10-Q 1 t29101e10-q.txt DELANO TECHNOLOGIES 9/30/2001 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------------------------- FORM 10-Q (x) Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the quarter ended September 30, 2001; or ( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from ____________ to _____________. COMMISSION FILE NO. 333-94505 DELANO TECHNOLOGY CORPORATION (Exact name of Registrant as specified in its charter) ONTARIO, CANADA 98-0206122 (Province or other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) ---------------------------------- 302 TOWN CENTRE BOULEVARD L3R 0E8 MARKHAM, ONTARIO, CANADA (Zip code) (Address of Registrant's principal executive offices) Registrant's telephone number, including area code 905-947-2222 Securities registered pursuant to Section 12(b) NONE of the Act: Securities registered pursuant to Section 12(g) COMMON STOCK NO PAR VALUE of the Act: (Title of Class) ---------------------------------- Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ]. As of Wednesday, October 31, 2001 Registrant had outstanding 37,761,323 shares of Common Stock. -------------------------------------------------------------------------------- 1 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ DELANO TECHNOLOGY CORPORATION FORM 10-Q QUARTER ENDED SEPTEMBER 30, 2001 TABLE OF CONTENTS

-------------------------------------------------------------------------------- 2 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ PART 1: FINANCIAL INFORMATION ITEM 1: FINANCIAL STATEMENTS DELANO TECHNOLOGY CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (DOLLAR AMOUNTS IN THOUSANDS OF U.S. DOLLARS)

See accompanying notes to consolidated financial statements. -------------------------------------------------------------------------------- 3 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ DELANO TECHNOLOGY CORPORATION UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLAR AMOUNTS IN THOUSANDS OF U.S. DOLLARS, EXCEPT PER SHARE AMOUNTS)

See accompanying notes to condensed consolidated financial statements. -------------------------------------------------------------------------------- 4 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ DELANO TECHNOLOGY CORPORATION UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLAR AMOUNTS IN THOUSANDS OF U.S. DOLLARS)

See accompanying notes to condensed consolidated financial statements. -------------------------------------------------------------------------------- 5 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ DELANO TECHNOLOGY CORPORATION NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. BASIS OF PRESENTATION The unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States by Delano Technology Corporation ("Delano" or the "Company") and reflect all adjustments (all of which are normal and recurring in nature) that, in the opinion of management, are necessary for a fair presentation of the interim financial information. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for any subsequent quarter or for the entire year ending March 31, 2002. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted under the Securities and Exchange Commission's rules and regulations. These unaudited condensed consolidated financial statements and notes included herein should be read in conjunction with Delano's audited consolidated financial statements and notes included in Delano's Annual Report on Form 10-K for the year ended March 31, 2001. NOTE 2. STOCKHOLDERS' EQUITY Stock Option Plan The Company's stock option plan (the "Plan") was established for the benefit of the employees, officers, directors and certain consultants of the Company. The maximum number of common shares which may be set aside for issuance under the Plan is 9,335,382 shares, provided that the Board of Directors of the Company has the right, from time to time, to increase such number subject to the approval of the shareholders of the Company when required by law or regulatory authority. Generally, options issued subsequent to March 4, 1999 under the Plan vest over a four-year period. Options issued prior to March 5, 1999 vest annually over a three-year period. Details of stock option transactions are as follows:

The stock options expire at various dates between May 2003 and September 2010. -------------------------------------------------------------------------------- 6 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ The Company recorded deferred stock-based compensation amounting to $1.2 million for the three months ended September 30, 2000 and reduced deferred stock-based compensation amounting to $3.2 million for the three months ended September 30, 2001 in relation to the reductions in headcount (see also Note 6, Special Charges). Amortization of deferred stock-based compensation amounted to $856,000 for the three months ended September 30, 2000, compared to a net recovery of $925,000 for the three months ended September 30, 2001 in relation to the reductions in headcount (see also Note 6, Special Charges). The amortization (recovery) of deferred stock-based compensation relates to the following cost of service revenues and operating expense categories (in thousands):

NOTE 3. COMPREHENSIVE LOSS The Financial Accounting Standards Board ("FASB") issued SFAS No. 130, "Reporting Comprehensive Income," which establishes standards for reporting and presentation of comprehensive income. This standard defines comprehensive income as the changes in equity of an enterprise except those resulting from shareholder transactions. Comprehensive loss for the three months and six months ended September 30, 2000 and September 30, 2001, was not materially different from net loss for the periods. NOTE 4. SEGMENT INFORMATION The Company reviewed its operations and determined that it operates in a single reportable operating segment, being the development and marketing of interaction-based e-business communications applications. All long-lived assets relating to the Company's operations are located in Canada. Revenue per geographic location, which is attributable to geographic location based on the location of the external customer, is as follows (in thousands):

For the three months ended September 30, 2001, two customers accounted for 29% and 18% of total revenues, respectively. For the three months ended September 30, 2000, no customer accounted for 10% of total revenues. For the six months ended September 30, 2001, three customers accounted for 26%, 12% and 11% of total revenues, respectively. For the six months ended September 30, 2000, no customer accounted for 10% of total revenues. As at September 30, 2001, the Company had a receivable from three significant customers amounting to 33%, 19% and 10% of total accounts receivable trade, respectively. As at September 30, 2000, the Company did not have a receivable from a customer amounting to 10% of total accounts receivable trade. NOTE 5. JOINT VENTURES AND INVESTMENT IN AFFILIATE In June 2000, the Company formed Delano Minerva Holdings Inc. ("Minerva"), and has a controlling position with a 50% ownership and a majority of the seats of the Board of Directors. During fiscal 2001, the Company's proportionate -------------------------------------------------------------------------------- 7 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ share of Minerva's losses exceeded its investment. Minerva's results of operations were included within the Company's fiscal 2001 revenue, cost and expense categories. During the three months ended September 30, 2001, the Company agreed to pay $100,000 for the remaining ownership interest in Minerva and subsequently closed down the operation. In December 2000, the Company invested in a joint venture, Delano Asia-Pacific, as a minority interest party by acquiring 19.9% of the common shares. The joint venture partner was eGlobal Technology Services Holding Limited ("eGlobal") of Singapore. The investment in this joint venture has been made in the form of a $398,000 capital contribution, as well as a long-term non-interest bearing loan receivable of $602,000. This investment is accounted for using the equity method of accounting. For the three months and six months ended September 30, 2001 the Company recognized $80,000 and $146,000 respectively of losses and during fiscal 2001, the Company recognized $278,000 of losses, which represent the Company's proportionate share of the joint ventures losses, net of the intercompany elimination. NOTE 6. SPECIAL CHARGES Special charges for the three months ended September 30, 2001 includes a $7.0 million asset impairment charge and a $6.7 million restructuring charge. Asset impairment: During the three months ended September 30, 2001, the Company restructured its operations to reduce operating expenses. During the restructuring, it was determined that $5.8 million of capital assets and $1.2 million of other assets, including the long-term non-interest bearing loan receivable from eGlobal of $602,000, had no future value to the Company. Restructuring charge: During the three months ended March 31, 2001, the Company incurred a restructuring charge of $6.3 million as part of a plan to improve its operating results by reducing employees, by closing duplicative Company facilities in the USA and Canada, and by implementing other measures. During the three months ended June 30, 2001 an additional $848,000 was accrued relating to a change in estimate for one of the facilities. During the three months ended September 30, 2001, an additional $683,000 was accrued relating to a change in estimate for our ASP model. This charge is part of a plan to streamline the Company's efforts to focus on achieving profitability. The restructuring charge was comprised of $3.2 million for reductions in employee numbers, $3.0 million (after adjustment) for facilities related costs including penalties associated with the reduction of lease commitments and future lease payments and $1.6 million (after adjustment) related to eliminating the Company's ASP sales model. As of September 30, 2001, $5.1 million had been paid out on the restructuring charge. Most of the remaining $2.7 million that was not yet paid is related to lease commitments and is payable monthly until July 2005. During the three months ended June 30, 2001, the Company incurred an additional restructuring charge of $3.4 million as part of a plan to improve its operating results by reducing employees, by closing duplicative Company facilities in the USA, and by implementing other measures. This charge is part of a plan to streamline the Company's efforts to focus on achieving profitability. The restructuring charge was comprised of $2.6 million for reductions in employee numbers, $573,000 for facilities related costs including penalties associated with the reduction of lease commitments and future lease payments and $240,000 related to the termination of the Minerva joint venture. As of September 30, 2001, $3.1 million had been paid out on the restructuring charge. Most of the remaining $300,000 relates to employee termination costs and lease commitments and will be paid by July 2002. During the three months ended September 30, 2001, the Company incurred an additional restructuring charge of $6.0 million as part of a plan to improve its operating results by reducing employees, by closing duplicative Company facilities in the USA, Canada and Europe and by implementing other measures. This charge is part of a plan to streamline the Company's efforts to focus on achieving profitability. The restructuring charge was comprised of $3.7 million for reductions in employee numbers and $2.3 million for facilities related costs including penalties associated with the reduction of lease commitments and future lease payments. As of September 30, 2001, $3.6 million had been paid out on the restructuring charge. Most of the remaining $2.4 million relates to employee termination costs and lease commitments and will be paid by July 2010. The Company determined its restructuring charge in accordance with Emerging Issues Task Force Issue No. 94-3 -------------------------------------------------------------------------------- 8 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ ("EITF 94-3") and Staff Accounting Bulletin No. 100 ("SAB 100"). EITF 94-3 and SAB 100 require that the Company commit to an exit plan before it accrues employee termination costs and exit costs. On January 4, 2001, the Company's senior management prepared and approved a detailed exit plan that included the termination of 102 employees, closure of certain facilities and the elimination of the ASP sales model. On April 23, 2001, the Company's senior management prepared and approved a second detailed exit plan that included the additional termination of 140 employees and closure of additional facilities. On July 3, 2001, the Company's senior management prepared and approved a third detailed exit plan that included the additional termination of 183 employees, closure of additional facilities, reduction of capital assets no longer in use and other various exit costs. In connection with the restructuring actions for the three months ended March 31, 2001, the Company terminated