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 June 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 July 31, 2001, Registrant had 30,386,592 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 June 30, 2001 (unaudited)
and December 31, 2000 3

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

Consolidated Condensed Statements of Cash Flows for the Six
Months Ended June 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 10

ITEM 3 Quantitative and Qualitative Disclosures About Market Risk 24

PART II OTHER INFORMATION

ITEM 1 Legal Proceedings 25

ITEM 2 Changes in Securities and Use of Proceeds 25

ITEM 4 Submission Of Matters To Vote Of Security Holders 26

ITEM 6 Exhibits and Reports on Form 8-K 27

SIGNATURES 28

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

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

ASSETS:
Current assets:
Cash and cash equivalents $ 6,158 $ 18,327
Marketable securities -- 3,420
Accounts receivable, less allowances of $4,340 and $3,616 30,148 38,920
Prepaid expenses and other current assets 4,878 3,626
Deferred tax assets 77 3,181
--------- ---------
Total current assets 41,261 67,474

Furniture, fixtures and equipment, net 10,959 10,007
Intangible assets, net 67,689 81,578
Restricted collateral deposits and other assets 3,350 1,832
--------- ---------
Total assets $ 123,259 $ 160,891
========= =========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 8,185 $ 6,706
Accrued expenses and other current liabilities 17,125 19,532
Current portion of deferred revenue 21,011 17,825
--------- ---------
Total current liabilities 46,321 44,063

Long-term deferred tax liability 2,377 3,777
Deferred revenue, less current portion 1,329 976
Other long term liabilities 2,472 669
--------- ---------
Total liabilities 52,499 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 30,379,092
shares and 29,846,902 shares 304 298
Additional paid-in capital 231,963 228,035
Accumulated deficit (158,111) (114,760)
Accumulated other comprehensive loss (3,152) (1,761)
Deferred compensation (244) (406)
--------- ---------
Total stockholders' equity 70,760 111,406
--------- ---------

Total liabilities and stockholders' equity $ 123,259 $ 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 Six Months Ended
June 30, June 30,
-------------------- --------------------
2001 2000 2001 2000
-------- -------- -------- --------

Revenues:
Software licensing $ 13,009 $ 20,397 $ 24,531 $ 38,704
Services 7,613 8,916 16,279 15,513
Maintenance 8,540 6,383 16,486 12,731
-------- -------- -------- --------
Total revenues 29,162 35,696 57,296 66,948
-------- -------- -------- --------

Cost of revenues:
Software licensing 364 368 601 653
Services 6,505 5,866 13,878 11,390
Maintenance 1,852 1,465 3,641 3,068
-------- -------- -------- --------
Total cost of revenues 8,721 7,699 18,120 15,111
-------- -------- -------- --------

Gross profit 20,441 27,997 39,176 51,837

Operating expenses:
Product development 5,324 5,120 10,570 10,209
Selling and marketing 17,143 17,378 33,951 31,160
General and administrative 7,933 4,832 16,529 8,362
Amortization of intangibles 6,945 12,251 13,889 23,228
Restructuring charge 5,318 -- 5,318 --
-------- -------- -------- --------
Total operating expenses 42,663 39,581 80,257 72,959
-------- -------- -------- --------

Operating loss (22,222) (11,584) (41,081) (21,122)

Other income, net 114 139 152 294
-------- -------- -------- --------

Loss before income taxes (22,108) (11,445) (40,929) (20,828)

Provision for income taxes 555 6,343 2,422 8,457
-------- -------- -------- --------

Net loss $(22,663) $(17,788) $(43,351) $(29,285)
======== ======== ======== ========

Net loss per share-Basic and Diluted $ (0.75) $ (0.61) $ (1.44) $ (1.02)
Weighted average number of common and common
equivalent shares outstanding:
Basic and Diluted 30,288 29,100 30,118 28,653

See accompanying notes to consolidated condensed financial statements.

