UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the quarterly period ended June 30, 2000.
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from _____ to _____.
Commission File Number: 0-22667
MERCATOR SOFTWARE, INC.
(Exact name of registrant as specified in its charter)
Delaware 06-1132156
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
45 Danbury Road, Wilton, CT 06897
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code:
203-761-8600
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
[X] Yes [_] No
As of June 30, 2000, Registrant had 29,353,491 outstanding shares of Common
Stock, $.01 par value.
1
MERCATOR SOFTWARE, INC.
TABLE OF CONTENTS
PAGE
PART 1 FINANCIAL INFORMATION
ITEM 1 - Consolidated Condensed Financial Statements
Consolidated Balance Sheets as of June 30, 2000 (unaudited) and December 31, 1999 3-4
Consolidated Statements of Operations for the Three and Six Months Ended
June 30, 2000 (unaudited) and 1999 (unaudited) 5-6
Consolidated Condensed Statements of Cash Flows for the Six Months
Ended June 30, 2000 (unaudited) and 1999 (unaudited) 7
Notes to Consolidated Condensed Financial Statements 8-10
ITEM 2 Managements' Discussion and Analysis of Financial
Condition and Results of Operations 10-22
ITEM 3 - Quantitative and Qualitative Disclosures About Market Risk 22
PART II OTHER INFORMATION
ITEM 1. Legal Proceedings 23
ITEM 2. Changes in Securities and Use of Proceeds 23
ITEM 4. Submission Of Matters To Vote Of Security Holders 24
ITEM 6. Exhibits and Reports on Form 8-K 25
SIGNATURES 25
2
Mercator Software, Inc.
Consolidated Balance Sheets
June 30, December 31,
2000 1999
---- ----
ASSETS:
Current assets:
Cash and cash equivalents $ 13,228,100 $ 9,237,100
Marketable securities 4,245,100 5,648,400
Accounts receivable, less allowances of
$2,652,500 and $1,766,400 43,708,800 38,270,500
Prepaid expenses and other current assets 2,167,300 2,984,500
Deferred tax assets 10,378,700 10,378,700
------------ ------------
Total current assets 73,728,000 66,519,200
Furniture, fixtures and equipment, net 8,087,500 6,516,700
Intangible assets, net 147,037,300 153,227,700
Other assets 582,800 551,800
------------ ------------
Total assets $229,435,600 $226,815,400
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,457,800 $ 3,936,700
Accrued expenses 13,063,700 8,175,800
Current portion of deferred revenue 15,974,300 14,737,700
------------ ------------
Total current liabilities 32,495,800 26,850,200
Long-term deferred tax liability 15,767,500 12,253,500
Deferred revenue, less current portion 127,700 58,600
------------ ------------
Total liabilities 48,391,000 39,162,300
------------ ------------
Stockholders' equity:
Convertible preferred stock: $.01 par value;
authorized 5,000,000 shares, no shares
issued and outstanding -- --
Common Stock: $.01 par value; authorized
190,000,000 shares; issued and outstanding 29,353,491 shares
and 27,834,350 shares 293,500 278,200
Additional paid-in capital 229,168,700 205,420,900
Deferred compensation (568,000) (883,200)
Accumulated deficit (45,952,400) (16,667,800)
Cumulative translation adjustment (1,897,200) (495,000)
------------ ------------
Total stockholders' equity 181,044,600 187,653,100
------------ ------------
Total liabilities and stockholders' equity $229,435,600 $226,815,400
============ ============
See accompanying notes to consolidated condensed financial statements.
3
Mercator Software, Inc.
Consolidated Statements of Operations
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
2000 1999 2000 1999
---- ---- ---- ----
Revenues:
Software licensing $ 20,397,100 $12,547,600 $ 38,704,300 $22,347,100
Service, maintenance and other 15,299,100 11,096,700 28,244,200 18,533,300
------------ ----------- ------------ -----------
Total revenues 35,696,200 23,644,300 66,948,500 40,880,400
------------ ----------- ------------ -----------
Cost of revenues:
Software licensing 367,700 381,300 652,800 817,400
Service, maintenance and other 7,331,800 5,235,900 14,458,800 9,467,000
------------ ----------- ------------ -----------
Total cost of revenues 7,699,500 5,617,200 15,111,600 10,284,400
------------ ----------- ------------ -----------
Gross profit 27,996,700 18,027,100 51,836,900 30,596,000
Operating expenses:
Product development 5,119,600 3,718,300 10,208,700 5,928,600
Selling and marketing 17,377,800 9,969,700 31,160,100 16,602,700
General and administrative 4,832,200 1,956,300 8,362,100 4,018,700
Amortization of intangibles 12,251,300 7,047,300 23,227,900 9,371,300
------------ ----------- ------------ -----------
Total operating expenses 39,580,900 22,691,600 72,958,800 35,921,300
------------ ----------- ------------ -----------
Operating loss (11,584,200) (4,664,500) (21,121,900) (5,325,300)
Other income, net 139,500 230,800 293,700 741,900
------------ ----------- ------------ -----------
Loss before income taxes (11,444,700) (4,433,700) (20,828,200) (4,583,400)
Provision for income taxes 6,343,100 102,000 8,456,400 172,000
------------ ----------- ------------ -----------
Net loss $(17,787,800) $(4,535,700) $(29,284,600) $(4,755,400)
============ =========== ============ ===========
Net loss per share-Basic
and Diluted $ (0.61) $ (0.18) $ (1.02) $ (0.20)
Weighted average number of common
and common equivalent shares
outstanding:
Basic and Diluted 29,099,779 25,373,556 28,653,460 24,106,210
See accompanying notes to consolidated condensed financial statements.
4
Mercator Software, Inc.
Consolidated Condensed Statements of Cash Flows
(unaudited)
Six Months Six Months
Ended Ended
June 30, 2000 June 30, 1999
------------- -------------
Cash flows from operating activities:
Net cash (used in) provided by operating activities 3,012,900 (3,457,300)
Cash flows from investing activities:
Purchase of furniture fixtures and equipment (3,324,600) (2,436,200)
Acquisition, net of cash -- (27,736,100)
Sales of marketable securities 1,403,000 20,688,200
Other (154,800) (294,300)
---------- -----------
Net cash (used in) investing securities (2,076,400) (9,778,400)
Cash flows from financing activities:
Payments under capital leases -- (5,200)
Proceeds from exercise of stock options 2,685,100 427,200
Proceeds from employee stock plan 1,190,400 598,300
---------- -----------
Net cash provided by financing activities 3,875,500 1,020,300
Effect of exchange rate changes on cash and cash equivalents (821,000) (178,700)
Net change in cash 3,991,000 (12,394,100)
Cash at the beginning of period 9,237,100 15,132,700
---------- -----------
Cash at end of period 13,228,100 2,738,600
========== ===========
Supplemental information:
Cash paid for:
Interest 29,100 15,300
Income taxes 659,400 1,224,700
Non cash investing and finance activities:
Issuance of stock in connection with the acquisition of Braid -- 63,723,500
Issuance of stock in connection with Braid earnout 20,000,000 --
Warrants exercised on a net exercise basis -- 2,300
See accompanying notes to consolidated condensed financial statements.
5
MERCATOR SOFTWARE, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
(1) UNAUDITED INTERIM FINANCIAL STATEMENTS
The accompanying consolidated interim condensed financial statements contained
herein are unaudited, but, in the opinion of management, include all adjustments
(consisting of normal recurring adjustments) necessary for a fair presentation
of the financial position, results of operations and cash flows for the periods
presented. Results of operations for the periods presented herein are not
necessarily indicative of results of operations for the entire year.
Reference should be made to Mercator Software, Inc. ("Mercator") 1999 Annual
Report on Form 10-K (filed under the Company's prior name, TSI International
Software Ltd.) which includes audited financial statements for the year ended
December 31, 1999.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to the Securities and Exchange
Commission's rules and regulations.