the employment of 102 employees, consisting primarily of sales and marketing employees, applications development employees, technical and other support employees, and administrative employees in all locations. In addition, the Company did not replace approximately 34 employees who resigned voluntarily during the three months ended March 31, 2001. At March 31, 2001, the Company had terminated all employees associated with these restructuring actions. At March 31, 2001, the Company had exited a portion of its facilities in Markham and most of its offices in the USA. The Company has entered into sublease arrangements for some of its office space. In connection with the restructuring actions for the three months ended June 30, 2001, the Company terminated the employment of 140 employees, consisting primarily of applications development employees, sales and marketing employees, technical and other support employees, and administrative employees in all locations. In addition, the Company did not replace approximately 39 employees who resigned voluntarily during the three months ended June 30, 2001. At June 30, 2001, the Company had terminated all employees associated with these restructuring actions. At June 30, 2001, the Company had exited its facilities in its offices in the USA identified in the restructuring plan. In connection with the restructuring actions for the three months ended September 30, 2001, the Company terminated the employment of 183 employees, consisting primarily of applications development employees, sales and marketing employees, technical and other support employees, and administrative employees in all locations. In addition, the Company did not replace approximately 9 employees who resigned voluntarily during the three months ended September 30, 2001. At September 30, 2001, the Company had terminated all employees associated with these restructuring actions. At September 30, 2001, the Company had exited its facilities in its offices in the USA, Canada and Europe identified in the restructuring plan. Restructuring charge accruals, both current and long-term, are shown separately on the condensed consolidated balance sheet at September 30, 2001. The long-term restructuring charge accrual relates specifically to future lease payment commitments that extend beyond one year. Detail of the restructuring charges as of and for the three months ended September 30, 2001 are summarized below:

-------------------------------------------------------------------------------- 9 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================

NOTE 7. RELATED PARTY TRANSACTIONS The Company has expensed consulting fees to a director and now Chief Executive Officer of the Company and two consultants that he is providing under his agreement amounting to $247,000 for the three-month period ended September 30, 2001. As at September 30, 2001, accrued consulting fees payable to a director of the Company amounted to $165,000. NOTE 8. RECENT ACCOUNTING PRONOUNCEMENTS In prior years, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities" or SFAS No. 133 and Statement of Financial Accounting Standards No. 138, "Accounting for Certain Hedging Activities" or SFAS No. 138, which amended SFAS No. 133. Because the Company currently holds no derivative financial instruments and the Company does not currently engage in hedging activities, the adoption of SFAS No. 133 and SFAS No. 138 has not had a material impact on the Company's financial condition or results of operations. NOTE 9. LEGAL ITEMS On February 22, 2001, We Media, Inc. ("WeMedia") filed a lawsuit against the Company in the Supreme Court for the State of New York, County of New York. During the three months ended September 30, 2001, the Company successfully settled the lawsuit filed against it by We Media, Inc. -------------------------------------------------------------------------------- 10 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ During the period from August 2 to October 1, 2001, three purported securities class action lawsuits were filed against the Company in the U.S. District Court for the Southern District of New York, Shapiro, et al. v. Delano Technology Corporation, et al., Ellis Investments Ltd, et al. v. Delano Technology Corporation, et al., and Wendy and Joe Scavuzzo, et al. v. Delano Technology Corporation, et al. The complaints also name one or more of the Company's underwriters in the Company's initial public offering and certain officers and directors of the Company. The complaints allege violations of the federal securities laws regarding statements in the Company's initial public offering registration statement concerning the underwriters' activities in connection with the underwriting of the Company's shares to the public. The actions seek rescission of the plaintiff's alleged purchases of Company stock and other damages and costs associated with the litigation. Various plaintiffs have filed similar actions asserting virtually identical allegations against more than 100 other companies. The Company believes it has meritorious defenses to these lawsuits and will vigorously defend itself. NOTE 10. SUBSEQUENT EVENT The Company named Vikas Kapoor as the Chief Executive Officer of the Company and certain subsidiaries of the Company, effective October 5, 2001. Mr. Kapoor has served as a member of the Company's Board of Directors since July 2001. Mr. Kapoor's compensation package includes a grant of 4,230,000 common shares, which vest over 30 months (705,000 vested upon grant and the balance vest at the rate of 117,500 per month) subject to accelerated vesting in certain circumstances as set out in the Restricted Share Agreement. -------------------------------------------------------------------------------- 11 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion of the Financial Condition and Results of Operations contains forward-looking statements within the meaning of Section 21e of the Securities Exchange Act of 1934. Our actual results and timing of certain events could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those set forth under "Risk Factors," elsewhere in this report and in our other public filings. The following discussion should be read in conjunction with our unaudited consolidated financial statements and the related notes appearing elsewhere in this Form 10-Q. OVERVIEW From the date of our incorporation on May 7, 1998 until April 1999 we were a development stage company and had no revenues. Our operating activities during this period consisted primarily of conducting research and developing our initial products. In May 1999, we released and sold the first commercially available version of the Delano e-Business Interaction Suite. On September 26, 2000 we acquired Continuity Solutions, Inc. pursuant to a transaction where Continuity became our wholly owned subsidiary. Continuity is a provider of integrated multi-channel eCRM solutions, consisting of licensed and ASP offerings. Continuity is headquartered in San Francisco, California and had 15 employees as of the date of the acquisition. In connection with the acquisition, we issued approximately 1.4 million shares of Delano common stock, no par value, and assumed options and warrants to acquire approximately 150,000 shares of Delano common stock. The transaction was accounted for using the purchase method of accounting. On October 13, 2000, we acquired Digital Archaeology Corporation ("DA") pursuant to a transaction where DA became our wholly owned subsidiary. DA is a provider of analytics for e-business. The company's solutions provide enterprises with a view of customer and trading partner behavior and preferences across traditional and e-commerce channels. DA was a privately held company based in Kansas City and had 68 employees as of the date of the acquisition. In connection with the acquisition, we issued approximately 4.6 million of the Company's common stock, no par value, and paid $17.4 million in cash, in exchange for all of the outstanding shares of capital stock of DA, and each outstanding option or right to purchase DA common stock was assumed by the Company and became a right to purchase 0.53 of the Company's common shares. The transaction was accounted for using the purchase method of accounting. To date, we have derived substantially all of our revenues from the sale of software product licenses and from the provision of professional services, including implementation, training and maintenance services. Our products have been sold primarily through our direct sales force. Our products are offered on a licensed basis. We license our products based on: - a fee for each client, which depends on the specific and individual needs of the client; - an additional fee, which covers installation, configuration, training and professional services; and - a variable component, which depends on, among other things, the number of servers and the number of optional applications and add-ons, servers and component packs purchased. We recognize our software license revenues in accordance with the American Institute of Certified Public Accountants, or ("AICPA"), Statement of Position ("SOP") 97-2, "Software Revenue Recognition," and related amendments and interpretations contained in the AICPA's SOP 98-9. We generally recognize revenues allocated to software licenses upon delivery of the software products, when all of the following conditions have been met: - persuasive evidence of an arrangement exists; - the license fee is fixed or determinable; and - the license fee is collectible. -------------------------------------------------------------------------------- 12 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ Because substantially all of our software license agreements include related maintenance services, these agreements are multiple-element arrangements. We allocate the fees in multiple-element arrangements based on the respective value for each element, with maintenance being allocated typically at 18% of license revenue in all sales. Delivery of the software generally is deemed to occur upon shipment of the software unless customers are provided the opportunity to return the products. Revenues are recognized only when all refund obligations have expired. In situations where we provide online offerings, delivery of the software occurs upon initiation of the online offerings. Revenues from maintenance and support services and online offerings are recognized ratably over the related contractual period. Our cost of revenues includes the cost of product documentation, the cost of compact disks used to deliver our products, personnel-related expenses, travel costs, equipment costs and overhead costs. Our operating expenses are classified into four categories: sales and marketing, research and development, general and administrative, and amortization of deferred stock-based compensation. - Sales and marketing expenses consist primarily of compensation and related costs for sales and marketing personnel and promotional expenditures, including public relations, advertising, trade shows and marketing materials; - Research and development expenses consist primarily of compensation and related costs for research and development employees and contractors and in connection with the enhancement of existing products and quality assurance activities; - General and administrative expenses consist primarily of compensation and related costs for administrative personnel, legal, accounting and other general corporate expenses; - Amortization (recovery) of deferred stock-based compensation includes the amortization, over the vesting period of a stock option, of the difference between the exercise price of options granted to employees and the deemed fair market value of the options for financial reporting purposes. In addition, deferred stock-based compensation includes compensation expense arising on the issuance of options and a warrant to employees and a consultant, calculated as the difference between the exercise price of the options and warrant and the fair market value at the date of issuance. Also included in amortization of deferred stock-based compensation is compensation expense relating to an option to acquire shares of the Company issued in connection with a professional services agreement between the Company and a related corporation. The compensation expense is calculated as the difference between the exercise price of the option and the fair market value at the time the option was issued or earned. Also included in amortization of deferred stock-based compensation is compensation expense relating to the unvested options assumed in the acquisitions of Continuity and DA. In connection with the restructuring actions, the Company has recorded a recovery of deferred stock-based compensation relating to terminated employees. We allocate common costs based on relative headcount or other relevant measures. These allocated costs include rent and other facility-related costs for the corporate head office, communication expenses and depreciation expenses for furniture and equipment. In connection with the granting of stock options and the issuance of a warrant to our employees and