Edgar Filing: MERCATOR SOFTWARE INC

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 September 30, 2001.

|_| Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ____________ to
____________.

Commission File Number: 0-22667

MERCATOR SOFTWARE, INC.
(Exact name of registrant as specified in its charter)

Delaware 06-1132156
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)

45 Danbury Road, Wilton, CT 06897
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code:
203-761-8600

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

|X| Yes |_| No

As of October 31, 2001, Registrant had 30,550,469 outstanding shares of Common
Stock $.01 par value.

MERCATOR SOFTWARE, INC.

TABLE OF CONTENTS

PAGE

PART I FINANCIAL INFORMATION

ITEM 1 Consolidated Condensed Financial Statements

Consolidated Balance Sheets as of September 30, 2001 (unaudited)
and December 31, 2001 3

Consolidated Statements of Operations for the Three and Nine
Months Ended September 30, 2001 (unaudited) and 2000 (unaudited) 4

Consolidated Condensed Statements of Cash Flows for the Nine
Months Ended September 30, 2001 (unaudited) and 2000 (unaudited) 5

Notes to Consolidated Condensed Financial Statements 6

ITEM 2 Managements' Discussion and Analysis of Financial Condition and
Results of Operations 9

ITEM 3 Quantitative and Qualitative Disclosures About Market Risk 24

PART II OTHER INFORMATION

ITEM 1 Legal Proceedings 24

ITEM 2 Changes in Securities and Use of Proceeds 25

ITEM 6 Exhibits and Reports on Form 8-K 26

SIGNATURES 27

EXHIBIT INDEX 28

MERCATOR SOFTWARE, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)

September 30, December 31,
2001 2000
---- ----
(unaudited)

ASSETS:
Current assets:
Cash and cash equivalents $ 7,296 $ 18,327
Marketable securities -- 3,420
Accounts receivable, less allowances of $4,276 and $3,616 30,726 38,920
Prepaid expenses and other current assets 4,383 3,626
Deferred tax assets 77 3,181
--------- ---------
Total current assets 42,482 67,474
Furniture, fixtures and equipment, net 10,300 10,007
Intangible assets, net 60,746 81,578
Restricted collateral deposits and other assets 3,443 1,832
--------- ---------
Total assets $ 116,971 $ 160,891
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 8,492 $ 6,706
Accrued expenses and other current liabilities 19,821 19,532
Current portion of deferred revenue 21,993 17,825
--------- ---------
Total current liabilities 50,306 44,063
Long-term deferred tax liability 2,417 3,777
Deferred revenue, less current portion 1,494 976
Other long term liabilities 3,144 669
--------- ---------
Total liabilities 57,361 49,485
--------- ---------
Stockholders' equity:
Convertible preferred stock: $.01 par value;
authorized 5,000,000 shares, no shares
issued and outstanding -- --
Common Stock: $.01 par value; authorized 190,000,000
shares; issued and outstanding 30,550,469
shares and 29,846,902 shares 306 298
Additional paid-in capital 232,296 228,035
Accumulated deficit (170,058) (114,760)
Accumulated other comprehensive loss (2,771) (1,761)
Deferred compensation (163) (406)
--------- ---------
Total stockholders' equity 59,610 111,406
--------- ---------
Total liabilities and stockholders' equity $ 116,971 $ 160,891
========= =========

See accompanying notes to consolidated condensed financial statements.

MERCATOR SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)

Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
2001 2000 2001 2000
---- ---- ---- ----

Revenues:
Software licensing $ 18,606 $ 16,689 $ 43,137 $ 55,394
Services 7,927 8,638 24,206 24,150
Maintenance 8,458 6,876 24,944 19,608
-------- -------- -------- --------
Total revenues 34,991 32,203 92,287 99,152
-------- -------- -------- --------
Cost of revenues:
Software licensing 152 182 753 835
Services 6,882 6,559 20,760 17,945
Maintenance 1,708 1,817 5,349 4,890
-------- -------- -------- --------
Total cost of revenues 8,742 8,558 26,862 23,670
-------- -------- -------- --------
Gross profit 26,249 23,645 65,425 75,482
Operating expenses:
Product development 4,528 5,532 15,098 15,741
Selling and marketing 16,231 17,176 50,182 48,336
General and administrative 7,328 7,601 23,857 15,963
Amortization of intangibles 6,944 11,829 20,833 35,057
Restructuring charge 2,793 -- 8,111 --
-------- -------- -------- --------
Total operating expenses 37,824 42,138 118,081 115,097
-------- -------- -------- --------
Operating loss (11,575) (18,493) (52,656) (39,615)
Other income (expense), net (174) 160 (22) 454
-------- -------- -------- --------
Loss before income taxes (11,749) (18,333) (52,678) (39,161)
Provision (benefit) for income taxes 200 (9,694) 2,622 (1,237)
-------- -------- -------- --------
Net loss $(11,949) $ (8,639) $(55,300) $(37,924)
======== ======== ======== ========
Net loss per share-Basic and Diluted $ (0.39) $ (0.29) $ (1.82) $ (1.31)
Weighted average number of common and common
equivalent shares outstanding:
Basic and Diluted 30,503 29,530 30,360 28,946

See accompanying notes to consolidated condensed financial statements.

MERCATOR SOFTWARE, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

Nine Months Nine Months
Ended Ended
September 30, 2001 September 30, 2000
------------------ ------------------

Cash flows from operating activities:
Net cash (used in) provided by operating activities $(11,683) $ 8,839
Cash flows from investing activities:
Purchase of furniture, fixtures and equipment (4,093) (4,361)
Sales of marketable securities 3,420 2,136
Restricted collateral deposits and other assets (1,507) (155)
-------- -------
Net cash used in investing activities (2,180) (2,380)
-------- -------
Cash flows from financing activities:
Payments under capital leases (336) --
Proceeds from exercise of stock options 199 3,096
Proceeds from issuance of stock under Employee Stock Purchase Plan 1,709 2,846
Proceeds from issuance of shares of restricted stock, net of expenses 1,635 --
Proceeds from issuance of warrants 167 --
-------- -------
Net cash provided by financing activities 3,374 5,942
-------- -------
Effect of exchange rate changes on cash and cash equivalents (542) (667)
-------- -------
Net change in cash (11,031) 11,734
Cash at the beginning of period 18,327 9,237
-------- -------
Cash at end of period $ 7,296 $20,971
======== =======
Supplemental information:
Cash paid for:
Interest $ 190 $ 39
Income taxes $ 145 $ 865
Non cash investing and finance activities:
Issuance of stock in connection with the acquisition of Braid -- $15,634

See accompanying notes to consolidated condensed financial statements.

MERCATOR SOFTWARE, INC.

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)

(1) UNAUDITED INTERIM FINANCIAL STATEMENTS

The accompanying consolidated interim condensed financial statements contained
herein are unaudited, but, in the opinion of management, include all adjustments
(consisting of normal recurring adjustments) necessary for a fair presentation
of the financial position, results of operations and cash flows for the periods
presented. Results of operations for the periods presented herein are not
necessarily indicative of results of operations for the entire year.

Reference should be made to Mercator Software, Inc. ("Mercator" or "the
Company") 2000 Annual Report on Form 10-K, which includes audited financial
statements for the year ended December 31, 2000.

Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to the Securities and Exchange
Commission's rules and regulations.

(2) STOCK ACTIVITIES

In January 2001 the Company issued for fair market value 228,180 shares of its
restricted common stock, $.01 par value, to Mitsui & Co., Ltd. for $2.0 million
in cash. The Company incurred costs of $365,000 in conjunction with raising this
capital. These costs were charged against additional paid-in capital to reflect
the reduction in proceeds from the restricted stock sale.

On May 17, 2001, the 1997 Equity Incentive Plan was amended to increase the
number of options Mercator may grant to its employees from 6,700,000 to
9,700,000 shares and on August 15, 2001 to modify the transferability
provisions.

In June 2001, in connection with a secured credit facility, the Company issued a
warrant to Silicon Valley Bank to purchase 220,000 shares of common stock at
$4.00 per share. The number of shares that may be purchased with this warrant,
along with the exercise price, are subject to adjustment based on certain
anti-dilution provisions in the warrant agreement. In addition, the shares of
common stock related to the warrant have certain registration rights. This
warrant expires in June 2008. The fair value of this warrant was determined to
be approximately $310,000 using the Black-Scholes pricing model and was charged
to prepaid expenses as a loan origination fee and credited to additional paid-in
capital in June 2001; the prepaid loan origination fees are being amortized to
operations over the term of the secured credit facility agreement.

In June 2001, pursuant to an exemption from registration under section 4(2) of
the Securities Act, as amended, the Company issued a warrant to purchase 101,694
shares of common stock at $4.00 per share in payment of $132,000 in advisory
fees to a third party in connection with a strategic partnership agreement.
These costs were expensed in the second quarter when counterparty performance
was complete. This warrant expires in June 2004.

In June 2001, pursuant to an exemption from registration under section 4(2) of
the Securities Act, as amended, the Company also issued a warrant to purchase
30,000 shares of common stock at $10.00 per share as payment for approximately
$35,000 in certain advisory fees. These costs were expensed in the second
quarter when counterparty performance was complete. This warrant expires in June
2003.

On September 17, 2001 the Company announced a voluntary option exchange program
for its employees. This tender offer related to an offer to all eligible
individuals to exchange all outstanding options granted under the Mercator
Software, Inc. 1997 Equity Incentive Plan ("EIP") for new options to purchase
shares of common stock under the EIP. Under the exchange program, for every two
options tendered and cancelled, one new option will be issued. The new options
will be granted no earlier than six months and one day after the cancellation
and the exercise price of the new options will be the fair market value of the
Company's common stock on the date of grant. The offer expired on October 19,
2001 and the Company accepted for cancellation options to purchase an aggregate
of 1,100,062 shares from 239 option holders who participated.

(3) COMPREHENSIVE LOSS

Mercator applies the provisions of SFAS No. 130, "Reporting Comprehensive
Income," which requires Mercator to report comprehensive income (loss) in its
financial statements, in addition to its net income (loss). Comprehensive income
(loss) includes all changes in equity during a period from non-owner sources.
Mercator's comprehensive (loss) consists of net income (loss) and foreign
currency translation adjustments. Total comprehensive (loss) was ($11.6 million)
and ($8.7 million) for the three months ended September 30, 2001 and 2000,
respectively, and ($56.3 million) and ($39.4 million) for the nine months ended
September 30, 2001

and 2000, respectively.

