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 September 30, 2000
OR
[ ] 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 0-17920
Metasolv Software, Inc.
(Exact name of registrant as specified in its charter)
Delaware 75-2436509
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
5560 Tennyson Parkway
Plano, Texas 75024
(Address of principal executive offices)
Registrant's telephone number, including area code: (972) 403-8300
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
As of October 31, 2000, there were 35,739,916 shares of the registrant's common
stock outstanding.
METASOLV SOFTWARE, INC.
INDEX
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Balance Sheets - September 30, 2000 and December 31, 1999................ 3
Condensed Statements of Operations - For the Three and Nine
Months Ended September 30, 2000 and 1999........................................... 4
Condensed Statements of Cash Flows - For the Nine Months Ended
September 30, 2000 and 1999........................................................ 5
Notes to Condensed Financial Statements............................................ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.......................................................... 7
Item 3. Quantitative and Qualitative Disclosures About Market Risk......................... 18
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K................................................... 19
SIGNATURES....................................................................................... 20
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
METASOLV SOFTWARE, INC.
Condensed Balance Sheets
(In thousands, except share data)
ASSETS
------
September 30, December 31,
2000 1999
-------- --------
(Unaudited)
Current assets:
Cash and cash equivalents........................................ $113,852 $112,341
Marketable securities............................................ 5,061 --
Trade accounts receivable, less allowance for doubtful accounts
of $4,968 in September 2000 and $1,523 in 1999................ 23,562 16,755
Unbilled receivables............................................. 1,916 4,064
Prepaid expenses................................................. 5,467 1,845
Other current assets............................................. 4,726 2,203
-------- --------
Total current assets.......................................... 154,584 137,208
Property, plant and equipment, net................................. 13,118 9,950
Equity investments................................................. 4,000 --
Other assets....................................................... 7,176 58
-------- --------
Total assets.................................................. $178,878 $147,216
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Accounts payable................................................ $ 8,758 $ 5,503
Accrued expenses................................................ 15,335 11,094
Deferred revenue................................................ 17,449 11,694
-------- --------
Total current liabilities...................................... 41,542 28,291
Deferred income taxes............................................. 200 310
Stockholders' equity:
Preferred stock, $.01 par value, 10,000,000 shares authorized,
no shares issued or outstanding................................ -- --
Common stock, $.005 par value, 100,000,000 shares authorized,
35,673,866 issued at September 30, 2000 and 34,504,334
issued at December 31, 1999.................................... 179 172
Additional paid-in capital...................................... 123,785 116,508
Deferred compensation........................................... (343) (556)
Treasury stock, at cost, 24,000 shares at December 31, 1999..... -- (14)
Retained earnings............................................... 13,515 2,505
-------- --------
Total stockholders' equity..................................... 137,136 118,615
-------- --------
Total liabilities and stockholders' equity..................... $178,878 $147,216
======== ========
See Notes to Condensed Financial Statements
-3-
METASOLV SOFTWARE, INC.
Condensed Statements of Operations
(In thousands, except per share data)
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2000 1999 2000 1999
------- ------- ------- -------
(Unaudited) (Unaudited)
Revenues:
License............................ $19,216 $10,038 $48,153 $27,202
Service............................ 16,570 8,811 45,920 23,783
------- ------- ------- -------
Total revenues.................. 35,786 18,849 94,073 50,985
------- ------- ------- -------
Cost of revenues:
License............................ 901 362 2,031 1,262
Service............................ 8,926 6,600 26,235 18,293
------- ------- ------- -------
Total cost of revenues.......... 9,827 6,962 28,266 19,555
------- ------- ------- -------
Gross profit.................... 25,959 11,887 65,807 31,430
------- ------- ------- -------
Operating expenses:
Research and development........... 8,450 4,675 22,528 12,017
Sales and marketing................ 6,287 3,940 17,525 9,940
General and administrative......... 5,875 2,394 13,430 7,496
------- ------- ------- -------
Total operating expenses........ 20,612 11,009 53,483 29,453
------- ------- ------- -------
Income from operations............... 5,347 878 12,324 1,977
Interest and other income (expense),
net................................ 2,016 (49) 5,604 87
------- ------- ------- -------
Income before taxes.................. 7,363 829 17,928 2,064
Income tax expense................... 2,677 366 6,918 890
------- ------- ------- -------
Net income........................... $ 4,686 $ 463 $11,010 $ 1,174
======= ======= ======= =======
Earnings per share of common stock:
Basic.............................. $0.13 $0.04 $0.31 $0.10
======= ======= ======= =======
Diluted............................ $0.12 $0.01 $0.27 $0.04
======= ======= ======= =======
See Notes to Condensed Financial Statements
-4-
METASOLV SOFTWARE, INC. AND SUBSIDIARIES
Condensed Statements of Cash Flows
(In thousands)
Nine Months Ended
September 30,
-------------------
2000 1999
-------- -------
(Unaudited)
Cash Flows from Operating Activities:
Net income....................................... $ 11,010 $ 1,174
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization.................. 2,121 1,104
Loss on asset disposal......................... 21 130
Deferred tax expense (benefit)................. (2,691) (261)
Tax benefit from employee stock options........ 3,892 --
Changes in operating assets and liabilities:
Trade accounts receivable, net.............. (6,807) (2,283)
Unbilled receivables........................ 2,148 (2,551)
Other assets................................ (3,591) (203)
Accounts payable and accrued expenses....... 7,496 1,147
Deferred revenue............................ 5,755 6,073
-------- -------
Net cash provided by operating activities.... 19,354 4,330
-------- -------
Cash Used In Investing Activities:
Purchases of property, plant and equipment....... (5,097) (1,904)
Purchases of equity investments.................. (4,000) --
Purchases of marketable securities............... (12,152) --
-------- -------
Net cash used in investing activities........ (21,249) (1,904)
-------- -------
Cash Flows from Financing Activities:
Borrowings from bank............................. -- 1,866
Payments on bank borrowings...................... -- (104)
Proceeds from common stock transactions.......... 3,018 246
Re-issuance and purchase of treasury stock....... 388 (14)
-------- -------
Net cash provided by financing activities.... 3,406 1,994
-------- -------
Increase in cash and cash equivalents............. 1,511 4,420
Cash and cash equivalents, beginning of period.... 112,341 7,984
-------- -------
Cash and cash equivalents, end of period.......... $113,852 $12,404
======== =======
See Notes to Condensed Financial Statements
-5-
METASOLV SOFTWARE, INC.
