsidiaries as of December 31, 2001, and the
related consolidated statement of operations, stockholders' equity and cash
flows for the year then ended. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Netegrity, Inc. and
subsidiaries as of December 31, 2001, and the results of their operations and
their cash flows for the year then ended, in conformity with accounting
principles generally accepted in the United States.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
January 30, 2002
39
NETEGRITY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
---------------------------
2003 2002
------------ ------------
(IN THOUSANDS, EXCEPT PER
SHARE DATA)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................................... $ 20,123 $ 25,707
Available-for-sale short-term marketable securities......................... 51,557 48,361
Accounts receivable -- trade, net of allowances of $829
at December 31, 2003; $922 at December 31, 2002.......................... 14,340 15,046
Prepaid expenses and other current assets................................... 2,513 2,949
Restricted cash............................................................. 538 281
------------ ------------
Total Current Assets..................................................... 89,071 92,344
Available-for-sale long-term marketable securities............................ 19,401 12,655
Property and equipment, net................................................... 4,848 6,837
Restricted cash............................................................... 767 790
Goodwill...................................................................... 34,503 --
Other intangible assets, net.................................................. 7,500 5,398
Other assets.................................................................. 1,134 338
------------ ------------
Total Assets............................................................. $ 157,224 $ 118,362
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable -- trade................................................... $ 1,415 $ 1,906
Accrued compensation and benefits........................................... 5,947 4,293
Other accrued expenses...................................................... 16,273 6,530
Deferred revenue............................................................ 18,503 14,875
------------ ------------
Total Current Liabilities................................................ 42,138 27,604
------------ ------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, voting, $.01 par value; 135,000 shares authorized;
37,577 shares issued and 37,539 shares
outstanding at December 31, 2003; 34,346 shares issued and 34,308 shares
outstanding at December 31, 2002............................................ 375 343
Additional paid-in capital.................................................... 226,019 197,250
Accumulated other comprehensive income (loss)................................. (137) 106
Accumulated deficit........................................................... (110,971) (106,741)
Loan to officer............................................................... (116) (116)
------------ ------------
115,170 90,842
Less -- Treasury Stock, at cost: 38 shares.................................... (84) (84)
------------ ------------
Total Stockholders' Equity.................................................... 115,086 90,758
------------ ------------
Total Liabilities and Stockholders' Equity.................................... $ 157,224 $ 118,362
============ ============
The accompanying notes are an integral part of the consolidated
financial statements.
40
NETEGRITY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31,
---------------------------------------
2003 2002 2001
----------- ----------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenues:
Software licenses................................. $ 44,030 $ 36,072 $ 55,314
Services.......................................... 31,536 30,158 29,199
Other............................................. 2,878 3,034 3,633
----------- ----------- ----------
Total revenues................................. 78,444 69,264 88,146
----------- ----------- ----------
Cost of revenues:
Cost of software licenses......................... 1,926 2,071 1,931
Non-cash cost of software licenses................ 5,398 5,449 153
Cost of services.................................. 11,385 13,664 15,113
Cost of other..................................... 1,841 1,827 2,221
----------- ----------- ----------
Total cost of revenues......................... 20,550 23,011 19,418
----------- ----------- ----------
Gross profit........................................ 57,894 46,253 68,728
Selling, general and administrative expenses........ 43,947 52,755 51,989
Research and development costs...................... 20,297 22,701 15,791
Gain on sale of portal technology................... (4,959) -- --
Impairment charge................................... -- 57,374 --
Acquired in-process research and development........ 3,800 -- 3,000
Restructuring and other non-recurring charges....... 459 2,080 529
----------- ----------- ----------
Loss from operations................................ (5,650) (88,657) (2,581)
Other income, net................................... 1,791 2,418 4,831
----------- ----------- ----------
Income (loss) before provision for income taxes..... (3,859) (86,239) 2,250
Provision for income taxes.......................... 371 70 607
----------- ----------- ----------
Net income (loss)................................... $ (4,230) $ (86,309) $ 1,643
=========== =========== ==========
Earnings (loss) per share:
Basic and diluted................................. $ (0.12) $ (2.53) $ 0.05
Weighted average shares outstanding:
Basic............................................. 34,559 34,078 31,076
Diluted........................................... 34,559 34,078 32,936
The accompanying notes are an integral part of the consolidated
financial statements.
41
NETEGRITY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
ACCUMULATED
OTHER
ADDITIONAL COMPREHENSIVE
COMMON PAID-IN INCOME ACCUMULATED
STOCK CAPITAL (LOSS) DEFICIT
--------- ---------- ------------- ------------
(IN THOUSANDS)
BALANCE AT DECEMBER 31,
2000 ................................. 302 139,886 -- (22,075)
Comprehensive income, net of taxes:
Net income ........................... -- -- -- 1,643
Other comprehensive loss--
translation adjustment ............. -- -- (44) --
Total comprehensive income ........... -- -- -- --
Issuance of common stock for
acquisition (2,500 shares) ........... 25 49,674 -- --
Issuance of common stock under stock
plans (1,114 shares).................. 12 6,909 -- --
Issuance of warrants ................... -- 23 -- --
--------- --------- ------------- ------------
BALANCE AT DECEMBER 31,
2001 ................................. $ 339 $ 196,492 $ (44) $ (20,432)
Comprehensive loss, net of taxes:
Net loss ............................. -- -- -- (86,309)
Other comprehensive income ........... -- -- 150 --
Total comprehensive loss ............. -- -- -- --
Issuance of common stock under stock
plans (476 shares) .................. 4 758 -- --
Repayment of loan to officer ........... -- -- -- --
--------- --------- ------------- ------------
BALANCE AT DECEMBER 31,
2002 ................................. $ 343 $ 197,250 $ 106 $ (106,741)
Comprehensive loss, net of taxes:
Net loss ............................. -- -- -- (4,230)
Other comprehensive loss ............. -- -- (243) --
Total comprehensive loss ............. -- -- -- --
Issuance of common stock for employee
stock purchase plans and stock options
(675 shares) .......................... 6 2,203 -- --
Issuance of common stock for
acquisition (2,557 shares) ............ 26 26,566 -- --
Repayment of loan to officer ........... -- -- -- --
--------- --------- ------------- ------------
BALANCE AT DECEMBER 31,
2003 ................................. $ 375 $ 226,019 $ (137) $ (110,971)
========= ========= ============= ============
LOAN TOTAL
TO TREASURY STOCKHOLDERS'
OFFICER STOCK EQUITY
--------- --------- -------------
(IN THOUSANDS)
BALANCE AT DECEMBER 31,
2000 ................................. (130) (84) 117,899
Comprehensive income, net of taxes:
Net income ........................... -- -- 1,643
Other comprehensive loss--
translation adjustment ............. -- -- (44)
------------
Total comprehensive income ........... -- -- 1,599
------------
Issuance of common stock for
acquisition (2,500 shares) ........... -- -- 49,699
Issuance of common stock under stock
plans (1,114 shares) ................ -- -- 6,921
Issuance of warrants ................... -- -- 23
--------- --------- ------------
BALANCE AT DECEMBER 31,
2001 ................................. $ (130) $ (84) $ 176,141
Comprehensive loss, net of taxes:
Net loss ............................. -- -- (86,309)
Other comprehensive income ........... -- -- 150
------------
Total comprehensive loss ............. -- -- (86,159)
------------
Issuance of common stock under stock
plans (476 shares) .................. -- -- 762
Repayment of loan to officer ........... 14 -- 14
--------- --------- ------------
BALANCE AT DECEMBER 31,
2002 ................................. $ (116) $ (84) $ 90,758
Comprehensive loss, net of taxes:
Net loss ............................. -- -- (4,230)
Other comprehensive loss ............. -- -- (243)
------------
Total comprehensive loss ............. -- -- (4,473)
Issuance of common stock for employee
stock purchase plans and stock options
(675 shares) .......................... -- -- 2,209
Issuance of common stock for
acquisition (2,557 shares) ............ -- -- 26,592
Repayment of loan to officer ........... -- -- --
--------- --------- ------------
BALANCE AT DECEMBER 31,
2003 ................................. $ (116) $ (84) $ 115,086
========= ========= ============
The accompanying notes are an integral part of the consolidated
financial statements.
