UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended July 31, 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)
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 [ ]
As of August 31, 1997 there were 7,381,177 shares of common stock outstanding,
par value $.01 per share.
VERSATILITY INC.
FORM 10-Q
TABLE OF CONTENTS
Page No.
PART I: FINANCIAL INFORMATION
Item 1: Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of April 30, 1997 and July 31, 1997 3
Condensed Consolidated Statements of Operations for the Three Months Ended July
31, 1996 and 1997 5
Condensed Consolidated Statements of Cash Flows for the Three Months Ended
July 31, 1996 and 1997 6
Condensed Consolidated Statements of Changes in Stockholders' Equity for the
Three Months Ended July 31, 1997 7
Notes to Condensed Consolidated Financial Statements 8
Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations 9
PART II: OTHER INFORMATION
Item 1: Legal Proceedings 17
Item 2: Changes in Securities 17
Item 3: Defaults upon Senior Securities 17
Item 4: Submission of Matters to a Vote of Security Holders 17
Item 5: Other Information 17
Item 6: Exhibits and Reports on Form 8-K 17
Signatures 18
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Part I: Financial Information
Item 1: Financial Statements
VERSATILITY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
APRIL 30, JULY 31,
1997 1997
---- ----
ASSETS
Current assets:
Cash and cash equivalents........................ $18,825,764 $14,742,713
Short-term investments........................... 6,039,255 5,987,436
Accounts receivable, net of allowance for
doubtful accounts of $356,195 and $381,195..... 15,971,315 15,434,610
Prepaid expenses................................. 1,181,865 1,267,354
Inventory........................................ 18,880 47,146
Notes receivable-trade........................... -- 2,207,212
Note receivable-related party.................... 519,305 519,305
Related party receivables........................ 153,381 164,354
Deferred income taxes............................ 230,729 230,729
----------- -----------
Total current assets........................ 42,940,494 40,600,859
----------- -----------
Other assets:
Deposits......................................... 187,650 227,429
Investments...................................... 1,433,464 1,437,021
Notes receivable-trade........................... -- 200,000
Deferred income taxes............................ 248,932 237,585
Assets held for sale............................. 648,314 1,573,554
Purchased software, net of accumulated
amortization of $62,098 and $83,059........... 357,136 336,175
----------- -----------
Total other assets.......................... 2,875,496 4,011,764
----------- -----------
Property and equipment
Computers........................................ 1,168,246 1,315,980
Office furniture and equipment................... 665,597 701,649
Leasehold improvements........................... 206,402 211,292
Capital leases................................... 652,533 652,533
----------- -----------
2,692,778 2,881,454
Less: Accumulated depreciation and
amortization.................................. (1,675,749) (1,767,346)
----------- -----------
Net property and equipment.................. 1,017,029 1,114,108
----------- -----------
Total assets.......................................... $46,833,019 $45,726,731
=========== ===========
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VERSATILITY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
APRIL 30, JULY 31,
1997 1997
---- ----
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................. $ 2,107,630 $ 1,777,981
Accrued liabilities.............................. 2,016,656 1,770,166
Related party payables........................... 28,030 19,440
Income taxes payable............................. 662,042 386,717
Capital lease payable............................ 181,069 174,400
Line of credit................................... 2,288,319 2,521,136
Deferred revenue................................. 978,008 399,617
------------ ------------
Total current liabilities................... 8,261,754 7,049,457
------------ ------------
Other liabilities:
Capital lease payable, less current
maturities..................................... 287,120 239,300
Deferred rent.................................... 316,360 331,565
Deferred income taxes............................ -- --
------------ ------------
Total other liabilities..................... 603,480 570,865
------------ ------------
Commitments and Contingencies
Stockholders' equity:
Preferred stock, $.01 par value,
2,000,000 shares authorized, no shares
issued or outstanding......................... -- --
Common stock, par value $.01-- 20,000,000
shares authorized, 7,297,365 shares issued and
outstanding at April 30, 1997; 7,381,177
shares issued and outstanding at July 31, 1997 72,974 73,812
Additional paid-in capital....................... 34,349,298 34,462,891
Foreign currency translation adjustments......... (83,880) (106,128)
Retained earnings................................ 3,629,393 3,675,834
------------ ------------
Total stockholders' equity.................. 37,967,785 38,106,409
------------ ------------
Total liabilities and stockholders' equity............ $ 46,833,019 $ 45,726,731
============ ============
1-4
VERSATILITY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED
JULY 31,
1996 1997
---- ----
Revenue:
License revenue................................... $3,788,164 $5,126,245
Service and maintenance revenue................... 1,631,868 3,884,918
--------- ---------
Total revenue................................ 5,420,032 9,011,163
--------- ---------
Cost of revenue:
License revenue................................... 205,224 171,851
Service and maintenance revenue................... 1,231,682 2,610,065