Notes to Condensed Financial Statements
(Unaudited)
1) Basis of Presentation
These unaudited condensed financial statements reflect all adjustments
(consisting only of those of a normal recurring nature), which are, in the
opinion of management, necessary to fairly present the financial position,
results of operations and cash flows for the interim periods. Certain
information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted, although the Company believes
that the disclosures are adequate to make the information presented not
misleading. These condensed financial statements should be read in
conjunction with the financial statements and the notes thereto for the year
ended December 31, 1999, contained in the Company's Annual Report to
Stockholders and Form 10-K filed with the Securities and Exchange
Commission.
2) Revenue Recognition
Effective January 1, 2000 the Company adopted Statement of Position (SOP)
98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect
to Certain Transactions. SOP 98-9 amends SOP 97-2 to require recognition of
revenue using the "residual method" when there is vendor-specific objective
evidence of the fair values of all undelivered elements in a multiple-
element arrangement that is not accounted for using long-term contract
accounting. Under the residual method, the arrangement fee is recognized as
follows: (1) the total fair value of the undelivered elements, as indicated
by vendor-specific objective evidence, is deferred and subsequently
recognized in accordance with the relevant sections of SOP 97-2 and (2) the
difference between the total arrangement fee and the amount deferred for the
undelivered elements is recognized as revenue related to the delivered
elements. Adoption of SOP 98-9 did not have a material effect on the
Company's financial position or results of operations.
3) Earnings Per Share
Following is a reconciliation of the weighted average shares used to
compute basic and diluted earnings per share (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
2000 1999 2000 1999
------ ------ ------ ------
Weighted average common shares outstanding.. 35,598 11,937 35,285 11,781
Effect of dilutive securities:
Preferred stock............................ -- 16,245 -- 16,245
Options.................................... 4,807 3,649 5,170 3,420
------ ------ ------ ------
Weighted average common and common
equivalent shares outstanding.............. 40,405 31,831 40,455 31,446
====== ====== ====== ======
4) Segment Information
The Company operates in a single operating segment: communications software
and related services. Revenue information regarding operations for different
products and services is as follows (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ----------------
2000 1999 2000 1999
------- ------- ------- -------
Software license fees........... $19,216 $10,038 $48,153 $27,202
Professional services........... 8,549 6,095 27,735 16,855
Post-contract customer support.. 8,021 2,716 18,185 6,928
------- ------- ------- -------
Total revenues................. $35,786 $18,849 $94,073 $50,985
======= ======= ======= =======
-6-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operation
Forward-Looking Statements
From time to time, information provided by the Company, statements made by its
employees or information included in its filings with the Securities and
Exchange Commission, including this Form 10-Q report, may contain certain
"forward-looking" information, as that term is defined by the Private Securities
Litigation Reform Act of 1995 (the "Act"), including without limitation,
statements contained in this "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and elsewhere in this report on Form 10-Q
regarding: our expectation that expenses will continue to increase; the
possibility that we will use third party developed software; our belief that
direct sales will continue to generate the majority of new license revenues; our
expectation of continued growth in the communications industry and the internet;
our expectation that an increasing portion of future revenues will be generated
overseas; the possibility that license costs may increase as a percentage of
revenue; our expectation that service costs, sales and marketing expenses, and
general and administrative expenses will continue to increase; our expectation
that we will continue to increase investment in product development; our belief
that current cash balances and expected cash flows will generate sufficient cash
for our needs; our plans to expand relationships with systems integrators and
third-party resellers; and our plans for international expansion. The words
"expects," "anticipates," "believes" and similar words generally signify a
"forward-looking" statement. These forward-looking statements are made pursuant
to the safe harbor provisions of the Act. The reader is cautioned that all
forward-looking statements are necessarily speculative and that there are
certain risks and uncertainties that could cause actual events or results to
differ materially from those referred to in forward-looking statements. Such
risks and uncertainties include those in the section below entitled "Certain
Factors That May Affect Future Results." The Company undertakes no obligation
to publicly revise any forward-looking statement due to changes in circumstances
after the date of this report, or to reflect the occurrence of unanticipated
events.
Results of Operations
Overview
We are a leading provider of software designed to make it easier for emerging
competitive communications service providers to take, manage and fulfill orders
for service from their customers. These communications service providers offer a
full array of communications services including local and long-distance
telephone services, high-speed data services and Internet services, often as a
bundled offering. We derive substantially all of our revenue from the sale of
licenses, related professional services, and maintenance and support of our
Telecom Business Solution(TM) (TBS(TM)) software to these convergent
communications service providers.
We market our software and services primarily through our direct sales
organization, but also participate with alliance partners to extend the
availability of our product and services in some geographic markets. We have
structured the pricing of our TBS software to meet the needs of each of our
target market segments, from start-up providers of next generation services to
large, facility-based incumbent service providers. We charge a base price for
the core TBS subsystems, coupled with additional license fees for add-on
modules. In addition, we charge a per-user license fee, with customary volume
discounts on purchases of large numbers of user licenses. We price annual
maintenance and support contracts as a percentage of license fees. For a new
customer, our initial sale of licenses and associated services, including
maintenance and support, will generally range from one to several millions of
dollars.
