10-Q 1 d10q.txt FORM 10-Q FOR 03/31/2002 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-Q [x] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended 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: 000-30883 I-MANY, INC. (Exact name of registrant as specified in its charter) Delaware 01-0524931 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 537 Congress Street 5/th/ Floor Portland, Maine 04101-3353 (Address of principal executive offices) (207) 774-3244 (Registrant's telephone number, including area code) 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 _______ ------ On May 9, 2002, 40,318,332 shares of the registrant's common stock, $.0001 par value, were issued and outstanding. CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. Discussions containing forward-looking statements may be found in the information set forth under "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "--Certain Factors That May Affect Future Operating Results" as well as in the Form 10-Q generally. The Company uses words such as "believes," "intends," "expects," "anticipates," "plans," "estimates," "should," "may," "will," "scheduled" and similar expressions to identify forward-looking statements. The Company uses these words to describe its present belief about future events relating to, among other things, its expected marketing plans, future hiring, expenditures and sources of revenue. This Form 10-Q may also contain third party estimates regarding the size and growth of our market, which also are forward-looking statements. Our forward-looking statements apply only as of the date of this Form 10-Q. The Company's actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including the risks described above and elsewhere in the Form 10-Q. Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, the Company cannot guarantee future results, levels of activity, performance or achievements. The Company is under no duty to update any of the forward-looking statements after the date of this Form 10-Q to conform these statements to actual results or to changes in our expectations, other than as required by law. 2 I-MANY, INC. FORM 10-Q TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION PAGE ---- Item 1. Financial Statements Consolidated Balance Sheets as of March 31, 2002 and December 31, 2001 ........................................................... 4 Consolidated Statements of Operations for the three months ended March 31, 2002 and 2001 ............................................... 5 Consolidated Statements of Cash Flows for the three months ended March 31, 2002 and 2001 ............................................... 6 Notes to Consolidated Condensed Financial Statements ........................ 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ................................................... 14 Item 3. Quantitative and Qualitative Disclosures About Market Risk .................. 24 PART II. OTHER INFORMATION Item 1. Legal Proceedings ........................................................... 25 Item 2. Changes in Securities and Use of Proceeds ................................... 25 Item 3. Defaults upon Senior Securities ............................................. 25 Item 4. Submission of Matters to a Vote of Security Holders ......................... 25 Item 5. Other Information ........................................................... 25 Item 6. Exhibits and Reports on Form 8-K ............................................ 26 Signatures .................................................................. 26 Exhibit Index ............................................................... 27

3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS I-MANY, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands)

March 31, December 31, 2002 2001 ------ ------ ASSETS (unaudited) Current assets: Cash and cash equivalents $ 41,138 $ 36,015 Restricted cash 17,000 - Accounts receivable, net of allowance 15,317 13,412 Prepaid expenses and other current assets 972 692 --------- --------- Total current assets 74,427 50,119 Property and Equipment, net 4,558 4,709 Other Assets 2,301 2,329 Goodwill and Other Purchased Intangibles 45,637 34,814 --------- --------- Total assets $ 126,923 $ 91,971 ========= ========= LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 2,373 $ 2,207 Accrued expenses 9,004 7,082 Deferred revenue 7,277 7,206 --------- --------- Total current liabilities 18,654 16,495 Capital Lease Obligations, net of current portion 78 105 Deferred Rent 72 115 Commitments and Contingencies Series A Redeemable Convertible Preferred Stock 17,000 - --------- --------- Stockholders' Equity: Undesignated preferred stock, $.01 par value Authorized - 5,000,000 shares Issued and outstanding - 0 shares - - Common stock, $.0001 par value - - Authorized - 100,000,000 shares Issued and outstanding - 40,265,374 and 37,200,988 shares at March 31, 2001 and December 31, 2001, respectively 4 4 Additional paid-in capital 144,030 125,224 Deferred stock-based compensation (82) (94) Stock subscription payable 4 1,168 Accumulated other comprehensive income (loss) 14 (5) Accumulated deficit (52,851) (51,041) --------- --------- Total stockholders' equity 91,119 75,256 --------- --------- Total liabilities and stockholders' equity $ 126,923 $ 91,971 ========= =========

The accompanying notes are an integral part of these consolidated condensed financial statements. 4 I-MANY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts) (Unaudited)

Three months ended March 31, 2002 2001 ---- ---- Net Revenues: Product $ 8,525 $ 8,481 Services 6,490 7,330 --------- --------- Total net revenues 15,015 15,811 Cost of revenues 3,547 4,902 --------- --------- Gross profit 11,468 10,909 Operating expenses: Sales and marketing 5,286 5,142 Research and development 3,957 3,497 General and administrative 1,436 1,966 Depreciation 591 1,366 Amortization of goodwill and other intangible assets 1,043 847 In-process research and development 1,000 - --------- --------- Total operating expenses 13,313 12,818 --------- --------- Loss from operations (1,845) (1,909) Other income, net 35 620 --------- --------- Net loss $ (1,810) $ (1,289) ========= ========= Basic and diluted net loss per common share $ (0.05) $ (0.04) ========= ========= Weighted average shares outstanding 37,984 33,095 ========= =========

The accompanying notes are an integral part of these financial statements 5 I-MANY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited)

Three Months Ended March 31, --------------------------- 2002 2001 ---- ---- Cash Flows from Operating Activities: Net loss $ (1,810) $ (1,289) Adjustments to reconcile net loss to cash provided by (used in) operating activities: Depreciation and amortization 1,620 2,188 In-process research and development 1,000 -- Amortization of deferred stock-based compensation 12 25 Deferred rent (44) -- Changes in current assets and liabilities net of acquisitions: Accounts receivable (1,855) (489) Prepaid expense and other current assets (241) (390) Accounts payable 166 (861) Accrued expenses (1,333) 752 Deferred revenue 34 669 -------- -------- Net cash provided by (used in) operating activities (2,451) 605 -------- -------- Cash Flows from Investing Activities: Purchases of property and equipment, net (227) (963) Additional cash paid to acquire Chi-Cor Information Management, Inc. -- (766) Cash paid to acquire Vintage Software, Inc. -- (731) Cash paid to acquire Intersoft International, Inc. -- (591) Additional cash paid to acquire BCL Vision, Ltd. (40) -- Cash paid to acquire Net Return, LLC (634) -- Cash paid to acquire Menerva Technologies, Inc. (331) -- (Increase) decrease in other assets 31 (133) -------- -------- Net cash used in investing activities (1,201) (3,184) -------- -------- Cash Flows from Financing Activities: Net proceeds from private placement sale of common stock 7,437 -- Payments on capital lease obligations (27) (12) Proceeds from exercise of stock options 1,346 581 -------- -------- Net cash provided by financing activities 8,756 569 -------- -------- Effect of foreign exchange rate changes 19 -- -------- -------- Net Increase (Decrease) in Cash and Cash Equivalents 5,123 (2,010) Cash and Cash Equivalents, beginning of period 36,015 50,639 -------- -------- Cash and Cash Equivalents, end of period $ 41,138 $ 48,629 ======== ========

6 Supplemental Disclosure of Cash Flow Information: Cash paid during the period for interest $ 12 $ 7 ======== ======== Supplemental Disclosure of Noncash Activities: Issuance of redeemable convertible preferred stock, proceeds held in escrow pending conversion $ 17,000 $ -- ======== ======== As of March, 2001, the Company recorded additional costs related to its acquisition of Chi-Cor Information Management, Inc. as follows: Fair value of additional assets acquired $ -- $ (1,453) Additional cash paid -- 766 Additional common stock issued -- 677 -------- -------- Additional liabilities assumed $ -- $ (10) ======== ======== On January 25, 2001, the Company acquired Vintage Software, Inc. as follows: Fair value of assets acquired $ -- $ (1,168) Cash paid for acquisition -- 731 Common stock issued -- 400 -------- -------- Liabilities assumed $ -- $ (37) ======== ======== On March 2, 2001, the Company acquired Intersoft International, Inc. as follows: Fair value of assets acquired $ (4) $ (3,242) Cash paid for acquisition -- 591 Common stock issued 4 2,240 -------- -------- Liabilities assumed $ -- $ (411) ======== ======== As of March 31, 2002, the Company incurred additional costs related to its Acquisition of BCL Vision, Ltd. as follows: Fair value of assets acquired $ (40) $ -- Cash paid for acquisition 40 -- -------- -------- Liabilities assumed $ -- $ -- ======== ======== On March 12, 2002, the Company acquired NetReturn LLC as follows: Fair value of assets acquired $ (3,420) $ -- Cash paid for acquisition 634 -- Common stock issued 2,750 -- -------- -------- Liabilities assumed $ (36) $ -- ======== ======== On March 28, 2002, the Company acquired Menerva Technologies, Inc. as follows: Fair value of assets acquired $ (9,691) $ -- Cash paid for acquisition 331 -- Cash to be paid for acquisition subsequent to March 31, 2002 2,484 -- Common stock and options issued 6,105 -- -------- -------- Liabilities assumed $ (771) $ -- ======== ======== The accompanying notes are an integral part of these consolidated condensed financial statements. 