a consultant, we recorded deferred stock-based compensation totaling $13.7 million through March 31, 2001. This amount represents the total difference between the exercise prices of stock options and the warrant and the deemed fair value of the underlying common stock for accounting purposes on the date these stock options were granted and the warrant issued. This amount is included as a component of stockholders' equity and is being amortized by charges to operations over the vesting period of the options, consistent with the method described in Financial Accounting Standards Board, or ("FASB"), Interpretation No. 28. We recorded $856,000 of stock-based compensation amortization expense during the three months ended September 30, 2000 compared to a recovery of $925,000 of stock-based compensation amortization expense during the three months ended September 30, 2001. We recorded $2.5 million of stock-based compensation amortization expense during the six months ended September 30, 2000 compared to a recovery of $2.1 million of stock-based compensation amortization expense during the six months ended September 30, 2001. As of September 30, 2001, we had a total of $2.2 million of deferred stock-based compensation that had not been amortized. The amortization of the remaining deferred stock-based compensation will result in additional charges to operations through December 2003 of approximately $200,000 per quarter. The amortization of deferred stock-based compensation is classified as a separate component of operation expenses in our consolidated statement of operations. The Company named Vikas Kapoor as the Chief Executive Officer of the Company and certain subsidiaries of the Company, effective October 5, 2001. Mr. Kapoor has served as a member of the Company's Board of Directors since July 2001. Mr. Kapoor's compensation package includes a grant of 4,230,000 common shares, which vest over 30 months -------------------------------------------------------------------------------- 13 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ (705,000 vested upon grant and the balance vest at the rate of 117,500 per month) subject to accelerated vesting in certain circumstances as set out in the Restricted Share Agreement. In our development of new products and enhancements of existing products, the technological feasibility of the software is not established until substantially all product development is complete. Historically, our software development costs eligible for capitalization have been insignificant and all costs related to internal product development have been expensed as incurred. Special charges for the three months ended September 30, 2001 includes a $7.0 million asset impairment charge and a $6.7 million restructuring charge. Asset impairment: During the three months ended September 30, 2001, the Company restructured its operations to reduce operating expenses. During the restructuring, it was determined that $5.8 million of capital assets and $1.2 million of other assets, including the long-term non-interest bearing loan receivable from eGlobal of $602,000, had no future value to the Company. Restructuring charge: During the three months ended March 31, 2001, the Company incurred a restructuring charge of $6.3 million as part of a plan to improve its operating results by reducing employees, by closing duplicative Company facilities in the USA and Canada, and by implementing other measures. During the three months ended September 30, 2001 an additional $848,000 was accrued relating to a change in estimate for one of the facilities. This charge is part of a plan to streamline the Company's efforts to focus on achieving profitability. The restructuring charge was comprised of $3.2 million for reductions in employee numbers, $3.0 million (after adjustment) for facilities related costs including penalties associated with the reduction of lease commitments and future lease payments and $1.6 million (after adjustment) related to eliminating the Company's ASP sales model. As of September 30, 2001, $5.1 million had been paid out on the restructuring charge. Most of the remaining $2.7 million that was not yet paid is related to lease commitments and is payable monthly until July 2005. During the three months ended June 30, 2001, the Company incurred an additional restructuring charge of $3.4 million as part of a plan to improve its operating results by reducing employees, by closing duplicative Company facilities in the USA, and by implementing other measures. This charge is part of a plan to streamline the Company's efforts to focus on achieving profitability. The restructuring charge was comprised of $2.6 million for reductions in employee numbers, $573,000 for facilities related costs including penalties associated with the reduction of lease commitments and future lease payments and $240,000 related to the termination of the Minerva joint venture. As of September 30, 2001, $3.1 million had been paid out on the restructuring charge. Most of the remaining $300,000 relates to employee termination costs and lease commitments and will be paid by July 2002. During the three months ended September 30, 2001, the Company incurred an additional restructuring charge of $6.0 million as part of a plan to improve its operating results by reducing employees, by closing duplicative Company facilities in the USA, Canada and Europe and by implementing other measures. This charge is part of a plan to streamline the Company's efforts to focus on achieving profitability. The restructuring charge was comprised of $3.7 million for reductions in employee numbers and $2.3 million for facilities related costs including penalties associated with the reduction of lease commitments and future lease payments. As of September 30, 2001, $3.6 million had been paid out on the restructuring charge. Most of the remaining $2.4 million relates to employee termination costs and lease commitments and will be paid by July 2010. The Company determined its restructuring charge in accordance with Emerging Issues Task Force Issue No. 94-3 ("EITF 94-3") and Staff Accounting Bulletin No. 100 ("SAB 100"). EITF 94-3 and SAB 100 require that the Company commit to an exit plan before it accrues employee termination costs and exit costs. On January 4, 2001, the Company's senior management prepared and approved a detailed exit plan that included the termination of 102 employees, closure of certain facilities and the elimination of the ASP sales model. On April 23, 2001, the Company's senior management prepared and approved a second detailed exit plan that included the additional termination of 140 employees and closure of additional facilities. On July 3, 2001, the Company's senior management prepared and approved a third detailed exit plan that included the additional termination of 183 employees, closure of additional facilities, reduction of capital assets no longer in use and other various exit costs. -------------------------------------------------------------------------------- 14 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ In connection with the restructuring actions for the three months ended March 31, 2001, the Company terminated the employment of 102 employees, consisting primarily of sales and marketing employees, applications development employees, technical and other support employees, and administrative employees in all locations. In addition, the Company did not replace approximately 34 employees who resigned voluntarily during the three months ended March 31, 2001. At March 31, 2001, the Company had terminated all employees associated with these restructuring actions. At March 31, 2001, the Company had exited a portion of its facilities in Markham and most of its offices in the USA. The Company has entered into sublease arrangements for some of its office space. In connection with the restructuring actions for the three months ended June 30, 2001, the Company terminated the employment of 140 employees, consisting primarily of applications development employees, sales and marketing employees, technical and other support employees, and administrative employees in all locations. In addition, the Company did not replace approximately 39 employees who resigned voluntarily during the three months ended June 30, 2001. At June 30, 2001, the Company had terminated all employees associated with these restructuring actions. At June 30, 2001, the Company had exited its facilities in its offices in the USA identified in the restructuring plan. In connection with the restructuring actions for the three months ended September 30, 2001, the Company terminated the employment of 183 employees, consisting primarily of applications development employees, sales and marketing employees, technical and other support employees, and administrative employees in all locations. In addition, the Company did not replace approximately 9 employees who resigned voluntarily during the three months ended September 30, 2001. At September 30, 2001, the Company had terminated all employees associated with these restructuring actions. At September 30, 2001, the Company had exited its facilities in its offices in the USA, Canada and Europe identified in the restructuring plan. We believe that period-to-period comparisons of our historical operating results are not necessarily meaningful and should not be relied upon as being a good indication of our future performance. Our prospects must be considered in light of the risks, expenses and difficulties frequently experienced by companies in early stages of development, particularly companies in new and rapidly evolving markets like ours. Although we have experienced significant revenue growth recently, this trend may not be sustainable. Furthermore, we may not achieve or maintain profitability in the future. RESULTS OF OPERATIONS Three months and six months ended September 30, 2001 compared to three months and six months ended September 30, 2000. Revenues. Total revenues for the three months ended September 30, 2001 were $4.0 million compared to $8.0 million for the three months ended September 30, 2000. In the three months ended September 30, 2001 license revenues accounted for $2.1 million or 52.0% of total revenues. In the three months ended September 30, 2000, license revenues accounted for $7.0 million, or 87.2% of total revenues. Total revenues for the six months ended September 30, 2001 were $7.0 million compared to $14.1 million for the six months ended September 30, 2000. In the six months ended September 30, 2001 license revenues accounted for $3.3 million or 46.6% of total revenues. In the six months ended September 30, 2000, license revenues accounted for $12.4 million, or 88.0% of total revenues. Services revenues, including maintenance and services fees, accounted for $1.9 million, or 48.0% of revenues for the three months ended September 30, 2001, compared to $1.0 million or 12.8% of total revenues for the three months ended September 30, 2000. Services revenues, including maintenance and services fees, accounted for $3.7 million, or 53.4% of revenues for the six months ended September 30, 2001, compared to $1.7 million or 12.0% of total revenues for the six months ended September 30, 2000. Approximately 72.8% of our total revenues were generated in the United States, 25.4% were generated in Canada and 1.8% were generated elsewhere in the three months ended September 30, 2001, compared to 63.5%, 24.2% and 12.3% respectively for the three months ended September 30, 2000. Approximately 75.5% of our total revenues were generated in the United States, 22.3% were generated in Canada and 2.2% were generated elsewhere in the six months ended September 30, 2001, compared to 61.0%, 22.6% and 16.4% respectively for the six months ended September 30, 2000. Cost of revenues. Cost of license revenues was $309,000 or 7.8% of total revenues for the three months ended September 30, 2001 compared to $122,000 for the three months ended September 30, 2000 or 1.5% of total revenues. Cost of services revenues was $1.0 million, or 26.2% of total revenues for the three months ended September 30, 2001, compared to $1.2 million for the three months ended September 30, 2000, or 14.6% of total revenues. Cost of license -------------------------------------------------------------------------------- 15 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ revenues was $386,000 or 5.5% of total revenues for the six months ended September 30, 2001 compared to $181,000 for the six months ended September 30, 2000 or 1.3% of total revenues. Cost of services revenues was $2.9 million, or 41.0% of total revenues for the six months ended September 30, 2001, compared to $2.0 million for the six months ended September 30, 2001, or 14.0% of total revenues. We anticipate that cost of service revenues will decrease in absolute dollars as we made a reduction in services personnel as part of our July restructuring. We anticipate that the cost of license revenues will be a smaller proportion of license revenues. Sales and marketing. Sales and marketing expenses decreased to $1.4 million or 35.5% of revenues for the three months ended September 30, 2001 from $11.1 million or 138.4% of