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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED MAY 31, 1996
COMMISSION FILE NUMBER 0-26880
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VERITY, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0182779
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
894 ROSS DRIVE
SUNNYVALE, CALIFORNIA 94089
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 541-1500
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $0.001 PAR VALUE
(TITLE OF CLASS)
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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 ____
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. /X/
The aggregate market value of the voting stock held by non-affiliates of
the registrant, based upon the closing price of the Common Stock on May 31,
1996, as reported on Nasdaq National Market was approximately $249,572,000.
Shares of Common Stock held by each executive officer and director and by each
person who owned 5% or more of the outstanding Common Stock as of such date have
been excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
The number of shares of the registrant's $0.001 par value Common Stock
outstanding on May 31, 1996, was 10,735,000.
Part III incorporates by reference from the definitive proxy statement for
the registrant's 1996 annual meeting of stockholders to be filed with the
Commission pursuant to Regulation 14A not later than 120 days after the end of
the fiscal year covered by this Form.
This report consists of 51 sequentially numbered pages, with the Index to
Exhibits commencing on page 47.
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TABLE OF CONTENTS
PAGE
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Part I................................................................................ 1
Item 1. Business.................................................................... 1
Item 2. Properties.................................................................. 10
Item 3. Legal Proceedings........................................................... 10
Item 4. Submission of Matters to a Vote of Securities Holders....................... 10
Part II............................................................................... 10
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters.... 10
Item 6. Selected Consolidated Financial Data........................................ 12
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations....................................................................... 13
Item 8. Financial Statements and Supplementary Data................................. 27
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure....................................................................... 27
Part III.............................................................................. 27
Item 10. Directors and Executive Officers of the Registrant......................... 27
Item 11. Executive Compensation..................................................... 27
Item 12. Security Ownership of Certain Beneficial Owners and Management............. 28
Item 13. Certain Relationships and Related Transactions............................. 28
Part IV............................................................................... 28
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K........... 28
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PART I
This report includes a number of forward-looking statements which reflect
the Company's current views with respect to future events and financial
performance. These forward-looking statements are subject to certain risks and
uncertainties, including those discussed below, that could cause actual results
to differ materially from historical results or those anticipated. In this
report, the words "anticipates," "believes," "expects," "intends," "future" and
similar expressions identify forward-looking statements. Readers are cautioned
not to place undue reliance on these forward-looking statements, which speak
only as of the date hereof.
ITEM 1. BUSINESS
Verity develops, markets and supports software tools and applications that
enable individuals, enterprises and publishers to intelligently search, filter
and disseminate textual information residing on enterprise networks, online
services, the Internet, CD-ROM and other electronic media. The Company believes
that growth in the volume and variety of available information has made it
increasingly important for individuals, businesses, government agencies and
information publishers to be able to search, filter and disseminate information
according to their particular criteria. The Company's Topic family of products
is designed to address these needs by providing rapid and timely search,
retrieval and categorization of archived textual information, as well as
real-time monitoring and filtering of information selected from dynamic text
files. Users are able to conduct personalized searches across Topic-indexed
information stored within multiple sources and formats. Verity's Topic
technology has been deployed within the Company's own suite of applications, and
also as an embedded feature within broadly distributed third-party software
applications, including Lotus Notes and Adobe Acrobat. Verity has recently
extended its product line to address the requirements of Internet users, and has
licensed its Topic technology to prominent providers of Internet products and
online services, including AT&T WorldNet Services, Netscape Communications,
NetManage, Quarterdeck and MCI's Delphi Internet, together with Internet
publishers, including Cisco Systems, Compaq Computer and Tandem Computer. Topic
software has been licensed to approximately 600 corporations, government
agencies, software developers, online service providers and Internet publishers.
Verity was incorporated in California in March 1988 and reincorporated in
Delaware in September 1995. The Company's principal executive offices are
located at 894 Ross Avenue, Sunnyvale, CA 94089, and the telephone number at
that address is (408) 541-1500. Verity's home page on the Web can be located at
http://www.verity.com.
INDUSTRY BACKGROUND
In recent years, significant advances in computer-based technologies have
enabled users to gain access to an unprecedented amount and breadth of
information. The increased power and decreased cost of personal computers and
workstations, together with the proliferation of networked computing
environments and improvements in document authoring software, have dramatically
improved a user's ability to electronically produce, publish, store, analyze and
rapidly process significant amounts of information. Within large business
enterprises, users commonly communicate with each other through e-mail and share
and gain access to various information resources through local area networks
(LANs), wide area networks (WANs) and the Internet.
A substantial amount of the available electronic information both within
the enterprise and on the Internet is "unstructured" textual information.
Currently, such information is created and stored electronically in a variety of
different formats, including Adobe's Portable Document Format ("PDF"), Microsoft
Word, Novell's WordPerfect, Standard Generalized Mark-up Language ("SGML"),
Hypertext Mark-up Language ("HTML") or even ASCII. In addition, the physical
location or source of unstructured information varies widely, including CD-ROM,
Lotus Notes databases, and dynamic information sources such as e-mail, changing
text files or newswire feeds.
Historically, there have not been generally available integrated solutions
to efficiently search, filter and assimilate the now vast amounts and varieties
of unstructured textual information in part due to technical
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challenges associated with interpreting unstructured information in its native
format. Thus, users desiring access to information residing in a variety of
formats and located within multiple sources typically have been required either
to export and re-index native documents into a single format comprehensible by
their text search and retrieval application, or to conduct duplicate queries
with multiple search and retrieval applications.
Most search and retrieval software applications operate by conducting
searches for information based upon the particular criteria or "query" specified
by the user. However, the query technology historically employed by most
applications has been relatively limited in its ability to generate precise
results. Simple search solutions have lacked the capacity to express the user's
interests and preferences with any significant degree of precision, and more
intricate searches have been difficult and time-consuming to construct and
modify.
Information consumers increasingly wish to conduct broad "horizontal"
searches over vast amounts of information stored in diverse formats and located
within disparate sources. They also seek to easily define sophisticated queries
that effectively narrow search results to meet their personal needs. Users want
to be able to re-use and refine their queries, and to supplement retrospective
searches with the capacity to watch dynamic text files and filter out relevant
information while performing other tasks. The needs of information consumers are
shared by information publishers, who also wish to deliver relevant information
to targeted audience segments within a broad base of users, and to present
information in an organized, useful format.
The Company believes that, in light of the vastly increased amounts of
available electronic information and a significantly increased base of
information consumers, a substantial market opportunity exists for solutions
addressing the diverse requirements of enterprises, publishers and applications
developers to search, filter and disseminate relevant and useful information.
THE VERITY SOLUTION
Verity's tools and applications enable individuals, enterprises and
publishers to intelligently search, filter and disseminate unstructured textual
information. The Company has deployed its Topic technology in a variety of
product offerings, both on a stand-alone basis and as part of third-party
applications, to meet the diverse requirements of businesses, government
agencies and information publishers. The Company's Topic technology employs
multiple search techniques to locate Topic-indexed textual information stored in
a variety of formats. Certain of the Company's products also utilize Topic
technology to permit search within multiple sources, such as an Adobe Acrobat
database and a database of word processing documents, from the same user
interface. The Company's products organize and rank the relevance of selected
information, thereby enabling users to filter and evaluate information
personalized to their specific needs and interests. The Topic system enables
users to both interactively query and browse for specific information, and also
to deploy software agents to continuously monitor dynamic information streams
and automatically notify users of new and relevant information responsive to
their specific requests.
The Company originally developed its core Topic technology for use by large
government agencies, such as the Central Intelligence Agency and the National
Security Agency, to perform complex, customized search and retrieval
applications. In the past three years, Verity has enhanced and expanded the
Company's Topic family of products and now offers or has under development a
number of products designed to address the markets for enterprise, CD-ROM,
online and Internet dissemination of electronic information.
Intranet/Enterprise. The Company markets an integrated client/server
solution to enterprises such as corporations and government agencies for
searching, retrieving and filtering enterprise textual information residing in a
variety of word processing and publishing document formats and residing within
database management systems, as well as intranet servers deployed within the
enterprise.
Development Tools. The Company offers a development toolkit that allows
software developers to embed the Company's search-and-retrieval engine within
their products.
Internet/Publishing. The Company's Internet products are designed to
supplement the hypertext capabilities of standard Web servers to provide
Internet publishers with an integrated solution enabling
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navigating and searching for the publishers' information. The Company offers an
integrated solution for CD-ROM publishers which is designed to provide, from a
single Web browser interface, capability for searching over both local CD-ROM
and updated Topic-indexed information located on a Web server.
Online. The Company has developed products, primarily for online
information publishers and corporate end users, designed to offer personalized
information filtering of dynamic document files and "live" newsfeeds. These
products are designed to be scalable to support the high data and user volumes
associated with large online services.
Groupware. The Company's add-on product for Lotus Notes provides users
with advanced searching across data residing within Lotus Notes databases. The
Company has under development an add-on product for the Microsoft Exchange
Server which is designed to provide users with advanced searching and filtering
capabilities across data residing both inside the Microsoft Exchange Server
environment and within other Topic-indexed repositories in the enterprise.
PRODUCTS
The Company's products include the following:
Topic Enterprise Server and Topic Client. These products together
provide an integrated client/server solution for corporations and
government agencies to access enterprise data across popular platforms and
formats. Topic Client operates on the Windows 3.1 and Windows 95 graphical
user interface (and Verity has under development Macintosh and Motif
interfaces), and is designed to search enterprise databases created by the
Topic Enterprise Server as well as those created by products from Verity
OEM partners such as Adobe Acrobat. Topic Client is also being designed to
search enterprise databases created by Lotus Notes (Version 4) as well.
Topic Agents is designed to perform retrospective searches, watch
proactively for information across multiple data sources and deliver
relevant information to the user. The Topic architecture is designed to
scale from standalone systems to the enterprise, and is capable of
supporting millions of documents and over one thousand simultaneous users.
Topic Developer's Toolkit. The Company's Topic Developer's Toolkit
("TDK") is a software development kit for building and embedding the topic
engine into applications and information services. TDK includes a
C-callable API (consisting of a library of program routines which can be
called or accessed to implement different features of the Company's
technology) and sample applications which permit third-party OEM developers
to create a customized user interface for the Topic engine.
Topic Internet Server and Topic CD Publisher. These products
incorporate the Topic search engine to address requirements of Internet
users. Topic CD Publisher is designed to complement the hypertext
navigational capabilities of the Web by communicating with standard Web
servers via a customizable gateway program. The Topic Internet Server
should be useful to businesses and other organizations who seek to publish
information internally or externally using the Web, and for information
publishers attempting to reach an Internet subscriber base. Verity's Topic
CD Publisher product is designed to integrate CD-ROM and World Wide Web
publishing, supporting both desktop and remote search and retrieval.
Through a standard Web browser interface, Topic CD Publisher provides an
integrated solution for searching over both local CD-ROM and remote
Internet data.
Topic Agent Server and Topic Newswire Access. These products are
designed to provide publishers, online information providers and corporate
end users a solution to provide personalized information analysis and
filtering of documents. The Topic Newswire Access product is designed to
add newswire feeds to Topic databases. The Topic Agent Server is designed
to monitor static and dynamic information sources and automatically deliver
relevant data directly to users via popular delivery mechanisms such as the
Internet, electronic mail, and eventually Topic Client and Lotus Notes.
These products are scalable to support the high data and user volumes
associated with large online services.
Topic Client for Lotus Notes and Topic for Microsoft Exchange. Topic
Client for Lotus Notes supplements the embedded Topic functionality within
Lotus Notes with advanced Topic search features such as topics, thesauri
and dictionaries. Topic for Microsoft Exchange enables users of Microsoft
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Exchange to deploy advanced searching and filtering capabilities across
data obtained from outside sources and residing within the Microsoft
Exchange Server environment, respectively.
SERVICES
The Company makes available extensive technical support and training
services for its customers, and also provides consulting services designed to
assist its customers in utilizing Topic software to develop custom search and
retrieval applications. As of May 31, 1996, the Company employed 14 people in
its technical support organization, 10 people in its consulting group, and 3
people focused on providing training services.
Technical Support and Maintenance. The Company provides post-sale customer
support directly through its own technical support engineers, who handle most
support calls by telephone. The Company offers annual maintenance contracts to
its customers which entitle them to full telephone support service, software
updates and bug fixes. The Company also provides its customers access to
technical support services by electronic mail and over a bulletin board system.
Consulting. The Company offers consulting services to its enterprise
customers, OEMs, VARs and SIs to assist them in designing and deploying Topic
applications tailored to meet their particular information search and retrieval
needs. Consulting services have typically been offered on a time and materials
basis. Since early 1994, consistent with the Company's strategy to de-emphasize
its relatively low-margin consulting services business, the Company has reduced
headcount in the consulting group. The Company has also significantly
streamlined the API for its Topic search engine to reduce the need for
specialized consulting services in connection with the incorporation by OEMs and
other third parties of the Company's search technology. Revenues derived from
consulting services have declined in each of fiscal 1994, 1995, and 1996.
However, the Company does not anticipate further material reductions in
headcount associated with its consulting business for the foreseeable future.
Training. The Company provides training services at its own training
facilities located in Sunnyvale, California, as well as at the facilities of its
enterprise customers, VARs and SIs worldwide. The Company also provides training
through certain authorized third parties. Verity has developed an extensive set
of courses and materials for presentation by its professional instructors. The
Company believes its high quality training helps assure increased customer
satisfaction while enhancing the Company's ability to make additional sales to
its existing customer base. Customers typically pay for training services on a
course or fee basis.
CUSTOMERS
Topic software has been licensed directly to approximately 600
corporations, government agencies, software developers, online service providers
and Internet publishers.
Through fiscal 1995, the substantial majority of the Company's revenues
were derived from the licensing of applications for use by large corporations
and government agencies. Since early fiscal 1994, Verity has pursued a strategy
to focus on providing more versatile, lower-priced software applications which
address a broader set of information media and platforms. The tools, online and
Internet markets are rapidly evolving and are characterized by an increasing
number of market entrants who have introduced or developed products and services
for search and retrieval over private and public networks, online services and
the Internet. As is typical in the case of a new and rapidly evolving industry,
demand and market acceptance for recently introduced products and services are
subject to a high level of uncertainty. There can be no assurance that the use
of intelligent information retrieval and filtering technologies will become
widespread in these or any markets, or that the Company's products or
technologies will achieve market acceptance.
SALES AND MARKETING
The Company's goal is to make its software a de facto standard and the most
popular means to search, filter and disseminate information on the desktop,
within the enterprise, and beyond the enterprise on the Internet and online
services. Verity seeks to tailor its marketing and sales efforts to most
effectively reach customers in each of these market segments. The Company
pursues opportunities within large organizations
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and government agencies through the combined efforts of the Company's direct
sales and telesales forces. The Company's products and tools are sold indirectly
through a network of VARs, SIs and OEMs.
Direct Sales. Members of the Company's direct sales force are trained to
assist enterprise customers to acquire and utilize the Company's suite of tools
and products to integrate information residing within the organization over a
variety of sources such as word processing documents, relational database
document repositories and Internet servers. The Company's direct sales force
also targets online service providers and publishers of information stored on
both CD-ROM and the Internet. The Company maintains direct sales offices or
personnel in a number of cities across the United States, including Sunnyvale,
Chicago, Houston, Boston, New York and Washington, D.C. European direct sales
operations are located in London, Utrecht, Frankfurt and Paris. Additional
information regarding foreign sales and operations is available in Note 13 of
Notes to Financial Statements.
Telesales. The Company began a telesales operation in 1995 which has been
initially focused on selling the Company's Internet products. The telesales
organization can use the Company's search technology to create and host an
Internet-based Topic database which demonstrates the Topic search engine
operating on data found within the prospective customer's public Web site. The
prospect can use the demonstration system for up to two weeks, and can then
elect to purchase the product. Although the telesales operation's initial focus
is on the Company's Internet products, the Company also plans to offer and sell
its other products through the telesales program.
Value Added Resellers and System Integrators. The Company's VARs and SIs
frequently distribute the Company's products as part of integrated turnkey
solutions for the enterprise and Internet, and often market other
products -- such as document management, support automation or Lotus
Notes -- which incorporate the Company's search engine. The Company is currently
actively seeking to increase its base of VARs and SIs.