(4) EARNINGS PER SHARE

The Company determines earnings per share in accordance with the provisions of
SFAS No. 128, "Earnings Per Share", which requires the calculation of basic and
diluted net income per share. Basic earnings per share is computed based upon
the weighted average number of common shares outstanding. Diluted earnings per
share is computed based upon the weighted average number of common shares
outstanding increased for any dilutive effects of options, warrants, and
convertible securities.

Diluted loss per share has not been presented separately in the statements of
operations as the outstanding stock options and warrants are anti-dilutive for
the periods reported. Common stock equivalents accounted for under the treasury
stock method were 89,492 and 2,375,476 for the three months ended September 30,
2001 and 2000, respectively, and 470,523 and 3,243,129 for the nine months ended
September 30, 2001 and 2000, respectively.

(5) DERIVATIVE FINANCIAL INSTRUMENTS

On January 1, 2001, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging
Activities." SFAS No. 133 establishes accounting and reporting standards for
derivative instruments and hedging activities. SFAS No. 133, as amended by SFAS
137 (deferral of effective date) and SFAS 138, "Accounting for Certain
Derivative Instruments and Certain Hedging Activities", requires that all
derivatives be recognized as either assets or liabilities at fair value.
Derivatives that are not hedges must be adjusted to fair value through income.
If the derivative is a hedge, depending on the nature of the hedge, changes in
fair value will either be offset against the change in fair value of the hedged
assets, liabilities, or firm commitments through earnings, or recognized in
other comprehensive income until the hedged item is recognized in earnings.

The Company has not entered into derivative contracts and does not have near
term plans to enter into such contracts; accordingly, the adoption of these
pronouncements has not had a material effect on the financial statements.

(6) RESTRUCTURING CHARGE

During the second and third quarters of 2001, the Company restructured its
operations to strategically align its personnel with its product and market
strengths. Consequently, the Company has incurred restructuring charges for the
nine months ended September 30, 2001 of $8.1 million, which consists of $5.2
million to accrue for lease payments associated with leased space no longer
required due to the reduction in the workforce and $2.9 million in
severance-related costs. For the three months ended September 30, 2001, $2.8
million of restructuring charges were incurred with $2.3 million relating to
leased space losses and $0.5 million relating to a reduction in workforce.
During the third quarter of 2001, $1.0 million of severance benefits and $0.5
million of lease space related payments were paid and charged against the
restructuring liability. At September 30, 2001 $2.7 million of the unpaid
restructuring charge was included in accrued expenses and other current
liabilities and $2.8 million was included in other long-term liabilities. As of
September 30, 2001, 226 full-time positions in sales, marketing, development,
services and administration had been eliminated.

(7) LONG-TERM DEBT

In March 2001 the $20 million line of credit agreement with Fleet Bank was
terminated. Since inception no amounts were borrowed under this agreement. All
remaining loan origination fees related to this agreement were charged against
net interest income.

In June 2001 the Company finalized a $15 million credit facility with Silicon
Valley Bank, expiring in June 2002. This facility is secured by certain
receivables and will be capped at $10 million until the Company generates
positive EBITDA in a fiscal quarter. Once this event occurs and the Company
continues to generate positive EBITDA, the facility should remain at $15
million. The facility requires the Company to comply with certain financial and
other affirmative covenants, including having a capitalization event by November
15, 2001. Accordingly, the Company engaged an investment banker to help it
accomplish this capitalization event. In connection with this facility, the
Company granted Silicon Valley Bank a warrant to purchase 220,000 shares of
common stock at an exercise price of $4.00 per share. The number of shares
subject to this warrant, along with the exercise price, are subject to
adjustment based on certain anti-dilution provisions in the warrant agreement.
In addition, the shares of common stock related to the warrant have certain
registration rights. This warrant expires in June 2008. Loan origination fees of
approximately $0.4 million, including the fair value of the warrant, have been
charged to prepaid expenses and are being amortized as interest expense over the
term of the facility. In November 2001 Silicon Valley Bank agreed in principle
to modify certain terms of the credit facility (including eliminating the
capitalization requirement and extending the expiration date to December 2002).
This modification is subject to execution of definitive agreements. If, for any
reason, the Company does not complete an agreement in regard to the proposed
modifications, the Company may be in default under the credit facility. Such
default, if uncured, could result in the Company being required to pay a
substantial termination fee and operating for some time without a credit
facility. We are continuing to seek additional debt or equity financing and are
continuing with the investment banker engaged for that purpose. As of November
14, 2001 the Company has not borrowed against this facility.

(8) SEGMENT INFORMATION

The Company reports its segment information in accordance with the SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information". SFAS No.
131 establishes standards for the way that public business enterprises report
information about operating segments. It also establishes standards for related
disclosures about products and services. Reportable segment information is
determined based on management defined operating segments used to make operating
decisions and assess financial performance.

Prior to January 1, 2001 the Company classified its business activities into two
reportable segments: Domestic and International. Effective January 1, 2001, the
Company restructured its operations into three reportable segments: Americas
(North America, Central and South America) including corporate, EMEA (Europe,
Middle East & Africa) and APAC (Asia Pacific). Prior period segment data has
been restated to conform to this presentation. Information regarding the
Company's operations in these three segments is set forth below (in thousands).
There are no significant corporate overhead allocations or intersegment sales or
transfers between the segments for the periods presented.

Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
2001 2000 2001 2000
---- ---- ---- ----

Revenue:
Americas $ 22,609 $ 20,872 $ 58,290 $ 61,980
EMEA 10,976 10,083 30,595 33,543
APAC 1,406 1,248 3,402 3,629
-------- -------- -------- --------
Total $ 34,991 $ 32,203 $ 92,287 $ 99,152
======== ======== ======== ========
Operating income (loss) before amortization of intangibles:
Americas (including corporate) $ (2,078) $ (7,435) $(23,404) $ (9,347)
EMEA (2,397) 403 (7,683) 3,623
APAC (156) 368 (736) 1,166
-------- -------- -------- --------
Total (4,631) (6,664) (31,823) (4,558)
-------- -------- -------- --------
Amortization of intangibles (6,944) (11,829) (20,833) (35,057)
Other income (expense), net (174) 160 (22) 454
Provision (benefit) for income taxes 200 (9,694) 2,622 (1,237)
-------- -------- -------- --------
Net loss $(11,949) $ (8,639) $(55,300) $(37,924)
======== ======== ======== ========

Total assets: As of September 30,
-------------------
2001 2000
---- ----

Americas $ 36,747 $ 88,575
EMEA 78,236 117,874
APAC 1,988 2,655
-------- --------
$116,971 $209,104
======== ========

(9) INCOME TAXES

During the second quarter of 2001, the Company determined that taxable income
for the full year of 2001 was unlikely to be sufficient to support the full
value of the U.S. federal and state deferred tax assets. As a result, for the
quarter ended June 30, 2001, the valuation allowance was increased to cover all
U.S. federal and state deferred tax assets.

(10) COMMITMENTS AND CONTINGENCIES

The Company, its former chief executive officer and former chief financial
officer have been named as defendants in several private securities class action
lawsuits. The complaints allege violations of United State federal securities
law. Mercator believes that the allegations in the complaints are without merit
and intends to contest them vigorously. However, there can be no guarantee as to
the ultimate outcome as to these pending litigation matters.

In addition, certain litigation of a nature considered normal to its business is
pending against the Company. See Item 1 in Part II of this filing for a
discussion of significant legal proceedings. While acknowledging the
uncertainties of litigation, management believes that these matters will be
resolved without a material adverse effect on the Company's financial position
or results of operations.

(11) RECENT ACCOUNTING PRONOUNCEMENTS

During July 2001 the Financial Accounting Standards Board (FASB) issued
Statements No. 141, "Business Combinations," (SFAS 141) and No. 142, "Goodwill
and Other Intangible Assets," (SFAS 142).

SFAS 141, addresses financial accounting and reporting for business combinations
and supersedes APB Opinion No. 16, "Business Combinations", and SFAS No. 38,
"Accounting for Preacquisition Contingencies of Purchased Enterprises". All
business combinations in the scope of this Statement are to be accounted for
using one method, the purchase method. The Statement also provides guidance on
purchase accounting related to the recognition of intangible assets and
accounting for negative goodwill. The provisions of this Statement apply to all
business combinations initiated after June 30, 2001. This Statement is not
expected to have a material effect on the Company's financial position or
results of operations.

SFAS 142 supersedes APB Opinion No. 17, "Intangible Assets" and addresses
financial accounting and reporting for acquired goodwill and other intangible
assets. Statement 142 changes the accounting for goodwill from an amortization
method to an impairment-only approach. Under Statement 142 goodwill will be
tested annually and whenever events or circumstances occur indicating that
goodwill might be impaired. Upon adoption of Statement 141, amortization of
goodwill recorded for business combinations consummated prior to July 1, 2001
will cease, and intangible assets acquired prior to July 1, 2001 that do not
meet the criteria for recognition under Statement 141 will be reclassified to
goodwill. Companies are required to adopt Statement 142 for fiscal years
beginning after December 15, 2001. In connection with the adoption of Statement
142, companies will be required to perform a transitional goodwill impairment
assessment. SFAS 142 is expected to have a material effect upon the Company's
results of operations, however, the extent of the impact has not been determined
as of September 30, 2001.

During August 2001 the Financial Accounting Standards Board (FASB) issued
Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" (SFAS 144), which supersedes both FASB Statement No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of" (SFAS 121) and the accounting and reporting provisions of APB Opinion No.
30, "Reporting the Results of Operations - Reporting the Effects of Disposal of
a Segment of Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions" (Opinion 30), for the disposal of a segment of a
business. SFAS 144 retains the fundamental provisions in SFAS 121 for
recognizing impairment losses on long-lived assets held for use and long-lived
assets to be disposed of by sale, while also resolving significant
implementation issues associated with SFAS 121. SFAS 144 provides guidance on
how a long-lived asset that is used as part of group should be evaluated for
impairment, establishes criteria for when a long-lived asset is held for sale,
and prescribes the accounting for a long-lived asset that will be disposed of
other than by sale. SFAS 144 retains the basic provisions of Opinion 30 on how
to present the discontinued operations in the income statement but broadens that
presentation to include a component of an entity (rather than a segment of a
business). Companies are required to adopt SFAS 144 for fiscal years beginning
after December 15, 2001. SFAS 144 is not expected to have a material effect on
the Company's financial position or results of operations.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following management's discussion and analysis of financial condition and
results of operations contains forward-looking statements that involve risks and
uncertainties. When used in the filing, the words "assume," "project," "should,"
"could," "may," "intend," "anticipate," "believe," "estimate," "plan" and
"expect" and similar expressions as they relate to Mercator are included to
identify forward-looking statements. Our actual results could differ materially
from those anticipated in these forward-looking statements as a result of
certain factors including those set forth under "Factors That May Affect Future
Results" and elsewhere in this document.