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

Six Months Six Months
Ended Ended
June 30, 2001 June 30, 2000
------------- -------------

Cash flows from operating activities:
Net cash (used in) provided by operating activities $(11,463) $ 3,013

Cash flows from investing activities:
Purchase of furniture, fixtures and equipment (3,909) (3,325)
Sales of marketable securities 3,420 1,403
Restricted collateral deposits and other (1,480) (155)
-------- --------
Net cash used in investing activities (1,969) (2,077)
-------- --------

Cash flows from financing activities:
Payments under capital leases (224) --
Proceeds from exercise of stock options 199 2,685
Proceeds from issuance of stock under Employee Stock Purchase Plan 1,374 1,191
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 3,151 3,876
-------- --------

Effect of exchange rate changes on cash and cash equivalents (1,888) (821)
-------- --------

Net change in cash (12,169) 3,991
Cash at the beginning of period 18,327 9,237
-------- --------

Cash at end of period $ 6,158 $ 13,228
======== ========

Supplemental information:
Cash paid for:
Interest $112 $29
Income taxes $65 $659

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. 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.

On May 17, 2001, the Equity Incentive Stock Option plan was amended to increase
the number of options Mercator may grant to its employees from 6,700,000 to
9,700,000 shares.

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 fee will be amortized to
operations over the one year term of the secured credit facility agreement.

In June 2001 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. This warrant expires
in June 2004.

In June 2001 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 from a third party incurred and recorded in December 2000. This
warrant expires in December 2002.

(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. 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 ($23.6 million)
and ($18.5 million) for the three months ended June 30, 2001 and 2000,
respectively, and ($44.7 million) and ($30.7 million) for the six months ended
June 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 100,157 and 3,160,541 for the three months ended June 30, 2001
and 2000, respectively, and 661,039 and 3,676,956 for the six months ended June
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 quarter of 2001, the Company restructured its operations to
strategically align its personnel with its product and market strengths.
Consequently, the Company incurred a restructuring charge of $5.3 million, which
consists of $2.9 million to accrue for losses related to leased space no longer
required due to the reduction in the workforce and $2.4 million in
severance-related costs. The Company announced that the restructuring eliminated
170 full-time positions in sales, marketing, development, services and
administration. 168 of these employees were terminated as of April 30, 2001.
During the second quarter of 2001, $1.1 million of severance benefits were paid
and charged against the restructuring liability. At June 30, 2001 $2.6 million
of the unpaid restructuring charge was included in accrued expenses and other
current liabilities and $1.6 million was included in other long-term
liabilities.

(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. 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 issuing
either equity or subordinated debt resulting in net proceeds to the Company of
at least $5.0 million by September 30, 2001. Accordingly, the Company has
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 will be amortized as
interest expense over the one year term of the facility. As of August 14, 2001
the Company has not had to borrow 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 Six Months Ended
June 30, June 30,
-------------------- --------------------
2001 2000 2001 2000
-------- -------- -------- --------

Revenue:
Americas $ 19,629 $ 22,092 $ 35,681 $ 41,108
EMEA 8,347 12,315 19,619 23,460
APAC 1,186 1,289 1,996 2,380
-------- -------- -------- --------
Total $ 29,162 $ 35,696 $ 57,296 $ 66,948
======== ======== ======== ========

Operating income (loss) before amortization of intangibles:
Americas (including corporate) $(11,294) $ (1,640) $(21,327) $ (1,908)
EMEA (3,933) 1,842 (5,286) 3,317
APAC (50) 465 (579) 697
-------- -------- -------- --------
Total (15,277) 667 (27,192) 2,106
Amortization of intangibles (6,945) (12,251) (13,889) (23,228)
Other income, net 114 139 152 294
Provision for income taxes 555 6,343 2,422 8,457
-------- -------- -------- --------

Net loss $(22,663) $(17,788) $(43,351) $(29,285)
======== ======== ======== ========

Total assets: As of June 30,
--------------
2001 2000
-------- --------
Americas $ 33,676 $ 97,115
EMEA 87,225 129,939
APAC 2,358 2,382
-------- --------
$123,259 $229,436
======== ========

(9) INCOME TAXES

During the second quarter of 2001, the Company determined that taxable income
for the full year of 2001 is unlikely to be sufficient to support the full value
of the U.S. federal deferred tax assets. As a result, for the quarter ended June
30, 2001, a full valuation allowance was established on the U.S. federal
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. See Item 1 in Part
II of this filing for further information.

(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 June 30, 2001.