Original Equipment Manufacturers. The Company's Topic search technology is
sold as an integrated feature of software products offered by OEM providers of
software products. These OEMs participate in a variety of markets, including
groupware (Lotus and Collabra), document management (Documentum and PC DOCs),
support automation (Remedy), resume tracking (Restrac) and publishing (Adobe,
Frame and Common Ground). The Company also recently licensed its Topic search
technology for use by database management software companies, including Informix
and Sybase.
The Company's marketing activities are targeted at building market
awareness and identifying prospective customers for enterprise, CD-ROM,
Internet/publishing and online services applications. Certain of the Company's
OEM contracts provide for brand name exposure in the OEM's packaging of the
embedded Topic search technology. The Company believes such exposure helps
promote market awareness for Topic products and can create sales opportunities
for add-on products to the OEM's installed base. The Company's marketing efforts
include participation in tradeshows, conference speaking engagements and direct
mail campaigns targeting specific market niches such as the Internet, Lotus
Notes, document management and online services. The Company also maintains a
home page on the Internet which has been a source of sales leads. As of May 31,
1996, the Company's sales and marketing organizations consisted of 80 employees.
THE VERITY TECHNOLOGY
The Company's core technology was originally developed by the Company for
use by large government agencies, such as the Central Intelligence Agency and
the National Security Agency, to perform complex, customized search and
retrieval applications over stand-alone, host-based systems. Since early in
fiscal 1994, the Company has refined and enhanced its core technology,
de-emphasized consulting services, and repositioned and modified its product
offerings to target the market for embedded search technology, as well as the
emerging Internet and online markets. All of the Company's products are
generally written in "C", a widely used application programming language, using
generally available "C" compilers. Verity technologies address the major aspects
of the intelligent search and filtering process, including document indexing,
query formulation, and ranking and presentation of results.
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Indexing. The Topic engine incorporated in Verity's server products or OEM
applications indexes documents automatically based upon user-specified criteria,
into a Topic database, or "collection." Collections created through the indexing
process contain the results of text analysis performed by the Topic engine,
including organized information about document attributes and content. End users
with Topic-based applications or standard Web browsers can search those Topic
collections available to them. The Topic architecture is designed to permit
real-time indexing of arriving documents into a Topic collection, even while
users actively search that collection. As a result, the system provides enhanced
availability, and is designed to operate during maintenance and back-up.
Query Formulation. The Company's search technology is designed to enable
users to formulate and refine queries using a variety of search tools such as
keywords, thesauri, dictionaries and concept-based "topics." Once formulated,
queries can be used to retrieve archived information with a standard,
interactive search. In addition, the same query may be incorporated in an agent
deployed to watch and "clip" relevant information arriving in dynamic text
files. This "profiling" feature of the Company's query technology is designed to
address high user and data volumes, such as those associated with enterprise
applications and large online services.
The Topic search engine is designed with an open architecture which employs
multiple search techniques and supports incorporation of additional techniques
by the Company in future or custom applications. The concept-based "topic"
search metaphor is one method by which the Company's products permit
construction of sophisticated search requests which can then easily be deployed
by users. Users construct a hierarchical "tree" of concepts with weighted
branches, which defines a "topic." The topic tree graphically represents
relationships among the user's terms, providing increased refinement of typical
Boolean or natural language expressions.
Results Presentation. The results obtained through matching queries
against document collections are provided with a relevance score calculated by
the Topic engine. This score may be presented, along with other available
document-attribute information desired by the user, in a customizable results
list. The Company is actively developing added functionality designed to enable
the organization, or "clustering," of search results according to common threads
within the retrieved documents.
PRODUCT DEVELOPMENT
The Company's development efforts are focused on expanding Verity's suite
of Topic products, designing enhancements to the Company's core technology, and
addressing additional technical challenges inherent in developing new
applications on CD-ROM and for online services and the Internet markets. The
Company released Topic CD Publisher, Topic Newswire Access, Topic for Microsoft
Exchange and Topic Agent Server in early 1996. In addition, the Company plans to
undertake development of further enhancements of the search performance,
functionality and deployability of its products. The Company is also engaged in
research and development relating to enhanced presentation and organization of
retrieved information, such as clustering search results. As of May 31, 1996,
there were 85 employees on the Company's research and development staff. The
Company's research and development expenditures in fiscal 1994, fiscal 1995 and
fiscal 1996 were $4.9 million, $5.9 million and $8.5 million, respectively, and
represented 29.3%, 37.1% and 27.6% of total revenues, respectively. The Company
expects that it will continue to commit substantial resources to product
development in the future.
The computer software industry is subject to rapid technological change,
changing customer requirements, frequent new product introductions and evolving
industry standards that may render existing products and services obsolete. As a
result, the Company's position in its existing markets or other markets that it
may enter could be eroded rapidly by product advancements by its competitors.
The life cycles of the Company's products are difficult to estimate. The
Company's future success will depend, in part, upon its ability to enhance
existing products and to develop new products on a timely basis. In addition,
its products must address increasingly sophisticated customer needs and keep
pace with technological developments, conform to evolving industry standards,
particularly client/server and Internet communication and security protocols, as
well as publishing formats such as HTML. There can be no assurance that the
Company will not experience
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difficulties that could delay or prevent the successful development,
introduction and marketing of new products, or that new products and product
enhancements will meet the requirements of the marketplace or achieve market
acceptance. If the Company is unable to develop and introduce products in a
timely manner in response to changing market conditions or customer
requirements, the Company's financial condition and results of operations would
be materially and adversely affected.
Software products as complex as those offered by the Company may contain
errors that may be detected at any point in the products' life cycles. The
Company has in the past discovered software errors in certain of its products
and has experienced delays in shipment of products during the period required to
correct these errors. There can be no assurance that, despite testing and
quality assurance efforts by the Company and by current and potential customers,
errors will not be found, resulting in loss of, delay in, market acceptance and
sales, diversion of development resources, injury to the Company's reputation,
or increased service and warranty costs, any of which could have a material
adverse effect on the Company's business, results of operations and financial
condition.
COMPETITION
The electronic information search and retrieval software market is
intensely competitive. The Company believes the principal competitive factors in
such market are product quality, performance and price, vendor and product
reputation, product architecture, strategic alliances, functionality and
features, ease of use and quality of support. A number of companies offer
competitive products addressing certain of the Company's target markets. In the
enterprise market, the Company competes with Information Dimensions, Dataware
and Excalibur, among others. In the Internet/Publishing market, the Company
competes with Folio, Dataware and Fulcrum, among others. Fulcrum is also the
Company's principal competitor in the tools market. The Company's principal
competitors in the online market are Fulcrum, which currently provides search
and retrieval technology for the Microsoft Network, and Logicon. The Company
also competes indirectly with database vendors that offer information search and
retrieval capabilities with their core database products. In the future, the
Company may encounter competition from companies that enhance products such as
word processing software, document management systems, groupware applications,
Internet products and operating systems to include text search and retrieval
features. Also, Microsoft recently announced its intention to market search and
retrieval software competitive with the Company's products. Many of the
Company's existing competitors, as well as Microsoft and a number of other
potential new competitors, have significantly greater financial, technical and
marketing resources than the Company. Because the success of the Company's
strategy is dependent in part on the success of the Company's strategic
partners, competition between the Company's strategic partners and the strategic
partners of the Company's competitors, or failure of the Company's strategic
partners to achieve or maintain market acceptance could have a material adverse
effect on the Company's competitive position. Although the Company believes that
its products and technologies compete favorably with respect to the factors
outlined above, there can be no assurance that the Company will be able to
compete successfully against its current or future competitors or that
competition will not have a material adverse effect on the Company's results of
operations and financial condition.
PROPRIETARY RIGHTS
To date, the Company has relied upon a combination of copyrights and trade
secrets to protect its proprietary technology. The Company generally enters into
confidentiality or license agreements with its employees, distributors,
customers and potential customers and limits access to and distribution of the
source code to its software and other proprietary information. To license its
client products, the Company primarily relies on "shrink-wrap" licenses that are
not signed by the end user and, therefore, may be unenforceable under the laws
of certain jurisdictions. Policing unauthorized use of the Company's products is
difficult. There can be no assurance that the steps taken by the Company in this
regard will be adequate to prevent misappropriation of its technology or that
the Company's competitors will not independently develop technologies that are
substantially equivalent or superior to the Company's technology.
In the future, the Company may receive communications from third parties or
have other reasons to seek licenses under third-party intellectual property
rights. In such cases, the Company may evaluate whether to
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obtain such licenses. However, there can be no assurance that such licenses will
be available or if such licenses are made available, that the terms will not
have a material adverse effect on the Company's results of operations.
Certain technology used in the Company's products is licensed from third
parties, generally on a nonexclusive basis. These licenses generally require the
Company to pay royalties and to fulfill confidentiality obligations. The Company
believes that there are alternative sources for each of the material components
of technology licensed by the Company from third parties. However, the
termination of any of such licenses, or the failure of the third party licensors
to adequately maintain or update their products, could result in delay in the
Company's ability to ship certain of its products while it seeks to implement
technology offered by alternative sources. Any required replacement licenses
could prove costly. Also, any such delay, to the extent it becomes extended or
occurs at or near the end of a fiscal quarter, could result in a material
adverse effect on the Company's results of operations. While it may be necessary
or desirable in the future to obtain other licenses relating to one or more of
the Company's products or relating to current or future technologies, there can
be no assurance that the Company will be able to do so on commercially
reasonable terms or at all. See "Business Risks -- Dependence on Proprietary
Technology".
EMPLOYEES
As of May 31, 1996, the Company had a total of 216 employees, including 85
in research and development, 107 in sales, marketing and related customer
support services, 20 in administration and 4 in manufacturing. Of these
employees, 188 were located in the United States and 28 in Europe. None of the
Company's employees is represented by a collective bargaining agreement, nor has
the Company experienced any work stoppage. The Company considers its relations
with its employees to be good.
The Company is heavily dependent upon its ability to attract, retain and
motivate skilled technical and managerial personnel. The loss of services of any
of its executive officers or other key employees could have a material adverse
effect on the business, operating results or financial condition of the Company.
The Company's future success also depends on its continuing ability to identify,
hire, train and retain other highly qualified technical and managerial
personnel. Competition for such personnel is intense, and there can be no
assurance that the Company will be able to attract, assimilate or retain other
highly qualified technical and managerial personnel in the future. The inability
to attract, hire or retain the necessary technical and managerial personnel
could have a material adverse effect upon the Company's business, operating
results or financial condition.
DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES
As of May 31, 1996, the directors, executive officers and key employees of
the Company were as follows:
NAME AGE POSITION
- - - ------------------------------ --- ----------------------------------------------
Philippe F. Courtot........... 51 Chairman of the Board, President, Chief
Executive Officer and Director
Donald C. McCauley............ 44 Vice President and Chief Financial Officer
Christopher Helgeson(1)....... 39 Vice President, Research and Development
Anthony J. Bettencourt........ 35 Vice President, Worldwide Sales and Marketing
Philip C. Nelson(3)........... 33 Chief Technology Officer
Timothy J. Moore.............. 39 Vice President, Strategic Investments, General
Counsel and Secretary
Steven M. Krausz(2)........... 41 Director
Stephen A. MacDonald.......... 50 Director
Charles P. Waite, Jr.(2)...... 41 Director
- - - ---------------
(1) Mr. Helgeson was employed in such capacity until July 8, 1996.
(2) Member of the Compensation and Audit Committees.
(3) Mr. Nelson was appointed to this position in August 1996.
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Mr. Courtot joined the Company in August 1993 as President and Chief
Executive Officer, and was elected Chairman of the Board in August 1995. Prior
to joining the Company, Mr. Courtot served as Executive Vice President and
General Manager of cc:Mail, a division of Lotus Development Corporation, from
May 1991 to June 1992 and as President and Chief Executive Officer of cc:Mail
from March 1989 to May 1991. From June 1992 to August 1993, Mr. Courtot worked
as an independent consultant on discrete projects and also served as a member of
the Board of Directors for two private, high-technology companies. From July
1987 to January 1989, Mr. Courtot served as Executive Vice President and General
Manager of Radiology Division, ADAC Laboratories. Prior to that time, Mr.
Courtot served as Chief Executive Officer of Thomson-CGR Medical, a producer of
radiology and magnetic resonance imaging equipment. Mr. Courtot is a recipient
of the Saturday Evening Post Benjamin Franklin Award for his role in a national
mammography awareness campaign. Mr. Courtot received an M.S. in Physics and a
B.S. in Electrical Engineering from the University of Paris.
Mr. McCauley joined the Company as Chief Financial Officer on a consulting
basis in March 1994. In May 1995, Mr. McCauley joined the Company as Vice
President, Chief Financial Officer and Secretary. From May 1992 to May 1995, Mr.
McCauley was an independent consultant. From 1991 to 1992, Mr. McCauley served
as Vice President and Chief Financial Officer of Voicesoft Corporation, a voice
processing software developer. From 1989 to 1991, Mr. McCauley served as
Executive Vice President, Chief Financial Officer and Treasurer of SemiTest,
Inc., a developer of semiconductor manufacturing instrumentation. Mr. McCauley
received a B.S. in Accounting from the University of Rhode Island, and is a
certified public accountant.
Mr. Helgeson was Vice President, Research & Development, until July 1996,
but he is no longer an employee of the Company. Mr. Helgeson joined the Company
in July 1995 as Vice President, Research and Development. From 1991 to July
1995, Mr. Helgeson served as Director of Communications Engineering at General
Magic, Inc. From 1989 to 1991, Mr. Helgeson served as manager of UNIX and
Macintosh software development at cc:Mail. Mr. Helgeson received concurrently a
B.A. in French and a B.S. in Biochemistry from the University of California at
Berkeley.
Mr. Nelson was a co-founder of the Company and has been employed by Verity
since its inception in 1988. He has served in a variety of technical and
management positions at Verity, and was appointed in August 1996 to the position
of Chief Technology Officer. He received a B.S. in Computer Science from the
Massachusetts Institute of Technology.
Mr. Bettencourt joined the Company in July 1995 as Vice President of North
American Sales, and was subsequently promoted to Vice President of Worldwide
Sales and Marketing. Prior to joining the Company, Mr. Bettencourt served as
Vice President of Sales for Versant Object Technology from 1992 to June 1995 and
as Director of U.S. Sales for Versant Object Technology from July 1990 to 1992.
From December 1988 to July, 1990, Mr. Bettencourt served as Vice President of
Sales for Rockwell CMC. Mr. Bettencourt received a B.A. from the University of
Santa Clara.
Mr. Moore joined the Company in January 1996 as Vice President, Strategic
Investments, General Counsel and Secretary. From August 1986 until joining the
Company, Mr. Moore was employed by the law firm of Gray Cary Ware & Freidenrich,
at which he was a shareholder since 1991. Mr. Moore received a B.A. in Economics
and a J.D. from Stanford University.
Mr. Krausz has served as a director of the Company since May 1988. Mr.
Krausz has been a General Partner of U.S. Venture Partners III, U.S.V.
Entrepreneur Partners and BHMS Partners III since 1985. Mr. Krausz is a director
of EPIC Design Technology, Inc.
Mr. MacDonald has served as a director of the Company since December 1988.
From May 1983 until May 1996, Mr. MacDonald was employed by Adobe Systems
Incorporated, where he served most recently as Senior Vice President and Chief
Operating Officer. Since May 1996, he has served as President and Chief
Executive Officer of Active Software. Mr. MacDonald is a director of Network
Computing Devices, Inc.
Mr. Waite has served as a director of the Company since May 1988. Mr. Waite
has been a General Partner of Olympic Venture Partners II and a Vice President
of Northwest Venture Services Corp. since 1987
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and a General Partner of Olympic Venture Partners III since 1994. Mr. Waite is a
director of CellPro Incorporated.
The Company's Certificate of Incorporation provides that the Board of
Directors is divided into three classes serving staggered three year terms. Each
class of directors consists of one or two directors. The Class I directors,
whose terms will end in 1996, are Steven M. Krausz and Charles P. Waite, Jr.;
the Class II director, whose term will end in 1997, is Stephen A. MacDonald; and
the Class III director, whose term will end in 1998, is Philippe F. Courtot.
