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, 1998
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 13, 1998,
as reported on the Nasdaq National Market was approximately $5,942,926. 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 13, 1998 the Registrant had
7,581,380 shares of Common Stock outstanding, par value $.01 per share.
1
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Definitive Proxy Statement, which the registrant
intends to file within 120 days of April 30, 1998 are incorporated by reference
in Part III hereof.
Table of Contents
PART I.
Item 1. Business................................................................................................... 3
Item 2. Properties................................................................................................. 11
Item 3. Legal Proceedings.......................................................................................... 11
Item 4. Submission of Matters to a Vote of Security Holders........................................................ 12
PART II.
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters......................... ............. 13
Item 6. Selected Financial Data.................................................................................... 14
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations...................... 14
Item 7A. Quantitative and Qualitative Disclosures about Market Risk................................................. 26
Item 8. Financial Statements and Supplementary Data................................................................ 27
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure....................... 27
PART III.
Item 10. Directors and Executive Officers of the Registrant......................................................... 28
Item 11. Executive Compensation..................................................................................... 28
Item 12. Security Ownership of Certain Beneficial Owners and Management............................................. 28
Item 13. Certain Relationships and Related Transactions............................................................. 28
PART IV.
Item 14. Exhibits, Financial Statements and Reports on Form 8-K..................................................... 29
SIGNATURE............................................................................................................ 30
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, and subsequent filings
with the Securities and Exchange Commission.
ITEM 1. BUSINESS
OVERVIEW
Versatility is a leading provider of client/server customer interaction
software that enables businesses to automate and enhance their telesales,
telemarketing and teleservicing capabilities. The Company's software products
are designed to increase the productivity and revenue-generating capabilities of
organizations operating call centers as they interact with existing and
potential customers. The Company's products include desktop software
applications, development and customization tools and optional server-based
software services. A wide variety of leading computing platforms are supported
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 Members
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.
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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 or service 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 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 the 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. 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 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.
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.
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. 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 or OLE Automation 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.
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In addition to Versatility Call Center Applications, the Versatility Series
provides 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, help 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.
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 license which 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.
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. As of April 30, 1998, the
Company employed 57 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 charged on a
time-and-materials basis or for a fixed fee.
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 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.
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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, 1998, the Company's two largest customers
accounted for 38.6% of the Company's total revenue, of which one customer,
British Telecommunications, Plc ("BT"), accounted for 22.1% and another, Century
Telecom accounted for 16.5%. 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. Revenue from customers outside the United
States accounted for 40.8 %, 54.6% and 39.0% of the Company's total revenue for
fiscal 1996, 1997 and 1998, respectively. See further discussion regarding the
business segment and geographic area information in Note 9 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 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 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 95 and Microsoft Windows
NT; leading relational databases from Oracle, Sybase, 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 Visual Basic, 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.
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 industry specific version of the Versatility Series - Versatility
Financial Services. This Financial industry vertical version is due to ship in
early 1999 and is designed to significantly lower the customization efforts and
costs by pre-building many of the vertical components typically requiring
customization during the deployment of the customer interaction application.
In June 1997, Versatility introduced the industry's first components-based
application architecture and delivered the initial products that contained
components - Versatility Telesales/Teleservice v3.0 and Versatility PowerGuide
v2.0 of this component based framework. The company will be working over the
next fiscal year to deliver the architecture and other components surrounding
what is now called the Versatility 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.
6
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. In addition, Nortel is bundling parts of the Versatility product line into
one of its Symposium Agent products and acting as an OEM to Versatility.
As of April 30, 1998, the Company's research and development and quality
assurance staff consisted of 30 employees. The Company's total expenses for
research and development for fiscal years 1996, 1997 and 1998 were $2.1 million,
$2.9 million and $4.4 million, respectively. The Company anticipates that it
will continue to commit substantial resources to research and development in the
future.
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. In May
1998, the Commercial Markets Group was discontinued and the Company focused on
rebuilding its direct sales force. The International selling unit sells directly
to customers in the U.K..
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 that require a customized
and integrated call center application.
International. During fiscal year 1997 and fiscal year 1998, the
International selling unit marketed the Versatility Series products to third
party systems integrators, distributors and resellers outside of North
America. This selling unit had regional sales and support teams covering
Western Europe, the Middle East and certain African countries. The
International selling unit is headquartered in Aldermaston, U.K.. Effective
June 1, 1998, the Company announced they had signed a non-exclusive
distribution agreement with Cincom Systems, Inc..
7
This non-exclusive agreement included Cincom's absorption of Versatility's
international distribution channels. As a result of the transaction
Versatility has eliminated all it's direct sales and support operations
outside of the U.K..
Marketing. The Company's marketing efforts supports the Company's selling
strategy. The Company's marketing programs include product management, product
marketing, maintenance and enhancement of the Company's Web site, direct
marketing, public relations, press and analyst communications and event support.
As of April 30, 1998, the Company's marketing department consisted of 9
employees.
Competition
The market for the Company's products is intensely competitive, highly
fragmented and subject to rapid change. Because the Company offers multiple
applications that 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
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 are not well developed or are poorly enforced.
8
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 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 laws 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, 1998, the Company had 134 full-time employees, of which 108
were based in the United States and 26 were based internationally. None of the
employees of the Company are covered by a collective bargaining agreement. 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
9
personnel is intense. There can be no assurance that the Company will be
successful in retaining or recruiting key personnel.
Recent Developments
On March 12, 1998, the Company announced that it expected to restate its
financial results for the fiscal year ended April 30, 1997 and the fiscal
quarters ended July 31, 1997 and October 30, 1997, and that its Form 10-Q for
the quarter ended January 31, 1998 would not be filed on time, all as a result
of concerns over the accounting treatment of certain transactions, which the
Company was examining. The report on Form 10-K/A included restated financial
statements for the fiscal year ended April 30, 1997 and reported total revenues
of $18.3 million rather than $27.4 million and a net loss of $7.9 million. The
Company's restated Forms 10-Q for the quarters ended July 31, 1997 and October
30, 1997 and the Company's Form 10-Q for the quarter ended January 31, 1998
reported net losses of $3.7 million, $5.0 million and $9.5 million,
respectively. As of July 20, 1998, the Company had $1.8 million in cash and cash
equivalents. The Company believes that its cash on hand and cash flow from
anticipated operating activities may not be sufficient to meet its ongoing
obligations through the second quarter of fiscal 1999. The Company has retained
NationsBanc Montgomery Securities LLC to help review its strategic alternatives,
which include additional capital raising activities and evaluating potential
corporate partners. There can be no assurance that the Company will be able to
raise additional capital on favorable terms, or at all. The uncertainties
regarding the Company's financial condition have had a material adverse affect
on the Company's business, financial condition and results of operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operation."
Since February 1998, the Company has replaced substantially all of it's
senior management. The Company's current President and Chief Operating Officer
and current Chief Financial Officer joined the Company in February 1998,
together with the new Senior Vice President of Operations. The Company's former
President, Chairman and Chief Executive Officer resigned from all positions with
the Company and the former Chief Financial Officer and Vice President in charge
of sales have also left the Company.
Between April 1997 and February 1998, the Company grew its work force to
256. In March and April 1998, the Company significantly reduced its workforce as
a result of the Company's continued operation losses. At April 30, 1998 the
Company employed 108 people in the United States and 26 in it's international
unit.
As a result of concerns over the matters disclosed in the Company's March
12, 1998 press release, the National Association of Securities Dealers ("NASD")
suspended trading of the Company's common stock on the Nasdaq National Market on
March 12, 1998 and instituted proceedings to remove the Company's common stock
from listing on the Nasdaq National Market. After the Company's release of
restated financial information and the filing of the Company's Form 10-Q for the
quarter ended January 31, 1998 the Nasdaq Stock Market's Listing and
Qualifications Panel allowed the Company's Common Stock to resume trading on May
5, 1998, contingent upon the Company's attainment of net tangible assets of $10
million by June 30, 1998. Although the Company requested an extension for 45
days from June 30, 1998, to secure needed financing and/or strategic
alternatives, Nasdaq denied the request and de-listed the company's Common Stock
on July 20, 1998. The Company's Common Stock began trading on the OTC Bulletin
Board on July 21, 1998. See "Risks Relating to Trading on the OTC Bulletin
Board" and " Risk Relating to Penny Stock; Possible Effect of Penny Stock Rules
on Liquidity for the Company's Common Stock."
The Company's restatement of its financial statements and delisting of its
Common Stock from The Nasdaq Stock Market have had a material adverse impact on
the Company's reputation, which could impair the Company's relationships with
existing and potential customers, further weakening the Company's business,
financial condition and results of operations. Certain of the Company's
customers have stated that they will postpone purchases of the Company's
products and services until the Company secures financing or enters into a
relationship with a strategic partner.
Versatility continues to explore both financing and strategic options,
including the possible sale of the Company and has engaged NationsBanc
Montgomery Securities, LLC to assist the Company with these efforts. There can
be no assurance that the Company will be able to raise such capital or sell the
Company on favorable terms, or at all. If the Company is unable to obtain
additional financing sufficient to meet its operating needs, the Company would
be
10
required to significantly reduce the scope of, or cease conducting, its
operations. See "Risks Relating to Trading on the OTC Bulletin Board" and " Risk
Relating to Penny Stock": Possible Effect of "Penny Stock" Rules on Liquidity
for the Company's Common Stock.
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. The Company also leases 6,600 square feet in Aldermaston, U.K.
Management believes its current facilities are adequate.
ITEM 3. LEGAL PROCEEDINGS
Between March 6, 1998 and April 8, 1998 the Company and certain of its
current and former officers and directors, among others, were sued in various
putative securities class actions filed in the United States District Court for
the Southern District of New York and the United States District for the
Eastern District of Virginia, as follows: Thomas Esposito, et al. v.
Versatility, Inc., et al. (S.D.N.Y.); Tammy Newsman v. Versatility, Inc., et al.
(S.D.N.Y.); Sam Succar v. Versatility, Inc. et al. (S.D.N.Y.); Thomas K. Doyle
v. Versatility, Inc. et al. (E.D. VA); and Steven Bowen v. Versatility, Inc.
et al. (S.D.N.Y.) (together "the putative class actions"). Collectively, the
putative class actions asserted claims under Sections 11, 12(2) and 15 of the
Securities Act of 1933 and Section 10(b) and 20(a) of the Securities Exchange
Act of 1934 for alleged misrepresentations and omissions in connection with the
SEC public filings and other public statements made by the Company. Among other
allegations, each of the putative class actions alleged that the Company
misrepresented its financial results and its accounting practices during the
period December 12, 1996 through March 12, 1998, including in the Company's IPO
Prospectus. The complaints in certain of the putative class actions also
asserted, among other allegations, that the Company and certain of the other
defendants made misrepresentations in the IPO Prospectus and thereafter
regarding the performance capabilities of the Company's CallCenter product. See
"Factors Which May Effect Future Operating Results - Litigation Risks" below.