We occasionally include complementary software developed by third parties to
extend the capabilities of TBS software, accelerate product introductions and to
otherwise utilize proprietary intellectual property. In July 2000 we entered
into a one year agreement with Cygent, Inc., which is renewable for two
additional annual periods at our option. Under this agreement we are
incorporating Cygent's eBusiness solutions within the TBS software suite under
our own brand to enable our customers to offer business online, including one-
to-one marketing, online shopping and ordering, electronic bill presentment and
payment, customer self-care, and provide a web-based solution for pre-
qualification and ordering of DSL services. Our contract with Cygent includes
royalty payments to Cygent for each license we sell that contains embedded
Cygent software, with a minimum payment of $10 million for the contractual year.
From time to time we also evaluate opportunities to provide a broader solution
to our customers by acquiring complementary software technology.
-7-
Percentage of Revenues and Year over Year Growth
The following table sets forth, for the periods indicated, the percentage of
total revenues represented by certain line items in the Company's statements of
operations.
Three Months Nine Months
Ended September 30, Ended September 30,
----------------------- ------------------------------------------
Percentage Dollar
2000 1999 2000 1999 Change
-------------------- ------------------------ -----------------
(Unaudited) (Unaudited)
Revenues:
License......................... 54% 53% 51% 53% 77%
Service......................... 46% 47% 49% 47% 93%
--- --- --- --- -----
Total revenues................. 100% 100% 100% 100% 85%
--- --- --- --- -----
Cost of revenues:
License......................... 3% 2% 2% 2% 61%
Service......................... 25% 35% 28% 36% 43%
--- --- --- --- -----
Total cost of revenues......... 27% 37% 30% 38% 45%
--- --- --- --- -----
Gross profit...................... 73% 63% 70% 62% 109%
--- --- --- --- -----
Operating expenses:
Research and development........ 24% 25% 24% 24% 87%
Sales and marketing............. 18% 21% 19% 19% 76%
General and administrative...... 16% 13% 14% 15% 79%
--- --- --- --- -----
Total operating expenses....... 58% 58% 57% 58% 82%
--- --- --- --- -----
Income from operations............ 15% 5% 13% 4% 523%
Interest and other income
(expense), net................... 6% 0% 6% 0% 6,341%
--- --- --- --- -----
Income before taxes............... 21% 4% 19% 4% 769%
Income tax expense................ 7% 2% 7% 2% 677%
--- --- --- --- -----
Net income........................ 13% 2% 12% 2% 838%
=== === === === =====
Revenues
We derive substantially all revenues from the license of our TBS software and
the sale of related services, including training, consulting and software
maintenance, or post-contract customer support. Licensing and service terms are
typically covered by a signed order that references our master agreement with
the customer.
We generally recognize license revenues when a customer has signed a license
agreement, we have delivered the software product, product acceptance is not
subject to expressed conditions, the fees are fixed or determinable and we
consider collection to be probable. Effective January 1, 2000, we began using
the "residual method" as required by SOP 98-9 to allocate the agreed fees for
multiple products and services licensed or sold in a single transaction among
the products and services by deferring the fair market value of the undelivered
elements and recognizing the residual amount of the fees as revenue upon
delivery of the software license. We generally recognize service revenues as the
services are performed. We recognize revenues from maintenance agreements
ratably over the maintenance period, usually one year.
To extend the capabilities of TBS software, some future license sales may
include complementary software developed by third parties. We are currently
incorporating Cygent's eBusiness solutions under our own brand within the TBS
software suite. Including Cygent's eBusiness solutions within the TBS software
suite will enable our customers to offer business online, including one-to-one
marketing, online shopping and ordering, electronic bill presentment and
payment, customer self-care, and provide a web-based solution for pre-
qualification and ordering of DSL services. From time to
-8-
time we also evaluate opportunities to provide a broader solution to our
customers by acquiring complementary software technology.
Total revenues: Total revenues increased 90% to $35.8 million for the quarter
ended September 30, 2000 from $18.8 million for the quarter ended September 30,
1999. For the first nine months of 2000, total revenues increased 85% to $94.1
million from $51.0 million in the first nine months of 1999. The increase in
revenues is primarily related to an increase in the size of the active customer
base from 59 at September 30, 1999 to 106 as of September 30, 2000.
License fees: Revenues from software license fees increased 91% to $19.2
million for the quarter ended September 30, 2000 from $10.0 million for the
quarter ended September 30, 1999. For the first nine months of 2000, software
license revenues increased 77% to $48.2 million from $27.2 million for the first
nine months of 1999. The increases in revenues were primarily due to a larger
number of next-generation communications service providers choosing our TBS
software product for managing and fulfilling their customer orders, and also to
new TBS software functionality that resulted in an increase in the size of the
average license sale to new customers and follow-on sales to existing customers.
License revenue in the most recent quarter included our first TBS software sale
to a European customer. Although we believe that direct sales will continue to
generate the majority of new license revenues, our strategy includes the use of
sales partners where practical to extend our market reach.
Services: Services revenue increased 88% to $16.6 million for the quarter
ended September 30, 2000 from $8.8 million for the quarter ended September 30,
1999. For the first nine months of 2000, services revenues increased 93% to
$45.9 million from $23.8 million for the equivalent period in 1999. Services
revenue includes both implementation consulting and training services, and
maintenance.