--------- ---------
Total cost of revenue........................ 1,436,906 2,781,916
--------- ---------
Gross margin.......................................... 3,983,126 6,229,247
--------- ---------
Operating expenses:
Selling, general and administrative............... 3,036,786 4,717,673
Research and development.......................... 618,566 981,276
Litigation settlement and related costs........... -- 600,000
Depreciation and amortization..................... 49,816 108,560
--------- ---------
Total operating expenses..................... 3,705,168 6,407,509
--------- ---------
Income from operations................................ 277,958 (178,262)
Interest income (expense), net........................ (5,612) 248,703
--------- ---------
Income before provision for income taxes............. 272,346 70,441
Provision for income taxes............................ 70,000 24,000
--------- ---------
Net income............................................ $ 202,346 $ 46,441
========= =========
Net income per share.................................. $ 0.04 $ 0.01
========= =========
Weighted average common and common
equivalent shares outstanding....................... 5,603,205 7,993,606
========= =========
1-5
VERSATILITY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED
JULY 31,
1996 1997
---- ----
Cash flows from operating activities:
Net income......................................... $ 202,346 $ 46,441
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation................................... 44,066 87,599
Amortization................................... 5,750 20,961
Gain on equity investment...................... (28) --
Deferred income taxes.......................... -- 11,347
Changes in assets and liabilities:
Accounts receivable........................ 641,940 536,705
Prepaid expenses........................... (9,260) (85,489)
Inventory.................................. (1,674) (28,266)
Related party receivables.................. (11,759) --
Deposits................................... 768 (39,779)
Accounts payable........................... (509,652) (329,649)
Accrued liabilities........................ 155,226 (246,490)
Related party payables..................... 26,557 (8,590)
Income taxes payable....................... (200,924) (275,325)
Deferred rent.............................. 49,339 15,205
Deferred revenue........................... 131,816 (578,391)
---------- -----------
Net cash (used in) provided by
operating activities................. 524,511 (873,721)
---------- -----------
Cash flows from investing activities:
Purchase of investments............................ -- 48,262
Purchase of property and equipment and assets
held for sale.................................... (172,789) (1,109,918)
Notes receivable................................... -- (2,407,212)
Related party note receivable...................... -- (10,973)
---------- -----------
Net cash used in investing activities.. (172,789) (3,479,841)
---------- -----------
Cash flows from financing activities:
Borrowings under line of credit.................... -- 232,817
Payments under line of credit...................... (545,008) --
Proceeds from sale of common stock, net............ -- 114,431
Principal payments under capital leases............ (10,600) (54,489)
---------- -----------
Net cash provided by (used in)
financing activities................. (555,608) 292,759
---------- -----------
Effect of exchange rate changes on cash................ 6,568 (22,248)
---------- -----------
Net decrease in cash and cash equivalents.............. (197,318) (4,083,051)
Cash and cash equivalents, beginning of period......... 2,280,273 18,825,764
---------- -----------
Cash and cash equivalents, end of period............... $2,082,955 $14,742,713
========== ===========
Supplemental disclosures of cash flow information:
Interest paid...................................... $ 51,630 $ 69,315
========== ===========
Income taxes paid.................................. $ 273,000 $ 290,000
========== ===========
1-6
VERSATILITY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(UNAUDITED)
NUMBER OF FOREIGN
SHARES OF ADDITIONAL CURRENCY
COMMON COMMON PAID-IN TRANSLATION RETAINED
STOCK STOCK CAPITAL ADJUSTMENTS EARNINGS TOTAL
--------- ------- --------- ----------- -------- -----
Balance, April 30, 1997..................... 7,297,365 $72,974 $34,349,298 $ (83,880) $3,629,393 $37,967,785
Issuance of common stock related to
exercise of stock options.............. 83,812 838 113,593 114,431
Foreign currency translation
adjustments............................ (22,248) (22,248)
Net income............................... 46,441 46,441
--------- ------- ----------- --------- ---------- -----------
Balance, July 31, 1997...................... 7,381,177 $73,812 $34,462,891 $(106,128) $3,675,834 $38,106,409
========= ======= =========== ========= ========== ===========
1-7
VERSATILITY INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared on the same basis as the audited consolidated financial statements and,
in the opinion of management, include all adjustments (consisting of only normal
recurring adjustments) necessary to present fairly the financial information set
forth therein, in accordance with generally accepted accounting principles. The
results of operations for the interim periods are not necessarily indicative of
the results to be expected for any future period. Certain information and
footnote disclosures normally contained in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted. These condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto,
together with management's discussion and analysis of financial condition and
results of operations, contained in Versatility Inc.'s Annual Report on Form
10-K for the fiscal year ended April 30, 1997.