Versatility reached a settlement in principle with the plaintiffs in
all six putative securities class action lawsuits currently pending against the
Company on July 9, 1998. The settlement in principle is conditioned upon the
execution and filing with the Court of a definitive agreement of settlement and
final Court approval.
Under the proposed settlement, the class actions would be dismissed and
a settlement fund would be created for the members of the proposed class
consisting of $3.5 million in cash, which represents proceeds from Versatility's
directors' and officers' liability insurance and related recoveries by the
Company. In addition, as part of the settlement, an aggregate of 350,000 shares
of Versatility Common Stock will be transferred to the Company by certain
defendants other than the Company in settlement of the claims against them.
Thereafter, the Company will issue 750,000 shares of its Common Stock for the
benefit of the proposed plaintiff class, 350,000 shares of which will be in
substitution of shares provided by those certain defendants in settlement of the
claims against them.
Since March, 1998 the Company has been responding to informal requests
for information from the Securities and Exchange Commission (the "Commission")
relating to certain of the Company's financial matters. In May 1998, the Company
was advised by the Commission that it had obtained a formal order of
investigation so that, among other matters, it may utilize subpoena powers to
obtain information relevant to its inquiry. The Commission has and may in the
future utilize its subpoena powers to obtain information from various officers,
directors and employees of the Company and from persons not presently associated
with the Company. If, after completion of its investigation, the Commission
finds that violations of the federal securities laws have occurred, the
Commission has the authority to order persons to cease and desist from
committing or causing such violations and any future violations. The Commission
may also seek administrative, civil, and criminal fines and penalties and
injunctive relief. The Department of Justice has the authority in respect of
criminal matters. There can be no assurance as to the timeliness of the
completion of the investigation or as to the final result thereof, and no
assurance can be given that the final result of the investigation will not have
a material adverse effect on the Company. The Company is cooperating fully with
the investigation, and has responded and will continue to respond to requests
for information in connection with the investigation.
11
One of the Company's former VARs had 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. In
April, 1997, the arbitration panel awarded $267,000 in net damages to the
plaintiff in the proceedings. The arbitration panel's decision was appealed. In
August 1997, the Company settled the litigation with the former VAR for
$250,000. The Company recorded a one-time charge in the quarter ending July 31,
1997 related to this litigation for $500,000, which included the settlement
charge and other costs and expenses associated with the litigation.
A former customer is seeking damages in excess $1,000,000 for alleged
breaches of contract and warranties, as well as alleged misrepresentations. On
April 16, 1998, the Company filed a response denying the allegations and
counter-claiming for damages in excess of $400,000 for breach of contract. This
matter is currently in the discovery stage. The Company intends to vigorously
defend this case. The outcome of this matter cannot be ascertained at this time.
A customer of a Versatility reseller has sued for damages for an amount
not less than $1,000,000. In December 1997, the District Court dismissed the
action. In February 1998, essentially the same claim was made in a different
District Court. The outcome of this matter cannot be ascertained at this time.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders in the year ended
April 30, 1998.
12
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Following the Company's initial public offering on December 13, 1996, until
July 20, 1998, the Company's Common Stock had been traded on The Nasdaq National
Market under the symbol "VERS". Nasdaq halted trading of the Common Stock on
March 12, 1998 and on July 20, 1998, Nasdaq delisted the Company's Common Stock.
On July 21, 1998 the Company's common stock began trading on the OTC Bulletin
Board. See "Business---Recent Developments." The following table reports the
high and low sale prices in each quarter until April 30, 1998 on The Nasdaq
National Market:
Fiscal 1997 Low High
----------- --- ----
Quarter ended January 31, 1997 (subsequent to December 13, 1996) $ 13.13 $ 18.25
Quarter ended April 30, 1997 8.00 13.63
Fiscal 1998
-----------
Quarter ended July 30, 1997 10.00 13.75
Quarter ended October 30, 1997 7.75 13.88
Quarter ended January 31, 1998 3.75 9.13
Quarter ended April 30, 1998 2.50 5.88
As of July 13, 1998, the Company had approximately 82 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.
13
ITEM 6. SELECTED FINANCIAL DATA
Year Ended April 30,
-------------------------------------------------
1994 1995 1996 1997 1998
--------- --------- --------- --------- ------
Consolidated Statement of Operations Data: (In thousands, except per share data)
Revenue:
License revenue................................. $5,393 $ 8,045 $ 10,345 $10,255 $ 9,306
Service and maintenance revenue................. 2,987 3,440 6,190 8,054 9,847
------ -------- -------- --------- ---------
Total revenue................................... 8,380 11,485 16,535 18,309 19,153
------ -------- -------- --------- ---------
Cost of revenue:
License revenue................................. 1,924 1,493 573 1,098 3,546
Service and maintenance revenue................. 2,056 2,385 4,267 5,868 13,345
------ -------- -------- --------- ---------
Total cost of revenue........................... 3,980 3,878 4,840 6,966 16,891
------ -------- -------- --------- ---------
Gross margin.................................... 4,400 7,607 11,695 11,343 2,262
------ -------- -------- --------- ---------
Operating expenses:
Selling, general and administrative............. 3,717 4,550 7,770 16,751 22,247
Research and development........................ 389 711 2,074 2,892 4,393
Litigation settlement and related costs......... -- -- -- -- 2,524
Depreciation and amortization................... 133 365 161 281 580
Write-off of capitalized software............... -- -- 829 -- --
------ -------- -------- --------- ---------
Total operating expenses........................ 4,239 5,626 10,834 19,924 29,744
------ -------- -------- --------- ---------
Income (loss) from operations..................... 161 1,981 861 (8,581) (27,482)
Interest income (expense), net.................... (20) (9) 3 404 456
------ -------- -------- --------- ---------
Income (loss) before provision (benefit) for
Income taxes...................................... 141 1,972 864 (8,177) (27,026)
Provision (benefit) for income taxes.............. 31 715 207 (323) --
------ -------- -------- --------- ---------
Net income (loss)................................. $ 110 $ 1,257 $ 657 $ (7,854) $(27,026)
====== ======== ======== ========= =========
Dividends accreted on preferred stock............. -- -- (88) (176) --
Income available to common shareholders........... -- -- 569 (8,030) (27,026)
Net income (loss) per share (1)................... $0.03 $0.31 $ 0.14 $ (1.53) $ (3.62)
====== ======== ======== ========= =========
Average common and common equivalent
shares outstanding (1)............................ 4,000 4,000 4,000 6,241 7,461
====== ======== ======== ======== =========
April 30,
1994 1995 1996 1997 1998
-------- -------- -------- ------- -------
Consolidated Balance Sheet Data:
Cash and cash equivalents........................ $ 192 $ 1,414 $ 2,280 $ 18,826 $ 5,591
Working capital (deficiency)..................... (573) 446 5,028 25,355 (765)
Total assets..................................... 2,060 4,288 9,631 37,090 15,546
Long-term debt, less current portion............. 114 51 70 25 73
Redeemable convertible preferred stock........... -- -- 3,561 -- --
Stockholders' equity............................. 75 1,331 1,834 28,168 1,543
- ----------
(1) Calculated on the basis described in Note 1 of Notes to Consolidated
Financial Statements. Basic and diluted income (loss) per share are the same
for all years presented.
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. Since fiscal 1996,
substantially all of the Company's revenue was derived from sales or services
related to the Versatility Series.
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 had $1.0 million, $767,000 and $1.4
million of hardware
14
revenue in fiscal years 1996, 1997 and 1998, respectively. 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
the achievement of certain performance milestones as defined in the contracts.
When the Company is under no obligation to install or customize the software,
license revenue is recognized upon shipment as long as cash collection is
probable. 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. An
allowance for doubtful accounts receivable and sales has been recorded which is
considered adequate to absorb currently estimated bad debts and disputed amounts
in these account balances.
For the fiscal year ended April 30, 1998, the Company's two largest
customers accounted for 38.6% of the Company's total revenue, of which one
customer, BT, accounted for 22.1% and another customer accounted for 16.5%.
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 40.8 %, 54.6%
and 39.0% of the Company's total revenue for fiscal 1996, 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 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.
15
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,
1996 1997 1998
---- ---- ----
Revenue:
License revenue......................... 62.6% 56.0% 48.6%
Service and maintenance revenue......... 37.4 44.0 51.4
-------- -------- --------
Total revenue...................... 100.0 100.0 100.0
-------- -------- --------
Cost of revenue:
License revenue......................... 3.5 6.0 18.5
Service and maintenance revenue......... 25.8 32.1 69.7
-------- -------- --------
Total cost of revenue.............. 29.3 38.1 88.2
-------- -------- --------
Gross margin................................. 70.7 61.9 11.8
-------- -------- --------
Operating expenses:
Selling, general and administrative..... 47.0 91.5 116.2
Research and development................ 12.5 15.8 22.9
Litigation settlement and related costs. -- -- 13.2
Depreciation and amortization........... 1.0 1.5 3.0
Write-off of capitalized software....... 5.0 -- --
-------- ---------- --------
Total operating expenses........... 65.5 108.8 155.3
-------- -------- --------
Income from operations....................... 5.2 (46.9) (143.5)
Interest income (expense), net............... (0.0) 2.2 2.4
-------- -------- --------
Income (loss) before provision (benefit)
for income taxes 5.2 (44.7) (141.1)
Provision (benefit) for income taxes......... 1.2 (1.8) --
-------- --------- -------
Net income (loss)............................ 4.0% (42.9)% (141.1)%
======= ======== =======
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,
1996 1997 1998
---- ---- ----
Cost of license revenue..................... 5.5% 10.7% 38.1%
Cost of service and maintenance revenue..... 68.9% 72.9% 135.5%
Fiscal 1998 Compared to Fiscal 1997
Revenue. Total revenue increased 4.6% from $18.3 million in fiscal 1997 to
$19.2 million in fiscal 1998. Revenue from license fees decreased 9.3% from
$10.3 million in fiscal 1997, or 56.0% of total revenue, to $9.3 million, or
48.6% of total revenue in fiscal 1998. The decrease was primarily related to
indirect sales not materializing, while the Company de-emphasized it's direct
sales activities. Service and maintenance revenue increased 22.3% from $8.1
million in fiscal 1997, or 44% of total revenue, to $9.8 million in fiscal 1998
or 51.4% of total revenue. The increase was due to greater demand for the
Company's implementation and project management services. The shift in revenue
mix was primarily related to the impact of the de-emphasis on direct sales
efforts in fiscal 1998 and the Company's decision to allocate more of it's
resources towards performing services for existing customers.