7 I-MANY, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1. BASIS OF PRESENTATION The accompanying unaudited interim financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission for reporting on Form 10-Q. Accordingly, certain information and footnote disclosures required for complete financial statements are not included herein. It is recommended that these financial statements be read in conjunction with the financial statements and related notes of I-many, Inc. (the "Company") for the year ended December 31, 2001 as reported in the Company's Annual Report on Form 10-K. In the opinion of management, all adjustments (consisting of normal, recurring adjustments) considered necessary for a fair presentation of financial position, results of operations and cash flows at the dates and for the periods presented have been included. The consolidated balance sheet presented as of December 31, 2001 has been derived from the financial statements that have been audited by the Company's independent public accountants not contained herein. The results of operations for the three months ended March 31, 2002 may not be indicative of the results that may be expected for the year ending December 31, 2002, or for any other period. NOTE 2. NET LOSS PER SHARE Basic net loss per share was determined by dividing the net loss applicable to common stockholders by the weighted-average number of shares of common stock outstanding during the period. Diluted net loss per share was the same as basic net loss per share for all periods presented since the effect of any potentially dilutive securities was excluded, as they are anti-dilutive as a result of the Company's net losses. The total numbers of common equivalent shares excluded from the diluted loss per share calculation were 3,342,445 and 3,336,022 for the three months ended March 31, 2002 and 2001, respectively. NOTE 3. RECLASSIFICATION OF PRIOR YEAR ACCOUNT BALANCES Effective in January 2002, in accordance with Issue No. 01-14, INCOME STATEMENT CHARACTERIZATION OF REIMBURSEMENTS RECEIVED FOR "OUT-OF-POCKET" EXPENSES INCURRED, as promulgated by the Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board (FASB), the Company accounts for reimbursements of out-of-pocket expenses related to its professional services business as revenue. Previously, these amounts were classified as reductions to cost of revenues in the Company's financial statements. For comparative purposes, the company has reclassified out-of-pocket reimbursement amounts as revenue in its 2001 financial statements. The effect of this reclassification is an increase in net revenues of $546,000 for the three-month period ended March 31, 2001. In the three-month period ended March 31, 2002, reimbursements of out-of-pocket expenses amounted to $275,000. NOTE 4. PRIVATE PLACEMENT On February 20, 2002, the Company completed a private placement of its common stock and preferred stock, issuing 1,100,413 shares of its common stock and the warrants described below at a total price of $7.27 per share and 1,700 shares of redeemable convertible preferred stock at a purchase price of $10,000 per share. The preferred stock has no dividends or coupon, no liquidation preference, no voting rights and no financial covenants. The Company received proceeds of approximately $7.4 million, net of commissions and other fees, from the sale of the common stock. The proceeds of $17.0 million related to the issuance of preferred stock are being held in escrow pending conversion or redemption of the shares of preferred stock. 8 The preferred stock is convertible into common stock at a price equal to the higher of (i) a floor price set by the Company, currently set at $7.00 per share, and (ii) a conversion price equal to the greater of $8.72 per share (but see below) or 80% of the average price of the Company's stock, measured over a 20-day period following the effectiveness of a registration statement. However, the conversion price of the preferred stock will not exceed 93% of the average price of the Company's stock, measured over the same 20-day period following the effectiveness of a registration statement. Also, the Company has the right to establish a new floor price above $7.00. In the event that the preferred stock is not converted into common stock by the date set for conversion, expected to be on or about August 2, 2002, the shares of preferred stock will be redeemed and the proceeds held in escrow, plus interest, will be refunded to the investors. As the initial, active conversion price of $7.00 per share is greater that the fair value of the underlying securities as the date of issuance, the Company concluded that, upon issuance, there was no beneficial conversion feature as defined in EITF Issue No. 98-5, ACCOUNTING FOR CONVERTIBLE SECURITIES WITH BENEFICIAL CONVERSION FEATURES OR CONTINGENTLY ADJUSTABLE CONVERSION RATIOS. However, as noted above, the conversion price is contingently adjustable and therefore may require beneficial conversion feature accounting in a future period, depending on whether or not the conversion price is adjusted and, if so, whether or not the new conversion price creates a beneficial conversion feature, pursuant to EITF Issues No. 98-5 and 00-27, APPLICATION OF EITF NO. 98-5 TO CERTAIN CONVERTIBLE INSTRUMENTS. In the event that such accounting is required, the Company would be required to compute the intrinsic value of the beneficial conversion feature and to amortize such amount as a preferred stock dividend over the remaining redemption period of the preferred stock. The effect of such accounting would be to reduce earnings available for common stockholders. The warrants issued by the Company to the common stock investors consist of a warrant exercisable for 180 days after the closing to purchase up to an additional 165,062 shares at an exercise price of $7.27 per share, and a seven-year warrant to purchase up to an additional 165,062 shares at an exercise price of $7.50 per share. If and only if the preferred stock is converted into common stock, the Company will grant a seven-year common stock warrant to the preferred stock investors to purchase up to a number of additional shares equal to 15% of the shares of common stock received on conversion, at an exercise price equal to 120% of the conversion price. NOTE 5. SIGNIFICANT CUSTOMERS The Company had one customer whose revenues individually represented 14% of total net revenues for the three-month period ended March 31, 2001. None of the Company's customers individually generated revenues comprising at least 10% of total net revenues during the three-month period ended March 31, 2002. NOTE 6. ACQUISITIONS CHI-COR INFORMATION MANAGEMENT, INC. On November 16, 2000, the Company acquired in a merger transaction all of the outstanding capital stock of Chi-Cor Information Management, Inc. ("Chicor") for an initial purchase price of $13.5 million, which consisted of cash of $5.7 million, a portion of which was used to pay off a $754,000 outstanding bank loan, 251,601 shares of Company common stock with a fair value at the date of closing of $4.9 million, assumed liabilities of $2.5 million and transaction costs of $458,000. In addition, based upon achievement of certain quarterly revenue and income milestones through December 31, 2001, the ChiCor shareholders received additional consideration of $3.5 million, consisting of $2.3 million in cash and 117,781 shares of Company common stock with a fair value as measured at the respective quarter ends of $1.2 million. The acquisition was accounted for as a purchase business combination in accordance with Accounting Principles Board (APB) Opinion No. 16, BUSINESS COMBINATIONS. The Company has consolidated the operations of ChiCor beginning on the date of acquisition. The Company retained an independent appraiser for the purpose of allocating the initial consideration of $13.5 million to the tangible and intangible assets acquired and liabilities assumed. The portion of the purchase price allocated to in-process research and development, totaling $2.4 million, was based on a risk-adjusted cash flow appraisal method and represents projects that had not yet reached technological feasibility and had no alternative future use. This portion of the purchase price was expensed upon consummation of the ChiCor acquisition. The entire $3.5 million in additional consideration was treated as additional purchase price and recorded as goodwill. 9 VINTAGE SOFTWARE, INC. On January 25, 2001, the Company acquired all of the outstanding capital stock of Vintage Software, Inc. ("Vintage"), a software company, which marketed a competing product to the Company's CARS software suite of products to mid-market pharmaceutical companies. The aggregate purchase price of $1.1 million included $433,000 of cash, 34,096 shares of Company common stock with a fair value of $400,000, earnout bonuses of $200,000, and transaction costs of $98,000. The acquisition was accounted for as a purchase business combination in accordance with APB Opinion No. 16, BUSINESS COMBINATIONS, and the Company has consolidated the operations of Vintage beginning on the date of acquisition. No pro forma information for the period ended March 31, 2002 has been presented as this purchase was not material. INTERSOFT INTERNATIONAL, INC. On March 2, 2001, the Company acquired all of the outstanding capital stock of Intersoft International, Inc. ("Intersoft"), a supplier of sales and marketing automation products for the foodservice broker industry. The initial purchase price of $3.2 million included $500,000 of cash, 115,733 shares of Company common stock with a fair value of $2.2 million, assumed liabilities of $411,000 and transaction costs of $99,000. In addition, based upon achievement of certain quarterly revenue and income milestones through March 31, 2002, the Intersoft shareholders were entitled to receive additional consideration of $84,000, consisting of 5,373 shares of Company common stock. The consideration amount payable at March 31, 2002 of $4,000, for