Officers are elected by and serve at the discretion of the Board of
Directors. There are no family relationships among the directors or officers of
the Company.
ITEM 2. PROPERTIES
The Company's principal administrative, sales, marketing, and research and
development facilities occupy approximately 96,000 square feet in Sunnyvale,
California. The Company's operating lease agreement for this facility commenced
in June 1996 and expires in September 2005. The Company's average annual lease
payment is scheduled to be approximately $1.1 million. In addition, the Company
also leases sales offices in Virginia, England, Netherlands, France and Germany,
and a small development office located in England.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS.
On March 28, 1996, at a special meeting of stockholders of the Company, a
proposal to amend the 1995 Stock Option Plan (the "Option Plan") of the Company
to increase the number of shares of Common Stock of the Company authorized for
issuance thereunder from 1,910,836 shares to 2,910,836 shares and to impose a
limit on the options that may be granted to any employee, was submitted to a
vote of the stockholders of the Company.
The proposal was approved by the following vote:
FOR THE PROPOSAL AGAINST THE PROPOSAL ABSTENTIONS BROKER NON-VOTES
- - - ---------------- -------------------- ----------- ----------------
5,552,106 2,288,382 2,739 0
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
MARKET PRICE OF COMMON STOCK
The Company's stock has been traded on the Nasdaq National Market since the
Company's initial public offering on October 5, 1995 under the Nasdaq symbol
VRTY. The following table sets forth, for the periods indicated, the high and
low closing sales prices for the Company's common stock as reported by Nasdaq:
HIGH LOW
------ ------
FISCAL 1996
Second Quarter (from October 6, 1995)......................... $49.75 $18.50
Third Quarter................................................. $55.25 $33.75
Fourth Quarter................................................ $44.00 $30.00
HOLDERS OF COMPANY STOCK
The closing sale price for the Common Stock on May 31, 1996 was $39.25.
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As of May 31, 1996, there were approximately 308 shareholders of record of
the Company's Common Stock and 10,735,000 shares of Common Stock outstanding.
The market price of the Company's Common Stock has fluctuated significantly
and is subject to significant fluctuations in the future. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Business Risks."
DIVIDEND POLICY
The Company has never paid cash dividends on its capital stock. The Company
currently intends to retain earnings, if any, for use in its business and does
not anticipate paying any cash dividends in the foreseeable future.
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ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected financial date should be read in conjunction with
"Item 7. Managements Discussion and Analysis of Financial Condition and Results
of Operations" and the consolidated financial statements and the notes thereto
included in "Item 8. Financial Statements and Supplementary Data."
FISCAL YEAR ENDED MAY 31,
---------------------------------------------------
1992 1993 1994 1995 1996
-------- -------- -------- -------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Revenues:
Software products.......................... $ 10,326 $ 12,332 $ 9,217 $ 10,143 $24,472
Service and other.......................... 4,494 6,943 7,385 5,743 6,246
------- ------- ------- ------- -------
Total revenues..................... 14,820 19,275 16,602 15,886 30,718
------- ------- ------- ------- -------
Costs of revenues:
Software products.......................... 622 686 720 623 2,074
Service and other.......................... 3,199 4,773 4,350 2,926 2,785
------- ------- ------- ------- -------
Total costs of revenues............ 3,821 5,459 5,070 3,549 4,859
------- ------- ------- ------- -------
Gross profit................................. 10,999 13,816 11,532 12,337 25,859
Operating expenses:
Research and development................... 2,506 3,208 4,872 5,892 8,488
Acquisition of in-process R&D.............. -- -- -- -- 381
Marketing and sales........................ 7,793 9,155 7,783 9,280 14,912
General and administrative................. 1,535 1,942 2,302 2,747 3,469
Restructuring charges...................... -- -- 1,175 -- --
------- ------- ------- ------- -------
Total operating expenses........... 11,834 14,305 16,132 17,919 27,250
------- ------- ------- ------- -------
Loss from operations......................... (835) (489) (4,600) (5,582) (1,391)
Other income (expense), net.................. 62 (232) (234) 57 1,342
Interest expense............................. (172) (236) (270) (313) (264)
------- ------- ------- ------- -------
Net loss..................................... $ (945) $ (957) $ (5,104) $ (5,838) $ (313)
======= ======= ======= ======= =======
Net loss per share(1)........................ $ (.97) $ (1.09) $ (2.67) $ (2.18) $ (0.12)
======= ======= ======= ======= =======
Number of shares used in per share
calculation(1)............................. 2,755 2,798 2,903 3,635 7,829
======= ======= ======= ======= =======
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents.................... $ 2,477 $ 2,941 $ 2,184 $ 324 $ 2,482
Working capital (deficit).................... 3,718 2,249 100 (1,338) 44,087
Total assets................................. 9,605 10,654 8,199 6,987 62,724
Long-term obligations, net of current
portion.................................... 561 273 1,154 924 639
Mandatorily redeemable convertible preferred
stock...................................... 18,859 20,944 25,582 32,069 0
Stockholders' (deficit) equity............... (14,002) (16,978) (24,602) (32,439) 52,808
- - - ---------------
(1) The net loss used in computing net loss per share has been increased by the
accretion of the mandatorily redeemable convertible preferred stock to its
redemption value in the years ended May 31, 1992, 1993, 1994, 1995 and 1996
of $1,717,000, $2,085,000, $2,646,000, $2,081,000 and $611,000,
respectively. See Note 2 of Notes to Consolidated Financial Statements for
an explanation of the method used to determine the number of shares used to
compute per share amounts.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion provides an analysis of the Company's financial
condition and results of operations and should be read in conjunction with the
"Selected Consolidated Financial Data" and the Note thereto and the Consolidated
Financial Statements and the Notes thereto of the Company.
OVERVIEW
Verity develops, markets and supports software tools and applications that
enable individuals, enterprises and publishers to intelligently search, filter
and disseminate textual information residing on enterprise networks, online
services, the Internet, CD-ROM and other electronic media. The Company was
founded in 1988, and, historically, derived the substantial majority of its
revenue from the licensing of high-priced, custom search and retrieval
applications for use almost entirely by large organizations and government
agencies. During these years, the Company also generated a substantial portion
of its revenues by providing the consulting services required to support these
products.
In early fiscal 1994, Verity retained a new Chief Executive Officer and
replaced several members of its senior management team. Shortly thereafter, the
Company shifted its strategy from the sale of high-priced products requiring
significant customization to leveraging the Company's Topic technology to
develop a number of new, lower-priced products that address the needs of broader
markets. During this period, the Company also focused on building strategic
alliances for the primary purpose of expanding the user base of the Company's
technology, rather than generating significant revenues. The objectives of the
Company's strategy are to establish its software as a de facto standard and to
offset lower unit prices for its products with higher sales volumes.
The Company's ongoing implementation of this strategy has involved several
significant actions. During recent years, the Company has reduced significantly
its average unit license fees. Also, during this period, the Company has devoted
significant resources to modify and enhance its core technology to support a
broader set of search and retrieval solutions for use on desktop and
enterprise-wide systems, and over the Internet. Key engineering efforts in this
regard have included the continued enhancement of the functionality of the
Company's Topic search engine and the modification of the Topic software to
facilitate its incorporation in third parties' information management,
publishing and groupware software applications. More recently, the Company's
engineering efforts have also resulted in the development of new applications of
Topic software for use with CD-ROM, online services and the Internet. The
Company's Topic technology is deployed within the Company's own suite of
applications, and also as an embedded feature within broadly distributed
third-party software applications, such as Lotus Notes, Adobe Acrobat, Frame
FrameViewer and Documentum Server and WorkSpace. The Company has also licensed
its Topic technology to prominent providers of Internet products and online
services, including Netscape Communications, NetManage, Quarterdeck, AT&T
WorldNet Services, and MCI's Delphi Internet, together with Internet publishers,
including Cisco Systems, Compaq Computer and Tandem Computer.
In connection with its new strategy, the Company has also replaced the
majority of its work force and substantially reorganized all of the departments
within the Company. While experiencing significant turnover, the Company
increased the number of research and development personnel from 29 at the
beginning of fiscal 1994 to 85 at the end of fiscal 1996. Given its reduced
focus on offering custom solutions, the Company was able to decrease the number
of personnel involved in its relatively low-margin consulting business from 29
at the beginning of fiscal 1994 to 10 at the end of fiscal 1996.
Since inception, the Company has incurred significant losses and
substantial negative cash flow. Due in part to the transition, the Company
experienced declining revenues and increased net losses in fiscal years 1994 and
1995. At May 31, 1996, the Company had cumulative operating losses of $21.4
million, with net losses of $5.1 million, $5.8 million and $313,000 for fiscal
years 1994 through 1996, respectively. However, fiscal 1995 and 1996 have
produced the first successes of the Company's strategic transition. Although
fiscal 1995 revenues were lower than fiscal 1994, fiscal 1995 revenues from
software products increased over fiscal 1994. In fiscal 1996, total revenues
increased 93% over fiscal 1995 primarily as a result of a 141% increase in
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software product revenues. The increase from fiscal 1994 to fiscal 1995 was due
principally to revenues derived from licensing new versions of the Company's TDK
product and early commercial versions of Internet/publishing products. The
increase for fiscal 1996 over the prior year was due principally to revenues
from early commercial versions of online and Internet/publishing products,
increased revenues from the Company's TDK Toolkit and, to a lesser extent, the
Company's enterprise products. Both fiscal 1995 and fiscal 1996 reflects lower
consulting revenues than the prior year periods due to intentional reductions in
the scope of the Company's lower-margin consulting business. The losses in
fiscal 1995 and, to a lesser extent, in fiscal 1996 also reflects significantly
larger investments in marketing and sales and research and development than the
respective prior year periods, as the Company rebuilt its sales and marketing
force and undertook development of a number of new products to implement its new
strategy. While it is the Company's goal to increase revenue and generate net
income in future periods, no assurance can be given that the Company's strategy
will continue to be successful, that the rate of revenue increase experienced by
the Company in fiscal 1996 will be experienced in future periods, or that the
Company will achieve positive cash flow or profitability.
In March 1996, the Company acquired InSite Computer Technology Limited, a
United Kingdom technology company which focused on developing groupware
applications for Microsoft Exchange and BackOffice platforms. As a result of the
acquisition, Verity incurred a one-time charge against earnings of $381,000
during the quarter ended May 31, 1996, when the transaction was consummated.
The ongoing implementation of the Company's new strategy has placed, and
may continue to place, a significant strain on the Company's resources,
including its personnel. The Company believes that hiring and retaining
qualified individuals at all levels in the Company is essential to its success,
and there can be no assurance that the Company will be successful in attracting
and retaining the necessary personnel. If Company management is unable to
effectively manage its planned transition, identify opportunities in a timely
fashion, and evaluate and manage the Company's business and competitive
position, the Company's results of operations and financial condition will be
materially and adversely affected. Furthermore, there can be no assurance that
the Company will introduce new products on a timely basis or that its new or
recently introduced products will achieve market acceptance.
The Company's revenues are derived from licenses fees for its software
products and fees for services complementary to its products, including software
maintenance, consulting and training. Fees for services generally are charged
separately from the license fees for the Company's software products. The
Company recognizes revenues in accordance with the provisions of American
Institute of Certified Public Accountants Statement of Position No. 91-1,
Software Revenue Recognition. Accordingly, maintenance revenues from ongoing
customer support and product upgrades are recognized ratably over the term of
the applicable maintenance agreement, which is typically 12 months. Payments for
maintenance fees generally are received in advance and are nonrefundable.
Revenues for consulting and training generally are recognized when the services
are performed.
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RESULTS OF OPERATIONS
The following table sets forth the percentage of revenue represented by
certain items in the Company's Consolidated Statements of Operations for the
periods indicated:
FISCAL YEAR ENDED MAY 31,
--------------------------
1994 1995 1996
------- ------- ------
Revenues:
Software products............................................... 55.5% 63.8% 79.7%
Service and other............................................... 44.5 36.2 20.3
----- ----- -----
Total revenues............................................... 100.0 100.0 100.0
----- ----- -----
Costs of revenues:
Software products............................................... 4.3 3.9 6.8
Service and other............................................... 26.2 18.4 9.1
----- ----- -----
Total costs of revenues...................................... 30.5 22.3 15.9
Gross profit...................................................... 69.5 77.7 84.1
Operating expenses:
Research and development........................................ 29.3 37.1 27.6
Acquisition of in-process research and development.............. 1.2
Marketing and sales............................................. 46.9 58.4 48.5
General and administrative...................................... 13.9 17.3 11.3
Restructuring charges........................................... 7.1 0.0 0.0
----- ----- -----
Total operating expenses..................................... 97.2 112.8 88.6
----- ----- -----
Loss from operations.............................................. (27.7) (35.1) (4.5)
Interest and other expenses....................................... (3.0) (1.6) 3.5
Net loss.......................................................... (30.7)% (36.7)% (1.0)%
===== ===== =====
Revenues
Total revenues decreased 4.3% from $16.6 million in fiscal 1994 to $15.9
million in fiscal 1995 and increased 93.4% to $30.7 million in fiscal 1996. The
decline in total revenues from fiscal 1994 to fiscal 1995 was principally due to
significant decreases in average unit license fees for the Company's software
products and intentional reductions in the scope of its consulting business,
partially offset by unit volume increases of certain products. These changes
were phased in commencing early in fiscal 1994 as part of a shift in the
Company's strategy to focus its business increasingly on providing more
versatile, lower-priced software products, as opposed to higher-priced custom
applications and associated specialized consulting and training services. The
increase in total revenues from fiscal 1995 to fiscal 1996 was due primarily to
increased revenues from licensing of Internet/publishing products, online
products, tools and, to a lesser extent, enterprise products. Software product
revenues increased as a percentage of total revenues from 55.5% in fiscal 1994
to 63.8% in fiscal 1995 and 79.7% in fiscal 1996. Conversely, service and other
revenues declined as a percentage of total revenues from 44.5% in fiscal 1994 to
36.2% in fiscal 1995 and 20.3% in fiscal 1996. These changes reflect both
increased software product revenues and intentional reductions in the Company's
consulting business.
Software product revenues. Software product revenues increased 10.0% from
$9.2 million in fiscal 1994 to $10.1 million in fiscal 1995 and increased 141.3%
to $24.5 million in fiscal 1996. The increase from fiscal 1994 to fiscal 1995
was due principally to revenues derived from licensing new versions of the
Company's TDK product and early commercial versions of Internet/publishing
products. Software product revenues in fiscal 1995 represented a significantly
increased proportion of overall revenues as compared to fiscal 1994, due to both
a higher level of software product revenues and decreased service revenues,
particularly decreased consulting revenues. The increase from fiscal 1995 to
fiscal 1996 was due primarily to increased revenues from
15
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licensing of Internet/publishing products, online products, tools and, to a
lesser extent, enterprise products. Revenues from enterprise products increased
principally due to significantly higher sales volumes, which were offset in part
by lower average unit license fees.
Service and other revenues. Service and other revenues consists primarily
of fees for software maintenance, consulting and training. Service and other
revenues decreased 22.2% from $7.4 million in fiscal 1994 to $5.7 million in
fiscal 1995 and increased 8.8% to $6.2 million in fiscal 1996. Maintenance
revenues increased in fiscal 1996, but these increases were substantially offset
by reduced consulting revenues. During fiscal 1994 and fiscal 1995, the Company
significantly reduced the scope of its consulting business, but increased
headcount slightly in fiscal 1996. The Company does not anticipate further
material reductions in headcount associated with its consulting business for the
foreseeable future.
Revenue derived from foreign operations accounted for 15.7%, 14.3% and 6.6%
of total revenues, respectively, in fiscal 1994, 1995 and 1996, with European
operations alone accounting for 12.1% , 11.9% and 5.6%, of total revenues for
these periods, respectively. The Company's export sales consist primarily of
products licensed for delivery outside of the United States. In fiscal years
1994, 1995 and 1996, export sales accounted for 28.7%, 24.1% and 19.1% of total
revenues, respectively. The decreases in foreign operations and export sales as
a percentage of revenues resulted primarily from increased domestic revenues.
