UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended April 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period from ____________________ to ____________________
Commission File Number: 0-21793
VERSATILITY INC.
(Exact name of registrant as specified in its charter)
DELAWARE 52-1214354
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization Identification No.)
11781 Lee Jackson Memorial Highway
Seventh Floor
Fairfax, Virginia 22033
(703) 591-2900
(Address and telephone number of principal executive offices)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01
par value
Indicate by check mark whether 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 the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based on the closing sale price of the Common Stock on July 14,
1997, as reported on the Nasdaq National Market was approximately $30,842,559.
Shares of Common Stock held by each executive officer and director and by each
person who is known to own 5% or more of the outstanding Common Stock have been
excluded from this computation in that such persons may be deemed to be
affiliates. This determination of affiliate status is not a conclusive
determination for other purposes. As of July 14, 1997 the Registrant had
7,355,753 shares of Common Stock outstanding, par value $.01 per share.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Definitive Proxy Statement dated July 28, 1997 to
be delivered to the Stockholders in connection with the Annual Meeting of
Stockholders to be held on August 26, 1997 are incorporated by reference in Part
III hereof.
Table of Contents
PART I.
Item 1. Business...................................................................................... 3
Item 2. Properties.................................................................................... 10
Item 3. Legal Proceedings............................................................................. 10
Item 4. Submission of Matters to a Vote of Security Holders........................................... 10
PART II.
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters.......................... 10
Item 6. Selected Financial Data....................................................................... 11
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations......... 11
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.................................... 20
Item 8. Financial Statements and Supplementary Data................................................... 20
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.......... 20
PART III.
Item 10. Directors and Executive Officers of the Registrant............................................ 21
Item 11. Executive Compensation........................................................................ 21
Item 12. Security Ownership of Certain Beneficial Owners and Management................................ 21
Item 13. Certain Relationships and Related Transactions................................................ 21
PART IV.
Item 14. Exhibits, Financial Statements and Reports on Form 8-K........................................ 21
SIGNATURE.............................................................................................. 23
2
PART I
This document contains various forward-looking statements and information
that are based on management's beliefs as well as assumptions made by and
information currently available to management. Such statements are subject to
various risks and uncertainties which could cause actual results to vary
materially from those contained in such forward looking statements. Should one
or more of these risks or uncertainties materialize, or should underlying
assumptions prove incorrect, actual results may vary materially from those
anticipated, estimated, expected or projected. Certain of these risks and
uncertainties as well as other risks and uncertainties are described in Factors
Which May Effect Future Operating Results herein and in the Company's
Registration Statement on Form S-1 filed under the Securities Act of 1933, as
amended, and declared effective on December 12, 1996.
ITEM 1. BUSINESS
OVERVIEW
Versatility is a leading provider of client/server customer interaction
software that enables businesses to automate and enhance their telemarketing and
teleselling capabilities. The Company's software products are designed to
increase the productivity and revenue-generating capabilities of organizations
operating call centers to interact with existing and potential customers. The
Company's products include desktop software applications, development and
customization tools and optional server-based software services, and support a
wide variety of leading computing platforms, allowing users to implement a
scalable, flexible and interoperable software solution that can be used
independently or as part of an integrated enterprise-wide customer interaction
implementation. Versatility also offers fee-based professional, consulting and
maintenance services to provide implementation, integration and ongoing support
of the Company's software products.
The Company's products are used by customers operating large and mid-sized
call centers for activities including telebanking, claims servicing, customer
service, consumer product telesales and other applications. Since introducing
the Versatility Series in May 1995, the Company has licensed Versatility Series
applications for use on over 12,000 agent desktops. The Company's customers
include Avantel, S.A., British Telecommunications, Plc, Chase Card Member
Services and Mellon Bank. Versatility markets its products and services to
customers in a number of targeted industries, including the financial services
and communications industries. The Company sells its software and services in
the United States through a direct sales organization that focuses primarily on
enterprise-wide, large-scale solutions with complex requirements. In addition,
Versatility markets and sells software through value-added resellers,
distributors and third party systems integrators, in the United States and
internationally.
Versatility provides a suite of software applications and related services
that allow its customers to operate flexible and highly functional inbound
and/or outbound call centers, which can significantly enhance their
telephony-based sales and marketing capabilities. The Company's applications
allow an organization to automate the most significant telephony-based customer
interaction functions, including generating and qualifying sales leads,
providing comprehensive product or service information, generating order quotes
and processing and fulfilling customer orders. The Company's products are
designed to support both formal call centers, typically involving large and
mid-sized installations, and informal call centers, requiring a smaller scale
implementation, for customers in the United States and internationally.
The Company's products include a number of software applications which
provide call center agents with desktop access to a variety of information in an
easy-to-use graphical format, including customer identity and call history,
comprehensive product descriptions such as features and benefits, and a list of
related products or services which an agent can cross-sell or up-sell to the
customer. The Company's software includes scripting capabilities which
efficiently guide agents through each stage of the sales process, including
initial contact, presentation of product offerings, responses to frequently
asked questions or objections, quote generation, order taking and fulfillment.
In addition, the Company's products can be easily tailored to the specific needs
of the organization or marketing campaign and customized to match the skill sets
of individual call center agents. The Company's products also facilitate
exchange of information between the call center and the organization's other
information systems, allowing the organization to incorporate data generated in
the call center into their other business operations, including new product
development. In addition to desktop applications, the Company's products include
optional server-based software which allows customers to leverage CTI and other
technologies to increase the speed and productivity of their telephony-based
activities.
The Versatility Series, the Company's principal product, uses an advanced,
scalable three-tier client/server architecture capable of supporting
installations with more than 1,000 simultaneous users on a single server. The
Versatility Series is highly
3
customizable, allowing modification to suit a specific industry or application.
The Versatility Series can also be integrated with the customer's information
systems or with third party applications, such as help desk or field sales
automation software, to provide a customer with a comprehensive, enterprise-wide
customer interaction solution.
In August 1996, the Company released the Versatility CallCenter
client/server packaged software application which provides the basic features
and functions of the Versatility Series desktop applications to smaller formal
or informal call centers, typically found in mid-sized companies or departments
of larger organizations. Customers using the Versatility CallCenter product can
expand to the more scalable Versatility Series.
Products
The Company's products include the Versatility Series, a suite of modular
applications that includes optional software-based marketing and telephony
services. The Versatility Series can be modified with available customization
tools and is designed to support customers with large user populations. For
smaller installations, the Company offers Versatility CallCenter, which includes
key elements of the Versatility Series applications, scaled to support 50 users
or less.
Versatility Series. The Versatility Series is generally marketed to large
organizations operating formal call centers. At the core of the Versatility
Series are the Versatility Call Center Applications, which allow call center
agents to effectively conduct telemarketing, telesales and customer services
activities. Versatility Series customers purchase one of the Versatility Call
Center Applications and usually purchase one or more optional services from
either the Versatility Marketing Management Services or the Versatility Open
Telephony Services.
The Versatility Series includes applications to address telemarketing,
telesales and customer services activities with Versatility
Telesales/Teleservice. The Company is also developing two additional
applications, Versatility Financial Services and Versatility Telecom, which will
include the same architecture and core functionality as the Company's current
application, with additional features specifically designed to address the
financial and telecommunications industries. The Versatility Series supplies a
call center agent with customer information as an outbound telephone call is
made or as an inbound call is routed to that agent. Once customer contact is
made, an agent can access product information, such as features, benefits and
commonly asked questions, in order to effectively and accurately market and sell
that product. An agent can then click to descriptions of other products to
cross-sell or up-sell. To close a sale, an agent can access on-line order taking
and fulfillment capabilities. Building on these core functions, the Versatility
Series provides additional capabilities to generate on-line quotes, readily
access information regarding discounts and schedule automatic customer
call-backs.
All Versatility Call Center Applications are Windows-based and are
integrated with the Versatility PowerGuide facility, a presentation support tool
providing call guides and scripting capabilities. Versatility PowerGuide enables
selling scripts to be tailored to the needs of the company or marketing campaign
and customized to match the skill sets of particular telemarketing agents.
Versatility PowerGuide can integrate with one or more external applications,
such as word processing, spreadsheet, and graphics presentation applications,
using Microsoft's Dynamic Data Exchange standard to exchange information between
applications. Versatility PowerGuide can also be used to generate Microsoft
Visual Basic forms and applications.
Versatility Call Center Applications allow customers to develop many
versions of the application which can be tailored extensively and used
simultaneously. For example, a call center may want to have a different
application design and functionality for each marketing and selling campaign.
Each tailored application can be augmented by its own tailored Versatility
PowerGuide session.
In addition to Versatility Call Center Applications, the Versatility Series
provide network server services, called the Versatility Marketing Management
Services, which provide the call center network and its managers with a number
of capabilities, including list, database and campaign management, adaptive
marketing, statistical tracking, data warehousing, decision support, document
production, integration with document management systems and centralized call
center operations management. Additionally, the Versatility Series CTI services,
called Versatility Open Telephony Services, which integrate the telephone and
computer systems, provide functions such as screen-based telephony, "screen
pops" in which relevant caller information appears on an agent's screen as an
inbound call arrives or as an outbound call is initiated, predictive dialing of
outbound campaigns, coordination of service levels, inbound and outbound dynamic
call blending and IVR integration and coordination.
4
All Versatility Series products are licensed based on the total number of
concurrent desktop users. The U.S. list price of the Versatility Series is $1950
per licensed user and includes Versatility Telesales/Teleservice, Versatility
PowerGuide, and Versatility OpenTel. Specific add-ons differ depending on
whether a customer's business model calls for an inbound only, outbound only, or
blended (inbound/outbound) center. These modules include Versatility Predictive
and Versatility Campaign Plus for outbound, and Versatility Call Blending for
blended centers. Other optional modules sold depend on the interfaces to the
customer interaction center and include Versatility OpenWeb for integrating the
Web with the call center, and Versatility IVR for integrating IVR with the call
center. The U.S. list price of these modules ranges from $200 to $1,000 per user
per service. A majority of the revenue from the Versatility Series products has
been derived from contracts with customers in amounts in excess of $200,000.
Versatility CallCenter. In August 1996, the Company released Versatility
CallCenter, a CD-ROM-based call center software application that supports formal
or informal call centers of 50 agents or less. Versatility CallCenter includes
many of the features of the Versatility Call Center Applications, including
customer profiles, product information, product features and benefits, question
and objection handling, quotation preparation and order taking and servicing,
literature fulfillment, activity tracking with call back calendars and
reminders, scripting and call guides. In addition, the product supports list
management and call recycling for outbound campaigns and CTI for screen-based
dialing and incoming call management, including screen pops of customer profile
information. Versatility CallCenter also incorporates several network-based
server facilities that include elements of the Versatility Marketing Management
and Versatility Open Telephony services, redesigned to meet the needs of this
smaller customer. Versatility CallCenter is also licensed based on the number of
concurrent users and has a U.S. list price of $1,695 per user.
Federal, state and foreign law, including the Telephone Consumer Protection
Act of 1991 and the Federal Fair Debt Collection Practices Act regulate certain
uses of outbound call processing systems. Although compliance with these laws
may limit the potential uses of the Company's products in some respects, the
Company's products can be programmed to operate automatically in full compliance
with these laws through the use of appropriate calling lists and calling
campaign time parameters. There can be no assurance, however, that future
legislation further restricting telephone solicitation practices, if enacted,
would not adversely affect the Company.
Services
Versatility provides fee-based maintenance and support services designed to
increase the effectiveness and ongoing performance of its customer's call center
operations and to increase the Company's revenue base. Substantially all of the
Company's customers have ongoing maintenance contracts. As of April 30, 1997,
the Company employed 31 employees providing professional services, maintenance
and training.
Professional Services. The Company's consultants work closely with customers
to provide assistance with application implementation and customization,
interface development, communications and information systems integration,
planning and project management. Fees for professional services are charged
separately from the Company's software product licenses and are generally
charged on a time-and-materials basis.
Maintenance. Maintenance services are available for an annual fee equal to a
percentage of the total license price. Maintenance services include software
updates, maintenance releases and technical support. The Company offers
telephone, pager, electronic mail, dialup modem and facsimile customer support.
The Company also provides customers with account management services, technical
bulletins, weekly status reports and ongoing communications on new features or
products under development.
Training. The Company offers a comprehensive set of training courses
covering systems administration, specific training on certain product modules
and project team training as well as training courses for the Company's
resellers. Training classes are offered at the Company's offices in Fairfax,
Virginia and Aldermaston, U.K. The Company also provides extensive on-site
training services for most enterprise installations, including customized
training for each customer. Fees for education and training are generally
charged in addition to the license fees and are charged on a per-student,
per-class or time-and-materials basis.
Customers
Since introducing the Versatility Series in May 1995, the Company has
licensed Versatility Series applications for use on over 12,000 agent desktops.
For the fiscal year ended April 30, 1997, the Company's eight largest customers
accounted for 59.3% of the Company's total revenue, of which one customer,
British Telecommunications, Plc ("BT"), accounted for 23.6%. Although the
particular customers may change from period to period, the Company expects that
large sales to a limited number of customers will
5
continue to account for a significant percentage of its total revenue in any
particular period. Revenue from customers outside the United States accounted
for 16.3%, 40.8 % and 41.2% of the Company's total revenue for fiscal 1995, 1996
and 1997, respectively. See further discussion regarding the business segment
and geographic area information in Note 11 of Notes to the Consolidated
Financial Statements.
Technology and Product Development
The Company's core technology was designed to facilitate the development and
customization of enterprise-wide customer interaction applications which are
interoperable with a number of other applications and can be used by a wide
variety of customers. The Company's applications are built upon a common core
architecture that is designed to leverage efficiently the performance and
scalability of client/server computing and object-oriented development
methodologies. Versatility believes that its product architecture allows it to
craft tailored solutions for its customers and to simplify and facilitate new
product development.
The Versatility Series and Versatility CallCenter products are built using a
highly scalable and flexible three-tier client/server model which takes
advantage of the difference in computing power between the desktop client and
the server to free-up limited desktop computing power and memory. The Company's
products support a number of client computing platforms, such as Microsoft
Windows 3.1, Microsoft Windows 95 and Microsoft Windows NT; leading relational
databases from Oracle, Informix, Sybase, Ingres, and Microsoft; and server
operating systems, such as Microsoft Windows NT Server and various versions of
Unix. The Company's products have been developed using Microsoft Visual C++,
Microsoft Foundation Classes and Centura Team Developer.