Implementation consulting and training revenues increased 40% to $8.5 million
for the quarter ended September 30, 2000 from $6.1 million for the quarter ended
September 30, 1999. For the first nine months of 2000, consulting and training
services revenue increased 65% to $27.7 million from $16.9 million for the first
nine months of 1999. The increase in consulting and training revenues was
primarily due to the larger number of TBS software sales requiring
implementation services, shortened implementation cycle times, an increase in
the number of implementation partners and increased sales of training classes to
our installed base of customers.
Maintenance revenues increased 195% to $8.0 million for the quarter ended
September 30, 2000 from $2.7 million for the quarter ended September 30, 1999.
For the first nine months of 2000, maintenance revenues increased 162% to $18.2
million from $6.9 million for the first nine months of 1999. The increases in
maintenance revenue are due to a continued increase in the number of TBS
software licenses sold and a high percentage of maintenance agreement renewals.
Cost of Revenues
License Costs. License costs consist primarily of royalties that relate to
product features that were originally developed for specific customers, and for
third party software used to develop our products. Cost of license revenues
also includes costs of packaging materials, the production of software media and
documentation.
License costs were $0.9 million and $0.4 million for the quarters ended
September 30, 2000 and 1999, respectively, representing 5% and 4% of license
revenues in each period respectively. For the nine month periods ended
September 30, 2000 and 1999, license costs were $2.0 million and $1.3 million,
representing 4% and 5% of revenues for each period, respectively. The increases
in costs resulted from an increase in revenues upon which royalties were based.
The increase as a percentage of license revenues in the most recent fiscal
quarter reflects our increased use of royalty-based third party software for
product development. The decrease as a percentage of revenue in the nine month
period ended September 30, 2000 was due to reduced reliance on customer-funded
development to introduce new software functionality.
Future license costs may increase as a percentage of revenue due to an
increased use of third party software that is sold or imbedded in our products.
In addition, license costs will increase in absolute terms due to minimum
purchase commitments contained in the Cygent agreement.
Service Costs. Service costs consist primarily of costs associated with
providing consulting, training and customer support services. These costs
include compensation, travel and related expenses for MetaSolv employees and
fees for third-party consultants who provide services for our customers.
-9-
Service costs were $8.9 million and $6.6 million for the quarters ended
September 30, 2000 and 1999, representing 54% and 75% of services revenues for
each quarter, respectively. For the nine months ended September 30, 2000 and
1999, service costs were $26.2 million and $18.3 million, representing 57% and
77% of revenues for each period, respectively. These increases in service costs
resulted from the significant increase in the number of consultants, trainers
and customer support staff. The decrease in service costs as a percentage of
service revenues was primarily due to efficiencies derived from repeatable
implementation processes and standard, customizable tools that have reduced
implementation times and costs for tasks such as data migration. Additionally,
the decrease in service costs as a percentage of revenue was also due to
proportionately less reliance on third-party subcontractors and the relatively
faster growth of revenues from maintenance agreements.
We expect service costs to continue to increase during the next twelve months
due to continued demand for implementation services, and for resources to
provide post-contract customer support and training to our installed customer
base. We anticipate additional infrastructure costs to strengthen local support
to our customers in Europe and Latin America.
Operating Expenses
Research and Development Expenses. Research and development expenses consist
of costs related to our staff of software developers, contracted development
services costs, and the associated infrastructure costs required to support
software product development. Product research and development expenses
increased 81% to $8.5 million for the quarter ended September 30, 2000 from $4.7
million for the quarter ended September 30, 1999, representing 24% and 25% of
total revenues for each period respectively. These same expenses were $22.5
million and $12.0 million for the nine month periods ended September 30, 2000
and 1999, representing 24% of revenues in both periods. The increases in
expenses were due to an increase in product development personnel and contracted
development expenses to meet market demand for new features, functionality and
advances in product architecture, as well as to address regulatory changes that
affect our customer base. The new functionality includes continued enhancements
for managing Internet and data communications networks, Internet commerce and
adapting our software for international differences in data formats, standards
and language. We expect to continue to increase our investment in product
development to address emerging technologies and to extend product functionality
for next-generation communications providers worldwide.
Our product development methodology generally establishes technological
feasibility near the end of the development process, when we have a working
model. Accordingly, we have not capitalized any software development costs.
Sales and Marketing Expenses. Sales and marketing expenses consist primarily
of salary, commission, travel, advertising, trade show and other related
expenses required to sell our TBS software in our targeted markets. Sales and
marketing expenses were $6.3 million and $3.9 million for the quarters ended
September 30, 2000 and 1999, respectively, representing 18% and 21% of revenues
for each period, respectively. These same expenses were $17.5 million and $9.9
million for the first nine months of 2000 and 1999, representing 19% of revenues
in both periods. Sales and marketing expenses increased primarily due to the
expansion of our sales and marketing staff and higher commission expense as a
result of higher revenues. We expect sales and marketing expenses will continue
to increase, particularly as we pursue business in Europe and Latin America.
Sales commission expense is also expected to increase as we increase sales
through partners who help generate orders through our lead referral and partner
sales programs.
General and Administrative Expenses. General and administrative expenses
consist of costs related to finance and accounting, legal, human resources,
facilities, information systems and corporate management that were not allocated
to other departments. General and administrative expenses were $5.9 million and
$2.4 million for the quarters ended September 30, 2000 and 1999, representing
16% and 13% of revenues for each period, respectively. These same expenses were
$13.4 million and $7.5 million for the first nine months of 2000 and 1999,
representing 14% and 15% of revenues, respectively. The increase in general and
administrative expenses resulted primarily from increases in staffing required
to support the increased scale of our operations, higher facilities expenses,
and an increase in the allowance for doubtful accounts. The increase as a
percentage of revenue in the quarter ended September 30, 2000, compared to the
year ago quarter, resulted primarily from the increase in allowance for doubtful
accounts. We expect general and administrative expenses to continue to increase
to support business growth, including costs to strengthen our international
operations.