No single customer accounted for 10% or more of the Company's revenues
during fiscal years 1994, 1995 or 1996. However, revenues derived from sales to
the federal government and its agencies were 29.3%, 25.5% and 10.5% of total
revenues in fiscal years 1994, 1995 and 1996, respectively. Sales to government
agencies declined as a percentage of revenues from fiscal 1994 to fiscal 1996,
and may decline in the future.
Costs of Revenues
Costs of software products. Costs of software products consist primarily
of product media, duplication, manuals, packaging materials, shipping expenses
and royalties and, in certain instances, licensing of third-party software
incorporated in the Company's products. Costs of software products decreased
13.5% from $720,000 in fiscal 1994 to $623,000 in fiscal 1995 and increased
232.9% to $2.1 millions in fiscal 1996, representing 7.8%, 6.1% and 8.5%,
respectively, of software product revenues. The increase in absolute dollars
from fiscal 1995 to fiscal 1996 was principally related to the higher level of
software product sales. The increase in costs as a percentage of software
product revenues was due primarily to the inclusion of purchased software
relating to third party software components included in certain products during
fiscal 1996.
Costs of service and other. Costs of service and other consist of costs
incurred in providing consulting services, customer training, telephone support
and product upgrades to customers. Costs of service and other decreased 32.7%
from $4.4 million in fiscal 1994 to $2.9 million in fiscal 1995 and decreased
4.8% to $2.8 million in fiscal 1996. As a percentage of service and other
revenue, these costs represented 58.9%, 50.9% and 44.6% in fiscal years 1994,
1995 and 1996, respectively. The significant decreases in costs of service and
other were directly related to the reductions in headcount associated with the
de-emphasis of the Company's consulting business.
Operating Expenses
Research and development. Research and development expenses increased
20.9% from $4.9 million in fiscal 1994 to $5.9 million in fiscal 1995 and
increased 44.1% to $8.5 million in fiscal 1996, representing 29.3%, 37.1% and
27.6% of total revenues, respectively. This increase in absolute dollars was
primarily due to a significant increase in headcount of research and development
personnel focused on development of products addressing Internet/publishing,
CDROM, online, and groupware applications. These decreases in research and
development expenses as a percentage of total revenue were due primarily to
increased total revenues over prior years. The Company intends to continue to
allocate substantial resources to research and development, but research and
development expenses may vary as a percentage of total revenues.
Acquisition of in-process research and development. In March 1996, the
Company acquired InSite Computer Technology Limited, a United Kingdom technology
company which focused on developing
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groupware applications for Microsoft Exchange and BackOffice platforms. As a
result of the acquisition, Verity incurred a one-time charge against earnings of
$381,000 during the quarter ended May 31, 1996, when the transaction was
consummated. See Note 3 of Notes to Consolidated Financial Statements.
Marketing and sales. Marketing and sales expenses consist primarily of
salaries and commissions of sales and marketing personnel, advertising and
promotion expenses and pre-sales customer service and support costs. Marketing
and sales expenses increased 19.2% from $7.8 million in fiscal 1994 to $9.3
million in fiscal 1995 and increased 60.7% to $14.9 million in fiscal 1996,
representing 46.9%, 58.4% and 48.5% of total revenues, respectively. These
increases in absolute dollars were primarily related to the Company's expansion
of its marketing and sales organization, particularly in the United States and
Europe. These decreases in marketing and sales expenses as a percentage to total
revenue were due primarily to increased total revenues over prior years. The
Company anticipates it will continue to make significant investments in
marketing and sales.
General and administrative. General and administrative expenses increased
19.3% from $2.3 million in fiscal 1994 to $2.7 million in fiscal 1995 and
increased 26.3% to $3.5 million in fiscal 1996, representing 13.9%, 17.3% and
11.3% of total revenues, respectively. These increases in absolute dollars were
primarily due to increases in personnel and professional service fees required
to support the Company's expanded operations relative to prior years. The
decrease in general and administrative expenses in fiscal 1996 as a percentage
of total revenues was due primarily to increased total revenues.
Restructuring charges. During fiscal 1994, the Company recorded a
provision for restructuring charges of $1.2 million. The restructuring related
primarily to severance payments and losses on vacated office leases associated
with the implementation of the Company's change in strategy. As of May 31, 1995,
all amounts reserved in connection with the restructuring had been paid.
Income Taxes
As of May 31, 1996, the Company had federal and state net operating loss
carryforwards of approximately $16.5 million and $9.0 million, respectively. The
Company also had federal and state research and development tax credit
carryforwards of approximately $692,000 and $420,000, respectively. These
carryforwards expire in the years 2004 to 2011. The Company's initial public
offering resulted in a change in ownership as defined under Section 382 of the
Internal Revenue Code which limited the annual utilization of net operating loss
carryforwards to approximately $4.9 million. See Note 10 of Notes to
Consolidated Financial Statements.
The Company has established a valuation allowance against its deferred tax
assets due to the uncertainty surrounding the realization of such assets.
Management evaluates on a quarterly basis the recoverability of the deferred tax
assets and the level of the valuation allowance. At such time as it is
determined that it is more likely than not that deferred tax assets are
realizable, the valuation allowance will be appropriately reduced. See Note 10
of Notes to Consolidated Financial Statements.
QUARTERLY RESULTS OF OPERATIONS
The Company's quarterly operating results have varied and are expected to
vary significantly in the future. These fluctuations may be caused by many
factors, including, among others, the size and timing of individual orders;
customer order deferrals in anticipation of new products; timing of introduction
or enhancement of products by the Company or its competitors; market acceptance
of new products; changes in the budgets or purchasing patterns of government
agencies; technological changes in search and retrieval, database, networking,
or communication technology; competitive pricing pressures; changes in the
Company's operating expenses; personnel changes; foreign currency exchange
rates; mix of products and services sold; quality control of products sold; and
general economic conditions.
A significant portion of the Company's revenues in recent quarters has been
derived from relatively large sales to a limited number of customers, and the
Company currently anticipates that future quarters will continue to reflect this
trend. Sales cycles for these customers can be up to six months or longer.
Accordingly,
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20
the cancellation or deferral of even a small number of purchases of the
Company's products could have a material adverse effect on the Company's results
of operations and financial condition in any particular quarter.
Product revenues are also difficult to forecast because the market for
search and retrieval software is uncertain and evolving. In addition, a
significant portion of the Company's revenues are derived from royalties based
upon sales by third-party vendors of products incorporating the Company's
technology. These revenues may be subject to extreme fluctuation and are
difficult for the Company to predict. Further, the Company typically generates a
large percentage of its quarterly revenues during the last weeks of the quarter.
The Company's expense levels are based in part on its expectations as to future
revenues and to a large extent are fixed. Therefore, the Company may be unable
to adjust spending in a timely manner to compensate for any unexpected revenue
shortfall. Accordingly, any significant shortfall of demand in relation to the
Company's expectations or any material delay of customer orders would have an
almost immediate adverse impact on the Company's operating results and on the
Company's ability to achieve profitability.
The Company's revenues, and particularly its software products revenues,
increased significantly in the last four fiscal quarters over the prior
quarters. Due to the evolving nature of the markets for the Company's products
and other factors, however, there can be no assurance that the Company's
revenues will continue to increase significantly or at all in future periods.
As a result of the foregoing and other factors, the Company believes that
period-to-period comparisons of its results of operations are not necessarily
meaningful and should not be relied upon as indications of future performance.
Fluctuations in operating results may also result in volatility in the price of
the shares of the Company's Common Stock.
The following table sets forth certain unaudited consolidated statements of
operations data, both in dollar amount and as a percentage of total revenues,
for each of the eight quarters in the period ended May 31, 1996. In the opinion
of management, this information has been presented on the same basis as the
audited consolidated financial statements appearing elsewhere in this annual
report, and all necessary adjustments, consisting only of normal recurring
adjustments, have been included in the amounts stated below to present fairly
the unaudited quarterly results when read in conjunction with the audited
consolidated financial statements of the Company and related notes thereto. The
operating results for any quarter should not be relied upon as any necessarily
indicative of results for any future period.
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QUARTER ENDED
-------------------------------------------------------------------------------------------------
AUG. 31, NOV. 30, FEB. 28, MAY 31, AUG. 31, NOV. 30, FEB. 29, MAY 31,
1994 1994 1995 1995 1995 1995 1996 1996
-------- -------- -------- ------- -------- -------- -------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Consolidated Statements of
Operations Data:
Revenues
Software products........... $ 1,971 $ 2,373 $ 2,977 $ 2,822 $4,164 $5,550 $6,444 $8,314
Service and other........... 1,597 1,422 1,325 1,399 1,371 1,614 1,557 1,704
------- ------- ------- ------- ------ ------ ------ ------
Total revenues....... 3,568 3,795 4,302 4,221 5,535 7,164 8,001 10,018
------- ------- ------- ------- ------ ------ ------ ------
Costs of revenues
Software products........... 96 117 151 259 153 499 718 704
Service and other........... 806 697 712 711 656 679 679 771
------- ------- ------- ------- ------ ------ ------ ------
Total costs of
revenues........... 902 814 863 970 809 1,178 1,397 1,475
------- ------- ------- ------- ------ ------ ------ ------
Gross profit.................. 2,666 2,981 3,439 3,251 4,726 5,986 6,604 8,543
Operating expenses
Research and development.... 1,291 1,441 1,516 1,644 1,779 2,016 2,163 2,532
Acquisition of in-process
R&D....................... 381
Marketing and sales......... 1,924 2,345 2,484 2,527 2,538 3,532 3,880 4,960
General and
administrative............ 586 683 682 796 733 891 881 964
Total operating
expenses........... 3,801 4,469 4,682 4,967 5,050 6,439 6,924 8,837
------- ------- ------- ------- ------ ------ ------ ------
Loss from operations.......... (1,135) (1,488) (1,243) (1,716) (324) (453) (320) (294 )
Interest income and other
expense..................... (117) (4) (71) (64) (112) 115 432 644
------- ------- ------- ------- ------ ------ ------ ------
Net income (loss)(1).......... $ (1,252) $ (1,492) $ (1,314) $(1,780) $ (436) $ (338) $ 112 $ 350
======= ======= ======= ======= ====== ====== ====== ======
Net income (loss) per
share(1).................... $ (0.66) $ (0.50) $ (0.46) $ (0.58) $(0.21) $(0.08) $ 0.01 $ 0.03
======= ======= ======= ======= ====== ====== ====== ======
Number of shares used in per
share calculation........... 3,222 3,756 3,769 3,796 4,058 6,316 11,105 11,395
======= ======= ======= ======= ====== ====== ====== ======
AS A PERCENTAGE OF REVENUES
-------------------------------------------------------------------------------------------------
Revenues
Software products........... 55.2% 62.5% 69.2% 66.8% 75.2% 77.5% 80.5% 83.0 %
Service and other........... 44.8 37.5 30.8 33.2 24.8 22.5 19.5 17.0
------- ------- ------- ------- ------ ------ ------ ------
Total revenues....... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
------- ------- ------- ------- ------ ------ ------ ------
Costs of revenues
Software products........... 2.7 3.1 3.5 6.1 2.8 7.0 9.0 7.0
Service and other........... 22.6 18.3 16.6 16.8 11.9 9.4 8.5 7.7
------- ------- ------- ------- ------ ------ ------ ------
Total costs of
revenues........... 25.3 21.4 20.1 22.9 14.7 16.4 17.5 14.7
------- ------- ------- ------- ------ ------ ------ ------
Gross profit.................. 74.7 78.6 79.9 77.1 85.3 83.6 82.5 85.3
Operating expenses
Research and development.... 36.2 38.0 35.2 38.9 32.1 28.2 27.0 25.3
Acquisition of in-process
R&D....................... 3.8
Marketing and sales......... 53.9 61.8 57.7 59.9 45.9 49.3 48.5 49.5
General and
administrative............ 16.4 18.0 15.9 18.9 13.2 12.4 11.0 9.6
Total operating
expenses........... 106.5 117.8 108.8 117.7 91.2 89.9 86.5 88.2
------- ------- ------- ------- ------ ------ ------ ------
Loss from operations.......... (31.8) (39.2) (28.9) (40.6) (5.9) (6.3) (4.0) (2.9 )
Interest income and other
expense..................... (3.3) (0.1) (1.6) (1.5) (2.0) 1.6 5.4 6.4
------- ------- ------- ------- ------ ------ ------ ------
Net income (loss)(1).......... (35.1)% (39.3)% (35.0)% (42.1)% (7.9)% (4.7)% 1.4% 3.5%
======= ======= ======= ======= ====== ====== ====== ======
- - - ---------------
(1) The net loss used in computing net loss per share has been increased by the
accretion of the mandatorily redeemable convertible preferred stock to its
redemption value.
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22
During fiscal 1995, cost of service and other revenues declined
significantly due to the reductions in the Company's consulting business. In
fiscal 1996, cost of software product revenues increased both in amount and as a
percentage of software product revenues due to software product sales which
required the incorporation of certain third-party software products and
associated royalty payments.
Operating expenses have generally increased in absolute dollars over the
quarters shown as the Company has increased staffing in its research and
development functions and sales and marketing functions.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has financed its operations primarily
through proceeds of approximately $23.6 million from private sales of Preferred
Stock, proceeds from its initial public offering and secondary offering of
Common Stock and, to a lesser extent, bank credit lines and capital operating
leases. The Company completed its initial public offering of Common Stock in
October 1995 and realized net proceeds of $32.5 million. In January 1996, the
Company completed its secondary offering of Common Stock, which generated net
proceeds of $16.5 million. The Company has used a portion of those proceeds to
repay borrowings under its line of credit in the amount of $1.6 million. As of
May 31, 1996, the Company had $48.0 million in cash and cash equivalents and
investments.
The Company's operating activities used cash of $2.3 million, $5.2 million,
and $1.2 million in fiscal 1994, 1995 and 1996, respectively. The cash used in
operations in fiscal 1994, 1995 and 1996, was accounted for primarily by the
Company's net losses reduced in each period by depreciation. In fiscal 1994,
accounts receivable decreased by $1.5 million, decreasing cash used in
operations. Conversely, accounts receivable increased by $1.3 million and $4.8
million in fiscal 1995 and fiscal 1996, respectively, increasing cash used in
operations.
Cash used in investing activities in fiscal 1994, 1995 and 1996 was $1.2
million, $1.1 million and $48.7 million, respectively. In fiscal 1994 and 1995,
the investing activities consisted primarily of purchases of property and
equipment. In fiscal 1996, the Company invested $44.6 million, net, in
marketable securities with its proceeds from the Company's initial public
offering and secondary offering of Common Stock, and, to a lesser extent, the
sale of Preferred Stock.
Cash provided by financing activities was $2.8 million, $4.4 million, and
$52.0 million in fiscal 1994, 1995 and 1996, respectively. For fiscal 1994 and
1995, such financing activities consisted primarily of the sale of Preferred
Stock. In fiscal 1996, such financing activities consisted primarily of the
proceeds of the Company's initial public offering and secondary offering of
Common Stock, and, to a lesser extent, the sale of Preferred Stock.
At May 31, 1996, the Company's principal sources of liquidity were its cash
and cash equivalents and short-term investments of $43.4 million. In October
1995, the Company repaid all borrowings under its $2.5 million collateralized
line of credit, which expired in November 1995. In December 1995, the Company
entered into an agreement with the same bank for a new line of credit. Under the
terms of the agreement, the Company has available an unsecured line of credit of
$7.5 million, bearing interest at the bank's prime rate, and expiring in
September 1997. The line of credit requires compliance with certain financial
covenants. See Note 6 of Notes to Consolidated Financial Statements.
Capital expenditures, including capital leases, were approximately $1.4
million, $1.2 million and $3.9 million in fiscal 1994, 1995 and 1996,
respectively. These expenditures consisted principally of purchases of property
and equipment, primarily for computer hardware and software. In January 1996,
the Company signed a lease agreement for a new facility to which the Company
relocated in July. The Company will incur leasehold improvements and capital
expenditures of approximately $6.0 million.