the three-month period then ended, was recorded as Stock Subscription Payable and treated as additional purchase price and recorded as goodwill. The acquisition was accounted for as a purchase business combination in accordance with APB Opinion No. 16, BUSINESS COMBINATIONS, and the Company has consolidated the operations of Intersoft beginning on the date of acquisition. No pro forma information for the period ended March 31, 2002 has been presented as this purchase was not material. BCL VISION LTD. On April 9, 2001, the Company acquired all of the outstanding capital stock of BCL Vision Ltd. ("BCL"), a provider of collection and dispute management software and services based in London, United Kingdom. The initial purchase price of $12.1 million consists of cash of $4.0 million, 690,000 shares of Company common stock with a fair value of $6.9 million, assumed liabilities of $680,000 and transaction costs of $500,000. The acquisition was accounted for as a purchase business combination in accordance with APB Opinion No. 16, BUSINESS COMBINATIONS, and the Company has consolidated the operations of BCL beginning on the date of acquisition. The Company retained an independent appraiser for the purpose of allocating the consideration of approximately $12.1 million to the tangible and intangible assets acquired. Based on this appraisal, $952,000 was allocated to tangible assets and $10.2 was allocated to goodwill and other intangible assets. The portion of the purchase price allocated to in-process research and development, totaling $1.0 million, was based on a risk-adjusted cash flow appraisal method and represents projects that had not yet reached technological feasibility and had no alternative future use. This portion of the purchase price was expensed upon consummation of the BCL acquisition. PROVATO, INC. On August 16, 2001, the Company acquired in a merger transaction all of the outstanding capital stock of Provato, Inc. ("Provato"). The purchase price 10 of $16.0 million consisted of 1,975,739 shares of the Company's common stock valued at approximately $11.2 million, a fully-vested warrant to purchase 4,546 shares of the Company's stock valued at approximately $25,000, the assumption of approximately $1.3 million of liabilities, and $1.7 million in convertible notes issued by the Company to Provato during the two month period immediately preceding the merger. In connection with the acquisition, the Company incurred transaction costs of $1.8 million, which included approximately $1.2 million of Provato's merger-related costs. The acquisition was accounted for as a purchase business combination in accordance with Statement of Financial Accounting Standards (SFAS) No. 141, BUSINESS COMBINATIONS, and the Company has consolidated the operations of Provato beginning on the date of acquisition. The Company retained an independent appraiser for the purpose of allocating the merger consideration of $16.0 million to the tangible and intangible assets acquired. Based on this appraisal, $870,000 was allocated to tangible assets and $12.4 was allocated to goodwill and other intangible assets. The portion of the purchase price allocated to in-process research and development, totaling $2.7 million, was based on a risk-adjusted cash flow appraisal method and represents projects that had not yet reached technological feasibility and had no alternative future use. This portion of the purchase price was expensed upon consummation of the Provato acquisition. NETRETURN LLC On March 12, 2002, the Company acquired substantially all the assets of NetReturn, LLC ("NetReturn"), a Connecticut limited liability company located in Fairfield, Connecticut, for a purchase price of up to $5.4 million. The primary asset acquired was NetReturn's library of software applications and tools. The initial consideration of approximately $3.4 million consisted of $500,000 of cash, 429,017 shares of the Company's common stock with a fair value at the time of acquisition of $2.8 million and estimated transaction costs of $134,000. In addition, upon achievement of certain revenue milestones through March 31, 2003, the NetReturn shareholders are entitled to additional consideration of up to $2.0 million, payable in cash or stock at the Company's election. The acquisition was accounted for as a purchase business combination in accordance with SFAS No. 141, BUSINESS COMBINATIONS. The Company has consolidated the operating results of NetReturn beginning on the date of acquisition. No pro forma information for the periods ended March 31, 2002 has been presented as this purchase was not material. MENERVA TECHNOLOGIES, INC. On March 28, 2002, the Company acquired all of the outstanding capital stock of Menerva Technologies ("Menerva"), a Delaware corporation located in Redwood City, California which markets buy-side contract software solutions, for a purchase price of up to $12.7 million. The initial consideration of approximately $9.7 million consisted of cash of $2.5 million, 982,191 shares of the Company's common stock with a fair value at the time of acquisition of $6.0 million, the assumption of fully-vested stock options to purchase an aggregate of 25,743 shares of Company stock valued at approximately $143,000, assumed liabilities of $772,000 and estimated transaction costs of $340,000. In addition, upon achievement of certain revenue milestones through March 31, 2003, the former Menerva shareholders are entitled to additional consideration of up to $3.0 million, payable in cash or stock at the Company's election. The acquisition was accounted for as a purchase business combination in accordance with SFAS No. 141, BUSINESS COMBINATIONS. The Company has consolidated the operating results of NetReturn beginning on the date of acquisition. NOTE 7. STRATEGIC RELATIONSHIP AGREEMENTS PROCTER & GAMBLE COMPANY In May 2000, the Company entered into a Strategic Relationship Agreement (the Agreement) with the Procter & Gamble Company ("P&G"), pursuant to which P&G designated the Company for a period of at least three years as their exclusive provider of purchase contract management software for their 11 commercial products group. In addition, P&G agreed to provide the Company with certain strategic marketing and business development services over the term of the Agreement. P&G also entered into an agreement to license certain software and technology from the Company. As consideration for entering into the Agreement, the Company will pay P&G a royalty of up to 10% of the revenue generated from the commercial products market, as defined. To date, no such royalties have been earned or paid. In addition, the Company granted to P&G a fully exercisable warrant to purchase 875,000 shares of the Company's common stock. The warrant did not require any future product purchases or performance of any kind. The warrant, which was exercisable for a period of two years at an exercise price of $9.00 per share, was converted into 561,960 shares of common stock via a cashless exercise during 2000. In addition, the Company agreed to grant P&G warrants to purchase up to 125,000 additional shares of common stock, exercisable at the then current fair market value per share, upon the achievement of milestones set forth in the Agreement, as defined. Using the Black-Scholes option pricing model and based upon an exercise price of $9.00 per share and a volatility factor of 85%, the Company has calculated the fair value of the fully exercisable warrant to purchase 875,000 shares of common stock as approximately $3,820,000. In accordance with Emerging Issues Task Force Issue No. 96-18, ACCOUNTING FOR EQUITY INSTRUMENTS THAT ARE ISSUED TO OTHER THAN EMPLOYEES FOR ACQUIRING, OR IN CONJUNCTION WITH SELLING, GOODS OR SERVICES, this amount was recorded by the Company in May of 2000 as, first, a $1.2 million reduction of the revenue derived from the license agreement with P&G, and, second, a component of sales and marketing expense. The Company will calculate and record the fair value of the warrants to purchase up to 125,000 additional shares of common stock as P&G provides the services set forth in the Agreement. Since future revenue will be generated from referrals and not directly from P&G, the Company will treat the fair value of future warrants issued as sales and marketing expense. In essence, the value of any such warrants will be a sales commission. ACCENTURE In April 2001, the Company entered into a Marketing Alliance Agreement (the Agreement) with Accenture LLP, pursuant to which Accenture has designated the Company for a period of at least one year as their preferred provider of automated contract management solutions. In addition, Accenture has agreed to provide the Company with certain strategic marketing and business development services at no charge over the term of the Agreement. As consideration for entering into the Agreement, the Company has designated Accenture as its preferred business integration provider for the Company's CARS suite of products. In addition, the Company granted to Accenture a fully exercisable warrant to purchase 124,856 shares of the Company's common stock. The warrant is exercisable for a period of three years at an exercise price of $9.725 per share. The warrant does not require any future product purchases or performance of any kind. Since Accenture is an integration provider for the Company's products and not a customer, the full fair value of the warrant issued to Accenture was recorded as sales and marketing expense. Accenture is a sales agent, not a principal as defined in EITF 99-19. In addition, the Company has agreed to grant Accenture additional future warrants, each with a value equal to 10% of any revenues generated from certain future software licenses to Accenture's clients and prospects. Since future revenue will be generated from referrals and not directly from Accenture, the Company will treat the fair value of future warrants issued as sales and marketing expense. In essence, the value of such warrants will be a sales commission. To date, no such warrants have been earned or paid. NOTE 8. RESTRUCTURING AND OTHER CHARGES In the quarter ended September 30, 2001, the Company recorded a $3.0 million charge in connection with