Cost of Revenue. Cost of license revenue is comprised of the costs of media,
packaging, documentation and hardware costs. Cost of service and maintenance
revenue consists of salaries, wages, benefits and other direct coats related to
installing, customizing and supporting customer implementation and support.
These costs also include telephone support and training. Total cost of revenue
increased 142.5% from $7.0 million in fiscal 1997, or 38% of total revenue, to
$16.9 million in fiscal 1998, or 88.2% of total revenue. Cost of license revenue
increased 222.8% from $1.1 million in fiscal 1997, or 10.7% of license revenue,
to $3.5 million in fiscal 1998, or 38.1% of license revenue. The increase was
directly related to the costs of third party software and hardware provided to
customers. Costs of service and maintenance revenue increased 127.4% from $5.9
million in fiscal 1997, or 72.9% of service and maintenance revenue, to $13.3
million in fiscal 1998, or 135.5% of service and maintenance revenue. The
16
increase was directly affiliated to the additional staff and consultants
personnel hired to support the Company's projects. Total cost of revenue was
adversely affected in fiscal 1998 compared to the prior year due to the change
in revenue mix between license and services and the use of third party
consultants which significantly increased the cost of project services.
Selling, General and Administrative. Selling expenses consist of personnel
costs, including compensation, benefits and the costs of travel, advertising,
public relations, seminars and trade shows. General and administrative expense
represents the costs of executive, financial, support personnel and corporate
expenses such as rent, utilities, legal and advertising. Selling, general and
administrative expenses increased 32.8% from $16.8 million in fiscal 1997, or
91.5% of total revenue, to $22.2 million in fiscal 1998 or 116.2% of total
revenue. The increase was due to addition to the Company's headcount, primarily
sales and marketing staff and expansion of US and international offices.
Research and Development. Research and development expenses consisted of
personnel as cost and direct overhead costs in developing software features and
functionality. Research and development expense increased 51.9% from $2.9
million in fiscal 1997, or 15.8% of total revenue, to $4.4 million in fiscal
1998, or 22.9% of total revenue. The increase was due to hiring of additional
software engineers and the use of outside consultants to assist with quality
assurance testing.
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. The Company defended this action in arbitration
proceedings. The Company settled the litigation with former VAR for $250,000.
The Company recorded a one-time charge in the quarter ending July 31, 1997
related to this litigation for $500,000, which includes the settlement charge
and other costs and expenses associated with defending the litigation.
Additionally, the Company has recorded a charge of $2,022,930 in the fourth
quarter fiscal 1998 to cover the cost of the class action settlement referred to
in "Litigation Risks" and related costs.
Depreciation and Amortization. Depreciation and amortization expenses were
$281,000 in fiscal 1997 and $580,000 in 1998. The increase in fiscal year 1998
was due to the amount of additional equipment the Company purchased in 1998.
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 (expense) was $404,000 and $456,000
for fiscal 1997 and fiscal 1998, respectively.
Provision (Benefit) 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 (benefit) for income taxed is computed based
on pretax income, taxes recorded for the differences between pretax accounting
and pretax taxable income (loss). The Company did not record a benefit in fiscal
1998. The Company's provision (benefit) for income taxes was ($323,000) in
fiscal 1997.
Fiscal 1997 Compared to Fiscal 1996
Revenue. Total revenue increased 10.7% from $16.5 million in fiscal 1996 to
$18.3 million in fiscal 1997. Revenue from license fees essentially stayed the
same in absolute dollars from $10.3 million in fiscal 1996, or 62.6% of total
revenue, to $10.3 million in fiscal 1997, or 56.0% of total revenue. Service and
maintenance revenue increased 30.1% from $6.2 million in fiscal 1996, or 37.4%
of total revenue, to $8.1 million in fiscal 1997, or 44.0% of total revenue. The
increase in total revenue was significantly influenced by the roll-out of the
Versatility Series at BT, which contributed $2.1 million in service and
maintenance revenue in fiscal year 1997.
Cost of Revenue. Total cost of revenue increased from $4.8 million in fiscal
1996, or 29.3% of total revenue to $7.0 million in fiscal 1997, or 38.1% of
total revenue. Cost of license revenue increase from $573,000 in fiscal 1996, or
5.5% of license revenue, to $1,098,000 in fiscal 1997, or 10.7% of license
revenue. The increase was primarily related to providing third-party hardware
and software products for customers, for which costs were recognized, but
17
revenue has not been recognized. The cost of service and maintenance revenue
increased from $4.3 million in fiscal 1996, or 68.9% of service and maintenance
revenue, to $5.9 million in fiscal 1997, or 72.9% of service and maintenance
revenue. The increase represents the addition of consulting and other staff
needed to support projects as well as the costs relating to the installation of
the Company's products at British Telecom 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 $16.8 million in fiscal 1997, or 91.5% 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. The Company had planned their fiscal 1997 budget based
upon forecasts of growth in fiscal 1997 and based upon reported operating
results during the year.
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 15.8% 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
$281,000 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 a benefit of $323,000 in fiscal 1997. The
effective rate in fiscal 1996 was 24.0% versus a benefit of 3.95% in fiscal
1997. The Company effective rate in fiscal 1996 was 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.
Liquidity and Capital Resources
The Company has funded its operations to date 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.
On October 29, 1997, the Company entered into a credit facility with
its commercial bank which provided for a $5.0 million operating line of credit
and a new $2.0 million equipment line of credit. Since the company was not in
compliance with various covenants in the above credit facility in subsequent
quarters, on April 28, 1998, the Company entered into an amendment to the credit
facility effective April 30, 1998, in which the bank waived all prior
non-compliance and provided for the following terms: the $2.0 million equipment
line was cancelled and the outstanding balance of $256,703 was transferred to
the operating line of credit. Subsequent to April 30, 1998, the Company
permanently paid down the operating line to $3.8 million and may not borrow any
additional amounts under the line. In addition, in exchange for the bank's
forbearance in exercising its rights under the previous arrangement, the Company
has agreed to issue to the Bank warrants to purchase 100,000 shares of the
Company's common stock with an exercise price of $2.50 per share. The credit
facility continues to be collateralized by all of the Company's assets and
Intellectual Property. The agreement provides that the Company must maintain
certain financial covenants,
18
including a minimum tangible net worth and a minimum cash balance. As of June
20, 1998 the Company is not in compliance with these new covenants and therefore
is in default under the operating line of credit.
At April 30, 1998, the Company had $5.6 million in cash and cash equivalents
and $566,000 in short term investments. For the year ended April 30, 1998, net
cash used in operating activities totaled $16.9 million. In addition, the
Company was provided $668,000 from investing activities, which included $1.8
million for capital expenditures. The net borrowings of $2.6 million under the
Company's working capital line of credit resulted in a net cash decrease of
$13.2 million.
The Company invested $235,000, $812,000 and $1.8 million in capital
expenditures in fiscal 1996, 1997 and 1998, respectively. Capital expenditures
include purchases of computer hardware used primarily in product development,
product demonstrations, training and support.
As shown in the financial statements contained herein, the Company has
incurred substantial operating losses and anticipates a loss in the first
quarter of fiscal 1999. On July 20, 1998, the Company had $1.8 million in cash
and cash equivalents. The Company believes that its cash on hand and cash flow
from anticipated operating activities may not be sufficient to meet its ongoing
obligations through the second quarter of fiscal 1999. At July 20, 1998, the
Company has outstanding approximately $3.5 million under it's line of credit and
is currently in default of the operating line. Additionally, the Company expects
to incur significant amounts to comply with and defend the lawsuits and
investigations described below in "Litigation Risks." While significant cost
cutting measures have been initiated, there can be no assurance that the
Company's cash on hand and cash flows from operations will be sufficient to meet
its' ongoing obligations. The Company has retained NationsBanc Montgomery
Securities LLC to help it review its strategic alternatives which include
additional capital raising activities and evaluating potential corporate
partners. There can be no assurance that the Company will be able to raise such
capital on favorable terms, or at all. If the Company is unable to obtain
additional financing sufficient to meet its operating needs, the Company would
be required to significantly reduce the scope of, or cease conducting, its
operations.
New Accounting Pronouncements -- In June 1997, SFAS No. 130, "Reporting
Comprehensive Income," was issued and requires that all items which meet the
definition of comprehensive income be reported for the period in which they are
recognized. Comprehensive income includes changes in the balances of items that
are reported directly in a separate component of stockholders' equity on the
consolidated balance sheets, such as foreign currency translation adjustments
and unrealized gains or losses on available-for-sale securities. SFAS No. 130 is
effective for fiscal years beginning after December 15, 1997 and the Company
will make the disclosures required by SFAS No. 130 in the first quarter of
fiscal 1999.
In June 1997, SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information," was issued and requires that a public business enterprise
report financial and descriptive information about its reportable operating
segments. Generally, financial information is required to be reported on the
basis used internally for evaluating segment performance and resource
allocation. SFAS No. 131 is effective for fiscal years beginning after December
15, 1997; however, disclosure is not required in interim financial statements in
the initial year of adoption. Accordingly, the Company will make the required
disclosures for the fiscal year ending April 30, 1999. The Company is still
determining the effect of adopting SFAS No. 131; however, management does not
anticipate that it will have a material impact.
In March 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." The provisions of SOP 98-1
require that certain costs to develop or obtain internal use software be
capitalized. SOP 98-1 is effective for fiscal years beginning after December
1998 and will be effective for the Company beginning May 1999. The Company is
still determining the effect of adopting SOP 98-1; however, management does not
anticipate that it will have a material impact on the Company's consolidated
results of operations or financial position.
Factors Which May Effect Future Operating Results
The following issues and uncertainties, among others, should be considered
in evaluating the Company's outlook.
Risks Relating to Cash Flow Levels. As of July 20, 1998, the Company had
$1.8 million in cash and cash equivalents. The Company believes that its cash on
hand and cash flow from anticipated operating activities may not be sufficient
to meet its ongoing obligations through the second quarter of fiscal 1999.