-10-
Interest and Other Income (Expense), Net
Interest and other income, net, consists primarily of interest income on cash
and marketable securities, and also includes gains and losses on disposition of
assets. Interest and other income, net, was $2.0 million and essentially zero
for the quarters ended September 30, 2000 and 1999, respectively, and $5.6
million and $0.1 million for the first nine months of 2000 and 1999,
respectively. The increase in other income, net, for both periods primarily
reflects the interest earned on higher cash and marketable security balances
that resulted from the Company's initial public offering in November 1999.
Income Tax Expense
Income tax expenses were $2.7 million and $0.4 million for the quarters ended
September 30, 2000 and 1999, representing 36% and 44% of pre-tax income for each
period, respectively. For the nine month period ended September 30, 2000 and
1999, income tax expenses were $6.9 million and $0.9 million, representing 39%
and 43% of pre-tax income for each period, respectively. The higher tax
expense for 2000 reflects higher pre-tax income. Tax expense as a percentage of
pre-tax income differs from the federal statutory rate primarily due to state
taxes, partially offset by estimated research and development tax credits in
2000, including recovery of credits for prior years. The 1999 tax expense also
includes a non-recurring state tax adjustment.
Liquidity and Capital Resources
At September 30, 2000, our primary sources of liquidity were cash and short
term marketable securities totaling $118.9 million and representing 66% of total
assets, an increase of $6.6 million compared to $112.3 million on December 31,
1999, representing 76% of total assets.
Cash provided by operating activities was $19.4 million for the nine months
ended September 30, 2000, compared to $4.3 million generated for the same period
in 1999. Net cash provided by operating activities increased primarily due to
improved profitability and tax benefits related to exercise and sale of stock
options, partially offset by an increase in accounts receivable.
Net cash used in investing activities was $21.2 million for the nine month
period ended September 30, 2000, compared to $1.9 million for the same period in
1999. The increase in cash used in investing activities reflects purchases of
$12.2 million of marketable securities and $4.0 million of equity investments in
companies with whom we have strategic relationships, and also increased
purchases of computing equipment, furniture and leasehold improvements related
to expansion of our facilities.
The Company generated $3.4 million in cash from the proceeds of stock option
exercises and reissuance of treasury stock during the nine month period ended
September 30, 2000, compared to $1.9 million in bank borrowings for the same
period in 1999.
We believe that our current cash balances, together with cash flows generated
by operations, will be sufficient to meet our anticipated cash needs for working
capital and capital expenditures for at least the next twelve months. From time
to time, we evaluate potential acquisitions in complementary businesses or
products. Should cash balances be insufficient to complete one of these
acquisitions, we may seek to sell additional equity or debt securities. The
decision to sell additional equity or debt securities could be made at any time
and could result in additional dilution to our stockholders.
Certain Factors That May Affect Future Results
The Communications Market is Changing Rapidly, and Failure to Anticipate and
React to the Rapid Change Could Result in Loss of Customers or Wasteful Spending
Over the last decade, the market for communications products and services has
been characterized by rapid technological developments, evolving industry
standards, dramatic changes in the regulatory environment, emerging companies
and frequent new product and service introductions. Our future success depends
largely on our ability to enhance our existing products and services and to
introduce new products and services that are based on leading
-11-
technologies and that are capable of adapting to changing technologies, industry
standards, regulatory changes and customer preferences. If we are unable to
successfully respond to these changes or do not respond in a timely or cost-
effective way, our sales could decline and our costs for developing competitive
products could increase.
New technologies, services or standards could require significant changes in
our business model, development of new products or provision of additional
services. New products and services may be expensive to develop and may result
in the introduction of additional competitors into the marketplace. Furthermore,
if the overall market for order processing, management and fulfillment software
grows more slowly than we anticipate, or if our products and services fail in
any respect to achieve market acceptance, our revenues would be lower than we
anticipate and operating results and financial condition could be materially
adversely affected.
The Communications Industry is Experiencing Consolidation, Which May Reduce
the Number of Potential Customers for Our Software
The communications industry has experienced significant consolidation. In the
future, there may be fewer potential customers requiring operations support
systems and related services, increasing the level of competition in the
industry. In addition, larger, consolidated communications companies have
strengthened their purchasing power, which could create pressure on the prices
we charge and the margins we could realize. These companies are also striving to
streamline their operations by combining different communications systems and
the related operations support systems into one system, reducing the number of
vendors needed. Although we have sought to address this situation by continuing
to market our products and services to new customers and by working with
existing customers to provide products and services that they need to remain
competitive, we cannot be certain that we will not lose customers as a result of
industry consolidation.
Limitations on the Ability of Our Customers to Obtain Financing May Lead to
Lower Sales and Decreased Profitability
Many of our customers are small to medium sized Competitive Communications
Service Providers. Many of these customers are highly dependent on private
sources of venture capital to fund their operations. We cannot be certain that
recent market conditions will not adversely affect the ability of these
customers to obtain adequate financing for capital expenditures. Because we
currently derive all of our revenue from the licensing, related professional
services and maintenance and support of our Telecom Business Solution software
product, if our customers are unable to obtain adequate financing, sales of our
TBS software could suffer. The failure to continue to increase revenue related
to our TBS software would adversely affect our operating results and financial
condition. In addition, limitations on the ability of our current customers to
obtain adequate financing could adversely affect our ability to collect
outstanding accounts receivable resulting in an increase in our bad debt
reserve, increased bad debt losses and a decrease in our overall profitability.