OVERVIEW

The Company was incorporated in Connecticut in 1985 as TSI International
Software Ltd. and reincorporated in Delaware in September 1993. We completed our
initial public offering in July 1997 and a secondary offering in June 1998. We
changed our name

to Mercator Software, Inc. effective April 3, 2000.

Mercator provides comprehensive business integration software solutions to
customers around the world. In April 2001 we initiated a corporate restructuring
to strategically align our personnel and operations with our differentiated
product and market strengths. We now align the sale of our business integration
solutions to leading global enterprises in four select vertical markets: (i)
financial services, (ii) product intensive enterprises including manufacturing,
retail and distribution companies, (iii) telecommunications, utilities and
energy, and (iv) healthcare. We sell our solutions through a direct sales force
organized into three global geographic regions: Americas (North America, Central
and South America), EMEA (Europe, Middle East and Africa) and APAC (Asia
Pacific). We also use strategic business partners, such as global systems
integrators and value-added resellers, to distribute our industry-specific
solutions to their clients.

Our revenues are derived principally from three sources: (i) license fees for
the use of our software products, (ii) fees for consulting services and training
and (iii) fees for maintenance and technical support.

We recognize license fee revenue when persuasive evidence of an agreement
exists, delivery has occurred, the fee is fixed and determinable, and the fee is
collectible. Revenue from professional service arrangements is recognized on
either a time and materials or percentage of completion basis as the services
are performed and amounts due from customers are deemed collectible and
contractually nonrefundable. Revenues from fixed price service agreements are
recognized on a percentage of completion basis in direct proportion to the
services provided. Maintenance contract revenues are recognized ratably over the
terms of the contracts, which are generally for one year. The unrecognized
portion of maintenance revenue is classified as deferred maintenance revenue in
the accompanying consolidated balance sheets. For additional information
regarding our revenue recognition policies, please refer to the "Summary of
Significant Accounting Policies" included in the notes to consolidated financial
statements in our Form 10K Annual Report for the year ended December 31, 2000.

Although not indicative in our year-to-date results, we believe that software
licensing revenues should account for a larger portion of total revenues in the
future than services and maintenance revenues. We intend to continue to increase
the scope of service offerings insofar as it supports the growth of software
licensing revenues. We derive maintenance revenues from initial software
licensing contracts as well as the renewal of technical support arrangements
related to these contracts.

The size of orders can range from a few thousand dollars to over $5.0 million
per order. The loss or delay of large individual orders, therefore, can have a
significant impact on revenue and other quarterly results. In addition, we
generally recognize a substantial portion of our quarterly software licensing
revenues in the last month of each quarter, and as a result, revenue for any
particular quarter may be difficult to predict in advance. Because operating
expenses are relatively fixed, a delay in the recognition of revenue from a
limited number of license transactions could cause significant variations in
operating results from quarter to quarter and could result in significant
losses. To the extent such expenses precede, or are not subsequently followed by
increased revenue, operating results would be materially and adversely impacted.
As a result of these and other factors, operating results for any quarter are
subject to variation, and period-to-period comparisons of results of operations
are not necessarily meaningful and should not be relied upon as indications of
future performance.

RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated, the percentage of
total revenues represented by certain items from our statements of operations:

Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
2001 2000 2001 2000
---- ---- ---- ----

Revenues:
Software licensing 53.2% 51.8% 46.8% 55.9%
Services 22.6 26.8 26.2 24.3
Maintenance 24.2 21.4 27.0 19.8
----- ----- ----- -----
Total revenues 100.0 100.0 100.0 100.0
----- ----- ----- -----
Cost of revenues:
Software licensing 0.4 0.6 0.8 0.8
Services 19.7 20.0 22.5 18.1
Maintenance 4.9 6.0 5.8 5.0
----- ----- ----- -----
Total cost of revenues 25.0 26.6 29.1 23.9
----- ----- ----- -----

Gross profit 75.0 73.4 70.9 76.1
----- ----- ----- -----
Operating expenses:
Product development 12.9 17.2 16.4 15.9
Selling and marketing 46.4 53.3 54.4 48.7
General and administrative 20.9 23.6 25.8 16.1
Amortization of intangibles 19.9 36.7 22.6 35.4
Restructuring charge 8.0 -- 8.8 --
----- ----- ----- -----
Total operating expenses 108.1 130.8 128.0 116.1
----- ----- ----- -----
Operating loss (33.1) (57.4) (57.1) (40.0)
Other income (expense), net (0.5) 0.5 -- 0.5
----- ----- ----- -----
Loss before income taxes (33.6) (56.9) (57.1) (39.5)
Provision (benefit) for income taxes 0.6 (30.1) 2.8 (1.2)
----- ----- ----- -----
Net Loss (34.2)% (26.8)% (59.9)% (38.3)%
===== ===== ===== =====
Gross profit (as percent of related revenue):
Software licensing 99.2% 98.9% 98.3% 98.5%
Services 13.2% 24.1% 14.2% 25.7%
Maintenance 79.8% 73.6% 78.6% 75.1%

THE QUARTER ENDED SEPTEMBER 30, 2001 COMPARED WITH THE QUARTER ENDED SEPTEMBER
30, 2000

During the third quarter of 2001 we incurred a net (loss) of ($11.9 million)
compared to a net (loss) of ($8.6 million) in the third quarter of 2000. Third
quarter operating (loss) was ($11.6 million) in 2001 compared to ($18.5 million)
in the same period of 2000. Our third quarter operating (loss) excluding
amortization of intangibles and a restructuring charge improved to ($1.8
million) in 2001 compared to ($6.7 million) in the third quarter of 2000. This
$4.9 million increase from third quarter 2000 to third quarter 2001 was the
result of a $2.8 million increase in revenues resulting in a $2.6 million
increase in gross profit, decreased general and administrative expenses of $0.3
million, decreased selling and marketing expenses of $1.0 million and decreased
product development expenses of $1.0 million. Total gross profit margin improved
to 75% in the third quarter of 2001 from 73% in the third quarter of 2000. Our
general and administrative expenses reflect certain incremental expenses and
reorganization costs, incurred beginning in the third quarter of 2000, which we
believe should continue to decline in the fourth quarter of 2001. The
restructuring charge was incurred in connection with our efforts in the second
and third quarters to strategically align our personnel and operations with our
product and market strengths.

REVENUES

Total Revenues. Our revenues are derived principally from three sources: (i)
license fees for the use of our software products, (ii) fees for consulting
services and training and (iii) fees for maintenance and technical support.
Total revenues increased 9% to $35.0 million in the third quarter of 2001 from
$32.2 million in the same period in 2000. Additionally, third quarter 2001
revenues increased 20% or $5.8 million from $29.2 million in the second quarter
of 2001.

Software Licensing. Total software licensing revenues increased 12% from $16.7
million for the three months ended September 30, 2000 to $18.6 million for the
three months ended September 30, 2001 as we began delivery of our new GSS
product in September 2001. Americas' licensing revenues increased 4% from $12.0
million to $12.4 million, EMEA licensing revenues increased 37% from $4.0
million to $5.5 million and APAC licensing revenues increased 2% from $700,000
to $712,000. Sequentially, total software licensing revenues increased 43% from
$13.0 million for the three months ended June 30, 2001 to $18.6 million for the
three months ended September 30, 2001 primarily due to GSS related contracts,
which were signed prior to July 1, 2001, but were completed with the delivery of
our GSS product in September 2001.

Services. Services revenues decreased 8% from $8.6 million for the three months
ended September 30, 2000 to $7.9 million for the three months ended September
30, 2001 primarily due to reduced service opportunities. Americas' services
revenues decreased 5% from $4.7 million to $4.5 million, EMEA services revenues
decreased 14% from $3.7 million to $3.1 million and APAC services revenues
increased 20% from $250,000 to $300,000. However, total services revenues
increased sequentially by 4% from $7.6 million for the three months ended June
30, 2001 to $7.9 million for the three months ended September 30, 2001.

Maintenance. Maintenance revenues increased 23% from $6.9 million for the three
months ended September 30, 2000 to $8.5 million for the three months ended
September 30, 2001. This growth is consistent with the growth in the worldwide
customer base and the

related renewals of annual maintenance contracts. Americas' maintenance revenues
increased 37% from $4.1 million to $5.7 million, EMEA maintenance revenues
decreased 2% from $2.5 million to $2.4 million and APAC maintenance revenues
increased 32% from $299,000 to $394,000. Sequentially, total maintenance
revenues decreased in the third quarter of 2001 by 1% or $82,000 from the second
quarter of 2001.

COST OF REVENUES

Cost of software licensing revenues consists primarily of CD-ROMs, manuals,
distribution costs and the cost of third-party software that we resell. Cost of
services consists primarily of personnel-related and travel costs in providing
consulting and training to customers. Cost of maintenance revenues consists
primarily of personnel-related and communication costs in providing maintenance
and technical support to customers.

Gross margin on software licensing revenues is higher than gross margins on
services and maintenance revenues reflecting the low materials, packaging and
other costs of software products compared with the relatively high personnel
costs associated with providing consulting and training services, maintenance
and technical support. Cost of services also varies based upon the mix of
consulting and training services.

Cost of Software Licensing. Total software licensing costs decreased 17% from
$182,000 for the three months ended September 30, 2000 to $152,000 for the three
months ended September 30, 2001. This decrease is a result of expanded
electronic transmission of our software over the internet. Software licensing
gross margin remained strong at 99% for the three months ended September 30,
2000 and for the three months ended September 30, 2001. Total software licensing
gross profit increased 12% from $16.5 million in the third quarter of 2000 to
$18.5 million in the third quarter of 2001. Sequentially, total software
licensing gross profit increased 46% from $12.6 million in the second quarter of
2001 to $18.5 million in the third quarter of 2001.

Cost of Services. Total cost of services increased 5% from $6.6 million for the
three months ended September 30, 2000 to $6.9 million for the three months ended
September 30, 2001. This increase was due primarily to the growth in the number
of services personnel on staff over the past year. As a result of the decline in
services revenues noted above, we reduced the number of services personnel as
part of restructuring activities in the third quarter. However, as these cost
reductions will not take full effect until the fourth quarter, total services
gross margin decreased from 24% for the three months ended September 30, 2000 to
13% for the three months ended September 30, 2001. Services gross margin for
Americas decreased from 19% to 2% due primarily to lower revenues and the
redeployment of certain technical staff to the services department, related
training costs and lower productivity rates. Services gross margin for EMEA
decreased from 33% to 30% primarily due to reduced billable work assignments.
Services gross margin for APAC increased from (6%) to 15% due primarily to the
increased billable work assignments.