Additionally, the Company expects to incur significant amounts to comply with
and defend the lawsuits and investigations described in "Litigation Risks." The
Company's independent auditors have stated in their report issued in connection
with the financial statements contained herein that they have substantial doubt
about the Company's ability to continue as a going concern. The Company has
retained NationsBanc Montgomery Securities LLC to help it review its strategic
alternatives, which include additional capital raising activities and evaluating
potential corporate partners. There can be no assurance that the Company will be
able to raise such capital on favorable terms, or at all. If the Company is
unable to obtain additional financing sufficient to meet its operating needs,
the Company would be required to significantly reduce the scope of, or cease
conducting, its operations. See Note 1 to the Company's Consolidated Financial
Statements contained herein.
Adverse Effects of Restatement of Financial Statements. On March 12, 1998,
the Company announced that it expected to restate its financial results for the
fiscal year ended April 30, 1997 and the fiscal quarters ended July 31, 1997 and
October 31, 1997, and that its Form 10-Q for the quarter ended January 31, 1998
would not be filed on time, all as a result of concerns over the accounting
treatment of certain transactions, which the Company was examining. The
uncertainties resulting from this announcement and the subsequent results of the
Company's restatement of those reports, have had a material adverse affect on
the Company's business and financial condition. In addition, such announcements
have and will continue to have additional adverse effects on the Company. First,
due to the Company's financial uncertainty, certain customers of the Company
have stated that they will postpone purchases of the Company's products and
services until the Company secures financing or enters into a relationship
19
with a strategic partner. There is no assurance that such financing or strategic
partner will be found on a timely basis, if at all. Furthermore, there can be no
assurance that the Company's Common Stock will not further decline due to
reactions by analysts or otherwise.
Risks Relating to Trading on the OTC Bulletin Board. The Company's Common
Stock is currently traded on the OTC Bulletin Board, a regulated quotation
service for non-Nasdaq over the counter securities. Because the Company's Common
Stock is no longer listed on the Nasdaq National Market, an investor could find
it more difficult to dispose of, or to obtain accurate quotations as to the
market value of the Company's Common Stock. This lack of liquidity may cause the
company to have difficulty raising sufficient capital, if at all, on favorable
terms. In addition, if the trading price of the Common Stock were to remain
below $5.00 per share or the company failed to maintain net tangible assets
(total assets less tangible assets less liabilities) in excess of $2.0 million
(the "Net Tangible asset Test") or average revenue of at least $6.0 million for
the last three years (the `Revenue Test"), trading in the Company's Common Stock
would also be subject to the requirements of certain rules under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), which require additional
disclosure by broker-dealers in connection with any trades involving a stock
defined as a penny stock (generally, any non-Nasdaq equity security that (i) has
a market price of less than $5.00 per share or (ii) fails to meet (A) the Net
Tangible asset Test of (B) the Revenue Test, subject to certain exception. The
additional burdens imposed upon broker-dealers by such requirements could
discourage broker-dealers from effecting transaction in the Common Stock, which
could severely limit the market liquidity of the Common Stock and the Ability to
investor to trade the Company's common Stock. See "Risks Relating to Penny
Stock"; "Possible Effect of Penny Stock Rules on Liquidity for the Company's
Common Stock."
Risks Relating to "Penny Stock"; Possible Effect of "Penny Stock" Rules on
Liquidity for the Company's Common Stock. Because the Company's Common Stock is
not listed on a National Securities Exchange nor listed on a national on a
qualified automated quotation system, they may become subject to Rule 15g-9
under the Exchange Act, which imposes additional sales practice requirements on
broker-dealer that sell such securities to persons other than established
customers and "accredited investors" (generally, individuals with a net worth in
excess or $1,000,000 or annual incomes exceeding $200,000 or $300,000 together
with their spouse). For transaction covered by Rule 15g-9, a broker-dealer must
make special suitability determination for the purchaser and have received the
purchaser's written consent to the transaction prior to sale. Consequently, such
Rule may affect the ability of broker-dealer to sell the Company's common stock
and may affect the ability of the purchaser to sell any of the Company's common
stock in the secondary market.
The Commission has adopted regulations that generally define a "penny stock"
to be any equity security that (I) has a market price (as therein defined) of
less than $5.00 per share or with an exercise price of less than $5.00 per share
or (ii) fails to meet (A) the Net Tangible Asset Test or (B) the Revenue Test,
subject to certain exceptions. For any transaction involving a penny stock,
unless exempt, the rules require delivery, prior to any transaction in a penny
stock, of a disclosure schedule prepared by the Commission relating to the penny
stock market. Disclosure is also required to be made about sales commissions
payable to both the broker-dealer and the registered representative and current
quotations for the securities. Finally, monthly statements are required to be
sent disclosing recent price information for the penny stock held in the account
and information on the limited market in penny stock.
There can be no assurance that the Company's Common Stock will qualify for
exemption from the penny stock restrictions. In any event, even if the Company's
Common Stock is exempt from such restrictions, the Company would remain subject
to Section 15(b)(6) of the Exchange Act, which gives the Commission the
authority to restrict any person from participating in a distribution of penny
stock, if the Commission finds that such a restriction would be in the public
interest.
If the Company's Common Stock was subject to the rules on penny stocks, the
market liquidity for the Company's Common Stock could be materially adversely
affected.
Litigation Risks. Between March 6, 1998 and April 8, 1998 the Company
and certain of its current and former officers and directors, among others,
were sued in various putative securities class action cases filed in the
United States District Court for the Southern District of New York and the
United States District Court for the Eastern District of Virginia, as follows:
Thomas Esposito, et al. v. Versatility, Inc. et al. (S.D.N.Y.); Tammy Newsman
v.
20
Versatility, Inc., et al. (S.D.N.Y.); Sam Succar v. Versatility, Inc., et al.
(S.D.N.Y.); Thomas K. Doyle v. Versatility, Inc. et al. (E.D. Va); and Steven
Bowen v. Versatility, Inc. et al. (S.D.N.Y.) (together "the putative class
actions"). In addition, the Company's auditors and the lead underwriters in
its December 1996 initial public offering (IPO) were named as defendants
in one or more of the putative class actions. Collectively, the putative
class actions asserted claims under Sections 11, 12(2), and 15 of Securities
Act of 1933 and Section 10(b) and 20(a) of the Securities Exchange Act of
1934 for alleged misrepresentations and omissions in connection with the SEC
public filings and other public statements made by the Company. Among other
allegations, each of the putative class actions alleged that the Company
misrepresented its financial results and its accounting practices during the
period December 12, 1996 through March 12, 1998, including in the Company's IPO
Prospectus. The complaints in certain of the putative class actions also
asserted, among other allegations, that the Company and certain of other
defendants made misrepresentations in the IPO Prospectus and thereafter
regarding the performance capabilities of the Company's CallCenter product.
Versatility reached a settlement in principle with the plaintiffs in all six
putative securities class action lawsuits currently pending against the Company
on July 9, 1998. The settlement in principle is conditioned upon the execution
and filing with the Court of a definitive agreement of settlement and final
Court approval.
Under the proposed settlement, the class actions would be dismissed and
a settlement fund would be created for the members of the proposed class
consisting of $3.5 million in cash, which represents proceeds from Versatility's
directors' and officers' liability insurance and related recoveries by the
Company. In addition, as part of the settlement, an aggregate of 350,000 shares
of Versatility Common Stock will be transferred to the Company by certain
defendants other than the Company in settlement of the claims against them.
Thereafter, the Company will issue 750,000 shares of its Common Stock for the
benefit of the proposed plaintiff class, 350,000 shares of which will be in
substitution of shares provided by those certain defendants in settlement of the
claims against them.
Since March, 1998 the Company has been responding to informal requests
for information from the Commission relating to certain of the Company's
financial matters. In May, 1998, the Company was advised by the Commission that
it had obtained a formal order of investigation so that, among other matters, it
may utilize subpoena powers to obtain information relevant to its inquiry. The
Commission has and may in the future utilize its subpoena powers to obtain
information from various officers, directors and employees of the Company and
from persons not presently associated with the Company. If, after completion of
its investigation, the Commission finds that violations of the federal
securities laws have occurred the Commission has the authority to order persons
to cease and desist from committing or causing such violations and any future
violations. The Commission may also seek administrative, civil and criminal
fines and penalties and injunctive relief. The Department of Justice has the
authority in respect of criminal matters. There can be no assurance as to the
timeliness of the completion of the investigation or as to the final result
thereof, and no assurance can be given that the final result of the
investigation will not have a material adverse effect on the Company. The
Company is cooperating fully with the investigation, and has responded and will
continue to respond to requests for information in connection with the
investigation.
A former customer is seeking damages in excess of $1,000,000 for
alleged breaches of contract and warranties, as well as alleged
misrepresentations. On April 16, 1998, the Company filed a response denying the
allegations and counter-claiming for damages in excess of $400,000 for breach of
contract. This matter is currently in the discovery stage. The Company intends
to vigorously defend this case. The outcome of this matter cannot be ascertained
at this time.
A customer of a Versatility reseller has sued for damages for an amount
not less than $1,000,000. In December 1997, the District Court dismissed the
action. In February 1998, essentially the same claim was made in a different
District Court. The outcome of this matter cannot be ascertained at this time.
Risks Relating to Year 2000 Issues. The Company believes that its software
is substantially year 2000 compliant and currently does not anticipate material
expenditures to remedy any year 2000 problems. However, many computer systems
were not designed to handle any dates beyond the year 1999, and therefore, many
companies will be required to modify their computer hardware and software prior
to the year 2000 in order to remain functional. Many enterprises, including the
Company's present and potential customers, will be devoting a substantial
portion of their information systems spending to resolving this upcoming year
2000 problem, which may result in spending being diverted from network
applications, such as the Combined Company's products, over the next two years.
21
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 will continue to account for a all of the
Company's revenue for the foreseeable future. However, the Company has little
operating history with the Versatility Series 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 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 outlook 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 1998, the Company's two largest
customers accounted for 38.6% of the Company's total revenue, of which, BT
accounted for 22.1%. 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. See "Risks Relating to Cash Flow Levels".
Quarterly Fluctuations in Revenue and Operating Results. The Company's
revenue and operating results have in the past and could continue in the future
to 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.
22
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 was to expand 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
revenue growth in the future will depend on its ability to attract, train and
retain additional qualified direct sales personnel. In addition, the Company was
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. Subsequent to fiscal 1997, the VARs relationships did not develop as
planned and the Company has significantly reduced its relationships with many
VARs and its dependence on them for future business.
Dependence on Indirect Distribution Channels; Potential for Channel
Conflict. The Company's strategy was 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.
International Operations. Revenue from sales outside the United States in
fiscal 1996, 1997 and 1998 accounted for approximately 40.8%, 54.6% and 39.0%,
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
23
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.