(2) BUSINESS COMBINATIONS
In March 1999, Mercator acquired Braid Group Limited ("Braid"), a leading
provider of integration software products for straight-through processing of
financial transactions in the international banking and securities markets.
Mercator purchased all of the outstanding capital stock of Braid for
approximately $110.2 million, excluding approximately $20 million of contingent
consideration to be paid upon the achievement of certain operating results. The
purchase price included $30 million in cash, 2,207,258 shares of Mercator common
stock and the issuance of 434,622 stock options. The transaction was accounted
for under the purchase method of accounting and the excess purchase price is
being amortized on a straight-line basis over a five-year period. During April
2000, Mercator determined that the operating targets for contingent
consideration of $20 million had been achieved. This resulted in the issuance of
218,302 shares to the shareholders of Braid, at an average price of $91.616 as
calculated in accordance with the terms of the agreement.
In September 1999, Mercator acquired Novera Software, Inc., a developer of Web
application integration solutions. Mercator purchased all of the outstanding
shares of capital stock of Novera for approximately $58.2 million, which
included the issuance of 1,789,916 shares of Mercator common stock and the
issuance of 369,142 stock options. The transaction was accounted for under the
purchase method of accounting and the excess purchase price is being amortized
on a straight-line basis over a three-year period.
(3) NEWLY ADOPTED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standard (SFAS) No. 133 "Accounting for Derivative
Instruments and Hedging Activities" which establishes accounting and reporting
standards for derivative instruments, including derivative instruments embedded
in other contracts, and for hedging activities. SFAS No. 133, as amended by SFAS
137 and 138 is effective for fiscal years beginning after June 15, 2000. These
statements are not expected to significantly effect Mercator, as the Company
currently does not have any significant derivative instruments or hedging
activities.
Statement of Position (SOP) 98-9, "Software Revenue Recognition with Respect to
Certain transactions", which amended (SOP) 97-2 "Software Revenue Recognition"
and clarified the specification of what was considered vendor specific evidence
of fair value for the various elements in a multiple element arrangement was
adopted by the company on January 1, 2000. The adoption of the provisions of
this statement did not have a material impact on Mercator's operating results,
financial position or cash flows.
6
On December 3, 1999, the SEC staff issued Staff Accounting Bulletin No. 101,
Revenue Recognition in Financial Statements (SAB 101). SAB 101 as amended is
required to be adopted no later than October 1, 2000. Mercator is currently
performing an analysis of SAB 101, as amended, to determine the impact, if any,
on our future operating results, financial position or cash flows.
FASB Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation" (FIN 44) provides guidance for applying APB Opinion No. 25,
"Accounting for Stock Issued to Employees." With certain exceptions, FIN 44
applies prospectively to new awards, exchanges of awards in a business
combination, modifications to outstanding awards and changes in grantee status
on or after July 1, 2000. Mercator does not believe that the implementation of
FIN 44 will have a significant effect on our results of operations.
Other pronouncements issued by the FASB or other authoritative accounting
standard groups with future effective dates are either not applicable or are not
significant to the financial statements of Mercator.
(4) STOCK ACTIVITIES
Effective April 5, 1999, Mercator completed a 2 for 1 common stock split in the
form of a stock dividend. The accompanying financial statements have been
retroactively adjusted to reflect this common stock split.
On June 19, 2000, Mercator increased the number of authorized shares of common
stock from 70 million to 190 million. Also on this date, the Equity Incentive
Stock Option plan was amended to increase the number of options Mercator may
grant to its employees from 4,750,000 to 6,700,000 shares.
(5) COMPREHENSIVE INCOME
Mercator adopted the provisions of SFAS No. 130, "Reporting Comprehensive
Income" during 1998. SFAS 130 requires Mercator to report comprehensive income
in its financial statements, in addition to its net income. Comprehensive income
(loss) consists of net income (loss) and foreign currency translation
adjustments. The total comprehensive loss was ($30.7 million) and ($4.8 million)
for the six months ended June 30, 2000 and 1999, respectively.
(6) EARNINGS PER SHARE
Earnings per share is presented in accordance with the provisions of SFAS No.
128, "Earnings Per Share" (SFAS 128) and SAB No. 98. Under SFAS 128, basic
earnings per share ("EPS") excludes dilution for common stock equivalents and is
computed by dividing income or loss available to common shareholders by the
weighted average number of common shares outstanding for the period. Diluted EPS
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted and resulted in the
issuance of common stock.
Diluted loss per share has not been presented separately for the three and six
months ended June 30, 2000, as the outstanding stock options and warrants,
representing an aggregate of 3,160,541 shares of common stock equivalents, are
antidilutive.
(7) SEGMENT INFORMATION
In the fourth quarter of 1998, Mercator adopted SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information" (SFAS 131). SFAS 131
establishes standards for the way that public business enterprises report
information about operating segments. It also establishes standards for related
disclosures about products and services. The method for determining what
information to report is based on the way that management organizes the
operating segments within Mercator for making operational decisions and
assessments of financial performance.
As a result of recent international acquisitions and expansion, Mercator
classifies its business activities into two reportable segments: Domestic and
International. These segments are organized, managed and analyzed
geographically. Information regarding Mercator's operations in these two
operating segments are set forth below. There are no significant corporate
overhead allocations or intersegment sales or transfers between the segments for
the periods presented.
7
(Amounts in 000's)
Quarter Ended June 30, Six Months Ended June 30,
2000 1999 2000 1999
---- ---- ---- ----
Revenue:
Domestic $ 22,092 $ 15,785 $ 41,108 $30,506
International 13,604 7,859 25,840 10,374
-------- -------- -------- -------
Total 35,696 23,644 66,948 40,880
======== ======== ======== =======
Operating income before
amortization of intangible:
Domestic (1,640) 1,506 (1,909) 3,304
International 2,307 876 4,014 742
-------- -------- -------- -------
Total 667 2,382 2,105 4,046
Amortization of intangibles (12,251) (7,047) (23,228) (9,371)
Other income, net 139 231 294 742
Provision for income taxes 6,343 102 8,456 172
-------- -------- -------- -------
Net loss (17,788) (4,536) (29,285) (4,755)
======== ======== ======== =======
Capital expenditures:
Domestic 968 405 2,686 1,371
International 322 583 639 1,065
Depreciation expense:
Domestic 673 376 1,246 656
International 265 234 413 286
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following management's discussion and analysis of financial condition and
results of operations contains forward-looking statements that involve risks and
uncertainties. When used in the filing, the words "intend," "anticipate,"
"believe," "estimate," "plan" and "expect" and similar expressions as they
relate to Mercator are included to identify forward-looking statements. Our
actual results could differ materially from those anticipated in these forward-
looking statements as a result of certain factors including those set forth
under "Factors That may Affect Future Results" and elsewhere in this document.
The financial results included in this Form 10-Q are different from results
previously announced on July 20, 2000. In addition, Mercator has filed a Form
10-Q/A for the quarter ended March 31, 2000, which includes a restatement of our
results for that quarter. Mercator has taken and intends to continue to take
action to maintain existing client relationships and attract new customers.
While Mercator is undertaking these actions with the intent to maintain revenue
growth there can be no assurance that Mercator's revenue growth will continue at
prior levels or at all.
OVERVIEW
Mercator Software, Inc., was incorporated in Connecticut in 1985 as TSI
International Software Ltd. and reincorporated in Delaware in September 1993.
The name change to Mercator Software, Inc. became effective on April 3, 2000.
Mercator derives a majority of its revenues from the Mercator suite of products.
Mercator believes that future growth in revenues, if any, will be mainly
attributed to the Mercator suite of products. Mercator believes it cannot
accurately predict the amount of revenues that will be attributable to this
product line or the life of such products. To the extent our Mercator products
do not maintain continued market acceptance, the business will be adversely
affected.