Cost of Maintenance. Total cost of maintenance decreased 6% from $1.8 million
for the three months ended September 30, 2000 to $1.7 million for the three
months ended September 30, 2001 as a result of reduced personnel costs as part
of current year restructuring activities. Total maintenance gross margin
increased from 74% for the three months ended September 30, 2000 to 80% for the
three months ended September 30, 2001. Maintenance gross margin increased from
67% to 83% in the Americas, decreased from 81% to 73% in EMEA and decreased from
97% to 73% in APAC.

OPERATING EXPENSES

Total Operating Expenses. Total operating expenses declined 10% from $42.1
million for the three months ended September 30, 2000 to $37.8 million for the
three months ended September 30, 2001. Sequentially, total operating expenses
declined 11% from $42.7 million in the second quarter of 2001 to $37.8 million
in the third quarter of 2001. These decreases are a result of the expense
rationalization and expense management actions initiated as part of current year
restructuring activities.

Product Development. Product development expenses include expenses associated
with the development of new products and enhancements to existing products.
These expenses consist primarily of salaries, recruiting, other
personnel-related costs, depreciation of development equipment, supplies,
travel, allocated facilities and allocated communication costs.

Total product development expenses decreased 18% from $5.5 million for the three
months ended September 30, 2000 to $4.5 million for the three months ended
September 30, 2001 due to reduced outside contractor costs as a result of
current year restructuring activities. Americas' development expenses decreased
20% from $4.2 million to $3.4 million, EMEA development expenses decreased 14%
from $1.3 million to $1.1 million and APAC had no development expenses in either
year.

We believe that a significant level of research and development expenditures is
required to remain competitive. Accordingly, we expect to continue to devote
substantial resources to research and development. We expect that the dollar
amount of research and development expenses will remain significant. To date,
all research and development expenditures have been expensed as incurred.

Selling and Marketing. Selling and marketing expenses consist of sales and
marketing personnel costs, including sales commissions,

recruiting, travel, advertising, public relations, seminars, trade shows,
product literature, allocated facilities and allocated communications costs.

Total selling and marketing expenses decreased 6% from $17.2 million for the
three months ended September 30, 2000 to $16.2 million for the three months
ended September 30, 2001. This decrease reverses the prior trend of continued
increased selling and marketing costs as we shifted our focus from increasing
our sales force to targeting certain key markets where our products have
particular value. Americas' selling and marketing expenses decreased 32% from
$12.3 million to $8.4 million primarily due to a reduced sales force. EMEA
selling and marketing expenses increased 53% from $4.6 million to $7.1 million
due to market expansion activities in continental Europe. APAC selling and
marketing expenses increased 138% from $314,000 to $746,000 as a result of
market expansion activities.

General and Administrative. General and administrative expenses consist
primarily of salaries, recruiting, and other personnel related expenses for the
Company's administrative, executive, and finance personnel as well as outside
legal, consulting, tax services and audit fees.

Total general and administrative expenses decreased 4% from $7.6 million for the
three months ended September 30, 2000 to $7.3 million for the three months ended
September 30, 2001 primarily due to decreased personnel as a result of current
year restructuring activities. Americas' general and administrative expenses,
which includes corporate headquarters costs, decreased 18% from $6.5 million to
$5.3 million, EMEA general and administrative expenses increased 100% from $0.8
million to $1.5 million and APAC general and administrative expenses increased
51% from $299,000 to $452,000.

Amortization of Intangibles. Intangible assets are comprised of the excess of
the purchase price and related costs of an acquired business over the value
assigned to tangible assets. The acquisitions we made in 1998 and 1999 were
accounted for under the purchase method of accounting. The purchase prices were
allocated to the tangible and identifiable intangible assets based on their
estimated fair values with any excess designated as goodwill. Intangible assets,
including goodwill, are amortized over their estimated useful lives, which range
from three to five years.

Amortization expense decreased from $11.8 million for the three months ended
September 30, 2000 to $6.9 million for the three months ended September 30,
2001, as a result of the intangible impairment charge we recorded in the fourth
quarter of 2000. As of September 30, 2001 Mercator had net intangible assets of
$60.7 million as compared to $132.6 million one year ago.

Restructuring Charge. The restructuring charge of $2.8 million for the three
months ending September 30, 2001 consists of $0.5 million in severance-related
costs and $2.3 million to accrue for losses related to leased space no longer
required due to a reduction in our workforce during the quarter. The Americas'
restructuring charge was $2.2 million and the EMEA restructuring charge was $0.6
million. At September 30, 2001, $2.7 million of the unpaid restructuring charge
was included in accrued expenses and other current liabilities and $2.8 million
was included in other long-term liabilities.

OTHER INCOME, NET

Total net interest income decreased from $160,000 for the three months ended
September 30, 2000 to net interest expense of $174,000 for the three months
ended September 30, 2001, due to the use of cash to fund operating losses,
including the expansion of worldwide operations, and the subsequent reduction of
interest bearing investments. This decrease is also due to fees in connection
with a $15 million credit facility with Silicon Valley Bank.

TAXES

The provision (benefit) for income taxes was $0.2 million for the three months
ended September 30, 2001 as compared to ($9.7 million) for the three months
ended September 30, 2000. The provision for income taxes is based on the
anticipated effective tax rates and taxable income for the full year taking into
account each jurisdiction in which the Company operates. The difference between
the Company's effective tax rate and the U.S. statutory rate is primarily
attributable to $5.8 million of non-deductible goodwill amortization and the
effect of certain expected full-year foreign taxable losses for the quarter
ended September 30, 2001 and $9.8 million of non-deductible goodwill
amortization for the quarter ended September 30, 2000.

NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH NINE MONTHS ENDED SEPTEMBER
30, 2000

During the first nine months of 2001 we incurred a net (loss) of ($55.3 million)
compared to a net (loss) of ($37.9 million) in the first nine months of 2000.
The first nine months operating (loss) was ($52.7 million) in 2001 compared to
($39.6 million) in the same period of 2000. Our first nine months operating
income (loss) excluding amortization of intangibles and a restructuring charge
was ($23.7 million) in 2001 compared to ($4.6 million) in the same period of
2000. This $19.1 million decrease from the first nine months of 2000 to the
first nine months of 2001 was primarily the result of a $10.1 million decrease
in gross profit and increased general and administrative expenses of $7.9
million. The decline in gross profit was primarily due to a $12.3 million
decline in software licensing

revenues. Our general and administrative expenses reflect certain incremental
expenses and reorganization costs, incurred beginning in the third quarter of
2000, but which we believe should continue to decline in the fourth quarter of
2001. The restructuring charge was incurred in connection with our efforts in
the second and third quarters to strategically align our personnel and
operations with our product and market strengths.

REVENUES

Total Revenues. Our revenues are derived principally from three sources: (i)
license fees for the use of our software products, (ii) fees for consulting
services and training and (iii) fees for maintenance and technical support.
Total revenues decreased 7% to $92.3 million in the first nine months of 2001
from $99.2 million in the same period of 2000.

Software Licensing. Total software licensing revenues decreased 22% from $55.4
million for the nine months ended September 30, 2000 to $43.1 million for the
nine months ended September 30, 2001. Continued weak economic conditions and
customers delaying purchasing decisions on larger deals negatively impacted
software licensing revenues in each region. Americas' licensing revenues
decreased 21% from $36.6 million to $28.9 million, EMEA licensing revenues
decreased 24% from $16.5 million to $12.6 million and APAC licensing revenues
decreased 30% from $2.3 million to $1.6 million.

Services. Services revenues were $24.2 million for the nine months ended
September 30, 2000 and for the nine months ended September 30, 2001. Americas'
services revenues decreased marginally from $13.5 million to $13.1 million, EMEA
services revenues increased marginally from $10.1 million to $10.3 million and
APAC services revenues increased 37% from $576,000 to $789,000.

Maintenance. Maintenance revenues increased 27% from $19.6 million for the nine
months ended September 30, 2000 to $24.9 million for the nine months ended
September 30, 2001. This growth is consistent with the growth in the worldwide
customer base and the related renewals of annual maintenance contracts.
Americas' maintenance revenues increased 36% from $11.9 million to $16.3
million, EMEA maintenance revenues increased 11% from $7.0 million to $7.7
million and APAC maintenance revenues increased 38% from $693,000 to $959,000.

COST OF REVENUES

Cost of Software Licensing. Total software licensing costs decreased 10% from
$835,000 for the nine months ended September 30, 2000 to $753,000 for the nine
months ended September 30, 2001. This decrease is consistent with lower delivery
costs connected with fewer software shipments and expanded electronic
transmission of our software over the internet. Software licensing gross margin
remained steady at 98% for the nine months ended September 30, 2000 and 2001.

Cost of Services. Total cost of services increased 16% from $17.9 million for
the nine months ended September 30, 2000 to $20.8 million for the nine months
ended September 30, 2001. This increase was primarily due to a higher services
headcount this year compared to last year. Consequently, total services gross
margin decreased from 26% for the nine months ended September 30, 2000 to 14%
for the nine months ended September 30, 2001. As part of the restructuring
activities in the current year, we have reduced the number of services
personnel. Services gross margin for Americas decreased from 24% to 4%. Services
gross margin for EMEA remained flat at 30%. Services gross margin for APAC
decreased from (8%) to (16%) due primarily to the addition of services personnel
in advance of billable work assignments.

Cost of Maintenance. Total cost of maintenance increased 9% from $4.9 million
for the nine months ended September 30, 2000 to $5.3 million for the nine months
ended September 30, 2001 as we added resources to support our increased customer
base worldwide. Total maintenance gross margin increased from 75% for the nine
months ended September 30, 2000 to 79% for the nine months ended September 30,
2001. Maintenance gross margin increased from 71% to 81% in the Americas,
decreased from 81% to 75% in EMEA and decreased from 87% to 73% in APAC.

OPERATING EXPENSES

Total product development expenses decreased 4% from $15.7 million for the nine
months ended September 30, 2000 to $15.1 million for the nine months ended
September 30, 2001. Americas' development expenses decreased 3% from $11.2
million to $10.9 million. EMEA development expenses decreased 6% from $4.5
million to $4.2 million and APAC had no development expenses in either year.

Selling and Marketing. Selling and marketing expenses consist of sales and
marketing personnel costs, including sales commissions, recruiting, travel,
advertising, public relations, seminars, trade shows, product literature,
allocated facilities and allocated communications costs.