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 focused on integration of
processes and systems with customers, suppliers, distributors and trading
partners, (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 current quarter and 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 $3.0 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 Six Months Ended
June 30, June 30,
------------------ ----------------
2001 2000 2001 2000
----- ----- ----- -----

Revenues:
Software licensing 44.6% 57.1% 42.8% 57.8%
Services 26.1 25.0 28.4 23.2
Maintenance 29.3 17.9 28.8 19.0
----- ----- ----- -----
Total revenues 100.0 100.0 100.0 100.0
----- ----- ----- -----

Cost of revenues:
Software licensing 1.2 1.0 1.0 1.0
Services 22.3 16.4 24.2 17.0
Maintenance 6.4 4.2 6.4 4.6
----- ----- ----- -----
Total cost of revenues 29.9 21.6 31.6 22.6
----- ----- ----- -----

Gross profit 70.1 78.4 68.4 77.4
----- ----- ----- -----

Operating expenses:
Product development 18.3 14.3 18.4 15.2
Selling and marketing 58.8 48.7 59.2 46.5
General and administrative 27.2 13.6 28.8 12.5
Amortization of intangibles 23.8 34.3 24.2 34.7
Restructuring charge 18.2 -- 9.3 --
----- ----- ----- -----
Total operating expenses 146.3 110.9 139.9 108.9
----- ----- ----- -----

Operating loss (76.2) (32.5) (71.5) (31.5)
Other income, net .4 .4 .3 .4
----- ----- ----- -----

Loss before income taxes (75.8) (32.1) (71.2) (31.1)
Provision for income taxes 1.9 17.8 4.2 12.6
----- ----- ----- -----

Net Loss (77.7)% (49.9)% (75.4)% (43.7)%
===== ===== ===== =====

Gross profit (as percent of related revenue):
Software licensing 97.2% 98.2% 97.6% 98.3%
Services 14.6% 34.2% 14.7% 26.6%
Maintenance 78.3% 77.0% 77.9% 75.9%

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

During the second quarter of 2001 we incurred a net (loss) of ($22.7 million)
compared to a net (loss) of ($17.8 million) in the second quarter of 2000.
Second quarter operating (loss) was ($22.2 million) in 2001 compared to ($11.6
million) in the same period of 2000. Our second quarter operating income (loss)
excluding amortization of intangibles and a restructuring charge was ($10.0
million) in 2001 compared to $0.7 million in the second quarter of 2000. This
$10.7 million decrease was the result of a $7.6 million decrease in gross profit
and increased general and administrative expenses of $3.1 million. The decline
in gross profit was primarily due to a $7.4 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 decline beginning in the fourth
quarter of 2001. The restructuring charge was incurred in connection with our
efforts in the second quarter 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 18% to $29.2 million in the second quarter of 2001 from
$35.7 million in the same period in 2000. However, second quarter 2001 revenues
increased $1.1 million from $28.1 million in the first quarter of 2001.

Software Licensing. Total software licensing revenues decreased 36% from $20.4
million for the three months ended June 30, 2000 to $13.0 million for the three
months ended June 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 25%
from $13.2 million to $9.9 million, EMEA licensing revenues decreased 60% from
$6.2 million to $2.5 million and APAC licensing revenues decreased 27% from
$928,000 to $673,000.

Services. Services revenues decreased 15% from $8.9 million for the three months
ended June 30, 2000 to $7.6 million for the three months ended June 30, 2001
primarily due to reduced service opportunities in connection with the lower
level of software licensing revenues. Americas' services revenues decreased 14%
from $5.0 million to $4.3 million, EMEA services revenues decreased 17% from
$3.8 million to $3.1 million and APAC services revenues increased 14% from
$186,000 to $212,000.

Maintenance. Maintenance revenues increased 34% from $6.4 million for the three
months ended June 30, 2000 to $8.5 million for the three months ended June 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 42% from $3.9 million to $5.5 million, EMEA maintenance
revenues increased 18% from $2.3 million to $2.7 million and APAC maintenance
revenues increased 73% from $174,000 to $301,000.

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 1% from
$368,000 for the three months ended June 30, 2000 to $364,000 for the three
months ended June 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
declined marginally from 98% for the three months ended June 30, 2000 to 97% for
the three months ended June 30, 2001.