Generally, Mercator recognizes revenue from software license fees upon delivery,
unless there are significant post-delivery obligations, in which case revenues
are recognized when these obligations are satisfied. This is the case with
certain customers who have purchased a financial services solution whereby
Mercator recognizes revenue using the percentage-of-completion method as
services are performed. Mercator intends to continue to increase the scope of
service offerings insofar as it supports the sale of license revenues from sales
of Mercator products. We believe that software licensing revenue will continue
to account for a larger portion of total revenues than service, maintenance and
other revenues.
8
Mercator can be used by information technology professionals as well as value
added resellers, independent software vendors, software integrators or other
third parties who resell, embed or otherwise bundle Mercator with their
products. License fee revenues are derived from direct sales of software
products through our direct sales force and indirect third parties.
International revenue accounted for 38.1% of total revenues for the three months
ended June 30, 2000 as compared to 33.2% of total revenues for the three months
ended June 30, 1999. The increase is primarily attributed to the purchase of
Braid in March of 1999 and the addition of a sales office in Frankfurt, Germany.
The size of orders can range from a few thousand dollars to over $1,000,000 per
order. The loss or delay of large individual orders, therefore, can have a
significant impact on revenue and other quarterly results. In addition,
Mercator generally recognizes a substantial portion of its quarterly software
licensing revenues in the last month of each quarter, and as a result, revenue
for any particular quarter may be difficult to predict in advance. Because
operating expenses are generally fixed, a delay in recognition of revenue from a
limited number of license transactions could cause significant variations in
operating results from quarter to quarter and could result in significant
losses. To the extent such expenses precede, or are not subsequently followed
by, increased revenue, operating results would be materially and adversely
affected. As a result of these and other factors, operating results for any
quarter are subject to variation, and period- to-period comparisons of results
of operations are not necessarily meaningful and should not be relied upon as
indications of future performance.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage of
total revenues represented by certain items from our statements of operations:
9
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
2000 1999 2000 1999
---- ---- ---- ----
Revenues:
Software licensing 57.1 53.1 57.8 54.7
Service, maintenance and other 42.9 46.9 42.2 45.3
------ ------ ------ ------
Total revenue 100.0 100.0 100.0 100.0
------ ------ ------ ------
Cost of revenues:
Software licensing 1.0 1.6 1.0 2.0
Service, Maintenance and other 20.6 22.1 21.6 23.2
------ ------ ------ ------
Total cost of revenues 21.6 23.7 22.6 25.2
------ ------ ------ ------
Gross profit 78.4 76.3 77.4 74.8
------ ------ ------ ------
Operating expenses:
Product development 14.3 15.7 15.2 14.5
Selling and marketing 48.7 42.2 46.5 40.6
General and administrative 13.6 8.3 12.5 9.8
Amortization of intangibles 34.3 29.8 34.7 22.9
------ ------ ------ ------
Total operating expenses 110.9 96.0 108.9 87.8
------ ------ ------ ------
Operating loss (32.5) (19.7) (31.5) (13.0)
Other income expense, net .4 1.0 .4 1.8
------ ------ ------ ------
Loss before taxes (32.1) (18.7) (31.1) (11.2)
Income tax expense 17.8 .4 12.6 .4
------ ------ ------ ------
Net Loss (49.9) (19.1) (43.7) (11.6)
====== ====== ====== ======
Gross profit:
Software licensing 98.2 97.0 98.3 96.3
Service, maintenance and other 52.1 52.8 48.8 48.9
====== ====== ====== ======
THREE MONTHS ENDED JUNE 30, 2000 COMPARED WITH THREE MONTHS ENDED JUNE 30, 1999
REVENUES
Total Revenues. Mercator's revenues are derived principally from two sources:
(i) license fees for the use of its Mercator name brand products and (ii)
service fees for maintenance, consulting services and training related to these
software products. Mercator's total revenues increased 51% to $35.7 million in
the second quarter of 2000 from $23.6 million in the comparable period of 1999.
This increase resulted primarily from increased license sales as well as from
increased billings for professional services.
10
Software Licensing. Software licensing revenues increased 63% to $20.4 million
in the second quarter of 2000 from $12.5 million in the comparable period of
1999, primarily due to an increase in Mercator product license revenues
including the completion of a $3,200,000 product license to a telecommunications
company. Domestic software licensing revenues increased $4.4 million to $13.2
million in the second quarter of 2000 from $8.8 million in the comparable period
of 1999, primarily due to an increase in Mercator license revenues as a result
of a larger customer base and increases in average licensing fees. International
software licensing revenues increased 90% to $7.2 million in the second quarter
of 2000 from $3.7 million in the same period of 1999. This increase was the
result of the greater market acceptance of Mercator products and the larger
salesperson base available to market our products.
Service, Maintenance and Other. Service, maintenance and other revenues
increased 38% to $15.3 million in the second quarter of 2000 from $11.1 million
in the comparable period of 1999, primarily due to higher professional services
associated with sales of Mercator products, and, to a lesser extent, an increase
in Mercator maintenance revenue, partially offset by a decrease attributable to
declining KEY/MASTER maintenance revenues. Domestic service, maintenance and
other revenues increased 26% to $8.9 million in the second quarter of 2000 from
$7.0 million in the comparable period of 1999. This increase was a result of
increased professional service needs of our Mercator product customers and the
related acquisition of service personnel to address them, as well as additional
maintenance revenues on Mercator's license sales. International service,
maintenance and other revenues increased $2.3 million to $6.4 million in the
second quarter 2000 from $4.1 million in the same period in 1999. This increase
is primarily attributed to the increased services on our Mercator product sales.
COST OF REVENUES
Cost of Revenues. Cost of software licensing revenues consists primarily of
media, manuals, distribution costs and the cost of third party software that
Mercator sub-licenses. Cost of service, maintenance and other revenues consists
primarily of personnel-related costs in providing maintenance, technical
support, consulting and training to customers. Gross margin on software
licensing revenues is higher than gross margin on service, maintenance and other
revenues, reflecting the low materials, packaging and other costs of software
products compared with the relatively high personnel costs associated with
providing maintenance, technical support, consulting and training services. Cost
of service, maintenance and other revenues also varies based upon the mix of
maintenance, technical support, consulting, and training services.
Total Cost of Revenues. Total cost of revenues increased 37% to $7.7 million in
the second quarter of 2000 from $5.6 million in the comparable period of 1999.
Cost of Software Licensing. Cost of software licensing revenues decreased 4% to
$367,700 in the second quarter of 2000 from $381,300 in the comparable period of
1999. The decrease is primarily due to the increased distribution of product and
documentation on CD Rom and electronic transmission of product over the WEB.
Software licensing gross margin increased to 98% for the second quarter of 2000
as compared to 97% for the same period in 1999.
Cost of Service, Maintenance and Other. Cost of service, maintenance and other
revenues increased 40% to $7.3 million in the second quarter of 2000 from $5.2
million for the same period in 1999. Gross margin on costs of service,
maintenance and other was 52% for the quarter ended June 30, 2000 as compared to
53% for the comparable period in 1999. Cost of service, maintenance and other
for domestic operations increased to $4.3 million for the three months ending
June 30, 2000 compared to $3.4 million for the same period in 1999. This
increase is primarily due to the increase in services performed for Mercator
product customers along with costs of training services purchased by our
increased customer base. Gross margin on domestic service, maintenance and
other, was 51% for the quarter ended June 30, 2000 and 49% in 1999. Gross margin
for the professional service component was 35%. The difference is related to
lower margins on professional services than on maintenance services. Cost of
service, maintenance and other for international operations increased to $3.0
million in the second quarter of 2000 from $1.8 million in the comparable period
of 1999. This increase was the result of our international expansion. Gross
margins on service, maintenance and other for international operations was 53%
for three months ending June 30, 2000.