revenues for the three months ended September 30, 2000. Sales and marketing expenses decreased to $9.6 million or 136.6% of revenues for the six months ended September 30, 2001 from $21.5 million or 153.0% of revenues for the six months ended September 30, 2000. This decrease was attributable primarily to the reduction of sales and marketing personnel and lower marketing costs due to reduced promotional activities. As part of the company's July restructuring, we anticipate that sales and marketing expenses will remain relatively constant in the next few quarters. Research and development. Research and development expenses decreased to $1.3 million or 33.2% of revenues for the three months ended September 30, 2001 from $3.9 million or 48.0% of revenues for the three months ended September 30, 2000. Research and development expenses decreased to $6.2 million or 89.3% of revenues for the six months ended September 30, 2001 from $6.2 million or 44.0% of revenues for the six months ended September 30, 2000. This decrease was attributable primarily to the reduction of product development and related services personnel and to decreased consulting and recruiting costs. We anticipate that research and development expenses will remain constant in absolute dollars, and will reduce as a percentage of total revenues from period to period as we have reduced research and development personnel as part of our July restructuring. General and administrative. General and administrative expenses decreased to $467,000 or 11.8% of revenues for the three months ended September 30, 2001 from $1.1 million or 14.2% of revenues for the three months ended September 30, 2000. General and administrative expenses decreased to $1.9 million or 27.2% of revenues for the six months ended September 30, 2001 from $2.1 million or 15.2% of revenues for the six months ended September 30, 2000. The decrease is due primarily to the reduction of administrative personnel, decreased consulting costs and to lower facilities-related expenses necessary to support our growth. We expect that general and administrative expenses will remain in absolute dollars as we have reduced personnel and related costs as part of our July restructurings. Amortization of goodwill and identifiable intangibles. On September 26, 2000, the Company completed its acquisition of Continuity. As a result of the acquisition, $19.4 million was allocated to goodwill, and identifiable intangibles. This amount is being amortized on a straight-line basis over a period of three years for identifiable intangibles, and five years for goodwill from October 1, 2000. On October 16, 2000, the Company completed its acquisition of Digital Archaeology. As a result of the acquisition, $94.2 million was allocated to goodwill and identifiable intangibles. This amount was being amortized from October 16, 2000 on a straight-line basis over a period of three years for identifiable intangibles and five years for goodwill. If events or changes in circumstances indicate that these long lived assets will not be recoverable, as determined based on the undiscounted cash flows of the acquired businesses or if determined that the amounts paid for them would have changed materially based on underlying changes in the financial markets and therefore fundamental changes in the value of technology companies, over the remaining amortization period, the carrying value is reduced to net realizable value. For the three months ended March 31, 2001, goodwill and identifiable intangibles was reduced by approximately $97.0 million. For the three months ended June 30, 2001, goodwill was reduced by a further $4.9 million. For the three months ended September 30, 2001, there is no amortization of goodwill and identifiable intangibles. Amortization of deferred stock-based compensation. We incurred a recovery of $925,000 or 23.4% of revenues in the three months ended September 30, 2001 compared to a charge of $856,000 or 10.7% of revenues for the three months ended September 30, 2000. We incurred a recovery of $2.1 million or 30.6% of revenues in the six months ended September 30, 2001 compared to a charge of $2.5 million or 17.6% of revenues for the six months ended September 30, 2000. The charge is related to the issuance of stock options with exercise prices less than the deemed fair market value for financial reporting purposes on the date of grant and the recovery is related to the unvested options of terminated employees from the restructuring actions. -------------------------------------------------------------------------------- 16 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ Interest income, net. Interest income, net for the three months ended September 30, 2001 was $218,000, compared to the three months ended September 30, 2000 at $1.4 million. Interest income, net for the six months ended September 30, 2001 was $563,000, compared to the six months ended September 30, 2000 at $3.0 million. Interest income reflects the interest earned on the cash and cash equivalents balance arising from our special warrant offering in September 1999 and our initial public offering in February 2000. The decrease in interest income reflects lower cash balances and lower interest rates. Provision for income taxes. A deferred tax asset of $29.1 million existed as of September 30, 2001 compared to $6.0 million at September 30, 2000. A valuation allowance is recorded against a deferred tax asset if it is more likely than not that the asset will not be realized. A valuation allowance taken against substantially the entire deferred tax asset reflects the lack of profitability in the past, the significant risk that taxable income would not be generated in the future and the non-transferable nature of the deferred tax asset under certain conditions. Three months and six months ended September 30, 2000 compared to the three months and six months ended September 30, 1999. Revenues. Total revenues for the three months ended September 30, 2000 were $8.0 million, compared to $1.6 million for the three months ended September 30, 1999. License revenues accounted for $7.0 million, or 87.2% of total revenues for the three months ended September 30, 2000, compared with $1.6 million or 96.7% for the three months ended September 30, 1999. Total revenues for the six months ended September 30, 2000 were $14.1 million, compared to $2.4 million for the six months ended September 30, 1999. License revenues accounted for $12.4 million, or 88.0% of total revenues for the six months ended September 30, 2000, compared with $2.3 million or 95.3% for the six months ended September 30, 1999. Services revenues, including maintenance and services fees, accounted for the remaining $1.0 million or 12.8% of total revenues for the three months ended September 30, 2000, compared with $54,000 or 3.3% for the three months ended September 30, 1999. Services revenues, including maintenance and services fees, accounted for the remaining $1.7 million or 12.0% of total revenues for the six months ended September 30, 2000, compared with $113,000 or 4.7% for the six months ended September 30, 1999. Approximately 63.5% of our total revenues were generated in the United States, 24.2% were generated in Canada and 12.3% were generated elsewhere in the three months ended September 30, 2000. Approximately 61.0% of our total revenues were generated in the United States, 22.6% were generated in Canada and 16.4% were generated elsewhere in the six months ended September 30, 2000. Cost of revenues. Cost of product revenues was $122,000 for the three months ended September 30, 2000 or 1.5% of total revenues, compared with $6,000 or 0.4% for the three months ended September 30, 1999. Cost of services revenues was $1.2 million for the three months ended September 30, 2000, or 14.6% of total revenues, compared with $231,000, or 14.3% of total revenues for the three months ended September 30, 1999. Cost of product revenues was $181,000 for the six months ended September 30, 2000 or 1.3% of total revenues, compared with $6,000 or 0.2% for the six months ended September 30, 1999. Cost of services revenues was $2.0 million for the six months ended September 30, 2000, or 14.0% of total revenues, compared with $380,000, or 15.7% of total revenues for the six months ended September 30, 1999. We anticipate that cost of service revenues will increase in absolute dollars as we continue to hire additional services personnel, but decrease proportionately as a percentage of service revenues. We anticipate that the cost of product revenues will increase proportionately with increases in product revenues. Sales and marketing. Sales and marketing expenses increased to $11.1 million for the three months ended September 30, 2000, or 138.4% of total revenues, compared with $1.2 million or 74.2% of total revenues for the three months ended September 30, 1999. Sales and marketing expenses increased to $21.5 million for the six months ended September 30, 2000, or 153.0% of total revenues, compared with $2.0 million or 83.1% of total revenues for the six months ended September 30, 1999. This increase was attributable primarily to the addition of 179 sales and marketing personnel and higher marketing costs due to expanded promotional activities. We anticipate that sales and marketing expenses will increase in absolute dollars as we continue to hire additional sales and marketing personnel and expand discretionary marketing programs, but decrease as a percentage of revenue. Research and development. Research and development expenses increased to $3.9 million for the three months ended -------------------------------------------------------------------------------- 17 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ September 30, 2000, or 48.0% of total revenues, compared with $801,000, or 49.6% of total revenues for the three months ended September 30, 1999. Research and development expenses increased to $6.2 million for the six months ended September 30, 2000, or 44.0% of total revenues, compared with $1.2 million, or 49.0% of total revenues for the six months ended September 30, 1999. This increase was attributable primarily to the addition of 156 product development and related services personnel and to increased consulting and recruiting costs. We anticipate that research and development expenses will increase in absolute dollars, but will decrease as a percentage of total revenues from period to period as we continue to hire additional research and development personnel. As a Canadian Controlled Private Corporation or ("CCPC"), we qualified for certain investment tax credits under the Income Tax Act (Canada) on eligible research and development expenditures. Prior to our initial public offering, refundable investment tax credits, which result in cash payments to us, have been recorded at a rate of 35% of eligible current and capital research and development expenditures. Prior to our initial public offering, we were entitled to an investment tax credit at these rates for the first Cdn$2.0 million (approximately $1.4 million) of eligible research and development expenditures and a further investment tax credit at the rate of 20% of eligible research and development expenditures in excess of Cdn$2.0 million. Investment tax credits on current expenditures earned at the 35% rate are fully refundable to CCPCs. Investment tax credits earned by a CCPC on capital expenditures at the 35% rate are refundable at a rate of 40% of the amount of the credit. We will earn investment tax credits at a rate of 20% of eligible current and capital research and development expenditures made after our initial public offering. While a portion of investment tax credits earned as a CCPC are refundable, investment tax credits earned after our initial public offering may only be used to offset income taxes otherwise payable. General and administrative. General and administrative expenses increased to $1.1 million, or 14.2% of total revenues for the three months ended September 30, 2000, compared to $255,000, or 15.8% of total revenues for the three months ended September 30, 1999. General and administrative expenses increased to $2.1 million, or 15.2% of total revenues for the six months ended September 30, 2000, compared to $412,000, or 17.0% of total revenues for the six months ended September 30, 1999. The increase was due primarily to the addition of 40 administrative personnel, increased consulting costs and to higher facilities-related expenses necessary to support our growth. We expect that general and administrative expenses will increase in absolute dollars as we add personnel and incur related costs to facilitate the growth of our business. Amortization of goodwill and identifiable intangibles. On September 26, 2000, the Company completed its acquisition of Continuity. As a result of the acquisition, $19.4 million was allocated to goodwill and identifiable intangibles. This amount is being amortized on a straight-line basis over a period of three years from October 1, 2000. For the three months and six months ended September 30, 2000, no goodwill amortization was recorded. Amortization of deferred stock-based compensation. We incurred a charge of $856,000 