a restructuring of the Company's operations and the abandonment of its proprietary internet portal. Included in the $3.0 million charge is $2.4 million, which is the net carrying value of the Company's internet portal, $540,000 in severance pay, and $108,000 in facility lease costs. In abandoning its internet portal, the Company has ceased all support of the portal site, discontinued all related development, and eliminated or reassigned all personnel previously assigned to the project. The balance of the severance and related charges were incurred in association with the Company's decision to restructure certain of its operations in order to improve workforce efficiencies. In the quarter ended December 31, 2001, the Company recorded $1.7 million in charges in connection with the closing of its Oakland, California office and a write-down in value of certain intangible assets. Included in the $1.7 million charge is $368,000 in severance costs, $445,000 in facility lease and related 12 costs, and a write-down $895,000 of the carrying value of goodwill related to the Intersoft acquisition. As of March 31, 2002, $458,000 in restructuring charges is accrued and unpaid, consisting of $27,000 in severance costs and $431,000 in facility lease and related costs. NOTE 9. RECENT ACCOUNTING PRONOUNCEMENTS In July 2001, the FASB issued SFAS No. 141, BUSINESS COMBINATIONS. SFAS No. 141, which requires all business combinations to be accounted for using the purchase method, is effective for all business combinations initiated after June 30, 2001. In July 2001, the FASB issued SFAS No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS. This statement applies to goodwill and intangible assets acquired after June 30, 2001, as well as to goodwill and intangible assets previously acquired. Under this statement, goodwill and other certain intangible assets deemed to have an infinite life will no longer be amortized. Instead, these assets will be reviewed for impairment on a periodic basis. This statement became effective for the Company on July 1, 2001 with respect to any acquisitions completed after June 30, 2001, and on January 1, 2002 for all other goodwill and intangible assets. As of December 31, 2001, goodwill totaled $21.7 million. The Company did not recognize an impairment charge upon adoption of SFAS No. 142. The impact of the cessation of goodwill amortization will be significant to the Company's financial statements, the estimated impact being a $7.2 million reduction in amortization in the year ended December 31, 2002 when compared to what would have been amortized under the previous accounting standard. In August 2001, the FASB issued SFAS No. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS. This statement supersedes SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF and APB 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. This statement provides guidance on recognizing and measuring impairment for long-lived assets excluding certain long-lived assets, such as goodwill, non-amortized intangible assets and deferred tax assets. This statement is effective for the Company in the first quarter of its fiscal year ending December 2002. Management is currently evaluating the impact that this statement will have on the Company's financial statements. 13 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS You should read the following discussion of our financial condition and results of operations in conjunction with our financial statements and related notes. In addition to historical information, the following discussion and other parts of this report contain forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated by such forward-looking statements due to various factors, including, but not limited to, those set forth under "Certain Factors That May Affect Our Future Operating Results" and elsewhere in this report. OVERVIEW We provide software and related services that allow our clients to more effectively manage their business-to-business relationships. Our products and services were originally developed to manage complex contract purchasing relationships in the healthcare industry. Our Contract Administration and Reporting System, or CARS, software suite is used by 8 of the 10 largest and 15 of the 20 largest pharmaceutical manufacturers, ranked according to 2000 annual healthcare revenues. We are seeking to expand our products and services to new vertical markets, particularly the consumer packaged goods and foodservice industries. Our acquisitions of Chi-Cor Information Management, Inc. (ChiCor) in November 2000 and Intersoft International, Inc. (Intersoft) in March 2001 have provided us with accepted products, customers and expertise in these new vertical markets. Also, our acquisition of BCL Vision Ltd. (BCL) (renamed I-many International Limited) in April 2001 has expanded our portfolio of software solutions, which we can market to customers within our currently-targeted and other vertical markets. Under the rules of purchase accounting, the acquired companies' revenues and results of operations have been included together with those of the Company from the actual dates of the acquisitions and materially affect the period-to-period comparisons of the Company's historical results of operations. We have generated revenues from both products and services. Product revenues, which had been principally comprised of software license fees generated from our CARS software suite and now includes deductions, trade promotions, and collections and disputes management software pursuant to our various acquisitions, accounted for 53.6% of net revenues in the three months ended March 31, 2001 and 56.8% of net revenues in the three months ended March 31, 2002. Service revenues include maintenance and support fees directly related to our licensed software products, professional service fees derived from consulting, installation, business analysis and training services related to our software products and hosting fees. Service revenues accounted for 46.4% of net revenues in the three months ended March 31, 2001 and 43.2% of net revenues in the three months ended March 31, 2002. After being profitable in both 1997 and 1998, we increased our spending significantly during 1999 and the first half of 2000, principally to increase the size of our sales and marketing workforce and for development and marketing expenses related to the development of our web-based initiatives. Our operating expenses (excluding acquisition-related amortization and write-offs) have increased significantly since 1997, from $4.2 million for the 12 months ended December 31, 1997 to $48.1 million for the 12 months ended December 31, 2001 and $11.3 million for the three months ended March 31, 2002. These increases are primarily due to additions to our staff, including through acquisitions, as we have expanded all aspects of our operations. We have grown from 67 employees as of December 31, 1997 to 371 employees at March 31, 2002. CRITICAL ACCOUNTING POLICIES Software license revenues are attributable to the addition of new customers, and the expansion of existing customer relationships through licenses covering additional users, licenses of additional software products and license renewals. We recognize revenue in accordance with Statement of Position (SOP) No. 97-2, SOFTWARE REVENUE RECOGNITION and SOP 98-9, SOFTWARE REVENUE RECOGNITION, with Respect to Certain Arrangements. We generate revenues from licensing our software and providing professional services, training and maintenance and support services. We sell software, professional services, training and maintenance and support services. In multiple-element arrangements, we allocate the total fee to professional services, training and maintenance and support services based on the fair value of those elements, which is defined as the price charged when those elements are sold separately. The residual amount is then allocated to the software license fee. We recognize software license fees upon execution of a signed license agreement and delivery of the software, provided there are no significant 14 post-delivery obligations, the payment is fixed or determinable and collection is probable. In cases where significant post-delivery obligations exist, such as customization or enhancements to the core software, we recognize the entire fee on a percentage-of-completion basis, and include the entire fee in product revenues. If an acceptance period is required, revenues are recognized upon customer acceptance. We provide for sales returns at the time of revenue recognition based on historical experience. To date, such returns have not been significant. Service revenues include professional services, training and maintenance and support services. Professional service revenues are recognized as the services are performed for time and materials contracts and using the percentage-of-completion method for fixed fee contracts. If conditions for acceptance exist, professional service revenues are recognized upon customer acceptance. For fixed fee professional service contracts, we provide for anticipated losses in the period in which the loss becomes known and can be reasonably estimated. To date, losses incurred on fixed fee contracts have not been significant. Training revenues are recognized as the services are provided. Maintenance and customer support fees are recognized ratably over the term of the maintenance contract, which is generally twelve months. When maintenance and support is included in the total license fee, we allocate a portion of the total fee to maintenance and support based upon the price paid by the customer to purchase maintenance and support in the second year. Payments received from customers at the inception of a maintenance period are treated as deferred service revenues and recognized ratably over the maintenance period. Payments received from customers in advance of product shipment or revenue recognition are treated as deferred product revenues and recognized when the product is shipped to the customer or when otherwise earned. Substantially all of the amounts included in cost of revenues represent direct costs related to the delivery of professional services, training