OPERATING EXPENSES
Product Development. Product development expenses include expenses associated
with the development of new products and enhancements to existing products and
consist primarily of salaries, recruiting and other personnel- related expenses,
depreciation of development equipment, supplies, travel, and allocated
facilities and communications costs.
Product development costs increased 38% to $5.1 million in the second quarter of
2000 from $3.7 million in the second quarter of 1999, primarily due to increased
product development activities related to Mercator's product line. Product
development expenses as a percentage of total revenue decreased to 14% in the
second quarter of 2000 from 16% in the second quarter of 1999. Mercator
introduced three new products in the first half of 2000, with enhancements for
next generation products continuing to be developed. In
11
addition, in June we announced the future delivery of a new product, Mercator
Web Integrator, which we expect to begin beta testing in the second half of
2000. These products are key to Mercator's continued success in the market and
therefore research and development expenditures have increased and we plan to
increase such expenditures, to support the further development of these products
and other new products. Mercator believes that a significant level of research
and development expenditures is required to remain competitive. Accordingly,
Mercator anticipates that it will continue to devote substantial resources to
research and development. Mercator expects that the absolute dollar amount of
research and development expenses will increase, through at least the remainder
of 2000. To date, all research and development expenditures have been expensed
as incurred.
Selling and Marketing. Selling and marketing expenses consist of sales and
marketing personnel costs, including sales commissions, recruiting, travel,
advertising, lead generation, public relations, seminars, trade shows, product
descriptive literature and allocated facilities and communications costs.
Mercator continues to invest in sales and marketing to provide for increased
revenue opportunities in future periods. These investments include sales force
hires, as well as marketing programs intended to increase their productivity.
Selling and marketing costs increased 74% to $17.4 million in the second quarter
of 2000 from $10.0 million in the second quarter of 1999, primarily due to the
increased number of sales and marketing personnel, and increased expenditures
for related marketing, lead generation and advertising programs, including costs
associated with our corporate identity activities and e-business products.
Selling and marketing costs for international operations were $5.3 million for
the three-month period ending June 30, 2000. During the second quarter of 2000,
Mercator hired additional sales representatives and sales managers in the US,
Europe, and Asia Pacific, ending the second quarter with 112 field sales
personnel, excluding sales management and administration. This is an increase
from 97 at the end of the first quarter. Mercator also participated in three
significant trade shows, held Mercator Exchange, our annual customer and partner
conference, as well as increased spending on advertising in order to build brand
and product awareness. Selling and marketing expenses as a percentage of total
revenues increased to 49% in the second quarter of 2000 from 42% in the second
quarter of 1999. Mercator expects to continue hiring additional sales and
marketing personnel and to increase expenses through the remainder of 2000 to
drive awareness and opportunities for the Mercator E-business Broker suite of
products.
General and Administrative. General and administrative expenses consist
primarily of salaries, recruiting and other personnel-related expenses for
Mercator's administrative, executive and finance personnel as well as outside
legal and audit costs.
General and administrative expenses increased 147% to $4.8 million in the second
quarter of 2000 from $2.0 million in the second quarter of 1999, primarily due
to increased administrative costs to support Mercator's growth, including legal
and consulting fees. During the quarter ended June 30, 2000, Mercator made
significant additions to its senior management team in response to our growth.
New management positions included a Vice President of Human Resources, a General
Counsel, and a Vice President of Asia Pacific Operations. General and
administrative expenses as a percentage of total revenues increased to 14% for
the second quarter of 2000 from 8% for the second quarter of 1999. The Company
believes that the absolute dollar amount of its general and administrative
expenses will continue to increase as Mercator expands to support Mercator's
worldwide growth and to review and enhance our systems and finance and
administrative processes.
Amortization of intangibles. Intangible assets are comprised of the excess of
the purchase price and related costs of an acquired business over the value
assigned to tangible assets. The acquisitions made by Mercator were accounted
for under the purchase method of accounting. The purchase prices were allocated
to the tangible and identifiable intangible assets based on their estimated fair
values with any excess designated as goodwill. Intangible assets, including
goodwill, are amortized over their estimated useful lives, which range from
three to five years.
Amortization expense increased to $12.3 million for the three-month period
ending June 30, 2000 from $7.0 million for the same period in 1999 as a result
of the acquisition of Novera in September 1999. Amortization expense increased
from the quarter ended March 31, 2000 to the quarter ended June 30, 2000 as a
result of the increase in goodwill of $20 million in connection with the Braid
earnout. As of June 30, 2000 and 1999, Mercator had net intangible assets of
$147.0 million and $121.5 million, respectively.
OTHER INCOME (EXPENSE) NET
Net other income, represents income earned on Mercator's cash balances and
interest on term contracts. Net interest income decreased to $139,500 in the
second quarter of 2000 from $230,800 in the comparable period of 1999, due to
lower cash balances resulting from the acquisitions of Braid and Novera and the
subsequent reduction of interest-bearing investments. Borrowing expenses were
insignificant during the second quarter of 2000 as there are no outstanding debt
obligations of the company.
INCOME TAXES
Income tax expense increased to $6,343,100 for the second quarter of 2000 from
$102,000 for the second quarter of 1999. The Company's tax expense is calculated
by applying the expected full year effective tax rate to the Company's loss
before income taxes
12
for the interim period. The difference between Mercator's effective tax rate and
the US Statutory Rate is primarily attributable to non-deductible goodwill
amortization.
Income tax expense excludes the impact of deductions expected from additional
compensation expense related to the Company's stock options, the benefit of
which will be recorded in stockholders' equity. With the inclusion of this
benefit, the Company does not expect to pay significant U.S. Federal taxes in
2000. In addition, income tax expense for the full year could be reduced as a
result of increased costs expected to be incurred over the remainder of the
year.
SIX MONTHS ENDED JUNE 30, 2000 COMPARED WITH SIX MONTHS ENDED JUNE 30, 1999
REVENUES:
Total Revenues. Mercator's total revenues increased 64% to $66.9 million for the
six months ended June 30, 2000 from $40.9 million in the comparable period of
1999. This increase primarily resulted from increased license revenue as well as
increased revenue for professional services.
Software Licensing. Software license revenues increased 73% to $38.7 million for
the six months ended June 30, 2000 from $22.3 million in the comparable period
of 1999, primarily due to an increase in Mercator license revenues. Just over
50% of Mercator software license revenues come from our existing customers.
Domestic software license revenues increased $6.9 million to $24.6 million for
the six month period ended June 30, 2000 from $17.7 million in the comparable
period of 1999, primarily due to the increased market opportunity and acceptance
of the Mercator product suite including the completion of a $3.2 million product
license to a telecommunications company. International software license
revenues increased 203% to $14.1 million in the first half of 2000 from $4.6
million in the same period in 1999. This increase was the result of the
acquisition of Braid, Mercator's focus on growing our international channels,
the larger salesperson base available to license our products, and the
continuing opportunity to license the Mercator suite of products into the former
Braid organization's financial services customer base, as well as new European
and Asia Pacific customers.
Service, Maintenance and Other. Service, maintenance and other revenues
increased 52% to $28.2 million for the six months ended June 30, 2000 from $18.5
million in the comparable period of 1999, primarily due to higher utilization of
professional services, including training and implementation, associated with
sales of Mercator. Domestic service, maintenance and other revenues increased
29% to $16.6 million in the first half of 2000 from $12.8 million in the same
period in 1999. International service, maintenance and other revenues increased
$5.9 million to $11.6 million in the second quarter of 2000 from $5.7 million in
the same period in 1999. This increase is primarily due to the increased
Mercator license revenue derived from International customers.
COST OF REVENUES:
Total Cost of Revenues. Total cost of revenues increased 47% to $15.1 million in
the first six months of 2000 from $10.3 million in the comparable period of
1999.