42
NETEGRITY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
-------------------------------------------
2003 2002 2001
------------ ------------ ------------
(IN THOUSANDS)
OPERATING ACTIVITIES:
Net income (loss).............................................. $ (4,230) $ (86,309) $ 1,643
Adjustments to reconcile net income (loss) to net cash
provided by (used for) operating activities:
Depreciation and amortization charges........................ 9,691 10,157 2,906
Impairment charge............................................ -- 57,374 --
Provision (recoveries) for doubtful accounts
receivable................................................ 652 (132) 2,573
Gain on sale of portal technology............................ (4,959) -- --
Acquired in-process research and development................. 3,800 -- 3,000
Loss on disposal of property and equipment................... 362 -- --
Other........................................................ 858 282 291
Changes in operating assets and liabilities, net of effects of
acquisition:
Accounts receivable -- trade................................. 1,463 1,208 (2,601)
Prepaid expenses and other current assets.................... 330 153 (1,058)
Other assets................................................. 622 318 (140)
Accounts payable -- trade.................................... (1,178) 200 (820)
Accrued compensation and benefits............................ 727 (859) (3,290)
Other accrued expenses....................................... (334) (3,539) 2,337
Deferred revenue............................................. 2,539 1,652 3,490
------------ ------------ ------------
Net cash provided by (used for) operating activities........... 10,343 (19,495) 8,331
------------ ------------ ------------
INVESTING ACTIVITIES:
Proceeds from sales of marketable securities................... 42,267 60,868 30,680
Proceeds from maturities of marketable securities.............. 25,170 120,619 160,610
Purchases of marketable securities............................. (78,504) (162,868) (271,315)
Purchases of property and equipment............................ (2,392) (3,052) (4,598)
Cash proceeds from sale of portal technology................... 4,877 -- --
Cash used for acquisition, net of cash acquired................ (9,881) -- (17,518)
Increase (decrease) in restricted cash......................... 303 (440) 311
------------ ------------ ------------
Net cash (used for) provided by investing activities........... (18,160) 15,127 (101,830)
------------- ------------ ------------
FINANCING ACTIVITIES:
Net proceeds from issuance of common stock under stock plans... 2,209 762 6,921
Repayment of loan to officer and other principal payments
under capital leases......................................... -- 14 172
------------ ------------ ------------
Net cash provided by financing activities...................... 2,209 776 7,093
------------ ------------ ------------
Effect of exchange rate changes on cash and cash
equivalents.................................................. 24 (33) (9)
Net change in cash and cash equivalents........................ (5,584) (3,625) (86,415)
Cash and cash equivalents at beginning of year................. 25,707 29,332 115,747
------------ ------------ ------------
Cash and cash equivalents at end of year....................... $ 20,123 $ 25,707 $ 29,332
============ ============ ============
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING
ACTIVITIES:
Acquisitions:
Fair value of assets acquired.................................. $ 42,003 $ -- $ 67,196
In-process research and development............................ 3,800 -- 3,000
Less:
Cash paid, net of cash acquired.............................. 9,881 -- 16,087
Fair value of stock issued................................... 26,592 -- 49,699
Accrued acquisition costs.................................... 920 -- 2,970
------------ ------------ ------------
Liabilities assumed (including remaining cash to be paid)...... $ 8,410 $ -- $ 1,440
============ ============ ============
The accompanying notes are an integral part of the consolidated
financial statements.
43
NETEGRITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: NATURE OF THE BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
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, or IAM, product line gives companies a secure
way to make corporate information assets and resources available online. We
believe open, protected access is essential as companies seek to utilize 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 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 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.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements of the Company also include the
accounts and operations of its wholly-owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in consolidation.
REVENUE RECOGNITION
Our revenues are primarily generated from the sale of perpetual licenses for
our proprietary SiteMinder, IdentityMinder Web Edition, IdentityMinder
eProvision 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 (for example, 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.
At the time of the transaction, we assess whether the fee associated with
the transaction is fixed or determinable based on the
44
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.
CASH AND CASH EQUIVALENTS AND STATEMENT OF CASH FLOWS SUPPLEMENTAL INFORMATION
Cash and cash equivalents include cash, money market investments and other
highly liquid investments with original maturities of three months or less.
Net cash used for operating activities reflect cash payments for income
taxes of approximately $233,000, $57,000 and $125,000 for the years ended
December 31, 2003, 2002 and 2001, respectively.
RESTRICTED CASH
Restricted cash represents time deposits held at financial institutions in
connection with the Company's lease of office space and in connection with a
line of credit previously held by Business Layers. Prior to the acquisition,
Business Layers paid off a line of credit with a financial institution and as of
December 31, 2003, restricted cash of approximately $538,000 held as collateral
for this line of credit was not released until February 2004. The restricted
cash held in connection with the lease of the Company's office space had an
expiration date of February 2004, however it has an automatic renewal clause.
MARKETABLE SECURITIES
Investments, which primarily consist of debt securities, are accounted for
under Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting
for Certain Investments in Debt and Equity Securities" issued by the Financial
Accounting Standards Board (FASB). Pursuant to the provisions of SFAS No. 115,
the Company has classified its investment portfolio as "trading",
"available-for-sale" or "held to maturity". "Trading" securities are bought and
held principally for the purpose of selling them in the near term and are
recorded at fair value. Fair value is based upon quoted market prices.
Unrealized gains and losses on trading securities are included in the
determination of net income (loss). "Available-for-sale" securities include debt
securities that are being held for an unspecified period of time and may be used
for liquidity or other corporate purposes and are recorded at fair value.
Unrealized gains and losses on available-for-sale securities are reported as a
separate component of accumulated other comprehensive income (loss) in
stockholders' equity, net of related taxes. "Held to maturity" securities are
debt securities that the Company intends to hold to maturity and are recorded at
amortized cost. See Note 4 for further information on the Company's marketable
securities.
OFF-BALANCE-SHEET AND CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to concentrations
of credit risk consist primarily of cash equivalents, marketable securities and
accounts receivable -- trade. The Company has no significant off-balance-sheet
risk such as foreign exchange contracts, option contracts or other foreign
hedging arrangements. Cash and cash equivalents are held with high quality
financial institutions. Marketable securities are primarily held in high quality
corporate debt instruments and government obligations. Concentration of credit
risk with respect to accounts receivable -- trade is limited due to a large
customer base. The Company periodically performs credit evaluations of its
customers and maintains reserves for potential losses. One customer accounted
for approximately 13% of accounts receivable as of December 31, 2003. No other
customer accounted for more than 10% of accounts receivable as of December 31,
2003. One customer accounted for approximately 24% of accounts receivable as of
December 31, 2002. No other customer accounted for more than 10% of accounts
receivable as of December 31, 2002. No one customer accounted for more than 10%
of revenue for each of the three years ended December 31, 2003.
45
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, less accumulated depreciation and
amortization. Depreciation and amortization is provided using the straight-line
method, based upon the following asset lives:
Computer equipment and purchased software........ 3-5 years
Furniture and office equipment................... 5-7 years
Leasehold improvements........................... Shorter of lease term or useful life of asset
Maintenance and repairs are charged to operations as incurred. Renewals and
betterments which materially extend the life of assets are capitalized and
depreciated. Upon disposal, the asset cost and related accumulated depreciation
are removed from their respective accounts and any resulting gain or loss is
reflected in earnings.
ACCOUNTING FOR IMPAIRMENT OF LONG-LIVED ASSETS
The Company follows the provisions of SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." This statement requires that
long-lived assets and certain identifiable intangibles be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset
to undiscounted future net cash flows expected to be generated by the asset. If
such assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceeds the
fair value of the assets. Assets to be disposed of are reported at the lower of
the carrying amount or fair value less cost to sell.
OTHER INTANGIBLE ASSETS, NET
The Company accounts for purchased technology and software development costs
in accordance with SFAS No. 86, "Accounting for the Costs of Computer Software
to Be Sold, Leased, or Otherwise Marketed". Under SFAS No. 86, the Company is
required to test for recoverability of its capitalized software costs as of each
balance sheet date or an interim period if events and circumstances indicate
that the carrying amount may not be recoverable. Impairment is recorded as the
excess of the unamortized cost over the expected future net realizable value of
the products.
Software development costs subsequent to the establishment of technological
feasibility are capitalized and amortized to non-cash cost of software. Based on
the Company's product development process, technological feasibility is
established upon completion of all planning, designing, coding and testing
activities. Such costs are amortized over the estimated life of the product.
During 2003, 2002 and 2001, costs incurred by the Company between completion of
all planning, designing, coding and testing activities and the point at which
the product is ready for general release were insignificant and, therefore, no
such costs have been capitalized during this time period.
GOODWILL
The Company reviews 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.
46
OTHER ACCRUED EXPENSES
Other accrued expenses consisted of the following (in thousands):
DECEMBER 31,
---------------------
2003 2002
--------- ---------
Acquisition related payments........... $ 5,234 $ --
Accrued severance related costs........ 888 --
Accrued loss contracts................. 1,162 --
Accrued acquisition costs.............. 880 --
Acquisition related lease obligations.. 704 1,053
Accrued sales taxes.................... 788 1,486
Accrued legal and accounting........... 819 448
Accrued professional fees.............. 552 --
Accrued income taxes................... 265 353
Other.................................. 4,981 3,190
--------- ---------
$ 16,273 $ 6,530
========= =========
COMPREHENSIVE INCOME
Comprehensive income (loss) is defined as the change in equity of a business
enterprise during a period from transactions and other events and circumstances
from non-owner sources, including foreign currency translation adjustments and
unrealized gains and losses on marketable securities held as "available-for-
sale". The components of comprehensive income (loss) were as follows (in
thousands):
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------
2003 2002 2001
---------- ---------- ---------
Net income (loss)..................................... $ (4,230) $ (86,309) $ 1,643
Net unrealized holding gain (loss) arising during
the period.......................................... (197) 180 --
Reclassification adjustment for net realized gains
included in net loss................................ (68) (3) --
---------- ---------- ---------
(265) 177 --
Net unrealized foreign currency translation
adjustment arising during the period................ 22 (27) (44)
---------- ---------- ---------
Comprehensive income (loss)........................... $ (4,473) $ (86,159) $ 1,599
========== ========== =========
The components of accumulated other comprehensive income (loss) as of
December 31, 2003 and 2002 were as follows (in thousands):
DECEMBER 31,
----------------------
2003 2002
------ ------
Net unrealized holding gain (loss)....................... $ (88) $ 178
Net unrealized foreign currency translation adjustment... (49) (72)
------ ------
Accumulated other comprehensive income (loss)........... $ (137) $ 106
====== ======
RESEARCH AND DEVELOPMENT
Research and development expenditures are charged to operations as incurred.