and maintenance and customer support. To date, cost of product revenues have not been significant. Effective on January 1, 2002, we assigned all of our goodwill to our various reporting units and discontinued amortizing goodwill, in accordance with SFAS No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS. Goodwill will be tested for impairment using a two-step approach. The first step is to compare the fair value of a reporting unit to its carrying amount, including goodwill. If the fair value of the reporting unit is greater than its carrying amount, goodwill is not considered impaired and the second step is not required. If the fair value of the reporting unit is less than its carrying amount, the second step of the impairment test measures the amount of the impairment loss, if any. The second step of the impairment test is to compare the implied fair value of goodwill to its carrying amount. If the carrying amount of goodwill exceeds its implied fair value, an impairment loss is recognized equal to that excess. The implied fair value of goodwill is calculated in the same manner that goodwill is calculated in a business combination, whereby the fair value of the reporting unit is allocated to all of the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the purchase price. The excess "purchase price" over the amounts assigned to assets and liabilities would be the implied fair value of goodwill. This allocation is performed only for purposes of testing goodwill for impairment and does not require us to record the "step-up" in net assets or any unrecognized intangible assets. Goodwill will be tested for impairment at least annually, or on an interim basis if an event occurs or circumstances change that would more-likely-than-not reduce the fair value of a reporting unit below its carrying value. Identified intangible assets (excluding goodwill) will continue to be amortized over their useful lives and reviewed for impairment in accordance with SFAS No. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS. Identified intangible assets with indefinite useful lives will not be amortized until their lives are determined to be definite. These assets will be tested for impairment annually and on an interim basis if an event or circumstance occurs between annual tests indicating that the assets might be impaired. The impairment test will consist of comparing the fair value of the identified intangible asset to its carrying amount. If the fair value is less than the carrying amount, an impairment loss will be recognized in an amount equal to that difference. In accordance with EITF Issue No. 01-14, INCOME STATEMENT CHARACTERIZATION OF REIMBURSEMENTS RECEIVED FOR "OUT-OF-POCKET" EXPENSES INCURRED, we classify reimbursements received from customers for out-of-pocket expenses as revenue in the income statement. Examples of such out-of-pocket expenses include, but are not limited to, expenses related to airfare, mileage, hotel stays, out-of-town meals, photocopies, and telecommunications and facsimile charges. This Issue became applicable beginning January 1, 2002. Prior to this Issue, we classified reimbursements received from customers as reductions of expenses incurred. Accordingly, comparative financial statements for prior periods have been reclassified to comply with the guidance in this Issue. 15 RECENT EVENTS On February 20, 2002, we completed a private placement with investors (the "Purchasers"), pursuant to the terms of a Securities Purchase Agreement among us and the Purchasers (the "Purchase Agreement"). The private placement was exempt from registration under the Securities Act of 1933, as amended, pursuant to Regulation D and Section 4(2) of such Act. The terms of this private placement were reported on a Form 8-K, which we filed with the Securities and Exchange Commission on February 28, 2002. At the closing, we issued 1,100,413 shares of common stock at a purchase price of $7.27 per share, aggregating $8,000,000, and 1,700 shares of a newly designated series of preferred stock, at a purchase price of $10,000 per share. The preferred stock has no dividends or coupon, no liquidation preference, no voting rights and no financial covenants. The preferred stock will be convertible into common stock at a price equal to the higher of $7.00 or 93% of the average price of our stock measured over a period following the effectiveness of the registration statement covering the resale of the shares, which we will file with the Securities and Exchange Commission on or before March 29, 2002. We have the right to establish a new floor for the conversion price, which will serve as the minimum conversion price. Subject to the establishment of a new floor price, the conversion price of the preferred stock also will not exceed $8.72 or 80% of the average price of our common stock measured over a period following the effectiveness of the registration statement, whichever is greater. The shares of preferred stock may be converted into common stock at the option of the holder during the five trading-day period commencing on the later 16 to occur of 110 business days after the closing date and 30 trading days after the effective date of the registration statement covering the resale of the shares. We may require the conversion of such shares into common stock during the same five-day period if the floor price established by us is less than the applicable conversion price. In the event that the preferred stock is not converted into common stock by the date set for conversion, the shares of preferred stock will be redeemed by us. Pending conversion or redemption of the shares of preferred stock, the proceeds from the sale of the preferred stock are being held in escrow. In addition, we granted the investors certain common stock purchase warrants, consisting of (i) warrants exercisable for 180 days after the closing to purchase up to an additional aggregate of 165,062 shares of common stock at an exercise price of $7.27 per share; (ii) seven-year warrants to purchase up to an additional aggregate of 165,062 shares of common stock at an exercise price of $7.50 per share; and (iii) seven-year warrants to purchase a number of additional shares of common stock equal to 15% of the shares of common stock received on conversion of the preferred stock, at an exercise price equal to 120% of the conversion price. The exercise price of the seven-year warrants is subject to downward adjustment on a "weighted average" basis in the event we issue additional shares of common stock, or instruments convertible or exercisable for common stock, at an effective price less than the then applicable exercise price. This adjustment does not apply, however, to the issuance of common stock or such instruments in underwritten public offerings, strategic transactions or pursuant to equity incentive plans. The warrants described in clause (iii) of this paragraph will become void if we redeem the preferred stock. On March 12, 2002, we acquired substantially all the assets of NetReturn, LLC, a Connecticut limited liability company located in Fairfield, Connecticut, for a purchase price of up to $5.4 million. The primary asset acquired was NetReturn's library of software applications and tools. The initial consideration of approximately $3.4 million consisted of $500,000 of cash, 429,017 shares of the Company's common stock with a fair value at the time of acquisition of $2.8 million and estimated transaction costs of $134,000. In addition, upon achievement of certain revenue milestones through March 31, 2003, the NetReturn shareholders are entitled to additional consideration of up to $2.0 million, payable in cash or stock at our election. On March 28, 2002, we acquired all of the outstanding capital stock of Menerva Technologies, Inc., a Delaware corporation located in Redwood City, California, which markets buy-side contract software solutions, for a purchase price of up to $12.7 million. The initial consideration of approximately $9.7 million consisted of cash of $2.5 million, 982,191 shares of the Company's common stock with a fair value at the time of acquisition of $6.0 million, the assumption of stock options to purchase an aggregate of 25,743 shares of Company stock valued at approximately $143,000, assumed liabilities of $772,000 and estimated transaction costs of $340,000. In addition, upon achievement of certain revenue milestones through March 31, 2003, the Menerva shareholders are entitled to additional consideration of up to $3.0 million, payable in cash or stock at our election. RESULTS OF OPERATIONS COMPARISON OF THE THREE MONTH PERIODS ENDED MARCH 31, 2002 AND 2001 NET REVENUES Net revenues decreased by $796,000, or 5%, to $15.0 million for the quarter ended March 31, 2002 from $15.8 million for the quarter ended March 31, 2001. Product revenues increased slightly by $44,000, or 1%, to $8.5 million for the quarter ended March 31, 2002. Both the number and average size of license deals sold were approximately the same in both quarters, and the distribution of product revenues by reportable segment was substantially unchanged as well. Approximately one-third of the decrease in net revenues was attributable to a reduction in reimbursable out-of-pocket expenses, which decreased from $546,000 in the quarter ended March 31, 2001 to $275,000 in the quarter ended March 31, 2002. 