Cost of Software Licensing. Cost of software licensing revenues decreased 20%
to $652,800 in the first six months of 2000 from $817,400 in the comparable
period of 1999. This decrease is primarily due to the increased distribution of
product and documentation on CD Rom and electronic transmission of product over
the Web. Software licensing gross margin was 98% and 96% for the six- month
period ended June 30, 2000 and 1999, respectively.
Cost of Service, Maintenance and Other. Cost of service, maintenance and other
revenues increased 53% to $14.5 million for the first six months of 1999 from
$9.5 million in the comparable period of 1999, primarily due to the increase in
services performed for Mercator product customers along with costs of training
services purchased by our increased customer base. Service, maintenance and
other gross margin was 49% for the six months ended June 30, 2000 and 1999.
Domestic and international gross margins were both 49% for the six months ended
June 30, 2000.
OPERATING EXPENSES
Product Development. Product development costs increased 72% to $10.2 million
for the six months ended June 30, 2000 from $5.9 million in the comparable
period of 1999, primarily due to increased product development activities
related to the Mercator E-business Broker Suite, as well as the acquisition of
Novera. Product development expenses as a percentage of total revenue remained
consistent at 15% for the first six months of 2000 and 1999. Mercator believes
that a significant level of research and development expenditures is required to
remain competitive. Accordingly, Mercator anticipates that it will continue to
devote substantial resources to research and development.
Selling and Marketing. Selling and marketing costs increased 88% to $31.2
million in the first half of 2000 from $16.6 million in the
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first half of 1999, primarily due to the increased number of sales and marketing
personnel as a result of Mercator's growth from 1999 to 2000, and increased
expenditures for related markets, lead generation, and advertising activities
including costs associated with our corporate identity programs and E-business
products. Selling and marketing expenses as a percentage of total revenues
increased to 47% in the first six months of 2000 from 41% in the first six
months of 1999. Mercator anticipates that sales and marketing expenses will
continue to increase in absolute dollar amount as the company grows so that the
company can maximize its revenue opportunity in the market. Mercator expects to
continue to hire additional sales and marketing personnel and to increase
expenses through the remainder of 2000 to drive awareness and opportunities for
the Mercator E-business Broker suite of products. In particular, we expect these
expenses to increase in the third quarter and beyond as we work to maintain
existing client relationships and attract new customers.
General and Administrative. General and administrative expenses increased 108%
to $8.4 million in the first six months of 2000 from $4.0 million in the first
six months of 1999, primarily due to increased headcount and other
administrative costs to support Mercator's growth including increased legal and
consulting costs. General and administrative expenses as a percentage of total
revenues increased to 12% for the first half of 2000 from 10% for the first half
of 1999. Mercator believes that the dollar amount of its general and
administrative expenses will continue to increase as we expand our
infrastructure staff to support our worldwide growth and review and enhance our
systems and finance and administrative processes. In particular, we expect these
expenses to increase in the third quarter and beyond as we recruit and hire
interim and permanent finance staff, including a chief financial officer and a
controller, and incur additional expenses to retain and incentivize our
employees, and review and enhance our systems and administrative processes.
Amortization of intangibles. Amortization expense increased to $23.2 million for
the six-month period ending June 30, 2000 from $9.4 million for the same period
in 1999 as a result of the acquisition of Braid in March 1999 and Novera in
September 1999. As of June 30, 2000 and 1999, Mercator had net intangible assets
of $147.0 million and $121.5 million, respectively.
OTHER INCOME (EXPENSE) NET
Net interest income decreased to $293,700 in the first six months of 2000 from
$741,900 in the comparable period of 1999, due to lower cash balances resulting
from the acquisitions of Braid and Novera and the subsequent reduction of
interest-bearing investments.
INCOME TAXES
Income tax expense increased to $8,456,400 for the six month period ended June
30, 2000 from $172,000 for the same period of 1999. The Company's tax expense is
calculated by applying the expected full year effective tax rate to the
Company's loss before income taxes for the interim period. The difference
between Mercator's effective tax rate and the US Statutory Rate is primarily
attributable to non-deductible goodwill amortization. Income tax expense
excludes the impact of deductions expected from additional compensation expense
related to the Company's stock options, the benefit of which will be recorded in
stockholders' equity. With the inclusion of this benefit the Company does not
expect to pay significant U.S. Federal Taxes in 2000. In addition, income tax
expense for the full year could be reduced as a result of increased costs
expected to be incurred over the remainder of the year.
LIQUIDITY AND CAPITAL RESOURCES
On June 30, 2000, Mercator had net working capital of $41.2 million, which
included cash and marketable securities of $17.5 million. Operating activities
provided (used) net cash of $3.0 million and ($3.5 million) during the six
months ended June 30, 2000 and 1999, respectively. The cash provided in the six
months ended June 30, 2000 was due to increases in accounts payable and accrued
expenses, offset by an increase in accounts receivable.
Investing activities (used) net cash of ($2.1 million) during the six months
ended June 30, 2000, primarily for the purchase of furniture, fixtures, and
equipment to support Mercator's growth, offset by the sale of marketable
securities. Investing activities (used) net cash of ($9.8 million) during the
six months ended June 30, 1999 primarily for the purchase of Braid Group Limited
in March of 1999, and the purchase of fixed assets, offset by the sale of
marketable securities.
Financing activities provided net cash of $3.9 million and $1.0 million for the
six months ended June 30, 2000 and 1999, respectively. The cash provided for
2000 and 1999 was due to proceeds from sale of stock through employee stock
option exercises and employee stock purchase plan purchases.
Net accounts receivable was $43.7 million at June 30, 2000 compared to $26.3
million at June 30, 1999. The number of days sales in accounts receivables was
110 at June 30, 2000 compared to 100 at June 30, 1999. The increase in accounts
receivable is due to the large percentage of sales billed during the last month
of the quarter.
Capital expenditures have been, and future capital expenditures are anticipated
to be primarily for facilities, equipment and computer software to support
expansion of Mercator's operations. As of June 30, 2000, Mercator had no
material commitments for capital
14
expenditures.
In April 2000, Mercator entered into a three year agreement with Fleet Bank for
a $20 million dollar line of credit. This line is to ensure Mercator has the
funds necessary to take advantage of any opportunity that may require additional
capital. There has been no draw on this line since inception.
Mercator believes that its current cash and cash equivalent balances and any net
cash generated by operations and available bank line will be sufficient to meet
its anticipated cash needs for working capital, capital expenditures, employee
retention, recruiting, and incentive costs; systems and finance and
administrative process review and enhancements; and business growth for at least
the next 12 months.
CONVERSION TO A SINGLE EUROPEAN CURRENCY
Mercator has sales in a number of foreign countries, but at the present time
they are not significant and the conversion to a single European currency has
not had and is not expected to have a material impact on Mercator's financial
results.
FACTORS THAT MAY AFFECT FUTURE RESULTS
Our quarterly and annual operating results are volatile and difficult to predict
and may have caused our stock price to fluctuate and may cause our stock price
to fluctuate in the future
Our quarterly and annual operating results have varied significantly in the past
and are expected to do so in the future. We believe that you should not rely on
period to period comparisons of our results of operations, as they are not
necessarily indications of our future performance. In some future periods, our
results of operations may be below the expectation of public market analysts and
investors. In this case, the price of our common stock would likely decline.
Our revenues and results of operations are difficult to forecast and depend on a
variety of factors. These factors include the following:
. the size, timing and terms of individual license transactions;
. the sales cycle for our products;
. demand for and market acceptance of our products and related services,
particularly our Mercator products;
. personnel changes, our ability to attract and retain qualified sales,
professional services and research and development personnel and the rate at
which this personnel becomes productive;
. our ability to expand, and market acceptance of, our services business;
. the timing of our expenditures in anticipation of product releases or
increased revenue;
. the timing of product enhancements and product introductions by us and our
competitors;
. market acceptance of enhanced versions of our existing products and of new
products;
. changes in pricing policies by our competitors and us;
. variations in the mix of products and services sold by us;
. the mix of channels through which our products and services are sold;
. our success in penetrating international markets;
. the buying patterns and budgeting cycles of customers; and
. general economic conditions.