Versatility began the development of products based on a client/server
architecture in November 1993. The Company made substantial investments in new
product development in 1994 and introduced the Versatility Series in May 1995.
In August 1996, the Company released Versatility CallCenter. The Company
continues to make substantial investments in product development to improve and
enhance the functionality of its existing products. The Company also intends to
expand its existing product offerings and to introduce new products for the
client/server applications market. Although the Company expects that certain of
its new products will be developed internally, the Company may, based on timing
and cost considerations, acquire technology and products from third parties.
The Company's current development efforts include the completion of the
first two industry specific versions of the Versatility Series - Versatility
Telecom and Versatility Financial Services. These vertical versions are due to
ship in the fall and are designed to significantly lower the customization
efforts and costs by pre-building many of the vertical components typically
requiring customization during deployment of the customer interaction
application. By working with its existing customers and prospects in these
particular verticals, as well as industry analysts, Versatility has been able to
identify and develop these vertical requirements.
In June 1997, Versatility announced the industry's first components-based
application architecture and delivered the initial products - Versatility
Telesales/Teleservice v3.0 and Versatility PowerGuide v2.0 of this component
based framework. The company will be working aggressively over the rest of the
fiscal year to deliver the other components of this Application Framework.
In addition, Versatility continues to significantly expand the CTI
middleware options supported by Versatility OpenTel. Versatility OpenTel is the
window on telephony for the desktop and provides the desktop application with
access to various PBX, ACD, and IVRs. In the past, Versatility OpenTel primarily
supported the Dialogic CT-Connect CTI product that was resold by Versatility.
Now, Versatility OpenTel either supports or will support within the next three
months Genesys' T-Server product, Nabnasset's VESP product, and the Microsoft
TAPI 2.1 standard in addition to CT-Connect.
Lastly, Versatility continues to do integration work with Nortel's new
Symposium platform. In May, 1997, the two companies announced the selection of
Versatility as a Nortel Symposium Partner which provides for the reselling of
the Versatility products by the various Nortel distributors and resellers in the
U.S.
As of April 30, 1997, the Company's research and development and quality
assurance staff consisted of 35 employees. The Company's total expenses for
research and development for fiscal years 1995, 1996 and 1997 were $711,000,
$2.1 million and $2.9 million, respectively. The Company anticipates that it
will continue to commit substantial resources to research and development in the
future.
6
The Company's future success will depend on its ability to enhance its
current products and to develop and introduce new products on a timely basis
that keep pace with technological developments, emerging industry standards and
the increasingly sophisticated needs of its customers and markets. There can be
no assurance that the Company will not experience difficulties that could delay
or prevent the successful development, introduction and marketing of these
products, or that its new products and product enhancements will adequately meet
the requirements of the marketplace and achieve market acceptance. Furthermore,
changing resource allocations can delay new products and certain product
enhancements. If the Company is unable, for technological or other reasons, to
develop and introduce new products or enhancements, the Company's business,
financial condition and results of operations will be materially adversely
affected. In addition, software products as complex as those offered by the
Company may contain undetected errors or failures when first introduced or when
new versions are released. The Company has in the past discovered software
errors in certain of its new products or enhancements and has experienced delays
or lost revenue during the period required to correct these errors. Although the
Company has not experienced material adverse effects resulting from such errors
to date, there can be no assurance that, despite testing by the Company and by
current and potential customers, errors will not be found in new products or
releases after commencement of commercial shipments, resulting in loss of or
delay in market acceptance, which could have a material adverse effect upon the
Company's business, financial condition and results of operations.
Sales and Marketing
Sales. The Company believes that the coordinated use of multiple selling
channels is required to reach the diverse and growing base of prospective
customers. Based on their telemarketing strategies and buying patterns, these
prospective customers can be divided into three groups: (i) customers with
large-scale installations which are best served through direct sales teams, (ii)
customers with large-scale installations who require turnkey system solutions
from third party systems integrators, and (iii) customers with mid-sized
installations who need basic solutions that can be purchased relatively
inexpensively and can be quickly implemented. To address these groups, in
November 1995, the Company established four strategic selling units to focus
attention and specific solutions to targeted selling channels and markets. These
four selling units were Enterprise Solutions, Alliances, Channels and
International. Enterprise Solutions consists of two selling groups, which sell
directly to specific vertical markets, financial institutions and communications
services companies. In February 1997, Alliances and Channels were combined,
becoming Commercial Markets, which focuses on other opportunities in other
commercial markets, most of which are sold through third party resellers. The
International selling unit markets through third party resellers to customers in
Europe, the Middle East, South Africa and the Pacific Rim.
Enterprise Solutions. Enterprise Solutions consists of two selling
groups, Financial Services and Telecommunications. These direct sales units
focus on the financial services and communications industries throughout
North America. They market the Versatility Series to large organizations
which require a customized and integrated call center application. These
selling units include 40 employees divided into sales and sales support
teams for each target market, a professional services organization that
performs implementation, project management and customization activities and
a customer services group responsible for post-implementation support. In
addition, the Company has begun enlisting the support of a specific group of
professional services organizations which will engage in the practice of
implementing and customizing the Company's software products. Referred to as
"Practice Partners," these organizations do not resell or otherwise market
the Company's products. Instead, the Company intends to support the Practice
Partners' efforts to learn to install, customize and support the Company's
products.
Commercial Markets. The Commercial Markets selling unit markets the
Versatility Series to prospects in other markets, primarily through third
party systems integrators and distributors who provide comprehensive
solutions to large-scale enterprise-wide environments and who want to
provide their customers with an integrated call center solution. This
selling unit consists of sales and sales personnel supporting third party
systems integrators and distributors and a services department that handles
certain support activities for the distributors or for their customers. The
Company currently has active relationships with several third party systems
integrators including Electronic Data Systems Corporation, Norstan Inc. and
Cincom Systems, Inc. The unit also targets mid-sized companies that operate
formal and informal call centers of 10 to 50 agents with a product called
Versatility CallCenter. This product is sold through Versatility Integration
Professional ("VIP") resellers or is sold directly to an end user customer
if there is not a trained VIP reseller in place to support the sale. This
selling unit was formed to develop regional-based sales and support teams to
evaluate, recruit and train VIP resellers. As of April 30, 1997, this
selling unit consisted of 25 employees and had arrangements with 36 VIP
resellers.
7
International. The International selling unit markets the Versatility
Series and Versatility CallCenter products to third party systems
integrators, distributors and resellers outside of North America. This
selling unit has regional sales and support teams covering Western Europe,
the Middle East and certain African countries and expects to begin selling
in the Pacific Rim and Latin American regions. The International selling
unit is headquartered in Aldermaston, U.K., with support personnel located
in the Netherlands and Sweden and, as of April 30, 1997, consisted of 10
employees.
Marketing. The Company's marketing efforts support each of the strategic
selling units. The Company's marketing programs include product management,
product marketing, maintenance and enhancement of the Company's Web site, direct
marketing, including the operation of the Company's in-house direct mail and
telemarketing operation, public relations and press and analyst communications
and event support. The Company's marketing department also maintains marketing
relationships with a variety of third party vendors, such as telephone switch
manufacturers, computer manufacturers, database providers and others. As of
April 30, 1997, the Company's marketing department consisted of 23 employees.
The Company uses the Versatility CallCenter product in its in-house direct
marketing and telemarketing facility.
Competition
The market for the Company's products is intensely competitive, highly
fragmented and subject to rapid change. Because the Company offers multiple
applications which can be purchased separately or integrated as part of the
Versatility Series, the Company competes with a variety of companies depending
on the target market for their applications software products. The Company's
principal competitors in the customer interaction software market are Brock
International, Inc., Digital Systems International, Inc., Information Management
Associates, Inc., Scopus Technology, Inc., and The Vantive Corporation. For
installations where telephony functions are of prime importance, competitors
include Davox Corporation, Early Cloud and Company (a division of IBM) and EIS
International, Inc. The Company also competes with third party professional
service organizations that develop custom software and with the information
technology departments of potential customers. The Company's potential
competitors also include a number of large hardware and software companies that
may develop or acquire products that compete with the Company's products. The
Company believes that the principal competitive factors affecting its market
include product features such as flexibility, scalability, interoperability,
functionality and ease of use, as well as product reputation, quality,
performance, price, customer service and support, the effectiveness of sales and
marketing efforts and vendor reputation. Although the Company believes that its
products currently compete favorably with respect to such factors, there can be
no assurance that the Company can maintain its competitive position against
current and potential competitors, especially those with significantly greater
financial, marketing, service, support, technical and other resources.
In addition, the Company believes that existing competitors and new market
entrants will attempt to develop fully integrated customer interaction solution
applications suites that may include call center telesales and telemarketing
applications which provide comparable functionality to the Company's existing
applications. The Company also expects that competition will increase as a
result of software industry consolidation. Current and potential competitors
have established or may establish cooperative relationships among themselves or
with third parties to increase the ability of their products to address the
needs of the Company's potential customers. Accordingly, it is possible that new
competitors or alliances among competitors will emerge and rapidly acquire
significant market share.
Increased competition is likely to result in price reductions, reduced
operating margins and loss of market share, any of which could materially
adversely affect the Company's business, financial condition and results of
operations. Many of the Company's current and potential competitors have
significantly greater financial, technical, marketing and other resources than
the Company. As a result, they may be able to respond more quickly to new or
emerging technologies and changes in customer requirements, or to devote greater
resources to the development, promotion and sale of their products than can the
Company. There can be no assurance that the Company will be able to compete
successfully against current and future competitors or that competitive
pressures faced by the Company will not materially adversely affect its
business, financial condition and results of operations.
Intellectual Property and Other Proprietary Rights
The Company relies on a combination of copyright, trade secret and trademark
laws, confidentiality procedures and contractual provisions to protect its
proprietary rights in its products and technology. The Company does not rely
upon patent protection and does not currently expect to seek patents on any
aspects of its technology. There can be no assurance that the confidentiality
agreements and other methods on which the Company relies to protect its trade
secrets and proprietary technology will be adequate. Further, the Company may be
subject to additional risks as it enters into transactions in countries where
intellectual property laws
8
are not well developed or are poorly enforced. Legal protections of the
Company's rights may be ineffective in such countries. Litigation to defend and
enforce the Company's intellectual property rights could result in substantial
costs and diversion of resources and could have a material adverse effect on the
Company's business, financial condition and results of operations, regardless of
the final outcome of such litigation. Despite the Company's efforts to safeguard
and maintain its proprietary rights both in the United States and abroad, there
can be no assurance that the Company will be successful in doing so, or that the
steps taken by the Company in this regard will be adequate to deter
misappropriation or independent third-party development of the Company's
technology or to prevent an unauthorized third party from copying or otherwise
obtaining and using the Company's products or technology. There also can be no
assurance that others will not independently develop similar technologies or
duplicate any technology developed by the Company. Any such events could have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Company has entered into agreements with a small number of its customers
requiring the Company to place its source code in escrow. These escrow
agreements typically provide that these customers have a limited, non-exclusive
right to use such code in the event that there is a bankruptcy proceeding by or
against the Company, if the Company ceases to do business or if the Company
fails to meet its support obligations. Entering into such agreements may
increase the likelihood of misappropriation by third parties.
As the number of customer interaction software applications in the industry
increases and the functionality of these products further overlaps, software
development companies like the Company may increasingly become subject to claims
of infringement or misappropriation of the intellectual property rights of
others. There can be no assurance that third parties will not assert
infringement or misappropriation claims against the Company in the future with
respect to current or future products. Any claims or litigation, with or without
merit, could be time-consuming, result in costly litigation, cause product
shipment delays or require the Company to enter into royalty or licensing
arrangements. Such royalty or licensing arrangements, if required, may not be
available on terms acceptable to the Company, if at all, which could have a
material adverse effect on the Company's business, financial condition and
results of operations. Adverse determinations in such claims or litigation could
also have a material adverse effect on the Company's business, financial
condition and results of operations.
Regulatory Environment
Federal, state and foreign law regulate certain uses of outbound call
processing systems. The Federal Telephone Consumer Protection Act (the "TCPA")
prohibits the use of automatic dialing equipment to call emergency telephone
lines, health care and similar facility patient telephone lines, and telephone
lines where the called party is charged for incoming calls, such as those used
by pager and cellular phone services. The TCPA prohibits use of such equipment
to engage two or more lines of a multi-line business simultaneously. Among other
things, the TCPA required the Federal Communications Commission ("FCC") to
create regulations protecting residential telephone subscribers from unwanted
telephone solicitations. The rules adopted by the FCC require that telemarketers
maintain a company-specific "do-not-call list" which contains the names and
numbers of residential subscribers who do not want to receive calls. An entity
which has an "established business relationship" with a party it calls and
tax-exempt nonprofit organizations are exempt from do-not-call lists. The rules
also require that telemarketers may call consumers only after 8 a.m. and before
9 p.m., local time. Certain states have enacted similar laws limiting access to
telephone subscribers who object to receiving solicitations. Although compliance
with these laws may limit the potential use of the Company's products in some
respects, the Company's systems can be programmed to operate automatically in
full compliance with these laws through the use of appropriate calling lists and
calling campaign time parameters. There can be no assurance, however, that
future legislation further restricting telephone solicitation practices, if
enacted, would not adversely affect the Company.
Employees
As of April 30, 1997, the Company had 186 full-time employees, of which 165
were based in the United States and 21 were based internationally. None of the
employees of the Company is covered by a collective bargaining agreement. The
Company does not have long-term employment agreements with any of its employees.
The Company considers its relations with its employees to be good.
The Company believes its future success will depend in large part on the
Company's ability to recruit and retain qualified employees, especially
experienced software engineering and sales personnel. The competition for such
personnel is intense. There can be no assurance that the Company will be
successful in retaining or recruiting key personnel.
9
ITEM 2. PROPERTIES
The Company's principal administrative, sales, marketing, support, and
research and development facility is located in 41,940 square feet of modern
office space in Fairfax, Virginia. This facility is leased to the Company
through 2004. In addition, the Company has entered into a lease for an
additional 9,033 square feet of office space located in a building in Fairfax,
Virginia near its existing offices. The Company also leases 2,463 square feet in
Irvine, California and 6,600 square feet in Aldermaston, U.K. Management
believes its current facilities are adequate to meet its needs through the next
twelve months and that, if required, suitable additional or alternative space
will be available to accommodate expansion of the Company's operations on
commercially reasonable terms.