Total selling and marketing expenses increased 4% from $48.3 million for the
nine months ended September 30, 2000 to $50.2 million for the nine months ended
September 30, 2001. This increase was due to higher compensation expenses in the
first quarter of 2001 related to the growing sales force. However, we halted
this trend in the second and third quarters of 2001 as we focused on our
targeted vertical market strategy and reduced the size of our sales force.
Americas' selling and marketing expenses decreased 15% from $33.5 million to
$28.6 million primarily due to a reduced sales force and lower commission
expense related to lower revenues. EMEA selling and marketing expenses increased
46% from $13.8 million to $20.1 million despite lower revenues due to market
expansion activities in continental Europe. APAC selling and marketing expenses
increased 75% from $861,000 to $1.5 million as a result of market expansion
activities.

Total general and administrative expenses increased 49% from $16.0 million for
the nine months ended September 30, 2000 to $23.9 million for the nine months
ended September 30, 2001. This increase is primarily due to increased
incremental legal, accounting and consulting fees, turnover costs related to
senior management as well as other administrative costs incurred to support our
worldwide growth. We believe the incremental legal, accounting, consulting and
turnover costs should decline beginning in the fourth quarter of 2001. Americas'
general and administrative expenses, which includes corporate headquarters
costs, increased 53% from $12.3 million to $18.8 million, EMEA general and
administrative expenses increased 26% from $3.0 million to $3.8 million and APAC
general and administrative expenses increased 80% from $741,000 to $1.3 million.

Amortization expense decreased from $35.1 million for the nine months ended
September 30, 2000 to $20.8 million for the nine months ended September 30,
2001, as a result of the intangible impairment charge we recorded in the fourth
quarter of 2000. As of September 30, 2001 Mercator had net intangible assets of
$60.7 million as compared to $132.6 million one year ago.

Restructuring Charge. The restructuring charge of $8.1 million for the nine
months ending September 30, 2001 consists of $2.9 million in severance-related
costs and $5.2 million to accrue for lease payments associated with leased space
no longer required due to reductions in our workforce during the second and
third quarters of 2001. The Americas restructuring charge was $7.2 million and
the EMEA restructuring charge was $0.9 million. At September 30, 2001 $2.7
million of the unpaid restructuring charge was included in accrued expenses and
other current liabilities and $2.8 million was included in other long-term
liabilities.

OTHER INCOME, NET

Total net interest income decreased from $454,000 for the nine months ended
September 30, 2000 to net interest expense of $22,000 for the nine months ended
September 30, 2001, due to the use of cash to fund operating losses, including
the expansion of worldwide operations, the subsequent reduction of interest
bearing investments and borrowing costs related to terminating the Fleet Bank
credit line facility in the first quarter of 2001. This decrease is also due to
fees in connection with a $15 million credit facility with Silicon Valley Bank.

TAXES

The provision (benefit) for income taxes was $2.6 million for the nine months
ended September 30, 2001 as compared to ($1.2 million) for the nine months ended
September 30, 2000. The provision (benefit) for income taxes is based on the
anticipated effective tax rates and taxable income for the full year taking into
account each jurisdiction in which the Company operates. During the second
quarter of 2001, we determined that taxable income for the full year of 2001 was
unlikely to be sufficient to support the full value of the U.S. federal and
state deferred tax assets. Consequently, our 2001 nine months tax provision
includes a full valuation reserve for that asset. The difference between the
Company's effective tax rate and the U.S. statutory rate is primarily
attributable to $17.4 million of non-deductible goodwill amortization and the
effect of certain expected full-year foreign taxable losses for the nine months
ended September 30, 2001 and $29 million of non-deductible goodwill amortization
for the nine months ended September 30, 2000.

LIQUIDITY AND CAPITAL RESOURCES

Working Capital. On September 30, 2001 we had cash of $7.3 million and a net
working capital deficit of ($7.8 million). Net working capital at December 31,
2000 was $23.4 million including cash and marketable securities of $21.7
million. The $31.2 million decrease in working capital was caused primarily by a
$14.5 million decrease in cash and marketable securities, an $8.2 million
decrease in net accounts receivable and a $4.2 million increase in current
deferred revenues.

Net accounts receivable decreased from $38.9 million at December 31, 2000 to
$30.7 million at September 30, 2001 due primarily to a $4 million decrease in
revenues between the quarters then ended and improved collections, partially
offset by a $4.8 million increase in deferred revenue. The number of days sales
in net accounts receivable decreased from 89 at December 31, 2000 to 79 at
September 30, 2001 due primarily to the $8.2 million decrease in net accounts
receivable partially offset by the $4 million decrease in revenue for the
quarter then ended. The number of days sales in net accounts receivable of 79 at
September 30, 2001 was down from 93 at June 30, 2001.

Operating activities used net cash of $11.7 million during the nine months ended
September 30, 2001 compared to providing net cash of $8.8 million during the
nine months ended September 30, 2000. Of the $55 million net loss for the nine
months ended September 30, 2001, $30 million resulted from non-cash expenses,
primarily intangibles amortization, depreciation and restructuring charges. The
cash used to fund the remaining $25 million loss was offset primarily by cash
provided from an $8 million decrease in net accounts receivable and a $5 million
increase in deferred revenue. For the nine months ended September 30, 2000 the
net loss of $38 million was caused primarily by non-cash expenses of $38 million
of intangibles amortization and depreciation.

During the second and third quarters of 2001 we initiated strategic
restructurings and reorganizations, which eliminated 226 full-time positions
throughout the Company. We consider these positions to be unnecessary to support
current levels of revenues and product development because of our new focus on
targeting select vertical markets. Consequently we expect that costs of services
and product development, selling, marketing and general and administrative
expenses related to personnel should be lower in the future. These staffing
reductions resulted in $0.5 million in severance costs for the quarter ending
September 30, 2001. In addition, we accrued $2.3 million in losses related to
leased space no longer required due to this reduction in our workforce.

Investing Activities. Investing activities consumed cash of $2.2 million during
the nine months ended September 30, 2001 compared to $2.4 million during the
nine months ended September 30, 2000. Investing activities in the first nine
months of 2001 included a $4.1 million investment in furniture, fixtures and
equipment, a $1.5 million increase in the restricted collateral deposit in
connection with a facility lease partially offset by a $3.4 million liquidation
of investments in marketable securities. Investing activities in the first nine
months of 2000 included a $4.4 million investment in furniture, fixtures and
equipment partially offset by a $2.1 million liquidation of investments in
marketable securities.

Capital expenditures have been, and future capital expenditures are anticipated
to be primarily for facilities, computer equipment and software to support our
operations. Certain computer equipment used in development activities may be
available through operating leases. In January 2001, pursuant to a new
headquarters facility lease agreement, we increased the letter of credit to $2.5
million and the related restricted collateral deposit to $3.0 million. We are
currently seeking to sublease a majority of this space and other surplus office
space to third parties. As of September 30, 2001 we had no material commitments
for capital expenditures.

Financing Activities. Financing activities generated cash of $3.4 million during
the nine months ended September 30, 2001 compared to $5.9 million during the
nine months ended September 30, 2000. Financing activities in the first nine
months of 2001 generated cash of $1.6 million from a sale of restricted common
stock and $1.7 million from employee stock plan purchases. Financing activities
in the first nine months of 2000 generated cash of $3.1 million from employee
stock option exercises and $2.8 million from employee stock plan purchases.

In June 2001 we finalized a $15 million credit facility with Silicon Valley
Bank. This facility is secured by certain receivables and will be capped at $10
million until we generate positive EBITDA in a fiscal quarter. Once this event
occurs and we continue to generate

positive EBITDA, the facility should remain at $15 million. In November 2001,
Silicon Valley Bank agreed in principle to modify certain terms of the credit
facility (including eliminating the capitalization requirement and extending the
expiration date to December 2002). This modification is subject to execution of
definitive agreements. If, for any reason, the Company does not complete an
agreement with regard to the proposed modifications, the Company may be in
default under the credit facility. Such default, if uncured, could result in
the Company being required to pay a substantial termination fee and operating
for some period of time without a credit facility. We are continuing to seek
additional debt or equity financing and are continuing with the investment
banker engaged for that purpose. As of November 14, 2001 we have not borrowed
against this facility.

We believe that current cash and cash equivalent balances, combined with net
cash generated from operations, should be sufficient to meet anticipated needs
for working capital and capital expenditures through December 31, 2001. However,
recognizing the potential for a cash shortfall during the remainder of the year,
we established the credit facility with Silicon Valley Bank as described above.
We believe that, even in the event of an uncured default as described above, the
Company should be able to continue its operations, but, as noted, continues to
pursue alternative sources of financing to support growth opportunities and
other needs that may exceed cash resources available from operations and the
credit facility. However, any projections of future cash needs and cash flows
are subject to substantial uncertainty. If current cash, cash equivalents and
cash that may be generated from operations and the sources noted above are
insufficient to satisfy our liquidity requirements, we will likely seek to sell
additional debt or equity securities. The sale of additional equity or
equity-related securities, if achieved, would result in additional dilution to
our stockholders. In addition, we will, from time to time, consider the
acquisition of or investment in complementary businesses, products, services and
technologies, which might impact our liquidity requirements or cause us to issue
debt or additional equity securities. There can be no assurance that financing
will be available in amounts or on terms acceptable to us, or at all. A failure
to obtain such financing may adversely impact our business.

CONVERSION TO A SINGLE EUROPEAN CURRENCY

We generate revenues in a number of foreign countries. However, as the majority
of foreign license contracts are denominated in US dollars, we do not expect
conversion to a single European currency to have a material impact on our
financial results.

FACTORS THAT MAY AFFECT FUTURE RESULTS

Our cash resources may be insufficient to sustain operations.

We believe that current cash and cash equivalent balances, combined with net
cash generated from operations, should be sufficient to meet anticipated needs
for working capital and capital expenditures through December 31, 2001. However,
any projections of future cash needs and cash flows are subject to substantial
uncertainty. If current cash, cash equivalents and cash that may be generated
from operations and the credit line facility are insufficient to satisfy our
liquidity requirements, we will likely seek to sell additional debt or equity
securities. The sale of additional equity or equity-related securities would
result in additional dilution to our stockholders. In addition, we will, from
time to time, consider the acquisition of or investment in complementary
businesses, products, services and technologies, which might impact our
liquidity requirements or cause us to issue debt or additional equity
securities. There can be no assurance that financing will be available in
amounts or on terms acceptable to us, or at all.