17 As a percentage of total net revenues, product revenues increased to 56.8% for the quarter ended March 31, 2002, from 53.6% for the quarter ended March 31, 2001. This increase in product revenues as a percentage of total net revenues is entirely attributable to a reduction in service revenues, which decreased by $840,000, or 11%, to $6.5 million for the quarter ended March 31, 2002, from $7.3 million for the quarter ended March 31, 2001. More than 85% of this decrease is due to a contraction of our professional services business. The decrease in professional services revenue is largely attributable to a reduction in revenues of approximately $1.3 million in one specific consulting engagement from the quarter ended March 31, 2001 to the quarter ended March 31, 2002. COST OF REVENUES Cost of revenues consists primarily of payroll and related costs and subcontractor costs for providing professional services and maintenance and support services, and to a lesser extent, amounts due to third parties for royalties related to integrated technology. Historically, cost of product revenues has not been a significant component of total cost of revenues. Cost of revenues decreased by $1.4 million, or 28%, to $3.5 million for the quarter ended March 31, 2002, from $4.9 million for the quarter ended March 31, 2002. This decrease is due primarily to the reduction in subcontractor consulting costs from $1.2 million in the first quarter of 2001 to $211,000 in the first quarter of 2002. Most of this decrease in subcontractor consulting costs was related to one specific consulting engagement as discussed in "--Net Revenues" above. As a percentage of total net revenues, cost of revenues decreased to 23.6% for the quarter ended March 31, 2002, from 31.0% for the quarter ended March 31, 2001. This decrease in cost of revenues as a percentage of total net revenues is attributable to the decrease in subcontractor costs discussed above and to the smaller level of service revenues as a percent of total revenues (service revenues typically generating lower margins than product revenues). OPERATING EXPENSES SALES AND MARKETING. Sales and marketing expenses consist primarily of payroll and related benefits for sales and marketing personnel, commissions for sales personnel, travel costs, recruiting fees, expenses for trade shows and advertising and public relations expenses. Sales and marketing expense increased by $144,000, or 3%, to $5.3 million in the three months ended March 31, 2002 from $5.1 million in the three months ended March 31, 2001. This increase in sales and marketing expense is primarily the result of an increase in salary and fringe benefit costs, partially offset by reductions in spending for advertising, marketing and promotional materials. As a percentage of total net revenues, sales and marketing expense increased to 35.2% for the quarter ended March 31, 2002 from 32.5% for the quarter ended March 31, 2001. RESEARCH AND DEVELOPMENT. Research and development expenses consist primarily of payroll and related costs for development personnel and external consulting costs associated with the development of our products and services. Research and development costs, including the costs of developing computer software, are charged to operations as they are incurred. Research and development expenses increased by $460,000, or 13%, to $4.0 million for the quarter ended March 31, 2002, from $3.5 million for the quarter ended March 31, 2001. This increase in research and development expenses is attributable to higher salary costs and increased spending for external consulting services. As a percentage of total net revenues, research and development expense increased to 26.4% for the quarter ended March 31, 2002, from 22.1% for the quarter ended March 31, 2001. GENERAL AND ADMINISTRATIVE. General and administrative expenses consist primarily of salaries and related costs for personnel in our administrative, finance and human resources departments, and legal, accounting and other professional service fees. For the quarter ended March 31, 2001, general and administrative expenses also included payroll and related costs for the senior executives in Sales and Operations. General and administrative expenses decreased by $530,000, or 27%, to $1.4 million in the first quarter of 2002 from $2.0 million in the first quarter of 2001. As a percentage of total net revenues, general and administrative expenses decreased to 9.6% for the quarter ended March 31, 2002, from 12.4% for the quarter ended March 31, 2001. The 18 decrease in general and administrative expenses is primarily attributable to reductions in salary and benefit costs, travel and legal expenses. DEPRECIATION. From March 2000 to June 2001, depreciation included amortization of capitalized internal-use software development costs related to the company's Internet portal. Excluding amortization related to the Internet portal, the value of which was written off during the third quarter of 2001, depreciation expense increased by $59,000, or 11%, from $532,000 in the first quarter of 2001 to $591,000 in the first quarter of 2002. This increase is a result of additions of computer hardware and software related to infrastructure expenditures. AMORTIZATION OF GOODWILL AND OTHER PURCHASED INTANGIBLE ASSETS. Amortization of other purchased intangibles related to our acquisitions amounted to $1.0 million in the quarter ended March 31, 2002, which represents an increase of $196,000 over the amortization of goodwill and other purchased intangibles of $847,000 in the quarter ended March 31, 2001. Excluding the $560,000 of amortization of goodwill incurred in the quarter ended March 31, 2001, amortization expense increased by $756,000, or 163%, from $287,000 in the quarter ended March 31, 2001. This increase is attributable to the consummation of additional acquisitions during the second and third quarters of 2001. Based on new accounting pronouncements, the Company has stopped amortizing goodwill in the first quarter of 2002. IN-PROCESS RESEARCH AND DEVELOPMENT. In connection with the acquisition of Menerva Technologies, Inc., we allocated $1.0 million of the purchase price to in-process research and development, which was immediately expensed as it had no future alternative use. This allocation was based on an independent appraisal conducted for the purpose of allocating the initial consideration to the tangible and intangible assets acquired in the Menerva acquisition. OTHER INCOME, NET. Other income, net decreased by $585,000, or 94%, from $620,000 in the quarter ended March 31, 2001, to $35,000 in the quarter ended March 31, 2002. This decrease is primarily the result of reduced interest yields, lower average cash balances during the quarter and a significant increase in state franchise tax payments. PROVISION FOR INCOME TAXES. We incurred operating losses for all quarters in 2001 and the first quarter of 2002 and have consequently recorded a valuation allowance for the full amount of our net deferred tax asset, which consists principally of our net operating loss carryforwards, as the future realization of the tax benefit is uncertain. No provision or benefit for income taxes has been recorded in the three month periods ended March 31, 2002 and 2001. LIQUIDITY AND CAPITAL RESOURCES On July 13, 2000, we issued 7,500,000 shares of our common stock at an initial public offering price of $9.00 per share. On August 9, 2000 our underwriters exercised a 30-day option to purchase an additional 1,125,000 shares of common stock to cover over-allotments. Net cash proceeds to us from the initial public offering and subsequent overallotment option exercise were approximately $70.7 million. From inception until our initial public offering, our capital and liquidity needs were met, in large part, with the net proceeds from the private placement of debt and equity securities, cash flows generated from operations and through equipment lease financings. On February 20, 2002, we completed a private placement of common stock, preferred stock and warrants, resulting in our receipt of $25 million in gross proceeds. Of this amount, $17 million is being held in an escrow account pending conversion of the preferred stock into common stock. In the event that the preferred stock is not so converted, we will redeem it for an aggregate redemption price equal to $17 million. See "--Recent Events" above. 19 At March 31, 2002, we had cash and cash equivalents of $41.1 million and net working capital - excluding our $17.0 million restricted cash balance - of $38.8 million. Also on March 31, 2002, we had no long-term or short-term debt, other than obligations under capital lease financings. On March 12, 2002, we acquired substantially all the assets of NetReturn, LLC for a purchase price of up to $5.4 million, including $500,000 of cash, common stock valued at $2.8 million at the time of closing, $134,000 of estimated transaction costs and up to $2.0 million to be paid, subject to the achievement of certain revenue milestones through March 31, 2003, in cash or Company stock at our election. We used existing cash resources to pay the cash portion of the purchase price and the transaction costs. On March 28, 2002, we acquired Menerva Technologies, Inc. for a purchase price of up to $12.7 million, including $2.5 million of cash to be paid subsequent to March 31, 2002, common stock and options valued at $6.1 million at the time of closing, $772,000 of assumed liabilities, $340,000 of estimated transaction costs and up to $3.0 million to be paid, subject to the achievement of certain revenue milestones through March 31, 2003, in cash or Company stock at our election. We will use existing cash resources to pay the cash portion of the purchase price and the merger transaction costs. Net cash used in operating activities for the three months ended March 31, 2002 was $2.5 million, as compared to net cash provided by operating activities of $605,000 in the three months ended March 31, 2001. For the three months ended March 31, 2002, net cash used in operating activities consisted primarily of a $1.9 million increase in accounts receivable and a $1.3 million decrease in accrued expenses, partially offset by a $810,000 increase in cash resulting from our net loss of $1.8 million, as adjusted for depreciation and acquisition-related non-cash charges totaling $2.6 million. For the three months ended March 31, 2001, net cash provided by operating activities consisted primarily of our net loss of $1.3 million, as adjusted for depreciation and amortization of $2.2 million. For the three months ended March 31, 2001, increases in accounts receivable of $489,000 and $390,000 in prepaid expense, and a $861,000 decrease in accounts payable, were largely offset by increases of $752,000 and $669,000 in accrued expenses and deferred revenue, respectively. Net cash used in investing activities was $1.2 million for the three months ended March 31, 2002 and $3.2 million for the three months ended March 31, 2001. Net cash used in investing activities for the three months ended March 31, 2002 