Effective June 1, 1998 the company announced they signed a worldwide
distribution agreement with Cincom Systems, Inc.. This non-exclusive agreement
includes Cincom's absorption of Versatility's international distribution
channels. With the execution of this transaction, Versatility has eliminated all
it's direct sales and support presence outside of the U.K.
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
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. The delisting of the
Company's Common Stock from The Nasdaq Stock Market and the Company's current
financial condition could also impair the Company's ability to compete. 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.
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
24
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 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 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 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
25
personnel could have a material adverse effect on the Company's business,
financial condition and results of operations.
Since February 1998, the Company has replaced substantially all of its
senior management. The Company's current President and Chief Operating Officer
and current Chief Financial Officer joined the Company in February 1998,
together with the new Senior Vice President of Operations. The Company's former
President, Chairman and Chief Executive Officer resigned from all positions with
the Company and the former Chief Financial Officer and Vice President in charge
of sales have also left the Company.
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.
26
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's consolidated financial statements, together with related notes
and the independent auditors' report of Deloitte & Touche LLP are set forth on
the pages indicated in Item 14.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
27
PART III
Certain information required by Part III is omitted from this Annual Report
on Form 10-K since such information will be provided in the Company's Proxy
Statement to be filed 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" in 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" in 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" in 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" in 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" in the Proxy Statement.
28
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 Balance Sheets.................................................... F-4
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 for the years
ended April 30, 1996, 1997 and 1998....................................... F-21
3. Exhibits
Exhibit Number Description of Exhibit
-------------- ----------------------
23.1 Consent of Deloitte & Touche LLP
(b) Reports on Form 8-K:
A Current Report on Form 8-K was filed with the Securities and Exchange
Commission on March 17, 1998, reporting under Item 5, that (i) the
Company would not file its Quarterly Report on Form 10-Q for the third
quarter on time, (ii) the Company expected to restate its earnings for
fiscal 1997 and the first two quarters of 1998, (iii) that previously
issued financial statements for fiscal 1997 and the first two quarters
of 1998, (iii) that previously issued financial statements for fiscal
1997 and interim periods for fiscal 1998 should not be relied upon, (iv)
Ronald Charnock had resigned as Chairmen, Chief Executive Officer and a
Director of the Company and (v) Paul Zoukis, recently appointed
President and Chief Operating Officer, had been elected to the Board of
Directors.
(c) Exhibits
See (a) above
(d) Financial Statement Schedules
See (a) above
29
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 28, 1998 By: /s/
________________________________
Paul J. Zoukis
President and Chief Operating 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 DATE
- --------- ----- ----
/s/ Paul J. Zoukis President and Chief Operating Officer July 28, 1998
________________________
Paul J. Zoukis
/s/ Kenneth T. Nelson Chief Financial Officer (Principal Financial July 28, 1998
________________________ Accounting Officer)
Kenneth T. Nelson
/s/ Thomas A. Smith Director July 28, 1998
________________________
Thomas A. Smith
/s/ Charles A. Johnson Director July 28, 1998
________________________
Charles A. Johnson
/s/ Paul J. Palmer Director July 28, 1998
________________________
Paul J. Palmer
30
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
VERSATILITY INC.
Page
----
Independent Auditors' Report......................................................................................... F-2
Consolidated Balance Sheets at April 30, 1997 and 1998............................................................... F-3
Consolidated Statements of Operations for the years ended April 30, 1996, 1997 and 1998.............................. F-5
Consolidated Statements of Cash Flows for the years ended April 30, 1996, 1997 and 1998.............................. F-6
Consolidated Statements of Changes in Stockholders' Equity for the years ended April 30, 1996, 1997 and 1998......... 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, 1997 and 1998, and the
related consolidated statements of operations, changes in stockholders' equity,
and cash flows for each of the three years in the period ended April 30, 1998.
Our audits also included the financial statement schedules listed in the index
at Item 14(a)2. These consolidated financial statements and financial statement
schedules are the responsibility of the Company's management. Our responsibility
is to express an opinion on these consolidated financial statements and
financial statement schedules 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, 1997 and 1998, and the results of their operations and
their cash flows for each of the three years in the period ended April 30, 1998
in conformity with generally accepted accounting principles. Also, in our
opinion, the financial statement schedules referred to above, when considered in
relation to the basic consolidated financial statements taken as a whole,
present fairly, in all material respects, the information set forth therein.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has incurred significant losses
and used significant amounts of cash in operating activities during the fiscal
years ended April 30, 1997 and 1998. In addition, the Company has negative
working capital and is not in compliance with the terms of its credit facility,
and is defending itself in several legal proceedings (see Note 6). These matters
raise substantial doubt about the Company's ability to continue as a going
concern. Management's plans concerning these matters are also described in Note
1. The financial statements do not include any adjustments that might result
from the outcome of this uncertainty.
DELOITTE & TOUCHE LLP
Washington, DC
July 27, 1998
F-2
VERSATILITY INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
April 30, April 30,
1997 1998
---- ----
ASSETS
Current assets:
Cash and cash equivalents.......... $18,825,764 $5,591,067
Short-term investments............. 6,039,255 565,938
Accounts receivable, net of
allowance for doubtful accounts
of $909,501 and $871,389......... 5,844,987 3,681,293
Prepaid expenses................... 632,511
575,144
Inventory.......................... 18,880 --
Related party receivables.......... 153,381 94,421
Note receivable-related party...... 519,305 --
Note receivable-non/related party.. -- 200,000
Income taxes receivable............ -- 2,003,278
----------- -----------
Total current assets.......... 31,976,716 12,768,508
----------- -----------
Other assets:
Income taxes receivable............ 1,530,000 --
Deposits........................... 187,650 289,689
Prepaid Expenses................... 259,755 37,107
Investments........................ 1,433,464 --
Assets held for sale............... 508,210 --
Purchased software, net of
accumulated amortization of
$42,098 and $89,890.............. 177,136 168,230
----------- -----------
Total other assets............ 4,096,215 495,026
----------- -----------
Property and equipment:
Computers......................... 1,168,246 2,400,222
Office furniture and equipment.... 665,597 932,774
Leasehold improvements............ 206,402 416,881
Capital leases.................... 652,533 744,883
----------- -----------
2,692,778 4,494,760
Less: accumulated depreciation
and amortization............... (1,675,749) (2,212,113)
----------- -----------
Net property and equipment... 1,017,029 2,282,647
----------- -----------
Total.................................. $37,089,960 $15,546,181
=========== ===========
See notes to the consolidated financial statements.
F-3
VERSATILITY INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
April 30, April 30,
1997 1998
----------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.................................. $ 1,590,962 $2,277,692
Accrued liabilities............................... 2,337,034 2,995,756
Related party payables............................ 28,030 10,240
Income taxes payable.............................. 104,777 --
Capital lease payable............................. 38,900 27,252
Line of credit.................................... 2,692,997 5,294,203
Deferred revenue.................................. 1,788,037 2,928,048
----------- -----------
Total current liabilities.................... 8,580,737 13,533,191
----------- -----------
Long-term liabilities:
Capital lease payable, less current maturities.... 24,611 73,243
Deferred rent..................................... 316,360 397,006
----------- -----------
Total other liabilities...................... 340,971 470,249
----------- -----------
Total liabilities............................ 8,921,708 14,003,440
----------- -----------
Commitments and Contingencies (Notes 1 and 6)
Stockholders' equity:
Preferred stock, $.01 par value
2,000,000 shares authorized, no shares issued
or outstanding at April 30, 1997 and 1998
Common stock, par value $.01 --
20,000,000 shares authorized,
7,297,365 shares issued and
outstanding at April 30, 1997;
7,581,380 shares issued and
outstanding at April 30, 1998................... 72,974 75,814
Additional paid-in capital........................ 34,349,298 34,793,862
Foreign currency translation adjustments (83,880) (130,870)
Accumulated deficit............................... (6,170,140) (33,196,065)
----------- -----------
Stockholders' equity......................... 28,168,252 1,542,741
----------- -----------
Total.................................................. $37,089,960 $15,546,181
=========== ===========
See notes to the consolidated financial statements.
F-4
VERSATILITY INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended April 30,
1996 1997 1998
----------- ----------- ------------
Revenue:
License revenue.......................... $10,345,323 $10,254,344 $ 9,305,989
Service and maintenance revenue.......... 6,189,949 8,054,268 9,846,567
----------- ----------- ------------
Total revenue....................... 16,535,272 18,308,612 19,152,556
----------- ----------- ------------
Cost of revenue:
License revenue.......................... 573,329 1,098,434 3,545,647
Service and maintenance revenue.......... 4,266,984 5,867,917 13,345,416
----------- ----------- ------------
Total cost of revenue............... 4,840,313 6,966,351 16,891,063
----------- ----------- ------------
Gross margin................................. 11,694,959 11,342,261 2,261,493
----------- ----------- ------------
Operating expenses:
Selling, general and administrative...... 7,769,751 16,750,776 22,247,006
Research and development................. 2,073,797 2,891,889 4,393,139
Litigation settlements and related costs. -- -- 2,522,930
Depreciation and amortization............ 161,346 280,682 580,159
Write off of capitalized software........ 829,026 -- --
----------- ----------- ------------
Total operating expenses............ 10,833,920 19,923,347 29,743,234
----------- ----------- ------------
Income (loss) from operations................ 861,039 (8,581,086) (27,481,741)
Interest income (expense), net............... 3,140 403,989 455,816
----------- ----------- ------------
Income (loss) before provision for income
taxes........................................ 864,179 (8,177,097) (27,025,925)
Provision (benefit) for income taxes......... 207,309 (322,824) --
----------- ----------- ------------
Net income (loss)............................ $ 656,870 $(7,854,273) $(27,025,925)
=========== =========== ============
Dividends accreted on preferred stock........ $ (88,000) $ (176,000) --
----------- ----------- ------------
Net income (loss) available (attributed) to
common shareholders........................ $ 568,870 $(8,030,273) $(27,025,925)
=========== =========== ============
Basic income (loss) per share................ $ 0.14 $ (1.53) $ (3.62)
=========== =========== ============
Diluted income (loss) per share.............. $ 0.14 $ (1.53) $ (3.62)
=========== =========== ============
Weighted average common and common
equivalent shares outstanding - basic and
diluted...................................... 4,000,000 5,241,621 7,461,101
=========== =========== ============
See notes to the consolidated financial statements.
F-5
VERSATILITY INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended April 30,
----------------------------------------
1996 1997 1998
----------- ----------- -----------
Cash flows from operating activities:
Net income (loss)................................. $ 656,870 $ (7,854,273) $(27,025,925)
Adjustments to reconcile net income (loss) to.....