Cost of Services. Total cost of services increased 11% from $5.9 million for the
three months ended June 30, 2000 to $6.5 million for the three months ended June
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 current quarter. However, as these cost
reductions may not take full effect until the third quarter, total services
gross margin decreased from 34% for the three months ended June 30, 2000 to 15%
for the three months

ended June 30, 2001. Services gross margin for Americas decreased from 35% to 6%
due primarily to the redeployment of technical staff to the services department,
related training costs and lower productivity rates. Services gross margin for
EMEA decreased from 36% to 29% primarily due to reduced billable work
assignments. Services gross margin for APAC decreased from (16%) to (30%) due
primarily to the addition of services personnel in advance of billable work
assignments.

Cost of Maintenance. Total cost of maintenance increased 26% from $1.5 million
for the three months ended June 30, 2000 to $1.9 million for the three months
ended June 30, 2001 as we added resources to support our increased customer base
worldwide. Total maintenance gross margin increased marginally from 77% for the
three months ended June 30, 2000 to 78% for the three months ended June 30,
2001. Maintenance gross margin increased from 73% to 80% in the Americas,
decreased from 82% to 76% in EMEA and decreased from 99% to 61% in APAC.

OPERATING EXPENSES

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 increased 4% from $5.1 million for the three
months ended June 30, 2000 to $5.3 million for the three months ended June 30,
2001. Americas' development expenses increased 5% from $3.7 million to $3.9
million, EMEA development expenses remained flat at $1.4 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 should continue to increase. 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 marginally from $17.4 million for
the three months ended June 30, 2000 to $17.1 million for the three months ended
June 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 18% from $12.0 million to
$9.9 million primarily due to a reduced sales force and lower commission expense
related to lower revenues. EMEA selling and marketing expenses increased 35%
from $5.1 million to $6.9 million despite lower revenues due to market expansion
activities in continental Europe. APAC selling and marketing expenses increased
70% from $202,000 to $343,000 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 increased 64% from $4.8 million for
the three months ended June 30, 2000 to $7.9 million for the three months ended
June 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
92% from $3.5 million to $6.8 million, EMEA general and administrative expenses
decreased 30% from $1.0 million to $0.7 million and APAC general and
administrative expenses increased 48% from $294,000 to $435,000.

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 $12.3 million for the three months ended
June 30, 2000 to $6.9 million for the three months ended June 30, 2001, as a
result of the intangible impairment charge we recorded in the fourth quarter of
2000. As of June 30, 2001 Mercator had net intangible assets of $67.7 million as
compared to $147.0 million one year ago.

Restructuring Charge. The restructuring charge of $5.3 million for the three
months ending June 30, 2001 consists of $2.4 million in severance-related costs
and $2.9 million to accrue for losses related to leased space no longer required
due to a reduction in our workforce on April 30, 2001. The Americas
restructuring charge was $5.0 million and the EMEA restructuring charge was $0.3
million. At June 30, 2001 $2.6 million of the unpaid restructuring charge was
included in accrued expenses and other current liabilities and $1.6 million was
included in other long-term liabilities.

OTHER INCOME, NET

Total net interest income decreased from $139,000 for the three months ended
June 30, 2000 to $114,000 for the three months ended June 30, 2001, primarily
due to the use of cash to fund operating losses, including the expansion of
worldwide operations, and the subsequent reduction of interest bearing
investments.

TAXES

The provision for income taxes was $0.6 million for the three months ended June
30, 2001 as compared to $6.3 million for the three months ended June 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. 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 federal deferred tax asset. Consequently, our 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 $6.0 million of non-deductible goodwill amortization
and the effect of certain expected full-year foreign taxable losses for the
quarter ended June 30, 2001 and $9.8 million of non-deductible goodwill
amortization for the quarter ended June 30, 2000.

SIX MONTHS ENDED JUNE 30, 2001 COMPARED WITH SIX MONTHS ENDED JUNE 30, 2000

During the first six months of 2001 we incurred a net (loss) of ($43.4 million)
compared to a net (loss) of ($29.3 million) in the first six months of 2000. The
first six months operating (loss) was ($41.1 million) in 2001 compared to ($21.1
million) in the same period of 2000. Our first six months operating income
(loss) excluding amortization of intangibles and a restructuring charge was
($21.9 million) in 2001 compared to $2.1 million in the same period of 2000.
This $24.0 million decrease was primarily the result of a $12.6 million decrease
in gross profit and increased general and administrative expenses of $8.2
million. The decline in gross profit was primarily due to a $14.2 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 decline
beginning in the fourth quarter of 2001. The restructuring charge was incurred
in connection with our efforts in the second quarter 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 14% to $57.3 million in the first six months of 2001
from $66.9 million in the same period of 2000.