We have historically derived a substantial portion of our revenues from the
licensing of our software products, and we anticipate that this trend will
continue for the foreseeable future. Software license revenues are difficult to
forecast for a number of reasons, including
15
the following:
. we typically do not have a material backlog of unfilled orders, and revenues
in any quarter substantially depend on orders booked and shipped in that
quarter;
. the length of the sales cycles for our products can vary significantly from
customer to customer and from product to product and can be as long as nine
months or more;
. the terms and conditions of individual license transactions, including prices
and discounts, are often negotiated based on volumes and commitments, and may
vary considerably from customer to customer; and
. we have generally recognized a substantial portion of our quarterly software
licensing revenues in the last month of each quarter.
Accordingly, the cancellation or deferral of even a small number of purchases of
our products could harm our business.
It would be difficult for us to adjust our spending if we experience any revenue
shortfalls
Our future revenues will also be difficult to predict and we could fail to
achieve our revenue expectations. Our expense levels are based, in part, on our
expectation of future revenues, and expense levels are, to a large extent, fixed
in the short term. We may be unable to adjust spending in a timely manner to
compensate for any unexpected revenue shortfall. If revenue levels are below
expectations for any reason, our operating results are likely to be harmed. Net
income may be disproportionately affected by a reduction in revenue because
large portions of our expenses are related to headcount that cannot be easily
reduced without harming our business.
In addition, we currently intend to increase our operating expenses by our
appointment of a chairman of the board of directors, recruiting and hiring
additional interim and permanent finance staff and other staff (including a
chief financial officer and a controller), incurring additional expenses to
retain our employees and attract new employees, including expanding our research
and product development staff (particularly research and development personnel
to be devoted to our Mercator product line), increasing our sales and marketing
and professional services operations, expanding distribution channels, and
hiring personnel in other operating areas. In addition, we expect to incur
additional expenses to retain and motivate our employees and to maintain our
existing relationships with customers and attract new customers. We also expect
to experience a significant time lag between the date professional services,
sales, and technical personnel are hired and the date employees become fully
productive. The timing of expansion and the rate at which new technical,
professional services, and sales personnel become productive as well as the
timing of the introduction and success of new distribution channels could cause
material fluctuations in our results of operations. Furthermore, to the extent
increased operating expenses precede or are not subsequently followed by
increased revenues, our business could be harmed. We also expect to incur
additional costs to review and enhance our systems and future administrative
processes.
We may experience seasonal fluctuations in our revenues or results of
operations
It is not uncommon for software companies to experience strong fourth quarters
followed by weaker first quarters, in some cases with sequential declines in
revenues or operating profit. We believe that many software companies exhibit
this pattern in their sales cycles primarily due to customers' buying patterns
and budget cycles. We may display this pattern in future years.
We depend on the sales of our Mercator products and related services
We introduced our products in 1993. In recent years, a significant portion of
our revenue has been attributable to licenses of our Mercator products and
related services, and we expect that revenue attributable to our Mercator
products and related services will continue to represent a significant portion
of our total revenue for the foreseeable future. Accordingly, our future
operating results significantly depend on the market acceptance and growth of
our Mercator product line and enhancements of these products and services.
Market acceptance of our Mercator product line may not increase or remain at
current levels, and we may not be able to successfully market our Mercator
product line or develop extensions and enhancements to this product line on a
long-term basis. In the event that our current or future competitors release new
products that provide, or are perceived as providing, more advanced features,
greater functionality, better performance, better compatibility with other
systems or lower prices than our Mercator product line, demand for our products
and services would likely decline. A decline in demand for, or market acceptance
of, our Mercator product line would harm our business.
We may experience difficulties in developing and introducing new or enhanced
products necessitated by technological changes
Our future success all depend, in part, upon our ability to anticipate changes,
to enhance our current products and to develop and introduce new products that
keep pace with technological advancements and address the increasingly
sophisticated needs of our
16
customers. Our products may be rendered obsolete if we fail to anticipate or
react to change.
Development of enhancements to existing products and new products depends, in
part, on a number of factors, including the following:
. the timing of releases of new versions of applications systems by vendors;
. the introduction of new applications, systems or computing platforms;
. the timing of changes in platforms;
. the release of new standards or changes to existing standards; and
. Changing customer requirements.
Our product enhancements or new products may not adequately meet the
requirements of the marketplace or achieve any significant degree of market
acceptance. In addition, our introduction or announcement, or by one or more of
our current or future competitors, of products embodying new technologies or
features could render our existing products obsolete or unmarketable. Our
introduction or announcement of enhanced or new product offerings or by our
current or future competitors may cause customers to defer or cancel purchases
of our existing products. Any deferment or cancellation of purchases could harm
our business.
We could experience delays in developing and releasing new products or product
enhancements
We may experience difficulties that could delay or prevent the successful
development, introduction and marketing of new products or product enhancements.
We have in the past experienced delays in the introduction of product
enhancements and new products and we may experience delays in the future.
Furthermore, as the number of applications, systems and platforms supported by
our products increases, we could experience difficulties in developing, on a
timely basis, product enhancements which address the increased number of new
versions of applications, systems or platforms served by our existing products.
If we fail, for technological or other reasons, to develop and introduce product
enhancements or new products in a timely and cost-effective manner or if we
experience any significant delay in product development or introduction, our
customers may delay or decide against purchases of our products, which could
harm our business.
Our future success depends on retaining our key personnel and attracting and
retaining additional highly qualified employees
Our future success depends in large part on the continued service of our key
sales, professional services and research and development personnel, as well as
senior management. All employees are employed at-will and we have no fixed-term
employment agreements with our employees, which allows them to terminate their
employment at any time. The loss of the services of any of one or more of our
key employees could harm our business.
The current absence of senior financial officers could have an adverse impact on
certain aspects of Mercator's day to day operations
Our future success also depends on our ability to attract, train and retain
highly qualified sales, research and development, professional services and
managerial personnel, particularly sales, professional services and research and
development personnel with expertise in enterprise resource planning systems.
Competition for these personnel is intense. We may not be able to attract,
assimilate or retain qualified personnel. We have at times experienced, and we
continue to experience, difficulty in recruiting qualified sales and research
and development personnel, and we anticipate these difficulties will continue in
the future. Furthermore, we have in the past experienced, and in the future we
expect to continue to experience, a significant time lag between the date sales,
research and development and professional services personnel are hired and the
date these employees become fully productive.
We may encounter difficulties in managing our growth
Our business has grown in recent periods, with total revenues increasing from
approximately $16.1 million in 1995 to $98.6 million in 1999. We acquired the
assets of Software Consulting Partners in November 1998, Braid Group Limited in
March 1999, and Novera Software, Inc. in September 1999. The growth of our
business has placed, and is expected to continue to place, a strain on our
administrative, financial, sales and operational resources and increased demands
on our systems and controls. For example, we noted an increase in quarterly days
sales outstanding from June 30, 1999 to June 30, 2000 from approximately 100
days to approximately 110 days, and an increase in net accounts receivable from
$26.3 million to $43.7 million.
17
To deal with these concerns, we have recently implemented, or are in the process
of implementing and will implement in the future, a variety of new and upgraded
operational and financial systems, procedures and controls. In addition, we
intend to hire additional administrative personnel. We may not be able to
successfully complete the implementation and integration of these systems,
procedures and controls, or hire additional personnel, in a timely manner. The
failure of our management to respond to, and manage, our growth and changing
business conditions, or to adapt our operational, management and financial
control systems to accommodate our growth could harm our business.