Net cash provided by operating activities:
Depreciation.................................. 149,846 250,084 487,245
Amortization.................................. 11,500 30,598 49,119
Loss on equity investments.................... 989 6 --
Deferred income taxes......................... (208,291) (119,163) --
Write-off of capitalized software............. 829,026 -- --
Changes in assets and liabilities:
Accounts receivable, net.................. (4,284,630) (174,484) 2,163,694
Prepaid expenses.......................... (617,089) (192,854) 165,281
Inventory................................. 7,356 (18,880) 18,880
Related party receivables................. 34,016 (36,160) 58,960
Notes Receivable - Non Related Party...... -- -- (200,000)
Deposits.................................. (80,304) (29,815) (102,039)
Accounts payable.......................... (65,710) 766,217 686,730
Accrued liabilities....................... 641,578 943,381 658,722
Related party payables.................... (82,775) 24,587 (17,790)
Income taxes payable/receivable........... (92,264) (1,781,726) (578,055)
Deferred rent............................. 67,893 94,461 80,646
Deferred revenue.......................... 96,594 1,503,337 1,140,011
----------- ----------- -----------
Net cash used in operating activities. (2,935,395) (6,594,684) (22,414,521)
----------- ----------- -----------
Cash flows from investing activities:
Purchase of investments............................ -- (7,472,719) --
Proceeds from sale of investments.................. -- -- 6,906,781
Purchase of property and equipment and
assets held for sale............................. (235,310) (1,249,013) (1,293,772)
Purchased software................................. (115,000) (104,234) (38,886)
Related party note receivable...................... -- (516,174) 519,305
----------- ----------- -----------
Net cash (used in) provided by investing
activities............................... (350,310) (9,342,140) 6,093,428
Cash flows from financing activities:
Borrowings under line of credit................... 800,772 4,807,215 3,005,339
Payments under line of credit...................... -- (2,914,990) (404,133)
Proceeds from sale of preferred stock, net......... 3,473,293 -- --
Proceeds from sale of common stock, net............ -- 30,644,979 447,404
Principal payments under note payable.............. (35,250) -- --
Principal payments under capital leases............ (20,731) (37,320) (54,866)
----------- ----------- -----------
Net cash provided by financing
activities................................ 4,218,084 32,499,884 2,993,744
----------- ----------- -----------
Effect of exchange rate changes on cash................ (66,311) (17,569) 92,652
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents... 866,068 16,545,491 (13,234,697)
Cash and cash equivalents, beginning of period......... 1,414,205 2,280,273 18,825,764
----------- ----------- -----------
Cash and cash equivalents, end of period............... $ 2,280,273 $18,825,764 $ 5,591,067
=========== =========== ===========
Supplemental disclosures of cash flow information:
Interest paid...................................... $ 27,732 $ 160,061 $ 323,265
=========== =========== ===========
Income taxes paid.................................. $ 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 Retained
Common Common Paid-in Translation Earnings
Stock Stock Capital Adjustment (Deficit) Total
--------- ------ ---------- ----------- --------- -----
Balance, May 1, 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 admustments. -- -- -- (17,569) -- (17,569)
Accretion of dividends on redeemable
preferred stock.......................... -- -- -- (176,000) (176,000)
Net loss ................................ -- -- -- -- (7,854,273) 7,854,273)
--------- ------- ----------- ----------- ------------ -----------
Balance, April 30, 1997.................... 7,297,365 72,974 34,349,298 (83,880) (6,170,140) 28,168,252
Issuance of common stock related to
exercise of stock options and purchases
under the employee stock purchase plan... 284,015 2,840 444,564 -- -- 447,404
Foreign currency translation adjustments -- -- -- (46,990) -- (46,990)
Net loss................................. -- -- -- -- (27,025,925) (27,025,925)
--------- ------- ----------- ----------- ------------ -----------
Balance, April 30, 1998.................... 7,581,380 $75,814 $34,793,862 $ (130,870) $(33,196,065) $ 1,542,741
========= ======= =========== =========== ============ ===========
See notes to the consolidated financial statements.
F-7
VERSATILITY INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Years Ended April 30, 1996, 1997 and 1998
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 an 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.
Basis of Presentation of Financial Statements -- The accompanying
consolidated financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and the satisfaction of liabilities
in the normal course of business.
As shown in the financial statements, during the years ended April 30,
1998 and 1997, the Company incurred losses of $27.0 million and $7.9 million,
respectively. As of April 30, 1998, the Company's current liabilities exceeded
current assets by $765,000. The Company believes that its cash on hand and cash
flow from anticipated operating activities may not be sufficient to meet its
ongoing obligations through the second quarter of fiscal 1999. Additionally,
certain lawsuits have been filed against the Company (see Note 6) and the
National Association of Securities Dealers ("NASD") suspended trading of the
Company's common stock on the NASDAQ National Market, and removed the Company's
common stock from listing on the National Market (see Note 6). Additionally, the
Company expects to incur significant amounts to defend the lawsuits filed
against the Company. As discussed in Note 5, subsequent to April 30, 1998, the
Company was not in compliance with certain covenants in its line of credit.
These factors among others may indicate that the Company will be unable to
continue as a going concern.
The financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or the amounts and
classification of liabilities that might be necessary should the Company be
unable to continue as a going concern. The Company's continuation as a going
concern is dependent upon its ability to generate sufficient cash flow to meet
its obligations on a timely basis, to comply with the terms and covenants of its
financing agreement, to obtain additional financing or refinancing as may be
required, and ultimately to attain successful operations.
In addition to maintaining continuing contacts with the Company's
customers, management is continuing its efforts to obtain additional funding,
explore strategic alternatives, including a sale of the Company and reduce costs
so that the Company can meet its obligations and sustain operations. While
significant cost cutting measures have been initiated, there can be no assurance
that the Company will have cash flows sufficient to meet its ongoing
obligations. As discussed in Note 5, the Company entered into an amended loan
agreement effective April 30, 1998. Subsequent to April 30, 1998, the Company
was not in compliance with the amended credit agreement. The Company is
reviewing its strategic alternatives, which include additional capital raising
activities and evaluating potential
F-8
corporate partners. If the Company is unable to obtain additional financing
sufficient to meet its operating needs, the Company will be required to
significantly reduce the scope of its operations, which would have a material
adverse effect on the Company's business.
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 Standards 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 available for
sale. Fair value, which is based on quoted market prices, approximates carrying
value. At April 30, 1996, the Company had no investments.
As of April 30, 1998, 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........ $ -- $ -- $ -- $ --
Municipal bonds....... 565,938 298,501 $ -- 267,437
Corporate bonds....... -- -- -- --
---------- ----------- --------- ---------
$ 565,938 $ 298,501 -- $ 267,437
========== =========== ========= =========
Inventory -- Inventory consists of miscellaneous marketing collateral and is
stated at the lower of cost or market, on a first-in, first-out basis. During
FY98, the company wrote off its inventory as a result of its significantly
reduced operations.
Capitalized Software -- During 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
F-9
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.
Impairment of Long-Lived Assets -- The Company reviews its long-lived
assets, including property and equipment and intangibles, for impairment
whenever events or changes in circumstances indicate that the carrying amount of
the assets may not be fully recoverable. In performing an evaluation of
recoverability, the estimated future undiscounted net cash flows of the assets
are compared to the assets' carrying amount to determine if a write down is
required.
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.
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.
Loss Contingencies -- Accruals for loss contingencies are recorded when it
is probable that a liability has been incurred and the amount of the liability
can be reasonably estimated. Accruals are recorded for all costs associated with
the settling of certain contingencies (see Note 6). Insurance and other third
party recoveries are recorded when realization is probable based on agreements
with such parties.
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 the achievement of certain performance
milestones as defined in the contracts. When the Company is under no obligation
to install or customize the software, license revenue is recognized upon
shipment, as long as collection of cash is probable. 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. Amounts received in advance of revenue
recognition are classified as deferred revenues. An allowance for doubtful
accounts receivable has been recorded, which is considered adequate to absorb
currently estimated bad debts and disputed amounts in these account balances.
Revenue from hardware sales relating to the implementation of the Company's
VAX/VMS application is included in license revenue. These hardware sales were
$1.0 million, $767,000 and $1.4 million for the years ended April 30, 1996, 1997
and 1998, respectively. Revenue from the sale of hardware is recorded based on
shipping to the customer.
In October 1997, the AICPA issued SOP 97-2, "Software Revenue Recognition,"
which provides guidance in applying generally accepted accounting principles in
recognizing revenues on software transactions and supercedes SOP 91-1. The
provisions of SOP 97-2 are effective for the Company for transactions entered
into after April 30, 1998. SOP 97-2 requires revenues earned on software
arrangements involving multiple elements to be allocated to each element based
on vendor specific objective evidence of the relative fair values of the
elements. If a vendor does not have evidence of the fair value for all elements
in a multiple-element arrangement, all revenue from the arrangement is deferred
until such evidence exists or until all elements are delivered. In addition, SOP
97-2 requires that the Company have an executed software license agreement, the
license fee be fixed and determinable and collection deemed probable by
management in order to record software license revenue. The Company currently
believes the adoption of SOP 97-2 will not have a material impact on its
consolidated results of operations or financial position; however, because
implementation guidelines for this standard have not yet been issued and a wide
range of potential interpretations are being discussed by the accounting
profession, there can be no assurance that
F-10
SOP 97-2 will not have a material impact on the Company's consolidated results
of operations or financial position. In March 1998, the AICPA issued SOP 98-4
which defers the effective date of a provision of SOP 97-2. This provision
currently has no material impact to the Company.
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. A valuation allowance is provided
when realization of deferred tax debits does not appear probable.
Net Income (loss) Per Share -- During fiscal 1998, the Company adopted
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share." SFAS No. 128 requires the presentation of basic income per share and,
for companies with potentially dilutive securities, such as options, diluted
income per share. Basic income per share is computed using the weighted average
number of shares of common stock outstanding. Diluted income per share is
computed using the weighted average number of shares of common stock and, when
dilutive, common equivalent shares from options to purchase common stock using
the treasury stock method. The following table sets forth the computation of
basic and diluted income per share:
Year Ended April 30,
--------------------
1996 1997 1998
---- ---- ----
Weighted average common shares 4,000,000 5,241,621 7,461,101
Dilutive potential common shares -- -- --
---------- ------------ --------------
Shares used in diluted share computation 4,000,000 5,241,621 7,461,101
Net income (loss) available (attributable)
to common shareholders $ 568,870 ($8,030,273) ($27,025,925)
Basic income (loss) per share $ 0.14 $ (1.53) $ (3.62)
Diluted income (loss) per share $ 0.14 $ (1.53) $ (3.62)
The dilutive effect of options for -0-, 720,387 and 629,970 shares and
convertible preferred stock for 992,061, 992,061 and 0 shares has not been
considered in the computation of diluted income (loss) per share in fiscal 1996,
1997 and 1998 because such shares would be anti-dilutive. In applying the
treasury stock method, for options outstanding during fiscal 1996, the estimated
average fair value per share approximated the exercise price for all options. As
a result, there is no dilutive effect of the options for fiscal 1996.