for the three months ended September 30, 2000, compared to $211,000 for the three months ended September 30, 1999. We incurred a charge of $2.5 million for the six months ended September 30, 2000, compared to $318,000 for the six months ended September 30, 1999. The charge is related to the issuance of stock options with exercise prices less than the deemed fair market value for financial reporting purposes on the date of grant. In process research and development. In connection with the acquisition of Continuity, net intangibles of $360,000 were allocated to in-process research and development. The fair value allocation to in-process research and development was determined by identifying the research projects for which technical feasibility has not been achieved and which have no alternative future use at the acquisition date, assessing the stage and expected date of completion of the research and development effort at the acquisition date, and calculating the net present value of the cash flows expected to result from the successful deployment of the new technology resulting from the in-process research and development effort. The stages of completion were determined by estimating the costs and time incurred to date relative to the costs and time incurred to develop the in-process technology into a commercially viable technology or product, while considering the relative difficulty of completing various tasks and obstacles necessary to attain technological feasibility. The estimated net present value of cash flows was based on incremental future cash flows from revenues expected to be generated by the technologies in the process of development, taking into account the characteristics and applications of the technologies, the size and growth rate of existing and future markets and an evaluation of past and anticipated technology and product life cycles. Estimated net future cash flows included allocations of operating expenses and income taxes but excluded the expected completion costs of the in-process projects, and were discounted to arrive at a net present value. The discount rate included a factor that took into account the uncertainty surrounding the successful deployment of -------------------------------------------------------------------------------- 18 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ in-process technology projects. This net present value was allocated to in-process research and development based on the percentage of completion at the acquisition date. Interest income, net. Interest income, net for the three months ended September 30, 2000 was $1.4 million, compared to $165,000 for the three months ended September 30, 1999. Interest income, net for the six months ended September 30, 2000 was $2.9 million, compared to $176,000 for the six months ended September 30, 1999. Interest income, net reflects the interest earned on the cash and cash equivalents balance arising from our special warrant offering in June 1999 and our initial public offering in February 2000. Provision for income taxes. A deferred tax asset of $6.0 million existed as of September 30, 2000. A valuation allowance is recorded against a deferred tax asset if it is more likely than not that the asset will not be realized. A valuation allowance taken against substantially all of the deferred tax asset reflects the lack of profitability in the past, the significant risk that taxable income would not be generated in the future and the nontransferable nature of the deferred tax asset under certain conditions. LIQUIDITY AND CAPITAL RESOURCES Since the date of incorporation, we have raised an aggregate of $3.4 million through private placements of special shares. We have raised $14.4 million, net of the agents' commission and offering expenses, through a private placement of special warrants in June 1999. We have also raised $103.4 million, net of agents' commissions and offering expenses through our initial public offering in February 2000. Our operating activities used cash of $22.9 million for the six months ended September 30, 2001 and cash of $15.8 million for the six months ended September 30, 2000. Our negative operating cash flow resulted principally from the net losses that we incurred during these periods. The company has taken restructuring actions in January, April and July to reduce expenses. Our financing activities used $14,000 in the six months ended September 30, 2001 and provided $228,000 in six months ended September 30, 2000, mostly related to payments on capital leases net of receipts from issuance of common shares and warrants. Our investing activities, consisting of the purchase or sale of computer equipment, software, furniture and equipment, net of the sale of short-term investments provided cash of $1.1 million during the six months ended September 30, 2001 and provided $18.4 million in six months ended September 30, 2000. In March 1999, we obtained a lease line of credit from a Canadian chartered bank to purchase equipment and furniture. Approximately $145,000 was outstanding as of September 30, 2001. The ceiling on the lease line of credit is Cdn$1,000,000 (approximately $640,000). The lease line of credit is not collateralized with cash for the amount of the line that is used for leasing equipment. Our capital requirements depend on a number of factors. In January, April and July, the company completed restructurings of its operations to reduce the cost of operating the business and expects quarterly expenses to be less than the quarter ended September 30, 2001. The company will also have to pay out certain obligations related to these restructurings. We expect to continue to devote resources to continue our research and development efforts, our sales, support efforts, and marketing efforts. Our expenditures have increased substantially since the date of incorporation, but we anticipate that capital expenditures and quarterly expenses will decrease in absolute dollars compared to the September 30, 2001 quarter. At September 30, 2001, we had cash and cash equivalents aggregating $12.4 million. We believe based on current forecasts that our current cash and cash equivalents are sufficient to fund our operations and pay out our obligations as a result of our restructurings for at least the next 12 months. If cash generated from operations is insufficient to meet our long-term liquidity needs, we may need to raise additional funds or seek other financing arrangements. Additional funding may not be available on favorable terms or at all. In addition, although there are no present understandings, commitments or agreements with respect to any acquisition of other businesses, products or technologies, we may, from time to time, evaluate potential acquisitions of other businesses, products and technologies. In order to consummate potential acquisitions, we may issue additional securities or need additional equity or debt financing and any such financing may be dilutive to existing investors. -------------------------------------------------------------------------------- 19 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ RECENT ACCOUNTING PRONOUNCEMENT In prior years, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities" or SFAS No. 133 and Statement of Financial Accounting Standards No. 138, "Accounting for Certain Hedging Activities" or SFAS No. 138, which amended SFAS No. 133. Because the Company currently holds no derivative financial instruments and the Company does not currently engage in hedging activities, the adoption of SFAS No. 133 and SFAS No. 138 has not had a material impact on the Company's financial condition or results of operations. -------------------------------------------------------------------------------- 20 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ RISK FACTORS INVESTING IN OUR COMMON SHARES WILL SUBJECT YOU TO RISKS INHERENT IN OUR BUSINESS. YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING FACTORS AS WELL AS OTHER INFORMATION CONTAINED IN THIS QUARTERLY REPORT ON FORM 10-Q BEFORE DECIDING TO INVEST IN OUR COMMON SHARES. IF ANY OF THE RISKS DESCRIBED BELOW OCCURS, OUR BUSINESS, RESULTS OF OPERATIONS AND FINANCIAL CONDITION COULD BE ADVERSELY AFFECTED. IN SUCH CASES, THE PRICE OF OUR COMMON SHARES COULD DECLINE, AND YOU MAY LOSE PART OR ALL OF YOUR INVESTMENT. RISKS RELATED TO OUR BUSINESS OUR LIMITED OPERATING HISTORY MAKES IT DIFFICULT TO EVALUATE OUR BUSINESS AND FORECAST OUR FUTURE OPERATING RESULTS. We were incorporated on May 7, 1998, and we first recorded revenues in the quarter ended June 30, 1999. We are still in the early stages of our development and have a limited operating history, making it difficult to evaluate our business and prospects. As a result of our limited operating history, it is difficult or impossible for us to predict future operating results. For example, we cannot forecast operating expenses based on our historical results because our historical results are limited and we, to some extent, forecast expenses based on future revenue projections. Moreover, due to our limited operating history, any evaluation of our business and prospects must be made in light of the risks and uncertainties often encountered by early-stage companies in internet-related markets. Many of these risks are discussed in the sub-headings below, and include our ability to execute our product development activities, implement our sales and marketing initiatives, both domestically and internationally, and attract more clients. We may not successfully address any of these risks. FACTORS RELATING TO OUR BUSINESS MAKE OUR FUTURE OPERATING RESULTS UNCERTAIN, AND MAY CAUSE THEM TO FLUCTUATE FROM PERIOD TO PERIOD. Our quarterly revenues and operating results are difficult to predict and may fluctuate significantly from quarter to quarter, particularly because our products and services are relatively new and our prospects are uncertain. If our quarterly revenues or operating results fall below the expectations of investors, the price of our common shares could decline substantially. Factors that might cause quarterly fluctuations in our operating results include the risk factors described in the sub-headings below as well as the following: - the timing of new releases of our products; - changes in our pricing policies or those of our competitors, including the extent to which we may need to offer discounts to match competitors' pricing; - the mix of sales channels through which our products and services are sold; - the mix of our domestic and international sales; - costs related to the customization of our products; - our ability to expand our operations, and the amount and timing of expenditures related to this expansion; - any costs or expenses related to our move to new corporate offices; and, - our operating results may also be affected by the following factors over which we have little or no control: - the evolving and varying demand for interaction-based software products and services for e-businesses, particularly our products and services; - the discretionary nature of our client's purchasing and budgetary cycles; - the timing of execution of large contracts that materially affect our operating results; and - global economic conditions, as well as those specific to large enterprises with high e-mail volume. OUR OPERATING EXPENSES ARE RELATIVELY FIXED, WHICH WOULD CAUSE OUR OPERATING RESULTS TO VARY FROM PERIOD TO PERIOD. Most of our expenses, such as employee compensation and rent, are relatively fixed in the short term. Moreover, our expense levels are based, in part, on our expectations regarding future revenue levels. As a result, if total revenues for a particular quarter are below our expectations, we cannot proportionately reduce operating expenses for that quarter. Therefore, this revenue shortfall would have a disproportionate effect on our operating results for that quarter. -------------------------------------------------------------------------------- 21 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ WE HAVE A HISTORY OF LOSSES, WE MAY INCUR LOSSES IN THE FUTURE. Since we began operations in May 1998, we have incurred substantial operating losses in every quarter. As a result of accumulated operating losses, as of September 30, 2001, we had an accumulated deficit of $206.9 million. For the three months ended September 30, 2001, we had a net loss of $13.2 million, or 333.2% of total revenues for that period. Our revenue in recent periods has been from a limited base of clients, and we may not be able to sustain our revenue. We expect to decrease our operating expenses as part of our restructuring efforts. We may experience losses and negative cash flow, even if sale of our products and services continues to grow, and we may not generate sufficient revenues to achieve profitability in the future. WE ARE DEPENDENT UPON A LIMITED NUMBER OF CLIENTS, AND A LOSS OF ANY OF THESE CLIENTS OR A REDUCTION, DELAY OR CANCELLATION IN ORDERS FROM THESE CLIENTS COULD HARM OUR BUSINESS. To date, a significant portion of the total revenues has been derived from sales to a small number of clients. In the three months ended September 30, 2001, two customers accounted for 29% and 