The Company believes that its current cash and cash equivalents, its bank
line of credit, its capital leases and funds generated from operations, if any,
will provide adequate liquidity to meet the Company's capital and operating
requirements through at least fiscal 1997. Thereafter, or if the Company's
spending plans change, the Company may find it necessary to seek to obtain
additional sources of financing to support its capital
20
23
needs, but there is no assurance that such financing will be available on
commercially reasonable terms, or at all.
BUSINESS RISKS
This report includes a number of forward-looking statements which reflect
the Company's current views with respect to future events and financial
performance. These forward-looking statements are subject to certain risks and
uncertainties, including those discussed below that could cause actual results
to differ materially from historical results or those anticipated. In this
report, the words "anticipates," "believes," "expects," "intends," "future" and
similar expressions identify forward-looking statements. Readers are cautioned
not to place undue reliance on these forward-looking statements, which speak
only as of the date hereof.
History of Losses; Strategic Realignment. Since inception, the Company has
incurred significant losses and substantial negative cash flow. At May 31, 1996,
the Company had cumulative operating losses of $21.4 million, with net losses of
$5.1 million, $5.8 million and $313,000 for fiscal 1994, fiscal 1995, and fiscal
1996, respectively. The Company was founded in 1988, and historically derived
the substantial majority of its revenues from the licensing of high-priced,
custom search and retrieval applications for use almost entirely by large
organizations and government agencies. During these years, the Company also
generated a substantial portion of its revenues by providing the consulting
services required to support these products. In early fiscal 1994, the Company
shifted its strategy to focus increasingly on more versatile, lower-priced
software applications which require less specialized consulting. Due in part to
this transition, the Company has experienced declining revenues and net losses
in each of its last three fiscal years. To achieve revenue growth, the Company
must, among other things, continue to increase market acceptance of the
Company's technology, achieve significantly increased sales levels, respond
effectively to competitive developments, continue to attract, retain and
motivate qualified persons, and continue to upgrade its technologies and
commercialize products and services incorporating such technologies. There can
be no assurance that the Company's strategy will be successful or that the
Company will experience increased revenues or become profitable or cash flow
positive at any time in the future.
Management of Transition. The Company is experiencing a period of
transition and new product introductions that have placed, and will continue to
place, a significant strain on its resources, including personnel. During the
past two years, management and other personnel have focused on modifying and
enhancing the Company's core technology to support a broader set of search and
retrieval solutions for use on desktop and enterprise-wide systems, and over
online services, the Internet and on CD-ROM. In order for the Company's strategy
to succeed, the Company must, among other things, leverage its core technology
to develop new product offerings by the Company and by its original equipment
manufacturer ("OEM") customers that address the needs of these new markets. Many
of the Company's products are still being developed or have only recently been
introduced, and there is no assurance that such products will be successfully
completed on a timely basis, will achieve market acceptance or will generate
significant revenues. Projects relating to these efforts, including the
development and commercial deployment of the Company's next generation Search
'97 suite of products, including its Agent Server products and groupware
products for Microsoft Exchange, continued enhancement of the functionality of
the Company's search engine, and technical integration of the Company's products
with the products of the Company's strategic partners, when added to the
day-to-day activities of the Company, will continue to strain the Company's
resources and personnel.
In connection with its new strategy, the Company has also replaced the
majority of its work force and substantially reorganized all of the departments
within the Company. While experiencing substantial turnover, the Company
increased the number of research and development personnel from 29 at the
beginning of fiscal 1994 to 85 at May 31, 1996. During the same period, the
Company decreased the number of consulting personnel from 29 at the beginning of
fiscal 1994 to 10 at May 31, 1996. Continuity of personnel can be an important
factor in the successful completion of the Company's development projects, and
ongoing turnover in the Company's research and development personnel could
materially and adversely impact the Company's development and marketing efforts.
The Company believes that hiring and retaining qualified individuals at all
21
24
levels in the Company is essential to its success, and there can be no assurance
that the Company will be successful in attracting and retaining the necessary
personnel. If Company management is unable to effectively manage its planned
transition or any subsequent growth, identify opportunities in a timely fashion,
and evaluate and manage the Company's business and competitive position, results
of operations and financial condition will be materially and adversely affected.
Fluctuations in Operating Results. The Company's quarterly operating
results have varied and are expected to vary significantly in the future. These
fluctuations may be caused by many factors, including, among others, the size
and timing of individual orders; customer order deferrals in anticipation of new
products; changes in the budgets or purchasing patterns of government agencies;
timing of introduction or enhancement of products by the Company or its
competitors; market acceptance of new products; technological changes in search
and retrieval, database, networking, or communications technology; competitive
pricing pressures; changes in the Company's operating expenses; personnel
changes; foreign currency exchange rates; mix of products sold; quality control
of products sold; and general economic conditions.
A significant portion of the Company's revenues in recent quarters has been
derived from relatively large sales to a limited number of customers, and the
Company currently anticipates that future quarters will continue to reflect this
trend. Sales cycles for these customers can be up to six months or longer. In
addition, like many software companies, the Company has generally recognized a
substantial portion of its revenues in the last month of each quarter, with
these revenues concentrated in the last weeks of the quarter. Accordingly, the
cancellation or deferral of even a small number of purchases of the Company's
products could have a material adverse effect on the Company's business, results
of operations and financial condition in any particular quarter. To the extent
that significant sales occur earlier than expected, operating results for
subsequent quarters may fail to keep pace or even decline.
Product revenues are also difficult to forecast because the market for
search and retrieval software is uncertain and evolving. Because the Company
generally ships software products within a short period after receipt of an
order, the Company typically does not have a material backlog of unfilled
orders, and revenues in any quarter are substantially dependent on orders booked
in that quarter. In addition, a portion of the Company's revenues are derived
from royalties based upon sales by third-party vendors of products incorporating
the Company's technology. These revenues may be subject to extreme fluctuation
and are difficult for the Company to predict. The Company's expense levels are
based, in part, on its expectations as to future revenues and to a large extent
are fixed. Therefore, the Company may be unable to adjust spending in a timely
manner to compensate for any unexpected revenue shortfall. Any significant
shortfall of demand in relation to the Company's expectations or any material
delay of customer orders would have an almost immediate adverse affect on the
Company's operating results and on the Company's ability to achieve
profitability.
The Company's revenues, and particularly its software products revenues,
increased significantly in fiscal 1996. Due to the evolving nature of the
markets for the Company's products and other factors, however, there can be no
assurance that the Company's revenues will continue to increase significantly or
at all in future periods.
As a result of the foregoing and other factors, the Company believes that
period-to-period comparisons of its results of operations are not necessarily
meaningful and should not be relied upon as indications of future performance.
Fluctuations in operating results may also result in volatility in the price of
the shares of the Company's Common Stock.
Developing Market; Unproven Acceptance of the Company's Products. The
Company has recently introduced or announced several products addressing a
market which has only recently begun to develop, is rapidly evolving and is
characterized by an increasing number of market entrants who have introduced or
developed products and services addressing search and retrieval requirements
over private and public networks, CD-ROM, online services and the Internet. The
Company currently plans to commence commercial shipments of its enhanced Search
'97 line of products in the Fall 1996. There is no assurance that such products
will be developed and released on a timely basis, or that such products will
achieve market acceptance.
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25
As is typical in the case of a new and evolving industry, demand and market
acceptance for recently introduced products and services are subject to a high
level of uncertainty. The software industry addressing the information
management requirements of networked systems, CD-ROM, online services and the
Internet is young and has few proven products. Moreover, critical issues
concerning the commercial use of online services and the Internet (including
security, reliability, cost, ease of use and access, and quality of service)
remain unresolved and may impact the growth of the Internet and online markets,
together with the software standards and electronic media employed in such
markets.
The Company's future operating results will depend in substantial part upon
its ability to increase the installed base of its Topic intelligent search and
filtering technology and to begin to generate significant product revenues from
its Topic Enterprise Server, Topic Client, Topic CD Publisher, Topic Internet
Server, Topic Agent Server and Topic Newswire Access products, its Search '97
products under development and other products addressing the information
retrieval requirements of individuals and corporations from data sources within
an enterprise and on CD-ROM, online services and the Internet. The Company's
future operating results will also depend upon its ability to successfully
market its technology to online and Internet publishers who use such technology
to index their published information into Topic collections. To the extent that
such publishers do not adopt the Company's technology for indexing their
published information, users will be unable to search such information using the
Company's search and retrieval products, which in turn will limit the demand for
the Company's products.
Because the market for certain of the Company's products and services is
new and evolving, it is difficult to assess or predict with any assurance the
growth rate, if any, and size of this market. There can be no assurance that the
market for the Company's products and services will develop, or that the
Company's products or services will achieve market acceptance. If the market
fails to develop, develops more slowly than expected or becomes saturated with
competitors, or if the Company's products do not achieve significant market
acceptance, the Company's business, operating results and financial condition
will be materially adversely affected.
A significant element of the Company's strategy is to embed the Topic
technology in products offered by the Company's OEM customers. Many of the
markets for such products are also new and evolving and, therefore, subject to
the same risks faced by the Company in the markets for its own products. In
addition, consolidation in the industries served by the Company could, and
acquisition or development by any of the Company's significant customers of
technology competitive with the Company's would, materially and adversely affect
the Company's business and prospects. See "Item 1. Business -- Industry
Background."
Dependence on International Operations. In fiscal 1994, fiscal 1995 and
fiscal 1996, revenues derived from foreign operations accounted for
approximately 15.7%, 14.3% and 6.6% of the Company's total revenues,
respectively, with European operations alone accounting for 12.1%, 11.9% and
5.6% of revenues for these periods. The Company's export sales accounted for
28.7%, 24.1% and 19.1% of revenues in fiscal 1994, fiscal 1995 and fiscal 1996,
respectively. Accordingly, on a combined basis, foreign operations and export
sales accounted for approximately 44.4%, 38.4% and 25.7% of revenues in fiscal
1994, fiscal 1995 an fiscal 1996, respectively. The Company expects that
revenues derived from foreign operations and export sales will continue to
account for a significant percentage of the Company's revenues for the
foreseeable future; however, these revenues may fluctuate significantly as a
percentage of revenues from period to period. Certain of these revenues have
been derived from sales to foreign government agencies which may be subject to
risks similar to those described below.
There are a number of risks inherent in the Company's international
business activities, including unexpected changes in regulatory requirements,
tariffs and other trade barriers, costs and risks of localizing products for
foreign countries, longer accounts receivable payment cycles, potentially
adverse tax consequences, limits on repatriation of earnings and the burdens of
complying with a wide variety of foreign laws. Additionally, the Company does
not engage in hedging activities to protect against the risk of currency
fluctuations. Fluctuations in currency exchange rates could cause sales
denominated in U.S. dollars to become relatively more expensive to customers in
a particular country, leading to a reduction in sales or profitability in that
country. Also, such fluctuations could cause sales denominated in foreign
currencies to affect a reduction
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26
in the current U.S. dollar revenues derived from sales in a particular country.
Furthermore, future international activity may result in increased foreign
currency denominated sales and, in such event, gains and losses on the
conversion to U.S. dollars of accounts receivable and accounts payable arising
from international operations may contribute significantly to fluctuations in
the Company's results of operations. The financial stability of foreign markets
could also affect the Company's international sales. In addition, revenues of
the Company earned in various countries where the Company does business may be
subject to taxation by more than one jurisdiction, thereby adversely affecting
the Company's earnings. There can be no assurance that such factors will not
have an adverse effect on the revenues from the Company's future international
sales and, consequently, the Company's results of operations.
Dependence on United States Government and the Risk of Contract
Termination. Agencies of the United States government have accounted for a
significant portion of the Company's revenues. Specifically, these agencies
accounted for approximately 29.3%, 25.5% and 10.5% of revenues in fiscal 1994,
fiscal 1995 and fiscal 1996, respectively. Sales to government agencies declined
as a percentage of revenues during these periods, and may decline in the future.
In recent years, budgets of many government agencies have been reduced, causing
certain customers and potential customers of the Company's products to
re-evaluate their needs. Such budget reductions are expected to continue over at
least the next several years. Future reductions in United States spending on
information technologies could have a material adverse effect on the Company's
operating results.
Almost all of the Company's government contracts contain termination
clauses which permit contract termination upon the Company's default or for
convenience of the other contracting party. There can be no assurance such
cancellations will not occur in the future, and any such termination could
adversely affect the Company's operating results.
Technological Change; Market Acceptance of Evolving Standards.
Historically, the Company has derived substantially all of its revenues from the
license of custom search and retrieval applications and consulting and other
services related to such applications. Recently, the Company has refined and
enhanced its core technology to add functionality and facilitate incorporation
of the Company's technology in a variety of applications addressing the desktop,
CD-ROM, enterprise, online and Internet markets. Nevertheless, the Company
expects that for the foreseeable future it will continue to derive the largest
portion of its revenues from licensing its technology for enterprise
applications.
The computer software industry is subject to rapid technological change,
changing customer requirements, frequent new product introductions and evolving
industry standards that may render existing products and services obsolete. As a
result, the Company's position in its existing markets or other markets that it
may enter could be eroded rapidly by product advancements by competitors. The
life cycles of the Company's products are difficult to estimate. The Company's
future success will depend, in part, upon its ability to enhance existing
products and to develop new products on a timely basis. In addition, its
products must keep pace with technological developments, conform to evolving
industry standards, particularly client/server and Internet communication and
security protocols, as well as publishing formats such as Hypertext Markup
Language ("HTML"), and address increasingly sophisticated customer needs. There
can be no assurance that the Company will not experience difficulties that could
delay or prevent the successful development, introduction and marketing of new
products, or that new products and product enhancements will meet the
requirements of the marketplace and achieve market acceptance. If the Company is
unable to develop and introduce products in a timely manner in response to
changing market conditions or customer requirements, the Company's financial
condition and results of operations would be materially and adversely affected.
In addition, a significant strategy of the Company is to achieve
compatibility between the Company's products and the text publication formats
the Company believes are or will become popular and widely adopted. The Company
invests substantial resources in development efforts aimed at achieving such
compatibility. Any failure by the Company to anticipate or respond adequately to
technology or market developments could result in a loss of competitiveness or
revenue. For instance, to date the Company has focused its efforts on
integration with the Adobe PDF and Lotus Notes environments and, more recently,
the Microsoft Exchange environment. Should any of these products or technologies
lose or fail to achieve
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27
acceptance in the marketplace or be replaced by other products or technologies,
the Company's business could be materially adversely affected.
Because one of the Company's strategies is to embed its basic search engine
in key OEM application products, the Company's sales of its intelligent search
and filtering products depend in part on its ability to maintain compatibility
with these OEM applications. There is no assurance that the Company will be able
to maintain compatibility with these vendors' products or continue to be the
search technology of choice for such OEMs, and the failure to maintain
compatibility with or be selected by such OEMs would materially adversely affect
the Company's sales. Further, the failure of the products of the Company's key
OEM partners to achieve market acceptance could have a material adverse effect
on the Company's results of operations.
Software products as complex as those offered by the Company may contain
errors that may be detected at any point in the products' life cycles. The
Company has in the past discovered software errors in certain of its products
and has experienced delays in shipment of products during the period required to
correct these errors. There can be no assurance that, despite testing and
quality assurance efforts by the Company and by current and potential customers,
errors will not be found, resulting in loss of or delay in market acceptance and
sales, diversion of development resources, injury to the Company's reputation,
or increased service and warranty costs, any of which could have a material
adverse effect on the Company's business, results of operations and financial
condition. Although the Company generally attempts to limit by contract its
exposure to incidental and consequential damages, and to cap the Company's
liabilities to its proceeds under the contract, if a court failed to enforce the
liability limiting provisions of the Company's contracts for any reason, or if
liabilities arose which were not effectively limited, the Company's operating
results could be materially and adversely affected.
Dependence on the Internet. The Company's Topic Internet Server product
was released in May 1995, and its Topic CD Publisher product was released in
early 1996. Sales of the Company's products addressing Internet search
requirements will depend to a substantial degree upon the continued use and
future expansion of the Internet for text-based information publication and
distribution. Because global commerce and online exchange of information on the
Internet and other similar open wide area networks are new and evolving, it is
difficult to predict with any assurance whether the Internet will prove to be a
viable medium for the publication and distribution of information, including,
for example, sensitive proprietary information developed and published by
private enterprises.