Non-cash Transactions -- The Company acquired $47,544, $0 and $91,850 of
equipment through capital leases during fiscal 1996, 1997 and 1998,
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. In fiscal 1997, two
customers accounted for 34.6% and 10.4% of the Company's total revenue,
respectively, and in fiscal 1998, two customers accounted for 22.1% and 16.5%,
respectively. As of April 30, 1997 and 1998, 60.7% and 43.7% of accounts
receivable was concentrated with three customers. The Company 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 estimated
credit losses.
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 Standards 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 1998 as if the
fair-value-based method defined in SFAS 123 had been applied (see Note 7).
Reclassifications -- Certain amounts previously reported have been
reclassified to conform with current year presentation.
F-11
New Accounting Pronouncements -- In June 1997, SFAS No. 130, "Reporting
Comprehensive Income," was issued and requires that all items which meet the
definition of comprehensive income be reported for the period in which they are
recognized. Comprehensive income includes changes in the balances of items that
are reported directly in a separate component of stockholders' equity on the
consolidated balance sheets, such as foreign currency translation adjustments
and unrealized gains or losses on available-for-sale securities. SFAS No. 130 is
effective for fiscal years beginning after December 15, 1997 and the Company
will make the disclosures required by SFAS No. 130 in the first quarter of
fiscal 1999.
In June 1997, SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information," was issued and requires that a public business enterprise
report financial and descriptive information about its reportable operating
segments. Generally, financial information is required to be reported on the
basis used internally for evaluating segment performance and resource
allocation. SFAS No. 131 is effective for fiscal years beginning after December
15, 1997; however, disclosure is not required in interim financial statements in
the initial year of adoption. Accordingly, the Company will make the required
disclosures for the fiscal year ending April 30, 1999. The Company is still
determining the effect of adopting SFAS No. 131; however, management does not
anticipate that it will have a material impact.
In March 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." The provisions of SOP 98-1
require that certain costs to develop or obtain internal use software be
capitalized. SOP 98-1 is effective for fiscal years beginning after December
1998 and will be effective for the Company beginning May 1999. The Company is
still determining the effect of adopting SOP 98-1; however, management does not
anticipate that it will have a material impact on the Company's consolidated
results of operations or financial position.
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 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. 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
F-12
3. RELATED PARTY TRANSACTIONS
Related Party Receivables -- The Company has the following current
receivables from related parties or affiliated entities at April 30, 1997 and
1998 as follows:
April 30,
1997 1998
---------- -------
Stockholder/Officer loan............ $117,755 $ 113,045
Other............................... 35,626 94,421
---------- ----------
153,381 207,466
Reserve -- (113,045)
---------- -----------
$ 153,381 $ 94,421
========= ==========
The stockholder/officer 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/officer loan for fiscal 1997
and 1998 is $4,740 and $14,319, respectively, of accrued interest. The
stockholder/officer loan was not paid as of November 6, 1997 and went into
default during the third quarter of fiscal year 1998. During the fourth quarter
of fiscal 1998, the officer resigned from the Company. A reserve was established
during the third quarter of fiscal 1998 due to the uncertainty of collection.
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 1996, 1997 and 1998 was $120,000, $50,000 and $0
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 then President and
Chief Executive Officer, Mr. Marcus W. Heth, the Company's then Senior Vice
President, Technologies, and Mr. Keith P. Roberts, the Company's then 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 and
officers/stockholders of the Company. 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 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. The note receivable was repaid in the second quarter of fiscal
1998.
F-13
4. ACCRUED LIABILITIES
Accrued liabilities consisted of the following as of April 30, 1997 and
1998:
April 30,
------------------------
1997 1998
------------ ----------
Accrued commissions and salaries............... $ 511,676 $ 360,453
Accrued bonuses................................ 362,467 --
Accrued payroll taxes and withholdings......... 195,001 113,932
Accrued vacation............................... 289,034 259,399
Sales, use and other taxes payable............. 654,788 475,498
Class action settlement and related costs -- 1,465,000
Other.......................................... 324,068 321,474
----------- ----------
$ 2,337,034 $2,995,756
=========== ==========
Included in accrued liabilities at April 30, 1998 are amounts accrued for
employee severance costs of approximately $450,000.
5. LINE OF CREDIT
On August 28, 1996, the Company obtained a $2.5 million operating line of
credit from a bank for financing accounts receivable and working capital and a
$1.0 million equipment line of credit from the same bank to finance acquisitions
of property and equipment. These lines of credit expired on August 5, 1997. The
Company entered into a new line of credit on October 29, 1997 which provided for
a $5 million operating line and a $2 million equipment lease line of credit. The
operating and equipment lines of credit accrued 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 were
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 was not in compliance with
various covenants through April 28, 1998. The amount outstanding under the
operating line plus accrued interest at April 30, 1998 was $5.3 million.
On April 28, 1998, the Company entered into an amendment of the line of
credit described above (effective April 30, 1998), which waived all instances of
non-compliance and provided for the following terms: the $2.0 million equipment
line was canceled and the outstanding balance of $256,703 was transferred to the
operating line of credit. The Company permanently paid down the operating line
by $1.5 million to $3.8 million, subsequent to April 30, 1998, and agreed not to
borrow any additional amounts under the line. Subsequent to April 30, 1998, the
Company also issued 100,000 warrants convertible into common stock at an
exercise price of $2.50 per share. The line continues to be collateralized by
all of the Company's assets. As a further condition, the Company agreed to
permanently pay down the line upon receipt of any tax refunds resulting from the
Company's net operating loss carrybacks and payments made in the year ended
April 30, 1998. It is anticipated that these amounts will total approximately
$2.0 million. The line matures on November 5, 1998. The interest rate was
increased to prime plus 3.0% on the amendment date. Subsequent to April 30,
1998, the Company was not in compliance with the terms of the amended line of
credit agreement.
F-14
6. COMMITMENTS AND CONTINGENCIES
Operating Leases --The Company leases office space, equipment and
automobiles under non-cancellable 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, 1996, 1997 and 1998 was $876,093, $1.4
million and $2,264,610, respectively.
As of April 30, 1998, future minimum lease payments for the operating leases
are as follows:
Years Ending April 30,
1999.......................................... 1,345,342
2000.......................................... 1,241,709
2001.......................................... 1,047,124
2002.......................................... 794,985
2003.......................................... 818,508
Thereafter.................................... 1,306,725
----------
Total......................................... $6,554,393
==========
Capital Leases -- The Company is obligated under capital leases for various
office equipment. As of April 30, 1998, future minimum lease payments for the
capital leases are as follows:
Years Ending April 30,
1999.............................................. 29,793
2000.............................................. 33,147
2001.............................................. 36,879
2002.............................................. 11,056
2003.............................................. 0
----------
Total............................................. 110,875
Less: interest.................................... (10,380)
----------
Present value of future minimum lease payments.... $ 100,495
==========
Legal Proceedings -- One of the Company's former Value Added Resellers
(VAR's) had 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. In April, 1997, the arbitration panel awarded
$267,000 in net damages to the plaintiff in the proceedings. The arbitration
panel's decision was appealed. In August 1997, the Company settled the
litigation with the former VAR for $250,000. The Company recorded a one-time
charge in the quarter ending July 31, 1997 related to this litigation for
$500,000, which includes the settlement charge and other costs and expenses
associated with defending the litigation.
Between March 6, 1998 and April 8, 1998 the Company and certain of its
current and former officers and directors, among others, were sued in various
putative securities class action cases filed in the United States District Court
for the Southern District of New York and the United States District Court for
the Eastern District of Virginia, as follows: Thomas Esposito, et al, v.
Versatility, Inc. et al. (S.D.N.Y.); Thomas K. Doyle v. Versatility, Inc. et al.
(E.D. Va); and Steven Bowen v. Versatility, Inc. et al. (S.D.N.Y.) (together
"the putative class actions"). Collectively, the putative class actions asserted
claims under Sections 11, 12(2), and 15 of Securities Act of 1933 and Section
10(b) and 20(a) of the Securities Exchange Act of 1934 for alleged
misrepresentations and omissions in connection with the SEC public filings and
other public statements made by the Company. Among other allegations, each of
the putative class actions alleged that the Company misrepresented its financial
results and its accounting practices during the period of December 12, 1996
through March 12, 1998 including in the Company's IPO Prospectus. The complaints
in certain of the putative class actions also asserted, among other allegations,
that the Company and certain of other defendants made misrepresentations in the
IPO Prospectus and thereafter regarding the performance capabilities of the
Company's CallCenter product.
Versatility reached a settlement in principle with the plaintiffs in
all six putative securities class action lawsuits currently pending against the
Company on July 9, 1998. The settlement in principle is conditioned upon the
execution and filing with the Court of a definitive agreement of settlement and
final Court approval.
F-15
Under the proposed settlement, the class actions would be dismissed and
a settlement fund would be created for the members of the proposed class
consisting of $3.5 million in cash, which represents proceeds from Versatility's
directors' and officers' liability insurance and related recoveries by the
Company. In addition, as part of the settlement, an aggregate of 350,000 shares
of Versatility Common Stock will be transferred to the Company by certain
defendants other than the Company in settlement of the claims against them.
Thereafter, the Company will issue 750,000 shares of its Common Stock for the
benefit of the proposed plaintiff class, 350,000 shares of which will be in
substitution of shares provided by those certain defendants in settlement of the
claims against them. The Company has accrued liabilities of approximately $1.5
million (net of third party recoveries) at April 30, 1998 related to the
settlement.
Since March, 1998 the Company has been responding to informal requests
for information from the Commission relating to certain of the Company's
financial matters. In May, 1998, the Company was advised by the Commission that
it had obtained a formal order of investigation so that, among other matters, it
may utilize subpoena powers to obtain information relevant to its inquiry. The
Commission has and may in the future utilize its subpoena powers to obtain
information from various officers, directors and employees of the Company and
from persons not presently associated with the Company. If, after completion of
its investigation, the Commission finds that violations of the federal
securities laws have occurred the Commission has the authority to order persons
to cease and desist from committing or causing such violations and any future
violations. The Commission may also seek administrative and criminal fines and
penalties and injunctive relief. The Department of Justice has the authority in
respect of civil and criminal matters. There can be no assurance as to the
timeliness of the completion of the investigation or as to the final result
thereof, and no assurance can be given that the final result of the
investigation will not have a material adverse effect on the Company. The
Company is cooperating fully with the investigation, and has responded and will
continue to respond to requests for information in connection with the
investigation.
