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 March 31, 2002
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, INC.
(Exact name of registrant as specified in its charter)
Delaware 75-2912166
(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 March 31, 2002, there were 37,531,649 shares of the registrant's common
stock outstanding.
METASOLV, INC.
INDEX
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets - March 31, 2002 and December 31, 2001 .......... 3
Condensed Consolidated Statements of Operations - For the Three Months Ended
March 31, 2002 and 2001 ............................................................. 4
Condensed Consolidated Statements of Cash Flows - For the Three Months Ended
March 31, 2002 and 2001 ............................................................. 5
Notes to Condensed Consolidated Financial Statements .................................. 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ........................................................... 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk ............................ 26
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K ...................................................... 27
SIGNATURES ........................................................................................ 28
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
METASOLV, INC.
Condensed Consolidated Balance Sheets
(In thousands, except share data)
ASSETS
------
March 31, December 31,
2002 2001
----------- ------------
(Unaudited)
Current assets:
Cash and cash equivalents ..................................................... $ 88,325 $ 80,658
Marketable securities ......................................................... 6,173 56,919
Trade accounts receivable, less allowance for doubtful accounts
of $3,133 in 2002 and $3,171 in 2001 ....................................... 15,926 12,913
Unbilled receivables .......................................................... 1,523 617
Prepaid expenses .............................................................. 2,092 2,095
Deferred tax assets and other current assets .................................. 7,566 6,022
---------- ----------
Total current assets ...................................................... 121,605 159,224
Property and equipment, net ........................................................ 18,820 16,586
Equity investments ................................................................. 571 571
Goodwill ........................................................................... 28,081 6,375
Intangible assets .................................................................. 19,493 4,615
Other assets ....................................................................... 2,117 646
---------- ----------
Total assets .............................................................. $ 190,687 $ 188,017
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Accounts payable .............................................................. $ 6,540 $ 3,663
Accrued expenses .............................................................. 20,367 13,679
Deferred revenue .............................................................. 11,570 9,114
---------- ----------
Total current liabilities ................................................... 38,477 26,456
Deferred income taxes .............................................................. -- 388
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, shares
issued and outstanding: 37,531,649 in 2002, and 37,422,649 in 2001 .......... 188 187
Additional paid-in capital .................................................... 139,867 139,750
Deferred compensation ......................................................... (128) (154)
Accumulated other comprehensive income ........................................ 37 125
Retained earnings ............................................................. 12,246 21,265
---------- ----------
Total stockholders' equity .................................................. 152,210 161,173
---------- ----------
Total liabilities and stockholders' equity .................................. $ 190,687 $ 188,017
========== ==========
See Notes to Condensed Consolidated Financial Statements
-3-
METASOLV, INC.
Condensed Consolidated Statements of Operations
(In thousands, except per share data)
Three Months Ended
March 31,
---------------------------
2002 2001
---------- ----------
(Unaudited)
Revenues:
License ...................................... $ 7,027 $ 24,930
Service ...................................... 14,835 14,651
---------- ----------
Total revenues ........................... 21,862 39,581
Cost of revenues:
License ...................................... 156 2,998
Amortization of intangible assets ............ 2,271 -
Service ...................................... 7,091 8,099
---------- ----------
Total cost of revenues ................... 9,518 11,097
---------- ----------
Gross profit ............................. 12,344 28,484
Operating expenses:
Research and development ..................... 9,651 8,317
Sales and marketing .......................... 7,139 7,991
General and administrative ................... 3,809 5,869
Restructuring costs .......................... 2,787 -
In-process R&D write-off ..................... 4,060 -
---------- ----------
Total operating expenses ................. 27,446 22,177
---------- ----------
Income (loss) from operations ..................... (15,102) 6,307
Interest and other income, net .................... 515 1,877
---------- ----------
Income (loss) before taxes ........................ (14,587) 8,184
Income tax expense (benefit) ...................... (5,568) 3,069
---------- ----------
Net income (loss) ................................. $ (9,019) $ 5,115
========== ==========
Earnings (loss) per share of common stock:
Basic ........................................ $ (0.24) $ 0.14
========== ==========
Diluted ...................................... $ (0.24) $ 0.13
========== ==========
See Notes to Condensed Consolidated Financial Statements
-4-
METASOLV, INC.
Condensed Consolidated Statements of Cash Flows
(In thousands)
Three Months Ended
March 31,
----------------------------
2002 2001
----------- -----------
(Unaudited)
Cash flows from operating activities:
Net income (loss) ............................................. $ (9,019) $ 5,115
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization ............................. 3,596 917
Stock compensation ........................................ 26 79
Loss on asset disposal .................................... 1,122 --
Deferred tax benefit ...................................... (3,960) (222)
Purchased in-process research and development ............. 4,060 --
Changes in operating assets and liabilities:
Trade accounts receivable, net ........................ (3,013) (6,836)
Unbilled receivables .................................. (906) 323
Other assets .......................................... 560 1,869
Accounts payable and accrued expenses ................. 2,577 1,885
Deferred revenue ...................................... (1,638) 2,390
---------- ----------
Net cash provided (used) by operating activities ........ (6,595) 5,520
---------- ----------
Cash flows from investing activities:
Purchases of property and equipment ........................... (920) (1,882)
Purchase of marketable securities ............................. -- (11,109)
Proceeds from sale of marketable securities ................... 50,845 26,853
Other investing activities .................................... (185) (610)
Acquisition of assets ......................................... (35,594) --
---------- ----------
Net cash provided by investing activities ............... 14,146 13,252
---------- ----------
Cash flows from financing activities:
Proceeds from common stock transactions ....................... 118 553
Purchase of treasury stock .................................... -- (1,591)
---------- ----------
Net cash provided (used) by financing activities ........ 118 (1,038)
---------- ----------
Effect of exchange rate changes on cash .......................... (2) --
---------- ----------
Increase in cash and cash equivalents ............................ 7,667 17,734
Cash and cash equivalents, beginning of period ................... 80,658 93,695
---------- ----------
Cash and cash equivalents, end of period ......................... $ 88,325 $ 111,429
========== ==========
See Notes to Condensed Consolidated Financial Statements
-5-
METASOLV, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1) Basis of Presentation
These unaudited condensed consolidated 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
consolidated financial statements should be read in conjunction with the
consolidated financial statements and the notes thereto for the year ended
December 31, 2001, contained in the Company's Annual Report to Stockholders and
Form 10-K filed with the Securities and Exchange Commission. Operating results
for the three months ended March 31, 2002, are not necessarily indicative of the
results that may be expected for the full year ending December 31, 2002.
2) Revenue Recognition
The Company recognizes 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.
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
March 31,
--------------------
2002 2001
-------- --------
Weighted average common shares outstanding ..... 37,483 35,940
Effect of dilutive securities:
Options ...................................... -- 3,749
-------- --------
Weighted average common and common
equivalent shares outstanding ................ 37,483 39,689
======== ========
Securities that were not included in the computation of diluted earnings
per share because their effect was antidilutive consist of options to purchase
8,536,910 shares of common stock in the first quarter of 2002 and 1,211,265
shares of common stock in the first quarter of 2001.