Competition. The electronic information search and retrieval software
market is intensely competitive. The Company believes the principal competitive
factors in this market are product quality, performance and price, vendor and
product reputation, product architecture, strategic alliances, functionality and
features, ease of use and quality of support. A number of companies offer
competitive products addressing certain of the Company's target markets. In the
enterprise market, the Company competes with Information Dimensions, Dataware
and Excalibur, among others. In the Internet/Publishing market, the Company
competes with Folio, Dataware and Fulcrum, among others. Fulcrum is also the
Company's principal competitor in the tools market. The Company's principal
competitors in the online market are Fulcrum, which currently provides search
and retrieval technology for the Microsoft Network, and Logicon. The Company
also competes indirectly with database vendors that offer information search and
retrieval capabilities with their core database products. In the future, the
Company may encounter competition from companies that enhance products such as
word processing software, document management systems, groupware applications,
Internet products and operating systems to include text search and retrieval
features. Also, Microsoft recently announced its intention to market search and
retrieval software competitive with the Company's products. Many of the
Company's existing competitors, as well as Microsoft and a number of potential
new competitors, have significantly greater financial, technical and marketing
resources than the Company. Because the success of the Company's strategy is
dependent in part upon the success of the Company's strategic partners,
competition between the Company's strategic partners and the strategic partners
of the Company's competitors, or failure of the products of the Company's
strategic partners to achieve or maintain market acceptance, could have a
material adverse effect on the Company's competitive position. There can be no
assurance that the Company will be able to compete successfully against its
current or future competitors or that competition will not have a material
adverse effect on the Company's results of operations and financial condition.
25
28
Dependence on Strategic Alliances. The Company is relying on a number of
strategic relationships to achieve commercialization of the Company's
technologies and leverage the Company's development, sales and marketing
resources. Although the Company views these relationships as important factors
in development and commercialization of the Company's technologies, a majority
of the Company's agreements with its strategic partners or customers do not
require future minimum commitments to license the Company's technology, are not
exclusive and may be terminated at the convenience of the Company's customer.
There can be no assurance that the Company's strategic partners regard their
relationship with the Company as strategic to their own respective businesses
and operations, that they will not re-assess their commitment to the Company's
technologies at any time in the future or that they will not develop their own
competitive technology. Further, there can be no assurance that products of the
Company's strategic partners will achieve market acceptance or commercial
success.
In order to achieve widespread adoption of Topic technology, it will be
necessary for third-party developers to create, produce and market applications
which employ the Topic search and retrieval technology. A significant component
of the Company's strategy is to leverage the Topic technology through the
applications of third-party vendors and third-party information publishers.
However, no third-party developer is obligated to select or continue to use the
Company's Topic technology, and there can be no assurance that Topic technology
will be selected or used by any significant number of third-party developers in
the future. To assist in the development of third-party applications, the
Company has developed and is selling the Topic Developer's Toolkit ("TDK").
There can be no assurance that the TDK will achieve widespread commercial
acceptance or will result in the incorporation of Topic technology in
commercially successful third-party products.
Dependence on Key Personnel. The Company's performance is substantially
dependent on the performance of its executive officers and key employees, many
of whom have worked together for only a short period of time. In particular, the
services of Philippe Courtot, the Company's Chairman, President and Chief
Executive Officer, would be difficult to replace. The Company is heavily
dependent upon its ability to attract, retain and motivate skilled technical and
managerial personnel. The Company does not have in place key person life
insurance policies on any of its employees. The loss of the services of any of
its executive officers or other key employees could have a material adverse
effect on the business, operating results or financial condition of the Company.
The Company's future success also depends on its continuing ability to
identify, hire, train and retain other highly qualified technical and managerial
personnel. Competition for such personnel is intense, and there can be no
assurance that the Company will be able to attract, assimilate or retain other
highly qualified technical and managerial personnel in the future. The inability
to attract, hire or retain the necessary technical and managerial personnel
could have a material adverse effect upon the Company's business, operating
results or financial condition.
Dependence on Proprietary Technology. The Company's success and ability to
compete is dependent in part upon its proprietary technology. While the Company
relies on trademark, trade secret and copyright law to protect its technology,
the Company believes that factors such as the technological and creative skills
of its personnel, new product developments, frequent product enhancements, name
recognition and reliable product maintenance are more essential to establishing
and maintaining a technology leadership position. The Company presently has no
patents or patent applications pending. There can be no assurance that others
will not develop technologies that are similar or superior to the Company's
technology. The source code for the Company's proprietary software is protected
both as a trade secret and as a copyrighted work. Despite these precautions, it
may be possible for a third party to copy or otherwise obtain and use the
Company's products or technology without authorization, or to develop similar
technology independently. In addition, effective copyright and trade secret
protection may be unavailable or limited in certain foreign countries. To
license its client products, the Company primarily relies on "shrink wrap"
licenses that are not signed by the end user and, therefore, may be
unenforceable under the laws of certain jurisdictions. Despite the Company's
efforts to protect its proprietary rights, unauthorized parties may attempt to
copy aspects of the Company's products or to obtain and use information that the
Company regards as proprietary. Policing unauthorized use of the Company's
products is difficult. There can be no assurance that the steps taken by the
Company will prevent
26
29
misappropriation of its technology or that such agreements will be enforceable.
In addition, litigation may be necessary in the future to enforce the Company's
intellectual property rights, to protect the Company's trade secrets, to
determine the validity and scope of the proprietary rights of others, or to
defend against claims of infringement or invalidity. Such litigation could
result in substantial costs and diversion of resources and could have a material
adverse effect on the Company's business, operating results or financial
condition.
Certain technology used by the Company's products is licensed from third
parties, generally on a nonexclusive basis. The Company believes that there are
alternative sources for each of the material components of technology licensed
by the Company from third parties. However, the termination of any of such
licenses, or the failure of the third party licensors to adequately maintain or
update their products, could result in delay in the Company's ability to ship
certain of its products while it seeks to implement technology offered by
alternative sources. Any required replacement licenses could prove costly. Also,
any such delay, to the extent it becomes extended or occurs at or near the end
of a fiscal quarter, could result in a material adverse effect on the Company's
quarterly results of operations. While it may be necessary or desirable in the
future to obtain other licenses relating to one or more of the Company's
products or relating to current or future technologies, there can be no
assurance that the Company will be able to do so on commercially reasonable
terms or at all.
Possible Volatility of Stock Price. The Company's Common Stock is quoted
for trading on the Nasdaq National Market. The market price for the Common Stock
may be highly volatile for a number of reasons including future announcements
concerning the Company or its competitors, quarterly variations in operating
results, announcements of technological innovations, the introduction of new
products or changes in product pricing policies by the Company or its
competitors, proprietary rights or other litigation, changes in earnings
estimates by analysts or other factors. In addition, stock prices for many
technology companies fluctuate widely for reasons which may be unrelated to
operating results. These fluctuations, as well as general economic, market and
political conditions such as recessions or military conflicts, may materially
and adversely affect the market price of the Company's Common Stock.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Financial Statements and supplemental data of the Company required by
this item are set forth at the pages indicated at Item 14(a).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information relating to the directors and executive officers of the Company
is set forth in Part I of this report under the caption "Directors, Executive
Officers and Key Employees of the Registrant."
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference from the
definitive proxy statement for the Company's 1996 annual meeting of stockholders
to be filed with the Commission pursuant to Regulation 14A not later than 120
days after the end of the fiscal year covered by this Form (the "Proxy
Statement") under the caption "EXECUTIVE COMPENSATION AND OTHER MATTERS".
27
30
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference from the
Proxy Statement under the captions "STOCK OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference from the
Proxy Statement under the captions "CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS" and "EXECUTIVE COMPENSATION AND OTHER MATTERS -- Compensation
Committee Interlocks and Insider Participation in Compensation Decisions".
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this Form:
PAGE
NUMBER
------
1. Financial Statements:
Reports of Independent Accountants............................................. 29
Consolidated Balance Sheet -- As of May 31, 1996 and 1995...................... 30
Consolidated Statement of Operations -- For the Three Years Ended May 31,
1996........................................................................... 31
Consolidated Statement of Changes in Stockholders' Equity -- For the Three
Years Ended May 31, 1996....................................................... 32
Consolidated Statement of Cash Flows -- For the Three Years Ended May 31,
1996........................................................................... 33
Notes to Consolidated Financial Statements..................................... 34
2. Financial Statement Schedules -- For years ended May 31, 1996, 1995 and 1994:
Schedule II -- Valuation and Qualifying Accounts
All other schedules are omitted because they are not applicable or the required
information is shown in the consolidated financial statements or notes thereto.
3. Exhibits: See Index to Exhibits on page 47. The Exhibits listed in the
accompanying Index to Exhibits are filed or incorporated by reference as part
of this report.
(b) Reports on Form 8-K:
None.
28
31
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
Verity, Inc.
We have audited the accompanying consolidated balance sheets of Verity,
Inc. and Subsidiaries as of May 31, 1996 and 1995, and the related consolidated
statements of operations, changes in stockholders' equity and cash flows for
each of the three years in the period ended May 31, 1996. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Verity, Inc. and Subsidiaries as of May 31, 1996 and 1995, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended May 31, 1996, in conformity with generally accepted accounting
principles.
COOPERS & LYBRAND L.L.P.
San Jose, California
June 21, 1996, except for Note 14
for which the date is July 12, 1996
29
32
VERITY, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
MAY 31,
---------------------
1996 1995
-------- --------
ASSETS
Current assets:
Cash and cash equivalents............................................ $ 2,482 $ 324
Short-term investments............................................... 40,899
Trade accounts receivable, less allowance for doubtful accounts of
$389 in 1996 and $361 in 1995..................................... 8,822 4,457
Prepaid and other current assets..................................... 1,161 314
-------- --------
Total current assets......................................... 53,364 5,095
Property and equipment, at cost, net of accumulated depreciation and
amortization......................................................... 4,744 1,857
Long-term investments.................................................. 4,592
Other assets........................................................... 24 35
-------- --------
Total assets................................................. $ 62,724 $ 6,987
======== ========
LIABILITIES
Current liabilities:
Note payable to bank................................................. $ 895
Current portion of long-term debt and capital lease obligation....... $ 426
Accounts payable..................................................... 3,368 1,908
Accrued compensation................................................. 1,565 708
Other accrued liabilities............................................ 779 198
Deferred revenue..................................................... 3,139 1,920
-------- --------
Total current liabilities.................................... 9,277 6,433
Long-term debt and capital lease obligations, net of current portion... 639 924
-------- --------
Total liabilities............................................ 9,916 7,357
-------- --------
Commitments (Note 8)
MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK
Series A through H, $.001 par value:
Authorized: none in 1996 and 5,000,000 shares in 1995; Issued and
outstanding: none in 1996 and 4,572,000 shares in 1995........... 32,069
--------
STOCKHOLDERS' EQUITY
Preferred stock, $.001 par value:
Authorized: 2,000,000 shares in 1996
Issued and outstanding: none
Common stock, $.001 par value:
Authorized: 30,000,000 in 1996 and 8,000,000 shares in 1995;
Issued and outstanding: 10,735,000 in 1996 and 1,581,000 shares
in 1995.......................................................... 11 2
Additional paid-in capital............................................. 87,882 1,271
Notes receivable from stockholders..................................... (1,225) (901)
Unrealized loss on investments......................................... (125)
Accumulated deficit.................................................... (33,735) (32,811)
-------- --------
Total stockholders' equity................................... 52,808 (32,439)
-------- --------
Total liabilities, mandatorily redeemable preferred stock and
stockholders' equity....................................... $ 62,724 $ 6,987
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
30
33
VERITY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED MAY 31,
-------------------------------
1996 1995 1994
------- ------- -------
Revenues:
Software products........................................... $24,472 $10,143 $ 9,217
Service and other........................................... 6,246 5,743 7,385
------- ------- -------
Total revenues...................................... 30,718 15,886 16,602
------- ------- -------
Costs of revenues:
Software products........................................... 2,074 623 720
Service and other........................................... 2,785 2,926 4,350
------- ------- -------
Total costs of revenues............................. 4,859 3,549 5,070
------- ------- -------
Gross profit.................................................. 25,859 12,337 11,532
------- ------- -------
Operating expenses:
Research and development.................................... 8,488 5,892 4,872
Acquisition of in-process research and development.......... 381
Marketing and sales......................................... 14,912 9,280 7,783
General and administrative.................................. 3,469 2,747 2,302
Restructuring charges....................................... 1,175
------- ------- -------
Total operating expenses............................ 27,250 17,919 16,132
------- ------- -------
Loss from operations.......................................... (1,391) (5,582) (4,600)
Other income (expense), net................................... 1,342 57 (234)
Interest expense.............................................. (264) (313) (270)
------- ------- -------
Net loss................................................. $ (313) $(5,838) $(5,104)
======= ======= =======
Net loss...................................................... $ (313) $(5,838) $(5,104)
Accretion to redemption value of mandatorily redeemable
convertible preferred stock................................. (611) (2,081) (2,646)
------- ------- -------
Net loss applicable to common stockholders.................... $ (924) $(7,919) $(7,750)
======= ======= =======
Net loss per share............................................ $ (0.12) $ (2.18) $ (2.67)
======= ======= =======
Number of shares used in per share calculation................ 7,829 3,635 2,903
======= ======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
31
34
VERITY, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED MAY 31, 1996, 1995 AND 1994
(IN THOUSANDS)
NOTES TOTAL
COMMON STOCK ADDITIONAL RECEIVABLE UNREALIZED STOCKHOLDERS'
--------------- PAID-IN FROM LOSS ON ACCUMULATED (DEFICIT)
SHARES AMOUNT CAPITAL STOCKHOLDER INVESTMENTS DEFICIT EQUITY
------ ------ ---------- ----------- ----------- ----------- -------------
Balances, May 31, 1993................... 596 $ 1 $ 166 $ (3) $ (17,142) $ (16,978)
Issuance of common stock upon exercise
of stock options..................... 124 123 123
Payments of notes receivable from
stockholders......................... 3 3
Accretion to redemption value of
preferred stock...................... (2,646) (2,646)
Net loss............................... (5,104) (5,104)
------- ---- ------- -------
Balances, May 31, 1994................... 720 1 289 -- (24,892) (24,602)
Issuance of common stock:
Upon exercise of stock options....... 68 70 70
In exchange for notes receivable..... 783 1 900 (901)
Other................................ 10 12 12
Accretion to redemption value of
preferred stock...................... (2,081) (2,081)
Net loss............................... (5,838) (5,838)
------- ---- ------- -------
Balances, May 31, 1995................... 1,581 2 1,271 (901) (32,811) (32,439)
Issuance of common stock:
Upon exercise of stock options....... 561 1 726 (403) 324
In exchange for services............. 21 60 60
From public offerings, net of
issuance costs of $1,361........... 3,500 3 49,011 49,014
Upon exercise of warrants............ 17 99 99
Under employee stock purchase plan... 82 839 839
Conversion of mandatorily redeemable
preferred stock...................... 5,008 5 35,917 35,922
Payments on notes receivable from
stockholder.......................... 79 79
Repurchase of common stock from
stockholders......................... (35) (41) (41)
Unrealized loss on investments......... $(125) (125)
Accretion to redemption value of
preferred stock...................... (611) (611)
Net loss............................... (313) (313)
------- ---- ------- ------- -----
Balances, May 31, 1996................... 10,735 $ 11 $ 87,882 $(1,225) $(125) $ (33,735) $ 52,808
======= ==== ======= ======= =====
The accompanying notes are an integral part of these consolidated financial
statements.