Software Licensing. Total software licensing revenues decreased 37% from $39.7
million for the six months ended June 30, 2000 to $24.5 million for the six
months ended June 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 33%
from $24.6 million to $16.5 million, EMEA licensing revenues decreased 43% from
$12.5 million to $7.1 million and APAC licensing revenues decreased 43% from
$1.7 million to $0.9 million.

Services. Services revenues increased 5% from $15.5 million for the six months
ended June 30, 2000 to $16.3 million for the six months ended June 30, 2001.
This increase was due primarily to greater billable activities in the first
quarter of 2001 partially offset by lower services opportunities in the second
quarter of 2001. Americas' services revenues decreased marginally from $8.7
million to $8.6 million, EMEA services revenues increased 11% from $6.4 million
to $7.1 million and APAC services revenues increased 50% from $327,000 to
$489,000.

Maintenance. Maintenance revenues increased 29% from $12.7 million for the six
months ended June 30, 2000 to $16.5 million for the six months ended June 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 $7.8 million to $10.6 million,

EMEA maintenance revenues increased 18% from $4.5 million to $5.3 million and
APAC maintenance revenues increased 43% from $394,000 to $565,000.

COST OF REVENUES

Cost of Software Licensing. Total software licensing costs decreased 8% from
$653,000 for the six months ended June 30, 2000 to $601,000 for the six months
ended June 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 six months ended June 30, 2000 and 2001.

Cost of Services. Total cost of services increased 22% from $11.4 million for
the six months ended June 30, 2000 to $13.9 million for the six months ended
June 30, 2001 outpacing the 5% increase in services revenues previously noted.
This increase was primarily due to a higher services headcount this year
compared to last year. Consequently, total services gross margin decreased from
27% for the six months ended June 30, 2000 to 15% for the six months ended June
30, 2001. As part of the restructuring activities in the current quarter, we
have reduced the number of services personnel. Services gross margin for
Americas decreased from 27% to 5%. Services gross margin for EMEA increased from
27% to 30% due to increased utilization in the first quarter of 2001 partially
offset by reduced billable work assignments in the second quarter of 2001.
Services gross margin for APAC decreased from (8%) to (35%) due primarily to the
addition of services personnel in advance of billable work assignments.

Cost of Maintenance. Total cost of maintenance increased 19% from $3.1 million
for the six months ended June 30, 2000 to $3.6 million for the six months ended
June 30, 2001 as we added resources to support our increased customer base
worldwide. Total maintenance gross margin increased marginally from 76% for the
six months ended June 30, 2000 to 78% for the six months ended June 30, 2001.
Maintenance gross margin increased from 73% to 80% in the Americas, decreased
from 81% to 75% in EMEA and decreased from 79% to 73% in APAC.

OPERATING EXPENSES

Total product development expenses increased 4% from $10.2 million for the six
months ended June 30, 2000 to $10.6 million for the six months ended June 30,
2001. Americas' development expenses increased 8% from $7.0 million to $7.5
million. EMEA development expenses decreased marginally from $3.1 million to
$3.0 million and APAC had no development expenses in either year.

Total selling and marketing expenses increased 9% from $31.1 million for the six
months ended June 30, 2000 to $34.0 million for the six months ended June 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 quarter of 2001 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 5%
from $21.3 million to $20.3 million primarily due to a reduced sales force and
lower commission expense related to lower revenues. EMEA selling and marketing
expenses increased 43% from $9.1 million to $12.9 million despite lower revenues
due to market expansion activities in continental Europe. APAC selling and
marketing expenses increased 40% from $546,000 to $763,000 as a result of market
expansion activities.

Total general and administrative expenses increased 98% from $8.4 million for
the six months ended June 30, 2000 to $16.5 million for the six months ended
June 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
122% from $6.0 million to $13.4 million, EMEA general and administrative
expenses remained flat at $2.2 million and APAC general and administrative
expenses increased 99% from $442,000 to $881,000.

Amortization expense decreased from $23.2 million for the six months ended June
30, 2000 to $13.9 million for the six months ended June 30, 2001, as a result of
the intangible impairment charge we recorded in the fourth quarter of 2000. As
of June 30, 2001 Mercator had net intangible assets of $67.7 million as compared
to $147.0 million one year ago.