-6-
4) Acquisition
On February 1, 2002, the Company completed the acquisition of certain OSS
assets from Nortel Networks Corporation. With this acquisition, we extended our
product portfolio with a leading carrier-class service activation product and
several point solutions that allow communications service providers to
efficiently manage and deliver differentiated services for Internet Protocol
(IP), data, and wireless communications. As a result of the acquisition, we now
offer a comprehensive suite of OSS solutions available for wireless, IP, data,
and traditional networks and services. The purchase price was $35 million in
cash, plus the assumption of certain liabilities of the business.
The asset purchase agreement provides for the reduction of the cash
purchase price by $3 million, which was used to cover the cost related to the
issuance of stock options and retention bonuses to key employees. This cash
payment has been treated as a reduction of the purchase price. In addition,
direct transaction costs were approximately $4.6 million.
We accounted for the Acquisition as a business combination using the
purchase method of accounting, as required by Statements of Financial Accounting
Standards No.141, "Business Combinations," and No. 142 "Goodwill and Other
Intangible Assets." The results of Service Commerce have been included with
those of the Company effective February 2, 2002.
The total purchase price was allocated to tangible assets and liabilities
based on their respective estimated fair values as of the closing date of the
transaction. The tangible assets were inventoried and evaluated by an
independent third party, and do not differ materially from the net book value in
the historical financial statements of Nortel Networks. We allocated the excess
of the purchase price over the fair value of the net tangible assets acquired to
identifiable intangible assets, including customer arrangements, the core
technology related to the products, and in-process research and development
costs, with the remainder being allocated to goodwill which will be deductible
for tax purposes over the next fifteen years. In addition, deferred taxes have
been recognized for the difference between the book and tax basis of certain
intangible assets.
A summary of the allocation of the purchase price follows (in thousands):
Cash paid to Nortel Networks upon closing ............. $ 35,000
Less retention fund ................................... (3,000)
Less cash for vacation liabilities assumed ............ $ (1,037)
Estimated transaction costs ........................... 4,631
---------
$ 35,594
=========
Allocation of the purchase price:
Tangible assets acquired .............................. $ 3,761
Liabilities assumed ................................... (11,082)
---------
Net tangible assets acquired ........................ (7,321)
---------
In-process research and development ................ 4,060
Developed technology, including patents ............ 12,236
Customer contracts ................................. 4,913
---------
Net identifiable intangible assets acquired ...... 21,209
---------
Goodwill ........................................... 21,706
---------
$ 35,594
=========
The $4.1 million allocated to in-process research and development costs was
charged to expense upon closing on February 1, 2002. Under FAS 142, goodwill
recorded as a result of the acquisition will not be amortized. The developed
technology will be amortized over its useful life of two years and the customer
contracts will be amortized over their useful life of three years.
The following summary, which was prepared on a pro forma basis, reflects
the results of operations for three-month periods ended March 31, 2002 and 2001,
as if the acquisition had occurred at the beginning of the respective periods.
The table includes the impact of certain adjustments, including the adjustment
of interest income, intangible asset amortization, and the Company's income tax
benefit, but does not include a charge for in-process research and development
(in thousands except for share data).
-7-
income tax benefit, but does not include a charge for in-process research and
development (in thousands except for share data).
Three Months Ended
March 31,
---------------------
2002 2001
-------- ---------
Revenues ................................... $ 23,809 $ 56,206
Net Loss ................................... (10,773) (4,231)
Basic and Diluted loss per share ........... $ (0.29) $ (0.12)
Basic and diluted shares outstanding ....... 37,483 35,940
5) 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
March 31,
---------------------
2002 2001
-------- ---------
Software license fees .................. $ 7,027 $ 24,930
Professional services .................. 5,159 5,625
Post-contract customer support ......... 9,676 9,026
-------- ---------
Total Revenues ......................... $ 21,862 $ 39,581
======== =========
6) Restructuring
During the quarter ended March 31, 2002, the Company recorded a pre-tax
restructuring charge of $2.8 million. This charge consisted of $1.4 million for
a reduction in force of approximately 100 positions, and approximately $1.4
million for write-down of assets and closing of remote offices. This
restructuring program was implemented to align costs with expected market
conditions. The staff reduction expenditures are expected to be completed by
September 30, 2002. At March 31, 2002 there was $1.7 million included in accrued
liabilities for restructuring related activity, which includes $0.6 million of
severance related payments to be made, and $1.1 million of lease commitments
remaining. The following table summarizes the status of the restructuring
actions (in thousands).
Employee Severance Exit Costs Total
------------------ ---------- -------
Balance at December 31, 2001 ..... $ - $ 1,006 $ 1,006
Restructuring Charge ............. 1,428 1,359 2,787
Amounts utilized ............ (822) (1,295) (2,117)
------- ------- -------
Balance at March 31, 2002 ........ $ 606 $ 1,070 $ 1,676
-8-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
We are a leading global provider of operations support systems (OSS)
software solutions that help communications providers manage their networks and
services. Our products automate key communications management processes, from
network planning and engineering to operations and customer care. Our products
enable communications providers to increase revenue and reduce costs through
more efficient management of network resources, quick deployment of
communication services, and delivery of superior customer service. We derive
substantially all of our revenue from the sale of software licenses, related
professional services, and support of our packaged software to communications
services providers.
The communications provider industry continued to experience significant
financial weakness during the quarter ended March 31, 2002, reducing the number
of sales opportunities to many of our customers and prospective customers. The
adverse effects of weak markets on our business are moderated to some extent by
our regional diversification, by the wide spectrum of communication service
providers that buy our products, and by our expanded product portfolio, but our
financial results remain largely influenced by overall capital spending declines
by communications providers.
Critical Accounting Policies
The preparation of financial statements and related disclosures in
conformity with accounting principles generally accepted in the United States
requires management to make judgments, assumptions and estimates that affect the
amounts reported in the financial statements and accompanying notes. Estimates
are used for, but not limited to, the accounting for the allowance for doubtful
accounts, contingencies, restructuring costs and other special charges. Actual
results may differ from these estimates. The critical accounting policies are
impacted significantly by judgments, assumptions and estimates used in the
preparation of the financial statements.
We generally recognize license revenues when our customer has signed a
license agreement, we have delivered the software product, product acceptance is
not subject to express conditions, the fees are fixed or determinable and we
consider collection to be probable. We allocate the agreed fees for multiple
products and services licensed or sold in a single transaction among the
products and services using the "residual method" as required by SOP 98-9,
deferring the fair value of the undelivered elements and recognizing the
residual amount of the fees as revenue upon delivery of the software license. On
occasion we may enter into a license agreement with a customer requiring
development of additional software functions or services necessary for the
software's performance of specified functions. For those agreements, we
recognize revenue for the entire arrangement on a percentage-of-completion basis
as the development services are provided. We generally recognize service
revenues as the services are performed. We recognize revenues from maintenance
agreements ratably over the maintenance period, usually one year.