18% of our total revenues, respectively. We expect that we will continue to be dependent upon a limited number of clients for a significant portion of our revenue in future periods. There can be no assurance that our existing clients or any future clients will continue to use our products. A reduction, delay or cancellation in orders from our clients, including reductions or delays due to market, economic or competitive conditions, could have a materially adverse effect on our business, operating results and financial condition. DIFFICULTIES IN IMPLEMENTING OUR PRODUCTS COULD HARM OUR BUSINESS. Our success depends upon the ability of our staff and our clients to implement our products. This implementation typically involves working with sophisticated software, computing and communications systems. If we experience implementation difficulties or do not meet project milestones in a timely manner, we could be obligated to devote more customer support, engineering and other resources to a particular project than anticipated. Some clients may also require us to develop customized features or capabilities. If new or existing clients require more time to deploy our products than is originally anticipated, or require significant amounts of our professional services support or customized features, our revenue recognition could be further delayed and our costs could increase, causing increased variability in our operating results. OUR PRODUCTS AND SERVICES MAY NOT BE ACCEPTED BY THE MARKETPLACE. Of our total revenues of $4.0 million for the three months ended September 30, 2001, $2.1 million were derived from licenses of our products and $1.9 million was from related services. We are not certain that our target clients will widely adopt and deploy our products and services. Our future financial performance will depend on the successful development, introduction and client acceptance of new and enhanced versions of our products. In the future, we may not be successful in marketing our products and services or any new or enhanced products. WE EXPECT TO DEPEND ON SALES OF OUR DELANO INTERACTION SERVER AND APPLICATIONS FOR A SUBSTANTIAL MAJORITY OF OUR REVENUES FOR THE FORESEEABLE FUTURE. In the three months ended September 30, 2001, we derived most of our revenues from licenses of our Delano Interaction Server and applications. Although we have added a new product offering, we expect to continue to derive a substantial majority of our revenues from sales of the Delano Interaction Server and applications for the foreseeable future. Implementation of our strategy depends on our products being able to solve the communication needs of businesses engaging in commercial transactions over the internet or having an internet presence. If current or future clients are not satisfied with our products, our business and operating results could be seriously harmed. WE MUST CONTINUE TO DEVELOP ENHANCEMENTS TO OUR PRODUCTS AND NEW APPLICATIONS AND FEATURES THAT RESPOND TO THE EVOLVING NEEDS OF OUR CLIENTS, RAPID TECHNOLOGICAL CHANGE AND ADVANCES INTRODUCED BY OUR COMPETITORS. Future versions of hardware and software platforms embodying new technologies and the emergence of new industry standards could render our products obsolete. The market for e-business communications software is characterized by: - rapid technological change; - frequent new product introductions; - changes in customer requirements; and -------------------------------------------------------------------------------- 22 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ - evolving industry standards. Our products are designed to work on, or interoperate with, a variety of operating systems used by our clients. However, our software may not operate correctly on evolving versions of operating systems, or the hardware upon which, or with which, they are intended to run or interoperate, programming languages, databases and other systems that our clients use. If we cannot successfully develop these products in response to client demands or improve our existing products to keep pace with technological changes, our business could suffer. We must continually improve the performance, features and reliability of our products, particularly in response to competitive offerings. Our success depends, in part, on our ability to enhance our existing software and to develop new services, functionality and technologies that address the increasingly sophisticated and varied needs of our prospective clients. If we do not properly identify the feature preferences of prospective clients, or if we fail to deliver features that meet the requirements of these clients on a timely basis, our ability to market our products successfully and to increase our revenues will be impaired. DELAYS IN INTRODUCING NEW AND ENHANCED PRODUCTS COULD HARM OUR BUSINESS. The development of proprietary technologies and necessary service enhancements entail significant technical and business risks and requires substantial expenditures and lead time. If we experience product delays in the future we may face: - customer dissatisfaction; - cancellation of orders and license agreements; - negative publicity; - loss of revenues; - slower market acceptance; and - legal action by clients against us. In the future, our efforts to remedy product delays may not be successful and we may lose clients as a result. Delays in bringing to market new products or product enhancements could be exploited by our competitors. If we were to lose market share as a result of lapses in our product development, our business would suffer. INTENSE COMPETITION COULD REDUCE OUR MARKET SHARE AND HARM OUR FINANCIAL PERFORMANCE. The market for our products and services is intensely competitive, evolving and subject to rapid technological change. We expect the intensity of competition to increase in the future. Increased competition may result in price reductions, reduced gross margins and loss of market share. The market for e-business communications software is new and intensely competitive. There are no substantial barriers to entry in this emerging market segment, and we expect established or new entities to enter this market segment in the near future. We currently face competition for our products principally from systems designed by in-house and third-party development efforts. In addition, some of our competitors who currently offer licensed software products are now beginning to offer online offerings, which involve providing software on a rental basis hosted on the hardware of an application service provider, or ASP. We currently do not offer online offerings in any material way. Our competitors include companies providing software that is focused on operational and analytical CRM, such as Kana/Broadbase, e.Piphany, and Xchange Applications. We believe competition will increase as our current competitors increase the sophistication of their offerings and as new participants enter the market. Many of our competitors have longer operating histories, significantly greater financial, technical, marketing and other resources, significantly greater name recognition and a larger installed base of customers than we do. In addition, many of our competitors have well-established relationships with our current and potential clients and have extensive knowledge of our industry. We may lose potential clients to competitors for various reasons, including the ability or willingness of our competitors to offer lower prices and other incentives that we cannot match. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. We also expect that competition may increase as a result of industry consolidations. We may not be able to compete successfully against current and future competitors, and competitive pressures may seriously harm our business. -------------------------------------------------------------------------------- 23 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ THE DELANO INTERACTION SERVER ENABLES THIRD PARTIES TO DEVELOP APPLICATIONS THAT COMPETE WITH OUR APPLICATIONS. Third parties have the ability to develop their own applications on top of the Delano Interaction Server. The applications of these third parties could compete with products developed by us or services which we offer now or will offer in the future. If our target clients do not widely adopt and purchase our products, or if third parties compete with applications developed by us, our business would suffer. FAILURE TO ATTRACT AND RETAIN ADDITIONAL QUALIFIED PERSONNEL COULD ADVERSELY AFFECT OUR BUSINESS. Competition for these individuals is intense in our industry, particularly in the Toronto area where we are headquartered, and there are a limited number of experienced people available with the necessary technical skills. Our ability to increase revenues in the future depends considerably upon our success in retaining and in some cases recruiting additional direct sales personnel and the success of the direct sales force. Our business will be harmed if we fail to hire or retain qualified sales personnel, or if newly hired salespeople fail to develop the necessary sales skills or develop these skills more slowly than we anticipate. We also are substantially dependent upon our ability to develop new products and enhance existing products, and we may not be able to retain highly qualified research and development personnel. Similarly, our failure to attract and retain the highly trained personnel that are integral to our professional services group, which is responsible for the implementation and customization of, and technical support for, our products and services, may limit the rate at which we can develop and install new products or product enhancements, which would harm our business. FAILURE TO INTEGRATE OUR EXECUTIVE TEAM MAY INTERFERE WITH OPERATIONS. Our executive team has largely been hired in the past two years. To integrate into our company, these individuals must spend a significant amount of time developing interpersonal relationships and learning our business model and management system, in addition to performing their regular duties. Accordingly, the integration of new personnel has resulted, and may continue to result, in some disruption of our ongoing operations. OUR FUTURE REVENUE GROWTH COULD BE IMPAIRED IF WE ARE UNABLE TO DEVELOP ADDITIONAL DISTRIBUTION CHANNELS FOR OUR PRODUCTS. We believe that our success in penetrating our target markets depends in part on our ability to enter into agreements with established third-party distribution companies, consulting organizations and software vendors relating to the distribution of our products. We have entered into non-exclusive distribution agreements with various parties, including Nortel Networks, Deloitte Consulting and PricewaterhouseCoopers. Since these agreements are non-exclusive and normally terminable without penalty on short notice, some third parties may choose to discontinue working with us or may decide to work with our competitors. We derive revenues from these agreements through the sale of licenses. We may not be able to derive significant revenues in the future from these agreements. WE HAVE COMPLETED TWO ACQUISITIONS, AND THOSE ACQUISITIONS MAY RESULT IN DISRUPTIONS TO OUR BUSINESS AND MANAGEMENT DUE TO DIFFICULTIES IN ASSIMILATING PERSONNEL AND OPERATIONS. We may not realize the benefits from the acquisitions we have completed. In September 2000, we acquired Continuity, and in October 2000, we acquired Digital Archaeology. In July, 2001 we completed a restructuring of our operations that resulted in a reduction of many of the employees from the acquired companies. We may not be able to successfully assimilate the remaining personnel, operations, acquired technology and products into our business. This is particularly difficult since Digital Archaeology's operation is located in Kansas while we are headquartered in Markham, Canada. Key personnel from the acquired companies may in the future decide that they do not want to work for us. In addition, products of these companies will have to be integrated into our products, and it is uncertain whether we may accomplish this easily or at all. These difficulties could disrupt our ongoing business, distract management and employees or increase expenses. Acquisitions are inherently risky and we may also face unexpected costs, which may adversely affect operating results in any quarter. THE ACQUISITIONS OF CONTINUITY AND DIGITAL ARCHAEOLOGY INTO OUR COMPANY COULD ADVERSELY AFFECT OUR COMBINED FINANCIAL RESULTS. If the benefits of the acquisitions of Continuity and DA into our company do not exceed the costs associated with these acquisitions, including any dilution to our stockholders resulting from the issuance of shares in connection with the acquisitions, our financial results, including earnings per share, could be adversely affected. -------------------------------------------------------------------------------- 24 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ IF WE ACQUIRE ADDITIONAL COMPANIES, PRODUCTS OR TECHNOLOGIES, WE MAY FACE RISKS SIMILAR TO THOSE FACED IN OUR OTHER ACQUISITIONS. If we are presented with appropriate opportunities, we may make other investments in