A former employee had sued the Company for approximately $1,200,000 for
alleged breaches of contract amongst other claims. This action was settled as of
April 30, 1998 by execution of a written settlement agreement and mutual general
release whereby the Company agreed to pay $120,000 ($50,000 immediately and
$70,000 in seven equal monthly installments). The settlement was accrued as of
April 30, 1998.
In addition, the Company is a party to various legal proceedings in the
normal course of business, consisting of contract issues and employee matters,
which outcome cannot be ascertained at this time (the more significant of which
are described below). Taken together or individually, an adverse outcome on the
results of these suits, may have a materially adverse impact on the Company.
Because the outcome of these matters cannot be ascertained at this time, the
Company has not recorded any significant accruals related to these matters. The
more significant of these matters are as follows:
(bullet) A former customer is seeking damages in excess of $1,000,000 for
alleged breaches of contract and warranties, as well as alleged
misrepresentations. On April 16, 1998, the Company filed a
response denying the allegations and counter-claiming for damages
in excess of $400,000 for breach of contract. This matter is
currently in the discovery stage. The Company intends to
vigorously defend this case. The outcome of this matter cannot be
ascertained at this time.
(bullet) A customer of a Versatility reseller has sued for damages for an
amount not less than $1,000,000. In December 1997, the District
Court dismissed the action. In February 1998, essentially the same
claim was made in a different District Court. The outcome of this
matter cannot be ascertained at this time.
7. 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 contributions of $44,191 and $124,618 in fiscal 1997
and 1998, respectively. No contributions were made in fiscal 1996. Employee
contributions are vested immediately;
F-16
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 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
======= ========= ====== ========= ========== ========
Granted............................. -- -- -- -- 460,894 11.50
Exercised........................... (115,134) 0.80 (6,477) 0.80 (17,125) 10.97
Cancelled........................... (5,640) 0.80 (17,146) 0.80 (254,789) 10.38
------- --------- ------ --------- ---------- --------
April 30, 1998 options outstanding.... 78,790 $ 0.80 38,200 $ 0.80 327,980 $ 10.73
======= ========= ====== ========= ========== ========
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
======= ========= ====== ========= ========== ========
Exercisable as of April 30, 1998 78,790 $ 0.80 22,240 $ 0.80 106,556 $ 11.17
======= ========= ====== ========= ========== ========
Available for future grant............ -- -- 404,895
======= ====== ==========
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. 135,000 of these options were exercised as of April 30, 1998.
Pursuant to the 1996 Stock Option Plan, the Company granted options to
purchase 550,750 shares of Common Stock to employees, effective May 8, 1998. In
addition, options to purchase 25,000 shares of Common Stock were issued to a
Director of the Company on May 8, 1998.
In April 1998, the Board of Directors approved the 1998 Non-Qualified Stock
Option Plan. The Plan provides for the granting of non-qualified stock options
to purchase up to 1,250,000 shares of Common Stock. Options to purchase
1,107,000 shares of common stock were issued on May 8, 1998.
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 10,279 Shares have been purchased under
the 1996 Purchase Plan as of April 30, 1998.
F-17
The Company has computed the pro forma disclosures required under SFAS 123
for all stock options granted as of April 30, 1998 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 1997 and 1998 was $5.96 and
$6.51, respectively.
The assumptions used and the weighted average information for the years
ended April 30, 1997 and 1998 are as follows:
1997 1998
---- ----
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%
Stock options outstanding and exercisable at April 30, 1998 follows:
Options Outstanding Options Exercisable
------------------- -------------------
Remaining Weighted Weighted
Contractual Average Average
Exercise Price Number Life in Exercise Number Exercise
Range Outstanding Years Price Exercisable Price
----- ----------- ----- ----- ----------- -----
$ 0.80 301,990 7.75 $0.80 286,030 $ 0.80
$10.50 63,240 8.42 $10.50 35,677 $10.50
$11.50 264,740 9.08 $11.50 70,879 $11.50
The effect of applying SFAS 123 would be as follows:
1996 1997 1998
---- ---- ----
Pro forma net income (loss) available (attributable)
to common shareholders............................... $ 459,933 $(8,263,561) $ (28,611,004)
Pro forma net income (loss) per share.................. $ 0.08 $ (1.61) $ (3.83)
Compensation expense for shares issued under the employee stock purchase
plan has not been given effect as the amount is not material.
8. INCOME TAXES
The provision for income taxes is computed based on pretax accounting income
for April 30, 1996, 1997 and 1998. Deferred income taxes include the tax effects
of temporary differences between pretax accounting income and taxable income.
For April 30, 1998 the Company incurred losses in accounting and taxable income,
giving rise to a taxable net operating loss of approximately $27.4 million. The
Company will have federal net operating loss carryforwards from the April 30,
1998 year of approximately $4.2 million after relevant loss carryback claims.
These losses will expire in 2013. In addition, the Company will have State
operating loss carryforwards of approximately $4.3 million which will expire
beginning in 2003.
The provision for income taxes at April 30, 1996, 1997 and 1998 consists of
the following:
1996 1997 1998
---- ---- ----
Current provision (benefit):
Federal.................................... $ 284,641 $ (330,285) $ --
Foreign.................................... 78,520 104,777 --
State...................................... 51,229 (97,316) --
--------- ------------ --------
Total current provision (benefit)..... 414,390 (322,824) --
--------- ------------ --------
Deferred provision:
Federal.................................... (175,496) -- --
Foreign.................................... -- -- --
State...................................... (31,585) -- --
--------- ------------ --------
Total deferred provision (benefit).... (207,081) -- --
--------- ------------ --------
Total provision (benefit) for income taxes...... $ 207,309 $ (322,824) --
========= ============ ========
F-18
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:
1996 1997 1998
--------- --------- ------
Deferred tax assets:
Vacation expense.......................... $ 70,309 $ 89,858 $ 80,642
Bad debt reserve.......................... 59,929 290,907 182,050
Deferred rent............................. 84,233 129,712 162,772
Deferred revenue.......................... -- 305,315 177,605
Accelerated depreciation and other -- 37,241 82,915
Net operating loss carryforward- federal
& state.................................... -- 1,762,946 11,055,961
Foreign tax credit carryforward........... -- 35,708 35,708
General business credit carryforward...... -- 215,279 215,279
AMT tax credit carryforward............... -- 45,023 45,023
Other..................................... -- 15 --
---------- -------------- --------------
Total deferred tax assets................. 214,471 2,912,004 12,037,955
========== ============= ==============
Deferred tax liabilities:
Accelerated depreciation and other........ 333,634 -- --
---------- ------------ --------------
Total deferred tax liabilities............ 333,634 -- --
---------- ------------ --------------
Valuation allowance....................... -- (2,912,004) (12,037,955)
---------- ------------ --------------
Net deferred tax liabilities.............. $(119,163) $ -- $ --
========== ============ ==============
The provision for income taxes differs from the amount computed by applying the
statutory U.S. Federal income tax rate to income loss before taxes as a result
of the following:
1996 1997 1998
-------- --------- ---------
U.S. Federal statutory rate............................. 34.0% (34.0)% (34.0)%
State income taxes, net of Federal income tax benefit... 4.0 (0.7) --
Impact of foreign earnings and taxes.................... (1.7) 1.2 --
General business credits................................ -- -- --
Benefit from foreign sales corporation.................. (13.4) (2.0) --
Valuation Allowance..................................... -- 34.7 34.0
Other................................................... 1.0 (3.1) --
---------- --------- --------
Effective tax rate...................................... 23.9% (3.9)% --
========== ========= ========
F-19
9. 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,
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........................ $14,988,383 $ 3,576,683 (256,454) $18,308,612
Income (loss) from operations.. (2,072,077) 270,548 (6,779,557) (8,581,086)
Identifiable assets............ 35,535,826 1,554,134 -- 37,089,960
1998:
Revenue........................ $13,435,238 $ 6,065,000 $ (347,681) $19,152,556
Income (loss) from operations.. (17,821,970) (656,408) (9,003,363) (27,481,741)
Identifiable assets............ 15,189,795 612,683 -- 15,802,478
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
1996, 1997 and 1998 the royalty was $697,656, $256,454, and $387,801
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, $3.8 million, $6.4 million and $1.4
million of export revenue for fiscal 1996, 1997 and 1998, respectively. For
fiscal 1996 and 1997, $2.1 million and $3.8 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 $527,681, $1.3 million and $2.1 million of export revenue for
fiscal 1996, 1997 and 1998, 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%:
1996 1997 1998
-------- -------- -------
Customer A........ 25.7% 34.6% 22.1%
Customer B........ 22.2% 10.4% 16.5%
10. INTEREST INCOME (EXPENSE), NET
Interest income (expense), net includes interest income of $66,643,
$544,096, and $816,590 in fiscal 1996, 1997 and 1998, respectively, and interest
expense of $63,503, $140,107 and $360,765 in fiscal 1996, 1997 and 1998
respectively.
F-20
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,
----------- ------ -------- -------- ---------- ---------
For the year ended April 30, 1996
- ---------------------------------
Allowance for doubtful accounts 70,354 122,424 -- 34,904 157,874
For the year ended April 30, 1997 (1)
Allowance for doubtful accounts 157,874 997,046 -- 245,419 909,501
For the year ended April 30, 1998
Allowance for doubtful accounts 909,501 424,197 -- 462,309 871,389
Allowance for related party
receivables -- 113,045 -- -- 113,045
F-21
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
security holders, 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 1998 Non-Qualified Stock Option Plan
10.6 Lease Agreement between the State of California Public
Employees' Retirement System and the Company dated July 10,
1994, as amended (1)
10.7 Loan and Security Agreement between the Company and Silicon
Valley Bank dated as of August 28, 1996 (1)
10.8 Deed of Trust Note dated as of October 31, 1996 issued by
Serenity Real Properties Limited Partnership to the Company
(1)
10.9 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 * Independent Auditor's Consent
27.1 * Financial Data Schedule--FY98
27.2 * Financial Data Schedule--FY97
27.3 * Financial Data Schedule--FY96
* Filed herewith.
(1) Incorporated by reference to the Company's Registration Statement on Form
S-1 (File No. 333-13771), as amended.