2. NOTES RECEIVABLE
The Company has notes receivable at July 31, 1997 as follows:
Due less than one year $2,207,212
Due between one year and
five years 200,000
----------
$2,407,212
==========
The terms of the notes are between 90 days and 15 months. Any notes in
excess of one year bear interest equal to prime rate plus one percent.
3. LITIGATION SETTLEMENT AND RELATED COSTS
One of the Company's former VARs filed a claim for arbitration against the
Company in connection with the termination of the VAR's reseller agreement with
the Company, claiming not less than $1.0 million in damages. In August 1997, the
Company settled the litigation with the former VAR for $250,000. The Company has
recorded a one-time charge in the quarter ending July 31, 1997 related to this
litigation for $600,000, which includes the settlement charge and other costs
and expenses associated with defending the litigation.
1-8
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 and the Annual Report on
Form 10-K for the fiscal year ended April 30, 1997.
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. Beginning in
fiscal 1996, substantially all of the Company's revenue is 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 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.
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 first three months of fiscal 1997, British Telecommunications Plc
("BT") accounted for 43.6% of the Company's total revenue. For the first three
months of fiscal 1998, BT and CSI Data, Inc. accounted for 26.1% and 16.1%,
respectively, of the Company's total revenue. 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 57.8% and
38.6% of the Company's total revenue for the first three months of fiscal 1997
and 1998, 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
1-9
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.
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
THREE MONTHS ENDED
JULY 31,
1996 1997
---- ----
Revenue:
License revenue......................... 69.9% 56.9%
Service and maintenance revenue......... 30.1 43.1
------ -------
Total revenue...................... 100.0 100.0
------ -------
Cost of revenue:
License revenue......................... 3.8 1.9
Service and maintenance revenue......... 22.7 29.0
------ -------
Total cost of revenue.............. 26.5 30.9
------ -------
Gross margin................................. 73.5 69.1
------ -------
Operating expenses:
Selling, general and administrative..... 56.1 52.3
Research and development................ 11.4 10.9
Litigation settlement and related costs. -- 6.7
Depreciation and amortization........... 0.9 1.2
------ -------
Total operating expenses........... 68.4 71.1
------ -------
Income from operations....................... 5.1 (2.0)
Interest income (expense), net............... (0.1) 2.8
------ -------
Income before provision for income taxes..... 5.0 0.8
Provision for income taxes................... 1.3 0.3
------ -------
Net income (loss)............................ 3.7% 0.5%
====== =======
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:
THREE MONTHS ENDED
JULY 31,
1996 1997
---- ----
Cost of license revenue..................... 5.4% 3.4%
Cost of service and maintenance revenue..... 75.5% 67.2%
Revenue. Total revenue increased 66.3% from $5.4 million in the three months
ended July 31, 1996 to $9.0 million in the three months ended July 31, 1997. The
increase in total revenue was influenced by the continuing development of
Versatility's indirect channels. For the first three months of fiscal 1997, the
domestic and international indirect sales groups together generated 8.6% of
total revenue; versus for the first three months of fiscal 1998, these groups
generated 37.1% of total revenue. Revenue from license fees increased 35.3% from
$3.8 million in the three months ended July 31, 1996, or 69.9% of total revenue,
to $5.1 million in the three months ended July 31, 1997, or 56.9% of total
revenue. The increase was due to the increase in the number of customers for the
Company's telesales and teleservices solutions. Service revenue increased 138.1%
from $1.6 million in the three months ended July 31, 1996 to $3.9 million in the
three months ended July 31, 1997 due to greater demand for the Company's
implementation and project management services. The mix of revenue changed from
roughly 70% licenses, 30% services in the prior year to nearly 57% licenses, 43%
services in the current year, on the strength of the services revenue reported.