Our quarterly and annual operating results are volatile, difficult to predict
and may cause our stock price to fluctuate.

Our quarterly and annual operating results have varied significantly in the past
and are expected to do so in the future. In addition, our recent restructuring
plan that has been put in place is unproven, and could result in increased
volatility and have an adverse affect on our stock price. We believe that
investors should not rely on period-to-period comparisons of our results of
operations, as they are not necessarily indications of our future performance.
In some future periods, our results of operations may be below the expectation
of public market analysts and investors. We have had operating losses in the
first, second and third quarters of 2001 and may continue to have losses in the
future. In addition, we may not reach our expectations of returning to
profitability in the fourth quarter of 2001. In these cases, the price of our
common stock would likely decline.

Our revenues and results of operations are difficult to forecast and depend on a
variety of factors. These factors include the following:

o personnel changes, our ability to attract and retain qualified
sales, professional services and research and development
personnel and the rate at which these personnel become
productive;

o general economic conditions;

o the size, timing and terms of individual license transactions;

o the sales cycle for our products;

o demand for and market acceptance of our products and related
services, particularly our Mercator products;

o our ability to expand, and market acceptance of, our services
business;

o the timing of our expenditures in anticipation of product
releases or increased revenue;

o the timing of product enhancements and product introductions
by us and our competitors;

o market acceptance of enhanced versions of our existing
products and of new products;

o changes in pricing policies by our competitors and ourselves;

o variations in the mix of products and services we sell;

o the mix of channels through which our products and services
are sold;

o our success in penetrating international markets;

o the buying patterns and budgeting cycles of customers;

o our ability to raise cash to fund operations;

o the acceptance in the marketplace of our new vertical
strategy; and

o our ability to achieve profitability in the future.

We have historically derived a substantial portion of our revenues from the
licensing of our software products, and we anticipate that this trend will
continue for the foreseeable future.

Software license revenues are difficult to forecast for a number of reasons,
including the following:

o We typically do not have a material backlog of unfilled
orders, and revenues in any quarter substantially depend on
orders booked and shipped in that quarter;

o the length of the sales cycles for our products can vary
significantly from customer to customer and from product to
product and can be as long as nine months or more;

o the terms and conditions of individual license transactions,
including prices and discounts, are often negotiated based on
volumes and commitments, and may vary considerably from
customer to customer; and

o We have generally recognized a substantial portion of our
quarterly software licensing revenues in the last month of
each quarter.

Accordingly, the cancellation or deferral of even a small number of purchases of
our products could harm our business and affect our

profitability.

We have taken and expect to continue to take remedial measures to address any
slowdown in the market for our Mercator products, which could have long-term
effects on our business.

In particular, we have reduced our workforce and reduced our planned capital
expenditure and expense budgets. These measures will reduce our expenses.
However, each of these measures could have long-term effects on our business
including but not limited to reducing our pool of technical talent, decreasing
or slowing improvements in our products, and making it more difficult for us to
respond to customers.

Investors, customers and vendors may react adversely to change in our Company.

Our success depends in large part on the support of investors, key customers and
vendors who may react adversely to changes in our company since the restatement
of our first quarter 2000 earnings and the adjustment to previously disclosed
second quarter 2000 results. Many members of our senior management have joined
us since January 2001. It will take time and resources for these individuals to
effect change within our organization and during this period our vendors and
customers may re-examine their willingness to do business with us. If we are
unable to retain and attract our existing and new customers and vendors, our
business, operating results and financial condition could be materially
adversely affected.

Our future success depends on retaining our key personnel and attracting and
retaining additional highly qualified employees.

Other than Roy King, our Chairman, Chief Executive Officer, and President, all
employees are employed at-will and we have no fixed-term employment agreements
with our employees, which prevent them from terminating their employment at any
time. The loss of the services of any one or more of our key employees could
harm our business.

Our future success also depends on our ability to attract, train and retain
highly qualified sales, research and development, professional services and
managerial personnel, particularly sales, professional services and research and
development personnel with expertise in enterprise resource planning systems.
Competition for these personnel is intense. We may not be able to attract,
assimilate or retain qualified personnel. We have at times experienced, and we
continue to experience, difficulty in recruiting qualified sales and research
and development personnel, and we anticipate these difficulties will continue in
the future. Furthermore, we have in the past experienced, and in the future
expect to continue to experience, a significant time lag between the date sales,
research and development and professional services personnel are hired and the
date these employees become fully productive.

It would be difficult for us to adjust our spending if we experience any revenue
shortfalls.

Our future revenues will also be difficult to predict and we could fail to
achieve our revenue expectations. Our expense levels are based, in part, on our
expectation of future revenues, and expense levels are, to a large extent, fixed
in the short term. We may be unable to adjust spending in a timely manner to
compensate for any unexpected revenue shortfall. If revenue levels are below
expectations for any reason, our operating results and cash flows are likely to
be harmed. Net income may be disproportionately affected by a reduction in
revenue because large portions of our expenses are related to headcount that
cannot be easily reduced without harming our business. If cash flows are
negatively impacted, there can be no assurance that existing financing
arrangements, including lines of credit in the form of accounts receivable
financing agreements and the like, will be sufficient to meet cash needs or will
be available in the future, as there is no assurance that we will be able to
draw down upon our existing line of credit.

We may experience seasonal fluctuations in our revenues or results of
operations.

It is not uncommon for software companies to experience strong calendar year
ends followed by weaker subsequent quarters, in some cases with sequential
declines in revenues or operating profit. We believe that many software
companies exhibit this pattern in their sales cycles primarily due to customers'
buying patterns and budget cycles. We have displayed this pattern in the past
and may display this pattern in future years.

We are exposed to general economic conditions.

As a result of recent unfavorable economic conditions and reduced capital
spending, software licensing revenues have declined year to date as a percentage
of our total revenues as compared to the prior year. In particular, sales to
e-commerce and internet businesses, value-added resellers and independent
software vendors were impacted during the first, second and third fiscal
quarters of 2001. If the economic conditions in the United States worsen, or if
a wider global economic slowdown occurs, we may experience a material adverse
impact on our business, operating results, and financial condition.

We depend on the sales of our Mercator products and related services.

We first introduced our Mercator products in 1993. In recent years, a
significant portion of our revenue has been attributable to licenses of Mercator
products and related services, and we expect that revenue attributable to our
Mercator products and related services will continue to represent a significant
portion of our total revenue for the foreseeable future. Accordingly, our future
operating results significantly depend on the market acceptance and growth of
our Mercator product line and enhancements of these products and services.
Market acceptance of our Mercator product line may not increase or remain at
current levels, and we may not be able to successfully market our Mercator
product line or develop extensions and enhancements to this product line on a
long-term basis. In the event that our current or future competitors release new
products that provide, or are perceived as providing, more advanced features,
greater functionality, better performance, better compatibility with other
systems or lower prices than our Mercator product line, demand for our products
and services would likely decline. A decline in demand for, or market acceptance
of, the Mercator product line would harm our business.

We may experience difficulties in developing and introducing new or enhanced
products necessitated by technological changes.

Our future success will depend, in part, upon our ability to anticipate changes,
to enhance our current products and to develop and introduce new products that
keep pace with technological advancements and address the increasingly
sophisticated needs of our customers. Our products may be rendered obsolete if
we fail to anticipate or react to change. Development of enhancements to
existing products and new products depend, in part, on a number of factors,
including the following:

o the timing of releases of new versions of applications systems
by vendors;

o the introduction of new applications, systems or computing
platforms;

o the timing of changes in platforms;

o the release of new standards or changes to existing standards;

o changing customer requirements; and

o the availability of cash to fund development.

Our product enhancements or new products may not adequately meet the
requirements of the marketplace or achieve any significant degree of market
acceptance. In addition, our introduction or announcement, or those of one or
more of our current or future competitors, of products embodying new
technologies or features could render our existing products obsolete or
unmarketable. Our introduction or announcement of enhanced or new product
offerings or introductions by our current or future competitors may cause
customers to defer or cancel purchases of our existing products. Any deferment
or cancellation of purchases could harm our business.

We could experience delays in developing and releasing new products or product
enhancements.

We may experience difficulties that could delay or prevent the successful
development, introduction and marketing of new products or product enhancements.
We have in the past experienced delays in the introduction of product
enhancements and new products and we may experience delays in the future. We
furthermore, as the number of applications, systems and platforms supported by
our products increases, could experience difficulties in developing, on a timely
basis, product enhancements which address the increased number of new versions
of applications, systems or platforms served by our existing products. If we
fail, for technological or other reasons, to develop and introduce product
enhancements or new products in a timely and cost-effective manner or if we
experience any significant delays in product development or introduction, our
customers may delay or decide against purchases of our products, which could
harm our business.

The success of our products will also depend upon the success of the platforms
we target.

We may, in the future, seek to develop and market enhancements to existing
products or new products, which are targeted for applications, systems or
platforms that we believe will achieve commercial acceptance. This could require
us to devote significant development, sales and marketing personnel, as well as
other resources, to these efforts, which would otherwise be available for other
purposes. We may not be able to successfully identify these applications,
systems or platforms, and even if we do so, we may not achieve commercial
acceptance or we may not realize a sufficient return on our investment. Failure
of these targeted applications, systems or platforms to achieve commercial
acceptance or our failure to achieve a sufficient return on our investment could
harm our business.

We may not successfully expand our sales and distribution channels.

An integral part of our strategy is to expand our indirect sales channels,
including strategic partners, value-added resellers, independent software
vendors, systems integrators and distributors. This channel is accounting for a
growing percentage of our total revenues and we are increasing resources
dedicated to developing and expanding these indirect distribution channels. We
may not be successful in expanding the number of indirect distribution channels
for our products. If we are successful in increasing our sales through indirect
sales channels, we expect that those sales will be at lower per unit prices than
sales through direct channels, and revenue we receive for each sale will be less
than if we had licensed the same product to the customer directly.

Selling through indirect channels may also limit our contact with our customers.
As a result, our ability to accurately forecast sales, evaluate customer
satisfaction and recognize emerging customer requirements may be hindered.

Even if we successfully expand our indirect distribution channels, any new
strategic partners, value added resellers, independent software vendors, system
integrators or distributors may offer competing products, or have no minimum
purchase requirements of our products. These third parties may also not have the
technical expertise required to market and support our products successfully. If
the third parties do not provide adequate levels of services and technical
support, our customers could become dissatisfied, and we may have to devote
additional resources for customer support. Our brand name and reputation could
be harmed. Selling products through indirect sales channels could cause
conflicts with the selling efforts of our direct sales force.