Licensing and service terms are typically covered by signed orders that
reference our master agreement with the customer. Our sales for a given period
typically involve large financial commitments from a relatively small number of
customers. Accordingly, delays in the completion of sales during a quarter may
negatively impact revenues in that quarter. Consistent with industry practice,
we sometimes agree to bill our license fees in more than one installment over
extended periods. When installments extend beyond six months, amounts not due
immediately are deferred and recorded as revenue when payments are due, assuming
all revenue recognition criteria have been met.
Our software products are priced to meet the needs of our target market
segments, which include large facility-based incumbent service providers,
wireless and IP service providers, and large corporate enterprises. We charge a
base price for core products, coupled with additional license fees for add-on
modules. In addition, we typically scale our license pricing based on the extent
of our customers' usage as measured by the number of users of our product, the
number of our customers' subscribers, or the size of the network our product
helps manage. We sell additional license capacity for our products when our
customers' usage of our product exceeds earlier license limits. Annual
maintenance and support contracts are priced as a percentage of the license fee
for the product being maintained. For a new customer, our initial sale of
licenses and associated services, including maintenance and support, generally
ranges from several hundred thousand to several million dollars.
Service revenues consist principally of software implementation, consulting
and customer training, as well as software maintenance agreements that include
both customer support and the right to product updates. We use our own employees
and subcontract with our system integrator partners to provide
implementation-consulting services to our customers. We primarily offer and
expect to continue to offer the majority of our services on an hourly basis. We
also offer several fixed-price consulting packages, primarily for repeatable
solutions.
We recognize revenue only in cases where a customer's ability to pay is
probable. In situations where collection is doubtful or when we have indications
that a customer is facing financial difficulty, we recognize revenue as cash
payments are received. In addition, for customers not on the cash basis of
accounting, we maintain an allowance for doubtful accounts based upon the
expected collectibility of accounts receivable. We regularly review the adequacy
of our allowance for doubtful accounts through identification of specific
receivables where it is expected that payment will not be
-9-
received in addition to establishing a general reserve policy that is applied to
all amounts that are not specifically identified. In determining specific
receivables where collection may not be received, we review past due receivables
and give consideration to prior collection history, changes in the customer's
overall business condition and the potential risk associated with the customer's
industry among other factors. The allowance for doubtful accounts is based on
our assessment of the collectibility of specific customer accounts and the aging
of the accounts receivable. If there is a deterioration of a major customer's
credit worthiness or actual defaults are higher than our historical experience,
our estimates of the recoverability of amounts due us could be adversely
affected. The allowance for doubtful accounts reflects our best estimate as of
the reporting dates. Changes may occur in the future, which may make us reassess
the collectibility of amounts and at which time we may need to provide
additional allowances in excess of that currently provided.
We evaluate our goodwill at least annually for impairment. We evaluate our
long-lived assets, including goodwill and other intangibles, for impairment
whenever events or changes in circumstances indicate that the carrying amount of
such assets may not be recoverable. Recoverability of any assets to be held and
used is measured by a comparison of the carrying amount of any asset to future
undiscounted net cash flows expected to be generated by the asset. If these
assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceeds the
fair value of the assets. Assets to be disposed of are reported at the lower of
the carrying amount or fair value less costs to sell.
Acquisitions
On February 1, 2002, we acquired certain OSS assets from Nortel Networks
Corporation. With this acquisition, we extended our product portfolio with a
leading carrier-class service activation product and several point solutions
that allow communications service providers to efficiently manage and deliver
differentiated services for Internet Protocol (IP), data, and wireless
communications. As a result of the acquisition, we now offer a comprehensive
suite of OSS solutions available for wireless, IP, data, and traditional
networks and services. The acquisition also strengthens the worldwide scope of
our product sales and services through an established presence in Europe. We
acquired these assets for $35 million in cash and the assumption of certain
liabilities. The financial results for the fiscal quarter ended March 31, 2002,
includes revenues and costs of the acquired business effective February 2, 2002.
-10-
Results of Operations
The following table sets forth, for the periods indicated, the percentage
of total revenues represented by certain line items in our statements of
operations.
Three Months Ended
March 31, Percentage Dollar
2002 2001 Change
-------- -------- -----------------
(Unaudited)
Revenues:
License .............................. 32% 63% (72%)
Service .............................. 68% 37% 1%
----- ----
Total revenues ................... 100% 100% (45%)
----- ----
Cost of revenues:
License .............................. 1% 8% (95%)
Amortization of intangible assets .... 10% 0% nm
Service .............................. 32% 20% (12%)
----- ----
Total cost of revenues ........... 43% 28% (14%)
----- ----
Gross profit .............................. 57% 72% (57)%
Operating expenses:
Research and development ............. 44% 21% 16%
Sales and marketing .................. 33% 20% (11%)
General and administrative ........... 17% 15% (35%)
Restructuring costs .................. 13% 0% nm
In-process R&D write-off ............. 19% 0% nm
----- ----
Total operating expenses ......... 126% 56% 24%
----- ----
Income (loss) from operations ............. (69%) 16% nm
Interest and other income, net ............ 2% 5% (73%)
----- ----
Income (loss) before taxes ................ (67%) 21% nm
Income tax expense (benefit) .............. (25%) 8% nm
----- ----
Net income (loss) ......................... (42%) 13% nm
nm = not meaningful
Revenues
Total revenues decreased 45% to $21.9 million in the quarter ended March
31, 2002, from $39.6 million in the quarter ended March 31, 2001. This decrease
in revenues is primarily related to fewer customer orders for software licenses.
The sales slowdown also adversely affected our license and implementation
consulting revenues, partially offset by a 7% increase in maintenance revenues.
Approximately 70% of our revenues in the quarter ended March 31, 2002, were
derived from MetaSolv-developed products, and approximately 30% from products
acquired from Nortel Networks.
License fees. License fee revenues declined 72% to $7.0 million in the
quarter ended March 31, 2002, from $24.9 million in the quarter ended March 31,
2001. The sharp decline in license revenue between these two periods resulted
from fewer sales to new customers and lower sales of modules and additional
capacity licenses to existing customers. The average selling prices for initial
sales to new customers also declined between these periods due to lower-priced
products acquired from Nortel Networks, and new customers' purchase of smaller
capacity licenses.
We acquired approximately 60 new active customers, net, in the quarter
ended March 31, 2002, through the acquisition of OSS assets from Nortel
Networks, adjusting for companies that were customers of both businesses. We
also contracted with 6 new license customers during this quarter, compared to 11
new license customers in the year-ago quarter.
Although we expect weak market conditions to continue in the near-term, we
ultimately expect that our order activity and revenue will increase due to our
extensive product portfolio resulting from our recent acquisition, and the
opportunity to extend deployments at current customers with additional products
and capacity licenses.
Services. Revenues from services increased slightly to $14.8 million in the
quarter ended March 31, 2002, from $14.7 million in the quarter ended March 31,
2001. These results reflect a 7% increase in maintenance revenue and an 8%
decrease in consulting and training revenue.
Consulting and education services revenue was $5.2 million in the quarter
ended March 31, 2002, compared to $5.6 million in the quarter ended March 31,
2001. The decline in consulting and education revenues was largely due to fewer
new customer implementations related to fewer new license product sales and, to
a lesser extent, lower spending by our existing customers on upgrades, product
integrations and training of their employees.