INCOME TAXES
The Company accounts for income taxes using the asset and liability method
in accordance with SFAS No. 109, "Accounting for Income Taxes", pursuant to
which deferred income taxes are recognized based on temporary differences
between the financial statement and tax bases of assets and liabilities using
enacted tax rates in effect for the year in which the temporary differences are
expected to reverse. Valuation allowances are provided if based upon the weight
of available evidence, it is more likely than not that some or all of the
deferred tax assets will not be realized.
47
EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share (EPS) is calculated by dividing net income
(loss) by the weighted average number of shares outstanding during the period.
Diluted EPS is calculated by dividing net income by the weighted average number
of shares outstanding plus the dilutive effect, if any, of outstanding stock
options and warrants using the "treasury stock" method. During periods of net
loss, diluted net loss per share does not differ from basic net loss per share
since potential common shares from stock options and warrants are anti-dilutive
and therefore are excluded from the calculation. The following table presents
the calculation for both basic and diluted EPS (in thousands, except per share
data):
YEAR ENDED
--------------------------------------
2003 2002 2001
----------- ---------- ----------
Net income (loss)............................... $ (4,230) $ (86,309) $ 1,643
Basic weighted average shares outstanding....... 34,559 34,078 31,076
Dilutive effect of stock options and warrants... -- -- 1,860
Diluted shares outstanding...................... 34,559 34,078 32,936
Basic and diluted EPS........................... $ (0.12) $ (2.53) $ 0.05
Options to purchase a total of 409,000, 772,000 and 1.3 million shares for
the years ended December 31, 2003, 2002 and 2001, respectively, were excluded
from the computation of diluted EPS because the impact was anti-dilutive.
STOCK-BASED COMPENSATION
The Company accounts for its stock option plans under the recognition and
measurement principles of APB Opinion No. 25, Accounting for Stock Issued to
Employees, and related Interpretations. No stock-based compensation cost is
reflected in net income (loss) for these plans, as all options granted under
these plans had an exercise price equal to the market value of the underlying
common stock on the date of grant. The following table illustrates the effect on
net income (loss) and earnings (loss) per share if the Company had applied the
fair value recognition provisions of FASB Statement No. 123, Accounting for
Stock Based Compensation, to stock based compensation.
YEAR ENDED DECEMBER 31,
--------------------------------------
2003 2002 2001
----------- ---------- ----------
Net income (loss), as reported...................... $ (4,230) $ (86,309) $ 1,643
Add: Stock-based employee compensation expense
included in reported net income, net of related
tax effects....................................... (9,377) (86,431) (95,688)
----------- ---------- ----------
Pro-forma net (loss)................................ $ (13,607) $ (172,740) $ (94,045)
=========== ========== ==========
Earnings (loss) per share:
Basic and diluted -- as reported.................. $ (0.12) $ (2.53) $ 0.05
Basic and diluted -- pro-forma.................... $ (0.39) $ (5.07) $ (3.03)
The fair value of each stock option is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions:
YEAR ENDED DECEMBER 31,
----------------------
2003 2002 2001
----------------------------- ----------------- -----------------------------
STOCK STOCK STOCK
OPTIONS ESPP1 ESPP2 OPTIONS ESPP OPTIONS ESPP1 ESPP 2
------- ------- ------- ------- ------- ------- ------- -------
Risk-free interest rate ........... 2.89% 1.11% 1.04% 2.95% 1.65% 5.39% 2.71% 4.44%
Expected dividend yield ........... 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Expected volatility ............... 121% 99% 64% 140% 106% 126% 131% 143%
Expected life (years) ............. 5.0 0.5 0.5 5.0 0.4 4.0 0.6 0.6
The pro-forma net loss for the years ended December 31, 2002 and 2001
includes the effects of options that were canceled by the Company in connection
with the tender offers described in Note 10 to the consolidated financial
statements. The remaining unamortized pro-forma compensation expense at the date
of cancellation for these options in the amount of approximately $51.9 million
and $63.0 million, respectively, is reflected as an expense in these pro-forma
amounts.
48
FOREIGN CURRENCY
The functional currencies of the Company's wholly-owned subsidiaries are the
local currencies. The financial statements of the subsidiaries are translated to
U.S. dollars using period-end exchange rates for assets and liabilities and
average exchange rates during the corresponding period for revenues, cost of
revenues and expenses. Translation gains and losses (amounting to a loss of
approximately $(49,000) as of December 31, 2003) are deferred and accumulated as
a separate component of stockholders' equity (accumulated other comprehensive
income (loss)). Net gains and losses resulting from foreign exchange
transactions, amounting to a gain of approximately $341,000, $16,000 and
$325,000 for the years ended December 31, 2003, 2002 and 2001, respectively, are
included in other income, net in the accompanying consolidated statements of
operations.
EXPORT SALES
The Company generates revenues from international business. Export sales
amounted to approximately $17.9 million, or 23%, $14.8 million, or 21%, and
$17.9 million, or 20%, of total revenue for the years ended December 31, 2003,
2002 and 2001, respectively.
401(k) PLAN
The Company maintains a 401(k) Plan for its employees, which is intended to
be a retirement and tax deferred savings vehicle. The Company may make
discretionary contributions to the plan. The Company has made no contributions
to date.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
RESTATEMENT ADJUSTMENTS
The Company has recorded certain restatement adjustments to its previously
issued 2001 consolidated financial statements. The Company adopted EITF 01-14
effective January 1, 2002 and as a result, reclassified approximately $1.6
million into revenues from reduction of cost of revenues for the year ended
December 31, 2001, to comply with this guidance. Additionally, the Company has
restated the previously reported 2001 pro-forma impact of the fair value
recognition provisions of SFAS No. 123 to properly reflect pro-forma expense
associated with its employee stock purchase plans. The adjustment reflects
additional pro-forma expense of approximately $364,000 and a pro-forma basic and
diluted loss per share of ($3.03) in 2001.
NEW ACCOUNTING PRONOUNCEMENTS
In November 2003, the Emerging Issues Task Force (EITF) of the Financial
Accounting Standards Board (FASB) reached a consensus on certain disclosure
provisions under Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment
and Its Application to Certain Investments." The disclosure provisions indicate
that certain quantitative and qualitative disclosures are required for debt and
marketable equity securities classified as available-for-sale or
held-to-maturity under SFAS Nos. 115 and 124 that are impaired at the balance
sheet date but for which an other-than-temporary impairment has not been
recognized. The EITF has not reached a consensus on the proposed models for
evaluating impairment of equity securities and debt securities. The consensus on
the required quantitative and qualitative disclosures is effective for fiscal
years ending after December 15, 2003. The adoption of the disclosure provisions
of this Issue during the fourth quarter of 2003 did not have a material impact
on the Company's financial position or results of operations.
NOTE 2: RESTRUCTURING AND OTHER NON-RECURRING CHARGES
The Company recorded restructuring and other non-recurring expenses of
$459,000, $2.1 million and $529,000 for the years ended December 31, 2003, 2002
and 2001, respectively. These expenses are associated with the Company's
restructuring plans and other non-recurring expenses.
49
During 2003, pursuant to the terms of an asset purchase agreement dated
October 10, 2003, the Company sold certain assets and liabilities related to its
portal technology. In conjunction with this sale, the Company closed its
facility located in Bellevue, Washington and consolidated its research and
development operations in Waltham. As a result of these transactions, the
Company recorded restructuring charges of $459,000, which related primarily to
severance payments, costs associated with the closing of the office in Bellevue
and the write-off of certain property and equipment, during the year ended
December 31, 2003. All costs associated with this restructuring were paid as of
December 31, 2003.
During 2002, the Company, as a result of changing market dynamics and
economic factors, reduced its workforce by 32% through restructurings. 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 the
Company's decision to stop developing, marketing or selling its portal product
on a stand-alone basis. As a result of the 2002 restructurings, the Company
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. Approximately $1.3 million was paid as of
December 31, 2002, and the remainder was paid during 2003.
During 2001, the Company reduced its workforce by approximately 8% in order
to reduce expenses and realign its cost structure. The reduction in workforce
was 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.
Approximately $275,000 was paid as of December 31, 2001 and the remainder was
paid during 2002.
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.