Restructuring Charge. The restructuring charge of $5.3 million for the six
months ending June 30, 2001 consists of $2.4 million in severance-related costs
and $2.9 million to accrue for losses related to leased space no longer required
due to a reduction in our workforce on April 30, 2001. The Americas
restructuring charge was $5.0 million and the EMEA restructuring charge was $0.3
million. At June 30, 2001 $2.6 million of the unpaid restructuring charge was
included in accrued expenses and other current liabilities and $1.6 million was
included in other long-term liabilities.

OTHER INCOME, NET

Total net interest income decreased from $294,000 for the six months ended June
30, 2000 to $152,000 for the six months ended June 30, 2001, primarily 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.

TAXES

The provision for income taxes was $2.4 million for the six months ended June
30, 2001 as compared to $8.5 million for the six months ended June 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. 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 federal deferred tax asset. Consequently, our 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 $12 million of non-deductible goodwill amortization
and the effect of certain expected full-year foreign taxable losses for the six
months ended June 30, 2001 and $19 million of non-deductible goodwill
amortization for the six months ended June 30, 2000.

LIQUIDITY AND CAPITAL RESOURCES

Working Capital. On June 30, 2001 we had cash of $6.2 million and a net working
capital deficit of ($5.1 million).

Net working capital at December 31, 2000 was $23.4 million including cash and
marketable securities of $21.7 million. The $28 million decrease in working
capital was caused primarily by a $16 million decrease in cash and marketable
securities and a $9 million decrease in net accounts receivable.

Net accounts receivable decreased from $38.9 million at December 31, 2000 to
$30.1 million at June 30, 2001 due primarily to a $10 million decrease in
revenues between the quarters then ended and improved collections, partially
offset by a $3.5 million increase in deferred revenue. The number of days sales
in net accounts receivable increased from 89 at December 31, 2000 to 93 at June
30, 2001 due primarily to the decrease in revenues between the quarters then
ended. However, the number of days sales in net accounts receivable of 93 at
June 30, 2001 was down from 107 at March 31, 2001 due primarily to increased
collections in the Americas and higher reserves for bad debts due to the
softening of general economic conditions overseas.

Operating activities used net cash of $11.5 million during the six months ended
June 30, 2001 compared to providing net cash of $3.0 million during the six
months ended June 30, 2000. Of the $43 million net loss for the six months ended
June 30, 2001, $19 million resulted from non-cash expenses, primarily
intangibles amortization and depreciation. The cash used to fund the remaining
$24 million loss was offset primarily by cash provided from an $8 million
decrease in net accounts receivable and a $4 million increase in deferred
revenue. For the six months ended June 30, 2000 the net loss of $29 million was
caused primarily by $25 million of intangibles amortization and depreciation and
an $8 million tax provision, neither of which consumed any cash.

On April 30, 2001 we initiated a strategic restructuring and reorganization,
which eliminated 170 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 $2.4
million in severance costs for the quarter ending June 30, 2001. In addition, we
accrued $2.9 million in losses related to leased space no longer required due to
this reduction in our workforce.

Investing Activities. Investing activities consumed cash of $2.0 million during
the six months ended June 30, 2001 compared to $2.1 million during the six
months ended June 30, 2000. Investing activities in the first six months of 2001
included a $3.9 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 six months of 2000
included a $3.3 million investment in furniture, fixtures and equipment offset
by a $1.4 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 June 30, 2001 we had no material commitments for
capital expenditures.

Financing Activities. Financing activities generated cash of $3.2 million during
the six months ended June 30, 2001 compared to $3.9 million during the six
months ended June 30, 2000. Financing activities in the first six months of 2001
generated cash of $1.6 million from a sale of restricted common stock and $1.4
million from employee stock plan purchases. Financing activities in the first
six months of 2000 generated cash of $2.7 million from employee stock option
exercises and $1.2 million from employee stock plan purchases.

In March 2001 the $20 million line of credit agreement with Fleet Bank was
terminated. Since inception no amounts were borrowed under this agreement.

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. As of August 14, 2001 we have not had to borrow against this
facility. The facility requires us to issue either equity or subordinated debt
resulting in net proceeds to the Company of at least $5.0 million by September
30, 2001. Accordingly, we have engaged an investment banker to help us
accomplish this capitalization event.