consisted of $227,000 in purchases of property and equipment and $965,000 related to the acquisitions of NetReturn and Menerva. Net cash used in investing activities for the three months ended March 31, 2001 primarily reflects $963,000 in purchases of property and equipment and $2.1 million related to the acquisitions of ChiCor, Vintage and Intersoft. Net cash provided by financing activities was $8.8 million for the three months ended March 31, 2002, primarily from net proceeds of $7.4 million from a private placement sale of common stock and additionally from $1.3 million of stock option exercises. Net cash provided by financing activities was $569,000 for the three months ended March 31, 2001, consisting principally of proceeds from stock option exercises. The private placement also included the sale of preferred stock for aggregate proceeds of $17.0 million. The proceeds are being held in escrow pending conversion or redemption of the preferred stock, which is expected to take place in the quarter ended September 30, 2002. If the preferred stock is redeemed, we will use the amount held in escrow to pay the redemption price. We currently anticipate that our cash and cash equivalents of $41.1 million will be sufficient to meet our anticipated needs for working capital, capital expenditures, and acquisitions for at least the next 12 months. Our future long-term capital needs will depend significantly on the rate of growth of our business, acquisitions, the timing of expanded product and service offerings and the success of these offerings once they are launched. Accordingly, any projections of future long-term cash needs and cash flows are subject to substantial uncertainty. If our current balance of cash and cash equivalents is insufficient to satisfy our long-term liquidity needs, we may seek to sell additional equity or debt securities to raise funds, and those securities may have rights, preferences or privileges senior to those of the rights of our common stock. In connection with such a sale of stock, our stockholders may experience dilution. In addition, we cannot be certain that additional financing will be available to us on favorable terms when required, or at all. 20 CERTAIN FACTORS THAT MAY AFFECT OUR FUTURE OPERATING RESULTS In addition to other information in this Form 10-Q, the following factors could cause actual results to differ materially from those indicated by forward-looking statements made in this Form 10-Q and presented elsewhere by management from time to time. WE HAVE INCURRED SUBSTANTIAL LOSSES IN RECENT YEARS AND OUR RETURN TO PROFITABILITY IS UNCERTAIN We incurred net losses of $24.2 million in the year ended December 31, 2000, $21.2 million in the year ended December 31, 2001 and $1.8 million in the three months ended March 31, 2002, and we had an accumulated deficit at March 31, 2002 of $52.9 million. In these periods of net losses, our expenses exceeded our revenues generally due to increases in research and development expenses, sales and marketing expenses, and non-cash expenses related to acquisitions. We expect to continue spending significantly, principally for sales, marketing and development expenses, and therefore we will need to grow our revenues significantly before we reach profitability. In addition, our second quarter 2001 results were impacted by a number of factors that deferred purchases from us, and we cannot assure you that we will not be affected by these factors in future periods. Although we have been profitable in certain years, we cannot assure you that we will achieve sufficient revenues to become profitable in the future. If our revenue grows more slowly than we anticipate or if our operating expenses either increase more than we expect or cannot be reduced in light of lower than expected revenue, we may not be profitable. IT IS DIFFICULT FOR US TO PREDICT WHEN OR IF SALES WILL OCCUR AND WE OFTEN INCUR SIGNIFICANT SELLING EXPENSES IN ADVANCE OF OUR RECOGNITION OF ANY RELATED REVENUE Our clients view the purchase of our software applications and related professional services as a significant and strategic decision. As a result, clients carefully evaluate our software products and services. The length of this evaluation process is affected by factors such as the client's need to rapidly implement a solution and whether the client is new or is extending an existing implementation. The license of our software products may also be subject to delays if the client has lengthy internal budgeting, approval and evaluation processes which are quite common in the context of introducing large enterprise-wide tools. We may incur significant selling and marketing expenses during a client's evaluation period, including the costs of developing a full proposal and completing a rapid proof of concept or custom demonstration, before the client places an order with us. Clients may also initially purchase a limited number of licenses before expanding their implementations. Larger clients may purchase our software products as part of multiple simultaneous purchasing decisions, which may result in additional unplanned administrative processing and other delays in the recognition of our license revenues. If revenues forecasted from a significant client for a particular quarter are not realized or are delayed, as occurred in our second quarter 2001, we may experience an unplanned shortfall in revenues during that quarter. This may cause our operating results to be below the expectations of public market analysts or investors, which could cause the value of our common stock to decline. WE HAVE TWO MANAGEMENT LOCATIONS AND OTHER FACILITIES AND AS WE CONTINUE TO GROW WE MAY EXPERIENCE DIFFICULTIES IN OPERATING FROM THESE FACILITIES Certain members of our management team are based at our corporate headquarters located in Portland, Maine, and other members of our management team are based at our sales office in Edison, New Jersey. In addition, as a result of our acquisitions, we have added additional facilities, including offices in Chicago, Illinois, Fairfield, Connecticut, Redwood City, California and London, United Kingdom. The geographic distance between these offices could make it difficult for our management and other employees to effectively communicate with each other and, as a result, could place a significant strain on our managerial, operational and financial resources. Our total revenue increased from $7.5 million in the year ended December 31, 1997 to $57.8 21 million in the year ended December 31, 2001, and the number of our employees increased from 67 as of December 31, 1997 to 371 as of March 31, 2002. If we continue to grow, we will need to recruit, train and retain a significant number of employees, particularly employees with technical, marketing and sales backgrounds. Because these individuals are in high demand, we may not be able to attract the staff we need to accommodate our expansion. WE ARE HIGHLY DEPENDENT UPON THE HEALTHCARE INDUSTRY, AND FACTORS THAT ADVERSELY AFFECT THAT MARKET COULD ALSO ADVERSELY AFFECT US Most of our revenue to date has come from pharmaceutical companies and a limited number of other clients in the healthcare industry, and our future growth depends, in large part, upon increased sales to the healthcare market. As a result, demand for our solutions could be affected by any factors that could adversely affect the demand for healthcare products, which are purchased and sold pursuant to contracts managed through our solutions. The financial condition of our clients and their willingness to pay for our solutions are affected by factors that may impact the purchase and sale of healthcare products, including competitive pressures, decreasing operating margins within the industry, currency fluctuations, active geographic expansion and government regulation. The healthcare market is undergoing intense consolidation. We cannot assure you that we will not experience declines in revenue caused by mergers or consolidations among our clients and potential clients. OUR EFFORTS TO TARGET MARKETS OTHER THAN THE HEALTHCARE MARKET MAY DIVERT RESOURCES AND MANAGEMENT ATTENTION AWAY FROM OUR CORE COMPETENCIES In connection with our efforts to expand into other markets, it may be necessary for us to hire additional personnel with expertise in these other industries. We may also have to divert funds, talent, management attention and other resources toward markets that have not traditionally been the primary source of our revenues. The risks of such diversification include the possibility that we will not be successful in generating the revenue we expect from these markets and the possible detrimental effect of diverting resources from our traditional markets. WE MAY NOT BE SUCCESSFUL IN ACQUIRING NEW TECHNOLOGIES OR BUSINESSES AND THIS COULD HINDER OUR EXPANSION EFFORTS We intend in the future to consider additional acquisitions of or new investments in complementary businesses, products, services or technologies. We cannot assure you that we will be able to identify appropriate acquisition or investment candidates. Even if we do identify suitable candidates, we cannot assure you that we will be able to make such acquisitions or investments on commercially acceptable terms. Furthermore, we may incur debt or issue equity securities to pay for any future acquisitions. The issuance of equity securities could be dilutive to our existing stockholders and the issuance of debt could limit our available cash and accordingly restrict our activities. WE HAVE MADE SEVERAL ACQUISITIONS AND MAY MAKE ADDITIONAL ACQUISITIONS AND WE MAY HAVE DIFFICULTY INTEGRATING THEM We have acquired ChiCor, Intersoft, BCL Vision Ltd. (now I-many International Limited), Provato, NetReturn and Menerva, each of which are or were located in cities very distant from our management locations in Portland, Maine and Edison, New Jersey, and we are likely to make additional acquisitions. Any other company that we acquire is likely to be distant from our headquarters in Portland, Maine and will have a culture different from ours as well as technologies, products and services that our employees will need to understand and integrate with our own. We are continuing to assimilate the employees, technologies and products of the companies that we have acquired and will need do the same with any new companies we may acquire, and that effort is difficult, time-consuming and may be unsuccessful. If we are not successful, our investment in the acquired entity may be lost, and even if we are successful, the process of integrating an acquired entity may divert our attention from our core business. 