Also, the shift in revenue mix may be attributed to (i) seasonal timing of
transactions in the current year versus the first quarter of fiscal 1997; and
(ii) the impact of personnel changes that the Company made to its domestic sales
and professional services organizations for fiscal 1998.
1-10
Cost of Revenue. Cost of license revenue is comprised of the costs of media,
packaging, documentation and incidental hardware costs. Cost of service and
maintenance revenue consists of salaries, wages, benefits and other direct costs
related to installing, customizing and supporting customer implementations.
These costs also include telephone support and training.
Total cost of revenue increased from $1.4 million in the three months ended
July 31, 1996, or 26.5% of total revenue, to $2.8 million in the three months
ended July 31, 1997, or 30.9% of total revenue. Cost of license revenue
decreased from $205,000 in the three months ended July 31, 1996, or 5.4% of
license revenue to $172,000 in the three months ended July 31, 1997, or 3.4% of
license revenue. Cost of service and maintenance revenue increased from $1.2
million in the three months ended July 31, 1996, or 75.5% of service and
maintenance revenue, to $2.6 million in the three months ended July 31, 1997, or
67.2% of service and maintenance revenue. The increase was the result of
additions to the Company's consulting, customization and implementation staff to
support the growing number of the Company's customers. During the first quarter
of fiscal 1997, the Company's cost of service and maintenance revenue was higher
as a percentage of such revenue due in part to the engagement of contract
programmers to complete certain custom implementations of the Versatility
Series. Total cost of revenue was adversely affected in the current year
compared to the same period in the prior year due to the change in revenue mix
between licenses and services.
Selling, General and Administrative. Selling expenses consist of personnel
costs, including compensation and benefits and costs of travel, advertising,
public relations, seminars and trade shows. General and administrative expenses
represent the costs of executive, finance and support personnel and unallocated
corporate expenses such as rent, utilities, legal and auditing. Selling, general
and administrative expenses increased from $3.0 million for the three months
ended July 31, 1996, or 56.1% of total revenue, to $4.7 million for the three
months ended July 31, 1997, or 52.4% of total revenue. This increase was
attributable to additions to the Company's headcount, primarily sales and
marketing staff. At July 31, 1996, sales, marketing and administrative had 59
employees versus 92 employees at July 31, 1997.
Research and Development. Research and development expenses consist of
personnel costs and direct overhead costs incurred in developing software
features and functionality. Research and development expenses increased from
$619,000 for the three months ended July 31, 1996, or 11.4% of total revenue, to
$981,000 for the three months ended July 31, 1997, or 10.9% of total revenue.
The increase was due to the hiring of additional software engineers to support
increased development activities.
Litigation Settlement and Related Costs. One of the Company's former VARs
filed a claim for arbitration against the Company in connection with the
termination of the VAR's reseller agreement with the Company, claiming not less
than $1.0 million in damages. In August 1997, the Company settled the litigation
with the former VAR for $250,000. The Company has recorded a one-time charge in
the quarter ending July 31, 1997 related to this litigation for $600,000, which
includes the settlement charge and other costs and expenses associated with
defending the litigation.
Depreciation and Amortization. Depreciation and amortization expenses
were $50,000 in the three months ended July 31, 1996 and $109,000 in the three
months ended July 31, 1997.
Interest Income (Expense), Net. Interest income (expense), net consists of
interest earned on cash and cash equivalents, offset by interest expense on debt
and equipment financing. Net interest income was $(6,000) and $249,000 for the
three months ended July 31, 1996 and 1997, respectively. The difference results
from interest income attributable to the cash raised through the initial public
offering in the third quarter of fiscal 1997, partially offset by interest
expense related to borrowings on the line of credit.
Provision for Income Taxes. The Company accounts for income taxes under
Statement of Financial Accounting Standards No. 109 "Accounting for Income
Taxes"("SFAS 109"). The provision for income taxes is computed based on pretax
income, with deferred income taxes recorded for the differences between pretax
accounting and pretax taxable income. The Company's provision for income taxes
was $70,000 and $24,000 for the three months ended July 31, 1996 and 1997,
respectively, with an effective tax rate of approximately 25.7% and 34.0%,
respectively. The favorable effective tax rate for fiscal 1997 reflected a
significant portion of sales through the Company's Foreign Sales Corporation and
other tax benefits.