complementary companies, products or technologies. We may not realize the anticipated benefits of any other acquisition or investment. If we acquire another company, we will likely face the same risks, uncertainties and disruptions as discussed above with respect to our other acquisitions. Furthermore, we may have to incur debt or issue equity securities to pay for any additional future acquisitions or investments, the issuance of which could be dilutive to our company or our existing stockholders. In addition, our profitability may suffer because of acquisition-related costs or amortization costs for acquired goodwill and other intangible assets. WE MAY SEEK TO GROW BY MAKING ACQUISITIONS AND WE MAY NOT BE ABLE TO SUCCESSFULLY COMPLETE ANY ACQUISITIONS WE UNDERTAKE OR INTEGRATE ANY ACQUIRED BUSINESS WITH OUR OWN. We may consider other investments in complementary companies, products or technologies. If we undertake such an acquisition or investment, we may not realize the anticipated benefits. If we buy a company, we may not be able to successfully assimilate the acquired personnel, operations, technology and products into our business. In particular, we will need to assimilate and retain key technical, professional services, sales and marketing personnel. In addition, acquired products or technology will have to be integrated into our products and technology, and it is uncertain whether we may accomplish this. These difficulties could disrupt our ongoing business, distract our management and employees or increase our expenses. In connection with a merger, or acquisition for shares, the issuance of these securities may be dilutive to our existing shareholders or affect profitability. Furthermore, we may have to issue equity or incur debt to pay for future acquisitions or investments, the issuance of which could be dilutive to us or our existing shareholders or affect our profitability. In addition, our profitability may suffer because of acquisition-related costs or amortization costs for acquired goodwill and other acquired intangible assets. WE MAY NEED TO RAISE ADDITIONAL CAPITAL TO GROW OUR BUSINESS, WHICH WE MAY NOT BE ABLE TO DO. Our future liquidity and capital requirements are difficult to predict because they depend on numerous factors, including the success of our existing and new service offerings as well as competing technological and market developments. As a result, we may not be able to generate sufficient cash from our operations to meet additional working capital requirements, support additional capital expenditures or take advantage of acquisition opportunities. Accordingly, we may need to raise additional capital in the future. Our ability to obtain additional financing will be subject to a number of factors, including market conditions and our operating performance. These factors may make the timing, amount, terms and conditions of additional financing unattractive for us. If we raise additional funds by selling equity securities, the relative equity ownership of our existing investors could be diluted or the new investors could obtain terms more favorable than previous investors. If we raise additional funds through debt financing, we could incur significant borrowing costs. If we are unable to raise additional funds when needed, our ability to operate and grow our business could be impeded. TECHNICAL PROBLEMS WITH INTERNAL OR OUTSOURCED COMPUTER AND COMMUNICATIONS SYSTEMS COULD RESULT IN REDUCED REVENUES AND HARM TO OUR REPUTATION. The success of our online support services depends on the efficient and uninterrupted operation of our own and outsourced computer and communications hardware and software systems. These systems and operations are vulnerable to damage or interruption from human error, natural disasters, telecommunications failures, break-ins, sabotage, computer viruses and similar adverse events. Our operations depend on our ability to protect our systems against damage or interruption. We cannot guarantee that our internet access will be uninterrupted, error-free or secure. We have no formal disaster recovery plan in the event of damage or interruption, and our insurance policies may not adequately compensate us for losses that we may incur. Any system failure that causes an interruption in our service or a decrease in responsiveness could harm our relationships with our clients and result in reduced revenues. FAILURE TO SELL ONLINE SERVICES MAY IMPAIR OUR FUTURE REVENUE GROWTH. We currently focus primarily on software sales rather than online offerings. Our competitors may move to a heavier emphasis on online offerings, and our failure to focus on it at an early stage may make it difficult to compete if online offerings become a dominant means of generating revenues within the industry. In addition, although our sales force sells both our software products and online offerings, the skills necessary to market and sell online offerings are different than -------------------------------------------------------------------------------- 25 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ those relating to our software products. As a result, our sales and marketing groups may not be able to maintain or increase the level of sales of our online offerings. A DECLINE IN OUR LICENSE REVENUES COULD CAUSE A DECLINE IN OUR SERVICE REVENUES. Our products are designed to enable customers to rapidly develop and deploy e-business communication applications. Where desirable, our professional services group can assist our clients' internal IT personnel to implement our products. Because the revenues associated with these services are largely correlated with the licensing of our products, a decline in license revenues could also cause a decline in our service revenues. CONFLICTS BETWEEN OUR PRODUCTS AND OTHER VENDORS' PRODUCTS COULD HARM OUR BUSINESS AND REPUTATION. Our clients generally use our products together with products from other companies. As a result, when problems occur in the network, it may be difficult to identify the source of the problem. Even when these problems are not caused by our products, they may cause us to incur significant warranty and repair costs, divert the attention of our engineering personnel from our product development efforts and cause significant customer relations problems. OUR SUCCESS DEPENDS ON OUR ABILITY TO PROTECT OUR PROPRIETARY RIGHTS. We rely on contractual restrictions, such as confidentiality agreements and licenses, to establish and protect our proprietary rights. None of our trademarks is registered, nor do we have any trademark applications pending. We currently have no patent applications pending relating to our software. Despite any precautions that we take to protect our intellectual property: - laws and contractual restrictions may be insufficient to prevent misappropriation of our technology or deter others from developing similar technologies; - current laws that prohibit software copying provide only limited protection from software "pirates", and effective trademark, copyright and trade secret protection may be unavailable or limited in foreign countries; - other companies may claim common law trademark rights based upon state, provincial or foreign laws that precede any registrations we may receive for our trademarks; and - policing unauthorized use of our products and trademarks is difficult, expensive and time-consuming, and we may be unable to determine the extent of this unauthorized use. It is possible that our intellectual property rights could be successfully challenged by one or more third parties, which could result in our inability to exploit, or our loss of the right to prevent others from exploiting, certain intellectual property. We are aware that certain of our competitors have filed patent applications. Also, the laws of other countries in which we market our products may offer little or no effective protection of our technology. Reverse engineering, unauthorized copying or other misappropriation of our technology could enable third parties to benefit from our technology without paying us for it, which would significantly harm our business. WE RELY ON SOFTWARE LICENSED TO US BY THIRD PARTIES FOR FEATURES WE INCLUDE IN OUR PRODUCTS. We use and in the future will use certain software technologies and other information that we license or otherwise acquire from third parties, usually on a non-exclusive basis, including software that is integrated with our internally developed software and used in our products to perform what may be important functions. If we are not able to continue to use the third-party software and technologies, or if they fail to adequately update and support their products, we could suffer delays or reductions in shipments of our products until alternative software and technologies could be identified, which could adversely affect our business and financial condition. CLAIMS BY OTHER COMPANIES THAT OUR PRODUCTS INFRINGE THEIR PROPRIETARY RIGHTS COULD ADVERSELY AFFECT OUR ABILITY TO SELL OUR PRODUCTS AND INCREASE OUR COSTS. Substantial litigation over intellectual property rights exists in our industry. We expect that software in our industry may be increasingly subject to third-party infringement claims as the numbers of competitors grow and the functionality of products in different industry segments overlap. Third parties may currently have, or may eventually be issued patents that our products or technology infringe. -------------------------------------------------------------------------------- 26 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ Any of these third parties might make a claim of infringement against us. Many of our software license agreements require us to indemnify our clients and suppliers from any claim or finding of intellectual property infringement. Any litigation, brought by us or others, could result in the expenditure of significant financial resources and the diversion of management's time and efforts. In addition, litigation in which we are accused of infringement might cause negative publicity, have an impact on prospective clients, cause product shipment delays, require us to develop non-infringing technology or require us to enter into royalty or license agreements, which might not be available on acceptable terms, or at all. If a successful claim of infringement were made against us and we could not develop non-infringing technology or license the infringed or similar technology on a timely and cost-effective basis, our business could be significantly harmed. OUR INSURANCE MAY NOT BE SUFFICIENT TO COVER ALL POTENTIAL PRODUCT LIABILITY AND WARRANTY CLAIMS. Our products are integrated into our client's networks. The sale and support of our products results in the risk of product liability or warranty claims based on damage to these networks. In addition, the failure of our products to perform to client expectations could give rise to warranty claims. Although we carry general liability insurance, our insurance would likely not cover potential claims of this type or may not be adequate to protect us from all liability that may be imposed. OUR PRODUCTS COULD CONTAIN UNDETECTED DEFECTS OR ERRORS. We face the possibility of higher costs as a result of the complexity of our products and the potential for undetected errors. Due to the mission-critical nature of our products and services, undetected errors are of particular concern. We have only a limited number of clients that test new features and the functionality of our software before we make these features and functionalities generally available. If our software contains undetected errors or we fail to meet our client's expectations in a timely manner, we could experience: - loss of, or delay in revenues expected from the new product and an immediate and significant loss of market share; - loss of existing clients that upgrade to the new product and of new clients; - failure to achieve market acceptance; - diversion of development resources; - injury to our reputation; - increased service and warranty costs; - legal actions by clients against us; and - increased insurance costs. A product liability claim could harm our business by increasing our costs, damaging our reputation and distracting our management. OUR INTERNATIONAL EXPANSION EFFORTS MAY NOT BE SUCCESSFUL. Our operations outside the United States and Canada are located in the United Kingdom and Asia and, to date, have been limited. We may expand our existing international operations and establish additional facilities in other parts of Asia via our joint venture, specifically Australia, Singapore, Hong Kong, Taiwan, Malaysia, Korea, Indonesia, China, New Zealand and Thailand. We intend to increase our penetration of these markets by intensifying global activities, and allying ourselves with selected international third-party distribution companies, consulting organizations and software vendors. The expansion of our existing international operations and entry into additional international markets are key parts of our growth strategy and may require significant management attention and financial resources. In addition, to expand our international sales operations, we will need to, among