32
35
VERITY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED MAY 31,
---------------------------------
1996 1995 1994
--------- ------- -------
Cash flows from operating activities:
Net loss....................................................................... $ (313) $(5,838) $(5,104)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization................................................ 1,680 1,272 1,265
Provision for doubtful accounts.............................................. 455 383 277
Amortization of discount on securities....................................... (282)
Realized gain on sale of investments......................................... (761)
Acquisition of in-process research and development........................... 381
Changes in operating assets and liabilities:
Trade accounts receivable.................................................. (4,811) (1,318) 1,516
Prepaid and other current assets........................................... (838) 67 (80)
Accounts payable........................................................... 634 489 69
Accrued compensation and other accrued liabilities......................... 1,453 (248) (93)
Deferred revenue........................................................... 1,219 (24) (198)
--------- ------- -------
Net cash used in operating activities................................... (1,183) (5,217) (2,348)
--------- ------- -------
Cash flows from investing activities:
Acquisition of property and equipment.......................................... (3,899) (1,156) (1,356)
Decrease in other assets....................................................... 78 126
Acquisition of Insite.......................................................... (185)
Purchases of marketable securities............................................. (212,430)
Maturity of marketable securities.............................................. 142,145
Proceeds from sale of marketable securities.................................... 25,712
--------- ------- -------
Net cash used in investing activities................................... (48,657) (1,078) (1,230)
--------- ------- -------
Cash flows from financing activities:
Borrowings under line of credit................................................ 750 1,150 950
Payments on line of credit..................................................... (1,645) (1,205) (500)
Proceeds from the sale of mandatorily redeemable convertible preferred stock,
net of issuance costs........................................................ 3,242 4,406 1,992
Proceeds from the sale of common stock, net of issuance costs.................. 50,235 70 123
Payments from stockholders on notes receivable................................. 79 3
Proceeds from issuance of notes payable........................................ 150 1,545
Proceeds from sales and lease backs of property and equipment.................. 147 626
Principal payments on notes payable and capital lease obligations.............. (961) (697) (1,347)
--------- ------- -------
Net cash provided by financing activities............................... 51,997 4,350 2,766
--------- ------- -------
Effect of exchange rate changes on cash.......................................... 1 85 55
--------- ------- -------
Net increase (decrease) in cash and cash equivalents.................... 2,158 (1,860) (757)
Cash and cash equivalents, beginning of period................................... 324 2,184 2,941
--------- ------- -------
Cash and cash equivalents, end of period......................................... $ 2,482 $ 324 $ 2,184
========= ======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest....................................... $ 262 $ 313 $ 245
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Accretion to redemption value of mandatorily redeemable convertible preferred
stock........................................................................ $ 611 $ 2,081 $ 2,646
Equipment purchases included in accounts payable............................... $ 376 $ 95 $ 91
Issuance of common stock for notes receivable.................................. $ 403 $ 901
Conversion of mandatorily redeemable preferred stock to common stock........... $ 35,922
Assets acquired in Insite acquisition.......................................... $ 122
Liabilities assumed in Insite acquisition...................................... $ 208
Insite acquisition consideration included in accrued liabilities............... $ 110
The accompanying notes are an integral part of these consolidated financial
statements.
33
36
VERITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS:
Verity, Inc. (the Company) was incorporated in California in March 1988 and
reincorporated in Delaware in September 1995. The Company develops, markets and
supports software tools and applications that enable individuals, enterprises
and publishers to intelligently search, filter and disseminate textual
information residing on enterprise networks, on-line services, the Internet,
CD-ROM and other electronic media. The Company markets and sells its software
and services to commercial end users across many industries and government
entities through multiple distribution channels, including direct sales and
telesales organizations primarily in the United States, Europe and Australia,
and a worldwide network of value added resellers and system integrators. The
Company also licenses its software to original equipment manufacturers for use
in their applications sold to end users.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Basis of Consolidation:
The consolidated financial statements include the accounts of Verity, Inc.
and its wholly owned subsidiaries and branches in Australia, Canada, France,
Germany, the Netherlands and the United Kingdom. All intercompany balances and
transactions have been eliminated.
Accounting Estimates:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amount of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
Cash and Cash Equivalents:
Investments with an original or remaining maturity of 90 days or less as of
the date of purchase are generally considered cash equivalents. The Company
maintains the majority of its cash and cash equivalents in demand accounts with
two major financial institutions.
Property and Equipment:
Property and equipment are stated at cost and are depreciated on a
straight-line basis over the estimated useful lives of the related assets,
generally three to five years. Leased assets are amortized on a straight-line
basis over the lesser of the estimated useful life or the lease term. Gains and
losses upon asset disposal are taken into income in the year of disposition.
Revenue Recognition:
Revenues from the sale of software products are recognized upon delivery of
the product if remaining vendor obligations are insignificant and collection of
the resulting receivable is probable. Estimated sales returns and provisions for
insignificant vendor obligations are recorded upon shipment.
Service and other revenues include software maintenance revenues and other
service revenues, primarily from consulting and training. Software maintenance
revenues are deferred and recognized ratably over the life of the service
contract. Service revenues from consulting contracts are recognized on the
percentage of completion basis. Other service revenues are recognized as the
related services are performed.
34
37
VERITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Research and Development Costs:
Costs related to research, design and development of products are charged
to research and development expense as incurred. Software development costs are
capitalized beginning when a product's technological feasibility has been
established and ending when a product is available for general release to
customers. To date, completing a working model of the Company's products and
general release have substantially coincided. As a result, the Company has not
capitalized any software development costs since such costs have not been
significant.
Income Taxes:
Deferred tax assets and liabilities are determined based on the differences
between financial reporting and tax bases of assets and liabilities, measured at
tax rates that will be in effect when the differences are expected to reverse.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amounts expected to be realized.
Investments:
The Company has investments at May 31, 1996 which consist primarily of
commercial paper and debt securities. As of the balance sheet date, investments
with maturity dates of one year or less are classified as current, and those
with maturity dates of greater than one year are classified as long-term.
The Company has classified its investments as available-for-sale. Such
investments are recorded at fair value and unrealized gains and losses, if
material, are recorded as a separate component of equity, net of tax, until
realized. Interest income is recorded using an effective interest rate, with the
associated premium or discount amortized to investment income. The cost of
securities sold is based upon the specific identification method.
Concentration of Credit Risk:
The Company performs ongoing credit evaluations of its customers' financial
condition and generally does not require collateral. The Company maintains
allowances for potential losses, and such losses have been within management's
expectations. No single customer accounted for more than 10% of the accounts
receivable balance at May 31, 1996 and 1995.
Foreign Currency Translation:
The Company translates the accounts of its branches and subsidiaries using
historical rates for nonmonetary assets and current rates for monetary assets.
Remeasurement gains and losses from the translation of these branches and those
that arise from exchange rate changes on transactions denominated in a currency
other than the local currency are included in the statements of operations. The
Company's foreign branches and subsidiaries use the U.S. dollar as their
functional currency as the U.S. parent exclusively funds the branches and
subsidiaries' operations with U.S. dollars. The net gain (loss) on foreign
currency remeasurement and exchange rate changes for fiscal years 1996, 1995 and
1994 which is included in other income (expense), net on the accompanying
statements of operations, was $(24,000), $36,000, and $(260,000), respectively.
Fair Value of Financial Instruments:
Carrying amounts of certain of the Company's financial instruments
including cash and cash equivalents, accounts receivable, accounts payable,
accrued expenses and other liabilities approximate fair value due to their short
maturities. Based upon borrowing rates currently available to the Company for
loans with similar terms, the carrying value of capital lease obligations and
notes payable approximate fair value.
35
38
VERITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Computation of Net Loss Per Share:
Net loss per share is computed using the weighted average number of shares
of common and common stock equivalents outstanding. Common equivalent shares
from stock options, warrants and preferred stock are excluded from the
computation when their effect is antidilutive, except that, pursuant to the
Securities and Exchange Commission Staff Accounting Bulletins, common and common
equivalent shares and mandatorily redeemable convertible preferred stock, issued
at prices below the public offering price during the twelve months immediately
preceding the Company's initial filing date of the registration statement with
the Securities and Exchange Commission, have been included in the calculation as
if they were outstanding for all periods ending prior to the effectiveness of
the Company's October 1995 initial public offering, using the treasury stock
method and the initial public offering price.
Recent Pronouncements:
In March 1995, the Financial Accounting Standards Board issued Statement
No. 121 (SFAS 121) which establishes accounting standards for the impairment of
long-lived assets, certain identifiable intangibles, and goodwill related to
those assets which are held and used or disposed of. SFAS 121 will be effective
for fiscal years beginning after December 15, 1995. The Company does not
anticipate that the adoption of SFAS 121 will have an adverse material effect on
the Company's financial position or results of operations.
During October 1995, the Financial Accounting Standards Board issued
Statement No. 123 (SFAS 123) which establishes a fair value based method of
accounting for stock based compensation plans and requires additional
disclosures for those companies who elect not to adopt the new method of
accounting. While the Company is studying the impact of the pronouncement, it
continues to account for employee stock options under APB Opinion No. 25,
"Accounting for Stock Issued to Employees." SFAS 123 will be effective for
fiscal years beginning after December 15, 1995.
3. ACQUISITION:
In March 1996, the Company acquired substantially all of the assets of
Insite Computer Technology Limited (Insite), a company which has focused on
developing groupware solutions, for a total purchase price of approximately
$295,000 and assumed liabilities of $208,000. The purchase price has been
allocated to the fair value of the tangible assets and in-process research and
development in the amounts of $122,000 and $381,000, respectively. The amount of
the purchase price allocated to in-process research and development, which had
no alternative future use and relates to products for which technological
feasibility has not been established, was expensed at the acquisition date. The
acquisition has been accounted for as a purchase and the results of Insite's
operations have been included in the consolidated financial statements from the
date of acquisition.
The operations of the acquired company are not material to the consolidated
financial statements of the Company, and accordingly, separate pro forma
financial information has not been presented for fiscal years 1996 and 1995 as
if Insite had been acquired as of June 1, 1994.
36
39
VERITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. INVESTMENTS:
As of May 31, 1996, available-for-sale securities consist of the following
(in thousands):
GROSS
AMORTIZED UNREALIZED FAIR
COST LOSSES VALUE
--------- ---------- -------
Corporate commercial paper -- short-term............. $40,964 $ (65) $40,899
Corporate commercial paper -- long-term.............. 4,652 (60) 4,592
------- ----- -------
Total investments.......................... $45,616 $ (125) $45,491
======= ===== =======
At May 31, 1996, scheduled maturities of investments classified as
available-for-sale are as follows (in thousands):
Within one year.................................................... $40,964
After one year through five years.................................. 4,652
-------
$45,616
=======
5. PROPERTY AND EQUIPMENT (IN THOUSANDS):
MAY 31,
-------------------
1996 1995
------- -------
Computer equipment............................................... $ 8,212 $ 5,903
Furniture and fixtures........................................... 2,037 958
Leasehold improvements........................................... 805
------- -------
11,054 6,861
Less accumulated depreciation and amortization................... (6,463) (5,004)
------- -------
4,591 1,857
Construction in progress......................................... 153
------- -------
$ 4,744 $ 1,857
======= =======
Assets acquired under capital leases included in property and equipment
above are as follows (in thousands):
MAY 31,
-------------------
1996 1995
------- -------
Computer equipment............................................... $ 3,454 $ 2,749
Furniture and fixtures........................................... 208 99
------- -------
3,662 2,848
Less accumulated amortization.................................... (2,124) (1,862)
------- -------
$ 1,538 $ 986
======= =======
6. BANK LINE OF CREDIT:
The Company has available an unsecured $7,500,000 line of credit under an
agreement with a bank which expires on September 30, 1997. Borrowings under the
line of credit bear interest at the lender's prime rate (8.25% at May 31, 1996).
The agreement requires the Company to comply with certain financial covenants
and prohibits the assumption of any major debt, except for equipment leases
without the bank's approval. As of May 31, 1996, no borrowings were outstanding
under the line of credit.
37
40
VERITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS:
At May 31, 1996, the Company has long-term debt and capital lease
obligations as follows (in thousands):
Note payable to bank................................................ $ 18
Capital lease obligations........................................... 550
Equipment notes payable............................................. 497
------
1,065
Less current portion................................................ (426)
------
$ 639
======
The capital lease obligations, which expire through December 1999, are
collateralized by the related assets. Under the terms of the capital lease
obligations, the Company is responsible for property taxes, insurance and
maintenance costs.
During fiscal year 1996, the Company sold certain equipment at cost less
accumulated depreciation of $147,000 and leased back such equipment. No gain or
loss was recognized on the sale.
The equipment notes payable are due between November 1997 and July 1998,
bear interest at a rate of 16.4% and are collateralized by the underlying
equipment.
Future minimum payments under long-term debt and capital lease obligations,
are as follows (in thousands):
FISCAL YEAR ENDED MAY 31,
--------------------------------------------------------------------
1997................................................................ $ 560
1998................................................................ 575
1999................................................................ 125
------
1,260
Less amount representing interest................................... (195)
------
$1,065
======
8. COMMITMENTS:
The Company leases various facilities and vehicles under noncancelable
operating leases expiring through December 1999. Under the terms of the leases,
the Company is responsible for taxes, insurance and normal maintenance costs.
The Company has entered into an operating lease agreement for its new
primary operating facility which will commence in June 1996 and expire in
September 2005. Under the terms of the new lease, the Company will be
responsible for taxes, insurance and normal maintenance costs. The Company may
extend the lease term for an additional five years by providing written notice
of its exercise of this option no later than six months before the expiration of
the lease term.
38
41
VERITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At May 31, 1996, the future minimum rental payments under the operating
leases are as follows (in thousands):
FISCAL YEAR ENDED MAY 31,
-------------------------------------------------------------------
1997............................................................... $ 1,399
1998............................................................... 1,346
1999............................................................... 1,317
2000............................................................... 1,186
2001............................................................... 1,051
Thereafter......................................................... 4,570
--------
$10,869
========
Rent expense for fiscal years 1996, 1995 and 1994 was $1,070,000, $986,000
and $1,236,000, respectively.
9. STOCKHOLDERS' EQUITY:
Changes in and Conversion of Mandatorily Redeemable Convertible Preferred
Stock:
In August 1995, the Company designated 500,000 shares of its preferred
stock as Series H mandatorily redeemable convertible preferred stock and issued
436,000 shares of such preferred stock at $7.50 per share for gross proceeds of
$3,267,000.
In October 1995, all outstanding shares of Series A through H mandatorily
redeemable convertible preferred stock were converted to shares of the Company's
common stock in conjunction with its initial public offering.
Initial Public Offering:
In August 1995, the Company's Board of Directors authorized the
reincorporation of the Company in Delaware. As part of this reincorporation, the
outstanding shares of the predecessor California corporation's common stock and
all classes of its mandatorily redeemable convertible preferred stock were
converted automatically into shares of the new Delaware corporation's common and
mandatorily redeemable convertible preferred stock. As a result of the
reincorporation, the Company's authorized common stock was increased to
30,000,000 shares, with a par value of $.001 per share, and upon the conversion
of all outstanding mandatorily redeemable convertible preferred stock and the
completion of the Company's initial public offering, the authorized preferred
stock was reduced to 2,000,000 shares with a par value of $.001.
In October 1995, the Company successfully completed its initial public
offering of common stock. The Company sold 2,999,500 shares of common stock in
this offering for $32,505,000, net of issuance costs of $961,000.
In January 1996, the Company successfully completed its second public
offering of common stock. The Company sold 500,000 shares of common stock in
this offering for $16,509,000, net of issuance costs of $400,000.
1995 Stock Option Plan:
Under the 1988 Stock Option Plan, the Company initially reserved 1,300,000
shares of common stock for issuance to employees, directors and consultants of
the Company. In July 1995, the Company adopted the Amended and Restated 1995
Stock Option Plan (which amends and restates the 1988 Stock Option Plan) and
reserved an additional 611,000 shares for a total of 1,911,000 shares of the
Company's common stock. In March 1996, the Company's stockholders approved a
further increase to the number of shares reserved under the 1995 Stock Option
Plan from 1,911,000 to 2,911,000 shares of the Company's common stock.
39
42
VERITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Under the terms of the Plan, incentive options may be granted at prices not
lower than fair market value at date of grant, while nonqualified options may be
granted at prices not lower than 85% of fair market value at the date of grant
as determined by the Board of Directors. Options granted under the Plan are
exercisable immediately and expire ten years from date of grant.
Common shares purchased under the Plan are subject to the Company's right
of repurchase, which generally lapses as to 12.5% of the shares six months from
the individual's date of employment and thereafter, ratably over the remainder
of a 3 1/2 year period, at the holder's original purchase price. Thereafter, the
Company has the right of first refusal to purchase such shares. At May 31, 1996,
866,000 shares of common stock were available for grant under the 1988 Stock
Option Plan.