The following table summarizes the restructuring activity from December 31,
2001 to December 31, 2003 (in thousands):
EMPLOYEE
RELATED CONTRACTUAL ASSET
EXPENSES OBLIGATIONS IMPAIRMENTS TOTAL
-------- ----------- ----------- -----
Restructuring reserve as of December 31, 2001......... $ 28 $ -- $ -- $ 28
Q2 2002 Restructuring................................. 612 77 -- 689
Q4 2002 Restructuring................................. 1,391 -- -- 1,391
Cash charges.......................................... (1,251) (77) -- (1,328)
Restructuring reserve as of December 31, 2002......... 780 -- -- 780
Q4 2003 Restructuring................................. 43 144 272 459
Non cash charges...................................... -- -- (272) (272)
Cash charges.......................................... (823) (144) -- (967)
------------- ------------- ------------- -------------
Restructuring reserve as of December 31, 2003......... $ -- $ -- $ -- $ --
============= ============= ============= =============
NOTE 3: ACQUISITIONS
BUSINESS LAYERS
On December 30, 2003, the Company acquired all of the outstanding stock of
Business Layers, Inc., a Delaware corporation (Business Layers). Business Layers
is a provider of resource provisioning solutions. In conjunction with the
acquisition, Business Layers became a wholly-owned subsidiary of the Company.
The aggregate consideration of $42.5 million included approximately $15.0
million in cash, $920,000 in acquisition costs and 2,556,940 shares of the
Company's common stock valued at approximately $26.6 million. A portion of the
purchase price consideration, comprised of approximately 358,000 shares of
Netegrity common stock and approximately $400,000 of cash, has been placed in
escrow for up to one year from the acquisition date to secure the
indemnification obligations of certain former employees and the shareholders of
Business Layers under the merger agreement. The acquisition was accounted for
using the purchase method of accounting. The results of operations of Business
Layers from the acquisition date are included in the Company's consolidated
results of operations.
In connection with the acquisition, the Company initiated an overall
integration plan that included the elimination of redundant
50
headcount and facilities. The Company accrued approximately $1.4 million of
costs related to the integration plan consisting of approximately $545,000 of
facilities costs and $888,000 for planned workforce reductions consisting
primarily of duplicative selling, general and administrative employees. None of
these costs were paid as of December 31, 2003. The Company expects the majority
of these costs to be paid prior to March 31, 2004, although the facilities costs
will not be paid in full until April 2006.
The Company engaged a third party appraiser to conduct a valuation of the
intangible assets and to assist in the determination of useful lives for such
assets. Based on the appraisal, approximately $7.5 million of the purchase price
has been allocated to developed technology and $3.8 million has been allocated
to in-process research and development, which was expensed upon closing of the
transaction. Due to the non-recurring nature of the in-process research and
development charge, the amount has not been included in the unaudited pro forma
statements of operations below. The amount allocated to developed technology is
expected to be amortized over its estimated useful life ranging from two to five
years.
The valuation of in-process research and development was determined using
the income method. Revenue and expense projections for the in-process research
and development project were prepared by management. The value was determined
using the present value of the cash flows from the projections using a 30%
discount rate. The technologies under development were approximately 60%
complete based on project duration and costs. 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.
The total goodwill of approximately $34.5 million related to the acquisition
will not be amortized in accordance with SFAS No. 142. In lieu of being
amortized, goodwill is required to be tested for impairment annually or on an
interim basis if an event or circumstance indicates that it is more likely than
not that an impairment loss has been incurred.
DATACHANNEL
On December 14, 2001, the Company acquired all of the outstanding stock of
DataChannel, Inc., a Washington corporation (DataChannel) and a provider of
enterprise portal solutions, and DataChannel became a wholly-owned subsidiary of
the Company. The aggregate consideration included approximately $17.5 million in
cash (including assumed debt of approximately $1.4 million), $3.0 million in
acquisition costs and 2,499,968 shares of the Company's common stock valued at
approximately $49.7 million. The acquisition was accounted for using the
purchase method of accounting. The results of operations of DataChannel from the
acquisition date are included in the Company's consolidated results of
operations.
The Company initially amortized the acquired existing technology of
approximately $11.0 million over an estimated remaining useful life of three
years. This technology was embedded in the initial version of one of the
Company's products that was released in the fourth quarter of 2002. During the
fourth quarter of 2002, the Company made the decision to remove the acquired
technology from its products. As a result of this decision, it was determined
that there had been a change in the estimated useful life of the acquired
technology and therefore it was appropriate to amortize the associated expense
over a nine month period starting at the beginning of the fourth quarter of 2002
(the period during which the change in estimated life was identified) through
June 30, 2003. Amortization expense related to the purchased technology was $5.4
million for each of the years ended December 31, 2003 and 2002 and $153,000 for
the year ended December 31, 2001, and was classified as non-cash cost of
software licenses in the accompanying consolidated statements of operations.
In accordance with SFAS No. 142, the total goodwill of approximately $57.4
million related to the acquisition was not amortized. During the first quarter
of 2002, the Company performed a transitional impairment test on goodwill and
concluded that there was no impairment as of January 1, 2002. During the third
quarter of 2002, the Company determined that a significant decline in its 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 impairment review in accordance with SFAS No.
142. As a result, the Company 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 the
Company operates 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, the Company
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. The Company recorded a
charge of $57.4 million in the third quarter of 2002, classified as impairment
charge in the accompanying consolidated statements of operations, to write down
goodwill to its implied fair value of zero.
51
The purchase prices for the acquisitions were allocated as follows (in
thousands):
NET IN-PROCESS
SHARES CONSIDERATION TRANSACTION LIABILITIES RESEARCH AND CAPITALIZED
ISSUED PAID COSTS ASSUMED DEVELOPMENT GOODWILL SOFTWARE
------ ---- ----- ------- ----------- -------- --------
2003:
Business Layers, Inc............ 2,557 $ 41,592 $ 920 $ (3,291) $ 3,800 $ 34,503 $ 7,500
2001:
DataChannel, Inc................ 2,500 67,200 3,000 (1,173) 3,000 57,373 11,000
PRO-FORMA INFORMATION
The following unaudited pro-forma financial information for 2003 presents
the combined results of operations of the Company and Business Layers as if the
acquisition of Business Layers occurred on January 1, 2003, after giving effect
to certain adjustments, (including the elimination of revenue and cost of
revenue associated transactions between the Company and Business Layers under an
OEM agreement, amortization expense and interest income). The results of
operations of the Company for 2002 include the results of Business Layers as if
the acquisition had occurred on January 1, 2002 and the results of DataChannel
for the full year since that acquisition was consummated in 2001. Due to the
non-recurring nature of the in-process research and development charge from the
Business Layers acquisition, the amount has not been included in the unaudited
pro-forma financial information. However the 2003 results from operations do
include the $5.0 million gain on the sale of the portal technology. The
unaudited pro-forma financial information does not necessarily reflect the
results of operations that would have occurred had the acquisition been
completed as of the dates indicated or of the results that may be obtained in
the future (in thousands except per share data).
YEAR ENDED DECEMBER 31,
------------------------
2003 2002
---------- ----------
Revenues.............................................. $ 85,008 $ 77,532
Net loss.............................................. $ (13,768) $ (102,902)
Net loss per basic and fully diluted common share..... $ (0.37) $ (2.81)
NOTE 4: MARKETABLE SECURITIES
As of December 31, 2003 and 2002, based on management's intentions, all
marketable securities have been classified as "available-for-sale" and consist
of the following (in thousands):
DECEMBER 31, 2003
-----------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
---------- ---------- ---------- ----------
Municipal securities..................... $ 23,300 $ 2 $ (1) $ 23,301
Corporate bonds and notes................ 37,040 44 (40) 37,044
Asset backed corporate debt securities... 10,597 26 (10) 10,613
---------- ---------- ---------- ----------
$ 70,937 $ 72 $ (51) $ 70,958
========== ========== ========== ==========
DECEMBER 31, 2002
-----------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
---------- ---------- ---------- ----------
Municipal securities..................... $ 25,180 $ 11 $ -- $ 25,191
Corporate bonds and notes................ 25,165 197 (20) 25,342
Asset backed corporate debt securities... 10,386 98 (1) 10,483
---------- ---------- ---------- ----------
$ 60,731 $ 306 $ (21) $ 61,016
========== ========== ========== ==========
The total carrying value of all marketable securities as of December 31,
2003 includes approximately $19.4 million that mature in 2004 through 2006 and
were therefore classified as long term.
52
The total carrying value of all marketable securities as of December 31,
2002 includes approximately $12.7 million that mature in 2003 through 2005 and
were therefore classified as long-term.
Gross realized gains from the sales and maturities of marketable securities
amounted to $68,000, $16,000 and $1.1 million for the years ended December 31,
2003, 2002 and 2001, respectively. Gross realized losses from the sales and
maturities of marketable securities amounted to $0, $13,000 and $825,000 for the
years ended December 31, 2003, 2002, and 2001, respectively. These realized
gains and losses are included in other income, net in the accompanying
consolidated statements of operations. The net unrealized holding gain (loss) of
approximately ($88,000) and $178,000 has been included in "Accumulated other
comprehensive income (loss)" on the consolidated balance sheets at December 31,
2003 and 2002, respectively.