The success of our products will also depend upon the success of the platforms
we target
We may, in the future, seek to develop and market enhancements to existing
products or new products, which are targeted for applications, systems or
platforms that we believe, will achieve commercial acceptance. This could
require us to devote significant development, sales and marketing personnel, as
well as other resources, to these efforts, which would otherwise be available
for other purposes. We may not be able to successfully identify these
applications, systems or platforms, and even if we do so, they may not achieve
commercial acceptance or we may not realize a sufficient return on our
investment. Failure of these targeted applications, systems or platforms to
achieve commercial acceptance or our failure to achieve a sufficient return on
our investment could harm our business.
We may not successfully expand our sales and distribution channels
An integral part of our strategy is to expand our indirect sales channels,
including value-added resellers, independent software vendors, systems
integrators and distributors. This channel is accounting for a growing
percentage of our total revenues and we are increasing resources dedicated to
developing and expanding these indirect distribution channels. We may not be
successful in expanding the number of indirect distribution channels for our
products. If we are successful in increasing our sales through indirect sales
channels, we expect that those sales will be at lower per unit prices than sales
through direct channels, and revenue we receive for each sale will be less than
if we had licensed the same product to the customer directly.
Selling through indirect channels may also limit our contact with our customers.
As a result, our ability to accurately forecast sales, evaluate customer
satisfaction and recognize emerging customer requirements may be hindered.
Even if we successfully expand our indirect distribution channels, any new value
added resellers, independent software vendors, system integrators or
distributors may offer competing products, or have no minimum purchase
requirements of our products. These third parties may also not have the
technical expertise required to market and support our products successfully. If
the third parties do not provide adequate levels of services and technical
support, our customers could become dissatisfied, or we would have to devote
additional resources for customer support. Our brand name and reputation could
be harmed. Selling products through indirect sales channels could cause
conflicts with the selling efforts of our direct sales force.
Our strategy of marketing products directly to end-users and indirectly through
value added resellers; independent software vendors, systems integrators and
distributors may result in distribution channel conflicts. Our direct sales
efforts may compete with those of our indirect channels and, to the extent
different resellers target the same customers, resellers may also come into
conflict with each other. Although we have attempted to manage our distribution
channels to avoid potential conflicts, channel conflicts may harm our
relationships with existing value added resellers, independent software vendors,
systems integrators or distributors or impair our ability to attract new value
added resellers, independent software vendors, systems integrators and
distributors.
We may face significant risks in expanding our international operations
International revenues accounted for 11.8% of our total revenues for 1998
however, as a result of the acquisitions of Braid, and the establishment of a
sales office in Germany during 1999, international revenues accounted for 25% of
our total revenues for the first half of 1999 and 39% for the first half of
2000. Continued expansion of our international sales and marketing efforts will
require significant management attention and financial resources. We also expect
to commit additional time and development resources to customizing our products
for selected international markets and to developing international sales and
support channels.
International operations involve a number of additional risks, including the
following:
. impact of possible recessionary environments in economies outside the United
States;
. longer receivables collection periods and greater difficulty in accounts
receivable collection;
. unexpected changes in regulatory requirements;
18
. dependence on independent resellers;
. reduced protection for intellectual property rights in some countries,
tariffs and other trade barriers;
. foreign currency exchange rate fluctuations;
. difficulties in staffing and managing foreign operations;
. the burdens of complying with a variety of foreign laws;
. potentially adverse tax consequences; and
. political and economic instability.
To the extent that our international operations expand, we expect that an
increasing portion of our international license and service and other revenues
will be denominated in foreign currencies, subjecting us to fluctuations in
foreign currency exchange rates. We do not currently engage in foreign currency
hedging transactions. However, as we continue to expand our international
operations, exposures to gains and losses on foreign currency transactions may
increase. We may choose to limit our exposure by the purchase of forward foreign
exchange contracts or similar hedging strategies. The currency exchange strategy
that we adopt may not be successful in avoiding exchange-related losses. In
addition, the above-listed factors may cause a decline in our future
international revenue and, consequently, may harm our business. We may not be
able to sustain or increase revenue that we derive from international sources.
Our success depends upon the widespread use and adoption of the internet and
intranets
We believe that demand for enterprise application integration solutions, such as
those that we offer, will depend, in part, upon the adoption by businesses and
end-users of the internet and intranets as platforms for electronic commerce and
communications. The internet and intranets are new and evolving, and they may
not be widely adopted, particularly for electronic commerce and communications
among businesses. Critical issues concerning the internet and intranets,
including security, reliability, cost, ease of use and access and quality of
service, and remain unresolved at this time, inhibiting adoption by many
enterprises and end- users. If the internet and intranets are not widely used by
businesses and end- users, particularly for electronic commerce, this could harm
our business.
Government regulation and legal uncertainties relating to the internet could
adversely affect our business
Congress has recently passed legislation and several more bills have recently
been sponsored in both the House and Senate that are designed to regulate
certain aspects of the internet, including on-line content, copyright
infringement, user privacy, taxation, access charges, liability for third-party
activities and jurisdiction. In addition, federal, state, local and foreign
governmental organizations are also considering other legislative and regulatory
proposals that would regulate the internet. Areas of potential regulation
include libel, pricing, quality of products and services, and intellectual
property ownership.
The laws governing the use of the internet, in general, remain largely
unsettled, even in areas where there has been some legislative action. It may
take years to determine whether and how existing laws such as those governing
intellectual property; privacy, libel and taxation apply to the internet. In
addition, the growth and development of the market for online commerce may
prompt calls for more stringent consumer protection laws, both in the United
States and abroad. This occurrence may impose additional burdens on companies
conducting business online by limiting how information can flow over the
internet and the type of information that can flow over the internet. The
adoption or modification of laws or regulations relating to the internet could
adversely affect our business.
It is not known how courts will interpret both existing and new laws. Therefore,
we are uncertain as to how new laws or the application of existing laws will
affect our business. In addition, our clients who may be subject to such
legislation may indirectly affect our business. Increased regulation of the
internet may decrease the growth in the use of the internet, which could
decrease the demand for our services, increase our cost of doing business or
otherwise have a material adverse effect on our business, results of operations
and financial condition.
Capacity constraints caused by growth in the use of the internet may, unless
resolved, impede further development of the internet to the extent that users
experience delays, transmission errors and other difficulties. Further, the
adoption of the internet for commerce and communications, particularly by those
individuals and companies that have historically relied upon alternative means
of commerce and communication generally requires the understanding and
acceptance of a new way of conducting business and exchanging information. In
particular, companies that have already invested substantial resources in other
means of conducting commerce and exchanging information may be particularly
reluctant or slow to adopt a new internet-based strategy that may make their
existing personnel and infrastructure obsolete. If the necessary infrastructure,
products, services or facilities are not developed, or if the internet does not
19
become a viable commercial medium, our business, results of operations and
financial condition could be materially and adversely affected.
The United States Omnibus Appropriations Act of 1998 places a moratorium on
taxes levied on internet access from October 1, 1998 to October 21, 2001.
However, states may place taxes on internet access if taxes had already been
generally imposed and actually enforced prior to October 1, 1998. States which
can show they enforced internet access taxes prior to October 1, 1998 and states
after October 21, 2001 may be able to levy taxes on internet access resulting in
increased cost to access to the internet, resulting in a material adverse effect
on our business.
We face significant competition in the market for e-business integration
software
The market for our products and services is extremely competitive and subject to
rapid change. Because there are relatively low barriers to entry in the software
market, we expect additional competition from other established and emerging
companies.
In the e-business integration market, our Mercator products and related services
compete primarily against solutions developed internally by individual
businesses to meet their specific e-business integration needs. In addition, we
face increasing competition in the e-business integration market from other
third-party software vendors.
Many of our current and potential competitors have longer operating histories,
significantly greater financial, technical, product development and marketing
resources, greater name recognition and larger customer bases than we do. Our
present or future competitors may be able to develop products that are
comparable or superior to those we offer, adapt more quickly than we do to new
technologies, evolving industry trends or customer requirements, or devote
greater resources than we do to the development, promotion and sale of their
products. Accordingly, we may not be able to compete effectively in our target
markets against these competitors.