We Rely on a Limited Number of Customers for a Significant Portion of Our
Revenue
A significant portion of revenue each quarter is derived from a relatively
small number of large sales. The amount of revenue we derive from a specific
customer is likely to vary from period to period, and a major customer in one
period may not produce significant additional revenue in a subsequent period.
During the first nine months of 2000, our top 10 customers accounted for 31% of
our total revenue, compared to 44% during the year 1999. Although no customer
accounted for more than 10% of our revenue this year, to the extent that any
major customer terminates its relationship with us, our revenue could be
adversely affected.
Competition from Larger, Better Capitalized or Emerging Competitors for the
Communications Products and Services that We Offer Could Result in Price
Reductions, Reduced Gross Margins and Loss of Market Share
Competition in the communications products market is intense. We compete
against other companies selling communications software and services, and
against the in-house development efforts of our customers. We expect competition
to persist and intensify in the future. We cannot be certain that we will be
able to compete successfully with
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existing or new competitors, and increased competition could result in price
reductions, reduced gross margins and loss of market share.
Competitors vary in size and scope, in terms of products and services offered.
We encounter competition from several vendors, including Telcordia Technology
(formerly Bellcore), Lucent Technologies, Architel Systems, Eftia OSS Solutions,
Granite Systems and CommTech Corp. We also compete with systems integrators and
with the information-technology departments of large communications service
providers. We are aware of numerous other communications service providers,
software developers, and smaller entrepreneurial companies that are focusing
significant resources on developing and marketing products and services that
will compete with our TBS software. We anticipate continued growth in the
communications industry and the entrance of new competitors in the order
processing, management and fulfillment software market, and that the market for
our products and services will remain intensely competitive.
Some of our current competitors have longer operating histories, a larger
customer base, greater brand recognition and greater financial, technical,
marketing and other resources than we do. This may place us at a disadvantage in
responding to our competitors' pricing strategies, technological advances,
advertising campaigns, strategic alliances and other initiatives. In addition,
many of our competitors have well-established relationships with our current and
potential customers and have extensive knowledge of our industry. As a result,
our competitors may be able to respond more quickly to new or emerging
technologies and changes in customer requirements. They may also be able to
devote more resources to the development, promotion and sale of their products
and services than we can. To the extent that our competitors offer customized
products that are competitive with our more standardized product offerings, our
competitors may have a substantial competitive advantage, which may cause us to
lower our prices and realize lower margins.
Current and potential competitors also have established or may establish
cooperative relationships among themselves or with others to increase their
ability to address customer needs. Accordingly, it is possible that new
competitors or alliances among competitors may emerge and rapidly acquire
significant market share. In addition, some of our competitors may develop
products and services that are superior to, or have greater market acceptance
than, the products and related services that we offer.
If the Internet and Internet-Based Services Growth Slows, Demand for Our
Products May Fall
Our success depends heavily on the Internet being accepted and widely used as
a medium of commerce and communication. The growth of the Internet has driven
changes in the public communications network and has given rise to the growth of
the next-generation service providers who are our core customers. Rapid growth
in the use of the Internet and on-line services is a recent phenomenon, and it
may not continue. If use of the Internet does not continue to grow or grows more
slowly than expected, the market for software that manages communications over
the Internet may not develop and our sales would be adversely affected.
Consumers and businesses may reject the Internet as a viable commercial medium
for a number of reasons, including potentially inadequate network
infrastructure, slow development of technologies or insufficient commercial
support. The Internet infrastructure may not be able to support the demands
placed on it by increased Internet usage and bandwidth requirements. In
addition, delays in the development or adoption of new standards and protocols
required to handle increased levels of Internet activity, or increased
government regulation could cause the Internet to lose its viability as a
commercial medium. Even if the required infrastructure, standards, protocols or
complementary products, services or facilities are developed, we may incur
substantial expense adapting our solutions to changing or emerging technologies.
Changes in Communications Regulation Could Adversely Affect Our Customers and
May Lead to Lower Sales
Our customers are subject to extensive regulation as communications service
providers. Changes in legislation or regulation that adversely affect our
existing and potential customers could lead them to spend less on order
processing, management and fulfillment software, which would reduce our
revenues, which could seriously affect our business and financial condition.
-13-
We Have Relied and Expect to Continue to Rely on Sales of Our Telecom Business
Solution Product for Our Revenue
We currently derive all of our revenue from the licensing, related
professional services and maintenance and support of our Telecom Business
Solution software product. We expect that we will continue to depend on revenue
related to new and enhanced versions of our TBS software for the foreseeable
future. We cannot be certain that we will be successful in upgrading and
marketing our TBS software or that we will successfully develop and market new
products or services. Any failure to continue to increase revenue related to our
TBS software or to generate revenue from new products and services would
adversely affect our operating results and financial condition.
If We Fail to Accurately Estimate the Resources Necessary to Complete Any
Fixed-Price Contract, Or If We Fail to Meet Our Performance Obligations, We May
Be Required to Absorb Cost Overruns and We May Suffer Losses On Projects
In addition to time and materials contracts, we have periodically entered into
fixed-price contracts for software implementation, and we may do so in the
future. These fixed-price contracts involve risks because they require us to
absorb possible cost overruns. Our failure to accurately estimate the resources
required for a project or our failure to complete our contractual obligations in
a manner consistent with the project plan would likely cause us to have lower
margins or to suffer a loss on such a project, which would negatively impact our
operating results. On occasion we have been required to commit unanticipated
additional resources to complete projects. We may experience similar situations
in the future. In addition, for specific projects, we may fix the price before
the requirements are finalized. This could result in a fixed price that turns
out to be too low, which would cause us to suffer a loss on the project that
would negatively impact our operating results.