NOTE 5: PROPERTY AND EQUIPMENT, NET
Property and equipment are stated at acquisition cost and consisted of the
following (in thousands):
DECEMBER 31,
-----------------------
2003 2002
---------- ----------
Computer equipment and purchased software........ $ 13,737 $ 12,875
Leasehold improvements........................... 1,395 1,504
Furniture and office equipment................... 1,463 1,677
---------- ----------
16,595 16,056
Less accumulated depreciation.................... (11,747) (9,219)
---------- ----------
$ 4,848 $ 6,837
========== ==========
Depreciation expense for the years ended December 31, 2003, 2002 and 2001
was $4.3 million, $4.7 million and $2.8 million, respectively.
NOTE 6: COMMITMENTS AND CONTINGENCIES
The Company has commitments that expire at various times through 2010.
Non-cancelable operating leases shown below are primarily for facility costs for
the Company's corporate headquarters and world-wide sales offices (in
thousands).
YEARS ENDED DECEMBER 31,
------------------------
2004....................... $ 2,421
2005....................... 1,925
2006....................... 1,791
2007....................... 1,750
2008....................... 1,107
Thereafter................. 263
----------
$ 9,257
==========
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,
$4.9 million and $3.7 million for the years ended December 31, 2003, 2002 and
2001, respectively.
In April 2002, we entered into an agreement with a system integrator to
assist us in the development and launch of one of our products. Under the terms
of the agreement, for consideration of the system integrator's time in assisting
with the development of the product, we agreed to promote the system integrator
as an integrator of the developed product. Our obligation under the agreement
will be considered satisfied once the system integrator receives consulting
revenues totaling approximately $3.9 million from our customers, or by April
2004, whichever occurs first. In the event that we recommend a competitor of the
system integrator to perform the integration work for a customer, we could
potentially owe a royalty to the system integrator based on the net license fee.
As of December 31, 2003, no royalties were due under this agreement to the
system integrator.
In August 2002, we entered into a five year non-cancelable operating lease
for an office building for our corporate headquarters. We moved into the new
facility in March 2003. In connection with the lease agreement, we delivered an
irrevocable, unconditional, negotiable letter of credit in the amount of
$767,000 as a security deposit. Additionally, we spent $1.0 million in leasehold
improvements to build out the new facility.
53
In December 2003, we acquired Business Layers, Inc. for 2,556,940 shares of
our common stock, cash payments of $15.0 million and estimated transaction costs
of $1.0 million. As of December 31, 2003, approximately $10.8 million of the
cash payment had been made. The remaining $4.2 million of the cash payment and
$1.0 million of transaction costs are expected to be paid by March 31, 2004.
We enter into standard indemnification agreements with our business
partners or customers in our ordinary course of business. Pursuant to these
agreements, we agree to repair or replace the product, pay royalties for a right
to use, or reimburse the indemnified party for actual damages awarded by a court
against the indemnified party for a intellectual property infringement claim by
a third party with respect to our products. The term of these indemnification
agreements is generally perpetual. The maximum potential amount of future
payments we could be required to make under these indemnification agreements is
unlimited. We have never incurred costs to defend lawsuits or settle claims
related to these indemnification agreements. As a result, we believe the
estimated fair value of these agreements is minimal. Accordingly, we have no
liabilities recorded for these agreements as of December 31, 2003.
We enter into standard indemnification agreements with our customers,
whereby we indemnify them for certain damages, such as personal property damage,
which may be caused in connection with consulting services performed at a
customer location by our employees or our subcontractors. The maximum potential
amount of future payments we could be required to make under these
indemnification agreements is unlimited. However, we have general and umbrella
insurance policies that enable us to recover a portion of any amounts paid. We
have never incurred costs to defend lawsuits or settle claims related to these
indemnification agreements. As a result, we believe the estimated fair value of
these agreements is minimal. Accordingly, we have no liabilities recorded for
these agreements as of December 31, 2003.
We generally warrant for ninety days from delivery to a customer that our
software products will perform free from material errors which prevent
performance in accordance with user documentation. Additionally, we warrant that
our consulting services will be performed consistent with generally accepted
industry standards. We have never incurred significant expense under our product
or service warranties. As a result, we believe the estimated fair value of these
agreements is minimal. Accordingly, we have no liabilities recorded for these
agreements as of December 31, 2003.
We have entered into employment and executive retention agreements with
certain employees and executive officers which, among other things, include
certain severance and change of control provisions. We have also entered into
agreements whereby we indemnify our officers and directors for certain events or
occurrences while the officer or director is, or was, serving at our request in
such capacity.
From time to time, we are involved in litigation relating to claims arising
out of our operations in the normal course of business. We are not presently a
party to any legal proceedings, the adverse outcome of which, in our opinion,
would have a material adverse effect on our results of operations or financial
position.
NOTE 7: RELATED PARTY TRANSACTIONS
LOAN TO OFFICER
The consolidated balance sheets as of December 31, 2003 and 2002 include
$116,000 in loans to an officer of the Company, issued in connection with the
exercise of stock options in 1996. The loan is reflected as a reduction of
stockholders' equity in the accompanying consolidated balance sheets. The loan
is payable upon demand and bears interest at 7% per year. The loan was
originally represented by a secured note. However, in May 2002, the note was
amended such that it became a full recourse unsecured note. In January 2004,
$25,000 was paid on this loan. In accordance with the terms of the note, $9,000
was applied to interest owed and $16,000 was applied to reduce the balance of
the note.
MARKETING SERVICES
During the years ended December 31, 2003, 2002 and 2001, we paid
approximately $109,000, $125,000 and $68,000, respectively, to a company for
marketing services. The principal shareholder of such company is the son-in-law
of one of the members of our Board of Directors. We have similar arrangements
with other marketing services firms and believe the arrangement was entered into
on substantially the same terms and conditions as its arrangements with such
other firms.
54
NOTE 8: INCOME TAXES
The components of income tax expense are as follows (in thousands):
YEAR ENDED
DECEMBER 31,
------------
2003 2002 2001
---- ---- ----
Current:
Federal........................ $ 81 $ (135) $ 223
State.......................... 75 21 168
Foreign........................ 215 184 216
-------- -------- --------
$ 371 $ 70 $ 607
-------- -------- --------
Deferred:
Federal........................ $ -- $ -- $ --
State.......................... -- -- --
Foreign........................ -- -- --
-------- -------- --------
-- -- --
-------- -------- --------
Total income tax expense.... $ 371 $ 70 $ 607
======== ======== ========
The provision for income taxes differs from the federal statutory rate of
34% as follows (in thousands):
YEAR ENDED
DECEMBER 31,
------------
2003 2002 2001
---- ---- ----
Expected federal tax provision (benefit)................ $ (1,313) $ (29,321) $ 765
State provision......................................... (2) 14 288
Non-deductible in-process research and development...... 1,292 -- 1,020
Other................................................... (60) (113) 282
Goodwill impairment..................................... -- 19,507 --
Losses not benefited.................................... 454 9,983 (1,748)
----------- ---------- ---------
$ 371 $ 70 $ 607
=========== ========== =========
Significant components of the deferred tax assets and liabilities are as
follows (in thousands):
DECEMBER 31,
------------
2003 2002
---- ----
Net operating loss carryforward.......... $ 72,182 $ 70,837
Loss on investment....................... -- 908
Accruals and reserves.................... 1,338 2,274
Research and development tax credits..... 6,468 3,806
Intangible assets........................ (2,700) (2,159)
Other.................................... 1,616 236
Valuation allowance...................... (78,904) (75,902)
----------- -----------
$ -- $ --
=========== ===========
Subsequently reported tax benefits relating to the valuation allowance for
deferred tax assets as of December 31, 2003 will be allocated as follows (in
thousands):
DECEMBER 31,
2003
------------
Income tax benefit recognized in the consolidated
statement of operations................................. $ 34,608
Goodwill and other intangibles............................ $ 49,740
Additional paid-in capital................................ $ 98,736
-----------
Total..................................................... $ 183,084
===========
In assessing the realizability of deferred tax assets, the Company
considers whether it is more likely than not that some portion or all of the
deferred taxes assets will not be realized. The ultimate realization of deferred
tax assets is dependent upon the generation of future taxable income during the
periods in which the net operating losses are allowed to be carried forward or
temporary differences become deductible. Due to the uncertainty of the Company's
ability to realize the benefit of the deferred tax assets, the deferred tax
assets are fully offset by a valuation allowance. The net change in the
valuation allowance during 2003 and 2002 was an increase of approximately $3.0
million and $10.1 million, respectively. The Company re-evaluates the positive
and negative evidence on a quarterly basis.
At December 31, 2003, the Company has available for federal and state income
tax purposes a net operating loss carryforward of approximately $161.6 million
expiring at various dates through fiscal 2023. The Company also has
approximately $21.5 million of a foreign loss carryforward acquired through the
purchase of Business Layers. The net operating loss carryforward includes
approximately $98.7 million of tax deductions relating to stock options that
will be credited to additional paid-in capital when realized.
55
Additionally, approximately $49.7 million of the net operating loss
carryforward at December 31, 2003 is attributable to the Business Layers
acquisition which when realized, will first reduce any remaining goodwill and
then any remaining non-current intangible assets.