Our future consulting and training revenue will continue to be dependent on
sales of new license products requiring implementations, and our customers'
spending for enhancements and integrations that make their businesses more
efficient.
Post-contract customer support, or maintenance revenues, increased 7% to
$9.7 million in the quarter ended March 31, 2002, from $9.0 million in the
quarter ended March 31, 2001. The increase in maintenance revenue was primarily
due to the inclusion of customers using our newly acquired products, while
maintenance revenue from pre-acquisition products
-11-
declined 20% from the quarter ended by March 31, 2001. The decline in revenue
from pre-acquisition products resulted primarily from an 18% decline in the
number of customers supported.
We expect future maintenance revenues to be strengthened by support for
customers using our newly acquired products and from additional
maintenance-bearing license sales to new and existing customers. However, we
also expect continued consolidations and financial weakness in some customers,
and this may adversely impact their ability to pay for maintenance support.
Concentration of Revenues. During the quarter ended March 31, 2002, our top
ten customers represented 42% of our total revenue, with no one customer
accounting for more than 8% of revenue. In any given quarter, we generally
derive a significant portion of our revenue from a small number of relatively
large sales. We believe that the loss of any one of these customers would not
seriously harm our overall business or financial condition, but our inability to
consummate one or more substantial sales in any future period could seriously
harm our operating results for that period.
Our number of active customers increased from 90 at December 31, 2001, to
more than 150 on March 31, 2002, primarily as a result of our February 2002
acquisition.
International Revenues. We recognized $5.8 million of revenue from sources
outside the United States during the quarter ended March 31, 2002, representing
27% of total revenue. This compares to $0.5 million during the quarter ended
March 31, 2001. We expect our international revenues to continue to increase and
be a higher percentage of our total revenue than during 2001 due to our local
sales and support infrastructure in both Europe and Latin America, and to our
February 2002 acquisition that brought an established European base of
customers.
Cost of Revenues
License Costs. License costs consist primarily of royalties for third party
software that is used to develop or is embedded in our products. Licensing costs
also include costs of packaging materials and the production of software media
and documentation. License costs were $0.2 million in the quarter ended March
31, 2002 and $3.0 million in the quarter ended March 31, 2001, representing 2%
and 12% of license revenue in each period, respectively. The decrease in license
costs, in dollars and as a percentage of license revenue, is primarily due to
less royalty expenses for use of third party e-commerce software. In July 2001
we replaced this royalty-based agreement with a one-time payment for a perpetual
license, thus reducing royalty expense as a percentage of license revenue. Lower
license revenue in the most recent fiscal quarter also resulted in lower license
costs. We expect future license costs to increase as a percentage of license
revenue as we sell our newly acquired OSS products, as those products each
require royalty payments. We plan to continue the use of third party software
where it provides an advantage for our customers. While this plan lowers our
overall product development cost, it increases our cost of license revenues.
Amortization of Intangible Assets. For the quarter ended March 31, 2002,
cost of revenues includes a $2.3 million charge for amortization of intangible
assets acquired from Nortel Networks Corporation and Lat45 Information Systems
Inc. Technology rights and customer contracts purchased from Nortel resulted in
$1.8 million expense in the most recent fiscal quarter, while technology rights
and customer contracts purchased from Lat45 Information Systems Inc. resulted in
amortization of $0.4 million. The value assigned to intangible assets is
amortized over the estimated useful life of the assets using the greater of
straight-line or the ratio that current gross revenues related to those assets
bears to the total current and anticipated future gross revenues related to
those assets. The estimated useful lives of these assets range from nine months
to thirty-six months.
Service Costs. Service costs consist primarily of costs associated with
providing consulting, training and maintenance services. These costs include
compensation and related expenses for employees and fees for third party
consultants who provide services for our customers under subcontract
arrangements.
Service costs were $7.1 million in the quarter ended March 31, 2002, down
from $8.1 million in the quarter ended March 31, 2001, representing 48% and 55%
of service revenues in each year, respectively. The decline in service costs in
the most recent fiscal quarter primarily resulted from lower use of contracted
consultants due to lower demand for consulting services. Customer support costs
remained relatively unchanged from the year-ago period. The decrease in service
costs as a percentage of service revenue was primarily due to the relatively
higher proportion of higher-margin maintenance revenues, compared to consulting
and training revenues. We expect that future services margins as a percent of
services revenue will decline in periods where services revenue contains a
higher proportion of consulting revenues.
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Operating Expenses
Research and Development Expenses. Research and development expenses
consist primarily of costs related to our staff of software developers,
contracted development costs and the associated infrastructure costs required to
support product development. Product research and development expenses increased
16% to $9.7 million for the quarter ended March 31, 2002, from $8.3 million for
the quarter ended March 31, 2001, representing 44% and 21% of revenue in each
period, respectively. This increase in research and development investment was
primarily due to a 62% increase in research and development staffing due to our
February 2002 acquisition. The expense increase was partially offset by a 45%
reduction in contracted development spending. As a percentage of revenue, the
increase in research and development was magnified by lower revenue in the most
recent fiscal quarter.
During the most recent fiscal quarter, our research and development
investments were focused on new products and enhancements to address
next-generation communications networks, including 2.5/3G wireless technologies,
and user-group defined product enhancements. Specific enhancements include ease
of integration between our existing products and also with major CRM, billing,
and service assurance systems, so that communications providers can more quickly
realize business efficiencies using MetaSolv products. We are also developing
functionality capabilities for our larger tier 1 customers, and extending the
breadth of functionality for IP management.
We expect to continue a relatively large future investment in product
development as we further enhance our integrated, modular suite of products to
address emerging communications technologies. The modular structure of our
products allows communications service providers to implement product
functionality in phases, depending on their needs, to realize near-term value
and maximize opportunities for longer-term benefits from an integrated OSS
system.
Our product development methodology generally establishes technological
feasibility near the end of the development process, when we have a working
model. Costs incurred after the development of a working model and prior to
product release are insignificant. Accordingly, we have not capitalized any
software development costs.
Sales and Marketing Expenses. Sales and marketing expenses consist
primarily of salary, commission, travel, trade show and other related expenses
required to sell our software in our targeted markets. Sales and marketing
expenses decreased 11% to $7.1 million for the quarter ended March 31, 2002,
from $8.0 million for the quarter ended March 31, 2001, representing 33% and 20%
of revenue in each period, respectively. The decrease in sales and marketing
expenses was primarily due to a 58% reduction in commission expense related to
lower revenues, partially offset by staffing increases that correspond to
marketing support for our new products and our strengthened sales force in
Europe and South America.
General and Administrative Expenses. General and administrative expenses
consist of costs related to information systems infrastructure, facilities,
finance and accounting, legal, human resources and corporate management not
directly allocated to other departments. General and administrative expenses
decreased 35% to $3.8 million in the quarter ended March 31, 2002, from $5.9
million for the quarter ended March 31, 2001, representing 17% and 15% of
revenue in each period, respectively. The decrease in general and administrative
expenses was due to an unusually high provision for doubtful accounts in last
year's first fiscal quarter, primarily related to financial weakness in smaller
start-up customers. Staffing for administrative functions remained relatively
unchanged between the most recent fiscal quarter and the year-ago period, as we
have absorbed the workload from acquired products and customers with existing
staff.