Our strategy of marketing products directly to end-users and indirectly through
value added resellers, independent software vendors, systems integrators and
distributors may result in distribution channel conflicts. Our direct sales
efforts may compete with those of our indirect channels and, to the extent
different resellers target the same customers, resellers may also come into
conflict with each other. Although we have attempted to manage our distribution
channels to avoid potential conflicts, channel conflicts may harm our
relationships with existing value added resellers, independent software vendors,
systems integrators or distributors or impair our ability to attract new value
added resellers, independent software vendors, systems integrators and
distributors.

We may encounter difficulties in managing our growth.

Our business has grown in recent periods, with total revenues increasing from
approximately $16.1 million in 1995 to $138.3 million in 2000. We acquired
certain assets of Software Consulting Partners in November 1998 and acquired
Braid Group Limited in March 1999, and Novera Software, Inc. in September 1999.
The growth of our business has placed, and is expected to continue to place, a
strain on our administrative, financial, sales and operational resources and
increased demands on our systems and controls.

To address this growth, we have recently implemented, or are in the process of
implementing and will implement in the future, a variety of new and upgraded
operational and financial systems, procedures and controls. We may not be able
to successfully complete the implementation and integration of these systems,
procedures and controls, or hire additional personnel, in a timely manner. Our
inability to manage our growth amid changing business conditions, or to adapt
our operational, management and financial control systems to accommodate our
growth could harm our business.

We may face significant risks in expanding our international operations.

International revenues accounted for approximately 29% of our total revenues for
1999 compared to approximately 38% of our total revenues for 2000 and 37% of our
total revenues in the first nine months of 2001. Continued expansion of our
international sales and marketing efforts will require significant management
attention and financial resources. We also expect to commit additional time and
development resources to customizing our products for selected international
markets and to developing international sales and support channels.
International operations involve a number of additional risks, including the
following:

o impact of possible recessionary environments in economies
outside the United States;

o longer receivables collection periods and greater difficulty
in accounts receivable collection;

o unexpected changes in regulatory requirements;

o dependence on independent resellers;

o reduced protection for intellectual property rights in some
countries;

o tariffs and other trade barriers;

o foreign currency exchange rate fluctuations;

o difficulties in staffing and managing foreign operations;

o the burdens of complying with a variety of foreign laws;

o potentially adverse tax consequences; and

o political and economic instability.

To the extent that our international operations expand, we expect that an
increasing portion of our international license and service and other revenues
will be denominated in foreign currencies, subjecting ourselves to fluctuations
in foreign currency exchange rates. We do not currently engage in foreign
currency hedging transactions. However, as we continue to expand our
international operations, exposures to gains and losses on foreign currency
transactions may increase. We may choose to limit our exposure by the purchase
of forward foreign exchange contracts or similar hedging strategies. The
currency exchange strategy that we adopt may not be successful in avoiding
exchange-related losses. In addition, the above-listed factors may cause a
decline in our future international revenue and, consequently, may harm our
business. We may not be able to sustain or increase revenue that we derive from
international sources.

Our success depends upon the widespread use and adoption of the internet and
intranets.

We believe that the demand for enterprise application integration solutions,
such as those that we offer, will depend, in part, upon the adoption by
businesses and end-users of the internet and intranets as platforms for
electronic commerce and communications. The internet and intranets are new and
evolving, and they may not be widely adopted, particularly for electronic
commerce and communications among businesses. Critical issues concerning the
internet and intranets, including security, reliability, cost, ease of use and
access and quality of service remain unresolved at this time, inhibiting
adoption by many enterprises and end-users. If the internet and intranets are
not widely used by businesses and end-users, particularly for electronic
commerce, this could harm our business.

Government regulation and legal uncertainties relating to the internet could
adversely affect our business.

Congress has passed legislation and several more bills have been sponsored in
both the House and Senate that are designed to regulate various aspects of the
internet, including, for example, on-line content, copyright infringement, user
privacy, and taxation. In addition, federal, state, local and foreign
governmental organizations are considering other legislative and regulatory
proposals that would regulate aspects of the internet, including libel, pricing,
quality of products and services, and intellectual property ownership. The laws
governing the use of the internet, in general, remain largely unsettled, even in
areas where there has been some legislative action. It may take years to
determine whether and how existing laws apply to the internet. In addition, the
growth and development of the market for online commerce may prompt calls for
more stringent consumer protection laws, both in the United States and abroad,
which may impose additional burdens on companies conducting business online by
limiting the type and flow of information over the internet. The adoption or
modification of laws or regulations relating to the internet could adversely
affect our business.

It is not known how courts will interpret both existing and new laws. Therefore,
we are uncertain as to how new laws or the application of existing laws will
affect our business. In addition, our clients who may be subject to such
legislation may indirectly affect our business. Increased regulation of the
internet may decrease the growth in the use of the internet, which could
decrease the demand for our services, increase our cost of doing business or
otherwise have a material adverse effect on our business, results of operations
and financial condition.

Capacity constraints caused by growth in internet use may, unless resolved,
impede further development of the internet to the extent that users experience
delays, transmission errors and other difficulties. Further, the adoption of the
internet for commerce and communications, particularly by those individuals and
companies that have historically relied upon alternative means of commerce and
communication, generally requires the understanding and acceptance of a new way
of conducting business and exchanging information. In particular, companies that
have already invested substantial resources in other means of conducting
commerce and exchanging information may be particularly reluctant or slow to
adopt a new internet-based strategy that may make their existing personnel and
infrastructure obsolete. If the necessary infrastructure, products, services or
facilities are not developed, or if the internet does not become or remain a
viable commercial medium, our business, results of operations and financial
condition could be materially and adversely affected.

The United States Omnibus Appropriations Act of 1998, which placed a moratorium
on taxes levied on internet access, expired October 21, 2001. Although similar
federal legislation has been proposed, there can be no assurance that any such
legislation will become law. Additionally, states may tax internet access
resulting in increased cost to access the internet, resulting in a material
adverse effect to our business.

We face significant competition in the market for e-business integration
software.

The market for our products and services is extremely competitive and subject to
rapid change. Because there are relatively low barriers to entry in the software
market, we expect additional competition from other established and emerging
companies.

In the e-business integration market, our products and related services compete
primarily against solutions developed internally by individual businesses to
meet their specific e-business integration needs. In addition, we face
increasing competition in the e-business integration market from other
third-party software vendors.

Many of our current and potential competitors have longer operating histories,
significantly greater financial, technical, product development and marketing
resources, greater name recognition and larger customer bases than we do. Our
present or future competitors may be able to develop products that are
comparable or superior to those we offer, adapt more quickly than we do to new
technologies, evolving industry trends or customer requirements, or devote
greater resources than we do to the development, promotion and sale of their
products. Accordingly, we may not be able to compete effectively in our target
markets against these competitors.

We expect that we will face increasing pricing pressures from our current
competitors and new market entrants. Our competitors may engage in pricing
practices that reduce the average selling prices of our products and related
services. To offset declining average selling prices, we believe that we must
successfully introduce and sell enhancements to existing products and new
products on a timely basis. We must also develop enhancements to existing
products and new products that incorporate features that can be sold at higher
average selling prices. To the extent that enhancements to existing products and
new products are not developed in a timely manner, do not achieve customer
acceptance or do not generate higher average selling prices, our operating
margins may decline.

We have only limited protection for our proprietary technology.

Our success is dependent upon our proprietary software technology. We do not
currently have any patents and we rely principally on trade secret, copyright
and trademark laws, nondisclosure and other contractual agreements and technical
measures to protect our technology. We also believe that factors such as the
technological and creative skills of our personnel, product enhancements and new
product developments are essential to establishing and maintaining a technology
leadership position. We enter into confidentiality and/or license agreements
with our employees, distributors and customers, and it limits our access to and
distribution of our software, documentation and other proprietary information.
The steps taken by us may not be sufficient to prevent misappropriation of our
technology, and such protections do not preclude competitors from developing
products with functionality or features similar to our products. Furthermore, it
is possible that third parties will independently develop competing technologies
that are substantially equivalent or superior to our technologies. In addition,
effective copyright and trade secret protection may be unavailable or limited in
certain foreign countries, which could pose additional risks of infringement as
we continue to expand internationally. Our failure or inability to protect our
proprietary technology could have a material adverse effect on our business.

Although we do not believe our products infringe the proprietary rights of any
third parties, infringement claims could be asserted against us or our customers
in the future. Furthermore, we may initiate claims or litigation against third
parties for infringement of our proprietary rights, or for purposes of
establishing the validity of our proprietary rights. Litigation, either as
plaintiff or defendant, would cause us to incur substantial costs and divert
management resources from productive tasks whether or not such litigation is
resolved in our favor, which could have a material adverse effect on our
business. Parties making claims against us could secure substantial damages, as
well as injunctive or other equitable relief, which could effectively block our
ability to license our products in the United States or abroad. Such a judgment
could have a material adverse effect on our business. If it appears necessary or
desirable, we may seek licenses to intellectual property that we are allegedly
infringing. Licenses may not be obtainable on commercially reasonable terms, if
at all. The failure to obtain necessary licenses or other rights could have a
material adverse effect on our business. As the number of software products in
the industry increases and the functionality of these products further overlaps,
we believe that software developers may become increasingly subject to
infringement claims. Any such claims, with or without merit, can be
time-consuming and expensive to defend and could adversely affect our business.
We are not aware of any currently pending claims that our products, trademarks
or other proprietary rights infringe upon the proprietary rights of third
parties.

Securities litigation.

As outlined below in Part II, Item 1, after the restatement of our first quarter
2000 earnings and the adjustment to previously disclosed second quarter 2000
results, the Company was named in a series of similar purported securities class
action lawsuits. These lawsuits have now been consolidated into one matter. The
amended complaint in the consolidated matter alleges violations of United States
federal securities law through alleged material misrepresentations and omissions
and seeks an unspecified award of damages. We believe that the allegations in
the amended complaint are without merit, and we intend to contest them
vigorously. However, there can be no guarantee as to the ultimate outcome of
this pending litigation matter.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

In the ordinary course of operations, our financial position and cash flows are
subject to a variety of risks, which include market risks associated with
changes in foreign currency exchange rates and movement in interest rates. We do
not, in the normal course of business, use derivative financial instruments for
trading or speculative purposes. Uncertainties that are either non-financial or
non-quantifiable, such as political, economic, tax, other regulatory or credit
risks are not included in the following assessment of our market risks.