Our Quarterly Operating Results Have Varied Significantly and May Cause Our
Stock Price to Fluctuate
Our quarterly operating results have varied significantly and are difficult to
predict. As a result, we believe that period-to-period comparisons of our
results of operations are not a good indication of our future performance. It is
likely that in some future quarter or quarters our operating results will be
below the expectations of public market analysts or investors. In such an event,
the market price of our common stock may decline significantly. A number of
factors are likely to cause our quarterly results to vary, including:
. The overall level of demand for communications services by consumers and
businesses and its effect on demand for our products and services by our
customers;
. Our customers' willingness to buy, rather than build, order processing,
management and fulfillment software;
. The timing of individual software orders, particularly those of our major
customers involving large license fees that would materially affect our
revenue in a given quarter;
. The introduction of new communications services and our ability to react
quickly compared to our competitors;
. Our ability to manage costs, including costs related to professional
services and support services costs;
. The utilization rate of our professional services employees and the extent
to which we use third party subcontractors to provide consulting services;
. Costs related to possible acquisitions of other businesses;
. Our ability to collect outstanding accounts receivable from very large
product licenses;
. Innovation and introduction of new technologies, products and services in
the communications and information technology industries; and
. Costs related to the expansion of our operations.
-14-
We forecast the volume and timing of orders for our operational planning, but
these forecasts are based on many factors and subjective judgments, and we
cannot assure their accuracy. We have hired and trained a large number of
personnel in core areas, including product development and professional
services, based on our forecast of future revenues. As a result, significant
portions of our operating expenses are fixed in the short term. Therefore,
failure to generate revenue according to our expectations in a particular
quarter could have an immediate negative effect on results for that quarter.
Our quarterly revenue is dependent, in part, upon orders booked and delivered
during that quarter. We expect that our sales will continue to involve large
financial commitments from a relatively small number of customers. As a result,
the cancellation, deferral, or failure to complete the sale of even a small
number of licenses for our products and related services may cause our revenues
to fall below expectations. Accordingly, delays in the completion of sales near
the end of a quarter could cause quarterly revenue to fall substantially short
of anticipated levels. Significant sales may also occur earlier than expected,
which could cause operating results for later quarters to compare unfavorably
with operating results from earlier quarters.
Some contracts for software licenses may not qualify for revenue recognition
upon product delivery. Revenue may be deferred when there are significant
elements required under the contract that have not been completed, there are
express conditions relating to product acceptance, there are deferred payment
terms, or when collection is not considered probable. With these uncertainties
we may not be able to predict accurately when revenue from these contracts will
be recognized.
In Order to Generate Increased Revenue, We Need to Expand Our Sales and
Distribution Capabilities
We must expand our direct and indirect sales operations to increase market
awareness of our products and to generate increased revenue. We cannot be
certain that we will be successful in these efforts. Our products and services
require a sophisticated sales effort targeted at the senior management of our
prospective customers. New hires will require training and take time to achieve
full productivity. We cannot be certain that our recent hires will become as
productive as necessary or that we will be able to hire enough qualified
individuals in the future. We also plan to expand our relationships with systems
integrators and other third-party resellers to build an indirect sales channel.
Failure to expand these sales channels could adversely affect our revenues and
operating results. In addition, we will need to manage potential conflicts
between our direct sales force and third-party reselling efforts.
We Depend on Certain Key Personnel, and the Loss of Any Key Personnel Could
Affect Our Ability to Compete
We believe that our success will depend on the continued employment of our
senior management team and key technical personnel. This dependence is
particularly important to our business because personal relationships are a
critical element of obtaining and maintaining business contacts with our
customers. Our senior management team and key technical personnel would be very
difficult to replace and the loss of any of these key employees could seriously
harm our business. In addition, we currently do not have non-compete agreements
in place, and if any of these key employees were to join a competitor or form a
competing company, some of our customers might choose to use the products or
services of that competitor or of a new company instead of ours.
Our Ability to Attract, Train and Retain Qualified Employees is Crucial to
Results of Operations and Future Growth
As a company focused on the development, sale and delivery of software
products and related services, our personnel are our most valued assets. Our
future success depends in large part on our ability to hire, train and retain
software developers, systems architects, project managers, communications
business process experts, systems analysts, trainers, writers, consultants and
sales and marketing professionals of various experience levels. Skilled
personnel are in short supply, and this shortage is likely to continue. As a
result, competition for these people is intense, and the industry turnover rate
for them is high. Any inability to hire, train and retain a sufficient number of
qualified employees could hinder the growth of our business.
-15-
Our Future Success Depends on Our Continued Use of Strategic Relationships to
Implement and Sell Our Products
We have entered into relationships with third-party systems integrators, as
well as with hardware platform and software applications developers. We rely on
these third parties to assist our customers and to lend expertise in large
scale, multi-system implementation and integration projects, including overall
program management and development of custom interfaces for our product. Should
these third parties go out of business or choose not to provide these services,
we may be forced to develop those capabilities internally, incurring significant
expense and adversely affecting our operating margins. In addition, we have
derived and anticipate that we will continue to derive, a significant portion of
our revenues from customers that have established relationships with our
marketing and platform alliances. We could lose sales opportunities if we fail
to work effectively with these parties or fail to grow our base of marketing and
platform alliances.
Our Planned International Operations May Be Difficult and Costly
We intend to expand our operations in the future by opening more international
offices and will need to devote significant management and financial resources
for our international expansion. In particular, we will have to attract
experienced management, technical, sales, marketing and support personnel for
our international offices. Competition for these people is intense and we may be
unable to attract qualified staff. International expansion may be more difficult
or take longer than we anticipate, especially due to language barriers, currency
exchange risks and the fact that the communications infrastructure in foreign
countries may be different than the communications infrastructure in the United
States. If we are unable to expand our international operations successfully and
in a timely manner, our expenses could increase at a greater rate than our
revenues, and our operating results could be adversely affected.