Restructuring Costs. In February 2002, we restructured our operations to
align costs with expected market conditions. In the quarter ended March 31,
2002, we recorded a pre-tax restructuring charge of $2.8 million. This charge
consisted of $1.4 million for severance costs related to a reduction in force of
approximately 100 people, and $1.4 million for write-down of assets and closing
of remote offices. We expect these actions to yield approximately $10 million on
annual cost savings. There was no similar restructuring charge in the quarter
ended March 31, 2001. We periodically review our expectations for future costs,
revenues and market conditions, and may take future restructuring actions to
better position our company for profitable growth.
In-Process Research and Development. In connection with our acquisition of
certain OSS assets from Nortel Networks, we recorded a pre-tax charge of $4.1
million for acquired in-process research and development (IPR&D) during the
quarter ended March 31, 2002. At the date of this acquisition, the IPR&D
projects had not yet reached technological feasibility and had no alternative
future uses. The projects generally included enhancements and upgrades to
existing technology, enhanced communication among systems, introduction of new
functionality and the development of new technology primarily for integration
purposes. The value of the IPR&D was calculated using a discounted cash flow
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analysis of the anticipated income stream of the related product sales. The
projected net cash flows were computed using a discount rate of 18% for the
IPR&D project. It is anticipated that the remaining costs to complete the
projects will be approximately $1.7 million and project release dates will range
from mid 2002 through the end of 2003. If these projects are not successfully
developed, future revenues and profitability may be adversely affected, and the
value of intangible assets acquired may become impaired.
Interest and Other Income, Net
Interest and other income, net, was $0.5 million in the quarter ended March
31, 2002, compared to $1.9 million in the quarter ended March 31, 2001. The
decrease in interest and other income in the most recent fiscal quarter and was
due to lower interest rates earned on invested balances and, to a lesser extent,
a 35% decline in cash and marketable securities balances upon which we receive
interest income.
Income Tax Expense (Benefit)
Our income tax benefit for the quarter ended March 31, 2002, was $5.6
million, compared to $3.1 million expense in the quarter ended March 31, 2001.
The effective tax rate for the first quarter of 2002 was 38.2% compared to 37.5%
for the first quarter of 2001. The effective tax rate differs from the Federal
statutory rate due to state taxes, items that are not deductible for tax
purposes, and our realization of research and development tax credits.
Net Income (Loss)
Our net loss for the quarter ended March 31, 2002 was $9.0 million, or
$0.24 per share of common stock. This compares to net income of $5.1 million for
the quarter ended March 31, 2001, or $0.13 per diluted share.
Our net loss for the quarter ended March 31, 2002 includes:
o Write-off of $4.1 million in in-process research and development
costs;
o Amortization $2.3 million of intangible assets;
o Restructuring charges of $2.8 million; and
o A tax benefit of $3.5 million related to the above items
Excluding these items, our pro forma net loss for the first quarter of 2002
was approximately $3.4 million, or $0.09 per share.
Liquidity and Capital Resources
At March 31, 2002, our primary sources of liquidity were $88.3 million in
cash and cash equivalents, and $6.2 million in marketable securities, totaling
$94.5 million and representing 50% of total assets. We have invested our cash in
excess of current operating requirements in short and intermediate term
investment grade securities that are available for sale as needed to finance our
future growth. Total cash and marketable securities decreased $43.1 million,
from $137.6 million at the end of 2001, due to expenditures to acquire certain
OSS assets from Nortel Networks and expenditures of cash for ongoing operations.
Cash used by operating activities during the quarter ended March 31, 2002,
was $6.6 million, compared to $5.5 million generated from operations during the
equivalent period in 2001. The $6.6 million use of cash during 2002 resulted
from our $9.0 million net loss, adjusted for the following non-cash expenses:
intangible asset amortization expense of $2.3 million related to acquisitions,
acquired in-process research and development charges of $4.1 million, other
depreciation and amortization expense of $1.3 million, income tax related
adjustments of $4.0 million, and an increase in operating assets and liabilities
of $2.4 million. The operating assets and liability change is net of acquired
amounts, and result primarily from higher trade receivables and accrued
expenses, and lower deferred revenue.
Deferred revenue consists primarily of prepaid maintenance revenue that we
recognize on a pro-rata basis over the term of the agreement, and also includes
customer payments that we have received for license products and services yet to
be performed. Deferred revenues were $11.6 million at March 31, 2002 and $9.1
million at December 31, 2001. The increase in deferred revenue was primarily due
to amounts added for support of partially completed maintenance
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agreements pertaining to our acquisition. The value of these partially completed
maintenance terms was computed on a cost plus margin basis.
Accounts receivable, net, increased from $12.9 million at the end of 2001
to $15.9 million at March 31, 2002. The $3.0 million increase in receivables
resulted primarily from nonlinear revenues during the quarter that resulted in
higher customer billing activity late in the quarter. We did not acquire any
receivables in our acquisition of OSS assets from Nortel Networks.
Accrued liabilities and accounts payable at March 31, 2002 totaled $26.9
million, compared to $17.3 million at December 30, 2001. The acquisition in
February added approximately $7.0 million in accrued liabilities to our balance
sheet for liabilities acquired from Nortel Networks. The remaining $2.6 million
increase in accrued liabilities during the first quarter of 2002 relates
primarily to acquisition costs incurred but not paid at March 31, 2002.
Net cash generated from investing activities was $14.1 million in the
quarter ended March 31, 2002, comprised of the sale of $50.8 million in
marketable securities, partially offset by $35.6 million in acquisition-related
cash outflows. Additionally, we invested $0.9 million in capital assets during
the quarter, primarily for computer hardware and software. We acquired
approximately $3.8 million in capital assets from Nortel Networks as part of the
acquisition, primarily leasehold improvements, furniture and computing hardware.
We have no unusual capital commitments at March 31, 2002, and our principal
commitments consist of obligations under operating leases.
Net cash provided from financing activities consisted of $0.1 million in
proceeds from issuance of common stock upon the exercise of employee stock
options.
We believe that our cash flows generated by operations, together with
current cash and marketable securities balances, will be sufficient to meet our
anticipated cash needs for working capital and capital expenditures for at least
the next 12 months. From time to time, we evaluate potential acquisitions of
complementary businesses, products and technologies. 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.
New Accounting Standards
In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible
Assets. SFAS No. 141 requires that the purchase method of accounting be used and
establishes new standards on the recognition of certain identifiable intangible
assets separate from goodwill for all business combinations initiated after June
30, 2001. SFAS No. 142 requires that goodwill and intangible assets with
indefinite useful lives no longer be amortized but instead tested for impairment
at least annually. SFAS No. 142 also requires that intangible assets with
definite useful lives be amortized over their respective estimated useful lives
to their estimated residual values.
We adopted the provisions of SFAS No. 141 effective July 1, 2001 and
adopted SFAS No. 142 effective January 1, 2002. In accordance with the
transitional provisions of SFAS No. 142, goodwill that was acquired in purchase
business combinations completed after June 30, 2001 is not amortized, but is
evaluated for impairment in accordance with the accounting literature in effect
prior to the issuance of SFAS No. 142.