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.
Additionally, management believes that the application of IRC section 382
will prevent the Company from using approximately $39.9 million of previously
unbenefitted net operating loss carryforwards acquired in connection with the
Datachannel purchase and therefore has been excluded from the table above. As
these losses have been fully reserved in prior years, the reversal of the gross
asset and associated valuation allowance has no impact on earnings.
NOTE 9: CAPITAL STOCK AND CAPITAL STOCK WARRANTS
AUTHORIZED CAPITAL STOCK
As of December 31, 2003, the authorized capital stock of the Company
consisted of 135.0 million shares of common stock (approximately 37.6 million
shares issued), and 5.0 million shares of preferred stock, $0.01 par value (see
Preferred Stock Issuances, below).
PREFERRED STOCK ISSUANCES
The 5.0 million shares of preferred stock were designated as Series D.
Between January 6, 1998 and June 30, 1998, the Company sold 3.3 million shares
of Series D Preferred Stock to an institutional investor under a Preferred Stock
and Warrant Purchase Agreement, as amended. The Series D Preferred Stock
converted one for one to common stock in September 1999 and such shares cannot
be reissued by the Company. The remaining authorized shares of Series D
Preferred Stock of approximately 1.7 million shares have not been issued by the
Company.
WARRANTS
Outstanding warrants as of December 31, 2003 consisted of the following:
DATE GRANTED NUMBER OF WARRANTS EXERCISE PRICE EXPIRATION DATE
------------ ------------------ -------------- ---------------
December 15, 2000..... 4,004 $ 62.50 December 15, 2004
June 29, 2001......... 6,965 $ 24.77 June 29, 2005
------
10,969
======
The outstanding warrants were granted to a customer and, accordingly,
revenue was reduced on the grant date based on the value of the warrant using
the Black-Scholes option-pricing model.
NOTE 10: STOCK PLANS
STOCK OPTION PLANS
The Company has several stock option plans, as described hereunder, that
provide for the issuance of an aggregate of 12,570,000 shares of the Company's
common stock. All options issued under the plans are granted at fair market
value at the date of grant, become exercisable at varying rates, generally over
three or four years, as determined by the Board of Directors, and generally
expire seven to ten years from the date of grant.
Stock Option Plans for Outside Directors: The Company maintains stock
option plans intended only for members of the
56
Company's Board of Directors who are neither employees nor officers of the
Company (the Directors' Plans). The Directors' Plans provide for the grant of
options to purchase up to 187,500 shares of Company common stock. The timing,
amounts, recipients and other terms of the option grants are determined by the
provisions of or formulas in the Directors' Plans. As of December 31, 2003,
options for 70,562 shares were available for future grant.
Stock Option Plans for Employees and Others: The Company maintains stock
option plans intended for employees, consultants and officers and, in the case
of one of the plans, directors, providing for the granting of options to
purchase up to 12,382,500 shares of Company common stock as an inducement to
obtain and retain the services of qualified persons. Incentive stock options may
be granted to officers and employees, and non-qualified stock options may be
granted to directors, officers, employees or consultants. As of December 31,
2003, aggregate options for 1,952,002 shares were available for future grant to
employees, officers and consultants to the Company.
TENDER OFFERS
On August 9, 2001 and as subsequently amended, the Company filed a tender
offer statement with the Securities and Exchange Commission in connection with
certain stock options issued after December 1, 1999 (the Option Offer). Under
the Option Offer, the Company offered to exchange certain employee options to
purchase shares of the Company's common stock for new options to purchase shares
of its common stock. The Option Offer, which excluded executive officers,
directors and non-employees of the Company and which expired on September 7,
2001, provided for the grant of new options on March 11, 2002 to eligible
employees who were actively employed on the grant date. The number of shares
underlying the new options was equal to the number of shares underlying the
cancelled eligible options. The exercise price of the new options was equal to
the fair market value of one share of common stock on the date of grant of the
new options as determined in accordance with the applicable option plans. Each
new option vests in accordance with a vesting schedule that is equivalent to
what would have been in place had the cancelled option remained in effect.
On March 11, 2002, the Company granted options to purchase an aggregate of
2,103,406 shares of its common stock at fair market value in connection with the
Option Offer. In accordance with FASB Interpretation No. 44, since the
replacement options were granted more than six months after cancellation of the
old options and were granted at an exercise price equal to the then fair market
value of the Company's common stock, the new options were considered a fixed
award and therefore did not result in any compensation expense.
On August 23, 2002 and as subsequently amended, the Company filed a tender
offer statement with the Securities and Exchange Commission in connection with
certain stock options outstanding under non-director stock plans (the Offer to
Exchange). Under the Offer to Exchange, the Company offered to exchange certain
employee options to purchase shares of the Company's common stock for new
options to purchase shares of its common stock. The Offer to Exchange, which
excluded directors and non-employees of the Company and which expired on
September 23, 2002, provided for the grant of new options on two different
dates. The Company granted approximately 50% of the new options on March 25,
2003 and approximately 50% on April 25, 2003 to employees that were continuously
and actively employed from the date the employee tendered eligible options for
exchange to the date of the grant of the new options. The number of shares
underlying the new options were equal to the number of shares underlying the
cancelled eligible options, except that certain options granted to certain
executive officers were exchanged at a rate of one share underlying a new option
for each two shares underlying the tendered options. The exercise price of the
new options was equal to the fair market value of one share of common stock on
the date of grant of the new options as determined in accordance with the
applicable option plans. Each new option will vest in accordance with a schedule
tied to the length of time of an individual's employment with the Company.
57
SUMMARY OF OPTION ACTIVITY
Stock option activity for the years ended December 31, 2003, 2002 and 2001
is as follows (in thousands, except price data):
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
2003 2002 2001
---- ---- ----
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------ ----- ------ ----- ------ -----
Options outstanding at
beginning of year....... 2,131 $7.63 4,114 $ 20.11 6,500 $ 24.58
Option activity during the
year:
Granted................. 6,104 5.64 5,025 13.06 1,898 34.38
Exercised............... (468) 3.19 (364) 1.62 (1,073) 5.57
Forfeited............... (922) 11.48 (899) 19.80 (1,031) 31.48
Option Offer............ -- (5,745) 20.02 (2,180) 45.62
----- -----
Options outstanding at end
of year................... 6,845 $5.53 2,131 $ 7.63 4,114 $ 20.11
===== ===== ===== ======= ===== =======
Options exercisable....... 2,644 1,030 1,896
===== ===== =====
The weighted average grant date fair value of options granted during 2003,
2002 and 2001 was $4.65, $11.51 and $27.61, respectively.
Stock options outstanding at December 31, 2003 are as follows (in
thousands, except weighted average life and price data):
OPTIONS EXERCISABLE
OPTIONS OUTSTANDING -------------------
------------------- WEIGHTED
WEIGHTED WEIGHTED AVERAGE
AVERAGE AVERAGE EXERCISE
RANGE OF EXERCISE PRICES NUMBER LIFE(a) EXERCISE PRICE NUMBER PRICE
------------------------ ------ ------- -------------- ------ -----
$.0.52-$2.05............ 754 4.5 $ 1.33 543 $ 1.06
$2.06-$3.62............. 2,271 6.1 3.41 1,085 3.43
$3.71-$4.55............. 2,039 6.3 4.50 844 4.54
$4.74-$10.35............ 1,554 8.5 9.95 46 7.12
$11.86-$44.38........... 225 7.8 19.26 125 22.72
$61.50-$78.00........... 2 7.0 69.75 1 71.40
----- -----
6,845 6.6 $ 5.53 2,644 $ 4.31
===== === ======== ===== =======
---------
(a) Average contractual life remaining in years.
EMPLOYEE STOCK PURCHASE PLAN
During May 2002, the Company established the 2002 Employee Stock Purchase
Plan ("2002 Stock Purchase Plan") under which eligible employees could purchase
shares of the Company's common stock, subject to certain limitations, at 85% of
the market value. Purchases were limited to 10% of an employee's eligible
compensation, up to a maximum of 1,000 shares per purchase period. The 2002
Stock Purchase Plan originally authorized the issuance of 700,000 shares of
common stock (subject to adjustment for capital changes) pursuant to the
exercise of nontransferable options granted to participating employees and the
maximum number of shares which are available in any single purchase period is
112,500. Prior to establishing the 2002 Stock Purchase Plan, the Company
maintained the 1990 Employee Stock Purchase Plan ("1990 Stock Purchase Plan")
under which eligible employees could purchase shares of the Company's common
stock, subject to certain limitations, at 85% of the market value. Purchases
were limited to 10% of an employee's eligible compensation, up to a maximum of
500 shares per purchase period. The 1990 Stock Purchase Plan originally
authorized the issuance of 150,000 shares of common stock (subject to adjustment
for capital changes) pursuant to the exercise of nontransferable options granted
to participating employees. During the year ended December 31, 2003, 206,760
shares of the Company's common stock were issued under the 2002 Stock Purchase
Plan and during the years ended December 31, 2001, 41,000 shares of the
Company's common stock were issued under the 1990 Stock Purchase Plan. As of
October 1, 2001, all authorized shares had been issued under the 1990 Stock
Purchase Plan and the plan was terminated.