Foreign Currency Exchange Rates

Operations outside of the U.S. expose us to foreign currency exchange rate
changes and could impact translations of foreign denominated assets and
liabilities into U.S. dollars and future earnings and cash flows from
transactions denominated in different currencies. During the quarter ended
September 30, 2001, 35% of our total revenue was generated from our
international operations, and the net assets of our foreign subsidiaries totaled
approximately 69% of consolidated net assets as of September 30, 2001. Our
exposure to currency exchange rate changes is diversified due to the number of
different countries in which we conduct business. We operate outside the U.S.
primarily through wholly owned subsidiaries in the United Kingdom, France,
Germany, Sweden, Singapore, Hong Kong, and Australia. These foreign subsidiaries
use local currencies as their functional currency, as certain sales are
generated and expenses are incurred in such currencies. Foreign currency gains
and losses will continue to result from fluctuations in the value of the
currencies in which we conduct our operations as compared to the U.S. dollar. We
do not believe that possible near-term changes in exchange rates will result in
a material effect on our future earnings or cash flows and, therefore, have
chosen not to enter into foreign currency hedging instruments. There can be no
assurance that this approach will be successful, especially in the event of a
sudden and significant decline in the value of foreign currencies relative to
the United States dollar.

Interest Rates

We invest our cash in a variety of financial instruments, consisting principally
of investments in commercial paper, interest-bearing demand deposit accounts
with financial institutions, money market funds and highly liquid debt
securities of corporations, municipalities and the U.S. Government. These
investments are denominated in U.S. dollars. Cash balances in foreign currencies
overseas are operating balances and are only invested in short-term deposits of
the local operating bank.

We classify our investment instruments as available-for-sale in accordance with
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities", (SFAS No. 115). Investments in both
fixed rate and floating rate interest earning instruments carry a degree of
interest rate risk. Changes in interest rates could impact our anticipated
interest income or could impact the fair market value of our investments.
However, we believe these changes in interest rates will not cause a material
impact on our financial position, results of operations or cash flows.

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On or about February 1, 2000, Mercator was named as a defendant and served with
a complaint in an action entitled Carpet Co-Op of America Association, Inc., and
FloorLINK, L.L.C. v. TSI International Software, Ltd., Civil Action No. 00CC-
0231, pending in the Circuit Court of St. Louis County, Missouri (the "Missouri
Action"). The complaint includes counts for breach of contract, fraud and
negligent misrepresentation in connection with certain software implementation
work provided under contract by Mercator. The plaintiffs allege that Mercator
failed to provide and implement certain software products and designs within an
alleged time requirement and misrepresented Mercator's ability to implement the
products within that timeframe. The complaint seeks an unspecified damage amount
in excess of $2 million. On or about March 30, 2000, plaintiffs in the Missouri
Action filed an amended complaint adding a claim of negligence in connection
with the contract. On April 10, 2000, Mercator filed a motion to dismiss the
Missouri Action in its entirety, which was denied. Mercator denies liability and
on March 30, 2000, Mercator filed an action entitled TSI International Software,
Ltd. (d/b/a Mercator Software Inc.) v. Carpet Co-op of America Association, Inc.
and FloorLink, LLC, Civil Action No. 300-CV-603 (SRU), in the United States
District Court for the District of Connecticut (the "Connecticut Action"). The
Connecticut Action asserts claims for copyright infringement, trademark
infringement, unfair competition, misappropriation of trade secrets, breach of
contract, fraud, unjust enrichment and violation of the Connecticut Unfair Trade
Practices Act, in connection with the software implementation project at issue
in the Missouri Action. The Mercator complaint in the Connecticut Action alleges
that the defendants have failed to pay the more than $1.7 million still owed to
Mercator under the contract, and that, during the course of the project, the
defendants fraudulently misappropriated certain of Mercator's copyrighted
software, trademarks and other software implementation related secrets. On May
9, 2000, the court in the Connecticut Action entered a Stipulated Injunction
barring the defendants from using, copying or disclosing any of Mercator's
copyrighted software, trademarks or other trade secrets or proprietary
information. On May 12, 2000, the defendants filed a motion to dismiss the
Connecticut Action. On December 15, 2000, the court in

the Connecticut Action denied the defendants' motion to dismiss insofar as it
related to Mercator's federal claims and, on March 21, 2001, the Connecticut
Court denied the motion to dismiss as to the state law claims. On April 4, 2001,
defendants filed an answer to Mercator's complaint along with counterclaims
asserting substantially the same claims as those asserted in the Missouri
Action. On May 1, 2001, Mercator filed a motion to dismiss defendants'
counterclaims for fraud, negligent misrepresentation, and negligence and to
strike defendants' prayers for consequential and punitive damages. The
Connecticut Court denied this motion. Mercator believes that the allegations in
defendants' counterclaims are without merit and intends to contest them
vigorously.

Between August 23, 2000 and September 21, 2000 a series of fourteen purported
securities class action lawsuits was filed in the United States District Court
for the District of Connecticut, naming as defendants Mercator, Constance Galley
and Ira Gerard. Kevin McKay was also named as a defendant in nine of these
complaints. On or about November 24, 2000, these lawsuits were consolidated into
one lawsuit captioned: In re Mercator Software, Inc. Securities Litigation,
Master File No. 3:00-CV-1610 (GLG). The lead plaintiffs purport to represent a
class of all persons who purchased Mercator's common stock from April 20, 2000
through and including August 21, 2000. Each complaint in the consolidated action
alleges violations of Section 10(b) and Rule 10b-5 through alleged material
misrepresentations and omissions and seeks an unspecified award of damages. On
January 26, 2001 the lead plaintiffs filed an amended complaint in the
consolidated matter with substantially the same allegations. Named as defendants
in the amended complaint are Mercator, Constance Galley and Ira Gerard. The
amended complaint in the consolidated action alleges violations of Section 10(b)
and Rule 10b-5 through alleged material misrepresentations and omissions and
seeks an unspecified award of damages. Mercator filed a motion to dismiss the
amended complaint on March 12, 2001. The lead plaintiffs filed an opposition to
Mercator's motion to dismiss on or about April 18, 2001, and Mercator filed its
reply brief on May 7, 2001. The Court heard oral argument on the motion to
dismiss on July 6, 2001. On September 13, 2001, the Court denied Mercator's
motion to dismiss. Mercator believes that the allegations in the amended
complaint are without merit and intends to contest them vigorously.

The company has been named as a defendant in an action filed on August 3, 2001
in the United States District Court for the Eastern District of Pennsylvania,
entitled Ulrich Neubert v. Mercator Software, Inc., f/k/a TSI International
Software, Ltd., Civil Action No. 01-CV-3961. The complaint alleges claims of
breach of contract, breach of the implied covenant of good faith and fair
dealing, breach of fiduciary duty, and fraud in connection with the Company's
acquisition of Software Consulting Partners ("SCP") in November 1998. Neubert,
who was the sole shareholder of SCP prior to November 1998, seeks purported
damages of up to approximately $7.5 million, plus punitive damages and
attorney's fees. The complaint has not yet been served. The Company believes
that the allegations in the complaint are without merit and intends to contest
the lawsuit vigorously.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

In January 2001 the Company issued for fair market value 228,180 shares of its
restricted common stock, $.01 par value, to Mitsui & Co., Ltd. for $2.0 million
in cash. In May 2001 the Company incurred an advisory fee of $365,000 to a third
party in connection with this restricted stock sale. The total advisory fee was
charged against additional paid-in capital to reflect the reduction in proceeds
from the restricted stock sale.

tendered and cancelled, one new option will be issued. The new options
will be granted no earlier than six months and one day after the cancellation
and the exercise price of the new options will be the fair market value of the
Company's common stock on the date of grant. The offer expired on October 19,
2001 and the Company accepted for cancellation options to purchase an aggregate
of 1,100,062 shares from 239 option holders who participated.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

a. List of Exhibits

Exhibit Description of Exhibit
------- ----------------------

10.1 1997 Equity Incentive Plan, as amended

10.2 Agreement between the Registrant and David Linthicum, dated as of
March 12, 2001

10.3 Agreement between the Registrant and Eileen Garry dated as of May
25, 2001

10.4 Agreement between the Registrant and Ron Smith dated as of May 31,
2001

10.5 Agreement between the Registrant and Robert J. Farrell dated as of
June 13, 2001

10.6 Agreement between the Registrant and Kenneth J. Hall dated as of
June 28, 2001

10.7 Agreement between the Registrant and Gregory G. O'Brien dated as of
July 11, 2001

10.8 Agreement between the Registrant and Michael Wheeler dated as of
August 16, 2001

10.9 Employment Agreement between the Registrant and Jill Donohoe dated
as of September 13, 2001

10.10 Agreement between the Registrant and Mark Register dated as of
September 18, 2001

10.11 Letter Agreement between the Registrant and Richard Applegate dated
as of July 12, 2001

10.12 Separation and Release Agreement between the Registrant and Saydean
Zeldin dated as of March 13, 2001

b. Reports on Form 8-K

1. Current Report on Form 8-K, filed October 1, 2001 announcing date
extension of funding requirement between Registrant and credit facility
lender.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

MERCATOR SOFTWARE, INC.

Dated: November 14, 2001 By: /s/ Roy C. King
---------------

Chairman, Chief Executive
Officer and President

Dated: November 14, 2001 By: /s/ Kenneth J. Hall
-------------------

Senior Vice-President, Chief
Financial Officer and Treasurer

EXHIBIT INDEX

a. List of Exhibits

Exhibit Description of Exhibit
------ ----------------------

10.1 1997 Equity Incentive Plan, as amended

10.2 Agreement between the Registrant and David Linthicum, dated as of
March 12, 2001

10.3 Agreement between the Registrant and Eileen Garry dated as of May
25, 2001

10.4 Agreement between the Registrant and Ron Smith dated as of May 31,
2001

10.5 Agreement between the Registrant and Robert J. Farrell dated as of
June 13, 2001

10.6 Agreement between the Registrant and Kenneth J. Hall dated as of
June 28, 2001

10.7 Agreement between the Registrant and Gregory G. O'Brien dated as of
July 11, 2001

10.8 Agreement between the Registrant and Michael Wheeler dated as of
August 16, 2001

10.9 Agreement between the Registrant and Jill Donohoe dated as of
September 13, 2001

10.10 Agreement between the Registrant and Mark Register dated as of
September 18, 2001

10.11 Letter Agreement between the Registrant and Richard Applegate dated
as of July 12, 2001

10.12 Separation and Release Agreement between the Registrant and Saydean
Zeldin dated as of March 13, 2001

b. Reports on Form 8-K

1. Current Report on Form 8-K, filed October 1, 2001 announcing date
extension of funding requirement between Registrant and credit facility
lender.