ITEM 3. LEGAL PROCEEDINGS
One of the Company's former VARs has filed a claim for arbitration
(non-binding) against the Company asserting, among other things, that the
Company misrepresented the functionality of its products and wrongfully
terminated the VAR's reseller agreement, and claiming not less than $1.0 million
in damages. The Company defended this action in arbitration proceedings that
ended in April 1997. Upon conclusion, the arbitration panel awarded $267,000 in
net damages to the plaintiff in the proceedings. The Company has challenged the
findings of the arbitration panel on the grounds that the arbitrator appointed
by the plaintiff was also a witness to the actions of the plaintiff and the
Company which led to the action. The Company maintains that, as a result, the
plaintiff-appointed arbitrator lacked objectivity and has filed a motion to have
the findings vacated. The Company intends to vigorously pursue this and all
other avenues available through which the findings of the arbitration panel
might be vacated. Because all these avenues are in a preliminary stage, the
Company cannot predict the outcome of such actions. While neither the Company
nor its legal counsel can offer any assurances that the findings of the
arbitration panel might be overturned, management currently believes that the
resolution of this matter will not have a material adverse impact on its
financial position and therefore has not recorded a loss accrual. However, if
the motion to overturn the decision is denied, the outcome could materially
affect consolidated results of operations in a given year or quarter.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders in the quarter ended
April 30, 1997.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq National Market under the
symbol "VERS." Following the Company's initial public offering on December 13,
1996, Nasdaq reported the following high and low sales prices in each quarter:
High Low
---- ---
Quarter ended January 31, 1997 (subsequent to December 13, 1996)...... $18.25 $13.13
Quarter ended April 30, 1997.......................................... 13.63 8.00
As of July 14, 1997, the Company had approximately 30 holders of record of
its Common Stock. The Company has never declared or paid cash dividends on its
Common Stock. The Company currently intends to retain any earnings for use in
its business and does not anticipate paying any cash dividends on its capital
stock in the foreseeable future. In addition, the Company's loan agreement with
its commercial bank prohibits the payment of cash dividends.
10
ITEM 6. SELECTED FINANCIAL DATA
Year Ended April 30,
--------------------------------------------------
1993 1994 1995 1996 1997
------ ------ ------ ------ ------
(In thousands, except per share data)
Consolidated Statement of Operations
Data:
Revenue:
License revenue..................... $5,510 $5,393 $ 8,045 $ 10,345 $ 18,590
Service and maintenance revenue..... 2,411 2,987 3,440 6,190 8,762
------ ------ -------- -------- --------
Total revenue................... 7,921 8,380 11,485 16,535 27,352
------ ------ -------- -------- --------
Cost of revenue:
License revenue..................... 1,890 1,924 1,493 573 889
Service and maintenance revenue..... 1,745 2,056 2,385 4,267 5,544
------ ------ -------- -------- --------
Total cost of revenue........... 3,635 3,980 3,878 4,840 6,433
------ ------ -------- -------- --------
Gross margin.......................... 4,286 4,400 7,607 11,695 20,919
------ ------ -------- -------- --------
Operating expenses:
Selling, general and administrative. 4,048 3,717 4,550 7,770 15,252
Research and development............ 183 389 711 2,074 2,860
Depreciation and amortization....... 438 133 365 161 301
Write-off of capitalized software... -- -- -- 829 --
------ ------ -------- -------- --------
Total operating expenses........ 4,669 4,239 5,626 10,834 18,413
------ ------ -------- -------- --------
Income (loss) from operations......... (383) 161 1,981 861 2,506
Interest income (expense), net........ (7) (20) (9) 3 404
------ ------ -------- -------- --------
Income (loss) before provision
(benefit) for income taxes............ (390) 141 1,972 864 2,910
Provision (benefit) for income taxes.. (18) 31 715 207 965
------ ------ -------- -------- --------
Net income (loss)..................... $ (372) $ 110 $ 1,257 $ 657 $ 1,945
====== ====== ======== ======== ========
Net income per share (1).............. $ 0.12 $ 0.30
======== ========
Average common and common equivalent
shares outstanding (1)................ 5,603 6,457
======== ========
April 30,
--------------------------------------------------
1993 1994 1995 1996 1997
-------- -------- -------- -------- --------
Consolidated Balance Sheet Data:
Cash and cash equivalents............. $ 108 $ 192 $ 1,414 $ 2,280 $18,826
Working capital (deficiency).......... (318) (573) 446 5,028 34,525
Total assets.......................... 2,832 2,060 4,288 9,631 46,833
Long-term debt, less current portion.. 101 114 51 70 287
Redeemable convertible preferred stock -- -- -- 3,561 --
Stockholders' equity (deficit)........ (35) 75 1,331 1,834 37,968
- ----------
(1) Calculated on the basis described in Note 1 of Notes to Consolidated
Financial Statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
Versatility is a leading provider of client/server customer interaction
software that enables businesses to automate their telemarketing and teleselling
capabilities. Founded in 1981 as an information management consulting firm,
Versatility introduced its first commercial product in 1985, a telemarketing
application product based on the Digital Equipment Corporation ("DEC") VAX/VMS
System. The Company operated as a DEC value-added reseller, supplying turnkey
call center solutions to large and mid-sized companies in a variety of
industries, until the end of fiscal 1994. In November 1993, the Company began
developing applications based on the client/server architecture which culminated
with the release of the Versatility Series in May 1995. In fiscal 1996,
substantially all of the Company's revenue was derived from sales or services
related to the Versatility Series. In August 1996, the Company released
Versatility CallCenter, a CD-ROM-based call center software application that
supports call centers of 50 agents or less.
The Company's revenue is derived principally from two sources: (i) product
license fees for the use of the Company's software products and (ii) service
fees for implementation, maintenance, consulting and training related to the
Company's software products. Historically, the Company's service and maintenance
revenue has increased with license revenue. However, to the extent the Company
is successful in implementing its strategy of distributing a greater proportion
of its products through third party systems
11
integrators and VARs, who will perform such services, the Company expects that,
in future periods, service and maintenance revenue will decrease as a percentage
of total revenue. While hardware sales relating to implementation of the
Company's VAX/VMS application represented 12.1% of the Company's revenue in
fiscal 1995, the Company has not had significant levels of hardware revenue
since the introduction of its client/server products beginning in fiscal 1996.
Revenue from hardware sales has been included in license revenue for such years.
The Company's contracts with its customers often involve significant
customization and installation obligations. In these situations, license revenue
is recognized based on the percentage of completion method which is based on
achievement of certain milestones. When the Company is under no obligation to
install or customize the software, license revenue is recognized upon shipment.
Service revenue for implementation, consulting and training is recognized as the
service is performed. Revenue from maintenance services is recognized ratably
over the term of the service agreement.
The Company's strategy is to increase its use of third party systems
integrators and VARs to distribute its products. Because the Company generally
has no obligation to provide installation, maintenance, training or other
services under such arrangements, the Company generally recognizes software
license revenue from third party systems integrators and VARs upon shipment of
an order. The Company does not expect to receive substantial amounts of service
or maintenance revenue under such arrangements.
For the fiscal year ended April 30, 1997, the Company's eight largest
customers accounted for 59.3% of the Company's total revenue, of which one
customer, BT, accounted for 23.6%. Although the particular customers may change
from period to period, the Company expects that large sales to a limited number
of customers will continue to account for a significant percentage of its total
revenue in any particular period. Given the customer concentration and the
duration of the sales and implementation cycle, the loss of a major customer or
any reduction or delay in sales to or implementation by these or other customers
could have a material adverse effect on the Company's operating results in any
particular period.
Revenue from customers outside the United States accounted for 16.3%, 40.8%
and 41.2% of the Company's total revenue for fiscal 1995, 1996 and 1997,
respectively. While the Company's expenses incurred in foreign countries are
typically denominated in the local currencies, revenue generated by the
Company's international sales typically is paid in U.S. dollars or British
pounds. Although exposure to currency fluctuations to date has been
insignificant, there can be no assurance that fluctuations in currency exchange
rates in the future will not have a material adverse impact on the Company's
international operations. The Company currently does not engage in hedging
activities.
During the course of the development of the client/server software
applications, the Company capitalized costs associated with the Versatility
Series in compliance with Statement of Financial Accounting Standards No. 86
"Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed" ("SFAS 86"). The amount of software capitalized totaled $995,000 and,
beginning in November 1994, was amortized over three years on a straight-line
basis. In connection with two major implementations of the Versatility Series
product in July 1995, the Company decided to add features and functions which
were substantially different than those included in the software as originally
capitalized. Management determined that these features and functions
substantially altered the content of the product, effectively eliminating any
remaining useful life of the capitalized asset. Accordingly, the Company wrote
off the remaining asset of $829,000 in the first quarter of fiscal 1996. The
Company anticipates that for the foreseeable future, no software development
costs will meet the requirements for capitalization under SFAS 86.
12
Results of Operations
The following table sets forth certain financial data for the periods
indicated as a percentage of total revenue:
Percentage of Total Revenue
---------------------------
Year Ended April 30,
--------------------------------
1995 1996 1997
---------- ---------- ----------
Revenue:
License revenue......................... 70.0% 62.6% 68.0%
Service and maintenance revenue......... 30.0 37.4 32.0
-------- -------- --------
Total revenue...................... 100.0 100.0 100.0
-------- -------- --------
Cost of revenue:
License revenue......................... 13.0 3.5 3.2
Service and maintenance revenue......... 20.8 25.8 20.3
-------- -------- --------
Total cost of revenue.............. 33.8 29.3 23.5
-------- -------- --------
Gross margin................................. 66.2 70.7 76.5
-------- -------- --------
Operating expenses:
Selling, general and administrative..... 39.6 47.0 55.8
Research and development................ 6.2 12.5 10.5
Depreciation and amortization........... 3.2 1.0 1.1
Write-off of capitalized software....... -- 5.0 --
-------- -------- --------
Total operating expenses........... 49.0 65.5 67.4
-------- -------- --------
Income from operations....................... 17.2 5.2 9.1
Interest income (expense), net............... (0.1) (0.0) 1.5
-------- -------- --------
Income before provision for income taxes..... 17.1 5.2 10.6
Provision for income taxes................... 6.2 1.2 3.5
-------- -------- --------
Net income................................... 10.9% 4.0% 7.1%
======== ======== ========
The following table sets forth, for each component of revenue, the cost of
such revenue expressed as a percentage of such revenue for the periods
indicated:
Year Ended April 30,
-------------------------------
1995 1996 1997
---------- ---------- ---------
Cost of license revenue..................... 18.6% 5.5% 4.8%
Cost of service and maintenance revenue..... 69.3% 68.9% 63.3%
Fiscal 1997 Compared to Fiscal 1996
Revenue. Total revenue increased 65.4% from $16.5 million in fiscal 1996 to
$27.4 million in fiscal 1997. Revenue from license fees increased 79.7% from
$10.3 million in fiscal 1996, or 62.6% of total revenue, to $18.6 million in
fiscal 1997, or 68.0% of total revenue. Service and maintenance revenue
increased 41.6% from $6.2 million in fiscal 1996, or 37.4% of total revenue, to
$8.8 million in fiscal 1997, or 32.0% of total revenue. The increase in total
revenue was significantly influenced by the roll-out of the Versatility Series
at BT, which contributed $4.4 million in license revenue and $2.1 million in
service and maintenance revenue. The composition of revenue was also influenced
by the development of Versatility's indirect channels. For fiscal 1997, the
domestic and international indirect sales groups together generated $7.7 million
or 28.3% of total revenue.
Cost of Revenue. Total cost of revenue increased from $4.8 million in fiscal
1996, or 29.3% of total revenue to $6.4 million in fiscal 1997, or 23.5% of
total revenue. Cost of license revenue increase from $573,000 in fiscal 1996, or
5.5% of license revenue, to $889,000 in fiscal 1997, or 4.8% of license revenue.
The increase was primarily the result of higher licenses volume partially offset
by a decrease resulting from the Company's shift away from providing lower
margin third-party hardware and software products. The cost of service and
maintenance revenue increased from $4.3 million in fiscal 1996, or 68.9% of
service and maintenance revenue, to $5.5 million in fiscal 1997, or 63.3% of
service and maintenance revenue. The increase represents the addition of
consulting and other staff to support additional revenue as well as the costs
relating to the installation of the Company's products at BT and Avantel.
Selling, General and Administrative. The Company's selling, general and
administrative expenses increased from $7.8 million in fiscal 1996, or 47.0% of
total revenue, to $15.3 million in fiscal 1997, or 55.8% of total revenue. The
increase was attributable to additions to the Company's headcount, primarily
sales and marketing staff. During fiscal 1997, the number of the Company's
employees grew from 135 to 186. Of the increase, 28 new hires joined the sales
and marketing departments, with the remainder accepting management or
administrative positions.
13
Research and Development. Research and development expenses increased from
$2.1 million in fiscal 1996, or 12.5% of total revenue, to $2.9 million in
fiscal 1997, or 10.5% of total revenue. The number of staff devoted to research
and development increased over 34.6%. This increase in research and development
expenditures resulted from the addition of software developers needed to support
the Company's new product development, as well as costs relating to enhancements
to the Versatility Series and Versatility CallCenter products.
Depreciation and Amortization and Write-off of Capitalized Software.
Depreciation and amortization expenses increased from $161,000 in fiscal 1996 to
$301,000 in fiscal 1997. While the Company entered into operating leasing
arrangements for capital equipment acquired both in fiscal 1996 and 1997, the
volume of assets purchased that were either retained or financed through capital
leases, led to the increase in depreciation expense. Additionally, in fiscal
1996, the Company wrote off all remaining capitalized software totaling
$829,000. No amounts were written off in fiscal 1997 and the Company anticipates
that, for the foreseeable future, no software development costs will meet the
requirements for capitalization.
Interest Income (Expense), Net. Interest income (expense), net was $3,000 in
fiscal 1996 and $404,000 in fiscal 1997. The difference resulted from higher
available cash balances in fiscal 1997, primarily due to the cash raised in the
Company's Initial Public Offering.