Under SFAS No. 142, we are required to perform transitional impairment
tests for our goodwill as of the date of adoption. Step one of the transitional
goodwill impairment test, which compares the fair values of our reporting units
to their respective carrying values, will be completed by June 30, 2002.
Transitional impairment losses for goodwill, if any, will be recognized as the
cumulative effect of a change in accounting principle in our consolidated
statement of income. Since we had not completed any acquisitions prior to June
30, 2001, we had no purchased intangible assets or goodwill that were being
amortized prior to January 1, 2002. We completed our acquisition of Lat45
Information Systems Inc. in July of 2001 and recorded $6.4 million of goodwill.
We completed our acquisition of certain OSS Assets from Nortel Networks in
February of 2002 and recorded $21.7 million of goodwill. Goodwill is not being
amortized pursuant to the provisions of this Standard.
In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment
or Disposal of Long-Lived Assets. SFAS No. 144 establishes one accounting model
to be used for long-lived assets to be disposed of by sale and broadens the
presentation requirements of discontinued operations to include more disposal
transactions. SFAS No. 144 supersedes
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SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of, and the accounting and reporting provisions
of Accounting Principles Board Opinion No. 30, Reporting the Results of
Operations -- Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions,
relative to discontinued operations. SFAS No. 144 is effective for fiscal years
beginning after December 31, 2001. The impact of its adoption did not have a
material impact to our results of operations or financial position.
In November 2001, the FASB issued a staff announcement regarding the income
statement characterization of reimbursements received for "out-of-pocket"
expenses incurred. This announcement indicated that the FASB believes that
reimbursements received for out-of-pocket expenses should be characterized as
revenue in the income statement, where the service provider is the primary
obligor with respect to purchasing goods and services from third parties, has
supplier discretion and assumes credit risk for the transaction. The
announcement is effective for financial reporting periods beginning after
December 15, 2001. Upon application of the statement, comparative financial
statements for prior periods have been reclassified. In January 2002, the
Company adopted the FASB staff position regarding the income statement
classification of reimbursements received for "out-of-pocket" expenses incurred.
Service revenues and services cost of revenues related to this change were
$630,000 in the first quarter of 2002. The first quarter of 2001 has been
reclassified to present amounts previously shown net on a comparable basis by
increasing services revenues and services cost of revenues by approximately
$774,000.
Certain Factors That May Affect Future Results
We operate in a dynamic and rapidly changing environment that involves
numerous risks and uncertainties. The following section describes some, but not
all, of these risks and uncertainties that we believe may adversely affect our
business, financial conditions or results of operations. There are additional
risks and uncertainties that we do not presently know, or that we currently view
as immaterial, that may also impair our business operations. This report is
qualified in its entirety by these risks. You should carefully consider the
risks described below before making an investment decision. If any of the
following risks actually occur, they could materially harm our business,
financial condition, or results of operations. In that case, the trading price
of our common stock could decline.
OUR QUARTERLY OPERATING RESULTS CAN VARY SIGNIFICANTLY AND MAY CAUSE OUR STOCK
PRICE TO FLUCTUATE.
Our quarterly operating results can vary 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:
o 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;
o Our customers' willingness to buy, rather than build, order
processing, management and fulfillment software;
o 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;
o The introduction of new communications services and our ability
to react quickly compared to our competitors;
o Our ability to manage costs, including costs related to
professional services and support services;
o The utilization rate of our professional services employees and
the extent to which we use third party subcontractors to provide
consulting services;
o Costs related to possible acquisitions of other businesses;
o Our ability to collect outstanding accounts receivable from very
large product licenses;
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o Innovation and introduction of new technologies, products and
services in the communications and information technology
industries;
o Costs related to the expansion of our operations;
o We may be required to defer recognition of revenue for a
significant period of time after entering into a contract due to
undelivered products, extended payment terms, or product
acceptance; and
o Changes in services and license revenue as a percentage of total
revenue, as license revenue typically has a higher gross margin
than services revenue.
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. A higher
concentration of large telecom service providers, and larger more complex
agreements may increase the frequency and amount of these deferrals. With these
uncertainties we may not be able to predict accurately when revenue from these
contracts will be recognized.
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 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 our encountering new competitors in 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 and in particular our customers have
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 realize.
These companies are
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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 additional customers as a result of industry consolidation.
CONSOLIDATIONS IN THE TELECOMMUNICATIONS INDUSTRY OR SLOWDOWN IN
TELECOMMUNICATIONS SPENDING COULD HARM OUR BUSINESS, FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
We have derived substantially all of our revenues from sales of products
and related services to the telecommunications industry. The global
telecommunications industry is currently experiencing a very challenging period
during which business activity has contracted. Since early 2001, we and a number
of other companies have been impacted by reduced spending by telecommunications
carriers and equipment manufacturers. Slowdowns in spending often cause delays
in sales and installations and could cause cancellations of current or planned
projects, any of which could harm our financial results in a particular period.
OUR CUSTOMERS' FINANCIAL WEAKNESS, THEIR INABILITY TO OBTAIN FINANCING, AND THE
RECENT DOWNTURN IN THE COMMUNICATIONS INDUSTRY MAY LEAD TO LOWER SALES AND
DECREASED PROFITABILITY.
Many of our customers are small to medium sized competitive communications
service providers with limited operating histories. Many of these customers are
not profitable and highly dependent on private sources of venture capital to
fund their operations. Many competitive communications service providers were
unable to obtain sufficient funds to continue expansion of their businesses. At
the same time, many communications companies are encountering significant
difficulties in achieving their business plans and financial projections. In
recent months several of our customers ceased their business operations and a
significant number of our customers initiated bankruptcy proceedings. It is
possible that this downturn in the communications industry could continue for an
indefinite period of time. The downturn in the communications industry and the
inability of many communications companies to raise capital have resulted in a
decrease in the number of potential customers that are capable of purchasing our
software, a delay by some of our existing customers in purchasing additional
products, delays in payments by existing customers, or failure to pay for our
products. If our customers are unable to obtain adequate financing, sales of our
software could suffer. If we fail to increase revenue related to our software,
our operating results and financial condition would be adversely affected. In
addition, adverse market conditions and limitations on the ability of our
current customers to obtain adequate financing could adversely affect our
ability to collect outstanding accounts receivable resulting in increased bad
debt losses and a decrease in our overall profitability. Any of our current
customers who cease to be viable business operations would no longer be a source
of maintenance revenue or revenue from sales of additional software or services
products, and this could adversely affect our financial results.
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. As consolidation in the telecommunications industry
continues, our reliance on a limited number of customers for a significant
portion of our revenue may increase. 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 year 2001, our top ten customers accounted for 36% of our
total revenue, compared to 27% during the year 2000. No single customer
accounted for more than 6% of total revenue in 2001. However, to the extent that
any major customer terminates its relationship with us, our revenue could be
adversely affected. While we believe that the loss of any single customer would
not seriously harm our overall business or financial condition, our inability to
consummate one or more substantial sales in any future period could seriously
harm our operating results for that period.