Net Income. Net income decreased from $202,000 to $46,000 for the three
months ended July 31, 1996 and 1997, respectively. Net income for the three
months ended July 31, 1997 would have been $442,000 if the one-time litigation
settlement and related costs were excluded.
1-11
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 $2.5 million at July
31, 1997. Advances under the working capital line bear interest at a variable
annual rate equal to the prime rate of the bank plus 0.5%. The line of credit
expired on August 5, 1997. The Company is in the process of negotiating an
extension of the line of credit.
At July 31, 1997, the Company had $20.7 million in cash, cash equivalents
and short-term investments and $15.4 million in accounts receivable. For the
three months ended July 31, 1997, net cash used in operations totaled $873,000.
In addition, the Company used $3.5 million for investing activities, which
included $1.1 million for capital expenditures and $2.4 million for notes
receivables related to several customers. These uses of cash were partially
offset by borrowings of $233,000 under the Company's working capital line of
credit and $114,000 related to employees exercising stock options, resulting in
a net cash decrease of $4.1 million.
The Company anticipates that its existing cash balances and funds
anticipated to be generated from operations 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%. For the first three months of fiscal 1998, BT and CSI
Data, Inc. accounted for 26.1% and 16.1%, respectively, of the Company's total
revenue. 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
1-12
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. In fiscal 1997, the Company's accounts
receivable balance increased significantly. While some of the Company's increase
in accounts receivable resulted in the ordinary course from the Company's growth
in 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 condition to their purchase or during the
course of the implementation process. As of July 31, 1997, the balance on those
accounts was approximately $735,000. In the first three months of fiscal 1998,
the Company signed notes with three customers. Two of the notes are due in 90
days and do not bear interest. The third note is for 15 months and bears
interest at prime plus one percent per annum. 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 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.
1-13
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.
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 and the first three months of fiscal 1998 accounted
for approximately 16.3%, 40.8%, 41.2% and 38.6% 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.
1-14
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 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.
1-15
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 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 Chairman
of the Board, 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.
1-16
Part II: Other Information
Item 1: Legal Proceedings:
One of the Company's former VARs filed a claim for arbitration against
the Company in connection with the termination of the VAR's reseller
agreement with the Company, claiming not less than $1.0 million in
damages. In August 1997, the Company settled the litigation with the
former VAR for $250,000. The Company has recorded a one-time charge in
the quarter ending July 31, 1997 related to this litigation for
$600,000, which includes the settlement charge and other costs and
expenses associated with defending the litigation.
Item 2: Changes in Securities and Use of Proceeds
On December 12, 1996, the Company's S-1 (File No. 333-13771) became
effective. The Company has filed Form SR disclosing the sale of
securities and the use of proceeds through March 12, 1997. The net
proceeds from the offering were $30,625,564. No information has
changed, except for the use of proceeds. The following are the use of
proceeds from the effective date (December 12, 1996) through July 31,
1997:
Purchase and installation of machinery and equipment $ 1,551,118
Repayment of indebtedness 1,526,195
Working capital 22,150,221
Cash and short-term securities 5,398,030
-----------
Total $30,625,564
===========
None of these payments were made to directors, officers, general
partners of the Company or their associates, or to persons owning ten
percent or more of any class of equity securities of the Company, and
to the affiliates of the Company.
Item 3: Defaults upon Securities:
Not Applicable.
Item 4: Submission of Matters to a Vote of Security Holders:
Not Applicable.
Item 5: Other Information:
Not Applicable.
Item 6: Exhibits and Reports on Form 8-K:
A. Exhibits
Exhibit No. Exhibits
- ----------- --------
10.9 Amendment to 1996 Employee Stock Purchase Plan
11.1 Statement Regarding Computation of Net Income Per Share
27.1 Financial Data Schedule
B. Reports on Form 8-K:
There were no reports on Form 8-K filed during the period.
1-17
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: September 12, 1997 By: /s/ Donald C. Yount
_________________________
Donald C. Yount
Senior Vice President, Finance
and Chief Financial Officer
(Principal Financial and
Accounting Officer)
1-18