Moreover, international operations are subject to a variety of additional
risks that could adversely affect our operating results and financial condition.
These risks include the following:
. Longer payment cycles;
. Problems in collecting accounts receivable;
. The impact of recessions in economies outside the United States;
. Unexpected changes in regulatory requirements;
. Higher levels of regulation specific to the communications industry;
. Trade barriers and barriers to foreign investment, in some cases
specifically applicable to the communications industry;
. Barriers to the repatriation of capital or profits;
. Fluctuations in currency exchange rates;
. Restrictions on the import and export of certain technologies;
. Lower protection for intellectual property rights;
. Seasonal reductions in business activity during the summer months,
particularly in Europe;
. Potentially adverse tax consequences;
. Increases in tariffs, duties, price controls or other restrictions on
foreign currencies; and
. Requirements of a locally domiciled business entity.
Potential Future Acquisitions Could Be Difficult to Integrate, Disrupt Our
Business, Dilute Stockholder Value and Adversely Affect Our Operating Results
We may acquire other businesses in the future, which would complicate our
management tasks. We may need to integrate widely dispersed operations that have
different and unfamiliar corporate cultures. These integration efforts may
-16-
not succeed or may distract management's attention from existing business
operations. Our failure to successfully manage future acquisitions could
seriously harm our business. Also, our existing stockholders would be diluted if
we financed the acquisitions by issuing equity securities.
Our Failure to Meet Customer Expectations or Deliver Error-Free Software Could
Result in Losses and Negative Publicity
The complexity of our products and the potential for undetected software
errors increase the risk of claims and claim-related costs. Due to the mission-
critical nature of order processing, management and fulfillment software,
undetected software errors are of particular concern. The implementation of our
products, which we accomplish through our professional services division and
with our alliance partners, typically involves working with sophisticated
software, computing and communications systems. If our software contains
undetected errors or we fail to meet our customers' expectations or project
milestones in a timely manner, we could experience:
. Delayed or lost revenues and market share due to adverse customer reaction;
. Loss of existing customers;
. Negative publicity regarding us and our products, which could adversely
affect our ability to attract new customers;
. Expenses associated with providing additional products and customer
support, engineering and other resources to a customer at a reduced charge
or at no charge;
. Claims for substantial damages against us, regardless of our responsibility
for any failure;
. Increased insurance costs; and
. Diversion of development and management time and resources.
Our licenses with customers generally contain provisions designed to limit our
exposure to potential claims, such as disclaimers of warranties and limitations
on liability for special, consequential and incidental damages. In addition, our
license agreements usually cap the amounts recoverable for damages to the
amounts paid by the licensee to us for the product or services giving rise to
the damages. However, we cannot be sure that these contractual provisions will
protect us from additional liability. Furthermore, our general liability
insurance coverage may not continue to be available on reasonable terms or in
sufficient amounts to cover one or more large claims, or the insurer may
disclaim coverage as to any future claim. The successful assertion of any large
claim against us could adversely affect our operating results and financial
condition.
Our Limited Ability to Protect Our Proprietary Technology May Adversely Affect
Our Ability to Compete, and We May Be Found to Infringe on the Proprietary
Rights of Others
Our success depends in part on our proprietary software technology. We rely
on a combination of patent, trademark, trade secret and copyright law and
contractual restrictions to protect our technology. We cannot guarantee that
the steps we have taken to protect our proprietary rights will be adequate to
deter misappropriation of our intellectual property, and we may not be able to
detect unauthorized use and take appropriate steps to enforce our intellectual
property rights. If third parties infringe or misappropriate our copyrights,
trademarks, trade secrets or other proprietary information, our business could
be seriously harmed. In addition, although we believe that our proprietary
rights do not infringe on the intellectual property rights of others, other
parties may assert infringement claims against us or claim that we have violated
their intellectual property rights. Claims against us, either successful or
unsuccessful, could result in significant legal and other costs and may be a
distraction to management. We currently focus on intellectual property
protection within the United States. Protection of intellectual property outside
of the United States will sometimes require additional filings with local
patent, trademark, or copyright offices, as well as the implementation of
contractual or license terms different from those used in the United States.
Protection of intellectual property in many foreign countries is weaker and less
reliable than in the United States. If our business expands into foreign
countries, costs and risks associated with protecting our intellectual property
abroad will increase.
-17-
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our exposure to market risks principally relates to changes in interest rates
that may affect our fixed income investments. Our excess cash is invested in
debt securities issued by U.S. government agencies and corporate debt
securities. We place our investments with high quality issuers, and limit our
credit exposure by restricting the amount of securities that may be placed with
any single issuer. Our exposure to adverse movements in foreign exchange rates
is insignificant. Therefore, we do not hedge our foreign currency exposure, nor
do we use derivative financial instruments for speculative trading purposes.
Our general policy is to limit the risk of principal loss and assure the
safety of invested funds by limiting market and credit risk. All highly liquid
investments with original maturities of three months or less are considered to
be cash equivalents; investments with maturities between three months and twelve
months are considered to be short-term investments; investments with maturities
in excess of twelve months are considered to be long-term investments. At
September 30, 2000 the weighted average pre-tax interest rate on the investment
portfolio is approximately 6.7%. We do not expect any material loss with
respect to our investment portfolio.
-18-
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
None
(b) Current Report on Form 8-K of Metasolv Software, Inc. dated October
5, 2000 reporting the filing of a press release.
-19-
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.
Dated: November 13, 2000
METASOLV SOFTWARE, INC.
/s/ Glenn A. Etherington
-----------------------------------------------------
Glenn A. Etherington
Chief Financial Officer
Duly Authorized Officer on behalf of the Registrant
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