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. Although we
compete against other companies selling communications software and services,
the in-house development efforts of our customers may also result in our making
fewer sales. We expect competition to persist in the future. We cannot be
certain that we can compete successfully with
-18-
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 of products and services offered. We
encounter direct competition from several vendors, including Astracon, Cramer
Systems, Eftia OSS Solutions, GE Smallworld, Granite Systems, Syndesis,
Telcordia Technology, and Wisor Telecom. Additionally, we compete with OSS
solutions sold by large equipment vendors such as ADC Telecommunications. We
also compete with systems integrators and with the information technology
departments of large communications service providers. Finally, we are aware of
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 us. We anticipate
continued long-term growth in the communications industry and the entrance of
new competitors in the order processing, management and fulfillment software
markets. We believe 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 OR BROADBAND COMMUNICATION SERVICES GROWTH SLOWS, DEMAND FOR OUR
PRODUCTS MAY FALL.
Our success depends heavily on the continued acceptance of the Internet as
a medium of commerce and communication and the growth of broadband communication
services. 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 customers. If use of the Internet or broadband
communication services 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, insufficient commercial support, and security or
privacy concerns. The Internet infrastructure may not be able to support the
demands placed on it by increased usage and bandwidth requirements. In addition,
delays in the development or adoption of new standards and protocols, 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
and could seriously affect our business and financial condition.
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IF WE FAIL TO ACCURATELY ESTIMATE THE RESOURCES NECESSARY TO COMPLETE ANY
FIXED-PRICE CONTRACT, IF WE FAIL TO MEET OUR PERFORMANCE OBLIGATIONS, OR IF WE
FAIL TO ANTICIPATE COSTS ASSOCIATED WITH PARTICULAR SALES OR SUPPORT CONTRACTS,
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. Also, in some instances our sales and support contracts may
require us to provide software functionality that we have procured from third
party vendors. The cost of this third party functionality may impact our
margins, and we could fail to accurately anticipate or manage these costs. On
occasion we have been asked or required to commit unanticipated additional
resources or funds to complete projects or fulfill sales and support contracts.
Our acquisitions of Lat45 Information Systems Inc. in July 2001, and certain OSS
assets from Nortel Networks in February 2002, and associated customer
obligations, may intensify these risks.
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 partners 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.
OUR ABILITY TO ATTRACT, TRAIN AND RETAIN QUALIFIED EMPLOYEES IS CRUCIAL TO
RESULTS OF OPERATIONS AND FUTURE GROWTH; MANAGEMENT TURNOVER COULD AFFECT OUR
ABILITY TO ACHIEVE OPERATING RESULTS.
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. Competition for
skilled personnel is intense. Any inability to hire, train and retain a
sufficient number of qualified employees could hinder the growth of our
business.
During the year 2001, we underwent significant changes and may experience
additional management changes in the future. New managers typically bring new
strengths to our business, but their short tenure with us could affect our
ability to execute business plans and achieve our planned operating results.
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 and
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
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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.
THE EXPANSION OF OUR PRODUCTS WITH NEW FUNCTIONALITY AND TO NEW CUSTOMER MARKETS
MAY BE DIFFICULT AND COSTLY.
We plan to invest significant resources and management attention to
expanding our products by adding new functionality and to expanding our customer
base by targeting customers in markets that we have not previously served. We
cannot be sure that expanding the footprint of our products or selling our
products into new markets will generate acceptable financial results due to
uncertainties inherent in entering new markets and in our ability to execute our
plans. Costs associated with our product and market expansions may be more
costly than we anticipate, and demand for our new products and in new customer
markets may be lower than we expect.
FOR SOME OF OUR PRODUCTS WE RELY ON SOFTWARE AND OTHER INTELLECTUAL PROPERTY
THAT WE HAVE LICENSED FROM THIRD PARTY DEVELOPERS TO PERFORM KEY FUNCTIONS.
Some of our products contain software and other intellectual property that
we license from third parties, including software that is integrated with
internally developed software and used in our products to perform key functions.
We could lose the right to use this software and intellectual property or it
could be made available to us only on commercially unreasonable terms. We could
fail to accurately recognize or anticipate the impact of the costs of procuring
this third party intellectual property. Although we believe that alternative
software and intellectual property is available from other third party
suppliers, the loss of or inability to maintain any of these licenses or the
inability of the third parties to enhance in a timely and cost-effective manner
their products in response to changing customer needs, industry standards or
technological developments could result in delays or reductions in product
shipments by us until equivalent software could be developed internally or
identified, licensed and integrated, which would harm our business.
OUR INTERNATIONAL OPERATIONS MAY BE DIFFICULT AND COSTLY.
We intend to continue to devote significant management and financial
resources to our international expansion. In particular, we will have to
continue to attract experienced management, technical, sales, marketing and
support personnel for our international offices. Competition for skilled people
in these areas 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 cultural differences, language barriers, and currency exchange
risks. Additionally, communications infrastructure in foreign countries may be
different from the communications infrastructure in the United States. Our
ability to successfully penetrate these markets is uncertain. If our
international operations are unsuccessful, 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:
o Longer payment cycles;
o Problems in collecting accounts receivable;
o The impact of recessions in economies outside the United States;
o Unexpected changes in regulatory requirements;
o Variable and changing communications industry regulations;
o Trade barriers and barriers to foreign investment, in some cases
specifically applicable to the communications industry;
o Barriers to the repatriation of capital or profits;
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o Political instability or changes in government policy;
o Restrictions on the import and export of certain technologies;
o Lower protection for intellectual property rights;
o Seasonal reductions in business activity during the summer
months, particularly in Europe;
o Potentially adverse tax consequences;
o Increases in tariffs, duties, price controls or other
restrictions on foreign currencies;
o Requirements of a locally domiciled business entity;
o Regional variations in adoption and growth of new technologies
served by our products; and
o Potential impact on the above factors of the failure, success, or
variability between countries of acceptance of the Euro monetary
unit, and other European Union initiatives.
WE HAVE ACQUIRED OTHER BUSINESSES AND WE MAY MAKE ADDITIONAL ACQUISITIONS OR
ENGAGE IN JOINT BUSINESS VENTURES THAT COULD BE DIFFICULT TO INTEGRATE, DISRUPT
OUR BUSINESS, DILUTE STOCKHOLDER VALUE AND ADVERSELY AFFECT OUR OPERATING
RESULTS.