Provision for Income Taxes. The Company's provision for income taxes was
$207,000 in fiscal 1996 compared to $964,000 in fiscal 1997. The effective rate
in fiscal 1996 was 24.0% versus an effective rate of 33.1%. The Company incurred
a lower effective rate in fiscal 1996 due to tax benefits derived from sales
made through the Company's Foreign Sales Corporation and due to a previously
unrecognized tax benefit derived from the write-off in a previous period of an
investment in a discontinued subsidiary.
Net Income. Net income increased from $657,000 for fiscal 1996 to $1.9
million for fiscal 1997. If the Company had not been required to capitalize
software development costs and no amortization or write-off had been recorded,
net income for fiscal 1996 would have been $1.3 million.
Fiscal 1996 Compared to Fiscal 1995
Revenue. Total revenue increased 44.0% from $11.5 million in fiscal 1995 to
$16.5 million in fiscal 1996. Revenue from license fees increased 28.6% from
$8.0 million in fiscal 1995, or 70.0% of total revenue, to $10.3 million in
fiscal 1996, or 62.6% of total revenue. Service and maintenance revenue
increased 79.9% from $3.4 million in fiscal 1995, or 30.0% of total revenue, to
$6.2 million in fiscal 1996, or 37.4% of total revenue. The increase in total
revenue was significantly influenced by the roll-out of the Versatility Series
at BT, which contributed $3.0 million in license revenue and $1.2 million in
service and maintenance revenue. Revenue from hardware sales decreased from $1.4
million in fiscal 1995 to $139,000 in fiscal 1996, as the Company completed its
transition to licensing products based on a client/server architecture. Hardware
revenue in fiscal 1995 was derived primarily from sales of DEC VAX/VMS hardware,
while such revenue for fiscal 1996 consisted of incidental sales of hardware
related to the Versatility Series product. The Company does not expect
significant hardware sales to occur in the future.
Cost of Revenue. Total cost of revenue increased from $3.9 million in fiscal
1995, or 33.8% of total revenue, to $4.8 million in fiscal 1996, or 29.3% of
total revenue. Cost of license revenue decreased from $1.5 million in fiscal
1995, or 18.6% of license revenue, to $573,000 in fiscal 1996, or 5.5% of
license revenue. This decrease resulted from the Company's shift away from
providing complete hardware and software configurations for its customers using
DEC hardware and software. The cost of service and maintenance revenue increased
from $2.4 million in fiscal 1995, or 69.3% of service and maintenance revenue,
to $4.3 million in fiscal 1996, or 68.9% of service and maintenance revenue. The
increase represents the addition of consulting and other staff to support
additional revenue as well as the costs relating to the installation of the
Company's products at BT.
Selling, General and Administrative. The Company's selling, general and
administrative expenses increased from $4.6 million in fiscal 1995, or 39.6% of
total revenue, to $7.8 million in fiscal 1996, or 47.0% of total revenue. The
increase was primarily attributable to additions to the Company's sales and
marketing staff. During fiscal 1996, the number of the Company's employees grew
from 67 to 135. Of the increase, 45 new hires joined the sales and marketing
departments, with the remainder accepting management or administrative
positions.
Research and Development. Research and development expenses increased from
$711,000 in fiscal 1995, or 6.2% of total revenue, to $2.1 million in fiscal
1996, or 12.5% of total revenue. In addition, $743,000 of research and
development expenditures were capitalized in fiscal 1995, while no such costs
were capitalized in fiscal 1996. If these capitalized software development
14
expenditures were added, research and development expenses for fiscal 1995,
would have been $1.5 million. This increase in research and development
expenditures resulted from the addition of software developers needed to support
the Company's new product development, as well as costs relating to enhancements
to the Versatility Series and Versatility CallCenter products.
Depreciation and Amortization and Write-off of Capitalized Software.
Depreciation and amortization expenses decreased from $365,000 in fiscal 1995 to
$161,000 in fiscal 1996. Certain assets had been fully amortized in fiscal 1995
and the Company entered into leasing arrangements for capital equipment acquired
in fiscal 1996. Depreciation and amortization expenses in fiscal 1995 included
$166,000 of amortization of capitalized software. The unamortized portion of
this asset, amounting to $829,000, was written off in fiscal 1996 as management
determined that no net realizable value in the asset remained. No such write-off
was recorded in fiscal 1995.
Interest Income (Expense), Net. Interest income (expense), net was ($9,000)
in fiscal 1995 and $3,000 in fiscal 1996. The difference resulted from higher
available cash balances in fiscal 1996, primarily due to the cash raised in a
private placement in January 1996, which was partially offset by increased
interest expense due to borrowings under the Company's line of credit.
Provision for Income Taxes. The Company's provision for income taxes was
$715,000 in fiscal 1995 compared to $207,000 in fiscal 1996. The effective rate
in fiscal 1995 was 36.3%, while the effective rate in fiscal 1996 was 24.0%. The
Company incurred a lower effective rate in fiscal 1996 due to tax benefits
derived from sales made through the Company's Foreign Sales Corporation and due
to a previously unrecognized tax benefit derived from the write-off in a
previous period of an investment in a discontinued subsidiary.
Net Income. Net income decreased from $1.3 million for fiscal 1995 to
$657,000 for fiscal 1996. If the Company had not been required to capitalize
software development costs and no amortization or write-off had been recorded,
net income for fiscal 1995 and fiscal 1996 would have been $889,000 and $1.3
million, respectively.
Liquidity and Capital Resources
The Company has funded its operations to date primarily through cash
generated from operations, through the private sale of preferred stock in
January 1996 totaling $3.5 million, from funds obtained from revolving credit
facilities with commercial banks and the Company's initial public offering in
December 1996 that raised $30.6 million in net proceeds. The Company's existing
$2.5 million line of credit had an outstanding balance of $2.3 million at April
30, 1997, and $437,000 was outstanding under its $1.0 million equipment line of
credit. Advances under the working capital line bear interest at a variable
annual rate equal to the prime rate of the bank plus 0.5%, and advances under
the equipment line bear interest at a variable annual rate equal to the prime
rate of the bank plus 1.0%. Both lines expire on August 5, 1997.
At April 30, 1997, the Company had $18.8 million in cash and cash
equivalents and $16.0 million in accounts receivable. For the year ended April
30, 1997, net cash used by operations totaled $6.3 million. In addition, the
Company used $9.2 million for investing activities, which included $952,000 for
the capital expenditures, $516,000 loaned to Serenity Real Properties Limited
Partnership and $7.5 million to purchase investments in corporate and municipal
bonds. These uses of cash were offset by the net proceeds of $30.6 million from
the Company's initial public offering and net borrowings of $1.5 million under
the Company's working capital line of credit, resulting in a net cash increase
of $16.5 million.
The $5.7 million in accounts receivable at April 30, 1996 compares to $16.0
million at April 30, 1997. While some of this increase resulted in the ordinary
course from growth in the Company's revenue year to year, approximately $3
million of the accounts receivable at April 30, 1997 represented balances over
90 days past due from customers with negotiated extended payment terms
(originally not to exceed 90 days from invoice date) as a condition to their
purchase or during the course of the implementation process. The Company does
not anticipate a further extension of payment terms. To the extent that
significant customers of the Company continue to have the negotiating leverage
to obtain extended payment terms, the Company's working capital requirements
will be increased.
The Company invested $156,000, $235,000 and $952,000 in capital expenditures
in fiscal 1995, 1996 and 1997, respectively. Capital expenditures include
purchases of computer hardware used primarily in product development, product
demonstrations, training and support. Over the course of fiscal 1996, the
Company had financed a portion of its capital equipment needs through operating
leases. During fiscal 1997, the Company financed $437,000 of the capital assets
acquired through a capital lease under its $1.0 million equipment line of credit
with the remainder through operating leases.
15
The Company anticipates that its existing cash balances, funds anticipated
to be generated from operations, combined with the proceeds from the initial
public offering and interest thereon, will be adequate to satisfy its working
capital requirements for its current and planned operations for at least the
next twelve months. The Company's future operating and capital requirements will
depend on numerous factors, including the progress of the Company's internal
research and development programs, the level of resources the Company devotes to
the development of marketing and sales capabilities, technological advances, the
status of competing products, and the successful development and timely
introduction of its own products. In the longer term, the Company may require
additional equity or debt financing. No assurance can be given that these funds
will be available to the Company on acceptable terms, if at all.
Factors Which May Effect Future Operating Results
The Company does not provide forecasts of future, financial performance.
While the Company's management is optimistic about its long-term prospects, the
following issues and uncertainties, among others, should be considered in
evaluating its growth outlook.
Dependence on New Products; Risk Associated with Servicing the Customer
Interaction Software Market. The Company currently derives substantially all of
its revenue from sales of its Versatility Series software and related services.
The Versatility Series was introduced in May 1995, and the Company expects that
this product and related services, together with Versatility CallCenter,
introduced in August 1996, will continue to account for a substantial portion of
the Company's revenue for the foreseeable future. However, the Company has
little operating history with the Versatility Series and Versatility CallCenter
products. The Company's financial results for periods prior to fiscal 1996
reflect sales of the Company's previous generation of products, which the
Company no longer actively markets. The lifecycle of the Company's current
products is difficult to estimate as a result of many factors, including the
unknown future demand for customer interaction software and the effects of
competition in this market. Moreover, although the Company intends to enhance
these products and develop related products, the Company's strategy is to
continue to focus on providing customer interaction software applications as its
sole line of business. As a result, any factor adversely affecting the market
for customer interaction software applications in general, or the Versatility
Series and Versatility CallCenter products in particular, could adversely affect
the Company's business, financial condition and results of operations. The
market for customer interaction software products is intensely competitive,
highly fragmented and subject to rapid change. The Company's future success will
depend on continued growth in the market for customer interaction applications.
There can be no assurance that the market for customer interaction applications
will continue to grow. If this market fails to grow or grows more slowly than
the Company currently anticipates, the Company's business, financial condition
and results of operations would be materially adversely affected.
Dependence on Large License Fees and Customer Concentration. A relatively
small number of customers have accounted for a significant percentage of the
Company's revenue in any given period. In fiscal 1997, the Company's eight
largest customers accounted for 59.3% of the Company's total revenue, of which,
BT accounted for 23.6%. Although the particular customers may change from period
to period, the Company expects that large sales to a limited number of customers
will continue to account for a significant percentage of its revenue in any
particular period for the foreseeable future. Therefore, the loss, deferral or
cancellation of an order could have a significant impact on the Company's
operating results in a particular quarter. The Company has no long-term
contracts with its customers and there can be no assurance that its current
customers will place additional orders, or that the Company will obtain orders
of similar magnitude from other customers. The loss of any major customer or any
reduction, delay in or cancellation of orders by any such customer, or the
failure of the Company to market successfully to new customers could have a
materially adverse effect on the Company's business, financial condition and
results of operations.
Some of the Company's increase in accounts receivable resulted in the
ordinary course from growth in the Company's revenue year to year, approximately
$3 million of the accounts receivable at April 30, 1997 represented balances
over 90 days past due from customers which negotiated extended payment terms as
a conditions to their purchase or during the course of the implementation
process. The Company does not anticipate a further extension of payment terms.
To the extent that significant customers of the Company continue to have the
negotiating leverage to obtain extended payment terms, the Company's working
capital requirements will be increased.
Quarterly Fluctuations in Revenue and Operating Results. The Company's
revenue and operating results could fluctuate significantly from quarter to
quarter due to a combination of factors, including variations in the demand for
the Company's products, the level of product and price competition, the length
of the Company's sales process, the size and timing of individual transactions,
the mix of products and services sold, the mix of sales through direct and
indirect channels, any delay in or
16
cancellation of customer implementations, the Company's success in expanding its
customer support organization, direct sales force and indirect distribution
channels, the timing of new product introductions and enhancements by the
Company or its competitors, the ratio of international to domestic sales,
commercial strategies adopted by competitors, changes in foreign currency
exchange rates, customers' budgets constraints, and the Company's ability to
control costs. In addition, a limited number of relatively large customer orders
has accounted for and is likely to continue to account for a substantial portion
of the Company's total revenue in any particular quarter. The timing of such
orders can be difficult to predict given the average size of the Company's
orders and the length of its sales process. The Company has in the past
recognized a substantial portion of its revenue in the last month of a quarter.
Therefore, the loss, deferral or cancellation of an order could have a
significant adverse impact on the Company's revenue and operating results in a
particular quarter. Because the Company's operating expense levels are
relatively fixed and tied to anticipated levels of revenue, any delay in the
recognition of revenue from a limited number of license transactions could cause
significant variations in operating results from quarter to quarter. Based upon
all of the foregoing, the Company believes that quarter-to-quarter comparisons
of its results of operations are not necessarily meaningful and such comparisons
should not be relied upon as indications of future performance. It is also
likely that the Company's future quarterly operating results in any given period
will not meet the expectations of market analysts or investors, which could have
an adverse effect on the price of the Company's Common Stock.
Length of Sales and Implementation Processes. Selling the Company's products
generally requires the Company to provide a significant level of education to
prospective customers regarding the use and benefits of the Company's products.
In addition, implementation of the Company's products involves a significant
commitment of resources by prospective customers and is commonly associated with
substantial integration efforts which may be performed by the Company, by the
customer, or by a third party systems integrator. For these and other reasons,
the length of time between the date of initial contact with the potential
customer and the implementation of the Company's products is often lengthy,
typically ranging from two to nine months or more, and is subject to delays over
which the Company has little or no control. The Company's implementation cycle
could be lengthened by increases in the size and complexity of its
implementations and by delays in its customers' adoption of client/server
computing environments. Delay in or cancellation of the sale or implementation
of applications could have a materially adverse effect on the Company's
business, financial condition and results of operations and cause the Company's
operating results to vary significantly from quarter to quarter.
Expansion of Sales Force and Channels of Distribution. Historically, the
Company has distributed its products primarily through its direct sales force.
An integral part of the Company's strategy includes expanding its direct sales
force while developing additional marketing, sales and implementation
relationships with third party systems integrators and VARs. The Company's
ability to achieve significant revenue growth in the future will depend on its
ability to attract, train and retain additional qualified direct sales
personnel. In addition, the Company currently is investing, and intends to
continue investing, significant resources to develop its relationships with
third party systems integrators and VARs, especially in international markets.