STOCK AWARD
58
During November 2001, the Company issued an aggregate of 5,291 shares of
common stock to certain employees as a stock award. This award resulted in
compensation expense of approximately $52,000 which is included in the
accompanying consolidated statement of operations for the year ended December
31, 2001.
NOTE 11: OPERATING SEGMENTS AND GEOGRAPHICAL INFORMATION
Based on the information provided to the Company's chief operating decision
maker for purposes of making decisions about allocating resources and assessing
performance, the Company's continuing operations have been classified into a
single segment. The Company operates primarily in three geographic regions:
North America, Europe and the Middle East, and Asia Pacific. Revenues (based on
the location of the customer) and long-lived assets by geographic region are as
follows (in thousands):
2003 2002 2001
---- ---- ----
Revenues:
United States of America...... $ 60,553 $ 54,492 $ 70,240
Europe and the Middle East.... 11,092 10,145 11,293
Asia Pacific.................. 5,348 2,964 4,831
Other......................... 1,451 1,663 1,782
---------- ---------- ----------
Total......................... $ 78,444 $ 69,264 $ 88,146
========== ========== ==========
Long-Lived Assets:
United States of America...... $ 46,367 $ 11,805
Europe and the Middle East.... 1,407 389
Asia Pacific.................. 211 379
Other......................... -- --
---------- ----------
Total......................... $ 47,985 $ 12,573
========== ==========
NOTE 12: RESTATEMENT OF QUARTERLY FINANCIAL STATEMENTS
The Company has restated its consolidated financial statements for the
second and third quarters of 2003 to correct the classification of
available-for-sale securities which were incorrectly classified on the
consolidated balance sheets as of June 30 and September 30, 2003. These
corrections were required because the Company inadvertently classified certain
short-term available-for-sale securities as long-term available-for-sale
securities on its balance sheet. The Company has filed amendments to its
Quarterly Reports on Form 10-Q for the second and third quarters of 2003 to
reflect these corrections. As of June 30, 2003, the Company has increased its
short-term available-for-sale securities and decreased its long-term
available-for-sale securities by $29.3 million. As of September 30, 2003, the
Company has decreased its long-term available-for-sale securities and increased
its short-term available-for-sale securities by $35.3 million. The restatements
of previously reported consolidated financial statements for the periods ended
June 30 and September 30, 2003 do not impact the value of the total assets but
rather only the classification of these assets as either current or long-term
based on the duration of time to maturity.
59
NOTE 13: SUMMARIZED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following financial information reflects all normal recurring
adjustments that are, in the opinion of management, necessary for a fair
statement of the results of the interim periods. The fourth quarter results
include a $5.0 million gain on the sale of the portal technology and a charge
for in-process research and development of $3.8 million. Summarized quarterly
data for fiscal 2003 and 2002 is as follows (in thousands, except per share
data):
1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER
----------- ----------- ----------- -----------
2003
Revenues............................ $ 16,679 $ 18,864 $ 20,397 $ 22,504
Gross profit........................ 10,139 12,639 16,556 18,560
Operating income (loss)............ (5,231) (2,890) 318 2,153
Net Income (loss).................. (4,857) (2,532) 659 2,500
Basic earnings (loss) per share..... (0.14) (0.07) 0.02 0.07
Diluted earnings (loss) per share... (0.14) (0.07) 0.02 0.06
2002
Revenues............................ $ 21,971 $ 15,808 $ 15,179 $ 16,306
Gross profit........................ 16,180 10,528 9,758 9,787
Operating loss...................... (3,370) (10,677) (66,673) (7,937)
Net loss............................ (2,754) (9,953) (66,153) (7,449)
Basic loss per share................ (0.08) (0.29) (1.94) (0.22)
Diluted loss per share.............. (0.08) (0.29) (1.94) (0.22)
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Our management evaluated, with the participation of our Chief Executive
Officer and Chief Financial Officer, the effectiveness of our disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Exchange Act) as of December 31, 2003. Based on such evaluation, our Chief
Executive Officer and Chief Financial Officer have concluded that, as of such
date, our disclosure controls and procedures were (1) designed to ensure that
material information relating to Netegrity, including our consolidated
subsidiaries, is made known to our Chief Executive Officer and Chief Financial
Officer by others within those entities, particularly during the period in which
this report was being prepared and (2) effective, in that they provide
reasonable assurance that information required to be disclosed by us in the
reports that we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms, except for the controls and procedures related to the classification of
marketable securities. Subsequent to the end of the fourth quarter of 2003, the
Company discovered that adjustments to the classification of marketable
securities were required in the second and third quarters of 2003 because it
inadvertently classified certain short-term available-for-sale securities as
long-term available-for-sale securities on its balance sheet. As a result, the
Company restated its financial results as of June 30, 2003 by increasing
short-term available-for-sale securities and decreasing long-term
available-for-sale securities by $29.3 million. The Company also restated its
financial results as of September 30, 2003 by decreasing long-term
available-for-sale securities and increasing short-term available-for-sale
securities by $35.3 million.
No change in our internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal
quarter ended December 31, 2003 that has materially affected , or is reasonably
likely to materially affect, our internal control over financial reporting.
Subsequent to the end of the fourth quarter of 2003, the Company adopted
additional controls and procedures to ensure the proper classification of
marketable securities on its balance sheet. The Company believes that the
control issues related to the restatement described above have been corrected.
60
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is incorporated by reference to the
Company's definitive proxy statement for its Annual Meeting of Stockholders to
be held in 2004 (the "2004 Proxy Statement"). The information regarding
executive officers of the Company is included in Part I of this Annual Report on
Form 10-K under the caption "Executive Officers of the Registrant."
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to the
2004 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference to the
2004 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to the
2004 Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this item is incorporated by reference to the
2004 Proxy Statement.
61
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
A. THE FOLLOWING DOCUMENTS ARE FILED AS PART OF THIS REPORT:
1. Financial Statements
The following financial statements are included in Item 8:
a. Reports of Independent Accountants
b. Consolidated Balance Sheets -- December 31, 2003 and 2002
c. Consolidated Statements of Operations for the years ended December
31, 2003, 2002 and 2001
d. Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2003, 2002 and 2001
e. Consolidated Statements of Cash Flows for the years ended December
31, 2003, 2002 and 2001
f. Notes to Consolidated Financial Statements
2. Financial Statement Schedules
Included at the end of this report are the following:
a. Reports of Independent Accountants
b. Schedule II: Valuation of Qualifying Accounts and Reserves
Schedules other than those listed above have been omitted since they are
either not required or the information is otherwise included.
3. List of Exhibits
The following exhibits, required by Item 601 of Regulation S-K, are filed
as part of this Annual Report on Form 10-K. Exhibit numbers, where applicable,
in the left column correspond to those of Item 601 of Regulation S-K.
EXHIBIT
ITEM NO. ITEM AND REFERENCE
-------- ------------------
2.01 Agreement and Plan of Merger, dated as of December 30., 2003, by
and among Netegrity, Inc., Tuna Acquisition Corp., and Business
Layers, Inc., (filed as Exhibit 2.1 to Current Report on Form 8-K
filed on January 9, 2004 and incorporated by reference).
3.01 Restated Certificate of Incorporation, as amended, of the
Registrant (filed as Exhibit 3.1 to Registration Statement on Form
S-3 filed February 12, 2002 and incorporated by reference).
3.02 Amended and Restated By-Laws of the Registrant (filed herewith).
4.01 Specimen certificate for shares of Common Stock of the Registrant
(filed as Exhibit 4.01 to the Registrant's Registration Statement
on Form S-18, No. 33-24446-B, and incorporated by reference).
10.01(1) 1994 Stock Plan, as amended (filed herewith).
10.02(1) 1997 Stock Option Plan, as amended (filed herewith).
62
10.03(1) 1997 Non-Employee Director Stock Option Plan (filed herewith).
10.04(1) 2001 Interim General Stock Incentive Plan (filed as Exhibit 4.1 to
Registration Statement on Form S-8, filed on October 31, 2002, and
incorporated by reference).
10.05(1) 2002 Employee Retention General Incentive Plan (filed as Exhibit
4.1 to Registration Statement on Form S-8, filed on October 31,
2002, and incorporated by reference).
10.06(1) 2002 General Stock Incentive Plan (filed as Exhibit 4.1 to
Registration Statement on Form S-8, filed on October 31, 2002, and
incorporated by reference).
10.07(1) 2002 Employee Stock Purchase Plan (filed as Exhibit 4.1 to
Registration Statement on Form S-8, filed on October 31, 2002, and
incorporated by reference).
10.08(1) Executive Employment Agreement between Netegrity, Inc. and Barry
Bycoff dated as of May 31, 1996 (filed as Exhibit 10.1 to Annual
Report on Form 10-K/A for the year ended December 31, 1998, and
incorporated by reference).
10.09(1) Netegrity Inc. 2000 Stock Incentive Plan as amended (filed
herewith).