1996 Nonstatutory Stock Option Plan:
In February 1996, the Company's Board of Directors approved the 1996
Nonstatutory Stock Option Plan. Under this plan, the Company has reserved
300,000 shares of common stock for issuance to certain employees and consultants
of the Company. The terms of the 1996 Nonstatutory Stock Option Plan are
substantially the same as those of the 1995 Stock Option Plan. At May 31, 1996,
85,000 shares of common stock were available for grant under the 1996
Nonstatutory Stock Option Plan.
Activity Under Stock Option Plans:
Activity under the 1995 Stock Option Plan and the 1996 Nonstatutory Stock
Option Plan is set forth below:
OPTIONS OUTSTANDING
------------------------
SHARES PRICE PER
AVAILABLE SHARES SHARE TOTAL
---------- --------- ------------ -----------
Balances, May 31, 1993.......... 63,000 618,000 $0.18-$2.00 $ 901,000
Shares reserved under plans... 524,000
Options granted............... (685,000) 685,000 $1.15-$2.00 803,000
Options canceled.............. 575,000 (575,000) $0.45-$2.00 (912,000)
Options exercised............. (124,000) $1.15-$2.00 (123,000)
----------- ---------- -----------
Balances, May 31, 1994.......... 477,000 604,000 $0.18-$1.15 669,000
Options granted............... (594,000) 594,000 $1.15 683,000
Options canceled.............. 277,000 (277,000) $0.75-$1.15 (317,000)
Options exercised............. (68,000) $0.18-$1.15 (70,000)
----------- ---------- -----------
Balance, May 31, 1995........... 160,000 853,000 $0.18-$1.15 965,000
Shares reserved under plans... 1,911,000
Options reinstated............ 35,000
Options granted............... (1,709,000) 1,709,000 $1.50-$44.00 39,644,000
Options canceled.............. 554,000 (554,000) $1.15-$44.00 (10,229,000)
Options exercised............. (561,000) $0.36-$12.00 (727,000)
----------- ---------- -----------
Balances, May 31, 1996.......... 951,000 1,447,000 $0.18-$44.00 $29,653,000
=========== ========== ===========
At May 31, 1996, 1,434,000 shares of common stock, including outstanding
common shares exercised under the plans and unexercised common shares under
option, are subject to the Company's right of repurchase.
40
43
VERITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
During fiscal year 1996, certain officers of the Company provided four year
recourse notes receivable totaling $403,000 bearing interest at approximately
6.5% in exchange for the purchase of a total of 284,000 shares of common stock
under option.
Stock Options Issued Outside of the Plan:
In June 1993, the Company's Board of Directors granted an officer of the
Company an option outside of the 1995 Stock Option Plan to purchase 365,000
shares of the Company's common stock at $2.00 per share. Such shares upon
purchase will be subject to the Company's right of repurchase, which lapses
ratably over four years. In addition, the officer was granted an option outside
of the Plan for an additional 418,000 shares of the Company's common stock at
$2.00 per share. Upon purchase, these shares are also subject to the Company's
right of repurchase, which lapses the earlier of the achievement of certain
specified Company performance goals or after completion by the officer of seven
years of continuous employment. In December 1993, the exercise price for the
shares under these options was reduced to $1.15 per share. In August 1994, the
officer exercised his right to purchase all of the shares of common stock under
option in exchange for a recourse note receivable of $901,000 bearing interest
at 7.05% due August 2003. At May 31, 1996, 152,000 shares of common stock are
subject to the Company's right of repurchase.
Employee Stock Purchase Plan:
In July 1995, the Company's Board of Directors approved the 1995 Employee
Stock Purchase Plan and reserved 250,000 shares of common stock for issuance to
eligible employees. The Employee Stock Purchase Plan permits eligible employees
to purchase shares of the Company's common stock at 85% of the lesser of fair
market value of the common stock on the first day of the offering period or the
last day of the purchase period. The initial offering period commenced on the
effective date of the offering. At May 31, 1996, 82,000 shares of the Company's
common stock have been issued under the plan and 168,000 shares remain available
for purchase.
Outside Directors Plan:
In July 1995, the Company's Board of Directors approved the 1995 Outside
Directors Plan and reserved 200,000 shares of common stock for issuance to
directors of the Company who are not employees of the Company. The Outside
Directors Plan provides for the automatic granting of nonqualified stock options
to directors of the Company who are not employees of the Company.
Each current outside director will automatically be granted an option to
purchase 20,000 shares of common stock at the next annual meeting of
stockholders and thereafter, each new outside director will automatically be
granted an option to purchase 20,000 shares of the Company's common stock at the
following annual meeting. Thereafter, at each annual meeting of the
stockholders, outside directors who have previously received options will
receive a new option to purchase 5,000 shares of the Company's common stock. The
exercise price of the options in all cases will be equal to the fair market
value of the Company's common stock on the date of grant. Options granted under
the Directors Plan are immediately exercisable but vest over four years and
generally must be exercised within ten years. As of May 31, 1996, no options
have been granted to outside directors.
41
44
VERITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. INCOME TAXES:
The components of the net deferred tax asset are:
MAY 31,
--------------------
1996 1995
-------- -------
Deferred tax assets:
Accumulated depreciation...................................... $ 901 $ 726
Accrued compensation.......................................... 224 150
Other accruals and allowance for doubtful accounts............ 206 72
Research and development credits.............................. 969 871
Net operating loss carryforwards.............................. 7,892 7,206
-------- -------
Total deferred tax asset.............................. 10,192 9,025
Valuation allowance............................................. (10,192) (9,025)
-------- -------
Net deferred tax asset................................ $ -- $ --
======== =======
The Company has established a valuation allowance against its deferred tax
assets due to the uncertainty surrounding the realization of such assets.
Management evaluates on a quarterly basis the recoverability of the deferred tax
assets and the level of the valuation allowance. At such time as it is
determined that it is more likely than not that deferred tax assets are
realizable, the valuation allowance will be reduced.
The Company's deferred tax asset related to its net operating loss
carryforwards includes the tax benefit derived from the disqualifying
dispositions of incentive stock options and the exercise of nonqualified stock
options. The benefit, which totaled $850,000 at May 31, 1996, will be credited
directly to additional paid-in capital when the Company's deferred tax asset is
recognized.
The Company's effective tax rate differs from the statutory federal income
tax rate as shown in the following schedule:
YEAR ENDED MAY 31,
----------------------
1996 1995 1994
---- ---- ----
Income tax (benefit) provision at statutory rate.............. (34)% (34)% (34)%
Net operating loss or deferred tax asset not benefited........ 34 34 34
--- --- ---
Effective tax rate............................................ --% --% --%
=== === ===
During fiscal year 1996, the Company had a current provision for income
taxes of $401,000 which was substantially offset by a benefit derived from the
utilization of net operating loss carryforwards.
As of May 31, 1996, the Company had approximately $16,500,000 and
$8,960,000 of net operating loss carryforwards for federal and California
purposes, respectively, to offset future taxable income. The Company also has
federal and state research and development tax credit carryforwards of
approximately $692,000 and $420,000, respectively, at May 31, 1996. These
carryforwards expire in the years 2004 to 2011 if not utilized. The Company's
net operating loss and tax credit carryforwards are subject to an annual
limitation of approximately $4,900,000 as a result of an ownership change, as
defined by tax laws.
11. RELATED PARTY TRANSACTIONS:
During the fiscal years 1996, 1995 and 1994, the Company provided
consulting services and sold software product aggregating $54,000, $172,000 and
$202,000, respectively to three stockholders. In addition, costs aggregating
approximately $27,000 during fiscal year 1994 were charged to the Company by one
of the shareholders for the sublease of certain office facilities and equipment,
certain other operational support costs and for services performed. These
revenues and costs are included in the accompanying statements of operations.
42
45
VERITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
12. EMPLOYEE BENEFIT PLAN:
The Verity, Inc. 401(k) Plan, as allowed under Section 401(k) of the
Internal Revenue Code, provides tax deferred salary deductions for eligible
employees. Employees are eligible to participate immediately upon date of hire.
Participants may make voluntary contributions to the plan up to 20% of
their compensation. The plan does not provide for Company contributions.
13. BUSINESS SEGMENT, FOREIGN SALES AND OPERATIONS, AND MAJOR CUSTOMERS:
The Company, whose operations consist of a single line of business,
develops, markets and supports software tools and applications that enable
individuals, enterprises and publishers to intelligently search, filter and
disseminate textual information residing on enterprise networks, on-line
services, the Internet, CD-ROM and other electronic media.
The Company has sales and marketing operations located outside the United
States in the Netherlands, United Kingdom, France, Germany, Canada and
Australia. Foreign branch and subsidiary revenues consist primarily of
maintenance and consulting services.
13. BUSINESS SEGMENT, FOREIGN SALES AND OPERATIONS, AND MAJOR CUSTOMERS,
CONTINUED:
UNITED OTHER
FINANCIAL DATA BY GEOGRAPHIC AREA STATES EUROPE FOREIGN ELIMINATIONS TOTAL
- - - ---------------------------------------- ------- ------- ------- ------------ -------
(IN THOUSANDS)
Revenues:
1996.................................. $28,309 $ 3,215 $ 552 $ (1,358) $30,718
1995.................................. 13,398 3,144 593 (1,249) 15,886
1994.................................. 14,357 1,961 594 (310) 16,602
Operating income (loss):
1996.................................. 70 (1,683) 222 -- (1,391)
1995.................................. (5,042) (716) 176 -- (5,582)
1994.................................. (3,250) (1,040) (310) -- (4,600)
Identifiable assets:
1996.................................. 61,206 1,354 164 -- 62,724
1995.................................. 5,399 1,475 113 -- 6,987
Transfers between geographic areas are recorded at amounts generally above
cost and in accordance with the rules and regulations of the respective
governing tax authorities. Operating income consists of total net sales less
operating expenses, and does not include either interest and other income, net,
or income taxes. Identifiable assets of geographic areas are those assets used
in the Company's operations in each area.
Included in software product revenues are export sales of approximately
$5,861,000, $3,825,000 and $4,771,000 in fiscal years 1996, 1995 and 1994,
respectively.
No single customer accounted for 10% or more of the Company's revenue
during fiscal years 1996, 1995 and 1994. Revenues from the federal government
and its agencies were $3,230,000, $4,056,000 and $4,872,000 for fiscal years
1996, 1995 and 1994, respectively.
14. SUBSEQUENT EVENT:
On July 12, 1996, the Company's Board of Directors approved a plan whereby
each individual holding options to purchase the Company's common stock were
given a choice to either retain their current option or replace such option with
an option for an equal number of shares of common stock with a fair market price
of $19.50 per share.
43
46
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
Verity, Inc.:
Our report on the consolidated financial statements of Verity, Inc. and
Subsidiaries has been incorporated in this Form 10-K on page 29. In connection
with our audits of such financial statements, we have also audited the related
financial statement schedule on page 45 of this Form 10-K.
In our opinion, the financial schedule referred to above when considered in
relation to the basic financial statements taken as a whole, presents fairly, in
all material respects, the information required to be included herein.
COOPERS & LYBRAND L.L.P.
San Jose, California
June 21, 1996, except for Note 14
for which the date is July 12, 1996
44
47
SCHEDULE II
VERITY, INC.
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
AMOUNTS
BALANCE AT CHARGED TO BALANCE
BEGINNING PROFIT AND AT END
DESCRIPTION OF YEAR LOSS DEDUCTIONS OF YEAR
- - - ------------------------------------------------ ---------- ---------- ---------- -------
Year ended May 31, 1994
Allowance for doubtful accounts............... $206 $277 $ (233) $ 250
Year ended May 31, 1995
Allowance for doubtful accounts............... $250 $383 $ (272) $ 361
Year ended May 31, 1996
Allowance for doubtful accounts............... $361 $455 $ (427) $ 389
45
48
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 thereunto duly authorized.
VERITY, INC.
Date: August 12, 1996 By: /s/ Donald C. McCauley
------------------------------------
Donald C. McCauley
Chief Financial Officer (Principal
Financial and
Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the date indicated.
SIGNATURE TITLE DATE
- - - --------------------------------- --------------------------------------- ----------------
/s/ Philippe F. Courtot Chairman of the Board, President, Chief August 12, 1996
- - - --------------------------------- Executive Officer and Director
Philippe F. Courtot (Principal Executive Officer)
/s/ Donald C. McCauley Vice President and Chief Financial August 12, 1996
- - - --------------------------------- Officer (Principal Financial and
Donald C. McCauley Accounting Officer)
/s/ Steven M. Krausz Director August 12, 1996
- - - ---------------------------------
Steven M. Krausz
/s/ Stephen A. MacDonald Director August 12, 1996
- - - ---------------------------------
Stephen A. MacDonald
/s/ Charles P. Waite, Jr. Director August 12, 1996
- - - ---------------------------------
Charles P. Waite, Jr.
46
49
INDEX TO EXHIBITS
EXHIBIT
NO. DESCRIPTION
- - - ------- ------------------------------------------------------------------------
2.1 Form of Agreement and Plan of Merger between Verity, Inc., a California
corporation, and Verity Delaware Corporation, a Delaware corporation,
filed September 22, 1995.(1)
3.1 Certificate of Incorporation of the Company.(1)
3.2 By-Laws.(1)
4.1 Amended and Restated Rights Agreement dated August 1, 1995, as
amended.(1)
10.1 Form of Indemnification Agreement for directors and officers.(1)
10.2 Amended and Restated 1995 Stock Option Plan and forms of agreements
thereunder.(1)
10.3 1995 Employee Stock Purchase Plan.(1),(4)
10.4 1995 Outside Directors Stock Option Plan and forms of agreement
thereunder.(1),(4)
10.5 Employment Agreement between Philippe F. Courtot and the Company dated
July 15, 1993, together with related Amended and Restated Stock Purchase
Agreement dated as of June 1, 1995.(1),(4)
10.6 Security and Loan Agreement between Imperial Bank and the Company dated
April 7, 1994, as amended.(2)
10.7 Series G Preferred Stock Purchase Agreement dated August 29, 1994.(1)
10.8 Series H Preferred Stock Purchase Agreement dated August 1, 1995.(1)
10.9 Sublease Agreement between Booz-Allen & Hamilton, Inc. and the Company
dated April 1, 1988, as amended.(1)
10.10 Lease Agreement between The Trustees of the Roman Catholic Church of the
Archdiocese of Canberra and Goulburn and the Company dated July 1, 1993
(Australia).(1)
10.11 Lease Agreement between Peel Investments (North) Limited and the Company
dated 1994 (England).(1)
10.12 Lease Agreement between Le Centre D'Affaires Perinord and the Company
dated November 26, 1992 (France).(1)
10.13 Lease Agreement between Oskam Vastgoed De Meern B.V. and the Company
dated September 1, 1990 (The Netherlands).(1)
10.14 OEM Software Development and Run Time License Agreement between Adobe
Systems, Inc. and the Company dated July 29, 1994, as amended.(1),(5)
10.15 License Agreement between Frame Technology Corporation and the Company
dated May 29, 1992(1),(5)
10.16 OEM Development and License Agreement between the Company and Delphi
Internet Services Corporation dated as of August 23, 1995.(1),(5)
10.18 Lease Agreement between Ross Drive Investors and the Company dated
January 22, 1996(3)
11.1 Statement of computation of income per share.
21.1 List of Subsidiaries.(1)
23.1 Consent of Independent Accountants
27.1 Financial Data Schedule (available in EDGAR format only)
- - - ---------------
(1) Incorporated by reference from the exhibits with corresponding numbers from
the Company's Registration Statement (No. 33-96228), declared effective on
October 5, 1996.
(2) Incorporated by reference from the exhibits with corresponding numbers from
the Company's Registration Statement (No. 33-80567), declared effective on
January 17, 1996.
(3) Incorporated by reference from the exhibits with corresponding numbers from
the Company's Form 10-Q for the quarter ended February 29, 1996.
(4) Management contract or compensatory plan covering executive officers and
directors of the Company.
(5) Confidential Treatment has been granted for portions of these exhibits.
47