The Company has only limited experience distributing its products through
indirect channels. If the Company is unable to develop its relationships with
third party systems integrators and VARs, or if the third party systems
integrators and VARs with which the Company develops relationships are unable to
effectively market, sell and implement the Company's software applications, the
Company's business, financial condition and results of operations could be
materially adversely affected.
Dependence on Indirect Distribution Channels; Potential for Channel
Conflict. The Company's strategy is to increase its use of third party systems
integrators and VARs to distribute its products. These independent sales
organizations, which generally install and support the product lines of a number
of companies, are not under the direct control of the Company, are not subject
to any minimum purchase requirements and can discontinue marketing the Company's
products at any time without cause. Many of the Company's third party systems
integrators and VARs sell or co-market potentially competitive products.
Accordingly, the Company must compete for the focus and sales efforts of its
third party systems integrators and VARs. Additionally, selling through indirect
channels may limit the Company's contacts with its customers. As a result, the
Company's ability to accurately forecast sales and revenue, evaluate customer
satisfaction and recognize emerging customer requirements may be hindered. In
addition, the Company's gross profit on sales to third party systems integrators
and VARs tends to be lower than on its direct sales, although the Company's
selling and marketing expenses and servicing costs also tend to be lower with
respect to these sales. There can be no assurance that the Company's current
third party systems integrators and VARs will continue to distribute or
recommend the Company's products or do so successfully. There can also be no
assurance that one or more of these companies will not begin to market products
in competition with the Company. The termination of one or more of these
relationships could adversely affect the Company's business, financial condition
and results of operations.
17
The Company's strategy of marketing its products directly to end-users and
indirectly through VARs and third party systems integrators may result in
distribution channel conflicts. The Company's direct sales efforts may compete
with those of its indirect channels and, to the extent different resellers
target the same customers, resellers may also come into conflict with each
other. Although the Company has attempted to manage its distribution channels in
a manner to avoid potential conflicts, there can be no assurance that channel
conflicts will not materially adversely affect its relationships with existing
third party systems integrators or VARs or adversely affect its ability to
attract new third party systems integrators and VARs.
Dependence on Practice Partners. The Company is currently enlisting the
support of a specific group of professional services organizations which will
engage in the practice of implementing and customizing the Company's software
products. Referred to as "Practice Partners," these organizations do not resell
or otherwise market the Company's products. Instead, the Company intends to
support the Practice Partners' efforts to learn to install, customize and
support the Company's products. The Company's future revenues may depend on the
ability of the Practice Partners to achieve this goal. Further, the costs
required to enlist, train and assist the Practice Partners could have a
materially adverse affect on the Company's business, financial condition and
results of operations.
International Operations. Revenue from sales outside the United States in
fiscal 1995, 1996 and 1997 accounted for approximately 16.3%, 40.8% and 41.2%,
respectively, of the Company's total revenue. International operations are
subject to inherent risks, including the impact of possible recessionary
environments in economies outside the United States, changes in demand for the
Company's products resulting from fluctuations in exchange rates, unexpected
changes in legal and regulatory requirements including those relating to
telemarketing activities, changes in tariffs, seasonality of sales, costs of
localizing products for foreign markets, longer accounts receivable collection
periods and greater difficulty in accounts receivable collection, difficulties
and costs of staffing and managing foreign operations, reduced protection for
intellectual property rights in some countries, potentially adverse tax
consequences and political and economic instability. There can be no assurance
that the Company will be able to sustain or increase international revenue, or
that the factors listed above will not have a material adverse impact on the
Company's international operations. While the Company's expenses incurred in
foreign countries are typically denominated in the local currencies, revenue
generated by the Company's international sales typically is paid in U.S. dollars
or British pounds. Although exposure to currency fluctuations to date has been
insignificant, there can be no assurance that fluctuations in currency exchange
rates in the future will not have a material adverse impact on the Company's
international operations. The Company currently does not engage in hedging
activities.
A significant element of the Company's strategy is to continue the expansion
of its operations in international markets. This expansion has required and will
continue to require significant management attention and financial resources to
develop international sales channels. Because of the difficulty in penetrating
new markets, along with the Company's size and geographic location, there can be
no assurance that the Company will be able to maintain or increase international
revenue. To the extent that the Company is unable to do so, the Company's
financial condition and results of operations could be materially adversely
affected. A substantial portion of the Company's international sales are
expected to be made using indirect selling channels, such as third party systems
integrators and VARs. A reduction in sales by all or some of these distributors
or a termination of their relationships with the Company could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Competition. The market for the Company's products is intensely competitive,
highly fragmented and subject to rapid change. Because the Company offers
multiple applications which can be purchased separately or integrated as part of
the Versatility Series, the Company competes with a variety of companies
depending on the target market for their applications software products. The
Company's principal competitors in the customer interaction software market are
Brock International, Inc., Digital Systems International, Inc., Information
Management Associates, Inc., Scopus Technology, Inc. and The Vantive
Corporation. For installations where telephony functions are of prime
importance, competitors include Davox Corporation, Early Cloud and Company (a
division of IBM) and EIS International, Inc. The Company also competes with
third party professional service organizations that develop custom software and
with the information technology departments of potential customers, which
develop applications internally. Among the Company's potential competitors are
also a number of large hardware and software companies that may develop or
acquire products that compete with the Company's products. Increased competition
is likely to result in price reductions, reduced operating margins and loss of
market share, any of which could materially adversely affect the Company's
business, financial condition and results of operations. Many of the Company's
current and potential competitors have significantly greater financial,
technical, marketing and other resources than the Company. As a result, they may
be able to respond more quickly to new or emerging technologies and changes in
customer requirements, or to devote greater resources to the development,
promotion and sale of products than can the Company. There can be no assurance
that the Company will be able to compete
18
successfully against current and future competitors or that competitive
pressures faced by the Company will not materially adversely affect its
business, financial condition and results of operations.
Management of Growth. The Company has recently experienced significant
growth in revenue, operations and personnel. Continued growth will challenge the
Company's management systems and resources and require the Company to improve
and upgrade its management information systems. In addition, the Company will
need to hire more technical, sales and marketing, support and administrative
personnel to adequately service and support its growing customer base. There can
be no assurance that the Company will be able to successfully upgrade its
systems or to attract, retain and successfully train the necessary personnel to
accomplish its growth strategies or that it will not experience constraints that
will adversely affect its ability to satisfy customer demand in a timely fashion
or to satisfactorily support its customers. Any of these events could injure the
Company's reputation or lead to loss of customers. If the Company is unable to
manage growth effectively, the Company's business, financial condition and
results of operations could be adversely affected.
Dependence on Growth of Client/Server Computing Environment. The
client/server software environment is relatively new. The Company markets its
products solely to customers that have committed or are committing their call
center systems to client/server environments, or are converting legacy systems,
in part or in whole, to a client/server environment. The Company's success will
depend on further development of and growth in the number of organizations
adopting client/server computing environments. There can be no assurance,
however, that the client/server market will maintain its current rate of growth.
There also can be no assurance that the client/server computing trends
anticipated by the Company will occur or that the Company will be able to
respond effectively to the evolving requirements of this market. If the
client/server market fails to grow, or grows at a rate slower than experienced
in the past, the Company's business, financial condition and results of
operations could be materially adversely affected.
Rapid Technological Change and Product Development Risks. The customer
interaction software market is subject to rapid technological change, changing
customer needs, frequent new product introductions and evolving industry
standards that may render existing products and services obsolete. As a result,
the Company's position in this market could be eroded rapidly by unforeseen
changes in application features and functions. The life cycles of the Company's
products are difficult to estimate. The Company's growth and future operating
results will depend in part upon its ability to enhance existing applications
and develop and introduce new applications that meet or exceed technological
advances in the marketplace, that meet changing customer requirements, that
respond to competitive products and that achieve market acceptance. The
Company's product development and testing efforts are expected to require
substantial investments by the Company. There can be no assurance that the
Company will possess sufficient resources to make these necessary investments.
The Company has in the past experienced delays both in developing new products
and in customizing existing products, and there can be no assurance that the
Company will not experience difficulties that could cause delays in the future.
In addition, there can be no assurance that such products will meet the
requirements of the marketplace and achieve market acceptance, or that the
Company's current or future products will conform to industry standards. If the
Company is unable, for technological or other reasons, to develop and introduce
new and enhanced products in a timely manner, the Company's business, financial
condition and results of operations could be materially 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. In particular, the computing environment is characterized
by a wide variety of standard and non-standard configurations that make
pre-release testing for programming or compatibility errors very difficult and
time consuming. There can be no assurance that, despite extensive testing 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, financial condition and results of operations.
Difficulty in Protecting Proprietary Technology; Risk of Infringement. The
Company relies on a combination of copyright, trade secret and trademark laws,
confidentiality procedures and contractual provisions to protect its proprietary
rights in its products and technology. The Company does not rely upon patent
protection and does not currently expect to seek patents on any aspects of its
technology. There can be no assurance that the confidentiality agreements and
other methods on which the Company relies to protect its trade secrets and
proprietary technology will be adequate. Further, the Company may be subject to
additional risks as it enters into transactions in countries where intellectual
property laws are not well developed or are poorly enforced. Legal protections
of the Company's rights may be ineffective in such countries. Litigation to
defend and enforce the Company's
19
intellectual property rights could result in substantial costs and diversion of
resources and could have a materially adverse effect on the Company's business,
financial condition and results of operations, regardless of the final outcome
of such litigation. Despite the Company's efforts to safeguard and maintain its
proprietary rights both in the United States and abroad, there can be no
assurance that the Company will be successful in doing so or that the steps
taken by the Company in this regard will be adequate to deter misappropriation
or independent third-party development of the Company's technology or to prevent
an unauthorized third party from copying or otherwise obtaining and using the
Company's products or technology. There also can be no assurance that others
will not independently develop similar technologies or duplicate any technology
developed by the Company. Any such events could have a material adverse effect
on the Company's business, financial condition and results of operations.
The Company has entered into agreements with a small number of its customers
requiring the Company to place its source code in escrow. These escrow
agreements typically provide that these customers have a limited, non-exclusive
right to use such code in the event that there is a bankruptcy proceeding by or
against the Company, if the Company ceases to do business or if the Company
fails to meet its support obligations. Entering into such agreements may
increase the likelihood of misappropriation by third parties.
As the number of customer interaction software applications in the industry
increases and the functionality of these products further overlaps, software
development companies like the Company may increasingly become subject to claims
of infringement or misappropriation of the intellectual property rights of
others. There can be no assurance that third parties will not assert
infringement or misappropriation claims against the Company in the future with
respect to current or future products. Any claims or litigation, with or without
merit, could be time-consuming, result in costly litigation, cause product
shipment delays or require the Company to enter into royalty or licensing
arrangements. Such royalty or licensing arrangements, if required, may not be
available on terms acceptable to the Company, if at all, which could have a
material adverse effect on the Company's business, financial condition and
results of operations. Adverse determinations in such claims or litigation could
also have a material adverse effect on the Company's business, financial
condition and results of operations.
Dependence on Key Personnel. The Company's success depends to a significant
extent upon the continued service of its executive officers and other key
management and technical personnel, and on its ability to continue to attract,
retain and motivate qualified personnel, such as experienced software developers
and sales personnel. Competition for such employees is very intense. The Company
has no long-term employment contracts with any of its employees. The loss of the
services of one or more of the Company's executive officers, software developers
or other key personnel or the Company's inability to recruit replacements for
such personnel could have a material adverse effect on the Company's business,
financial condition and results of operations. The Company maintains $1.0
million of key-man life insurance on Ronald R. Charnock, the Company's President
and Chief Executive Officer.
Regulatory Environment. Federal, state and foreign law regulate certain uses
of outbound call processing systems. Although the compliance with these laws may
limit the potential use of the Company's products in some respects, the
Company's systems can be programmed to operate automatically in full compliance
with these laws through the use of appropriate calling lists and calling
campaign time parameters. There can be no assurance, however, that future
legislation further restricting telephone solicitation practices, if enacted,
would not adversely affect the Company.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's consolidated financial statements, together with related notes
and the report of Deloitte & Touche LLP, the Company's independent accountants,
are set forth on the pages indicated in Item 14.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
20
PART III
Certain information required by Part III is omitted from this Annual Report
on Form 10-K since the Company will file its definitive Proxy Statement for its
Annual Meeting of Stockholders to be held on August 26, 1997, pursuant to
Regulation 14A of the Securities Exchange Act of 1934, as amended (the "Proxy
Statement"), not later than 120 days after the end of the fiscal year covered by
this Report, and certain information included in the Proxy Statement is
incorporated herein by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) Executive Officers
The information required by this Item is incorporated by reference to
the information set forth under the caption "Occupation of Directors and
Executive Officers" on pages 3 and 4 of the Proxy Statement.
(b) Directors
The information required by this Item is incorporated by reference to
the information set forth under the caption "Occupation of Directors and
Executive Officers" on pages 3 and 4 of the Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to the
information set forth under the caption "Compensation and Other Information
Concerning Directors and Officers" on pages 5 and 6 of the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference to the
information set forth under the caption "Management and Principal Holders of
Voting Securities" on pages 1 and 2 of the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference to the
information set forth under the caption "Certain Relationships and Related
Transactions" on page 10 of the Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Report:
1. Financial Statements
Page
Independent Auditors' Report.........................................F-2
Consolidated Balance Sheets..........................................F-3
Consolidated Statements of Operations................................F-5
Consolidated Statements of Cash Flows................................F-6
Consolidated Statements of Changes in Stockholders' Equity...........F-7
Notes to Consolidated Financial Statements...........................F-8
2. Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts.................S-1
21
3. Exhibits
See Index to Exhibits. The Exhibits listed in the accompanying
Index to Exhibits are filed herewith or incorporated by reference
as part of this report.
(b) Reports on Form 8-K:
None
(c) Exhibits
See (a) above
(d) Financial Statement Schedules
See (a) above
22
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VERSATILITY INC.