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 by December 31, 2001. However,
recognizing there could be a shortfall in cash during the remainder of the year,
we have established the credit facility with Silicon Valley Bank. We are also
exploring other financial alternatives to support growth opportunities and other
needs that may exceed cash resources available from operations and the credit
facility, and to fulfill the requirement of 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 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.

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 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 and second 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 the
recent 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 in the
face of decreased revenues due to decreased customer orders. 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 August 2000. 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 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 and second 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, we could experience difficulties in developing, on a
timely basis, product enhancements which address the increased number of new
versions of applications, systems or platforms served by our existing products.
If we fail, for technological or other reasons, to develop and introduce product
enhancements or new products in a timely and cost-effective manner or if we
experience any significant 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 value-added resellers, independent software vendors, systems
integrators and distributors. This channel is accounting for a growing
percentage of our total revenues and we are increasing resources dedicated to
developing and expanding these indirect distribution channels. We may not be
successful in expanding the number of indirect distribution channels for our
products. If we are successful in increasing our sales through indirect sales
channels, we expect that those sales will be at lower per unit prices than sales
through direct channels, and revenue we receive for each sale will be less than
if we had licensed the same product to the customer directly.

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

Even if we successfully expand our indirect distribution channels, any new value
added resellers, independent software vendors, system integrators or
distributors may offer competing products, or have no minimum purchase
requirements of our products. These third parties may also not have the
technical expertise required to market and support our products successfully. If
the third parties do not provide adequate levels of services and technical
support, our customers could become dissatisfied, 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 38% of our
total revenues in the first six 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 recently been
sponsored in both the House and Senate that are designed to regulate certain
aspects of the internet, including on-line content, copyright infringement, user
privacy, taxation, access charges, liability for third-party activities and
jurisdiction. In addition, federal, state, local and foreign governmental
organizations are also considering other legislative and regulatory proposals
that would regulate the internet. Areas of potential regulation include libel,
pricing, quality of products and services, and intellectual property ownership.
The laws governing the use of the internet, in general, remain largely
unsettled, even in areas where there has been some legislative action. It may
take years to determine whether and how existing laws such as those governing
intellectual property, privacy, libel and taxation apply to the internet. In
addition, the growth and development of the market for online commerce may
prompt calls for more stringent consumer protection laws, both in the United
States and abroad. This occurrence may impose additional burdens on companies
conducting business online by limiting how information can flow over the
internet and the type of information that can flow over the internet. The
adoption or modification of laws or regulations relating to the internet could
adversely affect our business.

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

Capacity constraints caused by growth in the use of the internet may, unless
resolved, impede further development of the internet to the extent that users
experience delays, transmission errors and other difficulties. Further, the
adoption of the internet for commerce and communications, particularly by those
individuals and companies that have historically relied upon alternative means
of commerce and communication, generally requires the understanding and
acceptance of a new way of conducting business and exchanging information. In
particular, companies that have already invested substantial resources in other
means of conducting commerce and exchanging information may be particularly
reluctant or slow to adopt a new internet-based strategy that may make their
existing personnel and infrastructure obsolete. If the necessary infrastructure,
products, services or facilities

are not developed, or if the internet does not become a viable commercial
medium, our business, results of operations and financial condition could be
materially and adversely affected.

The United States Omnibus Appropriations Act of 1998 places a moratorium on
taxes levied on internet access from October 1, 1998 to October 21, 2001.
However, states may place taxes on internet access if taxes had already been
generally imposed and actually enforced prior to October 1, 1998. States which
can show they enforced internet access taxes prior to October 1, 1998 and states
after October 21, 2001 may be able to levy taxes on internet access resulting in
increased cost to access 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.

We may become subject to infringement claims.

Although we do not believe that our products infringe the proprietary rights of
any third parties, third parties might assert infringement claims against us or
our customers in the future. Furthermore, we may initiate claims or litigation
against third parties for infringement of our proprietary rights or to establish
the validity of our proprietary rights. Litigation, either as plaintiff or
defendant, would cause us to incur substantial costs and divert management
resources from productive tasks. Any litigation, regardless of the outcome,
could harm our business. Furthermore, parties making claims against us could
secure substantial damages, as well as injunctive or other equitable relief,
which could effectively block our ability to license our products in the United
States or abroad. A large monetary judgment could harm our business.

Pending securities litigation could adversely affect our business.