10.10 Lease by and between Netegrity, Inc., and Stonybrook Associates,
LLC dated August 2002 (filed as Exhibit 10.1 to Quarterly Report on
Form 10-Q for the quarter ended September 30, 2002, and
incorporated by reference).
10.11(1) Offer letter from Netegrity, Inc., to Thomas Thimot, dated
September 6, 2002 (filed as Exhibit 10.2 to Quarterly Report on
Form 10-Q for the quarter ended September 30, 2002, and
incorporated by reference).
10.12(1) Indemnification Agreement by and between Netegrity, Inc., a
Delaware corporation, and Eric P. Giler, a director of the
Corporation (filed as Exhibit 10.3 to Quarterly Report on Form 10-Q
for the quarter ended September 30, 2002, and incorporated by
reference).
10.13(1) Indemnification Agreement by and between Netegrity, Inc., a
Delaware corporation, and Lawrence D. Lenihan, Jr., a director of
the Corporation (filed as Exhibit 10.4 to Quarterly Report on Form
10-Q for the quarter ended September 30, 2002, and incorporated by
reference).
10.14(1) Indemnification Agreement by and between Netegrity, Inc., a
Delaware corporation, and Michael L. Mark, a director of the
Corporation (filed as Exhibit 10.5 to Quarterly Report on Form 10-Q
for the quarter ended September 30, 2002, and incorporated by
reference).
10.15(1) Indemnification Agreement by and between Netegrity, Inc., a
Delaware corporation, and Ralph B. Wagner, a director of the
Corporation (filed as Exhibit 10.6 to Quarterly Report on Form 10-Q
for the quarter ended September 30, 2002, and incorporated by
reference).
10.16(1) Executive Retention Agreement by and between Netegrity, Inc., and
Barry Bycoff (filed as Exhibit 10.9 to Quarterly Report on Form
10-Q for the quarter ended September 30, 2002, and incorporated by
reference).
10.17(1) Executive Retention Agreement by and between Netegrity, Inc., and
Regina O. Sommer (filed as Exhibit 10.10 to Quarterly Report on
Form 10-Q for the quarter ended September 30, 2002, and
incorporated by reference).
10.18(1) Executive Retention Agreement by and between Netegrity, Inc., and
Deepak Taneja (filed as Exhibit 10.11 to Quarterly Report on Form
10-Q for the quarter ended September 30, 2002, and incorporated by
reference).
10.19(1) Executive Retention Agreement by and between Netegrity, Inc., and
William Bartow (filed as Exhibit 10.13 to Quarterly Report on Form
10-Q for the quarter ended September 30, 2002, and incorporated by
reference).
10.20(1) Executive Retention Agreement by and between Netegrity, Inc., and
Thomas Thimot (filed as Exhibit 10.14 to Quarterly Report on Form
10-Q for the quarter ended September 30, 2002, and incorporated by
reference).
63
10.21(1) Executive Retention Agreement by and between Netegrity, Inc., and
Stephanie Feraday, dated November 4, 2002, (filed as Exhibit 10.40
to Annual Report on Form 10-K for the year ended December 31, 2002,
and incorporated by reference).
21.1 Subsidiaries of the Registrant (filed herewith).
23.1 Consent of KPMG LLP (filed herewith).
23.2 Notice Regarding Consent of Arthur Andersen LLP (filed herewith).
31.1 Rule 13a-14(a)/15d-14(a) Certification of President and Chief
Executive Officer (filed herewith).
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
and Treasurer (filed herewith).
32.1 Section 1350 Certification of President and Chief Executive Officer
(filed herewith).
32.2 Section 1350 Certification of Chief Financial Officer and Treasurer
(filed herewith)..
---------
(1) Management contract or compensatory plan or arrangement required to be
filed as an exhibit pursuant to Item 15(c) of Form 10-K.
B. REPORTS ON FORM 8-K
None.
C. EXHIBITS:
The Company hereby files as part of this Form 10-K the exhibits listed in
15(A)(3) above.
D. FINANCIAL STATEMENT SCHEDULES:
The Company hereby files as part of this Form 10-K the financial statement
schedule listed in Item 15(A)(2) above.
64
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report on Form 10-K to
be signed on its behalf by the undersigned, thereunto duly authorized.
NETEGRITY, INC.
By: /s/ BARRY N. BYCOFF
---------------------------------
Barry N. Bycoff
President and Chief Executive Officer
February 27, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ BARRY N. BYCOFF President, Chief Executive February 27, 2004
-------------------------- Officer, Director (Principal
Barry N. Bycoff Executive Officer)
/s/ REGINA O. SOMMER Chief Financial Officer and February 27, 2004
-------------------------- Treasurer (Principal Financial
Regina O. Sommer Officer and Principal Accounting
Officer)
/s/ SANDRA K. BERGERON Director February 27, 2004
--------------------------
Sandra K. Bergeron
/s/ ERIC R. GILER Director February 27, 2004
--------------------------
Eric R. Giler
/s/ LAWRENCE D. LENIHAN Director February 27, 2004
--------------------------
Lawrence D. Lenihan
/s/ RONALD T. MAHEU Director February 27, 2004
--------------------------
Ronald T. Maheu
/s/ MICHAEL L. MARK Director February 27, 2004
--------------------------
Michael L. Mark
/s/ RALPH B. WAGNER Director February 27, 2004
--------------------------
Ralph B. Wagner
65
Independent Auditors' Report on Financial Statement Schedule
The Board of Directors and Stockholders
Netegrity, Inc.:
Under date of January 26, 2004, we reported on the consolidated balance sheets
of Netegrity, Inc. and subsidiaries as of December 31, 2003 and 2002, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for the years then ended, which are included in this Form 10-K. In
connection with our audits of the aforementioned consolidated financial
statements, we also audited the related consolidated financial statement
schedule for the years ended December 31, 2003 and 2002 included in this Form
10-K. This financial statement schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion on this financial
statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in relation
to the basic consolidated financial statements taken as a whole, presents
fairly, in all material respects, the information set forth therein for the
years ended December 31, 2003 and 2002.
As discussed in our Independent Auditors' Report, the consolidated financial
statements of Netegrity, Inc. and subsidiaries as of December 31, 2001 and for
the year then ended were audited by other auditors who have ceased operations.
As described in Note 1 to the consolidated financial statements, those financial
statements have been restated. In our opinion, the adjustments are appropriate
and have been properly applied. However, we were not engaged to audit, review,
or apply any procedures to the 2001 consolidated financial statements of
Netegrity, Inc. and subsidiaries other than with respect to such adjustments
and, accordingly, we do not express an opinion or any form of assurance on the
2001 consolidated financial statements taken as a whole.
KPMG LLP
Boston, Massachusetts
January 26, 2004
66
THE FOLLOWING REPORT OF ARTHUR ANDERSEN LLP (ANDERSEN) IS A COPY OF THE REPORT
PREVIOUSLY ISSUED BY ANDERSEN ON JANUARY 30, 2002. THE REPORT OF ANDERSEN IS
INCLUDED IN THIS ANNUAL REPORT ON FORM 10-K PURSUANT TO RULE 2-02(E) OF
REGULATION S-X. AFTER REASONABLE EFFORTS THE COMPANY HAS NOT BEEN ABLE TO OBTAIN
A REISSUED REPORT FROM ANDERSEN. ANDERSEN HAS NOT CONSENTED TO THE INCLUSION OF
ITS REPORT IN THIS ANNUAL REPORT ON FORM 10-K. BECAUSE ANDERSEN HAS NOT
CONSENTED TO THE INCLUSION OF ITS REPORT IN THIS ANNUAL REPORT, IT MAY BE
DIFFICULT TO SEEK REMEDIES AGAINST ANDERSEN AND THE ABILITY TO SEEK RELIEF
AGAINST ANDERSEN MAY BE IMPAIRED.
REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE
To the Board of Directors
of Netegrity, Inc.:
We have audited in accordance with auditing standards generally accepted in
the United States the consolidated financial statements of Netegrity, Inc. for
the year ended December 31, 2001 included in this Form 10-K, and have issued our
report thereon dated January 30, 2002. Our audit was made for the purpose of
forming an opinion on those statements taken as a whole. The schedule listed in
the index in item 14 is the responsibility of the Company's management and is
presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. This
schedule as of and for the year ended December 31, 2001 has been subjected to
the auditing procedures applied in the audit of the basic financial statements
and, in our opinion, fairly states, in all material respects, the financial data
required to be set forth therein in relation to the basic financial statements
taken as a whole.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
January 30, 2002
67
NETEGRITY, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
BALANCE AT BALANCE AT
BEGINNING END OF
OF PERIOD ADDITIONS DEDUCTIONS(1) PERIOD
--------- --------- ------------- ------
(IN THOUSANDS)
Year ended December 31, 2003:
Allowance for doubtful accounts receivable..... $ 922 783 (876) $ 829
Year ended December 31, 2002:
Allowance for doubtful accounts receivable..... $ 1,579 (132) (525) $ 922
Year ended December 31, 2001:
Allowance for doubtful accounts receivable..... $ 951 2,573 (1,945) $1,579
---------
(1) Primarily uncollectible accounts written off, net of recoveries.
68