Dated: July 23, 1997 By: /s/ Ronald R. Charnock
-----------------------
Ronald R. Charnock
Chairman, President and
Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
Report on Form 10-K has been signed by the following persons in the capacities
and on the dates indicated:
SIGNATURE TITLE
/s/ Ronald R. Charnock Chairman, President and Chief Executive Officer
- ------------------------------
Ronald R. Charnock
/s/ Donald C. Yount Chief Financial Officer (Principal Financial
- ------------------------------ and Accounting Officer)
Donald C. Yount
/s/ Marcus W. Heth Director
- ------------------------------
Marcus W. Heth
/s/ Thomas A. Smith Director
- ------------------------------
Thomas A. Smith
/s/ Charles A. Johnson Director
- ------------------------------
Charles A. Johnson
/s/ Paul J. Palmer Director
- ------------------------------
Paul J. Palmer
/s/ James R. Walker Director
- ------------------------------
James R. Walker
23
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
VERSATILITY INC.
Page
----
Independent Auditors' Report......................................................................................... F-2
Consolidated Balance Sheets at April 30, 1996 and 1997............................................................... F-3
Consolidated Statements of Operations for the years ended April 30, 1995, 1996 and 1997.............................. F-5
Consolidated Statements of Cash Flows for the years ended April 30, 1995, 1996 and 1997.............................. F-6
Consolidated Statements of Changes in Stockholders' Equity for the years ended April 30, 1995, 1996 and 1997......... F-7
Notes to Consolidated Financial Statements........................................................................... F-8
F-1
INDEPENDENT AUDITORS' REPORT
Board of Directors of Versatility Inc.:
We have audited the accompanying consolidated balance sheets of Versatility
Inc. and its subsidiaries (the "Company") as of April 30, 1996 and 1997, and the
related consolidated statements of operations, of changes in stockholders'
equity, and of cash flows for each of the three years in the period ended April
30, 1997. We have also audited the financial statement schedule listed in Item
14(a)2 of this Form 10-K. These financial statements and financial statement
schedule 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, such consolidated financial statements present fairly, in
all material respects, the financial position of Versatility Inc. and its
subsidiaries at April 30, 1996 and 1997, and the results of their operations and
their cash flows for each of the three years in the period ended April 30, 1997
in conformity with generally accepted accounting principles. In addition, in our
opinion, the financial statement schedule referred to above, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.
DELOITTE & TOUCHE LLP
Washington, DC
May 30, 1997
F-2
VERSATILITY INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
April 30, April 30,
1996 1997
---- ----
ASSETS
Current assets:
Cash and cash equivalents....... $ 2,280,273 $18,825,764
Short-term investments.......... -- 6,039,255
Accounts receivable, net of
Allowance for doubtful accounts
of $157,874 and $356,195...... 5,670,503 15,971,315
Prepaid expenses................ 642,045 1,181,865
Inventory....................... -- 18,880
Note receivable-related party... -- 519,305
Deferred income taxes........... 130,238 230,729
----------- -----------
Total current assets....... 8,723,059 42,787,113
----------- -----------
Other assets:
Related party receivables....... 117,221 153,381
Deposits........................ 157,835 187,650
Related party investment........ 3,137 --
Investments..................... -- 1,433,464
Deferred income taxes........... -- 248,932
Assets held for sale............ 76,004 648,314
Purchased software, net of
Accumulated amortization of
$11,500 and $62,098........... 103,500 357,136
----------- -----------
Total other assets......... 457,697 3,028,877
----------- -----------
Property and equipment
Computers....................... 893,674 1,168,246
Office furniture and equipment.. 637,559 665,597
Leasehold improvements.......... 181,485 206,402
Capital leases.................. 160,822 652,533
----------- -----------
1,873,540 2,692,778
Less: Accumulated depreciation
and amortization............. (1,423,234) (1,675,749)
----------- -----------
Net property and equipment. 450,306 1,017,029
----------- -----------
Total................................ $ 9,631,062 $46,833,019
=========== ===========
See notes to the consolidated financial statements
F-3
VERSATILITY INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
April 30, April 30,
1996 1997
---------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable....................... $ 824,745 $ 2,107,630
Accrued liabilities.................... 1,393,653 2,016,656
Related party payables................. 3,443 28,030
Income taxes payable................... 356,503 662,042
Capital lease payable.................. 30,848 181,069
Line of credit......................... 800,772 2,288,319
Deferred revenue....................... 284,700 978,008
---------- ------------
Total current liabilities......... 3,694,664 8,261,754
---------- ------------
Long-term liabilities:
Capital lease payable, less current
Maturities........................... 69,983 287,120
Deferred rent.......................... 221,899 316,360
Deferred income taxes.................. 249,401 --
---------- -----------
Total other liabilities........... 541,283 603,480
---------- -----------
Commitments and Contingencies (Note 6)
Redeemable preferred stock
Series A redeemable convertible preferred
stock, par value $.01 -- 992,061 shares
authorized, issued and outstanding,
liquidation preference -- $3.52784 per
share at April 30, 1996; no shares
authorized, issued or outstanding at
April 30, 1997............................ 3,561,293 --
Stockholders' equity
Preferred stock, $.01 par value, no
shares authorized, issued or
outstanding
at April 30, 1996; 2,000,000 shares
authorized, no shares issued or -- --
outstanding at April 30, 1996.........
Common stock, par value $.01 -- 20,000,000
shares authorized, 4,000,000 shares
issued and outstanding at April 30, 1997;
7,297,365 shares issued and
outstanding at April 30, 1997........ 40,000 72,974
Additional paid-in capital............. -- 34,349,298
Foreign currency translation
adjustments................................. (66,311) (83,880)
---------- -----------
Retained earnings...................... 1,860,133 3,629,393
---------- -----------
Stockholders' equity.............. 1,833,822 37,967,785
---------- -----------
Total....................................... $9,631,062 $46,833,019
========== ===========
See notes to the consolidated financial statements
F-4
VERSATILITY INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended April 30,
1995 1996 1997
------------ ------------ -----------
Revenue:
License revenue......................... $8,045,345 $10,345,323 $18,589,540
Service and maintenance revenue......... 3,439,806 6,189,949 8,762,355
---------- ----------- -----------
Total revenue...................... 11,485,151 16,535,272 27,351,895
---------- ---------- -----------
Cost of revenue:
License revenue......................... 1,493,194 573,329 889,163
Service and maintenance revenue......... 2,384,946 4,266,984 5,544,331
---------- ----------- -----------
Total cost of revenue.............. 3,878,140 4,840,313 6,433,494
---------- ----------- -----------
Gross margin................................ 7,607,011 11,694,959 20,918,401
--------- ----------- -----------
Operating expenses:
Selling, general and administrative..... 4,550,182 7,769,751 15,252,104
Research and development................ 710,828 2,073,797 2,859,639
Depreciation and amortization........... 365,490 161,346 300,985
Write off of capitalized software....... -- 829,026 --
---------- ----------- -----------
Total operating expenses........... 5,626,500 10,833,920 18,412,728
---------- ----------- -----------
Income from operations...................... 1,980,511 861,039 2,505,673
Interest income (expense), net.............. (8,977) 3,140 403,989
---------- ----------- -----------
Income before provision for income taxes... 1,971,534 864,179 2,909,662
Provision for income taxes.................. 714,947 207,309 964,402
---------- ----------- -----------
Net income.................................. $1,256,587 $ 656,870 $ 1,945,260
========== =========== ===========
Net income per share........................ $ 0.12 $ 0.30
=========== ===========
Weighted average common and common
equivalent shares outstanding............. 5,603,205 6,456,851
=========== ===========
See notes to the consolidated financial statements
F-5
VERSATILITY INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended April 30,
1995 1996 1997
------------ ------------ -------------
Cash flows from operating activities:
Net income......................................... $1,256,587 $ 656,870 $ 1,945,260
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation................................... 199,685 149,846 250,387
Amortization................................... 165,805 11,500 50,598
Loss (gain) on equity investment............... (122) 989 6
Deferred income taxes.......................... 288,719 (208,291) (598,824)
Write-off of capitalized software.............. -- 829,026 --
Changes in assets and liabilities:
Accounts receivable........................ (414,912) (4,284,630) (10,263,591)
Prepaid expenses........................... (8,156) (617,089) (539,820)
Inventory.................................. -- 7,356 (18,880)
Related party receivables.................. 3,143 34,016 (73,381)
Deposits................................... (52,184) (80,304) (29,815)
Accounts payable........................... 170,482 (65,710) 1,282,885
Accrued liabilities........................ 319,481 641,578 623,003
Related party payables..................... 4,460 (82,775) 24,587
Income taxes payable....................... 308,580 (92,264) 305,539
Deferred rent.............................. 20,938 67,893 94,461
Deferred revenue........................... (53,740) 96,594 693,308
---------- ----------- ------------
Net cash (used in) provided by
operating Activities................. 2,208,766 (2,935,395) (6,254,277)
---------- ----------- ------------
Cash flows from investing activities:
Purchase of investments............................ -- -- (7,472,719)
Purchase of property and equipment and assets held
for sale......................................... (155,734) (235,310) (952,036)
Software development costs......................... (743,396) -- --
Purchased software................................. -- (115,000) (304,234)
Related party note receivable...................... -- -- (516,174)
---------- ----------- ------------
Net cash used in investing activities.. (899,130) (350,310) (9,245,163)
---------- ----------- ------------
Cash flows from financing activities:
Borrowings under line of credit.................... -- 800,772 4,369,831
Payments under line of credit...................... -- -- (2,882,284)
Proceeds from sale of preferred stock, net......... -- 3,473,293 --
Proceeds from sale of common stock, net............ -- -- 30,644,979
Principal payments under note payable.............. (65,453) (35,250) --
Principal payments under capital leases............ (22,432) (20,731) (70,026)
---------- ----------- ------------
Net cash provided by (used in)
financing Activities................. (87,885) 4,218,084 32,062,500
---------- ----------- ------------
Effect of exchange rate changes on cash................ -- (66,311) (17,569)
---------- ----------- ------------
Net increase in cash and cash equivalents.............. 1,221,751 866,068 16,545,491
Cash and cash equivalents, beginning of period......... 192,454 1,414,205 2,280,273
---------- ----------- ------------
Cash and cash equivalents, end of period............... $1,414,205 $ 2,280,273 $18,825,764
========== =========== ============
Supplemental disclosures of cash flow information:
Interest paid...................................... $ 18,691 $ 27,732 $ 160,061
========== =========== ============
Income taxes paid.................................. $ 114,309 $ 506,490 $ 1,262,161
========== =========== ============
See notes to the consolidated financial statements
F-6
VERSATILITY INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Number of Foreign
Shares of Additional Currency
Common Common Paid-in Translation Retained
Stock Stock Capital Adjustments Earnings Total
--------- -------- ------------- ----------- ------------ -------------
Balance, May 1, 1994........................ 4,000,000 $40,000 $ -- $ -- $ 34,676 $ 74,676
Net income............................... 1,256,587 1,256,587
--------- ------- ------------- ----------- ----------- -----------
Balance, April 30, 1995..................... 4,000,000 40,000 -- -- 1,291,263 1,331,263
Foreign currency translation
adjustments ........................... (66,311) (66,311)
Accretion of dividends on redeemable
preferred stock........................ (88,000) (88,000)
Net income............................... 656,870 656,870
--------- ------- ------------- ----------- ----------- -----------
Balance, April 30, 1996..................... 4,000,000 40,000 -- (66,311) 1,860,133 1,833,822
Conversion of redeemable preferred
stock.................................. 992,061 9,921 3,727,372 3,737,293
Issuance of common stock related to
public offering....................... 2,275,364 22,754 30,598,273 30,621,027
Issuance of common stock related to
Exercise of stock options.............. 29,940 299 23,653 23,952
Foreign currency translation
adjustments............................ (17,569) (17,569)
Accretion of dividends on redeemable
Preferred stock........................ (176,000) (176,000)
Net income............................... 1,945,260 1,945,260
--------- ------- ------------- ----------- ---------- -----------
Balance, April 30, 1997..................... 7,297,365 $72,974 $ 34,349,298 $ (83,880) $3,629,393 $37,967,785
========= ======= ============= =========== ========== ===========
See notes to the consolidated financial statements
F-7
VERSATILITY INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Years Ended April 30, 1995, 1996 and 1997
Versatility Inc. (the "Company") was incorporated as National Political
Resources, Inc, in the District of Columbia in 1981 and merged into NPRI, Inc.,
a Virginia corporation, in July 1991. In January 1996, NPRI, Inc. reincorporated
in Delaware. The Company changed its name to Versatility Inc. in June 1996.
The Company is a provider of client/server customer interaction software
that enables businesses to automate and enhance their telemarketing and
teleselling capabilities. The Company's products include software applications,
development and customization tools and optional software services. The Company
also offers fee-based professional, consulting and maintenance services.
In December 1996, Versatility Inc. (the "Company"), completed an initial
public offering of 2.2 million shares of common stock at $15.00 per share. In
addition, in January 1997, the underwriters in such public offering exercised
their option to purchase additional 189,000 shares of common stock at $15.00 per
share. Of the additional shares purchased, the Company issued 75,364 shares and
certain selling stockholders of the Company sold 113,636 shares. Simultaneous
with the closing of the initial public offering, all outstanding shares of
preferred stock were converted to common stock on a one-for-one basis.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Accounting Principles -- The financial statements are prepared on a basis
consistent with U.S. generally accepted accounting principles.
Principles of Consolidation -- The financial statements include the results
of Versatility Inc., and its wholly owned subsidiaries, NPRI Technologies, Ltd.
and Versatility (UK) Limited. All significant intercompany accounts and
transactions have been eliminated in consolidation. On April 30, 1996, NPRI
Technologies, Ltd. was dissolved, and its operations were merged with
Versatility Inc. The Company accounted for its investment in Serenity Real
Property Limited Partnership using the equity method (See Note 3).
Cash and Cash Equivalents -- For purposes of the Statements of Cash Flows,
the Company considers all highly liquid investments with an original maturity of
three months or less to be cash equivalents. The Company's investments consist
of money market accounts, commercial paper and corporate bonds.
Estimates and Assumptions -- 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 at the date of the financial statements and the reported amounts of
revenue and expenses during the reported period. Actual results could differ
from those estimates.
Investments -- The Company accounts for investments in accordance with
Statement of Financial Accounting Standard No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" (SFAS 115). Under SFAS 115, the
investments are reported at amortized cost and are classified as
held-to-maturity since the Company has the positive intent and ability to hold
the securities to maturity. At April 30, 1997, the Company's investments
consisted primarily of treasury notes, municipal bonds and corporate bonds.
Remaining maturities at the time of purchase are generally less than one year.
Fair value, which is based on quoted market prices, approximates carrying value.