other things: - expand our international sales channel management and support organizations; - develop relationships with international service providers and additional distributors and systems integrators; and - customize our products for local markets. Our investments in facilities in other countries may not produce desired levels of revenues. Even if we are able to expand our international operations successfully, we may not be able to maintain or increase international market demand for our products. -------------------------------------------------------------------------------- 27 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ OUR BUSINESS MAY SUFFER IF WE FAIL TO ADAPT APPROPRIATELY TO THE CHALLENGES ASSOCIATED WITH OPERATING INTERNATIONALLY. Expanding our operations outside the United States and Canada subjects us to numerous inherent potential risks associated with international operations. These risks include greater difficulty in accounts receivable collection, the burden of complying with multiple and conflicting regulatory requirements, foreign exchange controls, longer payment cycles, import and export restrictions and tariffs, potentially adverse tax consequences, and political and economic instability, any of which could impair our sales and results of operations. In addition, our ability to expand our business in certain countries will require modification of our products, particularly domestic language support. Our international operations will increase our exposure to international laws and regulations. If we cannot comply with foreign laws and regulations, which are often complex and subject to variation and unexpected changes, we could incur unexpected costs and potential litigation. For example, the governments of foreign countries might attempt to regulate our products and services or levy sales or other taxes relating to our activities. In addition, foreign countries may impose tariffs, duties, price controls or other restrictions on foreign currencies or trade barriers, any of which could make it more difficult to conduct our business. The European Union, in which we have a sales office, recently enacted its own privacy regulations that may result in limits on the collection and use of certain user information, which, if applied to the sale of our products and services, could negatively impact our results of operations. FLUCTUATIONS IN EXCHANGE RATES MAY AFFECT OUR OPERATING RESULTS. A substantial portion of our revenues are now, and are expected to continue to be, realized in currencies other than Canadian dollars. Our operating expenses are primarily paid in Canadian dollars. Fluctuations in the exchange rate between the Canadian dollar and these other currencies may have a material effect on our results of operations. In particular, we may be adversely affected by a significant strengthening of the Canadian dollar against the U.S. dollar. We do not currently engage in currency hedging activities. We have not yet, but may in the future, experience significant foreign exchange rate losses, especially to the extent that we do not engage in hedging. IF WE ARE OR BECOME A PASSIVE FOREIGN INVESTMENT COMPANY WE MAY NOT BE ABLE TO SATISFY RECORD-KEEPING REQUIREMENTS, WHICH COULD HAVE ADVERSE U.S. TAX CONSEQUENCES TO YOU. The rules governing passive foreign investment companies can have significant effects on U.S. investors. We could be classified as a passive foreign investment company if, for any taxable year, either: - 75% or more of our gross income is passive income, which includes interest, dividends and some types of rents and royalties; or - the average percentage, by fair market value, or, in some cases, by adjusted tax basis, of our assets that produce or are held for the production of passive income is 50% or more. Distributions which constitute "excess distributions," as defined in Section 1291 of the Internal Revenue Code, from a passive foreign investment company and dispositions of shares of a passive foreign investment company are subject to the highest rate of tax on ordinary income in effect and to an interest charge based on the value of the tax deferred during the period during which the shares are owned. However, these rules generally will not apply if the U.S. investor elects to treat the passive foreign investment company as a qualified electing fund under Section 1295 of the Internal Revenue Code. If we are or become a passive foreign investment company we may not be able to satisfy record-keeping requirements that would permit you to make a qualified electing fund election. RISKS RELATED TO OUR INDUSTRY OUR FUTURE REVENUES AND PROFITS DEPEND ON THE CONTINUED GROWTH IN USE AND EFFICIENT OPERATION OF THE INTERNET AND E-MAIL. We sell our products and services primarily to organizations that receive large volumes of e-mail and communications over the web. Consequently, our future revenues and profits, if any, substantially depend upon the continued acceptance and use of the web and e-mail, which are evolving as communications media. Rapid growth in the use of e-mail is a recent phenomenon and may not continue. As a result, a broad base of enterprises that use e-mail as a primary means of communication may not develop or be maintained. Moreover, companies that have already invested significant resources in -------------------------------------------------------------------------------- 28 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ other methods of communications with customers, such as call centers, may be reluctant to adopt a new strategy that may limit or compete with their existing investments. If businesses do not continue to accept the web and e-mail as communications media, our business would suffer. GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES RELATING TO THE INTERNET COULD DISCOURAGE COMMUNICATION BY E-MAIL OR OTHER INTERNET-BASED COMMUNICATIONS FACILITATED BY OUR PRODUCTS. Due to the increasing popularity and use of the internet, it is possible that Canadian and U.S. federal, Canadian provincial, U.S. state, and other foreign regulators could adopt laws and regulations that impose additional burdens on those companies that conduct business online. These laws and regulations could discourage communication by e-mail or other internet-based communications facilitated by our products, which could reduce demand for our products and services. The growth and development of the market for online services may prompt calls for more stringent consumer protection laws or laws that may inhibit the use of internet-based communications or the information contained in these communications. The adoption of any additional laws or regulations may slow the growth of the internet. A decline in the growth of the internet, particularly as it relates to online communication, could decrease demand for our products and services and increase our cost of doing business, or otherwise harm our business. BECAUSE WE ARE A CANADIAN COMPANY, IT MAY BE DIFFICULT FOR YOU TO ENFORCE AGAINST US LIABILITIES BASED SOLELY UPON THE FEDERAL SECURITIES LAWS OF THE UNITED STATES. We have been incorporated under the laws of the Province of Ontario, and our executive offices are located in Ontario. Many of our directors, controlling persons and officers, and representatives of the experts named in our Annual Report on Form 10-K, are residents of Canada and a substantial portion of their assets and a majority of our assets are located outside the United States. Consequently, it may be difficult for you to enforce against us or any of our directors, controlling persons, officers or experts who are not resident in the United States, liabilities based solely upon the federal securities laws of the United States. OUR BOARD OF DIRECTORS MAY ISSUE, WITHOUT SHAREHOLDER APPROVAL, PREFERENCE SHARES THAT HAVE RIGHTS AND PREFERENCES SUPERIOR TO THOSE OF COMMON SHARES AND THAT MAY DELAY OR PREVENT A CHANGE OF CONTROL. Our articles of incorporation allow the issuance an unlimited number of preference shares in one or more series. After the offering, there will be no preference shares outstanding. However, our board of directors may set the rights and preferences of any class of preference shares in its sole discretion without the approval of the holders of common shares. The rights and preferences of these preference shares may be superior to those of the common shares. Accordingly, the issuance of preference shares may adversely affect the rights of holders of common shares. The issuance of preference shares also could have the effect of delaying or preventing a change of control of our company. WE DO NOT INTEND TO PAY ANY DIVIDENDS ON OUR COMMON SHARES. We have not paid any cash dividends on our shares and we currently do not have any plans to pay dividends on our shares. In addition, our lease line of credit specifically prohibits the payment of dividends on our shares. ITEM 3: QUALITATIVE AND QUANTITATIVE MARKET RISK We develop products in Canada and sell these products in North America, Europe and Asia Pacific. Generally, our sales are made in local currency, which to date has been mostly United States dollars. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. We do not currently use derivative instruments to hedge our foreign exchange risk. Our interest income is sensitive to changes in the general level of U.S. interest rates, particularly since the majority of our investments are in short-term instruments. Due to the nature of our short-term investments, we have concluded that there is no material market risk exposure. -------------------------------------------------------------------------------- 29 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ PART II: OTHER INFORMATION ITEM 1: LEGAL PROCEEDINGS On February 22, 2001, We Media, Inc. ("WeMedia") filed a lawsuit against the Company in the Supreme Court for the State of New York, County of New York. During the three months ended September 30, 2001, the Company successfully settled the lawsuit filed against it by We Media, Inc. During the period from August 2 to October 1, 2001, three purported securities class action lawsuits were filed against the Company in the U.S. District Court for the Southern District of New York, Shapiro, et al. v. Delano Technology Corporation, et al., Ellis Investments Ltd, et al. v. Delano Technology Corporation, et al., and Wendy and Joe Scavuzzo, et al. v. Delano Technology Corporation, et al. The complaints also name one or more of the Company's underwriters in the Company's initial public offering and certain officers and directors of the Company. The complaints allege violations of the federal securities laws regarding statements in the Company's initial public offering registration statement concerning the underwriters' activities in connection with the underwriting of the Company's shares to the public. The actions seek rescission of the plaintiff's alleged purchases of Company stock and other damages and costs associated with the litigation. Various plaintiffs have filed similar actions asserting virtually identical allegations against more than 100 other companies. The Company believes it has meritorious defenses to these lawsuits and will vigorously defend itself. ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS Not applicable ITEM 3: DEFAULTS UPON SENIOR SECURITIES Not applicable ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company's annual and special meeting of stockholders was held on July 26, 2001 and the following matters were considered and voted upon: To approve the election of each of following to serve as a member of Delano's Board of Directors: Dennis Bennie, Bahman Koohestani, Albert Amato, J. Ian Giffen, Donald Woodley, Al DeLorenzi and Vikas Kapoor Common Stock: FOR: 14,501,910 WITHHOLD: 47,167 To approve the selection and appointment of KPMG LLP as Delano's independent public accountants. Common Stock: FOR: 14,443,065 WITHHOLD: 123,048 To approve an amendment of the Employee Stock Purchase Plan (the "ESPP") to reserve an additional 2,000,000 Common Shares for issuance, which will bring the total number of Common Shares reserved for issuance under the ESPP to 2,538,177. Common Stock: FOR: 10,204,043 AGAINST: 288,018 -------------------------------------------------------------------------------- 30 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ ITEM 5: OTHER INFORMATION Not applicable ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K Not applicable -------------------------------------------------------------------------------- 31 DELANO TECHNOLOGY CORPORATION - 10 Q - Quarterly Report ================================================================================ SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereto duly authorized. November 9, 2001 Delano Technology Corporation Chief Executive Officer /s/ VIKAS KAPOOR (Principal Executive Officer) ------------------------------------------- Vikas Kapoor Chief Financial Officer /s/ THOMAS HEARNE (Principal Financial Officer ------------------------------------------- And Principal Accounting Officer) Thomas Hearne -------------------------------------------------------------------------------- 32

DELANO TECHNOLOGY CORP 10-Q