We have acquired other businesses and may make additional acquisitions, or
engage in joint business ventures in the future that may be difficult to
integrate, disrupt our business, dilute stockholder value, complicate our
management tasks and affect our operating results. In July 2001 we completed the
acquisition of Lat45 Information Systems Inc., a developer of geospatial
software for planning, design and management of communications networks, and in
February 2002 we completed the acquisition of certain OSS assets from Nortel
Networks that added service activation and other products to our product
portfolio. Acquisitions and investments in businesses involve significant risks,
and our failure to successfully manage acquisitions or joint business ventures
could seriously harm our business. Our past acquisitions and potential future
acquisitions or joint business ventures create numerous risks and uncertainties
including:
o Risk that the industry may develop in a different direction than
anticipated and that the technologies we acquire will not prove
to be those needed to be successful in the industry;
o Potential difficulties in completing in-process research and
development projects;
o Difficulty integrating new businesses and operations in an
efficient and effective manner;
o Risk that we have inaccurately evaluated or forecasted the
benefits, opportunities, liabilities, or costs of the acquired
businesses;
o Risk of our customers or customers of the acquired businesses
deferring purchase decisions as they evaluate the impact of the
acquisition on our future product strategy;
o Risk that we may not properly determine or account for risks and
benefits under acquired customer contracts;
o Potential loss of key employees of the acquired businesses;
o Risk that we will be unable to integrate the products and
corporate cultures of the acquired business;
o Risk of diverting the attention of senior management from the
operation of our business;
o Risk of entering new markets in which we have limited experience;
and
o Future revenues and profits from acquisitions and investments may
fail to achieve expectations.
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Our inability to successfully integrate acquisitions or to otherwise manage
business growth effectively could have a material adverse effect on our results
of operations and financial condition. Also, our existing stockholders may be
diluted if we finance the acquisitions by issuing equity securities.
THE VALUE OF OUR ASSETS MAY BECOME IMPAIRED.
Should our marketing and sales plan not materialize in the near term, the
realization of our intangible assets could be severely and negatively impacted.
The accompanying consolidated financial statements contained in this report have
been prepared based on management's estimates of realizability, and these
estimates may change in the future due to unforeseen changes in our results or
market conditions.
FUTURE SALES OF OUR COMMON STOCK WOULD BE DILUTIVE TO OUR STOCKHOLDERS AND COULD
ADVERSELY AFFECT THE MARKET PRICE OF OUR COMMON STOCK.
We cannot predict the effect, if any, that future sales of our common stock
by us, or the availability of shares of our common stock for future sale, will
have on the market price of our common stock prevailing from time to time. Sales
of substantial amounts of our common stock (including shares issued upon the
exercise of stock options), or the perception that such sales could occur, may
materially and adversely affect prevailing market prices for common stock.
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 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:
o Delayed or lost revenues and market share due to adverse customer
reaction;
o Loss of existing customers;
o Negative publicity regarding us and our products, which could
adversely affect our ability to attract new customers;
o Expenses associated with providing additional products and
customer support, engineering and other resources to a customer
at a reduced charge or at no charge;
o Claims for substantial damages against us, regardless of our
responsibility for any failure;
o Increased insurance costs; and
o 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.
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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 assess and 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. These risks may be increased
by the addition of intellectual property assets through business or product
acquisitions. 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. As our
business expands into foreign countries, costs and risks associated with
protecting our intellectual property abroad will increase. We also may choose to
forgo the costs and related benefits of certain intellectual property benefits
in some of these jurisdictions.
OUR STOCK PRICE HAS BEEN AND MAY REMAIN VOLATILE, WHICH EXPOSES US TO THE RISK
OF SECURITIES LITIGATION.
The trading price of our common stock has in the past and may in the future
be subject to wide fluctuations in response to factors such as the following:
o Revenue or results of operations in any quarter failing to meet
the expectations, published or otherwise, of the investment
community;
o Announcements of technological innovations by us or our
competitors;
o Acquisitions of new products or significant customers or other
significant transactions by us or our competitors;
o Developments with respect to our patents, copyrights or other
proprietary rights of our competitors;
o Changes in recommendations or financial estimates by securities
analysts;
o Rumors or dissemination of false and/or unofficial information;
o Changes in management;
o Stock transactions by our management or businesses with whom we
have a relationship;
o Conditions and trends in the software and communications
industries;
o Adoption of new accounting standards affecting the software
industry; and
o General market conditions, including geopolitical events.
Fluctuations in the price of our common stock may expose us to the risk of
securities lawsuits. Defending against such lawsuits could result in substantial
costs and divert management's attention and resources. In addition, any
settlement or adverse determination of these lawsuits could subject us to
significant liabilities.
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PROVISIONS OF OUR CHARTER DOCUMENTS, DELAWARE LAW, AND OUR STOCKHOLDER RIGHTS
PLAN COULD DISCOURAGE A TAKEOVER YOU MAY CONSIDER FAVORABLE OR THE REMOVAL OF
OUR CURRENT MANAGEMENT.
Some provisions of our certificate of incorporation and bylaws may
discourage, delay or prevent a merger or acquisition that you may consider
favorable or the removal of our current management. These provisions:
o Authorize the issuance of "blank check" preferred stock;
o Provide for a classified board of directors with staggered,
three-year terms;
o Prohibit cumulative voting in the election of directors;
o Prohibit our stockholders from acting by written consent without
the approval of our board of directors;
o Limit the persons who may call special meetings of stockholders;
and
o Establish advance notice requirements for nominations for
election to the board of directors or for proposing matters to be
approved by stockholders at stockholder meetings.
Delaware law may also discourage, delay or prevent someone from acquiring
or merging with us. In addition, purchase rights distributed under our
stockholder rights plan will cause substantial dilution to any person or group
attempting to acquire us without conditioning the offer on our redemption of the
rights. As a result, our stock price may decrease and you might not receive a
change of control premium over the then-current market price of the common
stock.
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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 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. At March 31, 2002, the weighted average
pre-tax interest rate on the investment portfolio is approximately 5.25%. Market
risk related to these investments can be estimated by measuring the impact of a
near-term adverse movement of 10% in short-term market interest rates. If these
rates average 10% more in 2002 than in 2001, there would be no material adverse
impact on our results of operations or financial position. During the quarter
ended March 31, 2002, had short-term market interest rates averaged 10% more
than in 2001, there would have been no material adverse impact on our results of
operations or financial position.
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. Market
risk related to foreign currency exchange rates can be estimated by measuring
the impact of a near-term adverse movement of 10% in foreign currency exchange
rates against the U.S. dollar. During the quarter ended March 31, 2002, had
these rates averaged 10% more than in 2001, there would have been no material
impact on our results of operations or financial position.
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PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
10.1 Consent to Assignment of lease dated February 1, 2002 by and
between Architel Systems Corporation, MetaSolv Software Canada
Inc. and First Real Properties Limited, and associated Lease
Agreement.
10.2 Indemnity Agreement dated February 1, 2002 by and between First
Real Properties Limited and MetaSolv Software, Inc.
(b) Reports on Form 8-K.
(i) Current report on Form 8-K of MetaSolv, Inc. dated January 30,
2002, reporting the filing of a press release.
(ii) Current report on Form 8-K of MetaSolv, Inc. dated February 1,
2002, reporting an acquisition.
(iii) Current report on Form 8-K/A of MetaSolv, Inc. dated February 1,
2002 and filed on April 17, 2002 reporting the filing of
financial statements in connection with an acquisition.
(iv) Current report on Form 8-K of MetaSolv, Inc. dated April 17,
2002, reporting the filing of a press release.
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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: May 14, 2002
METASOLV, INC.
/s/ Glenn A. Etherington
---------------------------------------------------
Glenn A. Etherington
Chief Financial Officer
Duly Authorized Officer on behalf of the Registrant
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