At April 30, 1996, the Company had no investments.
F-8
As of April 30, 1997, the Company's investments consisted of the following:
Maturity of Securities
Amortized Within One One to Five Five to Ten
Cost Basis Year Years Years
---------- ---------- ----------- -----------
Treasury notes........ $ 803,044 $ 803,044 $ -- $ --
Municipal bonds....... 1,737,175 303,711 1,160,809 272,655
Corporate bonds....... 4,932,500 4,932,500 -- --
---------- ---------- ---------- --------
$7,472,719 $6,039,255 $1,160,809 $272,655
========== ========== ========== ========
Inventory -- Inventory consists of miscellaneous marketing collateral and is
stated at the lower of cost or market, on a first-in, first-out basis.
Capitalized Software -- During the course of the development of the
Versatility Series software, the Company capitalized its development costs in
compliance with Statement of Financial Accounting Standards No. 86 "Accounting
for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed."
The amount of software capitalized totaled $995,000 and, beginning in November
1994, was amortized over three years on a straight-line basis. In connection
with two major implementations of the Versatility Series product in July 1995,
the Company decided to add features and functions to the product that were
substantially different than those included in the software as originally
capitalized. Management determined that these features and functions
substantially altered the content of the product, effectively eliminating any
remaining useful life of the capitalized asset. Accordingly, the Company wrote
off the remaining asset of $829,000 in the first quarter of fiscal 1996.
Purchased Software -- Purchased software is amortized on a straight-line
basis over the shorter of five years or the useful life of the asset.
Property and Equipment -- Property and equipment are stated at cost.
Depreciation on property and equipment, including amortization on capital
leases, is computed on a straight-line basis over the estimated useful lives of
the assets, ranging from three to ten years. The leasehold improvements are
depreciated over the shorter of the useful life of the assets or the term of the
related lease. Repairs and maintenance are charged to operations as incurred.
Major improvements and betterments are capitalized.
Deferred Rent -- Deferred rent represents the effects of certain rent
concessions that are amortized over the life of the lease on a straight-line
basis.
Recapitalization -- In conjunction with the issuance of the Series A
redeemable convertible preferred stock (the "Series A Preferred Stock") (See
Note 7), the Company declared, on January 24, 1996, a 4,000 for 1 stock split on
its common stock, and changed the par value from $1.00 to $.01. The shares
outstanding have been restated to give effect to the stock split.
Redeemable Preferred Stock -- The Company accreted the increase in the
redemption value of its Series A Preferred Stock through a charge to retained
earnings through December 13, 1996 when the Series A Preferred Stock was
converted to common stock (See Note 7).
Currency Translation -- Assets and liabilities of the Company's foreign
operations are translated into U.S. dollars at the exchange rate in effect at
the balance sheet date and revenues and expenses are translated at average rates
in effect during the period. The unrealized currency translation adjustment is
reflected as a separate component of stockholders' equity on the balance sheet.
Revenue Recognition -- The Company's revenue is derived principally from two
sources: (i) product license fees for the use of the Company's software products
and (ii) service fees for implementation, maintenance, consulting and training
related to the Company's software products. The Company's contracts with its
customers often involve significant customization and installation obligations.
In these situations, license revenue is recognized based on the percentage of
completion method, which is based on achievement of certain milestones. When the
Company is under no obligation to install or customize the software, license
revenue is recognized upon shipment. Service revenue for implementation,
consulting services and training is generally recognized as the services are
performed. Revenue from maintenance services is recognized ratably over the term
of the service agreement.
F-9
Revenue from hardware sales relating to the implementation of the Company's
VAX/VMS application is included in license revenue. These hardware sales were
$1.4 million for the year ended April 30, 1995. Hardware sales for the years
ended April 30, 1996 and 1997 were insignificant.
Income Taxes -- The Company accounts for income taxes under the provisions
of Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes" (SFAS 109). SFAS 109 requires, among other things, using the liability
method of computing deferred income taxes.
Net Income Per Share -- Net income per share is computed using the weighted
average number of common and common equivalent shares outstanding during the
period. Common equivalent shares consist of redeemable convertible preferred
stock (using the as if converted method) and stock options (using the treasury
stock method). Common equivalent shares are excluded from the computation if
their effect is antidilutive except that pursuant to the Securities and Exchange
Commission Staff Accounting Bulletins and staff policy, such computations
include all common and common equivalent shares issued within the 12 months
preceding the filing date of the initial public offering as if they were
outstanding for all periods presented (using the treasury stock method).
Historical earnings per share prior to fiscal 1996 have not been presented since
such amounts are not deemed meaningful due to the significant change in the
Company's capital structure that occurred in connection with the public
offering.
In February 1997, Statement of Financial Accounting Standards No. 128,
"Earnings Per Share" (SFAS 128) was issued and will become effective during the
Company's fiscal year ending April 30, 1998. The Company expects that the
implementation of SFAS 128 should not have a material effect on the earnings per
share calculation.
Non-cash Transactions-- The Company acquired $47,544 and $437,384 of
equipment through capital leases during fiscal 1996 and 1997, respectively.
Concentration of Credit Risk -- Financial instruments which potentially
subject the Company to a concentration of credit risk principally consist of
accounts receivable. In fiscal 1996, two customers accounted for 25.7% and 22.2%
of the Company's total revenue, respectively, and in fiscal 1997, one customer
accounted for 23.6% of the Company's total revenue. As of April 30, 1997, 39.7%
of accounts receivable was concentrated with three customers. The Company
generally does not require collateral on accounts receivable as the majority of
the Company's customers are large, well established companies. The Company
provides reserves for credit losses and such losses have been insignificant.
Stock Based Compensation -- The Company grants stock options for a fixed
number of shares to employees with an exercise price not less than the estimated
fair value of the shares as determined by the Board of Directors (prior to the
initial public offering) or the market price of the stock at the date of grant.
The Company accounts for stock option grants in accordance with APB Opinion No.
25, "Accounting for Stock Issued to Employees". In October 1995, Statement of
Financial Accounting Standard No. 123, "Accounting for Stock-Based Compensation"
(SFAS 123) was issued, which is effective for fiscal years beginning after
December 15, 1995. As permitted by SFAS 123, the Company accounts for
stock-based compensation in accordance with APB Opinion No. 25 and, accordingly,
recognizes compensation expense for stock option grants only when the exercise
price is less than the fair value of the shares at the date of grant. Pro forma
net income and pro forma earnings per share disclosures are provided for
employee stock option grants made in fiscal 1997 as if the fair-value-based
method defined in SFAS 123 had been applied (see Note 9).
Reclassifications -- Certain amounts previously reported have been
reclassified to conform with current year presentation.
Recent Pronouncements -- In June 1997, Statement of Financial Accounting
Standard No. 130, "Reporting Comprehensive Income" and Statement of Financial
Accounting Standard No. 131, "Disclosures about Segments of an Enterprise and
Related Information" were issued, which are effective for fiscal years beginning
after December 15, 1997. The Company will comply with all requirements no later
than fiscal 1999.
2. BUSINESS ACQUISITION
Versatility (UK) Limited was acquired by the Company during December 1995.
The stockholders of the Company were the same stockholders of Versatility (UK)
Limited, with proportionate ownership in both companies being the same. The
acquisition was completed by exchanging 2,000,000 shares of common stock of the
Company for all of the outstanding capital stock of
F-10
Versatility (UK) Limited. The shares of Versatility (UK) Limited were
subsequently retired. The business combination has been treated as an exchange
between companies under common control, which is accounted for in a manner
similar to a pooling of interests. Accordingly, the consolidated financial
statements for all periods prior to the combination have been restated to
reflect the combined operations. Intercompany transactions have been eliminated.
The following is a reconciliation of revenue and earnings previously
reported by the Company for the year ended April 30, 1995 with the combined
amounts currently presented in the financial statements for that year:
Versatility Intercompany Consolidated
Company (UK) Limited Royalties Amounts
------- ------------ --------- -------
Net sales................... $10,516,837 $1,801,964 ($833,650) $11,485,151
Income from operations...... 951,896 1,028,615 -- 1,980,511
Included in consolidated results of operations for the year ended April 30,
1996 are the following results of the previously separate companies for the
period of May 1, 1995 to December 31, 1995:
Versatility Intercompany Consolidated
Company (UK) Limited Royalties Amounts
------- ------------ --------- -------
Net sales................. $6,688,983 $2,530,343 ($571,361) $8,647,965
Income from operations.... 191,137 344,775 -- 535,912
3. RELATED PARTY TRANSACTIONS
Related Party Receivables -- The Company has the following non-current
receivables from related parties or affiliated entities at April 30, 1996 and
1997 as follows:
April 30,
----------------------
1996 1997
--------- ---------
Stockholder loan.................... $102,765 $117,755
Other............................... 14,456 35,626
--------- ---------
$117,221 $153,381
The stockholder loan accrues interest at the prime rate. The loans and any
interest accrued thereunder is payable on the earliest of (i) demand and (ii)
November 6, 1997. Included in the stockholder loan for fiscal 1996 and 1997 is
$37,221 and $4,740, respectively, of accrued interest.
The Company leased office space from Serenity Real Properties Limited
Partnership (the "Partnership"). The limited partners are stockholders in the
Company and the Company was the general partner.
Rent expense paid to the Partnership for fiscal 1995, 1996 and 1997 was
$120,000, $120,000 and $50,000, respectively.
Sale of Partnership Interest and Termination of Lease
Prior to October 31, 1996, the Company was the 1% general partner of the
Partnership of which Mr. Ronald R. Charnock, the Company's President and Chief
Executive Officer, Mr. Marcus W. Heth, the Company's Senior Vice President,
Technologies, and Mr. Keith P. Roberts, the Company's Director of Product
Development, were the limited partners holding the remaining 99% of the
partnership interests (the "Limited Partners"). The Partnership is the owner of
an office building in Alexandria, Virginia (the "Property"), which was the
Company's headquarters until October 1994 and which was leased by the Company
under a lease expiring in April 1997 and providing for monthly rental payments
of $10,000. In addition, the Company had guaranteed a mortgage loan made by a
commercial bank to the Partnership, which had an outstanding balance of $614,000
at September 30, 1996. This loan was also guaranteed by each of the Limited
Partners and was collateralized by a mortgage on the Property.
On October 31, 1996, the Company sold its general partnership interest in
the Partnership, for consideration equal to its capital account of $3,131, to
Serenity L.L.C., whose members are the Limited Partners. In connection with the
sale of its general partnership interest in the Partnership, the Company made to
the Partnership a loan of $519,305 evidenced by a Deed of Trust Note
F-11
which bears interest at the same rate and is payable upon the earliest of (i)
the sale of the Property, (ii) demand by the Company and (iii) October 31, 1997.
The Deed of Trust Note is collateralized by a mortgage on the Property and is
guaranteed by each of the Limited Partners. The Partnership used the proceeds of
this loan to repay its loan from the bank and discharge its mortgage on the
Property. In connection with these transactions, the Partnership agreed to the
termination of its lease with the Company.
4. ACCRUED LIABILITIES
Accrued liabilities consisted of the following as of April 30, 1996 and
1997:
April 30,
------------------------
1996 1997
---------- ----------
Accrued commissions and salaries............... $ 335,395 $ 511,676
Accrued bonuses................................ 461,586 362,467
Accrued payroll taxes and withholdings......... 341,397 195,001
Accrued vacation............................... 203,219 289,034
Sales tax payable (credit)..................... (44,529) 334,410
Other.......................................... 96,585 324,068
---------- ----------
$1,393,653 $2,016,656
========== ==========
5. LINE OF CREDIT
On August 28, 1996, the Company obtained a new $2.5 million operating line
of credit from a bank for financing accounts receivable and working capital and
a new $1.0 million equipment line of credit from the same bank to finance
acquisition of property and equipment. These lines of credit expire on August 5,
1997 and are secured by all of the Company's assets. The operating and equipment
lines of credit bear interest at the prime rate plus 0.5% and 1.0%,
respectively. The weighted average interest rate for fiscal 1996 and 1997 was
9.1% and 9.0%, respectively. The lines of credit are collateralized with a first
priority security interest in all assets. The lines of credit have various
covenants, including limitations on disposition of assets. The Company also must
maintain certain financial ratios and is prohibited from paying cash dividends.
The Company is in compliance with all debt covenants. The amount outstanding
under the operating line plus accrued interest at April 30, 1997 was $2.3
million. The amount borrowed under the equipment line was $437,384 at April 30,
1997 and is included with the capital lease payable.
6. COMMITMENTS AND CONTINGENCIES
Operating Leases --The Company leases office space, equipment and
automobiles under noncancelable operating leases expiring through 2004. The
leases for office space have abatements that range from two to six months and
scheduled annual rent escalations of approximately 3%. None of the equipment or
automobile agreements contain unusual renewal or purchase options. Total rent
expense for the years ended April 30, 1995, 1996 and 1997 was $514,963, $876,093
and $1.4 million, respectively.
As of April 30, 1996, future minimum lease payments for the operating leases
are as follows:
Years Ending April 30,
----------------------
1998.......................................... $ 1,373,342
1999.......................................... 1,314,992
2000.......................................... 1,210,442
2001.......................................... 1,014,924
2002.......................................... 761,819
Thereafter.................................... 2,015,145
-----------
Total......................................... $ 7,690,664
===========
F-12
Capital Leases -- The Company is obligated under capital leases for various
office equipment. As of April 30, 1997, future minimum lease payments for the
capital leases are as follows:
Years Ending April 30,
----------------------
1998................................................ $224,251
1999................................................ 179,916
2000................................................ 122,747
2001................................................ 7,920
--------
Total............................................... 534,834
Less: Imputed interest at 10%....................... (66,645)
--------
Present value of future minimum lease payments...... $468,189
========
Legal Proceedings -- One of the Company's former VARs has filed a claim for
arbitration (non-binding) against the Company asserting, among other things,
that the Company misrepresented the functionality of its products and wrongfully
terminated the VAR's reseller agreement, and claiming not less than $1.0 million
in damages. The Company defended this action in arbitration proceedings that
ended in April 1997. Upon conclusion, the arbitration panel awarded $267,000 in
net damages to the plaintiff in the proceedings. The Company has challenged the
findings of the arbitration panel on the grounds that the arbitrator appointed
by the plaintiff was also a witness to the actions of the plaintiff and the
Company, which led to the action. The Company has filed a motion to have the
findings vacated. The Company intends to vigorously pursue this and all other
avenues available through which the findings of the arbitration panel might be
vacated. Because all these avenues are in a preliminary stage, the Company
cannot predict the outcome of such actions. While neither the Company nor its
legal counsel can offer any assurances that the findings of the arbitration
panel might be overturned, management currently believes that the resolution of
this matter will not have a material adverse impact on its financial position
and therefore has not recorded a loss accrual. However, if the motion to
overturn the decision is denied, the outcome could materially affect
consolidated results of operations in a given year or quarter.