We expect that we will face increasing pricing pressures from our current
competitors and new market entrants. Our competitors may engage in pricing
practices that reduce the average selling prices of our products and related
services. To offset declining average selling prices, we believe that we must
successfully introduce and sell enhancements to existing products and new
products on a timely basis. We must also develop enhancements to existing
products and new products that incorporate features that can be sold at higher
average selling prices. To the extent that enhancements to existing products and
new products are not developed in a timely manner, do not achieve customer
acceptance or do not generate higher average selling prices, our operating
margins may decline.
We have only limited protection for our proprietary technology
Our success is dependent upon our proprietary software technology. We do not
currently have any patents and we rely principally on trade secret, copyright
and trademark laws, nondisclosure and other contractual agreements and technical
measures to protect our technology. We also believe that factors such as the
technological and creative skills of our personnel, product enhancements and new
product developments are essential to establishing and maintaining a technology
leadership position. We enter into confidentiality and/or license agreements
with our employees, distributors and customers, and we limit access to and
distribution of our software, documentation and other proprietary information.
The steps that we have taken may not be sufficient to prevent misappropriation
of our technology, and these protections do not preclude competitors from
developing products with functionality or features similar to our products.
Third parties could also independently develop competing technologies that are
substantially equivalent or superior to our technologies. Furthermore, effective
copyright and trade secret protection may be unavailable or limited outside of
the United States. Any failure by or inability of us to protect our proprietary
technology could harm our business.
We may become subject to infringement claims
Although we do not believe that our products infringe the proprietary rights of
any third parties, third parties might assert infringement claims against us or
our customers in the future. Furthermore, we may initiate claims or litigation
against third parties for infringement of our proprietary rights or to establish
the validity of our proprietary rights. Litigation, either as plaintiff or
defendant, would cause us to incur substantial costs and divert management
resources from productive tasks. Any litigation, regardless of the outcome,
could harm our business. Furthermore, parties making claims against us could
secure substantial damages, as well as injunctive or other equitable relief,
which could effectively block our ability to license our products in the United
States or abroad. A large monetary judgment could harm our business.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Mercator is exposed to market risk primarily through its investments in
marketable securities. Mercator investment policy calls for investment in short
term, low risk instruments. As of June 30, 2000, investments in marketable
securities were $4.2 million. Due to the nature of these investments, any
decrease in rates would not have material impact on Mercator's financial
statements.
20
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On or about February 1, 2000, Mercator was named as a defendant and served with
a complaint in an action entitled Carpet Co-Op of America Association, Inc. and
---------------------------------------------
FloorLINK, L.L.C. v. TSI International Software Ltd., Civil Action No. 00CC-
- ----------------------------------------------------
00231, pending in the Circuit Court of St. Louis County, Missouri (the "Missouri
Action"). The complaint includes counts of breach of contract, fraud and
negligent misrepresentation in connection with certain software implementation
work provided under contract by Mercator. The plaintiffs allege that Mercator
failed to provide and implement certain software products and designs within an
alleged time requirement and misrepresented Mercator's ability to implement the
products within that timeframe. The complaint seeks an unspecified damage amount
in excess of $2 million. On or about March 30, 2000, plaintiffs in the Missouri
Action filed an amended complaint adding a claim of negligence in connection
with the contract. On April 10, 2000, Mercator filed a motion to dismiss the
Missouri Action in its entirety, which currently is pending. Mercator believes
that the allegations in the amended complaint in the Missouri Action are without
merit and intends to contest them vigorously.
On March 30, 2000, Mercator filed an action entitled TSI International Software
--------------------------
Ltd. (d/b/a Mercator Software Inc.) v. Carpet Co-op of America Association, Inc.
- --------------------------------------------------------------------------------
and FloorLink, LLC, Civil Action No. 300-CV-603 (SRU) in the United States
- ------------------
District Court for the District of Connecticut (the "Connecticut Action"). The
Connecticut Action asserts claims for copyright infringement, trademark
infringement, unfair competition, misappropriation of trade secrets, breach of
contract, fraud, unjust enrichment and violation of the Connecticut Unfair Trade
Practices Act, in connection with the software implementation project at issue
in the Missouri Action. Mercator's complaint in the Connecticut Action alleges
that the defendants have failed to pay the more than $1.7 million still owed to
Mercator under the contract, and that, during the course of the project, the
defendants fraudulently misappropriated certain of Mercator's copyrighted
software, trademarks and other software implementation related trade secrets. On
May 9, 2000, the court in the Connecticut Action entered a Stipulated Injunction
barring the defendants from using, copying or disclosing any of Mercator's
copyrighted software, trademarks or other trade secrets or proprietary
information.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On April 13, 2000 Mercator distributed 218,302 shares of common stock at an
average price of $91.62 based on the achievement of operating results in
accordance with the Stock Purchase Agreement by and among Mercator Software,
Inc., and the Stockholders of Braid Group Limited dated March 18, 1999. The
shares issued to the Braid Stockholders were issued in reliance on the
exemptions for non-public offerings provided by Rule 506 and Section 4(2) of the
Securities Act of 1933. These shares constitute "restricted securities" under
Rule 144 of the Securities Act of 1933. The provisions of Rule 144 permit
limited resale of "restricted securities" subject to mandatory holding periods,
volume limitations and other restrictions.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On June 19, 2000, at Mercator's Annual Meeting of Stockholders, the stockholders
approved the proposals listed below. Proxies were solicited by Mercator
pursuant to Regulation 14A under the Securities Exchange Act of 1934, as
amended.
As of April 24, 2000 the record date for the Annual Meeting, there were
approximately 28,763,083 shares of Mercator Common Stock outstanding and
entitled to vote, of which 23,606,115 were present in person by proxy and voted
at the meeting.
1. Proposal to elect five directors of the Company each to serve until the next
Annual Meeting of stockholders and until his or her successor is duly elected
and qualified or until his earlier resignation or removal.
For Withheld
---------- --------
Constance F. Galley 23,505,460 100,655
Ernest E. Keet 23,509,460 96,655
Richard Little 23,501,911 104,204
James P. Schadt 23,509,560 96,555
Dennis G. Sisco 23,509,285 96,830
2. Proposal to amend the Certificate of Incorporation to increase the number of
shares of common stock reserved for issuance thereunder to 190,000,000 shares.
21
For 16,631,277
Against/Withheld 6,966,718
Abstain 8,120
3. Proposal to amend Mercator's 1997 Equity Incentive Plan to increase the
number of shares reserved for issuance thereunder by 1,950,000 shares to an
aggregate of 6,7000,000 shares.
For 13,810,536
Against/Withheld 7,670,873
Abstain 9420
4. Proposal to ratify the selection of KPMG LLP as Mercator's independent
accountants for the fiscal year ending December 31, 2000.
For 23,597,877
Against/Withheld 4349
Abstain 3889
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibit Description of Exhibit
------- ----------------------
3.1 Amended and Restated Certificate of Incorporation as
amended, of the Registrant
10.1 Credit Agreement between Registrant and Fleet National
Bank dated as of February 25, 2000
27.1 Financial Data Schedule
22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MERCATOR SOFTWARE, INC.
Dated: August 21, 2000 By: /s/ Constance F. Galley
-----------------------
President and Chief Executive Officer
Dated: August 21, 2000 By: /s/ Constance F. Galley
-----------------------
principal executive officer
Exhibit Index
Exhibit Description of Exhibit
- ------- ----------------------
3.1.................................Amended and Restated Certificate of
Incorporation, as amended, of the
Registrant.
10.1................................Credit Agreement between the Registrant and
Fleet National Bank dated as of February 25,
2000
27.1................................Financial Data Schedule
23