22 IF WE DO ACQUIRE NEW TECHNOLOGIES OR BUSINESSES, OUR RESULTS OF OPERATIONS MAY BE ADVERSELY AFFECTED In connection with our acquisitions, we have recorded substantial goodwill and other intangible assets. In addition, we recorded charges for write-offs of a portion of the purchase prices of acquired companies as in-process research and development. Although the amortization of goodwill has been discontinued pursuant to the recent issuance of Statement of Financial Accounting Standards No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS, the carrying value of any intangible assets will need to be reviewed for impairment on a periodic basis. We cannot assure you that future write-downs of any such assets will not affect future operating results. OUR FIXED COSTS HAVE LED, AND MAY CONTINUE TO LEAD, TO FLUCTUATIONS IN OPERATING RESULTS WHICH HAS RESULTED, AND COULD IN THE FUTURE RESULT, IN A DECLINE OF OUR STOCK PRICE A significant percentage of our expenses, particularly personnel costs and rent, are fixed costs and are based in part on expectations of future revenues. We may be unable to reduce spending in a timely manner to compensate for any significant fluctuations in revenues. Accordingly, shortfalls in revenues, as we experienced in the second quarter of fiscal 2001, may cause significant variations in operating results in any quarter. If our quarterly results do not meet the expectations of market analysts or investors, our stock price is likely to decline. WE HAVE MANY COMPETITORS AND POTENTIAL COMPETITORS AND WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY The market for our products and services is competitive and subject to rapid change. We encounter significant competition for the sale of our contract management software from the internal information systems departments of existing and potential clients, software companies that target the contract management markets, and professional services organizations. Our competitors vary in size and in the scope and breadth of products and services offered. We anticipate increased competition for market share and pressure to reduce prices and make sales concessions, which could materially and adversely affect our revenues and margins. Many of our existing competitors, as well as a number of potential new competitors, have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical and marketing resources than we do. Such competitors may also engage in more extensive research and development, undertake more far-reaching marketing campaigns, adopt more aggressive pricing policies and make more attractive offers to existing and potential employees and strategic partners. We cannot assure you that our competitors will not develop products or services that are equal or superior to our solutions or that achieve greater market acceptance than our solutions. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties. We cannot assure you that we will be able to compete successfully or that competitive pressures will not require us to make concessions that will adversely affect our revenues and our margins, or reduce the demand for our products and services. OUR EFFORTS TO TARGET MARKETS OTHER THAN THE HEALTHCARE MARKET FOR OUR CARS PRODUCTS HAVE NOT YET RESULTED IN SIGNIFICANT REVENUE, AND WE CANNOT BE SURE THAT OUR INITIATIVES IN THESE OTHER MARKETS WILL BE SUCCESSFUL As part of our growth strategy, we have acquired companies that target markets other than the healthcare market and have begun initiatives to sell our CARS software suite of products and services in markets other than the healthcare market, including the consumer packaged goods, foodservice and other industries. While we believe that the contractual purchase relationships between manufacturers and customers in these markets have similar attributes to those in the healthcare market, we cannot assure you that our assumptions are correct or that we will be successful in adapting our technology to these other 23 markets. Although we have entered into strategic relationships with Procter & Gamble and Accenture, we do not yet know how rapidly or successfully our purchase contract management software solutions will be implemented in the commercial products and other industries. WE RELY SIGNIFICANTLY UPON CERTAIN KEY INDIVIDUALS AND OUR BUSINESS WILL SUFFER IF WE ARE UNABLE TO RETAIN THEM We depend on the services of our senior management and key technical personnel. In particular, our success depends on the continued efforts of A. Leigh Powell, our Chief Executive Officer, and other key employees. The loss of the services of any key employee could have a material adverse effect on our business, financial condition and results of operations. CURRENT ECONOMIC CONDITIONS MAY WEAKEN OUR SALES The current downturn and uncertainty in general economic and market conditions may have negatively affected and could continue to negatively affect demand for our products and services. If the current economic downturn continues or worsens, our business, financial condition and results of operations could be harmed. In addition, current world economic and political conditions, including the effects of the September 11, 2001 terrorist attacks and the resulting military conflict, may reduce the willingness of our customers and prospective customers to commit funds to purchase our products and services. The resulting loss or delay in our sales could have a material adverse effect on our business, financial condition and results of operations. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK INTEREST RATE RISK The Company's exposure to market risk for changes in interest rates relates primarily to the Company's investment portfolio. The Company does not use derivative financial instruments in its investment portfolio. The primary objective of the Company's investment activities is to preserve principal while maximizing yields without assuming significant risk. This is accomplished by investing in widely diversified investments, consisting primarily of short-term, investment-grade securities. Due to the nature of our investments, we believe there is no material risk exposure. As of March 31, 2002, the Company's cash and cash equivalents consisted entirely of money market investments with maturities under 30 days and non-interest bearing checking accounts. The weighted average interest rate yield for all cash and cash equivalents at March 31, 2002 amounted to 1.90 percent. 24 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS None ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS (a) Modification of Constituent Instruments None (b) Change in Rights None (c) Changes in Securities On February 20, 2002, the Company completed a private placement with investors, pursuant to which it issued 1,100,413 shares of its unregistered common stock and 1,700 shares of preferred stock. The private placement was exempt from registration under the Securities Act of 1933, as amended, pursuant to Regulation D and Section 4(2) of such Act. The Company received proceeds of approximately $7.4 million, net of commissions and other fees, from the sale of common stock, and $17.0 million from the issuance of the preferred stock. The proceeds related to the issuance of the preferred stock are being held in escrow pending conversion or redemption of the shares of preferred stock. On March 12, 2002, the Company issued 429,017 shares of its unregistered common stock pursuant to its acquisition of substantially all the assets of NetReturn LLC. These shares were issued pursuant to an exemption from registration under Rule 506 under the Securities Act of 1933. On March 28, 2002, the Company issued 982,191 shares of its unregistered common stock and assumed options to purchase an additional 25,743 shares of its common stock pursuant to its acquisition of Menerva Technologies, Inc. These shares were issued pursuant to an exemption from registration under Rule 506 under the Securities Act of 1933. During the quarter ended March 31, 2002, the Company issued 37,118 shares of its unregistered common stock as additional consideration pursuant to its acquisitions of ChiCor Information Management, Inc. and Intersoft International, Inc. These shares were issued pursuant to an exemption from the Securities Act registration requirements set forth in Rule 506 under the Securities Act and, in the alternative, under Section 4(2) of the Securities Act of 1933. (d) Use of Proceeds The Company has continued to use the proceeds of its initial public offering in the manner and for the purposes described elsewhere in this Report on Form 10-Q. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None ITEM 5. OTHER INFORMATION None 25 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) The exhibits listed on the Exhibit Index are filed herewith. (b) On February 28, 2002, we filed a current report on Form 8-K pursuant to Items 5 and 7 thereof, reporting the completion of a private placement of our common stock and preferred stock. (c) On April 8, 2002, we filed a current report of Form 8-K pursuant to Items 2 and 7 thereof, reporting the acquisition of Menerva Technologies, Inc. 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. I-MANY, INC Date: May 15, 2002 By: /s/ Kevin F. Collins ------------------------------- Kevin F. Collins Chief Financial Officer and Treasurer /s/ Kevin F. Collins --------------------------------- Kevin F. Collins Chief Financial Officer 26 EXHIBIT INDEX Exhibit No. Description ----------- ----------- 2.1 + Agreement and Plan of Merger dated as of March 26, 2002, by and among I-many, Inc., IMA Delaware Corp., and Menerva Technologies, Inc. 10.1 Amendment dated April 19, 2002 to the Employment Agreement of Timothy P. Curran ___________________________ + Incorporated by reference to the Registrant's Form 8-K filed on April 8, 2002. 27