7. REDEEMABLE CONVERTIBLE PREFERRED STOCK
On January 24, 1996, the Company issued 992,061 shares of the Company's
Series A Preferred Stock. Shares of Series A Preferred Stock have the same
voting rights as common stock. On December 13, 1996 each share of Series A
Preferred Stock converted into one share of common stock as part of the public
offering. Subsequent to the public offering, the Second Amended and Restated
Certificate of Incorporation was filed, which deleted all references to the
formerly designated Series A Preferred Stock. In addition, 2,000,000 shares of
preferred stock were authorized. The Board of Directors has the authority to
issue the preferred stock in one or more series and to fix the rights,
preferences, privileges and restrictions thereof.
8. STOCKHOLDERS' EQUITY
As of April 30, 1995, the Company had 5,000 shares of common stock
authorized, 1,000 shares issued and outstanding, and no preferred stock
authorized, issued or outstanding. In January 1996, a recapitalization of the
Company was effected. A new corporation was formed, whereby 4,000 shares of
Versatility Inc. common stock were issued for every one share previously
outstanding. The total authorized shares of common stock were increased to
20,000,000 and 992,061 shares of Series A Preferred Stock were authorized.
Subsequently, the Series A Preferred Stock was canceled and 2,000,000 shares of
preferred stock was authorized (see Note 7).
9. BENEFIT PLANS
401(k) Plan. The Company has a savings and investment plan (the "Plan")
which covers employees of the Company and that qualifies under section 401(k) of
the Internal Revenue Code. All full-time employees who are at least 21 years old
and have completed at least six months of service are eligible to participate.
Under the terms of the Plan, employees may defer a portion of their salaries as
employee contributions. A discretionary corporate contribution is determined
annually. The Company made a contribution of $44,191 in fiscal 1997. No
contributions were made in fiscal 1995 and 1996. Employee contributions are
vested immediately; however, discretionary company contributions are 100% vested
upon three years of service. The Company is not obligated under any other post
retirement benefit plans.
Stock Option Plans. The 1996 Stock Option Plan (the "1996 Plan") provides
for the granting of incentive and nonqualified stock options to purchase up to
750,000 shares of common stock. The option price must be equal to or greater
than the fair market value at the date of grant. Options are granted for terms
of up to ten years and most are exercisable in cumulative annual
F-13
increments of 20% each year, with the first 20% becoming exercisable upon the
date of grant. The 1996 Plan superceded the 1995 Employee Plan (the "Employee
Plan") and the 1995 Incentive Plan (the "Incentive Plan") (collectively, the
"1995 Plans"), and on September 30, 1996 the Board of Directors determined that
no further options would be granted under the 1995 Plans.
Information regarding the Company's stock option plans is summarized below:
1995 Plans 1996 Plan
---------- ---------
Employee Plan Incentive Plan
------------- --------------
Weighted Weighted Weighted
Average Average Average
Number Exercise Number Exercise Number Exercise
Outstanding Price Outstanding Price Outstanding Price
----------- ----- ----------- ----- ----------- -----
May 1, 1995 options outstanding....... -- $ -- -- $ -- -- $ --
Granted............................. 228,758 0.80 62,569 0.80 -- --
Exercised........................... -- -- -- -- -- --
Cancelled........................... -- -- -- -- -- --
------- --------- -------- -------- ------- -------
April 30, 1996 options outstanding.... 228,758 0.80 62,569 0.80 -- --
Granted............................. -- -- -- -- 139,000 10.50
Exercised........................... (29,194) 0.80 (746) 0.80 -- --
Cancelled........................... -- -- -- -- -- --
------- ---------- -------- -------- ------- -------
April 30, 1997 options outstanding.... 199,564 $ 0.80 61,823 $ 0.80 139,000 $ 10.50
======= ========= ======== ======== ======= =======
Exercisable as of April 30, 1996...... 228,758 $ 0.80 12,514 $ 0.80 -- $ --
======= ========= ======== ======== ======= =======
Exercisable as of April 30, 1997...... 199,564 $ 0.80 24,282 $ 0.80 32,300 $ 10.50
======= ========= ======== ======== ======= =======
Available for future grant............ -- -- 611,000
======= ======== =======
Options to purchase 320,000 shares of Common Stock were granted to an
officer on January 17, 1996. These options are not part of the above plans.
These stock options vested immediately with an exercise price of $.80 per share,
which was determined by the Board of Directors of the Company to be the fair
market value. None of these options were exercised or cancelled.
1996 Employee Stock Purchase Plan. On September 30, 1996, the Board of
Directors adopted the 1996 Employee Stock Purchase Plan (the "1996 Purchase
Plan"). The 1996 Purchase Plan took effect on May 1, 1997 and provides for the
issuance of a maximum of 100,000 shares of common stock. The 1996 Purchase Plan
will enable eligible employees to purchase common stock at 85% of the lower of
the fair market value of the Company's common stock on the first day or the last
day of each six-month purchase period. No shares have been purchased under the
1996 Purchase Plan as of April 30, 1997.
The Company has computed the pro forma disclosures required under SFAS 123
for all stock options granted as of April 30, 1997 using the Black-Scholes
option pricing model prescribed by SFAS 123. The weighted average fair value at
date of grant for options granted during fiscal 1996 and 1997 was $0.45 and
$5.96, respectively.
The assumptions used and the weighted average information for the years
ended April 30, 1996 and 1997 are as follows:
1996 1997
---- ----
Risk-free interest rates........................ 6.0% 6.0%
Expected dividend yield......................... 0.0% 0.0%
Expected lives.................................. 3.5 years 3.5 years
Expected volatility............................. 75.0% 75.0%
F-14
Stock options outstanding and exercisable at April 30, 1997 follows:
Options Outstanding Options Exercisable
------------------- -------------------
Weighted Average
----------------
Remaining Weighted
Exercise Contractual Average
Price Number Life in Exercise Number Exercise
Range Outstanding Years Price Exercisable Price
- ----- ----------- ----- ----- ----------- -----
$ 0.80 582,133 3.78 $ 0.80 543,846 $ 0.80
$10.50 139,000 9.58 10.50 32,300 10.50
The effect of applying SFAS 123 would be as follows:
1996 1997
---- ----
Pro forma net income............................ $459,933 $1,672,750
Pro forma net income per share.................. $ 0.80 $ 0.26
10. INCOME TAXES
The provision for income taxes is computed based on pretax accounting
income. Deferred income taxes include the tax effects of temporary differences
between pretax accounting income and tax income. A deferred income tax liability
has been recorded to reflect the temporary differences between the financial
statements and the tax returns.
The provision for income taxes at April 30, 1995, 1996 and 1997 consist of
the following:
1995 1996 1997
--------- ---------- -----------
Current provision:
Federal.................................... $ 335,267 $ 284,641 $1,019,313
Foreign.................................... 51,518 78,520 14,971
State...................................... 39,443 51,229 230,434
--------- --------- -----------
Total current provision............... 426,228 414,390 1,264,718
--------- --------- -----------
Deferred provision:
Federal.................................... 258,328 (175,496) (241,705)
Foreign.................................... -- -- --
State...................................... 30,391 (31,585) (58,611)
--------- --------- -----------
Total deferred provision (benefit).... 288,719 (207,081) (300,316)
--------- --------- -----------
Total provision for income taxes................ $ 714,947 $ 207,309 $ 964,402
========= ========= ===========
The approximate tax effects of each type of temporary difference that gave
rise to the Company's deferred tax assets and liabilities are as follows:
1995 1996 1997
---- ---- ----
Deferred tax assets:
Vacation expense...................... $ 19,125 $ 70,309 $ 84,560
Accrued bonus expenses................ 78,703 -- --
Bad debt reserve...................... 26,735 59,929 146,046
Rent expense.......................... -- 84,233 129,712
Deferred revenue...................... -- -- 204,356
Other................................. 2,202 -- 123
---------- --------- ---------
Total deferred tax assets............. 126,765 214,471 564,797
Valuation allowance................... (126,765) -- --
---------- --------- ---------
Net deferred tax assets............... $ -- $ 214,471 $ 564,797
========== ========= =========
Deferred tax liabilities:
Software costs........................ $ 315,030 $ -- $ --
Accelerated depreciation and other.... 12,424 333,634 85,136
---------- --------- ---------
Total deferred tax liabilities........ $ 327,454 $ 333,634 $ 85,136
========== ========= =========
F-15
The provision for income taxes differs from the amount computed by applying the
statutory U.S. Federal income tax rate to income before taxes as a result of the
following:
1995 1996 1997
-------- -------- --------
U.S. Federal statutory rate............................. 34.0% 34.0% 34.0%
State income taxes, net of Federal income tax benefit... 4.0 4.0 4.6
Impact of foreign earnings and taxes.................... (1.0) (1.7) --
General business credits................................ (3.1) -- --
Benefit from foreign sales corporation.................. -- (13.4) (5.0)
Other................................................... 2.4 1.0 (0.5)
------- ------- ------
Effective tax rate...................................... 36.3% 23.9% 33.1%
======= ======= ======
11. BUSINESS SEGMENT AND GEOGRAPHIC AREA INFORMATION
Geographic Area Information -- The Company operates in one industry segment,
the development and marketing of computer software programs and related
services. The Company markets its products worldwide and operations can be
grouped into two main geographic areas. Pertinent financial data by major
geographic area is summarized below.
Eliminations
and Other
United United Corporate
States Kingdom Expenses Consolidated
------ ------- -------- ------------
Years ending April 30, 1995:
Revenue................... $ 10,516,837 $1,801,964 $ (833,650) $11,485,151
Income from operations.... 2,969,058 1,028,615 (2,017,162) 1,980,511
Identifiable assets....... 3,834,339 453,273 -- 4,287,612
1996:
Revenue................... $ 14,241,435 $2,991,493 $ (697,656) $16,535,272
Income from operations.... 5,250,464 1,060,603 (5,450,028) 861,039
Identifiable assets....... 9,518,498 112,564 -- 9,631,062
1997:
Revenue................... $23,776,666 $3,831,683 $ (256,454) $27,351,895
Income from operations.... 8,610,693 270,548 (6,375,568) 2,505,673
Identifiable assets....... 45,278,885 1,554,134 -- 46,833,019
The Company charges a royalty to Versatility (UK) Limited for software sales
of the Company's products sold by Versatility (UK) Limited. The royalty is
intended to cover primarily software development expense and marketing expense.
Versatility (UK) Limited reflects the royalty as a cost of revenue. For fiscal
1995, 1996 and 1997 the royalty was $833,650, $697,656 and $256,454,
respectively. These amounts were eliminated in consolidation and are not
reflected in the revenue and income from operations amounts above.
Included in United States revenue is $68,654, $3.8 million and $7.4 million
of export revenue for fiscal 1995, 1996 and 1997, respectively. For fiscal 1996
and 1997, $2.1 million and $4.4 million of United States export sales were
generated in the United Kingdom, with the remaining sales in both fiscal 1995,
1996 and 1997 generated in Canada and Mexico. Included in United Kingdom revenue
is $617,544, $527,681 and $1.3 million of export revenue for fiscal 1995, 1996
and 1997, respectively, which was mainly generated in Western Europe, exclusive
of the United Kingdom.
Significant customers -- The Company had the following customers with
revenue in excess of 10%:
1995 1996 1997
-------- -------- --------
Customer A........ -- 25.7% 23.6%
Customer B........ -- 22.2% --
Customer C........ 17.7% -- --
F-16
12. INTEREST INCOME (EXPENSE), NET
Interest income (expense), net includes interest income of $9,369, $66,643
and $544,096 in fiscal 1995, 1996 and 1997, respectively, and interest expense
of $18,346, $63,503, and $140,107 in fiscal 1995, 1996 and 1997, respectively.
F-17
Versatility Inc.
Schedule II-Valuation and Qualifying Accounts and Reserves
Additions
---------------------------
Charged to Charged to
Balance at Costs and Other Balance at
Description May 1, Expenses Accounts Deductions April 30
----------- ------ -------- -------- ---------- --------
Fiscal 1995
-----------
Allowance for doubtful accounts $ 70,354 $102,241 $102,241 $ 70,354
Fiscal 1996
-----------
Allowance for doubtful accounts 70,354 122,424 34,904 157,874
Fiscal 1997
-----------
Allowance for doubtful accounts 157,874 443,740 245,419 356,195
S-1
Index to Exhibits
Exhibit
Number Description of Document
- ------ -----------------------
3.1 Amended and Restated Certificate of Incorporation of the Company, as amended (1)
3.2 Form of Second Amended and Restated Certificate of Incorporation of the Company (1)
3.3 Amended and Restated By-laws of the Company (1)
4.1 Specimen Certificate representing the Common Stock (1)
4.2 Registration Rights Agreement between the Company and certain securityholders, dated as of
January 24, 1996 (1)
10.1 1995 Employee Stock Option Plan (1)
10.2 1995 Incentive Stock Option Plan (1)
10.3 1996 Employee Stock Purchase Plan (1)
10.4 1996 Stock Option Plan (1)
10.5 Lease Agreement between the State of California Public Employees' Retirement System and the
Company dated July 10, 1994, as amended (1)
10.6 Loan and Security Agreement between the Company and Silicon Valley Bank dated as of August 28,
1996 (1)
10.7 Deed of Trust Note dated as of October 31, 1996 issued by Serenity Real Properties Limited
Partnership to the Company (1)
10.8 * Lease Agreement between the Commonwealth Atlantic Land II Inc. and the Company dated June 5,
1997
11.1 * Computation of Earnings Per Share
21.1 * Subsidiaries
23.1 * Consent of Deloitte & Touche LLP
27.1 * Financial Data Schedule
* Filed herewith.
(1) Incorporated by reference to the Company's Registration Statement on
Form S-1 (File No. 333-13771), as amended.