After the restatement of our first quarter 2000 earnings and the adjustment to
previously disclosed second quarter 2000 results, we were 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. However, there can be no guarantee as to the ultimate outcome as to 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 June
30, 2001, 33% of our total revenue was generated from our international
operations, and the net assets of our foreign subsidiaries totaled approximately
73% of consolidated net assets as of June 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 currently is pending. On March 30, 2001
the Missouri Court heard oral argument on the motion. The Missouri Court has not
yet ruled on the motion. Mercator believes that the allegations in the amended
complaint in the Missouri Action are without merit and intends to contest them
vigorously.

On March 30, 2000, Mercator filed an action entitled TSI International Software,
Ltd. (d/b/a Mercator Software Inc.) v. Carpet Co-op of America Association, Inc.
and FloorLink, LLC, Civil Action No. 300-CV-603 (SRU), in the United States
District Court for the District of Connecticut (the "Connecticut Action"). The
Connecticut Action asserts claims for copyright infringement, trademark
infringement, unfair competition, misappropriation of trade secrets, breach of
contract, fraud, unjust enrichment and violation of the Connecticut Unfair Trade
Practices Act, in connection with the software implementation project at issue
in the Missouri Action. 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 has not yet ruled
on Mercator's motion and no hearing has been set. 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 were 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 new 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. On July 6, 2001, a hearing was
held on Mercator's motion to dismiss in the United States District Court for the
District of Connecticut. The Court has not yet ruled on the motion to dismiss.
Mercator believes that the allegations in the amended complaint are without
merit and intends to contest them vigorously.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

On May 17, 2001, the Equity Incentive Stock Option plan was amended to increase
the number of options Mercator may grant to its employees from 6,700,000 to
9,700,000 shares.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

On May 17, 2001, at Mercator's Annual Meeting of Stockholders, the stockholders
approved the proposals listed below. Proxies were solicited by Mercator pursuant
to Regulation 14A under the Securities Exchange Act of 1934, as amended.

As of April 9, 2001 the record date for the Annual Meeting, there were
approximately 30,355,522 total shares of Mercator Common Stock outstanding and
entitled to vote, of which 26,280,583 were present in person by proxy and voted
at the meeting.

1. Proposal to elect eight directors of the Company each to serve until the next
Annual Meeting of stockholders and until his or her successor is duly elected
and qualified or until his earlier resignation or removal.

For Withheld
--- --------

Diane P. Baker 25,325,989 954,594
Constance F. Galley 22,667,372 3,613,211
Ernest E. Keet 25,257,425 1,023,158
Roy C. King 24,382,559 1,898,024
Richard Little 25,240,846 1,039,737
James P. Schadt 25,266,218 1,014,365
Dennis G. Sisco 25,299,572 981,011
Mark C. Stevens 25,348,386 932,197

2. Proposal to amend the Company's 1997 Equity Incentive Plan to increase the
number of shares reserved for issuance thereunder by 3,000,000 shares to an
aggregate of 9,700,000 shares, and to increase the number of shares that may be
issued to an individual new employee from 450,000 shares to 1,000,000 shares.

For 11,046,343
Against/Withheld 4,423,089
Abstain 51,728

3. Proposal to ratify the selection of KPMG LLP as Mercator's independent
accountants for the fiscal year ending December 31, 2001.

For 26,179,843
Against/Withheld 76,996
Abstain 23,744

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

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

10.1 Lease dated April 20, 2001 between Registrant and The Prudential
Assurance Company Limited.

10.2 Accounts Receivable Financing Agreement between the Registrant and
Silicon Valley Bank dated June 22, 2001.

10.3 1997 Equity and Incentive Plan, as amended.

SIGNATURES

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

MERCATOR SOFTWARE, INC.

Dated: August 14, 2001 By: /s/ Roy C. King
-------------------------------
Chairman, Chief Executive
Officer and President

Dated: August 14, 2001 By: /s/ Kenneth J. Hall
-------------------------------
Senior Vice-President, Chief
Financial Officer and Treasurer

Exhibit Index

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

10.1 ....................... Lease dated April 20, 2001 between Registrant and
The Prudential Assurance Company Limited.

10.2 ....................... Accounts Receivable Financing Agreement between
the Registrant and Silicon Valley Bank dated June
22, 2001.

10.3 ....................... 1997 Equity and Incentive Plan, as amended.